SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549


Form
10-K





(Mark
One)


x
              ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934 [NO FEE REQUIRED]


For
the fiscal year ended: December 31, 2008


OR


 ̈
              TRANSITION REPORT
      PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO
      FEE REQUIRED]




For
the transition period from _________________ to _______________





Commission
File No. 001-33059





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


(Address
and telephone number of principal executive offices)




Securities
registered pursuant to Section 12(b) of the Act: None




Securities
registered pursuant to Section 12(g) of the Act:


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





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.


Yes
 ̈                      No
x





Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.


Yes
 ̈                      No
x





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





Indicate
by check mark whether the registrant: (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.


Yes
x                      No
 ̈





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, non-accelerated filer or a smaller reporting company (as
defined in rule 12b-2 under the Securities Exchange Act of 1934).


Large
      Accelerated Filer  ̈
                  Accelerated
      Filer xNon-accelerated
      Filer (Do not check if a smaller reporting company)  ̈
                  Smaller
      reporting company  ̈





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).


Yes
 ̈                      No
x





The
aggregate market value of the voting stock held by non-affiliates of the
registrant based on the average bid and asked prices of June 30, 2008 was
$331,257,000.  The aggregate market value of the voting stock held by
non-affiliates of the registrant based on the average bid and asked prices of
February 10, 2008 was $196,181,000.





Indicate
number of shares outstanding of each of the registered classes of Common Stock
at February 10, 2009: 24,110,967 shares of Common Stock, $0.01 par
value.





Documents
incorporated by reference:


Certain
portions of the Proxy Statement for the annual meeting of stockholders to be
held in 2009 are incorporated by reference in Parts II, III, and IV
hereof.







TABLE
OF CONTENTS


PagePART
      IItem
      1.
                        Business
                        3Item
      1A.
                        Risk
      Factors
                        9Item
      1B.
                        Unresolved
      Staff Comments
                        10Item
      2.
                        Properties
                        10Item
      3.
                        Legal
      Proceedings
                        11Item
      4.
                        Submission
      of Matters to a Vote of Security Holders
                        11PART
      IIItem
      5.
                        Market for
      Registrant’s Common Equity, Related Stockholder Matters and Issuer
      Purchase of
      Equity Securities
                        12Item
      6.
                        Selected
      Financial Data
                        14Item
      7.
                        Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations
                        15Item
      7A.
                        Quantitative
      and Qualitative Disclosures about Market Risk
                        22Item
      8.
                        Financial
      Statements and Supplementary Data
                        23Item
      9.
                        Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
                        45Item
      9A.
                        Controls
      and Procedures
                        45Item
      9B.
                        Other
      Information
                        45PART
      IIIItem
      10.
                        Directors,
      Executive Officers and Corporate Governance
                        46Item
      11.
                        Executive
      Compensation
                        47Item
      12.
                        Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
                        47Item
      13.
                        Certain
      Relationships and Related Transactions, and Director
      Independence
                        47Item
      14.
                        Principal
      Accountant Fees and Services
                        47PART
      IVItem
      15.
                        Exhibits
      and Financial Statement Schedules
                        48Signatures
      and Certifications
                        51




1





TABLE
OF DEFINED TERMS





Term
                        
                        DefinitionABC
                        
                        American
      Bailey CorporationAIG
                        
                        Ammonia
      Injection GridCAAA
                        
                        Clean
      Air Act Amendments of 1990CAIR
                        
                        Clean
      Air Interstate RuleCAVR
                        
                        Clean
      Air Visibility RuleCDT
                        
                        Clean
      Diesel Technologies, Inc.CFD
                        
                        Computational
      Fluid DynamicsCommon
      Shares
                        
                        Shares
      of the Common Stock of Fuel TechCommon
      Stock
                        
                        Common
      Stock of Fuel TechEPA
                        
                        Environmental
      Protection AgencyEPRI
                        
                        Electric
      Power Research InstituteFUEL
      CHEM®
                        
                        A
      trademark used to describe Fuel Tech’s fuel and flue gas treatment
      processes, including its TIFITM Targeted In-Furnace InjectionTM technology
      to control slagging, fouling, corrosion and a variety of sulfur
      trioxide-related issues.GSG
                        
                        Graduated
      Straightening GridInvestors
                        
                        The
      purchasers of Fuel Tech securities pursuant to a Securities Purchase
      Agreement as of March 23, 1998.Loan
      Notes
                        
                        Nil-coupon,
      non-redeemable convertible unsecured loan notes of Fuel
    TechNOx
                        
                        Oxides
      of nitrogenNOxOUT
      CASCADE®
                        
                        A
      trademark used to describe Fuel Tech’s combination of NOxOUT and
      SCR.NOxOUT®
      Process
                        
                        A
      trademark used to describe Fuel Tech’s SNCR process for the reduction of
      NOx.NOxOUT-SCR®
                        
                        A
      trademark used to describe Fuel Tech’s direct injection of urea as a
      catalyst reagent.NOxOUT
      ULTRA®
                        
                        A
      trademark used to describe Fuel Tech’s process for generating ammonia for
      use as SCR reagent.Rich
      Reagent Injection Technology (RRI)
                        
                        An
      SNCR-type process that broadens the NOx reduction capability of the NOxOUT
      Process at a cost similar to NOxOUT. RRI can also be applied on a
      stand-alone basis.SCR
                        
                        Selective
      Catalytic ReductionSIP
      Call
                        
                        State
      Implementation Plan RegulationSNCR
                        
                        Selective
      Non-Catalytic ReductionTCITM
      Targeted Corrosion InhibitionTM
                        
                        A
      FUEL CHEM program designed for high-temperature slag and corrosion
      control, principally in waste-to-energy boilers.TIFITM
      Targeted In-Furnace InjectionTM
                        
                        A
      proprietary technology that enables the precise injection of a chemical
      reagent into a boiler or furnace as part of a FUEL CHEM
      program.




