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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, DC 20549
 
 FORM 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended September 30, 2006
 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 No. 000-25367
 
 INTERNATIONAL FUEL TECHNOLOGY, INC.
  Nevada
    
    88-0357508(State or other jurisdiction of incorporation or
    
    (I.R.S. Employer Identification No.)organization)7777 Bonhomme, Suite 1920St. Louis, Missouri
    
    63105(Address of principal executive offices)
    
    (Zip Code)
 (314) 727-3333
 
  þ o
  o o þ
  o þ




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INDEX
 Page No.PART I. FINANCIAL INFORMATIONItem 1. Financial Statements (Unaudited)Balance Sheets September 30, 2006 and December 31, 2005
    
    
    3Statements of OperationsThree Month and Nine Month Periods Ended September 30, 2006 and September 30, 2005
    
    
    4Statement of Stockholders Equity Nine Month Period Ended September 30, 2006
    
    
    5Statements of Cash Flows Nine Month Periods Ended September 30, 2006 and September 30, 2005
    
    
    6Notes to Financial Statements
    
    
    7Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    10Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    16Item 4. Controls and Procedures
    
    
    16PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    16Item 1A. Risk Factors
    
    
    16Item 6. Exhibits
    
    
    17Certification of Chief Executive OfficerCertification of Chief Financial Officer906 Certification of Chief Executive Officer906 Certification of Chief Financial Officer
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INTERNATIONAL FUEL TECHNOLOGY, INC.
 
 BALANCE SHEETS
 September 30,
    
    December 31,2006
    
    2005(Unaudited)ASSETSCurrent assetsCash and cash equivalents
    
    $
    297,402
    
    
    $
    3,382,012Short-term investments
    
    
    2,495,500
    
    
    
    2,480,500Accounts receivable
    
    
    33,381
    
    
    
    5,451Inventory
    
    
    444,755
    
    
    
    122,724Prepaid expenses and other assets
    
    
    68,883
    
    
    
    74,280Total Current Assets
    
    
    3,339,921
    
    
    
    6,064,967Property and equipmentMachinery, equipment and office furniture
    
    
    63,953
    
    
    
    34,914Accumulated depreciation
    
    
    (32,660
    )
    
    
    (27,617
    )Net Property and Equipment
    
    
    31,293
    
    
    
    7,297Purchased technology, net of accumulated
amortization of $2,133,333 and
$1,833,332 at September 30, 2006 and
December 31, 2005, respectively
    
    
    266,667
    
    
    
    566,668Goodwill
    
    
    2,211,805
    
    
    
    2,211,805Total Assets
    
    $
    5,849,686
    
    
    $
    8,850,737LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilitiesAccounts payable
    
    $
    173,479
    
    
    $
    486,754Accrued compensation
    
    
    19,581
    
    
    
    155,154Total Current Liabilities
    
    
    193,060
    
    
    
    641,908Commitments and contingenciesStockholders equityCommon stock, $0.01 par value; 150,000,000
authorized, 84,861,326 and 84,719,724
shares issued and outstanding at September
30, 2006 and December 31, 2005,
respectively
    
    
    848,614
    
    
    
    847,198Common stock to be issued: 77,000
shares at December 31, 2005
    
    
    
    
    
    
    770Discount on common stock
    
    
    (819,923
    )
    
    
    (819,923
    )Additional paid-in capital
    
    
    54,030,606
    
    
    
    52,796,183Accumulated deficit
    
    
    (48,402,671
    )
    
    
    (44,615,399
    )Total Stockholders Equity
    
    
    5,656,626
    
    
    
    8,208,829Total Liabilities and Stockholders Equity
    
    $
    5,849,686
    
    
    $
    8,850,737
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INTERNATIONAL FUEL TECHNOLOGY, INC.
 
