SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K

(Mark (Mark One)
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the fiscal year ended: December 31, 20062008
OR
o
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

For the transition period from _________________ to _______________

Commission File No. 001-33059

Commission File No. 000-33059

Fuel Tech, Inc.
(Exact
 (Exact name of registrant as specified in its charter)


Delaware20-5657551
(State or other jurisdiction of incorporation of organization)(I.R.S. Employer Identification Number)

Fuel Tech, Inc.
512 Kingsland Drive27601 Bella Vista Parkway
Batavia,Warrenville, IL  60510-229960555-1617
630-845-4500
(Address and telephone number of principal executive offices)
 
Securities registered pursuant to Section 12(b) of the Act: None
 
Securities registered pursuant to Section 12(g) of the Act:

Common Stock $0.01 par value per share
The NASDAQ Stock Market, Inc
(Title of Class)
(Name of Exchange on Which Registered)

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

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

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

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, non-accelerated filer or a non-accelerated filersmaller reporting company (as defined in rule 12b-2 under the Securities Exchange Act of 1934).
Large Accelerated Filer o    Accelerated Filer x    Non-accelerated Filer o
Large Accelerated Filer ¨
Accelerated Filer x
Non-accelerated Filer (Do not check if a smaller reporting company) ¨
Smaller reporting company ¨

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

The aggregate market value of the voting stock held by non-affiliates of the registrant based on the average bid and asked prices of June 30, 20062008 was $200,262,000.$331,257,000.  The aggregate market value of the voting stock held by non-affiliates of the registrant based on the average bid and asked prices of February 16, 200710, 2008 was $477,460,000.$196,181,000.

Indicate number of shares outstanding of each of the registered classes of Common Stock at February 16, 2007: 22,086,72810, 2009: 24,110,967 shares of Common Stock, $0.01 par value.

Documents incorporated by reference:
Certain portions of the Proxy Statement for the annual meeting of stockholders to be held in 20072009 are incorporated by reference in Parts II, III, and IV hereof.


TABLE OF CONTENTS
  
Page
 
PART I
 
   
Item 1.Business13
Item 1A.Risk Factors of the Business69
Item 1B.Unresolved Staff Comments710
Item 2.Properties710
Item 3.Legal Proceedings711
Item 4.Submission of Matters to a Vote of Security Holders711
   
 
PART II
 
   
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchase of Equity Securities
812
Item 6.Selected Financial Data1014
Item 7.Management's Discussion and Analysis of Financial Condition and Results of Operations1115
Item 7A.Quantitative and Qualitative Disclosures about Market Risk1822
Item 8.Financial Statements and Supplementary Data1823
Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure4445
Item 9A.Controls and Procedures4445
Item 9B.Other Information4445
   
 
PART III
 
   
Item 10.Directors, Executive Officers and Corporate Governance4546
Item 11.Executive Compensation4647
Item 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters4647
Item 13.Certain Relationships and Related Transactions, and Director Independence4647
Item 14.Principal AccountingAccountant Fees and Services4647
   
 
PART IV
 
   
Item 15.Exhibits and Financial Statement Schedules4748
   
Signatures and Certifications5051
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TABLE OF DEFINED TERMS

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TABLE OF DEFINED TERMS

Term
 
Definition
   
ABC American Bailey Corporation
   
AIGAmmonia Injection Grid
CAAA Clean Air Act Amendments of 1990
CAIRClean Air Interstate Rule
CAVRClean Air Visibility Rule
   
CDT Clean Diesel Technologies, Inc.
   
CFD Computational Fluid Dynamics
   
Common Shares Shares of the Common Stock of Fuel Tech
   
Common Stock Common Stock of Fuel Tech
   
EPA Environmental Protection Agency
   
EPRI Electric Power Research Institute
   
FUEL CHEM®®
 A trademark used to describe Fuel Tech’s fuel and flue gas treatment processes, including its TIFI™ Targeted In-Furnace Injection™ technology to control slagging, fouling, corrosion and a variety of sulfur trioxide-related issuesissues.
   
Fuel TechGSG Fuel Tech, Inc. and its subsidiariesGraduated Straightening Grid
   
Investors The purchasers of Fuel Tech securities pursuant to a Securities Purchase Agreement as of March 23, 19981998.
   
Loan Notes Nil Coupon Non-redeemable Convertible Unsecured Loan NotesNil-coupon, non-redeemable convertible unsecured loan notes of Fuel Tech
   
NOx Oxides of nitrogen
   
NOxOUT CASCADE®®
 A trademark used to describe Fuel Tech’s combination of NOxOUT and SCRSCR.
   
NOxOUT®® Process
 A trademark used to describe Fuel Tech’s SNCR process for the reduction of NOxNOx.
   
NOxOUT-SCR®®
 A trademark used to describe Fuel Tech’s direct injection of urea as a catalyst reagentreagent.
   
NOxOUT ULTRA®®
 A trademark used to describe Fuel Tech’s process for generating ammonia for use as SCR reagentreagent.
   
Rich Reagent Injection Technology (RRI) An SNCR-type process that broadens the NOx reduction capability of the NOxOUT Process at a cost similar to NOxOUT. RRI can also be applied on a stand-alone basis.
   
SCR Selective Catalytic Reduction
   
SIP Call State Implementation Plan Regulation
   
SNCR Selective Non-Catalytic Reduction
   
TCI™ Targeted Corrosion Inhibition™ A FUEL CHEM program designed for high-temperature slag and corrosion control, principally in waste-to-energy boilersboilers.
   
TIFI™ Targeted In-Furnace Injection™ A proprietary technology that enables the precise injection of a chemical reagent into a boiler or furnace as part of a FUEL CHEM program.
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PART I

Forward LookingForward-Looking Statements

Statements in thisThis Annual Report on Form 10-K that are not historical facts, so-called "forward-lookingcontains “forward-looking statements,"” as defined in Section 21E of the Securities Exchange Act of 1934, as amended, are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.1995 and reflect our current expectations regarding our future growth, results of operations, cash flows, performance and business prospects, and opportunities, as well as assumptions made by, and information currently available to, our management. We have tried to identify forward-looking statements by using words such as “anticipate,” “believe,” “plan,” “expect,” “intend,” “will,” and similar expressions, but these words are not the exclusive means of identifying forward-looking statements.  These statements are based on information currently available to us and are subject to various risks, uncertainties, and other factors, including, but not limited to, those discussed herein under the caption “Risk Factors” that could cause our actual growth, results of operations, financial condition, cash flows, performance and business prospects and opportunities to differ materially from those expressed in, or implied by, these statements.  Except as expressly required by the federal securities laws, we undertake no obligation to update such factors or to publicly announce the results of any of the forward-looking statements contained herein to reflect future events, developments, or changed circumstances or for any other reason.  Investors are cautioned that all forward-looking statements involve risks and uncertainties, including those detailed in Fuel Tech's filings with the Securities and Exchange Commission.  See "Risk Factors of the Business"Factors" in Item 1A.

ITEM 1.1 - BUSINESS

As used in this Annual Report on Form 10-K, the terms “we,” “us,” “our,” “the Company,” and “Fuel Tech” refer to Fuel Tech, Inc. and our wholly-owned subsidiaries.

Fuel Tech

Fuel Tech, Inc. (“Fuel Tech”)(Fuel Tech) is a fully integrated company that uses a suite of advanced technologies to provide boiler optimization, efficiency improvement and air pollution reduction and control solutions to utility and industrial customers worldwide.  Originally incorporated in 1987 under the laws of the Netherlands Antilles as Fuel-Tech N.V., Fuel Tech became domesticated in the United States on September 30, 2006, and continues as a Delaware corporation with its corporate headquarters at 512 Kingsland Drive, Batavia,27601 Bella Vista Parkway, Warrenville, Illinois, 60510-2299.60555-1617.  Fuel Tech maintains an Internet web sitewebsite at www.ftek.comwww.ftek.com.  Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934 are made available through our website as soon as reasonably practical after we electronically file or furnish the reports to the Securities and Exchange Commission.  Also available on the Corporation’s website are the Company’s Corporate Governance Guidelines and Code of Ethics and Business Conduct, as well as the charters of the audit, compensation and nominating committees of the Board of Directors.  All of these documents are available in print without charge to stockholders who request them. Information on our website is not incorporated into this report.

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Fuel Tech's special focus is the worldwide marketing of its nitrogen oxide (“NOx”)(NOx) reduction and FUEL CHEM®® processes.  The NOx reductionAir Pollution Control (APC) technology segment which includes the NOxOUT®, NOxOUT CASCADE®, NOxOUT ULTRA® and NOxOUT-SCR® processes, reduces NOx emissions in flue gas from boilers, incinerators, furnaces and other stationary combustion sources.sources by utilizing combustion optimization techniques and Low-NOx and Ultra Low-NOx burners; NOxOUT® and HERT™ High Energy Reagent Technology™ SNCR systems; systems that incorporate NOxOUT CASCADE®, NOxOUT ULTRA® and NOxOUT-SCR® processes; and Ammonia Injection Grids and the Graduated Straightening Grid (GSG).  The FUEL CHEM technology segment improves the efficiency, reliability and environmental status of combustion units by controlling slagging, fouling corrosion, opacity, acid plume and loss on ignition,corrosion, as well as the formation of sulfur trioxide, ammonium bisulfate, particulate matter (PM2.52.5), carbon dioxide, NOx and NOxunburned carbon in fly ash through the addition of chemicals into the fuel or via TIFI™ Targeted In-Furnace Injection™ programs.  Fuel Tech has other technologies, both commercialcommercially available and in the development stage, all of which are related to the NOxOUTAPC and FUEL CHEM processes or are similar in their technological base.  Fuel Tech's business is materially dependent on the continued existence and enforcement of worldwide air quality regulations.

American Bailey Corporation

Ralph E. Bailey, Executive Chairman and Director of Fuel Tech, and Douglas G. Bailey, Deputy Chairman and Director of Fuel Tech, are shareholdersstockholders of American Bailey Corporation (“ABC”).(ABC), which is a related party.  Please refer to Note 9 to the consolidated financial statements in this document.document for information about transactions between Fuel Tech and ABC.  Additionally, see the more detailed information relating to this subject under the caption “Certain Relationships and Related Transactions” in Fuel Tech’s Proxy Statement, to be distributed in connection with Fuel Tech’s 20072009 Annual Meeting of Shareholders,Stockholders, which information is incorporated by reference.

NOx ReductionAir Pollution Control

Regulations and Markets

The U.S. air pollution control market is currently the primary driver in Fuel Tech’s NOx reduction technology segment.  This market is dependent on air pollution regulations and their continued enforcement. These regulations are based on the Clean Air Act Amendments of 1990 (the “CAAA”), which require reductions in NOx emissions on varying timetables with respect to various sources of emissions.  Under the SIP (StateState Implementation Plan)Plan (SIP) Call, a regulation promulgated under the Amendments (discussed further below), over 1,000 utility and large industrial boilers in 19 states were required to achieve NOx reduction targets by May 31, 2004.

In 1994, governors of 11 Northeastern states, known collectively as the Ozone Transport Region, signed a Memorandum of Understanding requiring utilities to reduce their NOx emissions by 55% to 65% from 1990 levels by May 1999.  In 1998, the Environmental Protection Agency (“EPA”)(EPA) announced more stringent regulations. The Ozone Transport SIP Call regulation, designed to mitigate the effects of wind-aided ozone transported from the Midwestern and Southeastern U.S. into the Northeastern non-attainment areas, required, following the litigation described below, 19 states to make even deeper aggregate reductions of 85% from 1990 levels by May 31, 2004.  Over 1,000 utility and large industrial boilers are affected by these mandates.  Additionally, most other states with non-attainment areas arewere also required to meet ambient air quality standards for ozone by 2007.

Although the SIP Call was the subject of litigation, an appellate court of the D.C. Circuit upheld the validity of this regulation.  This court’s ruling was later affirmed by the U.S. Supreme Court.

In February 2001, the U.S. Supreme Court, in a unanimous decision, upheld EPA’s authority to revise the National Ambient Air Quality Standard for ozone to 0.080 parts per million averaged through an eight-hour period from the current 0.120 parts per million for a one-hour period.  This more stringent standard provided clarity and impetus for air pollution control efforts well beyond the then current ozone attainment requirement of 2007.  In keeping with this trend, the Supreme Court, only days later, denied industry’s attempt to stay the SIP Call, effectively exhausting all means of appeal.
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On December 23, 2003, the EPA proposed a new regulation affecting the SIP Call states by specifying more expansive NOx reduction.  This rule, under the name “CleanClean Air Interstate Rule (CAIR),” was issued by the EPA on March 10, 2005.   UnderCommencing in 2009, CAIR specifies that additional annual NOx reduction requirements werebe extended to most SIP-affected units in 28 eastern states, commencing in 2009. The Company expects an additional 300 utility boilers to be affected by this rule, which allowswhile permitting a cap and trade format similar to the SIP Call.  The Company expects an additional 1,300 electric generating units using coal and other fuels to be affected by this rule.    In an action related to CAIR, on June 15, 2005, the EPA issued the “CleanClean Air Visibility Rule (CAVR),” which is a nationwide initiative to improve federally preserved areas through reduction of NOx and other pollutants.  CAVR expands the NOx reduction market to westernWestern states unaffected by CAIR or the SIP Call.  Compliance begins in 2013 and the Company believes that CAVR will potentially affect an additional 50 utility230 western coal-fired electric-generating units.  In addition, CAVR, along with the EPA rule for revised eight-hour ozone attainment, which was proposed on June 20, 2007, have the potential to impact thousands of boilers and a large number of industrial units in multiple industries.industries nationwide for units burning coal and other fuels starting in 2013.
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On July 11, 2008, the U.S. District Court of Appeals for the District of Columbia Circuit vacated the CAIR regulations under the CAAA under the premise that the EPA exceeded its authority when the rule was created in 2005.  The court found “more than several fatal flaws in the rule” but neither took issue with the concept that NOx emissions are to be controlled nor over the limits and thresholds established by CAIR.  In vacating the rule in its entirety, the court remanded to EPA to promulgate a rule consistent with the court’s opinion.  On September 24, 2008, the EPA filed a petition for the case to be reviewed by the full Court of Appeals, not just the three judge panel that issued the vacatur ruling in July 2008.  On October 22, 2008, the EPA was granted a 15-day period to present a basis as to why the court should reconsider its decision.  On December 23, 2008, the D.C. Circuit granted the EPA’s petition only to the extent that it remanded the case without vacatur for EPA to conduct further proceedings consistent with the court’s prior opinion.  In summary, the court stated that “…allowing CAIR to remain in effect until it is replaced by a rule consistent with our opinion would at least temporarily preserve the environmental values covered by CAIR.”  The court did not impose a particular schedule by which the EPA must alter CAIR.  CAIR requires the affected states to be in year-round NOx emission compliance beginning January 1, 2009.  While we cannot predict the ultimate outcome of this matter, and any unfavorable outcome could have a material adverse effect on our business, results of operations, cash flows, and financial position, the primary driver of CAIR, the Federal CAAA, including the associated National Ambient Air Quality Standards, is in effect and states must comply with this law.

Outside the United States, Fuel Tech also sells NOx control systems outside the United States, specifically in Europe.Europe and in the People's Republic of China (China).  NOxOUT systems have long been sold in the traditional markets of Western Europe, but interest is growing in newer markets like Eastern Europe as well as Israel for complete NOx reduction programs on both new and existing boilers.  Under European UnionEU Directives, certain waste incinerators and cement plants must be income into compliance with specified NOx reduction targets by 2008,the end of 2009, while certain power plants must be in compliance by 2010.2016.

Another foreign NOx control market representingChina also represents attractive opportunities for Fuel Tech isas the People's Republic of China (PRC). The Government's 11th Five-Year Economic Plangovernment has set pollution control and energy conservation and efficiency and savingsimprovements as the top two priorities.  Fuel Tech has viable technologies to help achieve boththese objectives.  While the PRCChina has taken an initial small stepsteps to reduce NOx emissions (by installing low NOx burners) on new electric utility units (principally low-NOx burners), and on-going research and demonstration projects will generateare generating cost performance data for use in tightening the standards in the near future. The PRC'sfuture, both for new and retrofit units.  China’s dominant reliance on coal as an energy resource willis not expected to change in the foreseeable future.  Clean air has been and will continue to be a pressing issue, especially with the PRC’s booming economy (8%-12% annual GDP increase),China’s robust economic growth, expected growth in power production (4%-5% average annual increase through 2020), and an increasingly expanded role in international events and organizations.  The PRC isChina hosted the host of the upcoming 2008 Beijing Summer Olympics and will host the 2010 Shanghai World Expo.  Fuel Tech has gained an enviableChina plans to address in a significant way the pollution control for the existing fleet of fossil plants in the Twelfth Five-Year Plan that takes effect in 2011.  Our goal is to establish a leading market position in NOx control due toresulting from the national demonstration projects utilizing NOxOUT CASCADE technology at Jiangsu Kanshan (two new 600 megawatt units), NOxOUT SNCRSelective Non-Catalytic Reduction (SNCR) technology at Jiangyin Ligang (four new 600 megawatt units) and Inner Mongolia (two new 600 megawatt units), and NOxOUT ULTRA technology on two retrofit projects in Beijing.  These projects are expected to showcaseshowcasing a wide spectrum of Fuel Tech capabilities for NOx emission control and help gainwith the intent of gaining immediate penetration within the market for new power units, nowand establishing Fuel Tech as well as withinthe leader for the larger market for retrofit units later.

The key market dynamic for this product line is the continued use of coal as the principal fuel source for global electricity production.  Coal accounts for approximately 50% of all U.S. electricity generation.  Coal’s share of global electricity generation is forecast to be approximately 45% by 2030.  Major coal consumers include China, the United States and India.

Products

Fuel Tech’s NOx reduction technologies are installed worldwide on over 400450 combustion units, including utility, industrial and municipal solid waste applications.  Products include customized NOx control systems and patented urea-to-ammonia conversion technology, which can provide safe reagent for use in Selective Catalytic Reduction (SCR) systems.

Fuel Tech's NOxOUT process is a Selective Non-Catalytic Reduction (“SNCR”) process that uses non-hazardous urea as the reagent rather than ammonia. The NOxOUT process on its own is capable of reducing NOx by up to 40% for utilities and by potentially significantly greater amounts for industrial units in many types of plants with capital costs ranging from $5 - $20/kw
·Fuel Tech's NOxOUT process is a Selective Non-Catalytic Reduction (SNCR) process that uses non-hazardous urea as the reagent rather than ammonia. The NOxOUT process on its own is capable of reducing NOx by up to 25% - 50% for utilities and by potentially significantly greater amounts for industrial units in many types of plants with capital costs ranging from $5 - $20/kW for utility boilers and with total annualized operating costs ranging from $1,000 - $2,000/ton of NOx removed.

Fuel Tech’s NOxOUT CASCADE process uses catalyst as an addition to the NOxOUT process to achieve performance similar to SCR. Based on demonstrations, capital costs for NOxOUT CASCADE systems, at $30 - $60/kw, are significantly less than that of SCRs, which can range as high as $300/kw,
·Fuel Tech’s NOxOUT CASCADE process uses a catalyst in addition to the NOxOUT process to achieve performance similar to SCR.  Capital costs for NOxOUT CASCADE systems can range from $30 - $75/kW which is significantly less than that of SCRs, which can cost $300/kW or more, while operating costs are competitive with those experienced by SCR systems.

·Fuel Tech’s NOxOUT-SCR process utilizes urea as a catalyst reagent to achieve NOx reductions of up to 85% from smaller stationary combustion sources with capital and operating costs competitive with equivalently sized, standard SCR systems.

Fuel Tech’s NOxOUT ULTRA system is designed to convert urea to ammonia safely and economically for use as a reagent in the SCR process for NOx reduction. In this fashion, Fuel Tech intends to participate in the SCR segment of the U.S. SIP Call and CAIR driven markets. Recent local hurdles in the ammonia permitting process have raised concerns regarding the safety of ammonia storage in quantities sufficient to supply SCR. In addition, as new power plants are constructed in the PRC during the next several years with SCR systems, Fuel Tech’s NOxOUT ULTRA process is believed to be a leading candidate
·Fuel Tech’s NOxOUT ULTRA process is designed to convert urea to ammonia safely and economically for use as a reagent in the SCR process for NOx reduction.  Recent local hurdles in the ammonia permitting process have raised concerns regarding the safety of ammonia storage in quantities sufficient to supply SCR.  In addition, the Department of Homeland Security has characterized anhydrous ammonia as a Toxic Inhalation Hazard (TIH) commodity.  This is contributing to new restrictions by rail carriers on the movement of anhydrous ammonia and to an escalation in associated rail transport and insurance rates.  Overseas, new coal-fired power plants incorporating SCR systems are expected to be constructed at a rapid rate in China, and Fuel Tech’s NOxOUT ULTRA process is believed to be a market leader for the safe delivery of ammonia, particularly near densely populated cities, major waterways, harbors or islands, or where the transport of anhydrous or aqueous ammonia is a safety concern.
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·Fuel Tech has licensed the Rich Reagent Injection Technology from Reaction Engineering International and Electric Power Research Institute.  The technology has been proven in full-scale field studies on cyclone-fired units to reduce NOx by 40% - 60%.  The technology is a generic SNCR process, whose applicability is outside the temperature range of the NOxOUT process.  The technology is seen as an add-on to Fuel Tech’s NOxOUT systems, thus potentially broadening the NOx reduction of the combined system to up to 60% with minimal additional capital requirement.

Fuel Tech has sublicensed the Rich Reagent Injection Technology from Reaction Engineering International, which has a direct license from the Electric Power Research Institute. The technology has been proven in full-scale field studies on cyclone-fired units to reduce NOx by 25%-40%. The technology is a generic SNCR process, whose applicability is outside the temperature range of the NOxOUT process. The technology is seen as an add-on to Fuel Tech’s NOxOUT systems, thus potentially broadening the NOx reduction of the combined system to almost 55% with minimal additional capital requirement.
·Under an exclusive licensing agreement with FGC Corporation, Fuel Tech sells flue gas conditioning systems incorporating FGC Corporation technology for utility applications in all geographies outside the United States and Canada.  Flue gas conditioning systems improve the efficiency of particulate collectors, also known as electrostatic precipitators (ESP).  These conditioning systems represent a far lower capital cost approach to improving ash particulate capture versus the alternative of installing larger ESPs or fabric filter technology to meet opacity levels.

·As a result of the acquisitions of substantially all of the assets of Tackticks, LLC and FlowTack, LLC in the fourth quarter of 2008, Fuel Tech now provides process design optimization, performance testing and improvement, and catalyst selection services for SCR systems on coal-fired boilers.  In addition, other related services, including start-ups, maintenance support and general consulting services for SCR systems, as well as ammonia injection grid design and tuning, to help optimize catalyst performance and catalyst management services to help optimize catalyst life, are now offered to customers around the world.  Fuel Tech also specializes in both physical experimental models, which involve construction of scale models through which fluids are tested, and computational fluid dynamics models, which simulate fluid flow by generating a virtual replication of real-world geometry and operating inputs.  We design flow corrective devices, such as turning vanes, ash screens, static mixers and our patent pending Graduated Straightening Grid.  Our models help clients optimize performance in flow critical equipment, such as selective catalytic reactors in SCR systems, where the effectiveness and longevity of catalysts are of utmost concern.  The Company’s modeling capabilities are also applied to other power plant systems where proper flow distribution and mixing are important for performance, such as flue gas desulphurization scrubbers, electrostatic precipitators, air heaters, exhaust stacks and carbon injection systems for mercury removal.

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Sales of the NOx reduction technologies were $46.4$44.4 million, $32.6$47.8 million and $14.6$46.4 million for the years ended December 31, 2008, 2007 and 2006, 2005 and 2004, respectively.
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NOx Reduction Competition

Competition with Fuel Tech's NOx reduction suite of products canmay be expected from companies supplying urea SNCR systems, combustion modifications,modification products, SCR systems and ammonia SNCR as well as from other licensed market participants.systems.  In addition, Fuel Tech experiences competition in the urea-to-ammonia conversion market.

Combustion modifications, including low NOxlow-NOx burners and over-fire-air systems, can be fitted to most types of boilers with cost and effectiveness varying with specific boilers.  Combustion modifications may effect 20-50%yield up to 20% - 60% NOx reduction economically with capital costs ranging from $5$10 - $40/kw$20/kW and levelized total costs ranging from $300 - $1,500/ton of NOx removed. The modifications are designed to reduce the formation of NOx and are typically the first NOx reduction efforts employed.  Such companies as Advanced Combustion Technology, Inc., Alstom, Foster Wheeler Corporation, The Babcock & Wilcox Company, Combustion Components Associates, Inc., Nalco Mobotec, Inc. and Babcock Power, Inc. are active competitors in the low-NOx burner business.  On December 8, 2008, Fuel Tech announced that it had signed a definitive agreement to acquire substantially all of the assets of Advanced Combustion Technology, Inc.  See Note 13, Subsequent Events, for more information regarding this acquisition.