2












PART
I





Forward-Looking
Statements





This
Annual Report on Form 10-K contains “forward-looking statements,” as
defined in Section 21E of the Securities Exchange Act of 1934, as amended,
are made pursuant to the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995 and reflect our current expectations regarding our
future growth, results of operations, cash flows, performance and business
prospects, and opportunities, as well as assumptions made by, and information
currently available to, our management. We have tried to identify
forward-looking statements by using words such as “anticipate,” “believe,”
“plan,” “expect,” “intend,” “will,” and similar expressions, but these words are
not the exclusive means of identifying forward-looking
statements.  These statements are based on information currently
available to us and are subject to various risks, uncertainties, and other
factors, including, but not limited to, those discussed herein under the caption
“Risk Factors” that could cause our actual growth, results of operations,
financial condition, cash flows, performance and business prospects and
opportunities to differ materially from those expressed in, or implied by, these
statements.  Except as expressly required by the federal securities
laws, we undertake no obligation to update such factors or to publicly announce
the results of any of the forward-looking statements contained herein to reflect
future events, developments, or changed circumstances or for any other
reason.  Investors are cautioned that all forward-looking statements
involve risks and uncertainties, including those detailed in Fuel Tech's filings
with the Securities and Exchange Commission.  See "Risk Factors" in
Item 1A.





ITEM
1 - BUSINESS





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





Fuel
Tech





Fuel
Tech, Inc. (Fuel Tech) 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.  Our
annual report on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K and any amendments to those reports filed or furnished
pursuant to Section 13(a) of the Securities Exchange Act of 1934 are made
available through our website as soon as reasonably practical after we
electronically file or furnish the reports to the Securities and Exchange
Commission.  Also available on the Corporation’s website are the
Company’s Corporate Governance Guidelines and Code of Ethics and Business
Conduct, as well as the charters of the audit, compensation and nominating
committees of the Board of Directors.  All of these documents are
available in print without charge to stockholders who request them. Information
on our website is not incorporated into this report.




3




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; NOxOUT®and
HERTTM High Energy Reagent TechnologyTM SNCR systems; systems that incorporate
NOxOUT CASCADE®, NOxOUT
ULTRA®and NOxOUT-SCR®processes; and Ammonia Injection Grids and the Graduated Straightening
Grid (GSG).  The FUEL CHEM technology segment improves the efficiency,
reliability and environmental status of combustion units by controlling
slagging, fouling 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 TIFITM Targeted In-Furnace InjectionTM
programs.  Fuel Tech has other technologies, both commercially
available and in the development stage, all of which are related to APC and FUEL
CHEM processes or are similar in their technological base.  Fuel
Tech's business is materially dependent on the continued existence and
enforcement of worldwide air quality regulations.





American
Bailey Corporation





Ralph E.
Bailey, Executive Chairman and Director of Fuel Tech, and Douglas G. Bailey,
Deputy Chairman and Director of Fuel Tech, are stockholders of American Bailey
Corporation (ABC), which is a related party.  Please refer to Note 9
to the consolidated financial statements in this document for information about
transactions between Fuel Tech and ABC.  Additionally, see the more
detailed information relating to this subject under the caption “Certain
Relationships and Related Transactions” in Fuel Tech’s Proxy Statement, to be
distributed in connection with Fuel Tech’s 2009 Annual Meeting of Stockholders,
which information is incorporated by reference.





Air
Pollution Control





Regulations
and Markets





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





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





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





In
February 2001, the U.S. Supreme Court, in a unanimous decision, upheld EPA’s
authority to revise the National Ambient Air Quality Standard for ozone to 0.080
parts per million averaged through an eight-hour period from the current 0.120
parts per million for a one-hour period.  This more stringent standard
provided clarity and impetus for air pollution control efforts well beyond the
then current ozone attainment requirement of 2007.  In keeping with
this trend, the Supreme Court, only days later, denied industry’s attempt to
stay the SIP Call, effectively exhausting all means of appeal.





On
December 23, 2003, the EPA proposed a new regulation affecting the SIP Call
states by specifying more expansive NOx reduction.  This rule, under
the name Clean Air Interstate Rule (CAIR), was issued by the EPA on March 10,
2005.   Commencing in 2009, CAIR specifies that additional annual
NOx reduction requirements be extended to most SIP-affected units in 28 eastern
states, while permitting a cap and trade format similar to the SIP
Call.  The Company expects an additional 1,300 electric generating
units using coal and other fuels to be affected by this
rule.    In an action related to CAIR, on June 15, 2005, the
EPA issued the Clean Air Visibility Rule (CAVR), which is a nationwide
initiative to improve federally preserved areas through reduction of NOx and
other pollutants.  CAVR expands the NOx reduction market to Western
states unaffected by CAIR or the SIP Call.  Compliance begins in 2013
and CAVR will potentially affect an additional 230 western coal-fired
electric-generating units.  In addition, CAVR, along with the EPA rule
for revised eight-hour ozone attainment, which was proposed on June 20, 2007,
have the potential to impact thousands of boilers and industrial units in
multiple industries nationwide for units burning coal and other fuels starting
in 2013.




