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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2011
or
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission file number: 001-33059
FUEL TECH, INC.
(Exact name of registrant as specified in its charter)
     
Delaware   20-5657551
(State or other jurisdiction of incorporation of organization)   (I.R.S. Employer Identification Number)
Fuel Tech, Inc.
27601 Bella Vista Parkway
Warrenville, IL 60555-1617
630-845-4500
www.ftek.com
(Address and telephone number of principal executive offices)
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 þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
             
Large accelerated filer o   Accelerated filer þ   Non-accelerated filer o (Do not check if a smaller reporting company)   Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
On August 5, 2011 there were outstanding 24,334,515 shares of Common Stock, par value $0.01 per share, of the registrant.
 
 

 


 

FUEL TECH, INC.
Form 10-Q for the six-month period ended June 30, 2011
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 EX-4.1
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 EX-32
 EX-101 INSTANCE DOCUMENT
 EX-101 SCHEMA DOCUMENT
 EX-101 CALCULATION LINKBASE DOCUMENT
 EX-101 LABELS LINKBASE DOCUMENT
 EX-101 PRESENTATION LINKBASE DOCUMENT
 EX-101 DEFINITION LINKBASE DOCUMENT

 


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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
FUEL TECH, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
                 
    June 30,     December 31,  
    2011     2010  
    (Unaudited)          
Assets
               
Current assets:
               
Cash and cash equivalents
  $ 30,647     $ 30,524  
Marketable securities
    109        
Accounts receivable, net of allowance for doubtful accounts of $152 and $82, respectively
    21,500       21,175  
Inventories
    648       807  
Deferred income taxes
    129       89  
Prepaid expenses and other current assets
    1,759       1,861  
 
           
Total current assets
    54,792       54,456  
 
               
Property and equipment, net of accumulated depreciation of $17,406 and $15,767, respectively
    14,021       14,384  
Goodwill
    21,051       21,051  
Other intangible assets, net of accumulated amortization of $3,658 and $3,203, respectively
    5,755       6,050  
Deferred income taxes
    4,894       5,000  
Other assets
    2,337       2,262  
 
           
Total assets
  $ 102,850     $ 103,203  
 
           
Liabilities and Shareholders’ Equity
               
Current liabilities:
               
Short-term debt
  $ 2,321     $ 2,269  
Accounts payable
    6,647       7,516  
Accrued liabilities:
               
Employee compensation
    1,958       2,863  
Income taxes payable
    412       1,857  
Other accrued liabilities
    2,369       3,306  
 
           
Total current liabilities
    13,707       17,811  
 
               
Other liabilities
    1,567       1,482  
 
             
Total liabilities
    15,274       19,293  
Shareholders’ equity:
               
Common stock, $.01 par value, 40,000,000 shares authorized, 24,334,515 and 24,213,467 shares issued and outstanding
    243       242  
Additional paid-in capital
    131,153       129,424  
Accumulated deficit
    (44,306 )     (46,075 )
Accumulated other comprehensive income
    410       243  
Nil coupon perpetual loan notes
    76       76  
 
           
Total shareholders’ equity
    87,576       83,910  
 
           
Total liabilities and shareholders’ equity
  $ 102,850     $ 103,203  
 
           
See notes to consolidated financial statements.

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FUEL TECH, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands, except share and per-share data)
                                 
    Three Months Ended     Six Months Ended  
    June 30     June 30  
    2011     2010     2011     2010  
Revenues
  $ 19,021     $ 18,902     $ 41,643     $ 36,519  
 
                               
Costs and expenses:
                               
Cost of sales
    10,553       11,067       22,019       20,567  
Selling, general and administrative
    7,966       8,018       15,917       15,498  
Gain on revaluation of ACT liability
    (758 )           (758 )      
Research and development
    315       165       717       311  
 
                       
 
    18,076       19,250       37,895       36,376  
 
                       
 
                               
Operating income (loss)
    945       (348 )     3,748       143  
 
                               
Interest expense
    (38 )     (33 )     (78 )     (77 )
Interest income
    4       1       5       2  
Other expense
    (155 )     (166 )     (195 )     (258 )
 
                       
Income before income taxes
    756       (546 )     3,480       (190 )
 
                               
Income tax (expense) benefit
    (326 )     237       (1,711 )     95  
 
                       
 
                               
Net income (loss)
  $ 430     $ (309 )   $ 1,769     $ (95 )
 
                       
 
                               
Net income (loss) per common share:
                               
Basic
  $ 0.02     $ (0.01 )   $ 0.07     $ 0.00
 
                       
Diluted
  $ 0.02     $ (0.01 )   $ 0.07     $ 0.00
 
                       
 
                               
Weighted-average number of common shares outstanding:
                               
Basic
    24,269,000       24,215,000       24,242,000       24,213,000  
 
                       
Diluted
    24,909,000       24,215,000       24,900,000       24,213,000  
 
                       
See notes to consolidated financial statements.

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FUEL TECH, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
                 
    Six Months Ended  
    June 30  
    2011     2010  
Operating Activities
               
Net income (loss)
  $ 1,769     $ (95 )
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
               
Depreciation
    1,534       1,626  
Amortization
    455       443  
(Gain) loss on equipment disposals
    (2 )     6  
Gain on revaluation of ACT liability
    (758 )      
Deferred income taxes
    (253 )     (887 )
Stock based compensation
    1,696       2,569  
Bad debt expense
    70       2  
Changes in operating assets and liabilities:
               
Accounts receivable
    (185 )     (4,435 )
Inventories
    168       5  
Prepaid expenses, other current assets and other noncurrent assets
    37       32  
Accounts payable
    (935 )     12  
Accrued liabilities and other noncurrent liabilities
    (2,675 )     2,099  
 
           
Net cash provided by operating activities
    921       1,377  
 
               
Investing Activities
               
Decrease in restricted cash
          200  
Proceeds from the sale of equipment
    2        
Purchases of property, equipment and patents
    (1,242 )     (642 )
 
           
Net cash (used in) investing activities
    (1,240 )     (442 )
 
               
Financing Activities
               
Proceeds from exercise of stock options
    313       10  
Payments on debt
          (722 )
Redemption of nil coupon loan note
          (5 )
 
           
Net cash provided by (used in) financing activities
    313       (717 )
 
               
Effect of exchange rate fluctuations on cash
    129       (117 )
 
           
 
               
Net increase in cash and cash equivalents
    123       101  
 
               
Cash and cash equivalents at beginning of period
    30,524       20,965  
 
           
 
               
Cash and cash equivalents at end of period
  $ 30,647     $ 21,066  
 
           
See notes to consolidated financial statements.