Once NOx is formed, then the SCR process is an effective and proven method of control for the removal of NOx up to 90% of NOx..  SCR hassystems have a high capital cost ranging from $150 - $300/kwof $300+/kW on retrofit coal applications.  Such companies as Alstom, The Babcock & Wilcox Company, Cormetech, Inc., Ceram Environmental, Inc.,Hitachi, Foster Wheeler Corporation, Peerless Manufacturing Company, and the Siemens WestinghouseBabcock Power, CorporationInc., are active SCR system providers, or providers of the catalyst itself.

The use of ammonia as the reagent for the SNCR process was developed by the ExxonMobil Corporation. Fuel Tech understands that the ExxonMobil patents on this process have expired. This process can reduce NOx by 30% - 70% on incinerators, but has limited applicability in the utility industry.  Ammonia system capital costs range from $15$5 - $20/kw,kW, with annualized operating costs ranging from $1,000 - $3,000/ton of NOx removed.  These systems require the use of storedeither anhydrous or aqueous ammonia, aboth of which are hazardous substance.substances.

Other NOx reduction competitors include Combustion Components Associates, whichInc. is a licensed implementer of our NOxOUT SNCR systems, and Reaction Engineering International, which sublicenses Rich Reagent Injection Technology to Fuel Tech.systems.

In addition to or in lieu of using the foregoing processes, certain customers willmay elect to close or deratede-rate plants, purchase electricity from third-party sources, switch from higher to lower NOx emittingNOx-emitting fuels or purchase NOx emission allowances.

Lastly, with respect to urea-to-ammonia conversion technologies, a competitive approach to Fuel Tech’s controlled urea decomposition system is available from Wahlco, Inc., which manufactures a system that hydrolyzes urea under high temperature and pressure.

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FUEL CHEM

FUEL CHEM

Product and Markets

The FUEL CHEM technology segment revolves around the unique application of specialty chemicals to improve the efficiency, reliability and environmental status of plants operating in the electric utility, industrial, pulp and paper, waste-to-energy, university and waste-to-energydistrict heating markets.  FUEL CHEM programs are currently in place on over 5095 combustion units, treating a wide variety of solid and liquid fuels, including coal, heavy oil, biomass and municipal waste.

Central to the FUEL CHEM approach is the introduction of chemical reagents, such as magnesium hydroxide, to combustion units via in-body fuel application (pre-combustion) or via direct injection (post-combustion) utilizing Fuel Tech’s proprietary TIFI technology.  By attacking performance-hindering problems, such as slagging, fouling corrosion, opacity, acid plume and loss on ignition (LOI),corrosion, as well as the formation of sulfur trioxide (SO33), ammonium bisulfate (ABS), particulate matter (PM2.52.5), carbon dioxide (CO22), NOx and NOx,unburned carbon in fly ash, the Company’s programs offer numerous operational, financial and environmental benefits to owners of boilers, furnaces and other combustion units.

The key market dynamic for this product line is the continued use of coal as the principal fuel source for global electricity production.  Coal accounts for approximately 50% of all U.S. electricity generation, with U.S. government projections forecasting an increase to approximately 57% by 2030.generation.  Coal’s share of global electricity generation is forecast to remain atbe approximately 41% through45% by 2030. Major coal consumers include the United States, the PRCChina and India.

The principal markets for this product line are electric power plants burning coals with slag- forming constituents. The slag-forming constituents aresuch as sodium, iron and high sulfur content.levels of sulfur.  Sodium is typically found in the Powder River Basin (PRB) coals of Wyoming and Montana.  Iron is typically found in coals produced in the Illinois Basin (IB) region.  High sulfur content is typical of IB coals and certain Appalachian coals.  High sulfur content can give rise to unacceptable levels of SO3SO3 formation in plants with SCR systems and flue gas desulphurization units (scrubbers).
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The combination of slagging coals and SO33-related issues, such as “blue plume” formation, air pre-heater fouling and corrosion, SCR fouling and the proclivity to suppress certain mercury removal processes, represents attractive market potential for Fuel Tech.

Internationally, market opportunities exist in Europe and in the Asia-Pacific region, particularly the PRCChina and India, where high-slagging coals are fueling a large and growing fleet of power plants.  To address the Chinese market, where particular emphasis is being placed on energy efficiency, Fuel Tech extended its exclusive teaming agreement with ITOCHU Hong Kong Ltd., a subsidiary of ITOCHU Corporation, through March 31, 2009.  Working under this agreement, the first FUEL CHEM demonstration program in China was announced in January 2008 and a second demonstration program was announced in October 2008.  In addition, Fuel Tech was awarded its first FUEL CHEM demonstration program in India in January 2008.  TIFI initiatives aimed at energy efficiency improvements often result in reduced CO2 emissions, which potentially can potentially be monetized under provisions of the Kyoto Protocol.

A potentially large fuel treatment market exists in Mexico, where high-sulfur, low-grade fuel oil containing vanadium and nickel is the primary source for electricity production.  The presence of these metallic constituents promotes slag build-up, and the fuel properties maycan result in acid gas and particulate emissions in local combustion units.  Fuel Tech has successfully treated such units with its TIFI technology.  To capitalize on this market opportunity, the Company signed a five-year license implementation agreement with Energy Marine Services, S.A. de C.V. (EMS), a private Mexican corporation, to implement our TIFI program for utility and end user customers in Mexico.

Sales of the FUEL CHEM products were $28.7$36.7 million, $20.3$32.5 million and $16.2$28.7 million for the years ended December 31, 2006, 20052008, 2007 and 2004,2006, respectively.

Competition

Competition for Fuel Tech's FUEL CHEM product line includes chemicals sold by specialty chemical and combustion engineering companies, such as GE Infrastructure, Ashland Inc., and Environmental Energy Services, Inc.  No substantive competition currently exists for Fuel Tech's TIFI technology, which is designed primarily for slag control and SO33 abatement, but there can be no assurance that such lack of substantive competition will continue.

PLANT OPTIMIZATION SERVICESINTELLECTUAL PROPERTY

Fuel Tech uses its advanced engineering capabilities to support the sale of its NOx reduction and FUEL CHEM systems, particularly through the use of computational fluid dynamics (“CFD”) tools. These CFD tools assist in the prediction of the behavior of gas flows, thereby enhancing the design, marketing and saleThe majority of Fuel Tech’s NOx reduction systems and FUEL CHEM product applications. To further aid the accuracy and expediency with which process solutions could be designed and delivered to a customer, Fuel Tech internally developed a virtual reality-based visualization software for exploring model results and discovering complex process behaviors. Fuel Tech intends to capitalize on its unique capabilities via offering plant optimization services to its customer base, either in conjunction with the NOx reduction and FUEL CHEM systems or on a stand alone basis.
4

INTELLECTUAL PROPERTY

See Item 2 "Description of Property" for information on Fuel Tech's intellectual property and proprietary position, which are material to its business.

EMPLOYEES

Fuel Tech has 137 employees, 129 in North America and 8 in Europe. Fuel Tech enjoys good relations with its employees and is not a party to any labor management agreements.
5
ITEM 1A. RISK FACTORS OF THE BUSINESS

Investors in Fuel Tech should be mindful of the following risk factors relative to Fuel Tech's business.

(i)Lack of Diversification

Fuel Tech has two broad technology segments which provide advanced engineering solutions to meet the pollution control, efficiency improvement, and operational optimization needs of energy-related facilities worldwide. They are as follows:

·  The NOx reduction technology segment, which includes the NOxOUT, NOxOUT CASCADE, NOxOUT ULTRA and NOxOUT-SCR processes for the reduction of NOx emissions in flue gas from boilers, incinerators, furnaces and other stationary combustion sources, and

·  
The fuel treatment chemicals technology segment, which uses chemical processes, including TIFI Targeted In-Furnace Injection technology, to control slagging, fouling, corrosion, opacity, acid plume and loss on ignition, as well as the formation of sulfur trioxide, ammonium bisulfate, particulate matter (PM2.5), carbon dioxide and NOx in furnaces and boilers.
An adverse development in Fuel Tech's advanced engineering solution business as a result of competition, technological change, government regulation, or any other factor could have a significantly greater impact than if Fuel Tech maintained more diverse operations.

(ii)Competition

Competitionin the NOx control market will come from processes utilizing low-NOx burners, over-fire air, flue gas recirculation, ammonia SNCR, SCR and, with respect to particular uses of urea not infringing Fuel Tech's patents, urea (see Item 2 "Description of Property"). Competition will also come from business practices such as the purchase rather than the generation of electricity, fuel switching, closure or derating of units, and sale or trade of pollution credits. Utilization by customers of such processes or business practices or combinations thereof may adversely affect Fuel Tech's pricing and participation in the NOx control market if customers elect to comply with regulations by methods other than Fuel Tech's NOxOUT or NOxOUT CASCADE Processes. See above text under the captions "Products" and “NOx Reduction Competition.”

Competitionin the FUEL CHEM markets includes chemicals sold by specialty chemical and combustion engineering companies, such as GE Infrastructure, Ashland Inc. and Environmental Energy Services, Inc. As noted previously, no substantive competition currently exists for Fuel Tech's TIFI technology, which is designed primarily for slag control and SO3 abatement. However, there can be no assurance that such lack of substantive competition will continue.

(iii)Dependence on Regulations and Enforcement

Fuel Tech's business is significantly impacted by the regulatory environment surrounding the markets in which it serves. Fuel Tech’s business will be adversely impacted to the extent that regulations are repealed or amended to significantly reduce the level of required NOx reduction, or to the extent that regulatory authorities minimize enforcement. See also the text above under the caption “Regulations and Markets.”

(iv) Protection of Patents and Proprietary Rights

Fuel Tech holds licenses to or owns a number of patents and also has patents pending. There can be no assurance that pending patent applications will be granted or that outstanding patents will not be challenged or circumvented by competitors. Certain critical technology relating to Fuel Tech's products is protected by trademark and trade secret laws and by confidentiality and licensing agreements. There can be no assurance that such protection will prove adequate or that Fuel Tech will have adequate remedies for disclosure of its trade secrets or violations of its intellectual property rights. See Item 2 “Description of Property.”

6

ITEM 1B. UNRESOLVED STAFF COMMENTS

None

ITEM 2. PROPERTIES

Fuel Tech’s products are generally protected by U.S. and non-U.S. patents.  Fuel Tech owns 8887 granted patents worldwide and has seven13 patent applications pending in the United States and 2037 pending in non-U.S. jurisdictions.  These patents and applications cover some 36 inventions, 23 associated with the NOx reduction business;business, eight associated with the FUEL CHEM business;business and five associated with non-commercialized technologies.  Graduated Straightening Grid (GSG) technology was added into Fuel Tech’s inventions through the acquisition of substantially all of the assets of FlowTack.  GSG improves flow distribution and direction to potentially improve SCR and CASCADE performance, and minimize flow-related erosion, dust accumulation and heat transfer problems.  These inventions represent significant enhancements of the application and performance of the technologies.  Further, Fuel Tech believes that the protection provided by the numerous claims in the above referenced patents or patent applications is substantial, and affords Fuel Tech a significant competitive advantage in its business.  Accordingly, any significant reduction in the protection afforded by these patents or any significant development in competing technologies could have a material adverse effect on Fuel Tech’s business.

Apart from its intellectual property, the property ofEMPLOYEES

At December 31, 2008, Fuel Tech had 196 employees, 170 in North America, 15 in China and 11 in Europe.  Fuel Tech enjoys good relations with its employees and is not material.a party to any labor management agreement.

8
ITEM 1A - RISK FACTORS

Investors in Fuel Tech should be mindful of the following risk factors relative to Fuel Tech's business.

(i)Lack of Diversification

Fuel Tech has two broad technology segments that provide advanced engineering solutions to meet the pollution control, efficiency improvement, and operational optimization needs of energy-related facilities worldwide.  They are as follows:

-The Air Pollution Control technology segment, which includes the NOxOUT, NOxOUT CASCADE, GSG, NOxOUT ULTRA and NOxOUT-SCR processes for the reduction of NOx emissions in flue gas from boilers, incinerators, furnaces and other stationary combustion sources; and

-
The FUEL CHEM technology segment, which uses chemical processes, including TIFI Targeted In-Furnace Injection technology, to control slagging, fouling and corrosion, as well as the formation of sulfur trioxide, ammonium bisulfate, particulate matter (PM2.5), carbon dioxide, NOx and unburned carbon in fly ash of furnaces and boilers.

An adverse development in Fuel Tech's advanced engineering solution business as a result of competition, technological change, government regulation, or any other factor could have a significantly greater impact than if Fuel Tech maintained more diverse operations.

(ii)Competition

Competition in the Air Pollution Control market will come from competitors utilizing their own NOx reduction processes, including  SNCR systems, low-NOx burners, over-fire air, flue gas recirculation, ammonia SNCR, SCR and, with respect to particular uses of urea not infringing Fuel Tech's patents, urea (see Item 1 "Intellectual  Property").  Competition will also come from business practices such as the purchase rather than the generation of electricity, fuel switching, closure or de-rating of units, and sale or trade of pollution credits and emission allowances.  Utilization by customers of such processes or business practices or combinations thereof may adversely affect Fuel Tech's pricing and participation in the NOx control market if customers elect to comply with regulations by methods other than the purchase of Fuel Tech's suite of Air Pollution Control products.  See above text under the captions "Products" and “NOx Reduction Competition” in the Air Pollution Control segment overview.

Competition in the FUEL CHEM markets includes chemicals sold by specialty chemical and combustion engineering companies, such as GE Infrastructure, Ashland Inc. and Environmental Energy Services, Inc.  As noted previously, no significant competition currently exists for Fuel Tech's patented TIFI technology, which is designed primarily for slag control and SO3 abatement.  However, there can be no assurance that such lack of significant competition will continue.

(iii)Dependence on and Change in Air Pollution Control Regulations and Enforcement

Fuel Tech's business is significantly impacted by and dependent upon the regulatory environment surrounding the electricity generation market.  Our business will be adversely impacted to the extent that regulations are repealed or amended to significantly reduce the level of required NOx reduction, or to the extent that regulatory authorities delay or otherwise minimize enforcement of existing laws.  Additionally, long-term changes in environmental regulation that threaten or preclude the use of coal or other fossil fuels as a primary fuel source for electricity production, based on the theory that gases emitted therefrom impact climate change through a greenhouse effect, and result in the reduction or closure of a significant number of fossil fuel-fired power plants, may adversely affect the Company's business, financial condition and results of operations.  See also the text above under the caption “Regulations and Markets” in the Air Pollution Control segment overview.

(iv)Protection of Patents and Proprietary Rights

Fuel Tech holds licenses to or owns a number of patents for our products and processes.  In addition, we also have numerous patents pending.  There can be no assurance that pending patent applications will be granted or that outstanding patents will not be challenged or circumvented by competitors.  Certain critical technology relating to our products is protected by trade secret laws and by confidentiality and licensing agreements.  There can be no assurance that such protection will prove adequate or that we will have adequate remedies against contractual counterparties for disclosure of our trade secrets or violations of Fuel Tech’s intellectual property rights. See Item 1 “Intellectual Property.”

(v)Foreign Operations

In 2007, we expanded our operations into China by establishing a wholly-owned subsidiary in Beijing.  The Asia-Pacific region, particularly China and India, offers significant market opportunities for Fuel Tech as these nations look to establish regulatory policies for improving their environment and utilizing fossil fuels, especially coal, efficiently and effectively.  The future business opportunities in these markets are dependent on the continued implementation of regulatory policies that will benefit our technologies, the acceptance of Fuel Tech’s engineering solutions in such markets, and the ability of potential customers to utilize Fuel Tech’s technologies on a cost-effective basis.

9
(vi)Product Pricing and Operating Results

The onset of significant competition for either of the technology segments might have an adverse impact on product pricing and a resulting adverse impact on realized gross margins and operating profitability.

(vii)Raw Material Supply and Pricing

The FUEL CHEM technology segment is reliant upon a long-term global supply of magnesium hydroxide.  Any adverse change in the availability of supply for this chemical will likely have an adverse impact on our cost structure.  On October 1, 2008 we entered into a Product Supply Agreement (“PSA”) with Martin Marietta Magnesia Specialties, LLC (MMMS) in order to assure the continuance of a stable supply from MMMS of magnesium hydroxide products for our requirements in the United States and Canada until December 31, 2013.  Magnesium hydroxide products are a significant component of the FUEL CHEM programs.  There can be no assurance that Fuel Tech will be able to obtain a stable source of magnesium hydroxide in markets outside the United States.

(ix)Customer Access to Capital Funds

Uncertainty about current economic conditions in the United States and globally poses risk that Fuel Tech’s customers may postpone spending for capital improvement projects in response to tighter credit markets, negative financial news and/or decline in demand for electricity generated by combustion units, all of which could have a material negative effect on demand for the Fuel Tech’s products and services.

(x)Customer Concentration

A small number of customers have historically accounted for a material portion of Fuel Tech’s revenues (see note 11 – Business Segment, Geographic and Quarterly Financial Data).  There can be no assurance that Fuel Tech’s current customers will continue to place orders, that orders by existing customers will continue at the levels of previous periods, or that Fuel Tech will be able to obtain orders from new customers.  The loss of one or more of our customers could have a material adverse effect on our sales and operating results.

 ITEM 1B - UNRESOLVED STAFF COMMENTS

None

ITEM 2 - PROPERTIES

Fuel Tech and its subsidiaries operate from leased office facilities in Batavia,Warrenville, Illinois; Stamford, Connecticut; Durham, North Carolina; Gallarate, Italy and Gallarate, Italy.Beijing, China.  Fuel Tech does not segregate any of its leased facilities by operating business segment.  The terms of the twothree material agreements are as follows:
 
·The Batavia, Illinois building lease term, for approximately 18,000 square feet, runs from June 1, 1999 to May 31, 2009. Fuel Tech has the option to extend the lease term for two successive terms of five years each at market rates to be agreed upon between Fuel Tech and the lessor.
·-The Stamford, Connecticut building lease term, for approximately 7,000 square feet, runs from February 1, 2004 to January 31, 2010.  The facility houses certain administrative functions such as Investor Relations, Benefit Plan Administration and certain APC sales functions.
-The Beijing, China building lease term, for approximately 4,000 square feet, runs from September 1, 2007 to August 31, 2009.  This facility serves as the operating headquarters for our Beijing Fuel Tech operation.  Fuel Tech has the option to extend the lease term for one successive term of five years at a market rate to be agreed upon between Fuel Tech and the lessor.
 
Please refer to Note 7
-The Durham, North Carolina building lease term, for approximately 16,000 square feet, runs from November 1, 2005 to April 30, 2014.  This facility houses the former Tackticks and FlowTack operations.  Fuel Tech has no option to extend the lease.
In addition to the consolidated financial statementsabove, on November 30, 2007, Fuel Tech purchased an office building in Warrenville, Illinois, which has served as our corporate headquarters since June 23, 2008.  This facility, with approximately 40,000 square feet of office space, was purchased for a further discussionapproximately $6,000,000 and subsequently built out and furnished for an additional cost of these arrangements.approximately $5,500,000.  This facility will meet our growth requirements for the foreseeable future.  Our prior headquarters, an 18,000 square foot location in Batavia, Illinois, remains under an operating lease until May 31, 2009.  We have no plans to renew this lease.

10

ITEM 3.3 - LEGAL PROCEEDINGS

Fuel Tech has no pendingWe are from time to time involved in litigation incidental to our business.  We are not currently involved in any litigation in which we believe an adverse outcome would have a material to its business.effect on our business, financial conditions, results of operations, or prospects.

ITEM 4.4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

During the fourth quarter of 2006,2008, no matters were submitted to a vote of security holders.

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PART II
 
ITEM 5.5 - MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASE OF EQUITY SECURITIES

Market

Fuel Tech's Common Shares have been traded since September 1993 on The NASDAQ Stock Market, Inc.  The trading symbol is FTEK.

Prices

The table below sets forth the high and low sales prices during each calendar quarter since January 2005.2007.

2006
 
High
 
Low
 
Fourth Quarter $27.44 $14.40 
Third Quarter  16.45  10.07 
Second Quarter  18.80  11.15 
First Quarter  16.75  8.11 
        
2005
       
Fourth Quarter $10.12 $7.24 
Third Quarter  10.13  5.75 
Second Quarter  7.20  5.10 
First Quarter  6.85  4.60 
2008 High  Low 
Fourth Quarter $18.95  $6.05 
Third Quarter  24.76   14.52 
Second Quarter  27.16   17.55 
First Quarter  22.94   14.15 

2007 High  Low 
Fourth Quarter $34.48  $16.89 
Third Quarter  35.85   20.65 
Second Quarter  38.20   21.65 
First Quarter  29.68   22.54 

Dividends

Fuel Tech has not to datenever paid cash dividends on its Common Sharescommon stock and is not expectedhas no current plan to do so in the foreseeable future. The declaration and payment of dividends on the Common Stock are subject to the discretion of the Company’s Board of Directors.  The decision of the Board of Directors to pay future dividends will depend on general business conditions, the effect of a dividend payment on our financial condition, and other factors the Board of Directors may consider relevant.  The current policy of the Company’s Board of Directors is to reinvest earnings in operations to promote future growth.

Share Repurchase Program

Fuel Tech purchased no equity securities during the quarter and year ended December 31, 2008.

Holders

Based on information from Fuel Tech’sthe Company’s Transfer Agent and from banks and brokers, the Company estimates that, as of February 16, 2006, there were 305 registered holders of Fuel Tech’s Common Shares. Management believes that, on such date,24, 2009, there were approximately 15,92424,000 beneficial holders and 277 registered stockholders of Fuel Tech’s Common Shares.

Transfer Agent

The Transfer Agent and Registrar for the Common Shares is BNY Mellon InvestorShareowner Services, LLC, 480 Washington Boulevard, Jersey City, New Jersey 07310.

Securities Authorized for Issuance Under Equity Compensation Plans

The following table provides information for all equity compensation plans as of the fiscal year ended December 31, 2006, under which the securities of Fuel Tech were authorized for issuance:07310-1900.

Plan Category
 
Number of Securities to be issued upon exercise of outstanding options, warrants and rights
 
Weighted-average exercise price of outstanding options, warrants and rights
 
Number of securities remaining available for future issuance under equity compensation plans excluding securities listed in column (a)
 
  
(a)
 
(b)
 
(c)
 
Equity compensation plans approved by security holders (1)  2,414,200 $13.02  866,000 
(1)Includes Common Shares of Fuel Tech authorized for awards under Fuel Tech’s Incentive Plan, as amended through June 3, 2004.
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Performance Graph

The following line graph compares (i) Fuel Tech’s total return to shareholdersstockholders per share of Common Stock for the five years ended December 31, 20062008 to that of (ii) the NASDAQ Composite index, and (iii) the WilderHill Clean Energy Index for the period December 31, 20012003 through December 31, 2006.2008.
 
 
913

ITEM 6.6 - SELECTED FINANCIAL DATA

Selected financial data are presented below as of the end of and for each of the fiscal years in the five-year period ended December 31, 2006.2008.  The selected financial data should be read in conjunction with the audited consolidated financial statements as of and for the year ended December 31, 2006,2008, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”Operations” included elsewhere in this report and the schedules thereto.

  
For the years ended December 31
 
CONSOLIDATED STATEMENT of OPERATIONS DATA
 2006 2005 2004 2003 2002 
(in thousands of U.S. dollars, except for share data)           
            
Net sales $75,115 $52,928 $30,832 $35,736 $32,627 
Selling, general and administrative and other costs and expenses  25,953  18,655  14,130  12,978  
11,777
 
Operating income  10,733  7,155  136  969  2,618 
Net income  6,826  7,588  1,572  1,120  3,057 
                 
Basic income per Common Share $0.32 $0.38 $0.08 $0.06 $0.16 
Diluted income per Common Share $0.28 $0.33 $0.07 $0.05 $0.14 
Weighted-average basic shares outstanding  21,491,000  20,043,000  19,517,000  19,637,000  19,350,000 
Weighted-average diluted shares outstanding  24,187,000  23,066,000  22,155,000  22,412,000  22,437,000 
  For the years ended December 31, 
CONSOLIDATED STATEMENT of
OPERATIONS DATA		 2008  2007  2006  2005  2004 
(in thousands of dollars, except for share and per-share data)               
                     
Revenues $81,074  $80,297  $75,115  $52,928  $30,832 
Cost of sales  44,345   42,471   38,429   27,118   16,566 
Selling, general and administrative and other costs and expenses  30,112   27,087   25,953   18,655   14,130 
Operating income  6,617   10,739   10,733   7,155   136 
Net income  3,602   7,243   6,826   7,588   1,572 
                     
Basic income per Common Share $0.15  $0.33  $0.32  $0.38  $0.08 
Diluted income  per Common Share $0.15  $0.29  $0.28  $0.33  $0.07 
Weighted-average basic shares outstanding  23,608,000   22,280,000   21,491,000   20,043,000   19,517,000 
Weighted-average diluted shares outstanding  24,590,000   24,720,000   24,187,000   23,066,000   22,155,000 
  
December 31
 
CONSOLIDATED BALANCE SHEET DATA
 2006 2005 2004 2003 2002 
(in thousands of U.S. dollars, except for share data)           
            
Working capital $38,715 $19,590 $11,292 $10,973 $13,930 
Total assets  65,660  44,075  23,828  21,598  25,869 
Long-term obligations  500  448  505  299  2,059 
Total liabilities  18,005  14,939  4,873  4,287  9,064 
Shareholders' equity  47,655  29,136  18,955  17,311  16,805 
Net tangible book value per share $1.83 $1.12 $0.70 $0.61 $0.64 

  December 31 
CONSOLIDATED BALANCE SHEET DATA 2008  2007  2006  2005  2004 
                
(in thousands of dollars)               
                
Working capital $44,346  $45,143  $38,715  $19,590  $11,292 
Total assets  88,873   87,214   65,660   44,075   23,828 
Long-term obligations  1,389   1,255   500   448   505 
Total liabilities  15,056   23,975   18,005   14,939   4,873 
Stockholders' equity (1)  73,817   63,239   47,655   29,136   18,955 

Notes:

(1)Shareholders’ equity includes $277,000 principal amount of nil coupon non-redeemable perpetual loan notes. See Note 5 to the consolidated financial statements.