4




On July
11, 2008, the U.S. District Court of Appeals for the District of Columbia
Circuit vacated the CAIR regulations under the CAAA under the premise that the
EPA exceeded its authority when the rule was created in 2005.  The
court found “more than several fatal flaws in the rule” but neither took issue
with the concept that NOx emissions are to be controlled nor over the limits and
thresholds established by CAIR.  In vacating the rule in its entirety,
the court remanded to EPA to promulgate a rule consistent with the court’s
opinion.  On September 24, 2008, the EPA filed a petition for the case
to be reviewed by the full Court of Appeals, not just the three judge panel that
issued the vacatur ruling in July 2008.  On October 22, 2008, the EPA was
granted a 15-day period to present a basis as to why the court should reconsider
its decision.  On December 23, 2008, the D.C. Circuit granted the EPA’s
petition only to the extent that it remanded the case without vacatur for EPA to
conduct further proceedings consistent with the court’s prior
opinion.  In summary, the court stated that “...allowing CAIR to remain
in effect until it is replaced by a rule consistent with our opinion would at
least temporarily preserve the environmental values covered by
CAIR.”  The court did not impose a particular schedule by which the
EPA must alter CAIR.  CAIR requires the affected states to be in
year-round NOx emission compliance beginning January 1, 2009.  While
we cannot predict the ultimate outcome of this matter, and any unfavorable
outcome could have a material adverse effect on our business, results of
operations, cash flows, and financial position, the primary driver of CAIR, the
Federal CAAA, including the associated National Ambient Air Quality Standards,
is in effect and states must comply with this law.





Fuel Tech
also sells NOx control systems outside the United States, specifically in Europe
and in the People's Republic of China (China).  NOxOUT systems have long
been sold in the traditional markets of Western Europe, but interest is growing
in newer markets like Eastern Europe as well as Israel for complete NOx
reduction programs on both new and existing boilers.  Under EU
Directives, certain waste incinerators and cement plants must come into
compliance with specified NOx reduction targets by the end of 2009, while
certain power plants must be in compliance by 2016.





China
also represents attractive opportunities for Fuel Tech as the government has set
pollution control and energy conservation and efficiency improvements as top
priorities.  Fuel Tech has viable technologies to help achieve these
objectives.  China has taken initial steps to reduce NOx emissions on
new electric utility units (principally low-NOx burners), and on-going research
and demonstration projects are generating cost performance data for use in
tightening standards in the near future, both for new and retrofit
units.  China’s dominant reliance on coal as an energy resource is not
expected to change in the foreseeable future.  Clean air has been and
will continue to be a pressing issue, especially with China’s robust economic
growth, expected growth in power production (4%-5% average annual increase
through 2020), and an increasingly expanded role in international events and
organizations.  China hosted the 2008 Beijing Summer Olympics and will
host the 2010 Shanghai World Expo.  China plans to address in a
significant way the pollution control for the existing fleet of fossil plants in
the Twelfth Five-Year Plan that takes effect in 2011.  Our goal is to
establish a leading market position in NOx control resulting from the national
demonstration projects utilizing NOxOUT CASCADE technology at Jiangsu Kanshan
(two new 600 megawatt units), NOxOUT Selective Non-Catalytic Reduction (SNCR)
technology at Jiangyin Ligang (four new 600 megawatt units) and Inner Mongolia
(two new 600 megawatt units), and NOxOUT ULTRA technology on two retrofit
projects in Beijing.  These projects are showcasing a wide spectrum of
Fuel Tech capabilities for NOx emission control with the intent of gaining
immediate penetration within the market for new power units, and establishing
Fuel Tech as the leader for the larger market for retrofit units
later.





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





Products





Fuel
Tech’s NOx reduction technologies are installed worldwide on over 450 combustion
units, including utility, industrial and municipal solid waste
applications.  Products include customized NOx control systems and
patented urea-to-ammonia conversion technology, which can provide safe reagent
for use in Selective Catalytic Reduction (SCR) systems.





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





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





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





·
            Fuel
      Tech’s NOxOUT ULTRA process is designed to convert urea to ammonia safely
      and economically for use as a reagent in the SCR process for NOx
      reduction.  Recent local hurdles in the ammonia permitting
      process have raised concerns regarding the safety of ammonia storage in
      quantities sufficient to supply SCR.  In addition, the
      Department of Homeland Security has characterized anhydrous ammonia as a
      Toxic Inhalation Hazard (TIH) commodity.  This is contributing
      to new restrictions by rail carriers on the movement of anhydrous ammonia
      and to an escalation in associated rail transport and insurance
      rates.  Overseas, new coal-fired power plants incorporating SCR
      systems are expected to be constructed at a rapid rate in China, and Fuel
      Tech’s NOxOUT ULTRA process is believed to be a market leader for the safe
      delivery of ammonia, particularly near densely populated cities, major
      waterways, harbors or islands, or where the transport of anhydrous or
      aqueous ammonia is a safety
concern.




5




·
            Fuel
      Tech has licensed the Rich Reagent Injection Technology from Reaction
      Engineering International and Electric Power Research
      Institute.  The technology has been proven in full-scale field
      studies on cyclone-fired units to reduce NOx by 40% - 60%.  The
      technology is a generic SNCR process, whose applicability is outside the
      temperature range of the NOxOUT process.  The technology is seen
      as an add-on to Fuel Tech’s NOxOUT systems, thus potentially broadening
      the NOx reduction of the combined system to up to 60% with minimal
      additional capital requirement.





·
            Under
      an exclusive licensing agreement with FGC Corporation, Fuel Tech sells
      flue gas conditioning systems incorporating FGC Corporation technology for
      utility applications in all geographies outside the United States and
      Canada.  Flue gas conditioning systems improve the efficiency of
      particulate collectors, also known as electrostatic precipitators
      (ESP).  These conditioning systems represent a far lower capital
      cost approach to improving ash particulate capture versus the alternative
      of installing larger ESPs or fabric filter technology to meet opacity
      levels.