 STATEMENTS OF OPERATIONS
 Three Months
    
    Nine MonthsEnded September 30,
    
    Ended September 30,2006
    
    2005
    
    2006
    
    2005Revenues
    
    $
    35,544
    
    
    $
    7,265
    
    
    $
    235,740
    
    
    $
    63,848Operating expensesCost of operations (exclusive of depreciation and
amortization)
    
    
    16,572
    
    
    
    1,454
    
    
    
    168,848
    
    
    
    38,201Selling, general and administrative expense
    
    
    780,038
    
    
    
    741,731
    
    
    
    2,556,727
    
    
    
    1,906,896Stock compensation expense
    
    
    349,444
    
    
    
    651,183
    
    
    
    1,116,088
    
    
    
    1,833,751Depreciation and amortization
    
    
    102,515
    
    
    
    100,844
    
    
    
    305,044
    
    
    
    301,357Total operating expenses
    
    
    1,248,569
    
    
    
    1,495,212
    
    
    
    4,146,707
    
    
    
    4,080,205Net earnings from operations
    
    
    (1,213,025
    )
    
    
    (1,487,947
    )
    
    
    (3,910,967
    )
    
    
    (4,016,357
    )Interest income
    
    
    46,984
    
    
    
    
    
    
    
    123,695
    
    
    
    Total other income (expense), net
    
    
    46,984
    
    
    
    
    
    
    
    123,695
    
    
    
    Net earnings
    
    $
    (1,166,041
    )
    
    $
    (1,487,947
    )
    
    $
    (3,787,272
    )
    
    $
    (4,016,357
    )Basic and diluted net earnings
per common share
    
    
    ($0.01
    )
    
    
    ($0.02
    )
    
    
    ($0.04
    )
    
    
    ($0.05
    )Weighted-average common shares outstanding
    
    
    84,506,935
    
    
    
    81,540,328
    
    
    
    84,497,275
    
    
    
    79,752,112
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INTERNATIONAL FUEL TECHNOLOGY, INC.
 
 STATEMENT OF STOCKHOLDERS EQUITY
FOR THE NINE MONTH PERIOD ENDED SEPTEMBER 30, 2006
 DiscountCommon
    
    Common
    
    on
    
    AdditionalStock
    
    Stock
    
    Common
    
    Paid-in
    
    AccumulatedShares
    
    Amount
    
    Stock
    
    Capital
    
    Deficit
    
    TotalBalance, December 31, 2005
    
    
    84,796,724
    
    
    $
    847,968
    
    
    $
    (819,923
    )
    
    $
    52,796,183
    
    
    $
    (44,615,399
    )
    
    $
    8,208,829Stock to be issued/options granted for directors
services (Note 3)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    138,430
    
    
    
    
    
    
    
    138,430Proceeds from stock options exercised (Note 3)
    
    
    64,602
    
    
    
    646
    
    
    
    
    
    
    
    31,655
    
    
    
    
    
    
    
    32,301Expense relating to stock-based compensation (Note 3)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,064,338
    
    
    
    
    
    
    
    1,064,338Net earnings
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,787,272
    )
    
    
    (3,787,272
    )Balance, September 30, 2006
    
    
    84,861,326
    
    
    $
    848,614
    
    
    $
    (819,923
    )
    
    $
    54,030,606
    
    
    $
    (48,402,671
    )
    
    $
    5,656,626
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INTERNATIONAL FUEL TECHNOLOGY, INC.
 
 STATEMENTS OF CASH FLOWS
 Nine Months
    
    
    Nine MonthsEnded
    
    
    EndedSeptember 30,
    
    
    September 30,2006
    
    
    2005Cash Flows from Operating Activities:Net earnings
    
    $
    (3,787,272
    )
    
    $
    (4,016,357
    )Adjustments to reconcile net earnings to net cash used in
operating activities:Depreciation and amortization
    
    
    305,044
    
    
    
    301,357Bad debt provision
    
    
    6,053
    
    
    
    6,741Non-cash stock-based compensation
    
    
    1,116,088
    
    
    
    1,833,751Change in assets and liabilities:Accounts receivable
    
    
    (33,983
    )
    
    
    (19,418
    )Inventory
    
    
    (322,031
    )
    
    
    (138,444
    )Prepaid expenses and other assets
    
    
    (9,603
    )
    