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FUEL TECH, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2011
(Unaudited)
(in thousands, except share and per-share data)
Note A: Nature of Business
Fuel Tech, Inc. (Fuel Tech or the Company or “we”, “us”, or “our”) 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 27601 Bella Vista Parkway, Warrenville, Illinois, 60555-1617. Fuel Tech maintains an Internet website at www.ftek.com. Fuel Tech’s 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 as amended (Exchange Act), are made available through our website as soon as reasonably practical after electronically filed or furnished to the Securities and Exchange Commission. Also available on Fuel Tech’s website are the Company’s Corporate Governance Guidelines and Code of Ethics and Business Conduct, as well as the charters of the Audit and Compensation & 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.
Fuel Tech’s special focus is the worldwide marketing of its nitrogen oxide (NOx) reduction and FUEL CHEM® processes. The Air Pollution Control (APC) technology segment reduces NOx emissions in flue gas from boilers, incinerators, furnaces and other stationary combustion sources by utilizing combustion optimization techniques and Low NOx and Ultra Low NOx Burners; Over-Fire Air systems, NOxOUT® and HERT High Energy Reagent Technology SNCR systems; systems that incorporate ASCR (Advanced Selective Catalytic Reduction) technologies including NOxOUT-CASCADE®, ULTRAand NOxOUT-SCR® processes, Ammonia Injection Grid (AIG) and Graduated Straightening Grid (GSG™). The FUEL CHEM® technology segment improves the efficiency, reliability and environmental status of combustion units by controlling 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 through the addition of chemicals into the fuel or via TIFI® Targeted In-Furnace Injection™ programs. Fuel Tech has other technologies, both commercially available and in the development stage, all of which are related to APC and FUEL CHEM technology segments or are similar in their technological base. We have expended significant resources in the research and development of new technologies in building our proprietary portfolio of air pollution control, fuel and boiler treatment chemicals, computer modeling and advanced visualization technologies. Fuel Tech’s business is materially dependent on the continued existence and enforcement of worldwide air quality regulations.
Note B: Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Exchange Act. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the balance sheet and results of operations for the periods covered have been included and all significant intercompany transactions and balances have been eliminated. The results of operations of all acquired businesses have been consolidated for all periods subsequent to the date of acquisition.
The balance sheet at December 31, 2010 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.
For further information, refer to the consolidated financial statements and footnotes thereto included in Fuel Tech’s Annual Report on Form 10-K for the year ended December 31, 2010 as filed with the Securities and Exchange Commission.
Note C: Revenue Recognition Policy
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.

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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. Construction costs include all direct costs such as materials, labor, and subcontracting costs, and indirect costs allocable to the particular contract such as indirect labor, tools and equipment, supplies, and depreciation. Revisions in completion estimates and contract values are made in the period in which the facts giving rise to the revisions become known and can influence the timing of when revenues are recognized under the percentage of completion method of accounting. The completed contract method is used for certain contracts when reasonably dependable estimates of the percentage of completion cannot be made. When the completed contract method is used, revenue and costs are deferred until the contract is substantially complete, which usually occurs upon customer acceptance of the installed product. Provisions are made for estimated losses on uncompleted contracts in the period in which such losses are determined. As of June 30, 2011, the Company had no contracts in progress that were identified as loss contracts.
Fuel Tech’s APC contracts are typically eight to sixteen months in length. A typical contract will have three or four critical operational measurements that, when achieved, serve as the basis for us to invoice the customer via progress billings. At a minimum, these 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 APC project agreements, Fuel Tech will agree to customer-specific acceptance criteria that relate to the operational performance of the system that is being 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 us are void if the operating condition information is inaccurate or is not met.
Accounts receivable includes unbilled receivables, representing revenues recognized in excess of billings on uncompleted contracts under the percentage of completion method of accounting. At June 30, 2011 and December 31, 2010, unbilled receivables were approximately $10,139 and $6,800, respectively, and are included in accounts receivable on the consolidated balance sheets. Billings in excess of costs and estimated earnings on uncompleted contracts were $510 and $650, at June 30, 2011 and December 31, 2010, respectively. Such amounts are included in other accrued liabilities on the consolidated balance sheets.
Fuel Tech has installed over 640 units with APC technology and normally provides performance guarantees to our customers based on the operating conditions for the project. As part of the project implementation process, we perform system start-up and optimization services that effectively serve as a test of actual project performance. We 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.
Note D: Cost of Sales
Cost of sales includes all internal and external engineering costs, equipment and chemical charges, inbound and outbound freight expenses, internal and site transfer costs, installation charges, purchasing and receiving costs, inspection costs, warehousing costs, project personnel travel expenses and other direct and indirect expenses specifically identified as project- or product line-related, as appropriate (e.g., test equipment depreciation and certain insurance expenses). Certain depreciation and amortization expenses related to tangible and intangible assets, respectively, are also allocated to cost of sales.
Note E: Selling, General and Administrative Expenses
Selling, general and administrative expenses primarily include the following categories except where an allocation to the cost of sales line item is warranted due to the project- or product-line nature of a portion of the expense category: salaries and wages, employee benefits, non-project travel, insurance, legal, rent, accounting and auditing, recruiting, telephony, employee training, Board of Directors’ fees, auto rental, office supplies, dues and subscriptions, utilities, real estate taxes, commissions and bonuses, marketing materials, postage and business taxes. Departments comprising the selling, general and administrative line item primarily include the functions of executive management, finance and accounting, investor relations, regulatory affairs, marketing, business development, information technology, human resources, sales, legal and general administration.