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


6




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





NOx
Reduction Competition





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





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





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





The use
of ammonia as the reagent for the SNCR process can reduce NOx by 30% - 70% on
incinerators, but has limited applicability in the utility
industry.  Ammonia system capital costs range from $5 - $20/kW, with
annualized operating costs ranging from $1,000 - $3,000/ton of NOx
removed.  These systems require the use of either anhydrous or aqueous
ammonia, both of which are hazardous substances.





Combustion
Components Associates, Inc. is a licensed implementer of our NOxOUT SNCR
systems.





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





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





FUEL
CHEM





Product
and Markets





The FUEL
CHEM technology segment revolves around the unique application of specialty
chemicals to improve the efficiency, reliability and environmental status of
plants operating in the electric utility, industrial, pulp and paper,
waste-to-energy, university and district heating markets.  FUEL CHEM
programs are currently in place on over 95 combustion units, treating a wide
variety of solid and liquid fuels, including coal, heavy oil, biomass and
municipal waste.





Central
to the FUEL CHEM approach is the introduction of chemical reagents, such as
magnesium hydroxide, to combustion units via in-body fuel application
(pre-combustion) or via direct injection (post-combustion) utilizing Fuel Tech’s
proprietary TIFI technology.  By attacking performance-hindering
problems, such as slagging, fouling and corrosion, as well as the formation of
sulfur trioxide (SO3), ammonium
bisulfate (ABS), particulate matter (PM2.5), carbon
dioxide (CO2), NOx and
unburned carbon in fly ash, the Company’s programs offer numerous operational,
financial and environmental benefits to owners of boilers, furnaces and other
combustion units.





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





The
principal markets for this product line are electric power plants burning coals
with slag-forming constituents such as sodium, iron and high levels of
sulfur.  Sodium is typically found in the Powder River Basin (PRB)
coals of Wyoming and Montana.  Iron is typically found in coals
produced in the Illinois Basin (IB) region.  High sulfur content is
typical of IB coals and certain Appalachian coals.  High sulfur
content can give rise to unacceptable levels of SO3 formation
in plants with SCR systems and flue gas desulphurization units
(scrubbers).




7





The
combination of slagging coals and SO3-related
issues, such as “blue plume” formation, air pre-heater fouling and corrosion,
SCR fouling and the proclivity to suppress certain mercury removal processes,
represents attractive market potential for Fuel Tech.





Internationally,
market opportunities exist in Europe and in the Asia-Pacific region,
particularly China and India, where high-slagging coals are fueling a large and
growing fleet of power plants.  To address the Chinese market, where
particular emphasis is being placed on energy efficiency, Fuel Tech extended its
exclusive teaming agreement with ITOCHU Hong Kong Ltd., a subsidiary of ITOCHU
Corporation, through March 31, 2009.  Working under this agreement,
the first FUEL CHEM demonstration program in China was announced in January 2008
and a second demonstration program was announced in October 2008.  In
addition, Fuel Tech was awarded its first FUEL CHEM demonstration program in
India in January 2008.  TIFI initiatives aimed at energy efficiency
improvements result in reduced CO2emissions,
which potentially can be monetized under provisions of the Kyoto
Protocol.




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





Sales of
the FUEL CHEM products were $36.7 million, $32.5 million and $28.7 million for
the years ended December 31, 2008, 2007 and 2006, respectively.





Competition





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





INTELLECTUAL
PROPERTY





The
majority of Fuel Tech’s products are protected by U.S. and non-U.S.
patents.  Fuel Tech owns 87 granted patents worldwide and has 13 patent
applications pending in the United States and 37 pending in non-U.S.
jurisdictions.  These patents and applications cover some 36 inventions, 23
associated with the NOx reduction business, eight associated with the FUEL CHEM
business and five associated with non-commercialized technologies. 
Graduated Straightening Grid (GSG) technology was added into Fuel Tech’s
inventions through the acquisition of substantially all of the assets of
FlowTack.  GSG improves flow distribution and direction to potentially
improve SCR and CASCADE performance, and minimize flow-related erosion, dust
accumulation and heat transfer problems.  These inventions represent
significant enhancements of the application and performance of the
technologies.  Further, Fuel Tech believes that the protection provided by
the numerous claims in the above referenced patents or patent applications is
substantial, and affords Fuel Tech a significant competitive advantage in its
business.  Accordingly, any significant reduction in the protection
afforded by these patents or any significant development in competing
technologies could have a material adverse effect on Fuel Tech’s
business.





EMPLOYEES





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


8




ITEM
1A - RISK FACTORS





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





(i)
            Lack
      of Diversification





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





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





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





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





(ii)
            Competition





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





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





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





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





(iv)
              Protection
      of Patents and Proprietary
Rights





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





(v)
            Foreign
      Operations





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


9




(vi)
            Product
      Pricing and Operating Results





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





(vii)
            Raw
      Material Supply and Pricing





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





(ix)
            Customer
      Access to Capital Funds





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





(x)
            Customer
      Concentration





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





ITEM 1B -
UNRESOLVED STAFF COMMENTS





None





ITEM
2 - PROPERTIES





Fuel Tech
and its subsidiaries operate from leased office facilities in Warrenville,
Illinois; Stamford, Connecticut; Durham, North Carolina; Gallarate, Italy and
Beijing, China.  Fuel Tech does not segregate any of its leased
facilities by operating business segment.  The terms of the three
material agreements are as follows:




-
            The
      Stamford, Connecticut building lease term, for approximately 7,000 square
      feet, runs from February 1, 2004 to January 31, 2010.  The
      facility houses certain administrative functions such as Investor
      Relations, Benefit Plan Administration and certain APC sales
      functions.