    
    (80,157
    )Accounts payable
    
    
    (313,275
    )
    
    
    9,569Accrued compensation
    
    
    (48,893
    )
    
    
    (5,703
    )Net cash used in operating activities
    
    
    (3,087,872
    )
    
    
    (2,108,661
    )Cash Flows from Investing Activities:Acquisition of office furniture
    
    
    (29,039
    )
    
    
    (4,721
    )Net cash used in investing activities
    
    
    (29,039
    )
    
    
    (4,721
    )Cash Flows from Financing Activities:Proceeds from stock options exercised
    
    
    32,301
    
    
    
    843,500Proceeds from common stock issued
    
    
    
    
    
    
    6,999,979Net cash provided by financing activities
    
    
    32,301
    
    
    
    7,843,479Net (decrease)/increase in cash and cash equivalents
    
    
    (3,084,610
    )
    
    
    5,730,097Cash and cash equivalents, beginning
    
    
    3,382,012
    
    
    
    530,275Cash and cash equivalents, ending
    
    $
    297,402
    
    
    $
    6,260,372Schedule of non-cash operating activities:Other
    
    $
    86,680
    
    
    $
    40,600Shares issued in payment of legal settlement
    
    
    
    
    
    
    150,473Shares issued in pre-payment of salary
    
    
    
    
    
    
    81,500
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NOTES TO FINANCIAL STATEMENTS
 (Unaudited)
 Note 1
 Basis of Presentation
    Note 2
 2005 Equity Issuances
  Note 3
 Accounting for Stock-based Compensation
 Share-Based Payment, an amendment of FASB Statements Nos. 123 and 95 Accounting for Stock Issued
to Employees
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Three Months
    
    
    Nine Months
    
    
    Three Months
    
    
    Nine MonthsEnded
    
    
    Ended
    
    
    Ended
    
    
    EndedSeptember 30,
    
    
    September
    
    
    September 30,
    
    
    September 30,2006
    
    
    30, 2006
    
    
    2005
    
    
    2005(SFAS 123R)
    
    
    (SFAS 123R)
    
    
    (APB 25)
    
    
    (APB 25)Variable plan accounting related to stock
compensation modifications
    
    $
    
    
    
    $
    
    
    
    $
    791,710
    
    
    $
    589,820Stock-based payments to non-employees
    
    
    80,000
    
    
    
    213,334
    
    
    
    (154,110
    )
    
    
    1,111,748Stock-based payments to employees/directors
    
    
    269,444
    
    
    
    902,754
    
    
    
    13,583
    
    
    
    132,183Total stock-based compensation expense
    
    $
    349,444
    
    
    $
    1,116,088
    
    
    $
    651,183
    
    
    $
    1,833,751
  Three Months
    
    Nine MonthsEnded
    
    EndedSeptember 30,
    
    September 30,2005
    
    2005Weighted-average fair value of options granted
    
    $
    1.48
    
    
    $
    1.92Weighted-average assumptions:Risk-free interest rate
    
    
    3.82
    %
    
    
    3.82
    %Dividend yield
    
    
    
    
    
    
    Expected volatility
    
    
    1.5
    
    
    
    1.5Expected option life (years)
    
    
    5
    
    
    
    4.75Net earningsAs reported
    
    ($
    1,487,947
    )
    
    ($
    4,016,357
    )Add recorded stock-based compensation expense
    
    $
    651,183
    
    
    
    1,833,751Deduct stock-based compensation expense as if recorded under the fair value based method
    
    ($
    842,441
    )
    
    ($
    4,306,795
    )Pro forma net earnings
    
    ($
    1,679,205
    )
    
    ($
    6,489,401
    )Basic and Diluted net earnings per share:As reported
    
    ($
    0.02
    )
    
    ($
    0.05
    )Pro forma
    
    ($
    0.02
    )
    
    ($
    0.08
    )
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Classification in the Statement of
Cash Flow of the Income Tax Benefit Received by a Company upon Exercise of a Nonqualified
Employee Stock Option.
 Options issued to employees
  Options issued to non-employees
   Sale of stock and issuance of warrants
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Exercise of options
  Issuance of stock for services and legal settlement
   Weighted-averageNo. of
    