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Note F: Marketable Securities
At the time of purchase, marketable securities are classified as available-for-sale as management has the intent and ability to hold such securities for an indefinite period of time, but not necessarily to maturity. Any decision to sell available-for-sale securities would be based on various factors, including, but not limited to asset/liability management strategies, changes in interest rates or prepayment risks, and liquidity needs. Available-for-sale securities are carried at fair value with unrealized gains and losses, net of related deferred income taxes, recorded in equity as a separate component of other comprehensive income (OCI). Our marketable securities consist of a single equity investment with a fair value of $109 and no cost basis at June 30, 2011.
Purchases and sales of securities are recognized on a trade date basis. Realized securities gains or losses are reported in other gains/losses in the Consolidated Statements of Operations. The cost of securities sold is based on the specific identification method. On a quarterly basis, we make an assessment to determine whether there have been any events or circumstances to indicate that a security for which there is an unrealized loss is impaired on an other-than-temporary (OTTI) basis. This determination requires significant judgment. OTTI is considered to have occurred (1) if management intends to sell the security, (2) if it is more likely than not we will be required to sell the security before recovery of its amortized cost basis; or (3) the present value of the expected cash flows is not sufficient to recover the entire amortized cost basis. The credit-related OTTI, represented by the expected loss in principal, is recognized in non-interest income, while noncredit-related OTTI is recognized in OCI. Noncredit-related OTTI results from other factors, including increased liquidity spreads and extension of the security. For securities which we do expect to sell, all OTTI is recognized in earnings. Presentation of OTTI is made in the income statement on a gross basis with a reduction for the amount of OTTI recognized in OCI. Once an other-than-temporary impairment is recorded, when future cash flows can be reasonably estimated, future cash flows are re-allocated between interest and principal cash flows to provide for a level-yield on the security. We have not experienced any other-than-temporary impairments during the periods ended June 30, 2011 and 2010.
Note G: Earnings per Share Data
Basic earnings per share excludes the dilutive effects of stock options, restricted stock units (RSUs), and the nil coupon non-redeemable convertible unsecured loan notes. Diluted earnings per share includes the dilutive effect of stock options, restricted stock units, and of the nil coupon non-redeemable convertible unsecured loan notes. The following table sets forth the weighted-average shares used in calculating the earnings per share for the three and six month periods ended June 30, 2011 and 2010.
                                 
    Three Months Ended     Six Months Ended  
    June 30     June 30  
    2011     2010     2011     2010  
Basic weighted-average shares
    24,269       24,215       24,242       24,213  
Conversion of unsecured loan notes
    7             7        
Unexercised options and RSUs
    633             651        
 
                       
Diluted weighted-average shares
    24,909       24,215       24,900       24,213  
 
                       
Note H: Total Comprehensive Income (Loss)
Total comprehensive income for Fuel Tech is comprised of net income, unrealized gains/(losses) from marketable securities that are available for sale, and the impact of foreign currency translation as follows:
                                 
    Three Months Ended     Six Months Ended  
    June 30     June 30  
    2011     2010     2011     2010  
Comprehensive income (loss):
                               
 
                               
Net income (loss)
  $ 430     $ (309 )   $ 1,769     $ (95 )
 
                               
Foreign currency translation
    38       (58 )     99       (117 )
Unrealized gains from marketable securities, net of tax
    68             68        
 
                       
 
  $ 536     $ (367 )   $ 1,936     $ (212 )
 
                       

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Note I: Stock-Based Compensation
Fuel Tech has a stock-based employee compensation plan, referred to as the Fuel Tech, Inc. Incentive Plan (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 (RSUs), Performance Awards, Bonuses or other forms of share-based or non-share-based awards or combinations thereof. Participants in the Incentive 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 Incentive Plan is 12.5% of outstanding shares calculated on a diluted basis. At June 30, 2011, Fuel Tech had approximately 970,000 equity awards available for issuance under the Incentive Plan.
Stock-based compensation is included in selling, general, and administrative costs in our consolidated statements of operations. The components of stock-based compensation for the three and six month periods ended June 30, 2011 and 2010 were as follows:
                                 
    Three Months Ended     Six Months Ended  
    June 30     June 30  
    2011     2010     2011     2010  
Stock options
  $ 869     $ 1,352     $ 1,405     $ 2,519  
 
                               
Restricted stock units
    173             254        
 
                               
Deferred directors fees
    17       22       37       50  
 
                       
 
                               
Total stock-based compensation expense
    1,059       1,374       1,696       2,569  
 
                               
Tax benefit of stock-based compensation expense
    (355 )     (469 )     (550 )     (868 )
 
                       
 
                               
After-tax effect of stock based compensation
  $ 704     $ 905     $ 1,146     $ 1,701  
 
                       
As of June 30, 2011, there was $4,198 of total unrecognized compensation cost related to all non-vested share-based compensation arrangements granted under the Incentive Plan.
Stock Option Exchange Program
On June 1, 2011 the Company commenced an exchange offer that offered to certain employees the right to exchange eligible options to purchase shares of common stock of the Company for a lesser number of replacement awards of restricted stock units. The exchange offer expired on June 29, 2011. Pursuant to the exchange offer, 814,500 eligible options were tendered and the Company granted 267,372 restricted stock units in exchange for those options. As a result of the exchange, which is deemed a modification of the original stock option awards under generally accepted accounting principles, additional stock-based compensation of approximately $251 will be recognized over the two year vesting period associated with the replacement awards commencing June 30, 2011. Additional information regarding the stock option exchange program may be found on the Company’s Tender Offer Statement on Schedule TO filed with the SEC on June 1, 2011.
Stock Options
Stock options granted to employees under the Incentive 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 for employee option awards based on the grant date fair value of the award, less expected annual forfeitures, and recognizes expense on a straight-line basis over the four-year service period of the award. Stock options granted to members of our board of directors vest immediately. Stock compensation for these awards is based on the grant date fair value of the award and is recognized in expense immediately.
Fuel Tech uses the Black-Scholes option pricing model to estimate the grant date fair value of employee stock options. 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-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

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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 six-month period ended June 30, 2011 was $4.08 per option using the following assumptions:
         
Expected dividend yield
    0.0 %
 
       
Risk-free interest rate
    1.8 %
 
       
Expected volatility
    57.2 %
 
       
Expected life of option
  5.0 years
Stock option activity for Fuel Tech’s Incentive Plan for the six months ended June 30, 2011 was as follows:
                                 
                    Weighted-        
                    Average        
    Number     Weighted-     Remaining     Aggregate  
    of     Average     Contractual     Intrinsic  
    Options     Exercise Price     Term     Value  
     
Outstanding on January 1, 2011
    2,856,125     $ 14.68                  
Granted
    60,000       8.16                  
Converted to RSUs
    (814,500 )     22.06                  
Exercised
    (70,000 )     4.47                  
Expired or forfeited
    (79,625 )     20.51                  
 
                             
Outstanding on June 30, 2011
    1,952,000     $ 11.53     5.4 years   $ 984  
 
                             
 
                               
Exercisable on June 30, 2011
    1,692,375     $ 11.59     5.0 years   $ 962  
Non-vested stock option activity for the three months ended June 30, 2011 was as follows:
                 
    Non-Vested Stock     Weighted-Average  
    Options     Grant Date  
    Outstanding     Fair Value  
     