-
            The
      Beijing, China building lease term, for approximately 4,000 square feet,
      runs from September 1, 2007 to August 31, 2009.  This facility
      serves as the operating headquarters for our Beijing Fuel Tech
      operation.  Fuel Tech has the option to extend the lease term at
      a market rate to be agreed upon between Fuel Tech and the
      lessor.




-
            The
      Durham, North Carolina building lease term, for approximately 16,000
      square feet, runs from November 1, 2005 to April 30, 2014.  This
      facility houses the former Tackticks and FlowTack
      operations.  Fuel Tech has no option to extend the
      lease.




In
addition to the above, on November 30, 2007, Fuel Tech purchased an office
building in Warrenville, Illinois, which has served as our corporate
headquarters since June 23, 2008.  This facility, with approximately
40,000 square feet of office space, was purchased for approximately $6,000,000
and subsequently built out and furnished for an additional cost of approximately
$5,500,000.  This facility will meet our growth requirements for the
foreseeable future.  Our prior headquarters, an 18,000 square foot
location in Batavia, Illinois, remains under an operating lease until May 31,
2009.  We have no plans to renew this lease.


10





ITEM
3 - LEGAL PROCEEDINGS





We are
from time to time involved in litigation incidental to our
business.  We are not currently involved in any litigation in which we
believe an adverse outcome would have a material effect on our business,
financial conditions, results of operations, or prospects.





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





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


11




PART
II




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





Market





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





Prices





The table
below sets forth the high and low sales prices during each calendar quarter
since January 2007.





2008
                  
                  High
                  
                  
                  LowFourth
      Quarter
                  
                  $
                  18.95
                  
                  
                  $
                  6.05Third
      Quarter
                  
                  
                  24.76
                  
                  
                  
                  14.52Second
      Quarter
                  
                  
                  27.16
                  
                  
                  
                  17.55First
      Quarter
                  
                  
                  22.94
                  
                  
                  
                  14.15





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





Dividends





Fuel Tech
has never paid cash dividends on its common stock and has no current plan
to do so in the foreseeable future. The declaration and payment of dividends
on the Common Stock are subject to the discretion of the
Company’s Board of Directors.  The decision of the Board of
Directors to pay future dividends will depend on general business conditions,
the effect of a dividend payment on our financial condition, and other factors
the Board of Directors may consider relevant.  The current policy of
the Company’s Board of Directors is to reinvest earnings in operations to
promote future growth.





Share
Repurchase Program





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





Holders





Based on
information from the Company’s Transfer Agent and from banks and brokers, the
Company estimates that, as of February 24, 2009, there were approximately 24,000
beneficial holders and 277 registered stockholders of Fuel Tech’s Common
Shares.





Transfer
Agent





The
Transfer Agent and Registrar for the Common Shares is BNY Mellon Shareowner
Services, 480 Washington Boulevard, Jersey City, New Jersey
07310-1900.


12




Performance
Graph





The
following line graph compares (i) Fuel Tech’s total return to stockholders per
share of Common Stock for the five years ended December 31, 2008 to that of (ii)
the NASDAQ Composite index, and (iii) the WilderHill Clean Energy Index for the
period December 31, 2003 through December 31, 2008.

















13





ITEM
6 - SELECTED FINANCIAL DATA





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





For the years ended December 31,CONSOLIDATED
      STATEMENT ofOPERATIONS DATA
                                                
                                                2008
                                                
                                                
                                                2007
                                                
                                                
                                                2006
                                                
                                                
                                                2005
                                                
                                                
                                                2004(in
      thousands of dollars, except for share and per-share data)Revenues
                                                
                                                $
                                                81,074
                                                
                                                
                                                $
                                                80,297
                                                
                                                
                                                $
                                                75,115
                                                
                                                
                                                $
                                                52,928
                                                
                                                
                                                $
                                                30,832Cost
      of sales
                                                
                                                
                                                44,345
                                                
                                                
                                                
                                                42,471
                                                
                                                
                                                
                                                38,429
                                                
                                                
                                                
                                                27,118
                                                
                                                
                                                
                                                16,566Selling,
      general and administrative and other costs and expenses
                                                
                                                
                                                30,112
                                                
                                                
                                                
                                                27,087
                                                
                                                
                                                
                                                25,953
                                                
                                                
                                                
                                                18,655
                                                
                                                
                                                
                                                14,130Operating
      income
                                                
                                                
                                                6,617
                                                
                                                
                                                
                                                10,739
                                                
                                                
                                                
                                                10,733
                                                
                                                
                                                
                                                7,155
                                                
                                                
                                                
                                                136Net
      income
                                                
                                                
                                                3,602
                                                
                                                
                                                
                                                7,243
                                                
                                                
                                                
                                                6,826
                                                
                                                
                                                
                                                7,588
                                                
                                                
                                                
                                                1,572Basic
      income per Common Share
                                                
                                                $
                                                0.15
                                                
                                                
                                                $
                                                0.33
                                                
                                                
                                                $
                                                0.32
                                                
                                                
                                                $
                                                0.38
                                                
                                                
                                                $
                                                0.08Diluted
      income  per Common Share
                                                
                                                $
                                                0.15
                                                
                                                
                                                $
                                                0.29
                                                
                                                
                                                $
                                                0.28
                                                
                                                
                                                $
                                                0.33
                                                
                                                
                                                $
                                                0.07Weighted-average
      basic shares outstanding
                                                
                                                
                                                23,608,000
                                                
                                                
                                                
                                                22,280,000
                                                
                                                
                                                
                                                21,491,000
                                                
                                                
                                                
                                                20,043,000
                                                
                                                
                                                
                                                19,517,000Weighted-average
      diluted shares outstanding
                                                
                                                
                                                24,590,000
                                                
                                                
                                                