(2)Net tangible book value per share assumes full conversion of Fuel Tech’s nil coupon non-redeemable perpetual loan notes into shares of Fuel Tech’s Common Shares.

(3)Net tangible book value per share is defined as shareholders’ equity less intangible assets, divided by weighted average shares outstanding.
(1)Stockholders’ equity includes principal amount of nil coupon non-redeemable perpetual loan notes.  See Note 5 to the consolidated financial statements.

10
14

ITEM 7.7 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Background

Fuel Tech, Inc. (“Fuel Tech”) has two broad technology segments that provide advanced engineering solutions to meet the pollution control, efficiency improvement and operational optimization needs of energy-related facilities worldwide.  They are as follows:

Nitrogen Oxide (“NOx”) ReductionAir Pollution Control Technologies

The Air Pollution Control technology segment focuses primarily on nitrogen oxide (“NOx”) reduction technology segment includes the NOxOUT, NOxOUT CASCADE, NOxOUT ULTRA and NOxOUT-SCR processes for the reduction of NOx emissionsemission reductions in flue gas from boilers, incinerators, furnaces and other stationary combustion sources.sources and includes the NOxOUT, NOxOUT CASCADE, GSG,  NOxOUT ULTRA and NOxOUT-SCR processes.  Fuel Tech distributes its products through its direct sales force, licensees and agents.

Fuel Treatment ChemicalsFUEL CHEM Technologies

The fuel treatment chemicalsFUEL CHEM technology segment uses chemical processes, including TIFI Targeted In-Furnace Injection technology, to control slagging, fouling corrosion, opacity, acid plume and loss on ignition,corrosion, as well as the formation of sulfur trioxide, ammonium bisulfate, particulate matter (PM2.52.5), carbon dioxide, NOx and NOxunburned carbon in fly ash in furnaces and boilers.  Fuel Tech sells its fuel treatment chemicalsFUEL CHEM program through its direct sales force and agents to industrial and utility power-generation facilities.  At December 31, 2008, FUEL CHEM programs were operating on over 95 combustion units around the world, treating a wide variety of solid and liquid fuels, including coal, heavy oil, biomass and municipal waste.  The FUEL CHEM program improves the efficiency, reliability and environmental status of plants operating in the electric utility, industrial, pulp and paper, waste-to-energy, university and district heating markets and offers numerous operational, financial and environmental benefits to owners of boilers, furnaces and other combustion units.

The key market dynamic for both technology segments is the continued use of fossil fuels, especially coal, as the principal fuel source for global electricity production.  Coal accounts for approximately 50% of all U.S. electricity generation, with U.S. government projections calling for an increase to approximately 57% by 2030.generation.  Coal’s share of global electricity generation is forecast to remain atbe approximately 41% through45% by 2030.  Major coal consumers include China, the United States the PRC and India.

Critical Accounting Policies and Estimates

The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America, which require Fuel Techus to make estimates and assumptions.  Fuel Tech believesWe believe that of itsour accounting policies (see Note 1 to the consolidated financial statements), the following involvesinvolve a higher degree of judgment and complexity and are deemed critical.  Fuel Tech discusses itsWe routinely discuss our critical accounting policies with the Company’s Audit Committee.

Revenue Recognition

Revenues from the sales of chemical products are recorded when title transfers, either at the point of shipment or at the point of destination, depending on the contract with the customer.

Fuel Tech uses the percentage of completion method of accounting for certain long-term equipment construction and license contracts that are sold within the nitrogen oxide reduction businessAir Pollution Control technology segment.  Under the percentage of completion method, sales and gross profitrevenues are recognized as work is performed based on the relationship between actual construction costs incurred and total estimated costs at completion.  Since the financial reporting of these contracts depends on estimates that are assessed continually during the term of the contract, recognized sales and profit are subject to revisions as the contract progresses to completion. Revisions in profitcompletion estimates are reflectedand contract values in the period in which the facts that givegiving rise to the revisionrevisions become known.known can influence the timing of when revenues are recognized under the percentage of completion method of accounting.  Provisions are made for estimated losses on uncompleted contracts in the period in which such losses are determined.  As of December 31, 2008 and December 31, 2007, Fuel Tech had no construction contracts in progress that were identified as loss contracts.

Fuel Tech’s constructionAPC contracts are typically six to twelve months in length.  A typical contract will have three or four critical milestonesoperational measurements  that, when achieved, serve as the basis for Fuel Techus to invoice the customer.customer via progress billings.  At a minimum, the milestonesthese measurements will include the generation of engineering drawings, the shipment of equipment and the completion of a system performance test.

As part of most of its contractual project agreements, Fuel Tech will agree to customer-specific acceptance criteria that relate to the operational performance of the system that is being sold to the customer.sold.  These criteria are determined based on mathematical modeling that is performed by Fuel Tech personnel, which is based on operational inputs that are provided by the customer.  The customer will warrant that these operational inputs are accurate as they are specified in the binding contractual agreement.  Further, the customer is solely responsible for the accuracy of the operating condition information; all performance guarantees and equipment warranties granted by Fuel Techus are void if the operating condition information is inaccurate or is not met.
 
15
Accounts receivable includes unbilled receivables, representing revenues recognized in excess of billings on uncompleted contracts under the percentage of completion method of accounting.  At December 31, 2008 and December 31, 2007, unbilled receivables were approximately $5,552 and $16,813, respectively.  Billings in excess of costs and estimated earnings on uncompleted contracts were $1,223 and $821 at December 31, 2008 and December 31, 2007, respectively.  Such amounts are included in other accrued liabilities on the consolidated balance sheet.
Fuel Tech has installed over 400450 units with the technology and has never failed to meet a performance guarantee when the customer has provided the required operating conditions for the project.  As part of the project implementation process, Fuel Tech willwe perform system start-up and optimization services that effectively serve as a test of actual project performance.  Fuel Tech believesWe believe that this test, combined with the accuracy of the modeling that is performed, enables revenue to be recognized prior to the receipt of formal customer acceptance.
 
11
Allowance for Doubtful Accounts

Allowance for doubtful accounts

Fuel Tech, inIn order to control and monitor the credit risk associated with itsour customer base, reviewswe review the credit worthiness of customers on a recurring basis.  Factors influencing the level of scrutiny include the level of business the customer has with Fuel Tech, the customer’s payment history and the customer’s financial stability.  Representatives of Fuel Tech’sour management team review all past due accounts on a weekly basis to assess collectibility.  At the end of each reporting period, the allowance for doubtful accounts balance is reviewed relative to management’s collectibility assessment and is adjusted if deemed necessary.  Fuel Tech’sOur historical credit loss has been insignificant.

Assessment of potential impairmentsPotential Impairments of goodwillGoodwill and intangible assets
Intangible Assets
 
Effective January 1, 2002, Fuel Tech adopted FASB (FinancialFinancial Accounting Standards Board)Board (FASB) Statement No. 142, “Goodwill and Other Intangible Assets.”Assets” (SFAS 142).  Under the guidance of this statement, goodwill and indefinite-lived intangible assets are no longer amortized, but rather are required to be reviewed annually or more frequently if indicators arise, for impairment.  The evaluation of impairment involves comparing the current fair value of the business to the carrying value.  Fuel Tech uses a discounted cash flow (DCF) model (DCF) to determine the current fair value of its two reporting units.  A number of significant assumptions and estimates are involved in the application of the DCF model to forecast operating cash flows, including markets and market share, sales volumes and prices, costs to produce and working capital changes.  Management considers historical experience and all available information at the time the fair values of its reporting units are estimated.  However, actual fair values that could be realized in an actual transaction may differ from those used to evaluate the impairment of goodwill.
 
Fuel Tech reviews other intangible assets, which include a customer list, a covenantlists and relationships, covenants not to compete, and patent assets and acquired technologies, for impairment on a recurring basis or when events or changes in circumstances indicate the carrying amount of an asset may not be recoverable.  In the event the sum of the expected undiscounted future cash flows resulting from the use of the asset is less than the carrying amount of the asset, an impairment loss equal to the excess of the asset’s carrying value over its fair value is recorded.  Management considers historical experience and all available information at the time the estimates of future cash flows are made, however, the actual cash values that could be realized may differ from those that are estimated.
 
Based upon the nature of the goodwill and other intangible assets recorded on the balance sheets as of December 31, 2008 and 2007, the Company believes that, in order for an impairment to occur, a series of material prolonged negative economic events would have to occur.  These events would most likely be seen in economic indicators such as suppressed consolidated revenues or Common Stock price, reduced cash flows or declining APC order backlog.
Valuation allowanceAllowance for deferred income taxes
Deferred Income Taxes
 
Deferred tax assets represent deductible temporary differences and net operating loss and tax credit carryforwards.  A valuation allowance is recognized if it is more likely than not that some portion of the deferred tax asset will not be realized.
At the end of each reporting period, Fuel Tech reviews the realizability of the deferred tax assets.  As part of this review, Fuel Tech willwe consider if there are taxable temporary differences that could generate taxable income in the future, if there is the ability to carrybackcarry back the net operating losses or credits, if there is a projection of future taxable income, and if there are any tax planning strategies whichthat can be readily implemented.

Stock-Based Compensation

Fuel Tech recognizes compensation expense for employee equity awards in which the expense (net of tax) is recognized ratably over the requisite service period of the award.  Fuel Tech utilizesWe utilize the Black-Scholes option-pricing model to estimate the fair value of awards.  Determining the fair value of stock options using the Black-Scholes model requires judgment, including estimates for (1) risk-free interest rate -– an estimate based on the yield of zero-couponzero–coupon treasury securities with a maturity equal to the expected life of the option; (2) expected volatility -– an estimate based on the historical volatility of Fuel Tech’s Common Stock for a period equal to the expected life of the option; and (3) expected life of the option -– an estimate based on historical experience including the effect of employee terminations.  If any of these assumptions differ significantly from actual, stock-based compensation expense could be impacted.

Recently Adopted Accounting Standards

In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,” (SAB 108). SAB 108 was issued to provide interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. The provisions of SAB 108 were effective for Fuel Tech for its December 31, 2006 year-end. The adoption of SAB 108 had no impact on Fuel Tech’s consolidated financial statements.

On January 1, 2006, Fuel Tech adopted SFAS No. 123 (revised 2004), “Share-Based Payment”, (SFAS 123(R)), which requires the company to recognize compensation expense for stock-based compensation based on the grant date fair value. SFAS 123(R) revises SFAS No. 123, “Accounting for Stock-Based Compensation,” and supersedes Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations (APB 25). Fuel Tech elected the modified prospective application method for adoption, therefore prior period financial statements have not been restated. As a result of the implementation of 123(R), Fuel Tech recognized additional compensation expense of $1,805,000 ($1,268,000 after-tax) related to stock options. See the notes to the consolidated financial statements for additional information.
 
1216

NewRecently Adopted Accounting PronouncementsStandards

In JulySeptember 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an interpretationStatement of FASB Statement No. 109,” (FIN 48), FIN 48 prescribes a comprehensive model for how a company should recognize, measure, present, and disclose in its financial statements uncertain tax positions that it has taken or expects to take on a tax return. On January 17, 2007, the FASB affirmed its previous decision to make FIN 48 effective for fiscal years beginning after December 15, 2006. Accordingly, FIN 48 is effective for Fuel Tech on January 1, 2007. Management has determined that the adoption of FIN 48 will not have a material impact on Fuel Tech’s consolidated financial statements.

In September 2006, the FASB issued SFASFinancial Accounting Standard No. 157, “Fair Value Measurements,”Measurements” (SFAS 157). SFAS 157, which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements.  The provisions of this standard apply to other accounting pronouncements thatSFAS 157 does not require or permitany new fair value measurements.measurements, but provides guidance on how to measure fair value by providing a fair value hierarchy used to classify the source of the information.  This statement is effective for fiscal years beginning after November 15, 2007.  On February 14, 2008, the FASB issued FSP FAS No. 157-1 “Application of FASB Statement No. 157 to FASB Statement 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement Under Statement 13” (SFAS 157-1) that amends SFAS 157 becomesto exclude its application for purposes of lease classification or measurement under SFAS 13.  On February 12, 2008, the FASB issued Staff Position Financial Accounting Standard (FSP FAS) No. 157-2 “Effective Date of FASB Statement No. 157” (FSP 157-2) that amends SFAS 157 to delay the effective date for Fuel Techall non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on January 1,a recurring basis to fiscal years beginning after November 15, 2008.  Upon adoption,The Company adopted the required provisions of SFAS 157-1 effective January 1, 2008 and there was no material effect on its consolidated financial statements. The Company has adopted FSP 157-2 to delay the adoption effects related to non-financial assets and does not anticipate there will be a material effect on its consolidated financial statements.  In October 2008, the FASB issued FSP 157-3, “Determining the Fair Value of a Financial Asset in a Market That Is Not Active.”  The FSP was effective upon issuance, including periods for which financial statements have not been issued. The FSP clarified the application of SFAS 157 arein an inactive market and provided an illustrative example to be applied prospectively with limited exceptions.demonstrate how the fair value of a financial asset is determined when the market for that financial asset is inactive.  The adoption of SFAS 157 isthis FSP FAS 157-3 did not expected to have a material impact on Fuel Tech’sthe Company’s consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (SFAS 141R). SFAS 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree and the goodwill acquired. SFAS 141R also establishes disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. SFAS 141R is effective for financial statements issued for fiscal years beginning after December 15, 2008. The Company is currently evaluating the potential impact of adoption of SFAS 141R on its consolidated financial statements. However, the Company does not expect the adoption of SFAS 141R to have a material effect on its consolidated financial statements.

In April 2008, the FASB issued FASB Staff Position No. FAS 142-3, Determination of the Useful Life of Intangible Assets (“FSP No. FAS 142-3”). FSP No. FAS 142-3 requires companies estimating the useful life of a recognized intangible asset to consider their historical experience in renewing or extending similar arrangements or, in the absence of historical experience, to consider assumptions that market participants would use about renewal or extension as adjusted for SFAS 142’s, Goodwill and Other Intangible Assets, entity-specific factors. FSP No. FAS 142-3 will be effective for fiscal years beginning after December 15, 2008. The Company is currently evaluating the potential impact of adoption of FSP No. FAS 142-3 on its consolidated financial statements. However, the Company does not expect the adoption of FSP No. FAS 142-3 to have a material effect on its consolidated financial statements.

In May 2008, the FASB issued Statement of Financial Accounting Standards No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (SFAS 162).  SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements that are presented in conformity with generally accepted accounting principles. SFAS 162 becomes effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles.”  The Company does not expect that the adoption of SFAS 162 to have a material effect on its consolidated financial statements.
 
1317

20062008 versus 20052007

Net salesRevenues for the years ended December 31, 20062008 and 20052007 were $75,115,000$81,074 and $52,928,000,$80,297, respectively.  The year over yearyear-over-year increase of $22,187,000,$777, or 42%1%, reflects anwas driven by a 13% increase of $13,804,000in revenues from the nitrogen oxide (NOx) reductionFUEL CHEM technology segment and an increase of $8,389,000 fromthat were largely offset by a modest revenue decline in the fuel treatment chemicalAPC technology segment.

Revenues for the NOx reductionAPC technology segment were $46,454,000$44,393 for the year ended December 31, 2008, a decrease of $3,357, or 7%, versus 2007.  The global financial crisis and the vacatur of the Clean Air Interstate Rule (CAIR) in 2006, an increase of $13,804,000, or 42%, over 2005.July 2008 (subsequently remanded in December 2008) had a negative effect on segment revenues and APC order backlog.  This segment continuesis well positioned to experience a high levelcapitalize on CAIR - the next phase of order activity as utilitiesincreasingly stringent U.S. air quality standards - which is effective January 1, 2009, and the Clean Air Visibility Rule (CAVR), which is effective January 1, 2013.  Thousands of utility and industrial facilities that areboilers will be impacted by the Environmental Protection Agency’s (EPA) State Implementation Plan (SIP) Call regulationthese regulations and other recently introduced regulatory mandates continue to utilize Fuel Tech’s technologytechnologies will serve as an important element of their ongoing regulatory compliance strategy.in enabling utility and industrial boiler unit owners to attain compliance.  During 2008, Fuel Tech announced new contracts valued at approximately $21,000.

Revenues for the Fuel Treatment Chemical businessFUEL CHEM technology segment were $28,661,000 in 2006,$36,681 for the year ended December 31, 2008, an increase of $8,389,000,$4,134, or 41%13%, over 2005.versus 2007.  This segment’s growth is indicative of the continued market acceptance of Fuel Tech’s patented TIFI™TIFI Targeted In-Furnace Injection™Injection technology, particularly on coal-fired units, which represent the largest market opportunity for the technology, both domestically and abroad.  During 2008, Fuel Tech’s oil-fired business was negatively impacted byTech added 15 new units to its customer base, 13 of which were coal-fired units, the high price of oil during 2006.largest annual total in the Company’s history.  Historically, most demonstrations convert into commercial accounts.

Fuel Tech’s TIFI technology alleviatesCost of sales for the slaggingyears ended December 31, 2008 and fouling issues associated with burning coals that are high in low-melting-point ash constituents, such as sodium2007 was $44,345 and iron. Powder River Basin (PRB) coal, which accounts for approximately 42% of the coal burned in the United States today to generate electricity, and Illinois Basin coal, are two examples of coal sources that have high levels of low-melting-point ash constituents. There are coal seams across the country that provide utility units with slagging and fouling issues. Additionally, demonstrations have recently been performed on utility units that burn higher sulfur coals. High sulfur coals represent an additional market opportunity for Fuel Tech, particularly as environmental regulations require coal-fired utility units to install sulfur reduction technologies. When high-sulfur coal is used on a unit that has a Selective Catalytic Reduction (SCR) system, sulfur trioxide (SO3) and acid plume issues are created, which are a key concern in many utility and industrial operations today. Fuel Tech’s TIFI Targeted In-Furnace Injection technology provides a solution for these issues.

$42,471, respectively.  Cost of sales as a percentage of net salesrevenues for the years ended December 31, 20062008 and 20052007 was 51%.54% and 53%, respectively.  The 2008 cost of sales percentage for 2006 for the NOx reductionAPC technology segment increased to 57%55% from 51%54% in 2005.2007.  The increase is attributable to the mix of project business.  For the fuel treatment chemical segment, theThe 2008 cost of sales percentage decreasedfor the FUEL CHEM technology segment increased to 42%55% in 20062008 from 50%51% in 2005.2007.  The decreaseincrease is due to costs associated with demonstration periods and other related start-up activities for the timingrecord number of revenue recognition on cost-shareincremental units noted above, especially for the demonstrations in India and to leveraging fixedChina where the Company bore a significantly higher portion of the costs on higher revenue-generating coal-fired utility units.versus typical demonstrations in the United States.

Selling, general and administrative expenses for the years ended December 31, 20062008 and 20052007 were $23,901,000$28,012 and $17,414,000,$24,950, respectively.  The $6,487,000 year over year$3,062 increase over 20052007 is principally attributable to the following:


·  
-Fuel Tech recorded $1,805,000$5,815 in stock compensation expense in 2008 in accordance with StatementSFAS 123(R), as discussed in Note 6 to the consolidated financial statements.  This amount represented a $1,024 increase over 2007, attributable to stock option awards to Directors and certain Fuel Tech employees in 2008 and the on-going expense recognition related to stock options awarded in prior years.

·  -Fuel Tech realized an increaseinvested approximately $2,000 in revenue-relatedpersonnel and other costs, including expenses associated with the start-up of the Company’s Beijing, China office, in the amountareas of $1,500,000 as both technology segments had significantly improved revenue growth versusEngineering, Sales, Marketing and Administration to ensure the comparable prior-year period.
·  Fuel Tech recorded an increase in human resource-related expenses of approximately $1,800,000 as staffing levels were increased in several areas in responseCompany’s financial and operational infrastructure are able to overall businessaccommodate anticipated future growth.

·  Finally, Fuel Tech realized incremental-Partially offsetting this unfavorable variance was a reduction in annual incentive expenses related to audit, tax, consultingof $1,500 as the minimum income threshold for the year ended December 31, 2008 was not met and, recruiting fees, all in support of achieving business growth. Of specific note arethus, no 2008 bonus payments were made under the costs that were incurred to domesticate Fuel Tech.Company’s incentive plan.

Research and development expenses were $2,052,000$2,100 and $1,241,000$2,137 for the years ended December 31, 20062008 and 2005,2007, respectively.  Fuel Tech has established a more focused approach in the pursuit of commercial applications for its technologies outside of its traditional markets, and in the development and analysis of new technologies that could represent incremental market opportunities.

Interest income for the year ended December 31, 2008 decreased by $893 versus 2007 due to decreases in the interest rates paid by institutions with whom the Company’s investments were located.   Further, Fuel Tech recorded interest expense of $135 in 2008 related specifically to a short-term credit facility that was used to support the start-up of Fuel Tech’s office in Beijing, China.  Finally, the change in other income / (expense) is due largely to the impact of foreign exchange rates related to balances denominated in foreign currencies.
18
For the year ended December 31, 2008, Fuel Tech recorded tax expense of $3,305.  For the year ended December 31, 2007, Fuel Tech recorded tax expense of $5,187 that predominantly represented deferred tax expense related to taxable income recognized in 2007.
2007 versus 2006

Revenues for the years ended December 31, 2007 and 2006 were $80,297 and $75,115, respectively.  The year-over-year increase of $5,182, or 7%, predominantly reflects moderate increases in both technology segments.

Revenues for the APC technology segment were $47,750 for the year ended December 31, 2007, an increase of $1,296 , or 3%, versus 2006.  This segment is positioned well to capitalize on the next phase of increasingly stringent U.S. air quality standards.  With the compliance for the EPA’s SIP Call regulation beginning to wind down, utilities and industrial facilities across the country are planning for compliance with the Clean Air Interstate Rule (CAIR) and the Clean Air Visibility Rule (CAVR), which take effect in 2009 and 2013, respectively.  Thousands of utility and industrial boilers will be impacted by these regulations and Fuel Tech’s technologies will serve as an important element in enabling utility and industrial boiler unit owners to attain compliance.  In 2007, Fuel Tech announced new contracts valued at $60 million, which exceeded the previous annual record by almost $800,000 year40%.

Revenues for the FUEL CHEM technology segment were $32,547 in 2007, an increase of $3,886, or 14%, over year,2006.  This segment’s growth is indicative of the continued market acceptance of Fuel Tech’s patented TIFI Targeted In-Furnace Injection technology, particularly on coal-fired units, which represent the largest market opportunity for the technology, both domestically and abroad.  In 2007, Fuel Tech added 10 new coal-fired units to its customer base, the largest annual total in the Company’s history.

Cost of sales for the years ended December 31, 2007 and 2006 was $42,471 and $38,429, respectively.  Cost of sales as a percentage of revenues for the years ended December 31, 2007 and 2006 was 53% and 51%, respectively.  The cost of sales percentage for 2007 for the APC technology segment decreased to 54% from 57% in 2006.  The decrease is attributable to the mix of project business.  For the FUEL CHEM technology segment, the cost of sales percentage increased to 51% in 2007 from 42% in 2006.  The increase is due to start-up costs related to the incremental units noted above, without the realization of related revenues as only two of the 10 new units contributed significant revenues during 2007 due to customer-related delays impacting the timing of startup.

Selling, general and administrative expenses for the years ended December 31, 2007 and 2006 were $24,950 and $23,901, respectively.  The $1,049 increase over 2006 is principally attributable to the following:

-Fuel Tech recorded $4,791 in stock compensation expense in 2007 in accordance with Statement 123(R), as discussed in Note 6 to the consolidated financial statements.  This amount represented a $2,986 increase over 2006 attributable to the awarding of stock options to all Fuel Tech employees in December 2006 and to an increase in the fair value of the options granted, which was driven by an increase in the price of Fuel Tech’s Common Stock.

-Partially offsetting this unfavorable variance was a reduction in revenue-related expenses of $2,100 as Fuel Tech aligned the focus of all employees under a common incentive plan in 2007.

Research and development expenses were $2,137 and $2,052 for the years ended December 31, 2007 and 2006, respectively.  Fuel Tech has established a more focused approach in the pursuit of commercial applications for its technologies outside of its traditional markets, and in the development and analysis of new technologies that could represent incremental market opportunities.