Outstanding on January 1, 2011
    578,500     $ 7.50  
Granted
    60,000       4.08  
Vested
    (272,500 )     7.03  
Converted to RSUs
    (91,500 )     9.97  
Forfeited
    (14,875 )     7.04  
     
Outstanding on June 30, 2011
    259,625     $ 6.36  
     
As of June 30, 2011, there was $2,129 of total unrecognized compensation cost related to non-vested stock options granted under the Incentive Plan. That cost is expected to be recognized over a weighted average period of 1.4 years.
Fuel Tech received proceeds from the exercise of stock options of $313 in the six-month period ended June 30, 2011. The intrinsic value of options exercised in the six-month period ended June 30, 2011 was $249. It is our policy to issue new shares upon option exercises, loan conversions, and vesting of restricted stock units. We have not used cash and do not anticipate any future use of cash to settle equity instruments granted under share-based payment arrangements.
Restricted Stock Units
Restricted stock units (RSUs) granted to employees vest over time based on continued service (typically vesting over a period between two and four years). Such time-vested RSUs are valued at the date of grant using the intrinsic value method. Compensation cost, adjusted for estimated forfeitures, is amortized on a straight-line basis over the requisite service period.

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In addition to the time vested RSUs described above, in March 2011 the Company entered into a performance-based RSU agreement (the Agreement) with each of the Company’s President/Chief Executive Officer, Treasurer/Chief Financial Officer, Executive Vice President, Marketing & Sales and Executive Vice President, Worldwide Operations. The Agreement provides each participating executive the opportunity to earn three types of awards with each award type specifying a targeted number of RSUs that may be granted to each executive based on either the individual performance of the executive or the Company’s relative performance compared to a peer group, as determined by the award type. The Compensation and Nominating Committee of our Board of Directors (the Committee) determines the extent to which, if any, RSUs will be granted based on the achievement of the applicable performance criteria specified in the Agreement. This determination will be made following the completion of the applicable performance period (each a “Determination Date”). Such performance based awards include the following:
    The first type of award is based on individual performance during the 2011 calendar year as determined by the Committee based on performance criteria specified in the Agreement. These awards will vest over a three year period beginning on the Determination Date. We estimated the fair value of these performance-based RSU awards on the date of the Agreement using the intrinsic value method and our estimate of the probability that the specified performance criteria will be met. The fair value measurement and probability estimate will be re-measured each reporting date until the Determination Date, at which time the final award amount will be known. For these job performance-based awards, we amortize compensation costs over the requisite service period, adjusted for estimated forfeitures, for each separately vesting tranche of the award.
 
    The second type of RSU award contains a targeted number of RSUs to be granted based on the Company’s revenue growth relative to a specified peer group during the 2011 and 2012 calendar years. These awards vest 67% on the second anniversary of the Agreement date and 33% on the third anniversary of the Agreement date. We estimated the fair value of these performance-based RSU awards on the Agreement date using the intrinsic value method and our estimate of the probability that the specified performance criteria will be met. For these revenue growth performance-based awards, we amortize compensation costs over the requisite service period, adjusted for estimated forfeitures, for each separately vesting tranche of the award.
 
    The third type of RSU award contains a targeted number of RSUs to be granted based on the total shareholder return (TSR) of the Company’s common stock relative to a specified peer group during the 2011 and 2012 calendar years. These awards vest 67% on the second anniversary of the Agreement date and 33% on the third anniversary of the Agreement date. We estimated the fair value of these market-based RSU awards on the Agreement date using a Monte Carlo valuation methodology and amortize the fair value over the requisite service period for each separately vesting tranche of the award.
At June 30, 2011 there is $1,818 of unrecognized compensation costs related to restricted stock unit awards to be recognized over a weighted average period of 3.8 years.
A summary of restricted stock unit activity for the six month period ended June 30, 2011 is as follows:
                 
            Weighted Average  
            Grant Date  
    Shares     Fair Value  
     
Unvested restricted stock units at December 31, 2010
    149,000     $ 8.63  
Granted
           
Converted from stock options
    267,372       6.53  
Forfeited
    (1,000 )     8.63  
Vested
           
 
           
Unvested restricted stock units at June 30, 2011
    415,372     $ 7.28  
 
           
Deferred Directors Fees
In addition to the Incentive Plan, Fuel Tech has a Deferred Compensation Plan for Directors (Deferred Plan). Under the terms of the Deferred Plan, Directors can elect to defer Directors’ fees for shares of Fuel Tech Common Stock that are issuable at a future date as defined in the agreement. In accordance with ASC 718, Fuel Tech accounts for these awards as equity awards as opposed to liability awards. In the periods ended June 30, 2011 and 2010, Fuel Tech recorded $37 and $28, respectively, of stock-based compensation expense under the Deferred Plan.