                                                24,720,000
                                                
                                                
                                                
                                                24,187,000
                                                
                                                
                                                
                                                23,066,000
                                                
                                                
                                                
                                                22,155,000





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





Notes:





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


14





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





Background





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





Air Pollution Control Technologies





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





FUEL CHEM Technologies





The FUEL
CHEM technology segment uses chemical processes, including TIFI Targeted
In-Furnace Injection technology, to control slagging, fouling and corrosion, as
well as the formation of sulfur trioxide, ammonium bisulfate, particulate matter
(PM2.5), carbon
dioxide, NOx and unburned carbon in fly ash in furnaces and
boilers.  Fuel Tech sells its FUEL CHEM program through its direct
sales force and agents to industrial and utility power-generation
facilities.  At December 31, 2008, FUEL CHEM programs were operating
on over 95 combustion units around the world, treating a wide variety of solid
and liquid fuels, including coal, heavy oil, biomass and municipal
waste.  The FUEL CHEM program improves the efficiency, reliability and
environmental status of plants operating in the electric utility, industrial,
pulp and paper, waste-to-energy, university and district heating markets and
offers numerous operational, financial and environmental benefits to owners of
boilers, furnaces and other combustion units.





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





Critical
Accounting Policies and Estimates





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





Revenue Recognition





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





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





Fuel
Tech’s APC contracts are typically six to twelve 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 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.




15






Accounts
receivable includes unbilled receivables, representing revenues recognized in
excess of billings on uncompleted contracts under the percentage of completion
method of accounting.  At December 31, 2008 and December 31, 2007,
unbilled receivables were approximately $5,552 and $16,813,
respectively.  Billings in excess of costs and estimated earnings on
uncompleted contracts were $1,223 and $821 at December 31, 2008 and December 31,
2007, respectively.  Such amounts are included in other accrued
liabilities on the consolidated balance sheet.




Fuel Tech
has installed over 450 units with the technology and has never failed to meet a
performance guarantee when the customer has provided the required operating
conditions for the project.  As part of the project implementation
process, 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.




Allowance for Doubtful Accounts





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





Assessment of Potential Impairments of Goodwill and
Intangible Assets




Effective
January 1, 2002, Fuel Tech adopted Financial Accounting Standards Board (FASB)
Statement No. 142, “Goodwill and Other Intangible Assets” (SFAS
142).  Under the guidance of this statement, goodwill and
indefinite-lived intangible assets are no longer amortized, but rather are
required to be reviewed annually or more frequently if indicators arise, for
impairment.  The evaluation of impairment involves comparing the
current fair value of the business to the carrying value.  Fuel Tech
uses a discounted cash flow (DCF) model to determine the current fair value of
its two reporting units.  A number of significant assumptions and
estimates are involved in the application of the DCF model to forecast operating
cash flows, including markets and market share, sales volumes and prices, costs
to produce and working capital changes.  Management considers
historical experience and all available information at the time the fair values
of its reporting units are estimated.  However, actual fair values
that could be realized in an actual transaction may differ from those used to
evaluate the impairment of goodwill.




Fuel Tech
reviews other intangible assets, which include customer lists and relationships,
covenants not to compete, patent assets and acquired technologies, for
impairment on a recurring basis or when events or changes in circumstances
indicate the carrying amount of an asset may not be recoverable.  In
the event the sum of the expected undiscounted future cash flows resulting from
the use of the asset is less than the carrying amount of the asset, an
impairment loss equal to the excess of the asset’s carrying value over its fair
value is recorded.  Management considers historical experience and all
available information at the time the estimates of future cash flows are made,
however, the actual cash values that could be realized may differ from those
that are estimated.




Based
upon the nature of the goodwill and other intangible assets recorded on the
balance sheets as of December 31, 2008 and 2007, the Company believes that, in
order for an impairment to occur, a series of material prolonged negative
economic events would have to occur.  These events would most likely
be seen in economic indicators such as suppressed consolidated revenues or
Common Stock price, reduced cash flows or declining APC order
backlog.




Valuation Allowance for Deferred Income
Taxes




Deferred
tax assets represent deductible temporary differences and net operating loss and
tax credit carryforwards.  A valuation allowance is recognized if it
is more likely than not that some portion of the deferred tax asset will not be
realized.  At the end of each reporting period, Fuel Tech reviews the
realizability of the deferred tax assets.  As part of this review, we
consider if there are taxable temporary differences that could generate taxable
income in the future, if there is the ability to carry back the net operating
losses or credits, if there is a projection of future taxable income, and if
there are any tax planning strategies that can be readily
implemented.