Interest income increased by $623 over 2006 reflecting higher average cash and short-term investment balances, and marketbalances.  Further, Fuel Tech recorded interest rates versus those experiencedexpense of $24 in 2007 related specifically to a short-term credit facility that was used to support the prior year. Thestart-up of Fuel Tech’s new office in Beijing, China.  Finally, the moderate increase in other income is due largely to foreign exchange gains related to balances denominated in foreign currencies.

On a year-to-date basis,For the year ended December 31, 2007, Fuel Tech recorded tax expense of $4,942,000. This amount primarily$5,187, which predominantly represents non-cash deferred tax expense related to taxable income recognized in 2006.

Fuel Tech’s income tax benefit of $419,000 for 2005 predominantly represented the recording of the reduction in the deferred tax asset valuation allowance representing the anticipated utilization of net operating loss and research and development tax credit carryforwards. Based on a review of both historical and projected taxable income, Fuel Tech concluded in 2005 that it was more likely than not that the net operating losses and the research and development tax credits would be utiized in subsequent periods and the valuation allowance was no longer required.

14

2005 versus 2004

Net sales for the years ended December 31, 2005 and 2004 were $52,928,000 and $30,832,000, respectively. The year on year increase of $22,096,000, or 72%, reflected gains from both the Nitrogen Oxide reduction (NOx) and Fuel Treatment Chemical business segments.

Revenues for the NOx product line were $32,650,000 in 2005, an increase of 124% over 2004. This business segment, which began to show increased strength in the second half of 2004, experienced a surge in order activity. Utilities and industrial facilities that are impacted by the Environmental Protection Agency’s (EPA) State Implementation Plan (SIP) Call regulation, which became effective on May 31, 2004, continued to prove that Fuel Tech’s technology is a viable tool in their ongoing regulatory compliance planning. Fuel Tech’s strategy in addressing this market has involved the development of alliance agreements with critical customers looking to finalize their compliance plans.

Revenues for the Fuel Treatment Chemical business segment were $20,272,000 in 2005, an increase of 25% over 2004. This segment’s growth, although indicative of the continued market acceptance of Fuel Tech’s patented TIFI Targeted In-Furnace Injection technology, would have been enhanced had revenues not been hampered by the following circumstances during 2005:

·  Demonstration programs - there were several demonstration programs during 2005, five of which did not yield commercial revenues at December 31, 2005. One was a no-cost demonstration at a critical coal-fired utility and one was a demonstration at a large coal-fired utility offered at 50% of commercial value. These two successful demonstrations had the impact of reducing revenue by approximately $500,000 and this revenue is non-recoverable. The other three demonstrations were structured on a cost-share basis and all were on coal-fired units. Under cost-share arrangements, during the demonstration period, Fuel Tech will invoice the customer at a specified percentage of the commercial price. At the end of the demonstration, if Fuel Tech meets the criteria for success that were established for the program, Fuel Tech will invoice the customer for the remaining percentage of the commercial price. These latter three demonstrations reached their evaluation date in the first quarter of 2006. If revenue was recognized at commercial pricing for these latter demonstrations, an incremental $600,000 in revenue would have been realized in 2005.

·  Coal supply chain issues - rail disruptions in the Powder River Basin during 2005 impacted several utilities’ ability to receive and burn Powder River Basin coal. The required repair and maintenance work on several rail lines impacted coal shipments in several parts of the country well into 2006. This market dynamic negatively impacted Fuel Tech’s revenue generating capability in 2005 as more than one critical Western-coal fired utility unit was forced to reduce capacity for an extended period of time due to transportation related shortages of Western coal deliveries. New sales initiatives were also negatively influenced by these issues as potential new customers were forced to delay their evaluation and implementation of the Fuel Chem technology.

·  Oil pricing - the high price of oil resulted in reduced oil-fired electricity generation in the United States. Fuel Tech’s oil-fired business was negatively impacted by this market dynamic in 2005.

Cost of sales as a percentage of net sales for2007.  For the year ended December 31, 2005 declined to 51% from 54% in the prior year. This improvement was primarily attributable to the nitrogen oxide business, where the percentage decreased to 51% in 2005 from 58% in 2004. The decrease was attributable to the mix of project business. The cost of sales percentage for the fuel treatment chemical business increased to 50% in 2005 from 48% in 2004. The increase was due to the impact of the demonstration programs discussed above.

Selling, general and administrative expenses were $17,414,000 and $12,775,000 for the years ended December 31, 2005 and 2004, respectively. Of the $4,639,000 variance with 2004, almost $2,800,000 was due to employee-related costs including the wages and benefits resulting from the addition of new personnel; recruiting costs; and incentive compensation. Revenue-related internal and external commission accounted for $1,100,000 of the increase. The remainder of the variance was attributable to audit and audit-related fees for Sarbanes Oxley compliance and legal and consulting fees derived from Fuel Tech’s strategic desire to engage in business in new geographies.

Research and development expenses were $1,241,000 and $1,355,000 for the years ended December 31, 2005 and 2004, respectively.2006, Fuel Tech continues to pursue commercial applications for technologiesrecorded tax expense of $4,942, also representing deferred tax expense related to its core businesses, with a particular focus on its FUEL CHEM technologies.

The year over year increase in interest income resulted from higher average cash and short-term investment balances and increased market interest rates in 2005 versus 2004. The increase in other expenses was due largely to foreign exchange losses related to balances denominated in foreign currencies.

Fuel Tech’s income tax benefit of $419,000 for 2005 predominantly represented the recording of the reduction in the deferred tax asset valuation allowance representing the anticipated utilization of net operating loss and research and development tax credit carryforwards. Based on a review of both historical and projected taxable income, Fuel Tech concluded that it was more likely than not that the net operating losses and the research and development tax credits would be utiized in subsequent periods and the valuation allowance was no longer required.income.
 
15

Liquidity and Sources of Capital

At December 31, 2006,2008, Fuel Tech had cash and cash equivalents and short-term investments of $32,405,000$28,149 and working capital of $38,715,000$44,346 versus $16,375,000$32,471 and $19,590,000$45,143 at the end of 2005,December 31, 2007, respectively.  Operating activities provided $8,159,000$8,047 of cash during 2006,for the year ended December 31, 2008, primarily due to the favorable operating results of the business segments.  
Investing activities used cash of $4,017,000 during 2006, as short-term investments were increased by $2,000,000 and $2,017,000 was utilized$11,769 for the year ended December 31, 2008, primarily for expenditures related to our new corporate headquarters building to support and enhance the operations of the business of $5,200, the acquisition funding for substantially all of the assets of Tackticks, LLC and FlowTack, LLC of $3,928 and the remainder used principally for equipment related to the fuel treatment chemicalFUEL CHEM technology segment.  Capital expenditures, which typically consist of equipment related to FUEL CHEM demonstration programs or commercial installations, are expected to be funded primarily from cash flows from operations.  Other than the outfitting of the new corporate headquarters building in 2008, the Company has historically incurred a nominal amount of maintenance capital expenditures.
Fuel Tech generated cash related to the exercise of stock optionsfrom financing activities in the amount of $9,770,000.$1,377.  Of this amount, $3,826,000$619 represents proceeds derived from the exercise price of options and warrants exercised in 2006,2008, while $5,944,000$548 represents the excess tax benefits realized from the exercise of stock options in 2006.2008.

19
Fuel Tech has a domestic $25.0 million revolving credit facility expiring July 31, 2009.  The facility is unsecured and bears interest at a rate of LIBOR plus 75 basis points.  Fuel Tech can use this facility for cash advances and standby letters of credit.

At December 31, 2006,2008, the bankCompany had providedoutstanding standby letters of credit and bank guarantees, predominantly to customers, totaling approximately $1,077,000$5,865 in connection with contracts in process.  Fuel Tech is committed to reimbursing the issuing bank for any payments made by the bank under these letters of credit.instruments.  At December 31, 2006,2008, there were no cash borrowings under the revolving credit facility and approximately $23,923,000$19,135 was available.  Management has met with the Company’s lending institutions and, during the course of those meetings, was not made aware of any information indicating that they will not be able to perform their obligations for any letters of credit or guarantees issued, nor be unable to supply funds to Fuel Tech if the Company chooses to borrow funds under its two revolving credit facilities.

ThereBeijing Fuel Tech Environmental Technologies Company, Ltd. (Beijing Fuel Tech), a wholly-owned subsidiary of Fuel Tech, entered into a revolving credit facility agreement during the third quarter of 2007 for RMB 35 million (approximately $4.8 million), which expires on July 31, 2009.  The facility is unsecured and bears interest at a rate of 90% of the People’s Bank of China (PBOC) Base Rate.  Beijing Fuel Tech can use this facility for cash advances and bank guarantees.  At December 31, 2008, Beijing Fuel Tech had borrowings outstanding in the amount $2,188.

Interest payments in the amount of $135 and $24 were no interest payments made during the years ended December 31, 2006, 2005 or 2004.2008 and 2007, respectively.  No payments were made during the year ended December 31, 2006.

In the opinion of management, Fuel Tech’s expected near-term revenue growth will be driven by the timing of penetration of the coal-fired utility marketplace via utilization of its TIFI technology, by utility and industrial entities’ adherence to the NOx reduction requirements of the various domestic environmental regulations, and by the expansion of both business segments in non-U.S. geographies.  Fuel Tech expects its liquidity requirements to be met by the operating results generated from these activities.

16

Contractual Obligations and Commitments

In its normal course of business, Fuel Tech enters into agreements that obligate Fuel Tech to make future payments.  The operating lease obligations noted below are primarily related to supporting the operations of the business.

Payments due by period in thousands of U.S. dollars
 
  
Contractual Cash Obligations
 
Total
 
Less than 1 year
 
2-3 years
 
4-5 years
 
Thereafter
 
Operating Leases $1,388 $521 $827 $40 $- 
Payments due by period in thousands of dollars 
Contractual Cash
Obligations		 Total  
Less than 1
year
  2-3 years  4-5 years  Thereafter 
Operating Leases $1,720  $663  $527  $468  $62 
Beijing Fuel Tech Environmental Technologies Company, Ltd. (Beijing Fuel Tech), a wholly-owned subsidiary of Fuel Tech, entered into a revolving credit facility agreement during the third quarter of 2007 for RMB 35 million (approximately $4.8 million), which expires on July 31, 2009.  The facility is unsecured and bears interest at a rate of 90% of the People’s Bank of China (PBOC) Base Rate.  Beijing Fuel Tech can use this facility for cash advances and bank guarantees.  At December 31, 2008, Beijing Fuel Tech had borrowings outstanding in the amount $2,188 as noted in the table below.
Commitment expiration by period in thousands of dollars 
Commercial
Commitments		 Total  
Less than 1
year
  2-3 years  4-5 years  Thereafter 
Short-term debt $2,188  $2,188  $-  $-  $- 

For the years ended December 31, 2008 and 2007, Fuel Tech has a sublease agreement that obligates the lessee to make future payments to Fuel Tech. The sublease obligations noted below areincurred interest expense related to a sublease agreement betweenthe Beijing Fuel Tech short-term debt of $135 and American Bailey Corporation (ABC). ABC will reimburse Fuel Tech$24, respectively.  We cannot estimate the fiscal 2009 interest expense for its share of lease and lease-related expenses under Fuel Tech’s January 29,2004 lease of its executive offices in Stamford, Connecticut. Please refer to Note 9 tothis short-term debt as the consolidated financial statements for a discussion of the relation between Fuel Tech and ABC.

Rental payments due to Fuel Tech by period in thousands of U.S. dollars
 
  
Contractual Cash Obligations
 
Total
 
Less than 1 year
 
2-3 years
 
4-5 years
 
Thereafter
 
Sublease $250 $81 $162 $7 $- 
debt may be repaid at any time during fiscal 2009.

Fuel Tech, in the normal course of business, uses bank performance guarantees and letters of credit in support of construction contracts with customers as follows:

·  -in support of the warranty period defined in the contract,contract; or
 
·  -in support of the system performance criteria that are defined in the contractcontract.

20
In addition, Fuel Tech uses letters of credit as security for other obligations as needed in the normal course of business.  As of December 31, 2006,2008, Fuel Tech hashad outstanding bank performance guarantees and letters of credit as noted in the table below:

Commitment expiration by period in thousands of U.S. dollars
 
  
Commercial Commitments
 
Total
 
Less than 1 year
 
2-3 years
 
4-5 years
 
Thereafter
 
Standby letters of credit and bank guarantees $1,077 $1,077 $- $- $- 
Commitment expiration by period in thousands of dollars 
Commercial
Commitments		 Total  Less than 1 year  2-3 years  4-5 years  Thereafter 
Standby letters of credit and bank guarantees $5,865  $1,794  $3,388  $683  $- 

Off-Balance-Sheet TransactionsThe following table summarizes Fuel Tech’s FIN 48 obligations as of December 31, 2008.  Please refer to Note 3 to the consolidated financial statements in this document for a description of our FIN 48 obligations.
 
Commitment expiration by period in thousands of dollars 
Commercial
Commitments		 Total  Less than 1 year  2-3 years  4-5 years  Thereafter 
FIN 48 Obligations $713  $-  $-  $-  $713 
Off-Balance-Sheet Transactions

There were no off-balance-sheet transactions during the two yeartwo-year period ended DecemberDecmeber 31, 2006.2008.
 
Forward-Looking InformationSubsequent Events

From time to time, information provided byOn January 5, 2009 Fuel Tech statements made bycompleted its employees or information includedacquisition of substantially all of the assets of Advanced Combustion Technology, Inc. and is currently in its filings with the Securities and Exchange Commission (including this Annual Report) may contain statements that are not historical facts, so-called “forward-looking statements.” These forward-looking statements are made pursuantprocess of allocating the purchase price to the safe harbor provisionsfair market values of the Private Securities Litigation Reform Actacquired tangible and intangible assets and assumed liabilities as of 1995. Fuel Tech’s actual future results may differ significantly from those stated in any forward-looking statements. Forward-looking statements involve a number of risks and uncertainties, including, but not limited to, product demand, pricing, market acceptance, litigation, risk of dependence on significant customers, third-party suppliers and intellectual property rights, risks in product and technology development and other risk factors detailed in the text under the caption “Risk Factors of the Business” in Item 1 “Business” under Part I of this Annual Report and in Fuel Tech’s Securities and Exchange Commission filings.January 6, 2009.
 
1721

ITEM 7A.7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Fuel Tech’s earnings and cash flow are subject to fluctuations due to changes in foreign currency exchange rates.  Fuel Tech doesWe do not enter into foreign currency forward contracts or into foreign currency option contracts to manage this risk due to the immaterial nature of the transactions involved.

Fuel Tech is also exposed to changes in interest rates primarily due to its long-term debt arrangement (refer to Note 8 to the consolidated financial statements).  A hypothetical 100 basis point adverse move in interest rates along the entire interest rate yield curve would not have a materially adverse effect on interest expense during the upcoming year ended December 31, 2007.2009.

22
ITEM 8.8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report Of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders
 Fuel Tech, Inc.

Management’s Report on Internal Control Over Financial Reporting

We have audited Fuel Tech’s management is responsible for establishingTech, Inc (a Delaware corporation) and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Exchange Act. As required by Rule 13a-15(c) under the Exchange Act, Fuel Tech’s management carried out an evaluation, with the participation of Fuel Tech’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of itsSubsidiaries’ (the “Company”) internal control over financial reporting as of the end of the last fiscal year. The frameworkDecember 31, 2008 based on which such evaluation was based is containedcriteria established in the report entitled “InternalInternal Control—Integrated Framework”Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO Report”)(COSO).
Fuel Tech’s system of internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Based on its assessment, management has concluded that Fuel Tech maintained effective internal control over financial reporting as of December 31, 2006, based on criteria in “Internal Control—Integrated Framework”issued by the COSO.
Management’s assessment of the effectiveness of internal control over financial reporting as of December 31, 2006, has been audited by Grant Thornton LLP, an independent registered public accounting firm, as stated in their report, which is included elsewhere herein.
18

Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting

The Board of Directors and Shareholders of Fuel Tech, Inc.

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that Fuel Tech, Inc. maintained effective internal control over financial reporting as of December 31, 2006 based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Fuel Tech, Inc.’sCompany’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting.reporting, included the accompanying Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A.  Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’sCompany’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment,assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
In our opinion, management’s assessment that Fuel Tech Inc. maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Fuel Tech, Inc. hasand Subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006,2008, based on criteria established in Internal Control – Integrated Frameworkthe COSO criteria. issued by COSO.
 
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Fuel Tech, Inc.the Company as of December 31, 20062008 and 2007 and the related consolidated statements of income, shareholders’stockholders’ equity, and cash flows for each of the yearthree years in the period ended December 31, 2006 of Fuel Tech, Inc.2008, and our report dated March 5, 20072009 expressed an unqualified opinion on those financial statements and included an explanatory paragraph regarding the Company's adoption of Statement of Financial Accounting Standards ("SFAS") No. 123(R), Share Based Payment, in 2006.statements.
/s/ GRANT THORNTON LLP


/s/ GRANT THORNTON, LLP
Chicago, Illinois
March 5, 20072009
 
1923

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders’Stockholders
Fuel Tech, Inc.:

We have audited the accompanying consolidated balance sheetsheets of Fuel Tech, Inc. (a Delaware corporation) and subsidiariesSubsidiaries (the “Company”) as of December 31, 2006,2008 and 2007, and the related consolidated statements of income, shareholders’stockholders’ equity, and cash flows for each of the year then ended.three years in the period ended December 31, 2008.  These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Fuel Tech, Inc. as of December 31, 2006 and the results of their operations and cash flows for the year ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note 6 to the consolidated financial statements, effective January 1, 2006 the Company changed the manner in which it accounts for share-based payments as a result of adopting the provisions of Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment.

Our audit was conducted for the purpose of forming an opinion on the basic financial statements taken as a whole. The accompanying Schedule II is presented to comply with SEC reporting requirements and is not a required part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic financial statements taken as a whole.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Fuel Tech Inc.’s internal control over financial reporting as of December 31, 2006, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 5, 2007 expressed an unqualified opinion on management’s assessment and an unqualified opinion on the effectiveness of Fuel Tech Inc.’s internal control over financial reporting.


/s/ GRANT THORNTON, LLP
Chicago, Illinois
March 5, 2007
20

Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders of Fuel Tech, Inc. (formerly FuelTech N.V.)

We have audited the accompanying consolidated balance sheet of Fuel Tech, Inc. as of December 31, 2005, and the related consolidated statements of income, shareholders’ equity and cash flows for each of the two years in the period ended December 31, 2005. Our audits also included the financial statement schedules listed in the Index at item 15(a) for each of the two years ended December 31, 2005. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Fuel Tech, Inc. atand Subsidiaries as of December 31, 2005,2008 and 2007 and the consolidated results of its operations and its cash flows for each of the twothree years in the period ended December 31, 2005,2008, in conformity with U.S.accounting principles generally accepted accounting principles. Also, in our opinion, the related financial statement schedule for eachUnited States of America.

We also have audited, in accordance with the standards of the two years endedPublic Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005, when considered2008, based on the criteria established in relation toInternal Control – Integrated Framework issued by the basicCommittee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 5, 2009 expressed an unqualified opinion on the effective operation of internal control over financial statements taken as a whole, presents fairly in all material respects the information set forth therein.reporting.

/s/ GRANT THORNTON LLP


/s/ Ernst & Young LLP
Chicago, Illinois
March 8, 20065, 2009

2124

Fuel Tech, Inc.
Consolidated Balance Sheets

(in thousands of U.S. dollars, except share and per shareper-share data)

  2006 2005 
December 31
     
      
ASSETS
     
Current assets:     
Cash and cash equivalents $24,405 $10,375 
Short-term investments  8,000  6,000 
Accounts receivable, net of allowances for doubtful accounts of $150 and $150, respectively  16,724  13,233 
Inventories  203  358 
Deferred income taxes  4,972  3,043 
Prepaid expenses and other current assets  1,916  1,072 
Total current assets  56,220  34,081 
        
Equipment, net of accumulated depreciation of $8,845 and $7,900, respectively  4,051  4,045 
Goodwill  2,119  2,119 
Other intangible assets, net of accumulated amortization of $1,205 and $1,087, respectively  1,156  1,224 
Deferred income taxes  885  1,579 
Other assets  1,229  1,027 
Total assets $65,660 $44,075 
        
LIABILITIES AND SHAREHOLDERS’ EQUITY
       
Current liabilities:       
Accounts payable $7,632 $6,493 
Accrued liabilities:       
Employee and director compensation  4,457  2,331 
Other accrued liabilities  5,416  5,667 
Total current liabilities  17,505  14,491 
        
Other liabilities  500  448 
Total liabilities  18,005  14,939 
        
Shareholders' equity:       
Common stock, $.01 par value, 40,000,000 shares       
authorized, 22,086,728 and 20,424,133 shares issued, respectively  221  204 
Additional paid-in capital  103,122  91,559 
Accumulated deficit  (56,044) (62,870)
Accumulated other comprehensive income (loss)  79  (39)
Nil coupon perpetual loan notes  277  282 
Total shareholders' equity  47,655  29,136 
Total liabilities and shareholders' equity $65,660 $44,075 
  2008  2007 
December 31      
       
ASSETS      
Current assets:      
Cash and cash equivalents $28,149  $30,473 
Short-term investments  -   1,998 
Accounts receivable, net of allowance for doubtful accounts of $80 and $150, respectively  23,365   31,856 
Inventories  1,014   186 
Deferred income taxes  767   1,589 
Prepaid expenses and other current assets  4,718   1,761 
Total current assets  58,013   67,863 
         
Property and equipment, net of accumulated depreciation of $12,588 and $10,091, respectively  17,515   11,302 
Goodwill  5,158   2,119 
Other intangible assets, net of accumulated amortization of $1,504 and $1,320, respectively  2,543   1,088 
Deferred income taxes  2,412   2,552 
Other assets  3,232   2,290 
Total assets $88,873  $87,214 
         
LIABILITIES AND STOCKHOLDERS’ EQUITY        
Current liabilities:        
Short-term debt $2,188  $2,051 
Accounts payable  8,196   13,632 
Accrued liabilities:        
Employee compensation  510   2,304 
Other accrued liabilities  2,773   4,733 
Total current liabilities  13,667   22,720 
         
Other liabilities  1,389   1,255 
Total liabilities  15,056   23,975 
         
Stockholders' equity:        
Common stock, $.01 par value, 40,000,000 shares authorized, 24,110,967 and 22,410,064 shares issued, respectively  241   224 
Additional paid-in capital  118,588   111,459 
Accumulated deficit  (45,280)  (48,882)
Accumulated other comprehensive income  187   166 
Nil coupon perpetual loan notes  81   272 
Total stockholders' equity  73,817   63,239 
Total liabilities and stockholders' equity $88,873  $87,214 

See notes to consolidated financial statements.
 
2225

Fuel Tech, Inc.
Consolidated Statements of Income
(in thousands of dollars, except share and per-share data)

  2008  2007  2006 
For the years ended December 31         
          
Revenues $81,074  $80,297  $75,115 
             
Costs and expenses:            
Cost of sales  44,345   42,471   38,429 
Selling, general and administrative  28,012   24,950   23,901 
Research and development  2,100   2,137   2,052 
   74,457   69,558   64,382 
Operating income  6,617   10,739   10,733 
             
Interest expense  (135)  (24)  - 
Interest income  741   1,634   1,011 
Other income (expense)  (226)  81   24 
Income before taxes  6,997   12,430   11,768 
Income taxes  (3,395)  (5,187)  (4,942)
Net income $3,602  $7,243  $6,826 
             
Net income per Common Share:            
Basic $0.15  $0.33  $0.32 
Diluted $0.15  $0.29  $0.28 
             
Weighted-average number of Common Shares outstanding:            
Basic  23,608,000   22,280,000   21,491,000 
Diluted  24,590,000   24,720,000   24,187,000 

See notes to consolidated financial statements.
26
Fuel Tech, Inc.
Consolidated Statements of Stockholders’ Equity
(in thousands of U.S. dollars except share and per share data)or thousand of shares, as appropriate)

  2006 2005 2004 
For the years ended December 31
       
        
Net sales
 $75,115 $52,928 $30,832 
           
Costs and expenses:
          
Cost of sales  38,429  27,118  16,566 
Selling, general and administrative  23,901  17,414  12,775 
Research and development  2,052  1,241  1,355 
   64,382  45,773  30,696 
Operating income
  10,733  7,155  136 
           
Interest income  1,011  244  65 
Other income (expense)  24  (230) (35)
Income before taxes
  11,768  7,169  166 
Income tax (expense) benefit  (4,942) 419  1,406 
Net income
 $6,826 $7,588 $1,572 
           
Net income per Common Share:
          
Basic $0.32 $0.38 $0.08 
Diluted $0.28 $0.33 $0.07 
           
Weighted-average number of Common Shares outstanding:
          
Basic  21,491,000  20,043,000  19,517,000 
Diluted  24,187,000  23,066,000  22,155,000 
  Common Stock  
Additional
Paid-in
  Accumulated  
Accumulated
Other
Comprehensive
  Treasury Stock  
Nil Coupon
Perpetual
    
  Shares  Amount  Capital  Deficit  Income (Loss)  Shares  Amount  Loan Notes  Total 
                            
Balance at January 1, 2006  20,424  $204  $91,559  $(62,870) $(39)  -  $-  $282  $29,136 
                                     
Comprehensive income:                                    
Net income              6,826                   6,826 
Foreign  currency translation adjustments                  118               118 
Comprehensive income                                  6,944 
Exercise of stock options and warrants  1,662   17   3,809                       3,826 
Conversion of nil coupon perpetual loan notes into Common Shares  1       5                   (5)  - 
Tax benefit from stock compensation expense          5,944                       5,944 
Stock compensation expense          1,805                       1,805 
Balance at December 31, 2006  22,087  $221  $103,122  $(56,044) $79   -  $-  $277  $47,655 
                                     
Comprehensive income:                                    
Net income              7,243                   7,243 
Foreign  currency translation adjustments                  87               87 
Comprehensive income                                  7,330 
Exercise of stock options and warrants  322   3   909                       912 
Conversion of nil coupon perpetual loan notes into Common Shares  1       5                   (5)  - 
Effect of FIN 48 adoption              (81)                  (81)
Tax benefit from stock compensation expense          1,482                       1,482 
Stock compensation expense          4,791                       4,791 
Issuance of deferred shares of stock          1,150                       1,150 
Balance at December 31, 2007  22,410  $224  $111,459  $(48,882) $166   -  $-  $272  $63,239 
                                     
Comprehensive income:                                    
Net income              3,602                   3,602 
Foreign  currency translation adjustments                  21               21 
Comprehensive income                                  3,623 
Exercise of stock  options and warrants  1,657   17   602                       619 
Conversion of nil coupon perpetual loan notes into Common Shares  44       191                   (191)  - 
Tax benefit from stock compensation expense          548                       548 
Stock compensation expense          5,815                       5,815 
Issuance of deferred shares of stock          73                       73 
 Reclassification of liability award          (100)                      (100)
Balance at December 31, 2008  24,111  $241  $118,588  $(45,280) $187   -  $-  $81  $73,817 
 
See notes to consolidated financial statements.
 