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At June 30, 2011, Fuel Tech had 1,924,000 weighted average stock awards outstanding that were not dilutive for the purpose of inclusion in the calculation of diluted earnings per share but could potentially become dilutive in future periods.
Note J: Debt
On June 30, 2011, Fuel Tech amended its existing revolving credit facility (the Facility) with JPMorgan Chase Bank, N.A (JPM Chase) to extend the maturity date through June 30, 2013. The amendment decreases the total borrowing base of the facility to $15,000 from $25,000 and contains a provision to increase the facility up to a total principal amount of $25,000 upon approval from JPM Chase. The Facility is unsecured, bears interest at a rate of LIBOR plus a spread range of 250 basis points to 375 basis points, as determined under a formula related to the Company’s leverage ratio, and has the Company’s Italian subsidiary, Fuel Tech S.r.l., as a guarantor. Fuel Tech can use this Facility for cash advances and standby letters of credit. As of June 30, 2011 and December 31, 2010, there were no outstanding borrowings on the amended or previous credit facilities.
The Facility contains several debt covenants with which the Company must comply on a quarterly or annual basis, including a maximum Funded Debt to EBITDA Ratio (or “Leverage Ratio”, as defined in the Facility) of 1.5:1.0 based on the four trailing quarterly periods. Maximum funded debt is defined as all borrowed funds, outstanding standby letters of credit and bank guarantees. EBITDA includes after tax earnings with add backs for interest expense, income taxes, depreciation and amortization, and stock-based compensation expenses. In addition, the Facility covenants include an annual capital expenditure limit of $10,000 and a minimum tangible net worth of $50,000, adjusted upward for 50% of net income generated and 100% of all capital issuances. At June 30, 2011, the Company was in compliance with all financial covenants specified by the Facility.
On June 30, 2011, Beijing Fuel Tech Environmental Technologies Company, Ltd. (Beijing Fuel Tech), a wholly-owned subsidiary of Fuel Tech, entered into a new revolving credit facility (the China Facility) agreement with JPM Chase for RMB 35 million (approximately $5,400), which expires on June 29, 2012. This new credit facility replaced the previous RMB 45 million facility that expired on June 30, 2011. The facility is unsecured, bears interest at a rate of 125% of the People’s Bank of China (PBOC) Base Rate, and is guaranteed by Fuel Tech. Beijing Fuel Tech can use this facility for cash advances and bank guarantees. As of June 30, 2011 and December 31, 2010, Beijing Fuel Tech has borrowings outstanding in the amount of $2,321 and $2,269, respectively. These borrowings were subject to interest rates of approximately 6.7% and 5.8% at June 30, 2011 and December 31, 2010, respectively.
At June 30, 2011 and December 31, 2010, the Company had outstanding standby letters of credit and bank guarantees, predominantly to customers, totaling approximately $1,213 and $1,265, respectively, in connection with contracts in process. Fuel Tech is committed to reimbursing the issuing bank for any payments made by the bank under these instruments. At June 30, 2011, there were no cash borrowings under the domestic revolving credit facility and approximately $13,787 was available for future borrowings. The Company pays a commitment fee of 0.25% per year on the unused portion of the revolving credit facility. 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.
In the event of default on either the domestic facility or the China facility, the cross default feature in each allows the lending bank to accelerate the payments of any amounts outstanding and may, under certain circumstances, allow the bank to cancel the facility. If the Company were unable to obtain a waiver for a breach of covenant and the bank accelerated the payment of any outstanding amounts, such acceleration may cause the Company’s cash position to deteriorate or, if cash on hand were insufficient to satisfy the payment due, may require the Company to obtain alternate financing to satisfy the accelerated payment.
Interest payments in the amount of $78 and $77 were made during the six month periods ended June 30, 2011 and 2010, respectively.
Note K: Business Segment and Geographic Disclosures
Fuel Tech segregates its financial results into two reportable segments representing two broad technology segments as follows:
    The Air Pollution Control technology segment includes technologies to reduce NOx emissions in flue gas from boilers, incinerators, furnaces and other stationary combustion sources. These include Low and Ultra Low NOx Burners (LNB and ULNB), Over-Fire Air (OFA) systems, NOxOUT® and HERT Selective Non-Catalytic Reduction (SNCR) systems, and Advanced Selective Catalytic Reduction (ASCR) systems. The ASCR system includes ULNB, OFA, and SNCR components, along with a downsized SCR catalyst, Ammonia Injection Grid (AIG), and Graduated Straightening Grid (GSG) systems to provide high NOx reductions at significantly lower capital and operating costs than conventional SCR systems. The NOxOUT-CASCADE® and NOxOUT-SCR® processes are basic types of ASCR

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      systems, using just SNCR and SCR catalyst components. ULTRA™ technology creates ammonia at a plant site using safe urea for use with any SCR application. Flue Gas Conditioning systems are chemical injection systems offered in markets outside the U.S. and Canada to enhance electrostatic precipitator and fabric filter performance in controlling particulate emissions.
 
    The FUEL CHEM® technology segment, which uses chemical processes in combination with advanced Computational Fluid Dynamics (CFD) and Chemical Kinetics Modeling (CKM) boiler modeling, for the control of slagging, fouling, corrosion, opacity and other sulfur trioxide-related issues in furnaces and boilers through the addition of chemicals into the furnace 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 (Note 1 in our annual report on Form 10-K). 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:
                                 
Three months ended   Air Pollution     FUEL CHEM              
June 30, 2011   Control Segment     Segment     Other     Total  
 
Revenues from external customers
  $ 9,644     $ 9,377     $     $ 19,021  
Cost of sales
    5,246       5,307             10,553  
     
Gross margin
    4,398       4,070             8,468  
Selling, general and administrative
                7,966       7,966  
Research and development
                315       315  
Gain from revaluation of ACT liability
                (758 )     (758 )
 
Operating income
  $ 4,398     $ 4,070     $ 7,523     $ 945  
 
                                 
Three months ended   Air Pollution     FUEL CHEM              
June 30, 2010   Control Segment     Segment     Other     Total  
 
Revenues from external customers
  $ 9,291     $ 9,611     $     $ 18,902  
Cost of sales
    6,046       5,021             11,067  
     
Gross margin
    3,245       4,590             7,835  
Selling, general and administrative
                8,018       8,018  
Research and development
                165       165  
 
Operating income (loss)
  $ 3,245     $ 4,590     $ 8,183     $ (348 )
 
                                 
Six months ended   Air Pollution     FUEL CHEM              
June 30, 2011   Control Segment     Segment     Other     Total  
 
Revenues from external customers
  $ 20,736     $ 20,907     $     $ 41,643  
Cost of sales
    10,799       11,220             22,019  
     
Gross margin
    9,937       9,687             19,624  
Selling, general and administrative
                15,917       15,917  
Research and development
                717       717  
Gain from revaluation of ACT liability
                (758 )     (758 )
 
Operating income
  $ 9,937     $ 9,687     $ 15,876     $ 3,748  
 
                                 
Six months ended   Air Pollution     FUEL CHEM              
June 30, 2010   Control Segment     Segment     Other     Total  
 
Revenues from external customers
  $ 17,505     $ 19,014     $     $ 36,519  
Cost of sales
    11,304       9,263             20,567  
     
Gross margin
    6,201       9,751             15,952  
Selling, general and administrative
                15,498       15,498  
Research and development
                311       311  
 
Operating income
  $ 6,201     $ 9,751     $ 15,809     $ 143  
 

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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.
                                 