Stock-Based Compensation





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




16




Recently Adopted Accounting
Standards


In
September 2006, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standard No. 157, “Fair Value Measurements” (SFAS
157), which defines fair value, establishes a framework for measuring fair value
in generally accepted accounting principles, and expands disclosures about fair
value measurements.  SFAS 157 does not require any new fair value
measurements, but provides guidance on how to measure fair value by providing a
fair value hierarchy used to classify the source of the
information.  This statement is effective for fiscal years beginning
after November 15, 2007.  On February 14, 2008, the FASB
issued FSP FAS No. 157-1 “Application of FASB Statement No. 157
to FASB Statement 13 and Other Accounting Pronouncements That Address Fair Value
Measurements for Purposes of Lease Classification or Measurement Under Statement
13” (SFAS 157-1) that amends SFAS 157 to exclude its application for
purposes of lease classification or measurement under
SFAS 13.  On February 12, 2008, the FASB issued Staff
Position Financial Accounting Standard (FSP FAS) No. 157-2 “Effective Date
of FASB Statement No. 157” (FSP 157-2) that amends SFAS 157 to delay
the effective date for all non-financial assets and non-financial liabilities,
except those that are recognized or disclosed at fair value in the financial
statements on a recurring basis to fiscal years beginning after
November 15, 2008.  The Company adopted the required provisions
of SFAS 157-1 effective January 1, 2008 and there was no material
effect on its consolidated financial statements. The Company has adopted
FSP 157-2 to delay the adoption effects related to non-financial assets and
does not anticipate there will be a material effect on its consolidated
financial statements.  In October 2008, the FASB issued
FSP 157-3, “Determining the Fair Value of a Financial Asset in a Market
That Is Not Active.”  The FSP was effective upon issuance, including
periods for which financial statements have not been issued. The FSP clarified
the application of SFAS 157 in an inactive market and provided an
illustrative example to demonstrate how the fair value of a financial asset is
determined when the market for that financial asset is inactive.  The
adoption of this FSP FAS 157-3 did not have a material impact on the
Company’s consolidated financial statements.
  In
December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business
Combinations” (SFAS 141R). SFAS 141R establishes principles and requirements for
how an acquirer recognizes and measures in its financial statements the
identifiable assets acquired, the liabilities assumed, any noncontrolling
interest in the acquiree and the goodwill acquired. SFAS 141R also establishes
disclosure requirements to enable the evaluation of the nature and financial
effects of the business combination. SFAS 141R is effective for financial
statements issued for fiscal years beginning after December 15, 2008. The
Company is currently evaluating the potential impact of adoption of SFAS 141R on
its consolidated financial statements. However, the Company does not expect the
adoption of SFAS 141R to have a material effect on its consolidated financial
statements.
 
 In April
2008, the FASB issued FASB Staff Position No. FAS 142-3, Determination of the Useful Life of
Intangible Assets(“FSP No. FAS 142-3”). FSP No. FAS 142-3 requires
companies estimating the useful life of a recognized intangible asset to
consider their historical experience in renewing or extending similar
arrangements or, in the absence of historical experience, to consider
assumptions that market participants would use about renewal or extension as
adjusted for SFAS 142’s, Goodwill and Other Intangible
Assets, entity-specific factors. FSP No. FAS 142-3 will be effective for
fiscal years beginning after December 15, 2008. The Company is currently
evaluating the potential impact of adoption of FSP No. FAS 142-3 on its
consolidated financial statements. However, the Company does not expect the
adoption of FSP No. FAS 142-3 to have a material effect on its consolidated
financial statements.
 
 In May
2008, the FASB issued Statement of Financial Accounting Standards No. 162,
“The Hierarchy of Generally Accepted Accounting Principles” (SFAS
162).  SFAS 162 identifies the sources of accounting principles
and the framework for selecting the principles used in the preparation of
financial statements that are presented in conformity with generally accepted
accounting principles. SFAS 162 becomes effective 60 days following
the SEC’s approval of the Public Company Accounting Oversight Board amendments
to AU Section 411, “The Meaning of Present Fairly in Conformity With
Generally Accepted Accounting Principles.”  The Company does not
expect that the adoption of SFAS 162 to have a material effect on its
consolidated financial statements.


17





2008
versus 2007





Revenues
for the years ended December 31, 2008 and 2007 were $81,074 and $80,297,
respectively.  The year-over-year increase of $777, or 1%, was driven
by a 13% increase in revenues from the FUEL CHEM technology segment that were
largely offset by a modest revenue decline in the APC technology
segment.





Revenues
for the APC technology segment were $44,393 for the year ended December 31,
2008, a decrease of $3,357, or 7%, versus 2007.  The global financial
crisis and the vacatur of the Clean Air Interstate Rule (CAIR) in July 2008
(subsequently remanded in December 2008) had a negative effect on segment
revenues and APC order backlog.  This segment is well positioned to
capitalize on CAIR - the next phase of increasingly stringent U.S. air quality
standards - which is effective January 1, 2009, and the Clean Air Visibility
Rule (CAVR), which is effective January 1, 2013.  Thousands of utility
and industrial boilers will be impacted by these regulations and Fuel Tech’s
technologies will serve as an important element in enabling utility and
industrial boiler unit owners to attain compliance.  During 2008, Fuel
Tech announced new contracts valued at approximately $21,000.





Revenues
for the FUEL CHEM technology segment were $36,681 for the year ended December
31, 2008, an increase of $4,134, or 13%, versus 2007.  This segment’s
growth is indicative of the continued market acceptance of Fuel Tech’s patented
TIFI Targeted In-Furnace Injection technology, particularly on coal-fired units,
which represent the largest market opportunity for the technology, both
domestically and abroad.  During 2008, Fuel Tech added 15 new units to
its customer base, 13 of which were coal-fired units, the largest annual total
in the Company’s history.  Historically, most demonstrations convert
into commercial accounts.





Cost of
sales for the years ended December 31, 2008 and 2007 was $44,345 and $42,471,
respectively.  Cost of sales as a percentage of revenues for the years
ended December 31, 2008 and 2007 was 54% and 53%, respectively.  The
2008 cost of sales percentage for the APC technology segment increased to 55%
from 54% in 2007.  The increase is attributable to the mix of project
business.  The 2008 cost of sales percentage for the FUEL CHEM
technology segment increased to 55% in 2008 from 51% in 2007.  The
increase is due to costs associated with demonstration periods and other related
start-up activities for the record number of incremental units noted above,
especially for the demonstrations in India and China where the Company bore a
significantly higher portion of the costs versus typical demonstrations in
the United States.