    
    Grant Date FairOptions
    
    
    ValueNon-vested as of December 31, 2005
    
    
    7,555,099
    
    
    $
    0.63Granted
    
    
    505,000
    
    
    $
    1.48Vested
    
    
    (458,367
    )
    
    $
    1.94Cancelled/Expired
    
    
    (6,100,000
    )
    
    $
    0.33Non-vested as of September 30, 2006
    
    
    1,501,732
    
    
    $
    1.76
   
 Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
  Forward-looking Statements and Associated Risks
  10




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Overview
  TM TM TM
   
    
    stage 1  independent laboratory testing;
 
    
    stage 2  initial customer contact detailing independent laboratory results generated;
 
    
    stage 3  small-scale field trials with potential customers; and
 
    
    stage 4  large-scale field trials with potential customers to confirm favorable results
generated from initial small-scale trials.
  11




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Three and Nine Months Ended September 30, 2006 Compared to the Three and Nine Months Ended
September 30, 2005
  TM
      12




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New Accounting Pronouncements
 Accounting for Uncertainty in Income Taxes  an interpretation of FASB Statement
No. 109
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Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current
Year Financial Statements.
 Fair Value Measurements ,
 Employers Accounting for Defined Benefit
Pension and Other Postretirement Plans  an amendment of FASB Statements No. 87, 88, 106, and
132(R),
 Critical Accounting Policies
  Valuation of Long-Lived Intangible Assets
  (1)
    
    Significant under-performance relative to expected historical or projected future operating
results;(2)
    
    Significant changes in the manner of our use of the acquired assets or the strategy for
our overall business;(3)
    
    Significant negative industry or economic trends;(4)
    
    Significant decline in our stock price for a sustained period; and(5)
    
    Our market capitalization relative to net book value.
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Valuation of Goodwill
 Valuation of Long-Lived Intangible Assets
  Deferred Income Taxes
  Liquidity and Capital Resources
      15




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Item 3. Quantitative and Qualitative Disclosures About Market Risk
  
 Item 4. Controls and Procedures
 (a)
    
    Our management has evaluated, with the participation of our principal executive officer
and principal financial officer, the effectiveness of our disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act
of 1934, as amended (Exchange Act)) as of September 30, 2006. Based on this evaluation,
the principal executive officer and principal financial officer concluded that our
disclosure controls and procedures were effective at the reasonable assurance level at
September 30, 2006.
 (b)
    
    There were no changes in our internal control over financial reporting (as defined in
Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the fiscal
quarter ended September 30, 2006, that have materially affected, or are reasonably likely
to materially affect, our internal control over financial reporting.
 
 PART II. OTHER INFORMATION
 
 Item 1. Legal Proceedings
   
 Item 1A. Risk Factors
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1) Because we have transitioned from a development stage to a commercialization phase for our
products with a new technology and little market and sales visibility, we may not be able to
create market demand for our products.
 (2) There is a risk that one or more of the raw material suppliers could stop making a building
block raw material necessary for production of our product and, therefore, cause a supply
shortage until substitution raw materials could be identified and located.
  
 Item 6. Exhibits
  31.1
    
    Certification of Chief Executive Officer pursuant to Rule 13a-14(a)
under the Securities Exchange Act of 1934, as amended.31.2
    
    Certification of Chief Financial Officer pursuant to Rule 13a-14(a)
under the Securities Exchange Act of 1934, as amended.32.1
    
    Certification of Chief Executive Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
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INTERNATIONAL FUEL TECHNOLOGY, INC.(Registrant)By:
    
    /s/ Jonathan R. Burst
    
    Date: November 13, 2006Jonathan R. BurstChief Executive Officer(Principal Executive Officer)By:
    
    /s/ Gary S. Hirstein
    
    Date:November 13, 2006Gary S. HirsteinExecutive Vice President, Chief
Financial Officer and Corporate Secretary(Principal Financial Officer)
 18