    Three months ended June 30     Six months ended June 30  
    2011     2010     2011     2010  
Revenues:
                               
United States
  $ 15,529     $ 14,461     $ 35,147     $ 29,502  
Foreign
    3,492       4,441       6,496       7,017  
 
                       
 
  $ 19,021     $ 18,902     $ 41,643     $ 36,519  
 
                       
                 
    June 30,     December 31,  
    2011     2010  
Assets:
               
United States
  $ 91,821     $ 92,485  
Foreign
    11,029       10,718  
 
           
 
  $ 102,850     $ 103,203  
 
           
Note L: Contingencies
Fuel Tech issues a standard product warranty with the sale of its products to customers. Our recognition of warranty liability is based primarily on analyses of warranty claims experienced in the preceding years as the nature of our historical product sales for which we offer a warranty are substantially unchanged. This approach provides an aggregate warranty accrual that is historically aligned with actual warranty claims experienced.
Changes in the warranty liability for the six months ended June 30, 2011 and 2010 are summarized below:
                 
    Six Months Ended June 30
    2011     2010  
     
Aggregate product warranty liability at beginning of period
  $ 215     $ 199  
Net aggregate expense related to product warranties
    100       60  
Aggregate reductions for payments
    (112 )     (57 )
     
Aggregate product warranty liability at end of period
  $ 203     $ 202  
     
In 2009 the Company recorded a contingent consideration accrual representing the fair value of the future consideration to be paid in connection with its acquisition of substantially all of the assets of Advanced Combustion Technology, Inc. (ACT). The contingent consideration arrangement required the Company to pay ACT a pro-rata amount of up to $4,000 annually for the achievement of a minimum annual gross margin dollar level (the Hurdle) of $10,000, $11,000, and $12,000 in fiscal 2009, 2010, and 2011, respectively. In addition, the agreement required the Company to pay ACT thirty-five percent of all qualifying gross margin dollars above the annual Hurdle rate for each of the three years. The potential undiscounted amount of all future payments that the Company could be required to make is between $0 and $4,000 in any one year, and $0 and $12,000 in total, not including the amount related to the thirty-five percent sharing of qualifying gross margin dollars above the pre-determined Hurdle. The fair value of the contingent consideration at inception was $2,307, which was recorded as a liability when the business combination was initially recorded.
The Company periodically evaluates the probability that payment of the contingent consideration accrual is probable based on a range of outcomes and assumptions used to develop the fair value estimate. Based upon this analysis, management concluded during the quarter ended June 30, 2011 that the payout for 2011 was not probable of being made. Thus, the Company recorded a gain of $758 from the revaluation of the contingent liability. A similar adjustment was made in the two preceding years for $781 and $768, respectively. As of June 30, 2011, there is no contingent liability accrual remaining.

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Note M: Income Taxes
The Company’s effective tax rates of 49.2% and 50% for the six month periods ended June 30, 2011 and 2010, respectively, differ from the statutory federal tax rate due primarily to state taxes, stock-based compensation, differences between U.S. and foreign tax rates, foreign losses incurred with no related tax benefit, changes in state rate rates, and non-deductible meals and entertainment expenses.
Fuel Tech had unrecognized tax benefits as of December 31, 2010 in the amount of $870 all of which, if ultimately recognized, will reduce Fuel Tech’s annual effective tax rate. There have been no material changes in unrecognized tax benefits during the three and six month periods ended June 30, 2011.
Note N: Goodwill and Other Intangibles
Goodwill and indefinite-lived intangible assets are not amortized, but are reviewed annually or more frequently if indicators arise, for impairment. The evaluation of impairment involves comparing the current fair value of our reporting units to their carrying values. Fuel Tech uses a discounted cash flow (DCF) model 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.
Goodwill is allocated among and evaluated for impairment at the reporting unit level, which is defined as an operating segment or one level below an operating segment. Fuel Tech has two reporting units which are reported in the FUEL CHEM technology segment and the APC technology segment. At June 30, 2011 and December 31, 2010, goodwill allocated to the FUEL CHEM technology segment was $1,723 while goodwill allocated to the APC technology segment was $19,328.
Goodwill is allocated to each of our reporting units after considering the nature of the net assets giving rise to the goodwill and how each reporting unit would enjoy the benefits and synergies of the net assets acquired. Our last fair value measurement test, performed annually as of October 1, revealed no indications of impairment. There were no indications of goodwill impairment in the three and six month periods ended June 30, 2011.
Fuel Tech reviews other intangible assets, which include customer lists and relationships, covenants not to compete, patent assets, tradenames, 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 that impairment indicators exist, a further analysis is performed and if 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. There were no indications of intangible asset impairment in the three- and six-month periods ended June 30, 2011.
Note O: Fair Value
The Company applies authoritative accounting guidance for fair value measurements of financial and nonfinancial assets and liabilities. This guidance defines fair value, establishes a consistent framework for measuring fair value and expands disclosure for each major asset and liability category measured at fair value on either a recurring or nonrecurring basis and clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, the standard establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:
    Level 1 — Observable inputs to the valuation methodology such as quoted prices in active markets for identical assets or liabilities.
 
    Level 2- Inputs to the valuation methodology including quoted prices for similar assets or liabilities in active markets, quoted prices for identical assets of liabilities in inactive markets, inputs other than quoted prices that are observable for the asset or liability, and inputs that are derived principally from or corroborated by observable market data by correlation or other means.
 
    Level 3 — Significant unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own estimates and assumptions or those expected to be used by market participants. Generally, these fair value measures are model-based valuation techniques such as discounted cash flows, option pricing models, and other commonly used valuation techniques.

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The fair value of our marketable securities was $109 at June 30, 2011 and was determined using quoted prices in active markets for identical assets (Level 1 fair value measurements). Transfers between levels of the fair value hierarchy are recognized based on the actual date of the event or change in circumstances that caused the transfer. We had no assets or liabilities that were valued using level 2 or level 3 inputs and therefore there were no transfers between levels of the fair value hierarchy during the three and six month periods ended June 30, 2011.
The carrying amount of our short-term debt and revolving line of credit approximates fair value due to its short-term nature and because the amounts outstanding accrue interest at variable market-based rates.
Note P: Recently Adopted and Pending Accounting Pronouncements
In June 2011, the Financial Accounting Standards Board (FASB) issued amended disclosure requirements for the presentation of comprehensive income. The amended guidance eliminates the option to present components of other comprehensive income (OCI) as part of the statement of changes in equity. Under the amended guidance, all changes in OCI are to be presented either in a single continuous statement of comprehensive income or in two separate but consecutive financial statements. The changes are effective January 1, 2012. Early application is permitted. There will be no impact to the consolidated financial results as the amendments relate only to changes in financial statement presentation.
In May 2011, the FASB issued guidance titled “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standard” (IFRS), to converge fair value measurement and disclosure guidance in U.S. GAAP with the guidance in the International Accounting Standards Board’s concurrently issued IFRS 13, Fair Value Measurement. This accounting guidance does not modify the requirements for when fair value measurements apply; rather, it generally provides clarifications on how to measure and disclose fair value under the Accounting Standards Codification 820, Fair Value Measurement. The amendments in this accounting guidance are effective prospectively for interim and annual periods beginning after December 15, 2011. Early adoption is not permitted for public entities. The Company is currently assessing the impact of this accounting guidance on its financial statements. Adoption of this standard is not expected to have a material impact on the financial statements.
In December 2010, the FASB issued an amendment to the guidance on goodwill impairment testing. The amendment modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. Specifically, for those reporting units with a zero or negative carrying value, it requires an entity to assess whether adverse qualitative factors indicate that it is more likely than not that an impairment of goodwill exists, and if an entity concludes that it is more likely than not that an impairment exists, the entity must measure the goodwill impairment by performing Step 2 of the goodwill impairment test. The amendment was effective January 1, 2011 for annual and interim reporting periods and did not have a material impact in the Consolidated Financial Statements.