2327

Fuel Tech, Inc.
Consolidated Statements of Shareholders’ Equity

(in thousands of U.S. dollars, except share data)

  Common Stock Additional Paid-in Accumulated Accumulated Other Comprehensive Treasury Stock Nil Coupon Perpetual Loan   
  Shares Amount Capital Deficit Income (Loss) Shares Amount Notes Total 
                    
Balance at January 1, 2004
  
19,621,503
 
$
196
 
$
89,698
 
$
(72,030
)
$
48
  
118
 
$
(1,133
)
$
532
 
$
17,311
 
Comprehensive income:                            
Net income           1,572              1,572 
Foreign currency translation adjustments              38           38 
Comprehensive income                          1,610 
Exercise of stock options and warrants  25,402     34                 34 
Purchase of shares for retirement  (116,953) (1) (1,132)       (118) 1,133     - 
Balance at December 31, 2004
  
19,529,952
 
$
195
 
$
88,600
 
$
(70,458
)
$
86
  
-
 
$
-
 
$
532
 
$
18,955
 
                             
Comprehensive income:                            
Net income           7,588              7,588 
Foreign currency translation adjustments              (125)          (125)
Comprehensive income                          7,463 
Exercise of stock options and warrants  855,720  9  1,221                 1,230 
Conversion of nil coupon perpetual loan notes into Common Shares  38,461     250              (250) - 
Tax benefit from stock compensation expense        1,488                 1,488 
Balance at December 31, 2005
  
20,424,133
 
$
204
 
$
91,559
 
$
(62,870
)
$
(39
)
 
-
 
$
-
 
$
282
 
$
29,136
 
                             
Comprehensive income:                            
Net income           6,826              6,826 
Foreign currency translation adjustments              118           118 
Comprehensive income                          6,944 
Exercise of stock options and warrants  1,661,826  17  3,809                 3,826 
Conversion of nil coupon perpetual loan notes into Common Shares  769     5              (5) - 
Tax benefit from stock compensation expense        5,944                 5,944 
Stock compensation expense        1,805                 1,80544 
Balance at December 31, 2006
  
22,086,728
 
$
221
 
$
103,122
 
$
(56,044
)
$
79
  
-
 
$
-
 
$
277
 
$
47,655
 
 
See notes to consolidated financial statements.
24

Fuel Tech, Inc.
Consolidated Statements of Cash Flows
(in thousands of U.S. dollars)

 2006 2005 2004  2008  2007  2006 
For the years ended December 31
                
                
OPERATING ACTIVITIES
                
Net income $6,826 $7,588 $1,572  $3,602  $7,243  $6,826 
Adjustments to reconcile net income to net cash provided by operating activities:                      
Depreciation  1,961  1,566  1,225   2,810   2,353   1,961 
Amortization  118  127  137   184   115   118 
Provision for doubtful accounts  -  26  92 
Effect of FIN 48 adoption  -   (81)  - 
Loss on equipment disposals/impaired assets  -  32  109   35   18   - 
Deferred income tax  (1,235) (2,978) (1,520)  962   1,716   (1,235)
Current stock compensation expense  1,805  -  - 
Stock compensation expense  5,815   4,791   1,805 
Changes in operating assets and liabilities:                      
Accounts receivable  (3,491) (5,901) (1,355)  8,491   (15,132)  (3,491)
Inventories  155  (47) -   (828)  17   155 
Prepaid expenses, other current assets          
and other noncurrent assets  (1,046) (439) (197)
Prepaid expenses, other current assets and other noncurrent assets  (3,899)  (906)  (1,046)
Accounts payable  1,139  3,788  461   (5,436)  6,000   1,139 
Accrued liabilities and other          
noncurrent liabilities  1,927  6,278  125 
Accrued liabilities and other noncurrent liabilities  (3,720)  (2,081)  1,927 
Other  -  3  65   31   46   - 
Net cash provided by operating activities  8,159  10,043  714   8,047   4,099   8,159 
                      
INVESTING ACTIVITIES
                      
Proceeds from sale of equipment  -  -  13 
Proceeds from sales of short-term investments  1,998   6,002   - 
Purchases of short-term investments  (2,000) (3,500) -   -   -   (2,000)
Purchases of equipment and patents  (2,017) (2,792) (2,080)
Purchases of property, equipment and patents  (9,839)  (9,715)  (2,017)
Acquisition of businesses  (3,928)  -   - 
Net cash used in investing activities  (4,017) (6,292) (2,067)  (11,769)  (3,713)  (4,017)
                      
FINANCING ACTIVITIES
                      
Proceeds from short-term borrowings  137   2,051   - 
Issuance of deferred shares  73   1,150   - 
Proceeds from exercise of stock options and warrants  3,826  1,230  34   619   912   3,826 
Income tax benefit from exercise of stock options  5,944  1,488  - 
Excess tax benefit for stock-based compensation  548   1,482   5,944 
Net cash provided by financing activities  9,770  2,718  34   1,377   5,595   9,770 
                      
Effect of exchange rate fluctuations on cash  118  (125) 38   21   87   118 
Net increase (decrease) in cash and cash equivalents  14,030  6,344  (1,281)  (2,324)  6,068   14,030 
Cash and cash equivalents at beginning of year  10,375  4,031  5,312   30,473   24,405   10,375 
Cash and cash equivalents at end of year $24,405 $10,375 $4,031  $28,149  $30,473  $24,405 
            
Supplemental Cash Flow Information:            
Cash paid for:            
Interest $135  $24  $- 
Income taxes paid $5,905  $173  $217 

See notes to consolidated financial statements.
 
2528

Notes to Consolidated Financial Statements

1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
(in thousands of dollars, except share and per-share data)

1.ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

Organization

Fuel Tech Inc. (“Fuel Tech”) is a company that provides advanced engineering solutions for the optimization of combustion systems in utility and industrial applications.  Fuel Tech’s primary focus is on the worldwide marketing and sale of its NOxOUT® Process and relatedNOx reduction technologies as well as its FUEL CHEM® fuel treatment chemical product line. program.  The NOxOUT Process reducesCompany’s NOx reduction technologies reduce nitrogen oxide (“NOx”) emissions from boilers, furnaces and other stationary combustion sources.  Fuel Tech’sOur FUEL CHEM program is based on proprietary TIFI™TIFI Targeted In-Furnace Injection™Injection technology in the unique application of specialty chemicals to improve the performanceefficiency, reliability and environmental status of combustion units. Fuel Tech’sunits by controlling slagging, fouling, corrosion, opacity and acid plume, as well as the formation of sulfur trioxide, ammonium bisulfate, particulate matter (PM2.5), carbon dioxide, NOx and unburned carbon in fly ash via the addition of chemicals into the boiler.  Our business is materially dependent on the continued existence and enforcement of air quality regulations, particularly in the United States.  Fuel Tech hasWe have expended significant resources in the research and development of new technologies in building itsour proprietary portfolio of air pollution control, fuel and boiler treatment chemicals, computer modeling and advanced visualization technologies.

International revenues were $17.5 million, $11.2 million$12,641, $12,763 and $4.7 million$17,487 for the years ended December 31, 2006, 20052008, 2007 and 2004,2006, respectively.  These amounts represented 23%16%, 21%16% and 15%23% of Fuel Tech’s total revenues for the respective periods of time.  Foreign currency changes did not have a material impact on the calculation of these percentages.   Fuel Tech has foreign offices in Beijing, China and in Gallarate, Italy.

Basis of Presentation

The consolidated financial statements include the accounts of Fuel Tech and its wholly ownedwholly-owned subsidiaries.  All intercompany transactions have been eliminated.

Originally incorporated in 1987 under the laws of the Netherlands Antilles as FuelTech N.V., effective September 30, 2006, Fuel Tech changed its place of incorporation from the Netherlands Antilles to the State of Delaware in a tax-free reorganization. In the reorganization, each outstanding share of FuelTech N.V. Common Stock held by our stockholders was converted into one share of Fuel Tech, Inc. Common Stock. The shares exchanged were all of Fuel Tech, Inc.’s issued and outstanding shares immediately after the reorganization. The number of shares of Fuel Tech, Inc.’s Common Stock outstanding immediately after the reorganization was the same as the number of shares of FuelTech N.V. Common Stock outstanding immediately prior to the reorganization. In connection with this reorganization, all option agreements and warrant rights to purchase shares of FuelTech N.V. Common Stock were converted into option agreements and warrant rights to purchase shares of Fuel Tech, Inc. Common Stock.

In addition to the reorganization, Fuel Tech, Inc. adopted a tax-free plan of merger whereby two of Fuel Tech, Inc.’s wholly owned United States subsidiaries were merged with and into Fuel Tech, Inc. as of December 31, 2006.

Reclassifications

Certain amounts included in prior year financial statements have been reclassified to conform to the current year presentation. Fuel Tech has reclassified the patent impairment losses recognized in 2005 and 2004 in the amounts of $30,000 and $113,000, respectively, in the consolidated statements of income from the line item “Other (expense) income, net” to the “Research and development” line item. In addition, Fuel Tech has reclassified $1,049,000 in billings in excess of costs and estimated earnings on uncompleted contracts as of December 31, 2005 to conform to current year presentation. Costs and estimated earnings in excess of billings on uncompleted contracts are included in accounts receivable on the consolidated balance sheet, while billings in excess of costs and estimated earnings on uncompleted contracts are included in other accrued liabilities on the consolidated balance sheet.

Use of Estimates

The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes.  The Company uses estimates in accounting for, among other items, revenue recognition, allowance for doubtful accounts, income tax provisions and warranty expenses.  Actual results could differ from those estimates.

Fair Value of Financial Instruments

The carrying values of cash and cash equivalents, short-term investments, accounts receivable, accounts payable and accrued liabilities are reasonable estimates of their fair value due to their short-term nature.  The carrying amount of our short-term debt, revolving line of credit and notes approximates fair value because the majority of the amounts outstanding accrue interest at variable rates.

Cash Equivalents and Financial InstrumentsShort-Term Investments

Fuel Tech includes cash and investments having an original maturity of three months or less at the time of acquisition in cash and cash equivalents.  Short-term investments consist of highly-liquid, municipal variable rate demand notes,highly liquid investments having an original maturity of greater than three months which are recorded at cost, and have been classified as available for sale securities. The cost of these securities closely approximates their fair market value due to their variable interest rates, which typically reset every 28 days. Generally, securities held have maturities of greater than 10 years and their classification as short-term results from their liquidity feature.  Fuel Tech has never incurred realized or unrealized holding gains or losses on these securities.  Income resulting from short-term investments is recorded as interest income.

At December 31, 2006, substantially all of Fuel Tech’s cash, cash equivalents and short-term investments are on deposit with three financial institutions.
26

Foreign Currency Risk Management

Fuel Tech's earnings and cash flow are subject to fluctuations due to changes in foreign currency exchange rates.  Fuel Tech doesWe do not enter into foreign currency forward contracts or into foreign currency option contracts to manage this risk due to the immaterial nature of the transactions involved.

Accounts Receivable

Accounts receivable includes unbilled receivables, representing costs and estimated earnings in excess of billings on uncompleted contracts under the percentage of completion method.   At December 31, 20062008 and 2005,2007, unbilled receivables were approximately $3,615,000$5,552 and $2,272,000,$16,813 respectively. The allowance for doubtful accounts is established based on Fuel Tech’s historical level of write-off activity and management’s review of specific accounts at each reporting date.

29
Allowance for Doubtful Accounts

Fuel Tech, inIn order to control and monitor the credit risk associated with itsour customer base, reviewswe review the credit worthiness of customers on a recurring basis.  Factors influencing the level of scrutiny include the level of business the customer has with Fuel Tech, the customer’s payment history and the customer’s financial stability.  Representatives of Fuel Tech’sour management team review all past due accounts on a weekly basis to assess collectibility.  At the end of each reporting period, the allowance for doubtful accounts balance is reviewed relative to management’s collectibility assessment and is adjusted if deemed necessary.  Our historical credit loss has been insignificant. The table below sets forth the components of the Allowance for Doubtful Accounts for the years ended December 31.

Year 
Balance at
January 1
  
Charged to costs
and expenses
  (Deductions)/Other  
Balance at
December 31
 
2006 $150   -   -  $150 
2007 $150   -   -  $150 
2008 $150   -  $(70) $80 
Translation of Foreign Currency

Assets and liabilities of consolidated foreign subsidiaries are translated into U.S. dollars at exchange rates in effect at year end. Revenues and expenses are translated at average exchange rates prevailing during the year.  Gains or losses on foreign currency transactions and the related tax effects are reflected in net income. The resulting translation adjustments are included in stockholders’ equity as part of accumulated comprehensive income.

Comprehensive Income

Other comprehensive income is defined as the change in equity resulting from transactions from non-owner sources.  Comprehensive income differs from net income due to the effects of foreign currency translation.

Research and Development

Research and development costs are expensed as incurred.  Research and development projects funded by customer contracts are reported as part of cost of goods sold.  Internally funded research and development expenses are reported as operating expenses.

Product/System Warranty

Fuel Tech typically warrants its air pollution control products and systems against defects in design, materials, and workmanship for one to two years.  A provision for estimated future costs relating to warranty expense is recorded when the products/systems become commercially operational.

Goodwill and Other Intangibles
 
Effective January 1, 2002, Fuel Tech adopted Financial Accounting Standards Board (FASB) Statement No. 142, “Goodwill and Other Intangible Assets.” Under the guidance of this statement, goodwillGoodwill and indefinite-lived intangible assets are no longernot amortized, but rather, are required to be reviewed annually or more frequently if indicators arise, for impairment.  The evaluation of impairment involves comparing the current fair value of the business to the recordedcarrying value.  Fuel Tech uses a discounted cash flow (DCF) model (DCF) to determine the current fair value of its two reporting units.  A number of significant assumptions and estimates are involved in the application of the DCF model to forecast operating cash flows, including markets and market share, sales volumes and prices, costs to produce and working capital changes.  Management considers historical experience and all available information at the time the fair values of its reporting units are estimated.  However, actual fair values that could be realized in an actual transaction may differ from those used to evaluate the impairment of goodwill.
 
Fuel Tech allocates goodwill to reporting units based on the relative excess of fair value over carrying value of the reporting units.  Fair value is determined as noted above.  The ratio of each reporting unit’s excess of fair value over carrying value, to the total excess of fair value over carrying value, is used as the basis for the allocation of the goodwill balance.  Fuel Tech’s annualOur fair value measurement test, performed annually as of October 1, revealed no evidenceindications of impairment.
 
Included with other intangible assets on the consolidated balance sheet are third-party costs related to the development of patents.  As of December 31, 20062008 and 2005,2007, the net patent asset balance was $172,000$249 and $144,000,$199, respectively.  The third-party costs capitalized during the years ended December 31, 20062008 and 20052007 were $50,000$60 and $38,000,$53, respectively.  Third-party costs are comprised of legal fees that relate to the review and preparation of patent disclosures and filing fees incurred to present the patents to the required governing body.
 
30
Fuel Tech’s intellectual property has been the primary building block for the Air Pollution Control and Fuel treatment chemical product lines.FUEL CHEM technology segments.  The patents are essential to the generation of revenue for Fuel Tech’sour businesses and are essential to protect Fuel Techus from competition in the markets in which it serves.  These costs are being amortized on the straight-line method over a period of 10 years from the date of patent issuance.  Patent maintenance fees are charged to operations as incurred. Further, the estimated amortization expense related to Fuel Tech’s intangible patent assets is expected to approximate $20,000 per year for the five-year period ending December 31, 2011.
 
27
Fuel Tech reviews other intangible assets, which include a customer list, a covenantlists and relationships, covenants not to compete, and patent assets and acquired technologies, for impairment on a recurring basis or when events or changes in circumstances indicate the carrying amount of an asset may not be recoverable.  In the event the sum of the expected undiscounted future cash flows resulting from the use of the asset is less than the carrying amount of the asset, an impairment loss equal to the excess of the asset’s carrying value over its fair value is recorded.  Management considers historical experience and all available information at the time the estimates of future cash flows are made, however, the actual cash values that could be realized may differ from those that are estimated.  Fuel Tech did not record an impairment loss in 2006, while the impact of impairment losses on Fuel Tech was $30,000 and $113,000 forFor the years ended December 31, 2005, 2004,2008, 2007 and 2006 the impact of impairment losses was $0, $7 and $0, respectively.  Such amounts are recorded in the “Research and development” line item in the consolidated statements of income.
 
The table below shows the amortization period and other intangible asset cost by intangible asset as of December 31, 20062008 and 2005,2007, and the accumulated amortization and net intangible asssetasset value in total for all other intangible assets.


Description of Other Intangible Amortization period (in thousands) 
    2066 2005 
Customer list  15 years $1,198 $1,198 
Patent asset  10 years  1,063  1,013 
Covenant not to compete  6 years  100  100 
Total cost    $2,361 $2,311 
Less accumulated amortization     1,205  1,087 
Total net intangible asset value    $1,156 $1,224 
28
  Amortization   
Description of Other Intangible period 2008  2007 
Customer list 3-15 years $1,548  $1,198 
Patent asset 10 years  1,170   1,110 
Covenant not to compete 5-6 years  336   100 
Technologies 3-8 years  603   - 
Miscellaneous 3-7 years  390   - 
Total cost    4,047  $2,408 
Less accumulated amortization    (1,504)  (1,320)
Total net intangible asset value   $2,543  $1,088 

The estimated amortization expense related to Fuel Tech’s intangible assets is expected to approximate $300 per year for the four-year period ending December 31, 2012, and $200 for the year ending December 31, 2013.

Property and Equipment

Equipment is stated on the basis ofat historical cost.  Provisions for depreciation are computed by the straight-line method, using estimated useful lives.  The table below shows the depreciable life and equipment cost by asset class as of December 31, 20062008 and 2005,2007, and the accumulated depreciation and net book value in total for all classes of assets.

Description of Equipment Depreciable life (in thousands) 
    
2006
Equipment
Cost
 
2005
Equipment
Cost
 
Field equipment  3-4 years $8,365 $7,487 
Computer equipment and software  2-3 years  2,857  2,805 
Furniture and fixtures  3-10 years  1,652  1,631 
Vehicles  3 years  22  22 
Total cost    $12,896 $11,945 
Less accumulated depreciation     8,845  7,900 
Total net book value    $4,051 $4,045 
Description of Property and
Equipment
 
Depreciable
life
 
2008
Cost
  
2007
Cost
 
Land   $1,440  $1,440 
Building 39 years  4,857   4,857 
Leasehold Improvements 3-39 years  4,719   - 
Field equipment 3-4 years  13,714   10,405 
Computer equipment and software 2-3 years  3,527   2,996 
Furniture and fixtures 3-10 years  1,823   1,673 
Vehicles 3 years  22   22 
Total cost   $30,102  $21,393 
Less accumulated depreciation    (12,587)  (10,091)
Total net book value   $17,515  $11,302 
31
Revenue Recognition

Revenue Recognition
Fuel Tech uses the percentage of completion method of accounting for certain long-term equipment construction and license contracts. Under the percentage of completion method, sales and gross profit are recognized as work is performed based on the relationship between actual construction costs incurred and total estimated costs at completion. Sales and gross profit are adjusted for revisions in completion estimates and contract values in the period in which the facts giving rise to the revisions become known. Revenues from the sales of chemical products are recorded when title transfers, either at the point of shipment or at the point of destination, depending on the contract with the customer.

Fuel Tech uses the percentage of completion method of accounting for equipment construction and license contracts that are sold within the Air Pollution Control technology segment.  Under the percentage of completion method, revenues are recognized as work is performed based on the relationship between actual construction costs incurred and total estimated costs at completion.  Revisions in completion estimates and contract values in the period in which the facts giving rise to the revisions become known can influence the timing of when revenues are recognized under the percentage of completion method of accounting.  Provisions are made for estimated losses on uncompleted contracts in the period in which such losses are determined.  As of December 31, 2008 and December 31, 2007, Fuel Tech had no construction contracts in progress that were identified as loss contracts.

Distribution Costs

Fuel Tech classifies shipping and handling costs in cost of sales in the consolidated statement of income.

Income Taxes

Deferred tax assets and liabilities are determined based on the differences between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.

At the end of each reporting period, for financial statement purposes, Fuel Tech reviews the realizability of the deferred tax assets.  As part of this review, Fuel Techwe will consider if there are taxable temporary differences that could generate taxable income in the future, if there is the ability to carryback the net operating losses or credits, if there is a projection of future taxable income, and if there are any tax planning strategies that can be readily implemented.  The table below sets forth the components of the Valuation Allowance for Deferred Tax Assets for the years ended December 31.
Year 
Balance at
January 1
  Charged to costs and expenses  (Deductions)/Other  
Balance at
December 31
 
2006 $45  $215   -  $260 
2007 $260   -   -  $260 
2008 $260   -   -  $260 


Stock-Based Compensation

Fuel Tech has onea stock-based employee compensation plan, referred to as the 1993Fuel Tech, Inc. Incentive Plan (1993(Incentive Plan), under which awards may be granted to participants in the form of Non-Qualified Stock Options, Incentive Stock Options, Stock Appreciation Rights, Restricted Stock, Performance Awards, Bonuses or other forms of share-based or non-share-based awards or combinations thereof.  Participants in the 1993Incentive Plan may be Fuel Tech’s directors, officers, employees, consultants or advisors (except consultants or advisors in capital-raising transactions) as the directors determine are key to the success of Fuel Tech’sour business. The amount of shares that may be issued or reserved for awards to participants under a 2004 amendment to the 1993Incentive Plan is 12.5% of outstanding shares calculated on a diluted basis.  In 2008, 2007 and 2006, 757,250, 310,500 and 1,094,000 options, respectively, were granted to employees and directors.  At December 31, 2006,2008, Fuel Tech has 866,000had 471,712 stock options available for issuance under the 1993Incentive Plan.

Prior to January 1, 2006, Fuel Tech accounted for the stock options granted under the 1993 Plan under the recognition and measurement provisions of APB Opinion No. 25, “Accounting for Stock Issued to Employees” (Opinion 25)and related Interpretations, as permitted by FASB Statement No. 123, “Accounting for Stock-Based Compensation” (Statement 123).No stock-based employee compensation cost was recognized in Fuel Tech’s historical Statements of Income prior to January 1, 2006 as all options granted under the 1993 Plan had an exercise price equal to the market value of the underlying common stock on the date of grant.