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FUEL TECH, INC.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Results of Operations
Revenues for the three months ended June 30, 2011 and 2010 were $19,021 and $18,902, respectively, while revenues for the six months ended June 30, 2011 and 2010 were $41,643 and $36,519 respectively. While revenues for the quarter remain flat, year-to-date revenues reflect an increase of $5,124 or 14% from the prior year period and is driven by both the FUEL CHEM and APC technology segments.
The Air Pollution Control (APC) technology segment generated revenues of $9,644 and $20,736 for the three and six-months ended June 30, 2011, respectively, an increase of $353, or 4%, and $3,231 or 18%, from the prior year periods due to the timing of recognition of prior period bookings and work progress on construction projects. This segment remains positioned to capitalize on the next phase of increasingly stringent U.S. air quality standards, specifically on NOx control. Interest in Fuel Tech’s suite of air pollution control technologies, on both a new and retrofit basis, remains strong both domestically and abroad. The Company expects demand for its APC products to grow significantly based on the compliance deadlines in multiple market segments that will be phased in over the next three years.
Consolidated APC backlog at June 30, 2011 was $15,300 versus backlog at June 30, 2010 of approximately $20,700. A substantial amount of the backlog as of June 30, 2011 should be recognized as revenue in fiscal 2011, although the timing of such revenue recognition in 2011 is subject to the timing of the expenses incurred on existing projects.
The FUEL CHEM technology segment generated revenues of $9,377 and $20,907 for the three and six-months ended June 30, 2011, a decrease of $234, or 2%, and an increase of $1,893 or 10% versus the respective prior year periods. The slight decrease in the current three-month period is attributed to fluctuation in consumption at existing accounts. The overall year-to-date increase is attributed to the addition of new accounts and a one-time pass through of $1,281 for installation related work at a customer site. We believe the marketplace acceptance for Fuel Tech’s patented TIFI® Targeted In-Furnace Injection™ technology remains strong, particularly on coal-fired units, which represents the largest market opportunity for the technology.
Cost of sales as a percentage of revenue for the quarters ended June 30, 2011 and 2010 was 55% and 59%, respectively. The cost of sales percentage for the APC technology segment decreased to 54% from 65% in the comparable prior-year period, primarily due to an increase in higher margin project mix. For the FUEL CHEM technology segment, the cost of sales percentage increased to 57% from 52% in the comparable prior-year quarter primarily due to costs associated with foreign demonstrations.
Cost of sales as a percentage of revenue for the six months ended June 30, 2011 and 2010 was 53% and 56%, respectively. The cost of sales for the APC technology segment decreased to 52% from 65% due to higher margin project mix. For the FUEL CHEM technology segment, the cost of sales percentage increased to 54% from 49% due to costs associated with foreign demonstrations and the one-time pass through of the lower margin installation work mentioned above.
Selling, general and administrative expenses (SG&A) for the quarters ended June 30, 2011 and 2010 were $7,966 and $8,018, respectively. Although SG&A remains flat for the quarter versus the prior year, decreases in employee related costs of $408 and stock compensation expense of $134 was partially offset by increases in fees to outside service providers, business taxes, bad debt expense, and depreciation of $512. SG&A for the six-month periods ended June 30, 2011 and 2010 were $15,917 and $15,498, respectively. The increase of $419 was primarily related to increases in employee related costs of $433, fees to outside service providers of $691, and business taxes, bad debt expense, and other sales and office related costs of $207, partially offset by a decrease in stock compensation of $882.
The Company recorded a gain during the quarter ended June 30, 2011 of $758 from the revaluation of the contingent liability recorded in connection with the ACT Acquisition in January 2009. The $758 had been recorded in the first quarter of 2009 as part of a $2,307 contingent consideration accrual representing the fair value, weighted-average probability of future consideration expected to be paid in connection with the ACT Acquisition. For the year ended December 31, 2011, management has concluded that the earnout payment related to the ACT Acquisition for fiscal 2011 is not probable, thus the remaining $758 portion of the total contingent liability was reversed.
Research and development expenses for the three and six-month periods ended June 30, 2011 and 2010 were $315 and $165, and $717 and $311, respectively. The Company has increased its R&D efforts in the pursuit of commercial applications for its technologies outside of

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its traditional markets, and in the development and analysis of new technologies that could represent incremental market opportunities.
Interest expense for the three- and six-month periods ended June 30, 2011 totaled $38 and $78, respectively, and relates to borrowings under the Beijing Fuel Tech Facility.
Income tax expense/(benefit) for the three and six months ended ended June 30, 2011 and 2010 were $326 and ($237), and $1,711 and ($95), respectively, and reflective of the Company’s net income/(loss) for the respective quarters. The Company is projecting a consolidated effective tax rate of 48% for 2011.
Liquidity and Sources of Capital
At June 30, 2011, Fuel Tech had cash and cash equivalents and short-term investments on hand of $30,756 and working capital of $41,085 versus $30,524 and $36,645 at December 31, 2010, respectively.
Operating activities provided cash of $921 during the six-month period ended June 30, 2011, primarily due to cash generated by our net income of $1,769, a net decreases in our inventory, prepaid expenses, and other assets accounts of $205, plus other non-cash items such as stock-based compensation of $1,659, depreciation and amortization of $1,989, deferred directors fees of $37, and bad debt expense of $70. Partially offsetting these items were net payments made during the quarter related to accounts payable, accrued liabilities, and income taxes of $3,610, a net increase in our accounts receivable of $185, and non-cash items including deferred income taxes of $253 and a gain on the revaluation of an accrued contingent liability of $758.
Investing activities used cash of $1,240 during the six month period ended June 30, 2011 primarily due to purchases of property, equipment, and patent expenditures.
Financing activities generated cash of $313 related to proceeds received from the exercise of stock options during the period.
On June 30, 2011, Fuel Tech amended its existing revolving credit facility (the Facility) with JPMorgan Chase Bank, N.A (JPM Chase) to extend the maturity date through June 30, 2013. The amendment decreases the total borrowing base of the facility to $15,000 from $25,000 and contains a provision to increase the facility up to a total principal amount of $25,000 upon approval from JPM Chase. The Facility is unsecured, bears interest at a rate of LIBOR plus a spread range of 250 basis points to 375 basis points, as determined under a formula related to the Company’s leverage ratio, and has the Company’s Italian subsidiary, Fuel Tech S.r.l., as a guarantor. Fuel Tech can use this Facility for cash advances and standby letters of credit. As of June 30, 2011 and December 31, 2010, there were no outstanding borrowings on the amended or previous credit facilities.
The Facility contains several debt covenants with which the Company must comply on a quarterly or annual basis, including a maximum Funded Debt to EBITDA Ratio (or “Leverage Ratio”, as defined in the Facility) of 1.5:1.0 based on the four trailing quarterly periods. Maximum funded debt is defined as all borrowed funds, outstanding standby letters of credit and bank guarantees. EBITDA includes after tax earnings with add backs for interest expense, income taxes, depreciation and amortization, and stock-based compensation expenses. In addition, the Facility covenants include an annual capital expenditure limit of $10,000 and a minimum tangible net worth of $50,000, adjusted upward for 50% of net income generated and 100% of all capital issuances. At June 30, 2011, the Company was in compliance with all financial covenants on the Facility.
On June 30, 2011, Beijing Fuel Tech Environmental Technologies Company, Ltd. (Beijing Fuel Tech), a wholly-owned subsidiary of Fuel Tech, entered into a new revolving credit facility (the China Facility) agreement with JPM Chase for RMB 35 million (approximately $5,400), which expires on June 29, 2012. This new credit facility replaced the previous RMB 45 million facility that expired on June 30, 2011. The facility is unsecured, bears interest at a rate of 125% of the People’s Bank of China (PBOC) Base Rate, and is guaranteed by Fuel Tech. Beijing Fuel Tech can use this facility for cash advances and bank guarantees. As of June 30, 2011 and December 31, 2010, Beijing Fuel Tech has borrowings outstanding in the amount of $2,321 and $2,269, respectively. These borrowings were subject to interest rates of approximately 6.7% and 5.8% at June 30, 2011 and December 31, 2010, respectively.
At June 30, 2011 and December 31, 2010, the Company had outstanding standby letters of credit and bank guarantees, predominantly to customers, totaling approximately $1,213 and $1,265, respectively, in connection with contracts in process. Fuel Tech is committed to reimbursing the issuing bank for any payments made by the bank under these instruments. At June 30, 2011, there were no cash borrowings under the domestic revolving credit facility and approximately $13,787 was available for future borrowings. The Company pays a commitment fee of 0.25% per year on the unused portion of the revolving credit facility. 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

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issued, nor be unable to supply funds to Fuel Tech if the Company chooses to borrow funds under its two revolving credit facilities.
In the event of default on either the domestic facility or the China facility, the cross default feature in each allows the lending bank to accelerate the payments of any amounts outstanding and may, under certain circumstances, allow the bank to cancel the facility. If the Company were unable to obtain a waiver for a breach of covenant and the bank accelerated the payment of any outstanding amounts, such acceleration may cause the Company’s cash position to deteriorate or, if cash on hand were insufficient to satisfy the payment due, may require the Company to obtain alternate financing to satisfy the accelerated payment.
In the opinion of management, Fuel Tech’s expected near-term revenue growth will be driven by the timing of penetration of the 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.
Contingencies and Contractual Obligations
Fuel Tech issues a standard product warranty with the sale of its products to customers as discussed in Note L. The change in the warranty liability balance during the three and six months ended June 30, 2011 was not significant.

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Forward-Looking Statements
This Quarterly Report on Form 10-Q contains “forward-looking statements,” as defined in Section 21E of the Securities Exchange Act of 1934, as amended, which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and reflect Fuel Tech’s current expectations regarding 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. Fuel Tech has tried to identify forward-looking statements by using words such as “anticipate,” “believe,” “plan,” “expect,” “estimate,” “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 Fuel Tech and are subject to various risks, uncertainties, and other factors, including, but not limited to, those discussed in Fuel Tech’s Annual Report on Form 10-K for the year ended December 31, 2010 in Item 1A under the caption “Risk Factors,” which could cause Fuel Tech’s 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. Fuel Tech undertakes 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.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Foreign Currency Risk Management
Fuel Tech’s earnings and cash flow are subject to fluctuations due to changes in foreign currency exchange rates. We do not enter into foreign currency forward contracts nor 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 J 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, 2011.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Fuel Tech maintains disclosure controls and procedures and internal controls designed to ensure (a) that information required to be disclosed in Fuel Tech’s filings under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and (b) that such information is accumulated and communicated to management, including the principal executive and financial officer, as appropriate to allow timely decisions regarding required disclosure. Fuel Tech’s Chief Executive Officer and Chief Financial Officer have evaluated the Company’s disclosure controls and procedures, as defined in Rules 13a - 15(e) and 15d -15(e) of the Exchange Act, as of the end of the period covered by this report, and they have concluded that these controls and procedures are effective.
Changes in Internal Control over Financial Reporting
There has been no change in the Company’s internal control over financial reporting during the quarter covered by this report that has materially affected, or is reasonably likely to materially affect, its internal control over financial reporting.

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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
     None
Item 1A. Risk Factors
     The risk factors included in our Annual Report on Form 10-K for fiscal year ended December 31, 2010 have not materially changed.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
     None
Item 6. Exhibits
     a. Exhibits (all filed herewith)
     
4.1
  Third Amendment to Credit Agreement and Amended Revolving Loan Note Agreement, each dated June 30, 2011, between Fuel Tech, Inc. and JPMorgan Chase Bank, N.A.
 
   
31.1
  Certification of CEO pursuant to Section 302 of Sarbanes-Oxley Act of 2002
 
   
31.2
  Certification of CFO pursuant to Section 302 of Sarbanes-Oxley Act of 2002
 
   
32
  Certification of CEO and CFO pursuant to Section 906 of Sarbanes-Oxley Act of 2002

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FUEL TECH, INC.
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
         
     
Date: August 8, 2011  By:   /s/ Douglas G. Bailey    
    Douglas G. Bailey   
    President and Chief Executive Officer
(Principal Executive Officer) 
 
 
     
Date: August 8, 2011  By:   /s/ David S. Collins    
    David S. Collins   
    Senior Vice President and Chief Financial Officer
(Principal Financial Officer) 
 
 

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