Effective January 1, 2006, Fuel Tech adopted the fair value recognition provisions of FASB Statement No. 123(R), “Share-Based Payment” (Statement 123(R))(SFAS 123R) using the modified-prospective transition method.  Under that transition method, compensation cost recognized for the year ended December 31, 20062008 includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of Statement 123, and (b) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of Statement 123(R).SFAS 123R.  Accordingly, results for prior periods have not been restated.
29

Basic and Diluted Earnings Perper Common Share

Basic earnings per share excludes the dilutive effects of stock options and stock warrants and of the nil coupon non-redeemable convertible unsecured loan notes (see Note 5).  Diluted earnings per share includes the dilutive effect of the nil coupon non-redeemable convertible unsecured loan notes and of in-the-money stock options and stock warrants. The following table below sets forth the weighted-average shares used at December 31 in calculating earnings per share (in thousands):

  2006 2005 2004 
Basic weighted-average shares  21,491  20,043  19,517 
Conversion of unsecured loan notes  46  59  85 
Unexercised options and warrants  2,650  2,964  2,553 
Diluted weighted-average shares  24,187  23,066  22,155 
share:
 
New
32
  2008  2007  2006 
Basic weighted-average shares  23,608,000   22,280,000   21,491,000 
Conversion of unsecured loan notes  43,000   45,000   46,000 
Unexercised options and warrants  939,000   2,395,000   2,650,000 
Diluted weighted-average shares  24,590,000   24,720,000   24,187,000 
Recently Adopted Accounting PronouncementsStandards

In JulySeptember 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an interpretationStatement of FASB Statement No. 109,” (FIN 48), FIN 48 prescribes a comprehensive model for how a company should recognize, measure, present, and disclose in its financial statements uncertain tax positions that it has taken or expects to take on a tax return. On January 17, 2007, the FASB affirmed it previous decision to make FIN 48 effective for fiscal years beginning after December 15, 2006. Accordingly, FIN 48 is effective for Fuel Tech on January 1, 2007. Management has determined that the adoption of FIN 48 will not have a material impact on Fuel Tech’s consolidated financial statements.

In September 2006, the FASB issued SFASFinancial Accounting Standard No. 157, “Fair Value Measurements,”Measurements” (SFAS 157). SFAS 157, which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements.  The provisions of this standard apply to other accounting pronouncements thatSFAS 157 does not require or permitany new fair value measurements.measurements, but provides guidance on how to measure fair value by providing a fair value hierarchy used to classify the source of the information.  This statement is effective for fiscal years beginning after November 15, 2007.  On February 14, 2008, the FASB issued FSP FAS No. 157-1 “Application of FASB Statement No. 157 to FASB Statement 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement Under Statement 13” (SFAS 157-1) that amends SFAS 157 becomesto exclude its application for purposes of lease classification or measurement under SFAS 13.  On February 12, 2008, the FASB issued Staff Position Financial Accounting Standard (FSP FAS) No. 157-2 “Effective Date of FASB Statement No. 157” (FSP 157-2) that amends SFAS 157 to delay the effective date for Fuel Techall non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on January 1,a recurring basis to fiscal years beginning after November 15, 2008.  Upon adoption,The Company adopted the required provisions of SFAS 157-1 effective January 1, 2008 and there was no material effect on its consolidated financial statements. The Company has adopted FSP 157-2 to delay the adoption effects related to non-financial assets and does not anticipate there will be a material effect on its consolidated financial statements.  In October 2008, the FASB issued FSP 157-3, “Determining the Fair Value of a Financial Asset in a Market That Is Not Active.”  The FSP was effective upon issuance, including periods for which financial statements have not been issued. The FSP clarified the application of SFAS 157 arein an inactive market and provided an illustrative example to be applied prospectively with limited exceptions.demonstrate how the fair value of a financial asset is determined when the market for that financial asset is inactive.  The adoption of SFAS 157 isthis FSP FAS 157-3 did not expected to have a material impact on Fuel Tech’sthe Company’s consolidated financial statements.

In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (SFAS 141R). SFAS 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree and the goodwill acquired.  SFAS 141R also establishes disclosure requirements to enable the evaluation of the nature and financial effects of the business combination.  SFAS 141R is effective for financial statements issued for fiscal years beginning after December 15, 2008.  The Company is currently evaluating the potential impact of adoption of SFAS 141R on its consolidated financial statements.  However, the Company does not expect the adoption of SFAS 141R to have a material effect on its consolidated financial statements.

In April 2008, the FASB issued FASB Staff Position No. FAS 142-3, Determination of the Useful Life of Intangible Assets (“FSP No. FAS 142-3”). FSP No. FAS 142-3 requires companies estimating the useful life of a recognized intangible asset to consider their historical experience in renewing or extending similar arrangements or, in the absence of historical experience, to consider assumptions that market participants would use about renewal or extension as adjusted for SFAS 142’s, Goodwill and Other Intangible Assets, entity-specific factors. FSP No. FAS 142-3 will be effective for fiscal years beginning after December 15, 2008.  The Company is currently evaluating the potential impact of adoption of FSP No. FAS 142-3 on its consolidated financial statements. However, the Company does not expect the adoption of FSP No. FAS 142-3 to have a material effect on its consolidated financial statements.
 
In May 2008, the FASB issued Statement of Financial Accounting Standards No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (SFAS 162).  SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements that are presented in conformity with generally accepted accounting principles. SFAS 162 becomes effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles.”  The Company does not expect that the adoption of SFAS 162 to have a material effect on its consolidated financial statements.
3033
 
2.CONSTRUCTION CONTRACTS IN PROGRESS
2.CONSTRUCTION CONTRACTS IN PROGRESS

The status of contracts in progress as of December 31, 20062008 and 2005,2007 is as follows:

(in thousands) 2006 2005 
Costs incurred on uncompleted contracts $18,696 $12,020 
Estimated earnings  13,810  11,442 
Earned revenue  32,506  23,462 
Less billings to date  31,524  25,179 
Total $982 $(1,717)
Classified as follows:     
Costs and estimated earnings in excess of billings on   uncompleted contracts $3,615 $2,272 
Billings in excess of costs and estimated earnings on    uncompleted contracts  (2,633) (3,989)
Total $982 $(1,717)
  2008 2007
Costs incurred on uncompleted contracts $18,220  $17,050 
Estimated earnings  14,882   15,247 
Earned revenue  33,102   32,296 
Less billings to date  (28,773)   (16,303) 
Total $4,330  $15,993 
Classified as follows:        
Costs and estimated earnings in excess of billings on uncompleted contracts $5,552  $16,813 
Billings in excess of costs and estimated earnings on  uncompleted contracts  (1,223)   (821) 
Total $4,330  $15,993 

Costs and estimated earnings in excess of billings on uncompleted contracts are included in accounts receivable on the consolidated balance sheet, while billings in excess of costs and estimated earnings on uncompleted contracts are included in other accrued liabilities on the consolidated balance sheet.

As of December 31, 20062008 and 20052007, Fuel Tech had no construction contracts in progress that were identified as loss contracts.

3.TAXATION
3.TAXATION

The components of income (loss) before taxes for the years ended December 31 are as follows (in thousands):follows:

Origin of income (loss) before taxes
 
2006
 
2005
 
2004
 
United States $13,279 $7,823 $1,218 
Foreign  (1,511) (654) (1,052)
Income before taxes $11,768 $7,169 $166 
Origin of income (loss) before taxes 2008  2007  2006 
United States $8,353  $13,242  $13,279 
Foreign  (1,356)  (812)  (1,511)
Income before taxes $6,997  $12,430  $11,768 

Significant components of the income tax benefitexpense for the years ended December 31 are as follows (in thousands):
  
2006
 
2005
 
2004
 
Current:       
Federal $144 $582 $20 
State  29  455  94 
Other  60  34  - 
Total current $233  1,071  114 
Deferred:          
Federal  4,314  2,179  1,512 
State  180  630  204 
Change in valuation allowance  215  (4,299) (3,236)
Total deferred  4,709  (1,490) (1,520)
Income tax expense (benefit) $4,942 $(419)$(1,406)
follows:

31

  2008  2007  2006 
Current:         
Federal $1,395  $1,401  $144 
State  411   588   29 
Other  (84)  -   60 
Total current $1,722  $1,989  $233 
Deferred:            
Federal  1,612   3,183   4,314 
State  61   15   180 
Change in valuation allowance  -   -   215 
Total deferred  1,673   3,198   4,709 
Income tax expense $3,395  $5,187  $4,942 
A reconciliation between the provision for income taxes calculated at the U.S. federal statutory income tax rate and the consolidated income tax benefit in the consolidated statements of income for the years ended December 31 is as follows (in thousands):

follows:
 
  
2006
 
2005
 
2004
 
Provision at the U.S. federal statutory rate $4,119 $2,509 $58 
State taxes, net of federal benefit  187  369  94 
Foreign losses without tax benefit  588  263  368 
Research credits  (229) (339) - 
Other  62  1,078  - 
Valuation allowance adjustment  215  (4,299) (1,926)
Income tax benefit $4,942 $(419)$(1,406)
34
  2008  2007  2006 
Provision at the U.S. federal statutory rate $2,449  $4,351  $4,119 
State taxes, net of federal benefit  311   405   187 
Foreign losses without tax benefit  391   284   588 
Research credits  (77)  (63)  (229)
Other  321   210   62 
Valuation allowance adjustment  -   -   215 
Income tax expense $3,395  $5,187  $4,942 

The table below depicts the data above on a percentage basis:

  
2006
 
2005
 
2004
 
Provision at the U.S. federal statutory rate  35.0% 35.0% 35.0%
State taxes, net of federal benefit  1.6% 5.1% 56.6%
Foreign losses without tax benefit  5.0% 3.7% 221.7%
Research credits  (1.9)% (4.7)% -%
Other  .5% 15.1% -%
Valuation allowance adjustment  1.8% (60.0)% (1,160.3)%
Income tax benefit  42.0% (5.8)% (847.0)%
32
  2008  2007  2006 
Provision at the U.S. federal statutory rate  35.0%  35.0%  35.0%
State taxes, net of federal benefit  4.4%  3.3%  1.6%
Foreign losses without tax benefit  5.6%  2.3%  5.0%
Research credits  (1.1)%  (.5)%  (1.9)%
Other  4.6%  1.6%  .5%
Valuation allowance adjustment  -%  -%  1.8%
Income tax expense  48.5%  41.7%  42.0%


The deferred tax assets and liabilities at December 31 are as follows (in thousands):follows:

  2006 2005 
Deferred tax assets:     
Research and development credit $2,296 $1,663 
Net operating loss carryforwards  2,116  2,268 
Accrued liability for compensation  537  344 
Stock compensation expense  526  - 
Equipment  379  159 
Alternative minimum tax credit  284  261 
Warranty reserve  180  94 
Accounts receivable  57  57 
Deferred rent liability  37  42 
Vacation accrual  33  28 
Charitable contribution  14  8 
Research and development asset  9  - 
        
Total deferred tax assets  6,468  4,924 
Valuation allowances for deferred tax assets  (260) (45)
Deferred tax assets net of valuation allowances $6,208 $4,879 
Deferred tax liabilities:       
Patents  (65) (54)
Goodwill  (286) (203)
Total deferred tax liabilities  (351) (257)
Net deferred tax asset $5,857 $4,622 
        
Net deferred tax assets and liabilities are recorded as follows within the consolidated balance sheets: 
        
Current assets $4,972 $3,043 
Long-term assets  885  1,579 
Net deferred tax asset $5,857 $4,622 
  2008  2007 
Deferred tax assets:      
Stock compensation expense $4,238  $2,306 
Research and development credit  492   1,302 
Equipment  -   648 
Alternative minimum tax credit  275   275 
Warranty reserve  101   176 
Accounts receivable  30   57 
Vacation accrual  45   40 
Deferred rent liability  49   33 
Effect of FIN 48 adoption  13   7 
Intangible assets  11   - 
Net operating loss carryforwards  84   - 
Total deferred tax assets  5,338   4,844 
Deferred tax liabilities:        
Equipment  (975)  - 
Prepaid expenses  (361)  - 
Patents  (94)  (76)
Goodwill  (469)  (367)
Total deferred tax liabilities  (1,899)  (443)
Net deferred tax asset before valuation allowance $3,349  $4,401 
Valuation allowances for deferred tax assets  (260)  (260)
Net deferred tax asset $3,179  $4,141 

Fuel Tech’s income tax benefit of $419,000 for 2005 predominantly represents the recording of the reduction in theNet deferred tax asset valuation allowance representingassets and liabilities are recorded as follows within the anticipated utilization of net operating loss and research and development tax credit carryforwards. Based on a review of both historical and projected taxable income, Fuel Tech concluded that it was more likely than not that the net operating losses and the research and development tax credits would be utilized in subsequent periods and the valuation allowance was no longer required.consolidated balance sheets:

Current assets $767  $1,589 
Long-term assets  2,412   2,552 
Net deferred tax asset $3,179  $4,141 

For the years ended December 31, 20062008 and 20052007, Fuel Tech recorded tax benefits from the exercise of stock options in the amount of $5,944,000$548 and $1,488,000$1,482, respectively.  The amounts were recorded as an increase in additional paid-in capital on the consolidated balance sheets.sheets and as cash from financing activities on the consolidated statements of cash flows.  With our adoption of SFAS 123R on January 1, 2006, all subsequent tax benefits from the exercise of stock options were recorded as cash flows from financing activities.
35
 
State and Federal Taxincome tax payments during the years ended December 31, 2008, 2007 and 2006 2005were $5,905, $173 and 2004 were $217,000, $326,000,$217, respectively.
In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109,” (FIN 48).  FIN 48 prescribes a comprehensive model for how a company should recognize, measure, present and $76,000, respectively.disclose in its financial statements uncertain tax positions that it has taken or expects to take on a tax return.  On January 17, 2007, the FASB affirmed its previous decision to make FIN 48 effective for fiscal years beginning after December 15, 2006.  Accordingly, Fuel Tech adopted the provisions of FIN 48 on January 1, 2007.

Previously, Fuel Tech had accounted for tax contingencies in accordance with Statement of Financial Accounting Standards 5, Accounting for Contingencies.  As required by FIN 48, which clarifies Statement 109, Accounting for Income Taxes, Fuel Tech recognizes the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit.  For tax positions meeting the more-likely-than-not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the relevant tax authority.  At the adoption date, we applied FIN 48 to all tax positions for which the statute of limitations remained open.  As a result of the implementation of FIN 48, we recognized an increase of approximately $86 in the liability for unrecognized tax benefits, of which $81 was accounted for as a reduction to the January 1, 2007 balance of retained earnings.
The following table summarizes Fuel Tech’s unrecognized tax benefit activity during 2008:
33
Description Balance 
    
Balance at January 1, 2008 $678 
Increases in positions taken in a prior period  - 
Decreases in positions taken in a prior period  - 
Increases in positions taken in a current period  35 
Decreases in positions taken in a current period  - 
Decreases due to settlements  - 
Decreases due to lapse of statute of limitations  - 
Balance at December 31, 2008 $713 

The amount of unrecognized tax benefits as of December 31, 2008, including interest and penalties, was $781.  This amount included $747 of unrecognized tax benefits which, if ultimately recognized, will reduce Fuel Tech’s annual effective tax rate.

Fuel Tech is subject to income taxes in the U.S. federal jurisdiction, and various states and foreign jurisdictions.  Tax regulations within each jurisdiction are subject to the interpretation of the related tax laws and regulations and require significant judgment to apply.  With few exceptions, we are no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for the years before 2004.

Fuel Tech recognizes interest and penalties accrued related to unrecognized tax benefits in income tax expense for all periods presented.  Fuel Tech had accrued approximately $68 for the payment of interest and penalties at December 31, 2008.
 
The management of Fuel Tech periodically estimates the probable tax obligations of the Company using historical experience in tax jurisdictions and informed judgments.  There are inherent uncertainties related to the interpretation of tax regulations in the jurisdictions in which Fuel Tech transactswe transact business. The judgments and estimates made at a point in time may change based on the outcome of tax audits, as well as changes to or further interpretations of regulations.  If such changes take place, there is a risk that the tax rate may increase or decrease in any period.  Tax accruals for tax liabilities related to potential changes in judgments and estimates for both federal and state tax issues are included in current liabilities on the consolidated balance sheet.
 
At December 31, 2006,2008, Fuel Tech has tax losses in the amount of $6,045,000 available in the United States to offset federal taxable income, and tax losses in the amount of $1,574,000$4,035 available to offset foreign income.  The foreign loss carryforwards beginbegan to expire in 2008 and at December 31, 20062008 a full valuation allowance of $3,699 is recorded against this amount. The remaining domestic tax loss carryforwards expire as follows (in thousands):

2007 $2,325 
2008  1,480 
2009  220 
2010  309 
2011  884 
2012  40 
2021  117 
2025  670 
  $6,045 
 
4.COMMON SHARES
4.COMMON SHARES

At December 31, 2006,2008, Fuel Tech had 22,086,72824,110,967 Common Shares issued, with an additional 45,5567,485 shares reserved for issuance upon conversion of the nil coupon non-redeemable convertible unsecured loan notes (see Note 5) and 2,414,2002,905,325 shares reserved for issuance upon the exercise of stock options, 711,4501,461,700 of which are currently exercisable (see Note 6).
 
5.NIL COUPON NON-REDEEMABLE CONVERTIBLE UNSECURED LOAN NOTES
36
5. NIL COUPON NON-REDEEMABLE CONVERTIBLE UNSECURED LOAN NOTES
 
At December 31, 2008, 2007 and 2006, 2005 and 2004,respectively, Fuel Tech had $277,000, $282,000,principal amounts of $81, $272 and $532,000 principal amount$277 of nil coupon non-redeemable convertible unsecured perpetual loan notes (the “Loan Notes”) outstanding.  The Loan Notes are convertible at any time into Common Shares at rates of $6.50 or $11.43 per share.share, as appropriate.  The Loan Notes bear no interest and have no maturity date.  They are generally repayable only in the event of Fuel Tech’s dissolution and, accordingly, have been classified within shareholders’stockholders’ equity in the accompanying balance sheet.
 
In 2008, Loan Notes in the principal amount of $191 were converted into 43,845 Common Shares.  In 2007 and 2006, Loan Notes in the principal amount of $5,000$5 and $5, respectively, were converted into 769 and 769 Common Shares, while in 2005 Loan Notes in the principal amount of $250,000 were converted into 38,461 Common Shares. There were no conversions in 2004.respectively.
 
6.STOCK OPTIONS AND WARRANTS
6. STOCK-BASED COMPENSATION AND WARRANTS
 
Fuel Tech has onea stock-based employee compensation plan, referred to as the 1993Fuel Tech, Inc. Incentive Plan (1993(Incentive Plan), under which awards may be granted to participants in the form of Non-Qualified Stock Options, Incentive Stock Options, Stock Appreciation Rights, Restricted Stock, Restricted Stock Units, Performance Awards, Bonuses or other forms of share-based or non-share-based awards or combinations thereof.  Participants in the 1993Incentive Plan may be Fuel Tech’s directors, officers, employees, consultants or advisors (except consultants or advisors in capital-raising transactions) as the directors determine are key to the success of Fuel Tech’s business.  The amount of shares that may be issued or reserved for awards to participants under a 2004 amendment to the 1993Incentive Plan is 12.5% of outstanding shares calculated on a diluted basis.  In 2008, 2007 and 2006, 2005 and 2004,757,000, 311,000, 1,094,000 557,000, and 408,000 options, respectively, were granted to employees and directors.  At December 31, 2006,2008, Fuel Tech has 866,000had 472,000 stock options available for issuance under the 1993Incentive Plan.

Prior to January 1, 2006, Fuel Tech accounted foruses the stock options granted under the 1993 Plan under the recognition and measurement provisions of APB Opinion No. 25, “Accounting for Stock IssuedBlack-Scholes options-pricing model to Employees” (Opinion 25)and related Interpretations, as permitted by FASB Statement No. 123, “Accounting for Stock-Based Compensation” (Statement 123).No stock-based employee compensation cost was recognized in Fuel Tech’s historical Statements of Income prior to January 1, 2006 as all options granted under the 1993 Plan had an exercise price equal to the market value of the underlying common stock on the date of grant.

Effective January 1, 2006, Fuel Tech adoptedestimate the fair value recognition provisions of FASB Statement No. 123(R), “Share-Based Payment” (Statement 123(R))using the modified-prospective transition method. Under that transition method, compensation cost recognizedemployee stock options for the required pro forma disclosure under Statement 123(R).  For the year ended December 31, 2006 includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of Statement 123, and (b) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of Statement 123(R). Accordingly, results for prior periods have not been restated.
34

As a result of adopting Statement 123(R) on January 1, 2006,2008, Fuel Tech recorded stock-based compensation expense of $1,805,000$5,815 ($1,268,000 after-tax)3,882 after tax).  The Company recorded $4,791 ($3,105 after tax) in stock-based compensation expense for the year ended December 31, 2006.comparable period in 2007.

The following table illustrates the effect on net income and earnings per share if Fuel Tech had applied the fair value recognition provisions of Statement 123(R) to options granted under Fuel Tech’s stock option plans in all periods presented. For purposes of this pro forma disclosure, as noted above, the value of the options is estimated using a Black-Scholes option pricing model.

For the year ended (in thousands) 2005 2004 
      
Net income as reported $7,588 $1,572 
        
Deduct:
Total stock-based compensation expense determined under fair value based method for all awards, net of related tax effects
  952  765 
Pro forma net income $6,636 $807 
        
Basic and diluted income per share:       
Basic - as reported $.38 $.08 
Basic - pro forma $.33 $.04 
        
Diluted - as reported $.33 $.07 
Diluted - pro forma $.29 $.04 

As of December 31, 2006,2008, there was $12.1$11.4 million of total unrecognized compensation cost related to nonvestednon-vested share-based compensation arrangements granted under the 1993 Plan.  That cost is expected to be recognized over a period of four years.

The awards granted under the 1993Incentive Plan have a 10-year life and they vest as follows: 50% after the second anniversary of the award date, 25% after the third anniversary, and the final 25% after the fourth anniversary of the award date.  Fuel Tech calculates stock compensation expense based on the grant date fair value of the award and recognizes expense on a straight-line basis over the four-year service period of the award.
 
Prior to January 1, 2006, Fuel Tech used the Black-Scholes option-pricing model to estimate the fair value of employee stock options for the required pro forma disclosure under Statement 123. This model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. With the adoption of Statement 123(R) as of January 1, 2006, Fuel Tech has continued to use the Black-Scholes option-pricing model to estimate the fair value of stock option grants.
The principal variable assumptions utilized in valuing options and the methodology for estimating such model inputs include: (1) risk-free interest rate -– an estimate based on the yield of zero-couponzero–coupon treasury securities with a maturity equal to the expected life of the option; (2) expected volatility -– an estimate based on the historical volatility of Fuel Tech’s Common Stock for a period equal to the expected life of the option; and (3) expected life of the option -– an estimate based on historical experience including the effect of employee terminations.

Based on the results of the model, the weighted-average fair value of the stock options granted during the 12-month periodperiods ended December 31, 2008, 2007 and 2006, respectively was $9.65, $14.01and $12.53 per share using the following assumptions:

  
2006
 
2005
 
2004
 
Expected dividend yield  0.00% 0.00% 0.00%
Risk-free interest rate  4.64% 4.38% 3.60%
Expected volatility  60.7% 48.0% 62.3%
Expected life of option  5.2 years  4.0 years  4.0 years 
  2008  2007  2006 
Expected dividend yield  0.00%  0.00%  0.00%
Risk-free interest rate  2.85%  4.39%  4.64%
Expected volatility  59.3%  57.4%  60.7%
             
Expected life of option 5.2 years  5.2 years  5.2 years 
 
3537

The following table presents a summary of Fuel Tech’s stock option activity and related information for the years ended December 31:

  2006 2005 2004 
  
Number
of
Options
 
Weighted-
Average
Exercise Price
 
Number
of
Options
 
Weighted-
Average
Exercise Price
 
Number
of
Options
 
Weighted-
Average
Exercise Price
 
  
Outstanding at beginning of year  2,799,000 $4.29  2,810,000 $3.24  2,447,050 $3.00 
Granted  1,094,000  22.06  557,000  7.84  408,000  4.67 
Exercised  (1,332,925) 2.88  (529,250) 2.32  (19,425) 1.74 
Expired or forfeited  (145,875) 5.91  (38,750) 5.97  (25,625) 4.82 
Outstanding at end of year  2,414,200 $13.02  2,799,000 $4.29  2,810,000 $3.24 
                    
Exercisable at end of year  711,450 $5.22  1,687,375 $2.87  1,806,125 $2.65 
Weighted-average fair value of                   
options granted during the year    $12.53    $3.35    $2.31 

  2008  2007  2006 
   
Number
of
Options
  
Weighted-
Average
Exercise Price
  
Number
of
Options
  
Weighted-
Average
Exercise Price
  
Number
of
Options
  
Weighted-
Average
Exercise Price
 
                    
Outstanding at beginning of year  2,464,325  $15.03   2,414,200  $13.02   2,799,000  $4.29 
Granted  757,250   18.05   310,500   25.80   1,094,000   22.06 
Exercised  (171,125)  3.61   (188,875)  4.83   (1,332,925)  2.88 
Expired or forfeited  (145,125)  18.69   (71,500)  20.82   (145,875)  5.91 
Outstanding at end of year  2,905,325  $16.30   2,464,325  $15.03   2,414,200  $13.02 
                         
Exercisable at end of year  1,461,700  $12.92   955,825  $7.11   711,450  $5.22 
Weighted-average fair value of options granted during the year     $9.65      $14.01      $12.53 
The following table provides additional information regarding Fuel Tech’s stock option activity for the 12 months ended December 31, 2006.

  
Number
of
Options
 
Weighted-
Average
Exercise Price
 Weighted- Average Remaining Contractual Term Aggregate Intrinsic Value 
Outstanding on January 1, 2006  2,799,000 $4.29       
Granted  1,094,000  22.06       
Exercised  (1,332,925) 2.88    $16,417 
Expired or forfeited  (145,875) 5.92       
Outstanding on December 31, 2006  2,414,200 $13.02  8.35 years $31,422 
              
Exercisable on December 31, 2006  711,450 $5.22  6.24 years $3,714 
Weighted-average fair value of             
options granted during 2006    $12.53       
2008.

  
Number
of
Options
  
Weighted-
Average
Exercise Price
 
Weighted-
Average
Remaining
Contractual
Term
 
Aggregate
Intrinsic Value
 
 Outstanding on January 1, 2008  2,464,325  $15.03     
 Granted  757,250   18.05     
 Exercised  (171,125)  3.61   $2,106 
 Expired or forfeited  (145,125)  18.69      
 Outstanding on December 31, 2008  2,905,325  $16.30 7.49 years $4,044 
              
 Exercisable on December 31, 2008        6.44 years $3,798 
3638

The following table summarizes information about stock options outstanding at December 31, 2006:2008:

Options Outstanding
 
Options Exercisable
 
Range of
Exercise Prices
 
Number of
Options
 
Weighted-Average
Remaining
Contractual Life
 
Weighted-Average
Exercise Price
 
Number of
Options
 
Weighted-Average
Exercise Prices
 
            
$2.55 - $5.10  709,200  6.39 years $3.87  485,450 $3.64 
$5.11 - $10.20  611,000  8.09 years $7.44  166,000 $5.98 
$10.21 - $17.84  317,500  9.31 years $13.66  60,000 $15.95 
$17.85 - $25.49  776,500  9.94 years $25.49       
$2.55 - $25.49  2,414,200  8.35 years $13.02  711,450 $5.22 
Options Outstanding  Options Exercisable 
 
Range of
  
 
Number of
 
Weighted-
Average
Remaining
 
Weighted-
Average
  
 
Number of
  
Weighted-
Average
 
Exercise Prices  Options Contractual Life Exercise Price  Options  Exercise Price 
               
$1.47 - $ 5.51   451,700 4.89 years $4.19   446,200  $4.17 
$5.52 - $ 11.03   536,125 6.40 years $7.96   380,250  $7.56 
$11.04 - $ 22.06   792,000 8.57 years $16.19   167,500  $14.09 
$22.07 - $ 27.57   1,125,500 8.31 years $25.22   467,750  $25.20 
$1.47 - $ 27.57   2,905,325 7.49 years $16.30   1,461,700  $12.92 

The weighted-average exercise price per nonvestednon-vested stock award at grant date was $22.41$17.55 per share for the nonvestednon-vested stock awards granted in 2006. Nonvested2008.  Non-vested stock award activity for all plans for the 12 months ended December 31, 20062008 was as follows:

  
Nonvested Stock Outstanding
 
Weighted-Average
Fair Value
 
Outstanding on January 1, 2006  1,111,625 $2.82 
Granted  1,094,000  12.53 
Released  (362,500) 3.59 
Expired or forfeited  (140,375) 2.75 
Outstanding on December 31, 2006  1,702,750 $8.90 
  
Non-Vested Stock
Outstanding
  
Weighted-Average
Grant Date
Fair Value
 
 Outstanding on January 1, 2008  1,508,500  $11.08 
 Granted  757,250   9.65 
 Released  (682,000)  10.36 
 Expired or forfeited  (140,125)  10.36 
 Outstanding on December 31, 2008  1,443,625  $10.75 

At December 31, 2008, Fuel Tech had 1,577,500 stock options with exercise prices per share that were not dilutive for the purpose of inclusion in the calculation of diluted earnings per share.

On November 10, 2005, the FASB issued Staff Position No. 123(R)-3, Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards, or Staff Position 123(R)-3.  Fuel Tech has elected to adopt the alternative transition method provided in Staff Position 123(R)-3 for calculating the tax effects of stock-based compensation pursuant to Statement 123(R).  The alternative transition method simplifies the calculation of the beginning balance of the additional paid-in-capital pool, or APIC pool, related to the tax effect of employee stock-based compensation.  This method also has subsequent impact on the APIC pool and the condensed consolidated statements of cash flows relating to the tax effects of employee stock-based compensation awards that are outstanding upon adoption of Statement 123(R).

In addition to the above,Incentive Plan, Fuel Tech has 1,742,000a Deferred Compensation Plan for Directors (Deferred Plan).  This Deferred Plan, as originally approved, provided for deferral of Directors’ fees in the form of either cash with interest or as “phantom stock” units, in either case, however, to be paid out only as cash and not as stock at the elected time of payout.  In the second quarter of 2007, Fuel Tech obtained stockholder approval for an amendment to the Deferred Plan to provide that instead of phantom stock units paid out only in cash, the deferred stock unit compensation may be paid out in shares of Fuel Tech Common Stock.  Under the guidance of Statement 123(R), this plan modification required that Fuel Tech account for awards under the plan for the receipt of Fuel Tech Common Stock, as equity awards as opposed to liability awards.  In 2008 and 2007, Fuel Tech recorded $73 and $150, respectively, of stock-based compensation expense under the Deferred Plan.

In addition to the above, at December 31, 2007, Fuel Tech had 1,601,043 warrants outstanding to purchase Common Shares at an exercise price of $1.75.  TheAs of December 31, 2008, all of these warrants expire on April 30, 2008.had been exercised.

39

7.COMMITMENTS

Operating Leases

Fuel Tech leases office space, autos and certain equipment under agreements expiring on various dates through 2011.2014. Future minimum lease payments under noncancellablenon-cancellable operating leases that have initial or remaining lease terms in excess of one year as of December 31, 20062008 are as follows (in thousands):follows:

Year of Payment
 
Amount
 
2007 $521 
2008  466 
2009  361 
2010  34 
2011  6 
Thereafter  0 
Year of Payment Amount 
2009 $663 
2010  279 
2011  249 
2012  251 
Thereafter  278 

For the years ended December 31, 2006, 20052008, 2007 and 2004,2006, rent expense approximated $829,000 $778,000$1,300, $852 and $640,000,$829, respectively.
37

Fuel Tech has a sublease agreement with American Bailey Corporation (ABC) that obligates the lessee to make future payments. The sublease obligations noted below are related to a sublease agreement between Fuel Tech and American Bailey Corporation (ABC).  ABC will reimburse Fuel Tech for its share of lease and lease-related expenses under Fuel Tech’s January 29,2004 lease of its executive offices in Stamford, Connecticut.  Please refer to Note 9 to the consolidated financial statements for a discussion of the relationrelationship between Fuel Tech and ABC.  The future minimum lease paymentsincome under this noncancellable sublease as of December 31, 2006 are2008 is as follows (in thousands):follows:

Year of Payment Amount 
2007 $81 
2008  81 
2009  81 
2010  7 
2011  - 
Thereafter  - 
Year of Payment Amount 
2009 $81 
2010  7 
2011  - 
2012  - 
Thereafter  - 
 
The terms of the twothree primary lease arrangements are as follows:
 
·
-The Stamford, Connecticut building lease term, for approximately 7,000 square feet, runs from February 1, 2004 to January 31, 2010.  The facility houses certain administrative functions such as Investor Relations, Benefit Plan Administration and certain APC sales functions.
-The Beijing, China building lease term, for approximately 4,000 square feet, runs from September 1, 2007 to August 31, 2009.  This facility serves as the operating headquarters for our Beijing Fuel Tech operation.  Fuel Tech has the option to extend the lease term at a market rate to be agreed upon between Fuel Tech and the lessor.
-The Durham, North Carolina building lease term, for approximately 16,000 square feet, runs from November 1, 2005 to April 30, 2014.  This facility houses the former Tackticks and FlowTack operations.  Fuel Tech has no option to extend the lease.
In addition to the above, on November 30, 2007, Fuel Tech purchased an office building in Warrenville, Illinois, which has served as our corporate headquarters since June 23, 2008.  Our prior headquarters, an 18,000 square foot location in Batavia, Illinois, buildingremains under an operating lease term runs from June 1, 1999 tountil May 31, 2009.  Fuel Tech has the optionWe have no plans to extend the lease term for two successive terms of five years each at market rates to be agreed upon between Fuel Tech and the lessor.renew this lease.
 
· The Stamford, Connecticut building lease term runs from February 1, 2004 to January 31, 2010. Fuel Tech has the option to extend the lease term for one successive term of five years at a market rate to be agreed upon between Fuel Tech and the lessor. Fuel Tech was provided with a 10 month “free rent” period under this lease, and the total minimum lease payments are being amortized over the lease term. The deferred rent liability is $158,000 at December 31, 2006, of which $20,000 and $138,000 are recorded in current “Other accrued liabilities” and long-term “Other liabilities,” respectively, on the consolidated balance sheet. Under the sublease noted above, ABC was also provided with a 10-month “free rent” period, and the total minimum lease rentals are also being amortized over the lease term. The deferred rent receivable is $59,000 at December 31, 2006, of which $8,000 and $51,000 are recorded in current “Prepaid expenses and other current assets” and long-term “Other assets”, respectively, on the consolidated balance sheet.
None of Fuel Tech’s lease arrangements are adjusted based on an index feature.

Performance Guarantees

The majority of Fuel Tech’s long-term equipment construction contracts contain language guaranteeing that the performance of the system that is being sold to the customer will meet specific criteria.  On occasion, bank performance guarantees and letters of credit are issued to the customer in support of the construction contracts as follows:

 ·-in support of the warranty period defined in the contract,contract; or
 ·-in support of the system performance criteria that are defined in the contractcontract.
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As of December 31, 2006,2008, Fuel Tech has outstanding bank performance guarantees and letters of credit in the amount of $1,077,000$5,765 in support of equipment construction contracts that have not completed their final acceptance test or that are still operating under a warranty period.  Management of Fuel TechTech’s management believes that these projects will be successfully completed and that there will not be a materially adverse impact on Fuel Tech’s operations from these bank performance guarantees and letters of credit.
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Product Warranties
 
Fuel Tech issues a standard product warranty with the sale of its products to customers. Fuel Tech’sOur recognition of warranty liability is based generally,primarily on analyses of warranty claims experience in the preceding years.  Changes in the warranty liability in 2006, 20052008, 2007 and 20042006 are summarized below:
 
(in thousands) 2006 2005 2004 
Aggregate product warranty liability at beginning of year $247 $137 $176 
Aggregate accruals related to product warranties  280  160  663 
Aggregate reductions for payments  (55) (50) (701)
Aggregate product warranty liability at end of year $472 $247 $137 
  2008  2007  2006 
Aggregate product warranty liability at beginning of year $464  $472  $247 
Net aggregate accruals related to product warranties  (45)  88   280 
Aggregate reductions for payments  (154)  (96)  (55)
Aggregate product warranty liability at end of year $265  $464  $472 

8.DEBT FINANCING

Fuel Tech has a domestic $25.0 million revolving credit facility expiring July 31, 2009.  The facility is unsecured and bears interest at a rate of LIBOR plus 75 basis points.   Fuel TechThe Company can use this facility for cash advances and standby letters of credit.  As of December 31, 20062008 and 2005,2007, there were no outstanding borrowings on this facility.

At December 31, 2006,2008, the bankCompany had providedoutstanding standby letters of credit and bank guarantees, predominantly to customers, totaling approximately $1,077,000$5,865 in connection with contracts in process.  Fuel Tech is committed to reimbursing the issuing bank for any payments made by the bank under these letters of credit.instruments.  At December 31, 2006,2008, there were no cash borrowings under the revolving credit facility and approximately $23,923,000$19,135 was available.

ThereDuring 2008 and 2007, under the domestic $25.0 million facility, the Company requested and received a waiver to enable us to exceed the capital spending covenant specified in the facility agreement to accommodate our purchase of land and building for our new corporate headquarters and the subsequent build out and furnishing of the premises.  During 2008, the Company also requested and received a waiver to enable us to exceed the allowable acquisition spending covenant specified in the facility agreement to accommodate our strategic acquisitions.
Beijing Fuel Tech Environmental Technologies Company, Ltd. (Beijing Fuel Tech), a wholly-owned subsidiary of Fuel Tech, entered into a revolving credit facility agreement during the third quarter of 2007 for RMB 35 million (approximately $4.8 million), which expires on July 31, 2009.  The facility is unsecured and bears interest at a rate of 90% of the People’s Bank of China (PBOC) Base Rate.  Beijing Fuel Tech can use this facility for cash advances and bank guarantees.  At December 31, 2008, Beijing Fuel Tech had borrowings outstanding in the amount of $2,188.

Interest payments in the amount of $135 and $24 were no interest payments made during the years ended December 31, 2006, 2005, or 2004.2008 and 2007, respectively.  No payments were made during the year ended December 31, 2006.

9.RELATED PARTY TRANSACTIONS

As of December 31, 2006,2008, Fuel Tech hashad a 6%4.5% common stock ownership interest in Clean Diesel Technologies, Inc. (CDT), which is being accounted for using the cost method.  Fuel Tech is precluded from selling its interest in CDT except pursuant to a registration statement, or in a broker/dealer transaction within the limitations of Rule 144 of the Securities and Exchange Commission (SEC), or in an exempt private placement within the limitations of Rule 144 of the SEC.  Fuel Tech’s investment in CDT, whose shares are publicly traded on the OTC Bulletin BoardThe NASDAQ Stock Market and the Alternative Investment Market of the London Stock Exchange, had a market value of $3.3 million$1,004 at December 31, 20062008.  Fuel Tech also owns 25,0005,000 warrants to purchase CDT common stock.  The warrants have an exercise price of $2.00$10.00 and can be exercised on or before November 14, 2010. The value assigned to the warrants on the consolidated balance sheet at December 31, 2006 and 2005 is not significant.
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On August 3, 1995, Fuel Tech signed a Management and Services Agreement with CDT.  According to the agreement, CDT is to reimburse Fuel Tech for management, services and administrative expenses incurred by Fuel Tech on behalf of CDT.  Additionally, Fuel Tech charges CDT an additional 3% of such costs annually.  For the years ended December 31, 2008, 2007 and 2006, 2005$72, $72 and 2004, $71,000, $71,000 and $70,000,$71, respectively, was charged to CDT as a management fee.

Pursuant to an assignment agreement of certain technology to CDT, Fuel Tech is due royalties from CDT of 2.5% of CDT’s annual revenue from sales of CDT’s Platinum Fuel Catalyst, commencing in 1998.  The royalty obligation expiresexpired in 2008.  CDT may terminateOver the life of the royalty obligation toagreement, Fuel Tech by payment of $12 million commencing in 1998 and declining annually to $1,090,910 in 2008. CDT as assignee and owner will maintain the technology at its own expense. To date, Fuel Tech has received approximately $31,000$61 in royalties.

Persons now or formerly associated with American Bailey Corporation (ABC) currently own approximately 25% of Fuel Tech’s Common Shares.  On April 30, 1998, Fuel Tech entered into an agreement with ABC for it to provide certain management and consulting services to Fuel Tech.  Persons now or formerly associated with ABC currently own 22% of Fuel Tech’s Common Shares and warrants to purchase an additional 1.7 million shares, which expire on April 30, 2008. No fees were to be payable under the agreement for the first 24 months. This agreement was amended in 1999 to extend its term to April 30, 2002, and provide for the payment of a management fee of $10,417 per month commencing September 1, 1999, through May 1, 2000, and $20,833 per month until the termination of the agreement. The agreement was further amended effective May 1, 2002 to increase the management fee to $29,167 per month until the termination of the agreement as of April 30, 2004. Effective January 1, 2004, this agreement was terminated.
39

As of January 1, 2004, two former employees ofrevised whereby ABC who were Directors ofreimburses Fuel Tech becamefor services that certain employees of Fuel Tech. Concurrently, in early 2004, a new agreement was put in place between Fuel Tech and ABC. Effective January 1, 2004, a compensation agreement was established whereby ABC will reimburse Fuel Tech for certain services that employees of Fuel Tech will provide to ABC.  In addition, ABC is a sublesseesub-lessee under Fuel Tech’s January 29,2004 lease of its executive offices in Stamford, Connecticut.  ABC will reimbursereimburses Fuel Tech for its share of lease and lease-related expenses under the sublease agreement.  Please refer to Note 7 to the consolidated financial statements for a further discussion of this topic.  $24,000At December 31, 2008, $23 is due from ABC at December 31, 2006 related to the compensation and sublease agreements.

10.DEFINED CONTRIBUTION PLAN

Fuel Tech has a retirement savings plan available for all U.S. employees who have met minimum length-of-service requirements. Fuel Tech’sOur contributions are determined based upon amounts contributed by Fuel Tech’s employees with additional contributions made at the discretion of Fuel Tech’s Board of Directors.  Costs related to this plan were $612,000, $285,000$851, $802 and $300,000$612 in 2008, 2007 and 2006, 2005 and 2004, respectively.
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11.BUSINESS SEGMENT, GEOGRAPHIC AND QUARTERLY FINANCIAL DATA

BUSINESS SEGMENT FINANCIAL DATABusiness Segment Financial Data

Fuel Tech segregates its financial results into two reportable segments representing two broad technology segments as follows:

· The NOx reduction technology segment, which includes the NOxOUT®, NOxOUT CASCADE®, NOxOUT ULTRA® and NOxOUT-SCR® processes for the reduction of NOx emissions in flue gas from boilers, incinerators, furnaces and other stationary combustion sources,
-
The Air Pollution Control technology segment, which includes the NOxOUT®, NOxOUT CASCADE®, GSG, NOxOUT ULTRA® and NOxOUT-SCR® processes for the reduction of NOx emissions in flue gas from boilers, incinerators, furnaces and other stationary combustion sources; and

· The fuel treatment chemicals technology segment, which uses chemical processes for the control of slagging, fouling, corrosion, opacity, acid plume, loss on ignition and sulfur trioxide-related issues in furnaces and boilers through the addition of chemicals into the fuel using TIFI™ Targeted In-Furnace Injection™ technology.
-The FUEL CHEM technology segment, which uses chemical processes for the control of slagging, fouling, corrosion, opacity, acid plume and sulfur trioxide-related issues in furnaces and boilers through the addition of chemicals into the fuel using TIFI™ Targeted In-Furnace Injection™ technology.

The “Other” classification includes those profit and loss items not allocated by Fuel Tech to each reportable segment.  Further, there are no intersegment sales that require elimination.

Fuel Tech evaluates performance and allocates resources based on reviewing gross margin by reportable segment.  The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies.  Fuel Tech does not review assets by reportable segment, but rather, in aggregate for Fuel Tech as a whole.
 
Information about reporting segment net sales and gross margin are provided below:

(in thousands)
For the year ended
December 31, 2006
 Nitrogen Oxide Reduction Fuel Treatment Chemical Other Total 
Net sales from external customers $46,454 $28,661 $- $75,115 
Cost of sales  26,328  11,932  169  38,429 
Gross margin  20,126  16,729  (169) 36,686 
Selling, general and administrative  -  -  23,901  23,901 
Research and development  -  -  2,052  2,052 
Operating income (loss) $20,126 $16,729 $(26,122)$10,733 

For the year ended
December 31, 2005
 Nitrogen Oxide Reduction Fuel Treatment Chemical Other Total 
Net sales from external customers $32,650 $20,272 $6 $52,928 
Cost of sales  16,744  10,096  278  27,118 
Gross margin  15,906  10,176  (272) 25,810 
Selling, general and administrative  -  -  17,414  17,414 
Research and development  -  -  1,241  1,241 
Operating income (loss) $15,906 $10,176 $(18,927)$7,155 

For the year ended
December 31, 2004
 Nitrogen Oxide Reduction Fuel Treatment Chemical Other Total 
Net sales from external customers $14,602 $16,216 $14 $30,832 
For the year ended
December 31, 2008
 
Air Pollution Control
Segment
  
FUEL CHEM
Segment
  Other  Total 
Revenues from external customers $44,393  $36,681  $-  $81,074 
Cost of sales  8,458  7,797  311  16,566   24,365   19,979   1   44,345 
Gross margin  6,144  8,419  (297) 14,266   20,028   16,702   (1)  36,729 
Selling, general and administrative  -  -  12,775  12,775   -   -   28,012   28,012 
Research and development  -  -  1,355  1,355   -   -   2,100   2,100 
Operating income (loss) $6,144 $8,419 $(14,427)$136  $20,028  $16,702  $(30,113) $6,617 
 
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GEOGRAPHIC SEGMENT FINANCIAL DATA
For the year ended
December 31, 2007
 
Air Pollution Control
Segment
  
FUEL CHEM
Segment
  Other  Total 
Revenues from external customers $47,750  $32,547  $-  $80,297 
Cost of sales  25,775   16,619   77   42,471 
Gross margin  21,975   15,928   (77)  37,826 
Selling, general and administrative  -   -   24,950   24,950 
Research and development  -   -   2,137   2,137 
Operating income (loss) $21,975  $15,928  $(27,164) $10,739 

For the year ended
December 31, 2006
 
Air Pollution Control
Segment
  
FUEL CHEM
Segment
  Other  Total 
Revenues from external customers $46,454  $28,661  $-  $75,115 
Cost of sales  26,328   11,932   169   38,429 
Gross margin  20,126   16,729   (169)  36,686 
Selling, general and administrative  -   -   23,901   23,901 
Research and development  -   -   2,052   2,052 
Operating income (loss) $20,126  $16,729  $(26,122) $10,733 

Geographic Segment Financial Data

Information concerning Fuel Tech’s operations by geographic area is provided below.  Revenues are attributed to countries based on the location of the customer.  Assets are those directly associated with operations of the geographic area.


  
For the years ended December 31 (in thousands)
 
 2006 2005 2004 
        
Net sales:       
United States $57,628 $41,721 $26,093 
Foreign  17,487  11,207  4,739 
  $75,115 $52,928 $30,832 
For the years ended December 31 2008  2007  2006 
          
Revenues:         
United States $68,433  $67,534  $57,628 
Foreign  12,641   12,763   17,487 
  $81,074  $80,297  $75,115 
December 31
 2006
 
2005
 
2004 
Assets:       
United States $62,190 $39,959 $21,641 
Foreign  3,470  4,116  2,187 
  $65,660 $44,075 $23,828 

During 2006 and 2005,
December 31, 2008  2007  2006 
Assets:         
United States $81,241  $79,132  $62,190 
Foreign  7,632   8,082   3,470 
  $88,873  $87,214  $65,660 

For the year ended December 31, 2008, Fuel Tech realized 24.5%had two customers that individually represented greater than 10% of revenues.  In total these two customers represented 28% of revenues, one procuring products solely from the APC technology segment and 13.1%, respectively,the other procuring products solely from the FUEL CHEM technology segment.

For the year ended December 31, 2007, Fuel Tech had two customers that individually represented greater than 10% of itsrevenues.  In total, these two customers represented 23% of revenues from one customer. This customerand utilized the product line offered by Fuel Tech’s Nitrogen Oxide Reduction businessAPC technology segment.

For the year ended December 31, 2006, Fuel Tech had one customer that represented greater than 10% of revenues.  This customer represented 25% of revenues and utilized the product line offered by Fuel Tech’s APC technology segment.
 
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QUARTERLY FINANCIAL DATA
Quarterly Financial Data

Set forth below are the unaudited quarterly financial data for the fiscal years ended December 31, 20062008 and 2005.2007.

For the quarters ended:
 March 31 June 30 September 30 December 31 
(in thousands, except share data)         
          
2006 (a)
         
Net sales $17,121 $19,759 $20,173 $18,062 
Cost of sales  9,056  10,112  10,042  9,219 
Net income  1,350  1,958  2,060  1,458 
Net income per Common Share:             
Basic $0.07 $0.09 $0.09 $0.07 
Diluted $0.06 $0.08 $0.09 $0.06 
              
2005 (b)
             
Net sales $12,051 $11,780 $12,821 $16,276 
Cost of sales  6,397  6,053  6,467  8,201 
Net (loss) income  753  3,172  1,048  2,615 
Net (loss) income per Common Share:             
Basic $0.04 $0.16 $0.05 $0.13 
Diluted $0.03 $0.14 $0.05 $0.11 
For the quarters ended: March 31  June 30  September 30  December 31 
             
2008 (a)            
Revenues $20,467  $18,791  $23,703  $18,113 
Cost of sales  10,669   9,833   13,019   10,824 
Net income  1,633   447   2,102   (580)
Net income (loss) per Common Share:                
Basic $0.07  $0.02  $0.09  $(0.02)
Diluted $0.07  $0.02  $0.09  $(0.02)
                 
2007 (b)                
Revenues $16,262  $16,210  $15,246  $32,579 
Cost of sales  8,957   9,083   8,018   16,413 
Net income  792   282   927   5,242 
Net  income per Common Share:                
Basic $0.04  $0.01  $0.04  $0.23 
Diluted $0.03  $0.01  $0.04  $0.21 

(a) The total of the basic and diluted net income amounts per share for the four quarters ending December 31, 20062008 does not sum to the amounts presented on the consolidated statement of income for the year ending December 31, 20062008 due to rounding.

(b) BasedThe total of the basic net income amounts per share for the four quarters ending December 31, 2007 does not sum to the amounts presented on a reviewthe consolidated statement of both historical and projected taxable income at June 30, 2005 Fuel Tech concluded that it was more likely than not that some portion of its net operating losses would be utilized in subsequent years and that a reduction infor the deferred tax asset valuation allowance neededyear ending December 31, 2007 due to be recorded. Fuel Tech recorded a reduction in the deferred tax asset valuation allowance of $2,200,000 in the second quarter of 2005 representing the anticipated utilization of net operating loss carryforwards in subsequent years.rounding.

In the fourth quarter ended December 31, 2005, Fuel Tech recorded a $2,099,000 reduction in the deferred tax asset valuation allowance primarily due to the anticipated utilization of net operating loss and research and development tax credit carryforwards. Based on a review of both historical and projected taxable income at the end of December 31, 2005, Fuel Tech concluded that it was more likely than not that carryforwards would be utilized in subsequent periods and that a reduction in the deferred tax valuation allowance was required.12.    BUSINESS ACQUISITIONS

Fuel Tech accounts for its acquisitions as purchases.  Accordingly, in connections with each acquisition, the purchase price is allocated to the estimated fair values of all acquired tangible and intangible assets and assumed liabilities as of the date of the acquisition.
Tackticks, LLC & FlowTack, LLC
On October 2, 2008, Fuel Tech completed its acquisitions of substantially all of the assets and assumed certain liabilities of Durham, North Carolina-based Tackticks, LLC (Tackticks) and FlowTack, LLC (FlowTack) for a total cash consideration of $4,000.  No future consideration is due.  We believe the addition of these companies will make Fuel Tech a synergistically more powerful company by broadening its product offerings, strengthening its modeling capabilities, exposing it to a new client base, and enabling it to participate in the sizable SCR end of the air pollution control market in a more meaningful way.  The addition of the two management teams, including one of the world’s foremost experts in the design and optimization of traditional catalyst-based SCR systems, will significantly enhance Fuel Tech’s ability to sell hybrids such as our NOxOUT CASCADE offering, which integrates a single layer of catalyst into the Selective Non-Catalytic Reduction process.  Tackticks and FlowTack will be reported as part of the APC segment.

The acquisition was accounted for as a purchase and, accordingly, the purchase price plus acquisition costs of approximately $4.2 million was allocated to the fair market values of acquired tangible and intangible assets of approximately $4.9 million and assumed liabilities of approximately $0.7 million as of October 3, 2008.  Intangible assets acquired include, among others, customer relationships, covenants not to compete, and technology with a fair value of approximately $0.9 million.  Based upon a preliminary purchase price allocation, goodwill of approximately $3.0 million has been recorded.  We expect the goodwill balance to be deductible for income tax purposes.  Subsequent adjustments may be made to the purchase price and purchase price allocation based upon, among other things, the settlement of the tangible net worth calculation; however, we do not expect that any such adjustments will be material.

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Advanced Combustion Technology, Inc.
On December 5, 2008, Fuel Tech signed a definitive agreement to acquire certain assets and assume certain liabilities of Hooksett, New Hampshire-based Advanced Combustion Technology, Inc. (ACT) for approximately $22,000 in cash plus performance-based contingent payments.  We believe the addition of ACT’s nitrogen oxide (NOx) control systems, including low-NOx burners and over-fire air systems, will strengthen Fuel Tech’s position in the combustion modification market and will provide us with a total technical solution for NOx control from the burner to the stack.  In addition, this acquisition should provide a natural conduit for potential follow-on business from those clients requiring deeper emission reductions that can only be satisfied with post-combustion NOx controls.  Our customers should benefit from the added flexibility afforded by ACT’s HERT High Energy Reagent Technology system, which will complement Fuel Tech’s suite of post-combustion technical solutions based on our NOxOUT technologies.  The acquisition closed on January 5, 2009; see note 13 – Subsequent Events, for additional information.  ACT will be reported as part of the APC segment.
13.    SUBSEQUENT EVENTS

On January 6, 2009 Fuel Tech announced that it had completed its acquisition of substantially all of the assets of Advanced Combustion Technology, Inc. and is currently in the process of allocating the purchase price to the fair market values of acquired tangible and intangible assets and assumed liabilities as of January 5, 2009.

ITEM 9.9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None

ITEM 9A.9A - CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

AsUnder the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, our management evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act), as of the end of the period covered by this Annual Report on Form 10-K (the “Evaluation Date”).  Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the Evaluation Date, our disclosure controls and procedures are effective to ensure that information required by Rule 13a-15(b)to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms and (ii) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as amended (the “Exchange Act”),appropriate to allow timely decisions regarding required disclosure.

Change in Internal Controls

There has been no change in our internal control over financial reporting that occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Management’s Report on Internal Control Over Financial Reporting

Fuel Tech’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Exchange Act.  As required by Rule 13a-15(c) under the Exchange Act, Fuel Tech’s management carried out an evaluation, with the participation of Fuel Tech’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of Fuel Tech’s disclosure controls and procedures,its internal control over financial reporting as of the end of the last fiscal quarter.year.  The framework on which such evaluation was based is contained in the report entitled “Internal Control—Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO Report”).

Fuel Tech’s system of internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.  Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Based upon that evaluation, the Chief Executive Officer and Chief Financial Officeron its assessment, management has concluded that Fuel Tech maintained effective internal control over financial reporting as of December 31, 2006, Fuel Tech’s disclosure controls and procedures were operating effectively to ensure that information required to be disclosed2008, based on criteria in “Internal Control - Integrated Framework” issued by Fuel Tech in the reports that Fuel Tech files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms.

Internal Control Over Financial ReportingCOSO.

Management’sGrant Thornton, LLP, our independent registered public accounting firm, who audited and reported on the consolidated financial statements included in this Annual Report on Internal ControlForm 10-K, has issued an attestation report on the effectiveness of our internal control over Financial Reporting and our Independent Registered Public Accounting Firm’s Attestationfinancial reporting.  This attestation report is included on page 23 of this Annual Report are included at Item 8.on Form 10-K.

Change in Internal Control Over Financial ReportingITEM 9B - OTHER INFORMATION

There were no significant changes in internal controls or in other factors that could significantly affect these controls during the quarter ended December 31, 2006.

ITEM 9B. OTHER INFORMATION
None

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PART III

ITEM 10.10 – DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

Information required by this Item will be set forth under the captions “Election of Directors,” “Directors and Executive Officers of Fuel Tech,” “Compensation Committee,” “Audit Committee,” and “Financial Experts” in Fuel Tech’s Proxy Statement related to the 20072009 Annual Meeting of ShareholdersStockholders (the “Proxy Statement”) and is incorporated by reference.

Fuel Tech has adopted a Code of Ethics and Business Conduct (the “Code”) that applies to all employees, officers and directors, including the Chief Executive Officer, Chief Financial Officer and Controller.  A copy of the Code is available free of charge to any person on written or telephone request to Fuel Tech’s Investor Relations at the address or telephone number set out in Fuel Tech’s Annual Report to Shareholders.Stockholders.  The Code is also available on Fuel Tech’s website at www.ftek.comwww.ftek.com.

The identities of the Fuel Tech directors and other information concerning the directors and executive officers of Fuel Tech and relating to corporate governance will be set forth under the captions “Election of Directors,” “Audit Committee,” “Compensation and Nominating Committee,” “Financial Experts,” “Corporate Governance” and “General” in Fuel Tech’s Proxy Statement related to its 20072009 Annual Meeting of Stockholders and is incorporated by reference.

The identities of and the employment history of Fuel Tech executive officers with Fuel Tech or its affiliates who are not directors are as follows:

Vincent M. Albanese, 58,60, has been Senior Vice President, Regulatory Affairs since February 28,, 2007; previously he had been Senior Vice President, Advanced Technology and Regulatory Affairs since April, 5, 2006; Senior Vice President, Air Pollution Control, Sales and Marketing since May, 2000; Vice President, Air Pollution Control since April, 1998 and Vice President, Sales and Marketing since 1990.

Ellen TT. Albrecht, 34,36, has been Vice President, and Controller since December, 7, 2006; previously she had been Controller since February, 1, 2004; Accounting Manager since May, 2001; and Senior Accountant since July, 1996.

Vincent J. Arnone, 43,Stephen P. Brady, 52, has been Senior Vice President, Treasurer and Chief Financial OfficerFuel Chem Sales since February 28, 2006;January, 2009; previously he had been Vice President, Treasurer and Chief Financial Officer since December, 2003; and Controller since May, 1999.

Stephen P. Brady, 50, became Senior Vice President, Sales and Marketing onsince April, 5, 2006; previously he had been Senior Vice President, Fuel Chem since January, 2002; and Vice President, Fuel Chem since February, 1998.

William E. Cummings, Jr., 50, became52, has been Senior Vice President, APC Sales since January, 2009; previously he had been Vice President, Sales onsince April, 5, 2006; previously he had been Vice President, Air Pollution Control Sales since May, 2000; Director, Utility Sales since April, 1998; and Director, Eastern Region since 1994.

Kevin R. Dougherty, 45, became46, has been Vice President, Business Development and Marketing onsince April, 5, 2006; previously he had been Vice President, Corporate Marketing and Procurement since December, 2005; Director, Marketing and Sales Administration, Air Pollution Control since November, 2000; and Manager, Contracts Administration, Air Pollution Control since 1999.

Timothy Eibes, 50,52, has been Vice President, Project Execution since August, 21, 2006; previously he had been employed by Alliant Energy, Inc. since 1987, his last position being Vice President, Asset Management.

John P. Graham, 43, has been Senior Vice President, Treasurer and Chief Financial Officer since June, 2008 after joining the Company as Senior Vice President in April, 2008; previously he had been employed as Chief Financial Officer of Hub International from 2006 to 2007 and as Senior Vice President, Finance, Treasurer and Assistant Secretary of Career Education Corporation from 2002 to 2006.

Albert G. Grigonis, 58, has been Vice President, General Counsel and Secretary since December, 2008; previously he had been Assistant General Counsel since July, 2008; and Corporate Counsel since July, 2003.

Charles W. Grinnell, 71, was Vice President, Legal Affairs since December, 2008 after serving as the Company’s Vice President, General Counsel and Secretary since 1988.  Mr. Grinnell retired from Fuel Tech on January 31, 2009 and now serves solely as a member of the Company’s Board of Directors.

Tracy Krumme, 39,41, has been Vice President, Investor Relations and Corporate Communications since December, 7, 2006; previously she had been Director, Investor Relations since September, 2002.

Dr. M. Linda Lin, 58, became60, has been Senior Vice President, China/Pacific Rim on December 7, 2006;since August, 2008; previously she had been Vice President, China/Pacific Rim since December, 2006; Vice President Asia/Pacific since April, 5, 2006; Marketing Manager since 1992; and Research Associate/Research Manager since 1990.

46
 
Michael P. Maley, 49, became50, prior to his resignation from Fuel Tech effective February 13, 2009, had been Senior Vice President, International Business Development and Project Execution onsince joining the Company in April, 5, 2006; previously he had been employed as President and Chief Operating Officer of Alliant Energy Generation from 2001 to 2005; Vice President of Business Development of Calpine Corporation since 1998; and Vice President of Project Development of Cogentrix Energy LLC since 1993.

Volker Rummenhohl, 51, has been Vice President, Catalyst Technologies since joining the Company on October 3, 2008; previously he had been President of Tackticks, LLC since February, 2001 and co-majority owner of FlowTack, LLC, since December, 2003.  Substantially all of the assets of both companies were acquired by Fuel Tech on October 3, 2008 in an asset purchase.

Nolan R. Schwartz, 56, became57, has been Vice President, Strategic Business Development since August, 2008; he had been Vice President, Corporate Development onsince January, 1, 2004; previously he had been2004 and a director of Fuel Tech, Inc., a former subsidiary of Fuel Tech, since 1998; and, prior to that, a principal of American Bailey Corporation.

Christopher R. Smyrniotis, 54, became56, has been Vice President, Fuel Chem Technologies onsince April 5, 2006; previously he had been Vice President, Fuel Chem Technology and Market Development since December, 2005;2003; Director of Marketing and Technology, Fuel Chem since October, 1998; and Market Development manager since 1993.
45

Dr. William H. Sun, 50, became51, has been Vice President, Europe, India and Latin America since February 9, 2009; he had been Vice President, Air Pollution Technologies onsince April, 5, 2006; previously he had been Vice President and Chief Technology Officer since December, 2003; Vice President, Engineering and Technology since April, , 1998; and Director of Process Engineering since 1990.

ITEM 11.11 - EXECUTIVE COMPENSATION

Information required by this Item will be set forth under the caption “Executive Compensation” in the Proxy Statement and is incorporated by reference.

ITEM 12.12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

InformationThe following table provides information for all equity compensation plans as of the fiscal year ended December 31, 2008, under which the securities of Fuel Tech were authorized for issuance:

Plan Category 
Number of Securities to be
issued upon exercise of
outstanding options, warrants
and rights
  
Weighted-average
exercise price of
outstanding options,
warrants and rights
  
Number of securities
remaining available for
future issuance under equity
compensation plans
excluding securities listed in
column (a)
 
  (a)  (b)  (c) 
Equity compensation plans approved by security holders (1)  2,905,325  $16.31   471,712 

(1)Includes Common Shares of Fuel Tech authorized for awards under Fuel Tech’s Incentive Plan, as amended through June 3, 2004.

In addition to the above, Fuel Tech has a Deferred Compensation Plan for directors under which 100,000 Common Shares of Fuel Tech stock have been reserved for issuance as a form of deferred compensation with respect to directors fees elected to be deferred.  At December 31, 2008, 47,677 Common Shares have been earned as stock units to be granted on a one to one basis in Common Shares at the election of the Directors.

Further information required by this Item will be set forth under the caption “Principal ShareholdersStockholders and Stock Ownership of Management” in the Proxy Statement and is incorporated by reference.

ITEM 13.13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

Information required by this Item will be set forth under the captions “Compensation Committee Interlocks and Insider Participation” and “Certain Relationships and Related Transactions” in the Proxy Statement and is incorporated by reference.

ITEM 14.14 - PRINCIPAL ACCOUNTINGACCOUNTANT FEES AND SERVICES

Information required by this Item will be set forth under the caption “Approval of Appointment of Auditors” in the Proxy Statement and is incorporated by reference.
 
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PART IV


ITEM 15.15 - EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a)(1) Financial Statements
(a)(1) Financial Statements

The financial statements identified below and required by Part II, Item 8 of this Form 10-K are set forth above.

Management’s Report on Internal Control Over Financial Reporting
Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting
Report of Independent Registered Public Accounting Firm
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2006 and 2005
Consolidated Statements of Income for Years Ended December 31, 2006, 2005 and 2004
Consolidated Statements of Shareholders’ Equity for the Years Ended December 31, 2006, 2005 and 2004
Consolidated Statements of Cash Flows for the Years Ended December 31, 2006, 2005 and 2004
Notes to Consolidated Financial Statements
Management’s Report on Internal Control Over Financial Reporting
Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting
Report of Independent Registered Public Accounting Firm
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2008 and 2007
Consolidated Statements of Income for Years Ended December 31, 2008, 2007 and 2006
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2008, 2007 and 2006
Consolidated Statements of Cash Flows for the Years Ended December 31, 2008, 2007 and 2006
Notes to Consolidated Financial Statements

(2) Financial Statement Schedules

Schedule II - Valuation and Qualifying Accounts

Fuel Tech, Inc. - Allowance for Doubtful Accounts:

Year 
Balance at
January 1
 Charged to costs and expenses (Deductions)/Other 
Balance at
December 31
 
2004 $311,000  92,000  (329,000)$74,000 
2005 $74,000  26,000  50,000 $150,000 
2006 $150,000  -  - $150,000 
Fuel Tech, Inc. - Valuation Allowance for Deferred Tax Assets:
Year 
Balance at
January 1
 Charged to costs and expenses (Deductions)/Other 
Balance at
December 31
 
2004 $7,580,000  -  (3,236,000)$4,344,000 
2005 $4,344,000  -  (4,299,000) $45,000 
2006 $45,000  215,000  - $260,000 
(2) Financial Statement Schedules
 
All other schedules have been omitted because of the absence of the conditions under which they are required or because the required information, where material, is shown in the financial statements or the notes thereto.
 
47
(3) Exhibits

^^3.1Certificate of Incorporation of Fuel Tech, Inc. filed September 30, 2006
^^3.2Certificate of Conversion of Fuel Tech, Inc. filed September 30, 2006
^^3.3By-Laws of Fuel Tech, Inc. adopted September 30, 2006
*4.1Instrument Constituting US $19,200,000 Nil Coupon Non-Redeemable Convertible Unsecured Loan Notes of Fuel-Tech N.V., dated December 21, 1989
*4.2First Supplemental Instrument Constituting US $3,000,000 Nil Coupon Non-Redeemable Convertible Unsecured Loan Notes of Fuel-Tech N.V., dated July 10, 1990
**4.3Instrument Constituting US $6,000,000 Nil Coupon Non-Redeemable Convertible Unsecured Loan Notes of Fuel-Tech N.V., dated March 12, 1993
**4.4Form of Warrants issued April 30, 1998 evidencing right to purchase 3 million shares of Fuel-Tech N.V. Common Stock.
^^^4.5Fuel Tech, Inc. Incentive Plan as amended through June 3, 2004
o4.6Fuel Tech, Inc. Form of Non-Executive Director Stock Option Agreement.
o
4.7Fuel Tech, Inc. Form of Non-Qualified Stock Option Agreement.
o
4.8Fuel Tech, Inc. Form of Incentive Stock Option Agreement.
^4.9The Business Loan Agreement dated as of July 31, 2006 between Wachovia Bank N.A. and Fuel Tech, Inc.
**10.1Securities Purchase Agreement dated as of March 23, 1998, between Fuel-Tech N.V., and the several Investors signatory thereto, including exhibits.
#&10.2License Agreement dated November 18, 1998 between The Gas Technology Institute and Fuel Tech, Inc. relating to the FLGR Process
#&10.3Amendment No. 1, dated February 28, 2000, to License Agreement of November 18, 1998 between The Gas Technology Institute and Fuel Tech, Inc.
oooo
10.4Employment Agreement as of February 28, 2006 between John (Johnny) F. Norris, Jr. and Fuel Tech, Inc.
^^^^10.5Form of Indemnity Agreement between Fuel Tech, Inc. and its Directors and Officers
oo
19.0Those portions of the Proxy Statement to be distributed to Shareholders of Fuel Tech for the 2007 Annual Meeting of Shareholders of Fuel Tech, Inc. specifically incorporated by reference into this Annual Report on Form10-K.
o
23.1Consent of Independent Registered Public Accounting Firm
o
23.2Consent of Independent Registered Public Accounting Firm
o
31.1Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
o
31.2Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
o
32.0Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

48
 
The following are incorporated by reference from the documents indicated.
*
Filed with Registration Statement on Form 20-F, No. 000-21724 on August 26, 1993, as amended
**Filed with Registrant’s Report on Form 6-K for the month of March 1998
†Filed with Registrant’s Report on Form 20-F for the year 1997
o
Filed herewith
oo
Filed with the Registrant’s definitive proxy material for its 2007 Annual Meeting
oooo
Filed with Registrant’s report on Form 10-K for the year 2006
#Confidential information removed and filed separately
&Filed with Registrant’s report on Form 10-K for the year 1999
^Filed with Registrant’s Form 8-K on August 10, 2006
^^Filed with Registrant’s Form 8-K on September 30, 2006
^^^
Filed with Registration Statement on Form S-8 No. 333-137735 on October 2nd 2006
^^^^Filed with Registrant’s Form 8-K on February 7, 2007
   (3) Exhibits                    
                          
            Incorporated by reference
Exhibit  Description  
Filed
herewith
  Form  
Period
ending
  Exhibit  Filing date
               
3.1  Certificate of Incorporation of Fuel Tech, Inc.   8-K   3.2 10/05/06
             
3.2  Certificate of Conversion of Fuel Tech, Inc.   8-K   3.1 10/05/06
             
3.3  By-Laws of Fuel Tech, Inc.   8-K   3.3 10/05/06
             
4.1  Instrument Constituting US $19,200 Nil Coupon Non-Redeemable Convertible Unsecured Loan Notes of Fuel-Tech N.V., dated December 21, 1989   20-F   4.1 08/26/93
             
4.2  First Supplemental Instrument Constituting US $3,000 Nil Coupon Non-Redeemable Convertible Unsecured Loan Notes of Fuel-Tech N.V., dated July 10, 1990   20-F   4.2 08/26/93
             
4.3  Instrument Constituting US $6,000 Nil Coupon Non-Redeemable Convertible Unsecured Loan Notes of Fuel-Tech N.V., dated March 12, 1993   6-K 03/31/93 4.3 04/01/93
             
4.4*  Fuel Tech, Inc. Incentive Plan as amended through June 3, 2004   S-8   4.5 10/02/06
             
4.5*  Fuel Tech, Inc. Form of Non-Executive Director Stock Option Agreement   10-K 12/31/06 4.6 03/06/07
             
4.6*  Fuel Tech, Inc. Form of Non-Qualified Stock Option Agreement   10-K 12/31/06 4.7 03/06/07
             
4.7*  Fuel Tech, Inc. Form of Incentive Stock Option Agreement   10-K 12/31/06 4.8 03/06/07
             
4.8 Business Loan Agreement, dated as of July 31, 2006, between Wachovia Bank N.A. and Fuel Tech, Inc.   8-K   99.1 08/10/06
 
49
 
         Incorporated by reference
Exhibit  Description  
Filed
herewith
  Form  
Period
ending
  Exhibit  Filing date
             
10.1  Securities Purchase Agreement dated as of March 23, 1998, between Fuel-Tech N.V., and the several Investors signatory thereto, including exhibits.     6-K  03/31/98  10.1  04/01/98
             
10.2  License Agreement dated November 18, 1998 between The Gas Technology Institute and Fuel Tech, Inc. relating to the FLGR Process (Certain confidential information removed and filed separately).     10-K  12/31/99  3.28  03/30/00
             
10.3  Amendment No. 1, dated February 28, 2000, to License Agreement dated November 18, 1998 between The Gas Technology Institute and Fuel Tech, Inc. relating to the FLGR Process (Certain confidential information removed and filed separately).     10-K  12/31/99  3.29  03/30/00
             
10.4  Employment Agreement as of February 28, 2006 between John (Johnny) F. Norris Jr. and Fuel Tech, Inc.     10-K  12/31/05  3.18  03/10/06
             
10.5  Amendment to Employment Agreement as of February 28, 2007  between John (Johnny) F. Norris Jr. and Fuel Tech, Inc.     10-K  12/31/07  10.5  03/05/08
             
10.6  Form of Indemnity Agreement between Fuel Tech, Inc. and its Directors and Officers.     8-K     99.1  02/07/07
             
10.7  Restated Supply Agreement, dated March 4, 2009, between Fuel Tech, Inc. and Martin Marietta Magnesia Specialties, LLC (Certain confidential information removed and filed separately).  X        
             
10.8  Asset Purchase Agreement, dated December 5, 2008, among Fuel Tech, Inc., Advanced Combustion Technology, Inc., Peter D. Marx, Robert W. Pickering and Charles E. Trippel.  X        
             
23.1  Consent of Independent Registered Public Accounting Firm  X        
             
31.1  Certifications of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. X        
             
31.2 Certifications of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. X        
             
31.3 Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. X        
             
31.4  Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. X        

*Indicates a management contract or compensatory plan or arrangement.
50
SIGNATURES AND CERTIFICATIONS
 
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.

FUEL TECH, INC.
   
Date:  March 6, 20075, 2009By:/s/ John F. Norris Jr.
 
John F. Norris Jr.
 Chief Executive Officer President and Director
     (Principal Executive Officer)
   
Date:  March 6, 20075, 2009By:/s/ Vincent J. ArnoneJohn P. Graham
 
Vincent J. Arnone
     John P. Graham
 
Chief Financial Officer
Sr. Vice President and
Treasurer
     (Principal Financial Officer)
 
5051

Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been duly signed below by the following persons on behalf of Fuel Tech, Inc. and in the capacities and on the date indicated.

Date: March 6, 20075, 2009

SignatureTitle
/s/ Ralph E. Bailey Executive Chairman and Director
Ralph E. Bailey
  
   
/s/ Douglas G. Bailey Deputy Chairman and Director
Douglas G. Bailey
/s/ Thomas J. ShawDirector
Thomas J. Shaw  
   
/s/ Miguel Espinosa Director
Miguel Espinosa  
   
/s/ Samer S. KhanachetCharles W. Grinnell Director
Samer S. Khanachet      Charles W. Grinnell
/s/ Thomas L. JonesDirector
      Thomas L. Jones  
   
/s/ John D. Morrow Director
John D. Morrow  
   
/s/ John F. Norris Jr.Director, President and Chief Executive Officer
      John F. Norris Jr.(Principal Executive Officer)
/s/ Thomas L. JonesS. Shaw, Jr. Director
Thomas L. JonesS. Shaw, Jr.  
   
/s/ Charles W. GrinnellDelbert L. Williamson Director Vice President, General Counsel and Corporate Secretary
Charles W. Grinnell      Delbert L. Williamson  
/s/ Ellen T. AlbrechtVice President and Controller
      Ellen T. Albrecht(Controller)
/s/ John P. GrahamSr. Vice President, Chief Financial Officer and Treasurer
      John P. Graham(Principal Financial Officer)
 
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