Selling,
general and administrative expenses for the years ended December 31, 2008 and
2007 were $28,012 and $24,950, respectively.  The $3,062 increase over
2007 is principally attributable to the following:





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





-
              Fuel
      Tech invested approximately $2,000 in personnel and other costs, including
      expenses associated with the start-up of the Company’s Beijing, China
      office, in the areas of Engineering, Sales, Marketing and Administration
      to ensure the Company’s financial and operational infrastructure are able
      to accommodate anticipated future
growth.





-
              Partially
      offsetting this unfavorable variance was a reduction in annual incentive
      expenses of $1,500 as the minimum income threshold for the year ended
      December 31, 2008 was not met and, thus, no 2008 bonus payments were made
      under the Company’s incentive
plan.





Research
and development expenses were $2,100 and $2,137 for the years ended December 31,
2008 and 2007, respectively.  Fuel Tech has established a more focused
approach in the pursuit of commercial applications for its technologies outside
of its traditional markets, and in the development and analysis of new
technologies that could represent incremental market opportunities.





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




18




For the
year ended December 31, 2008, Fuel Tech recorded tax expense of
$3,305.  For the year ended December 31, 2007, Fuel Tech recorded tax
expense of $5,187 that predominantly represented deferred tax expense related to
taxable income recognized in 2007.




2007
versus 2006





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





Revenues
for the APC technology segment were $47,750 for the year ended December 31,
2007, an increase of $1,296 , or 3%, versus 2006.  This segment is
positioned well to capitalize on the next phase of increasingly stringent U.S.
air quality standards.  With the compliance for the EPA’s SIP Call
regulation beginning to wind down, utilities and industrial facilities across
the country are planning for compliance with the Clean Air Interstate Rule
(CAIR) and the Clean Air Visibility Rule (CAVR), which take effect in 2009 and
2013, respectively.  Thousands of utility and industrial boilers will
be impacted by these regulations and Fuel Tech’s technologies will serve as an
important element in enabling utility and industrial boiler unit owners to
attain compliance.  In 2007, Fuel Tech announced new contracts valued
at $60 million, which exceeded the previous annual record by almost
40%.





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





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





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





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





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





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





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





For the
year ended December 31, 2007, Fuel Tech recorded tax expense of $5,187, which
predominantly represents deferred tax expense related to taxable income
recognized in 2007.  For the year ended December 31, 2006, Fuel Tech
recorded tax expense of $4,942, also representing deferred tax expense related
to taxable income.




Liquidity
and Sources of Capital





At
December 31, 2008, Fuel Tech had cash and cash equivalents and short-term
investments of $28,149 and working capital of $44,346 versus $32,471 and $45,143
at December 31, 2007, respectively.  Operating activities provided
$8,047 of cash for the year ended December 31, 2008, primarily due to the
favorable operating results of the business segments.




Investing
activities used cash of $11,769 for the year ended December 31, 2008, primarily
for expenditures related to our new corporate headquarters building to support
and enhance the operations of the business of $5,200, the acquisition funding
for substantially all of the assets of Tackticks, LLC and FlowTack, LLC of
$3,928 and the remainder used principally for equipment related to the FUEL CHEM
technology segment.  Capital
expenditures, which typically consist of equipment related to FUEL CHEM
demonstration programs or commercial installations, are expected to be funded
primarily from cash flows from operations.  Other than the outfitting
of the new corporate headquarters building in 2008, the Company has historically
incurred a nominal amount of maintenance capital
expenditures.




Fuel Tech
generated cash from financing activities in the amount of $1,377.  Of
this amount, $619 represents proceeds derived from the exercise price of options
and warrants exercised in 2008, while $548 represents the excess tax benefits
realized from the exercise of stock options in 2008.




19




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





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





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





Interest
payments in the amount of $135 and $24 were made during the years ended December
31, 2008 and 2007, respectively.  No payments were made during the
year ended December 31, 2006.





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





Contractual
Obligations and Commitments





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




Payments
      due by period in thousands of dollarsContractual
      CashObligations
                                                      
                                                      Total
                                                      
                                                      
                                                      Less
      than 1
                                                        year
                                                      
                                                      
                                                      2-3
      years
                                                      
                                                      
                                                      4-5
      years
                                                      
                                                      
                                                      ThereafterOperating
      Leases
                                                      
                                                      $
                                                      1,720
                                                      
                                                      
                                                      $
                                                      663
                                                      
                                                      
                                                      $
                                                      527
                                                      
                                                      
                                                      $
                                                      468
                                                      
                                                      
                                                      $
                                                      62




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




Commitment
      expiration by period in thousands of dollarsCommercialCommitments
                                                  
                                                  Total
                                                  
                                                  
                                                  Less
      than 1
                                                    year
                                                  
                                                  
                                                  2-3
      years
                                                  
                                                  
                                                  4-5
      years
                                                  
                                                  
                                                  ThereafterShort-term
      debt
                                                  
                                                  $
                                                  2,188
                                                  
                                                  
                                                  $
                                                  2,188
                                                  
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  -





For the
years ended December 31, 2008 and 2007, Fuel Tech incurred interest expense
related to the Beijing Fuel Tech short-term debt of $135 and $24,
respectively.  We cannot estimate the fiscal 2009 interest expense for
this short-term debt as the debt may be repaid at any time during fiscal
2009.





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





-
            in
      support of the warranty period defined in the contract;
  or


-
            in
      support of the system performance criteria that are defined in the
      contract.




20




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




Commitment
      expiration by period in thousands of dollarsCommercialCommitments
                                                  
                                                  Total
                                                  
                                                  
                                                  Less
      than 1 year
                                                  
                                                  
                                                  2-3
      years
                                                  
                                                  
                                                  4-5
      years
                                                  
                                                  
                                                  ThereafterStandby
      letters of credit and bank guarantees
                                                  
                                                  $
                                                  5,865
                                                  
                                                  
                                                  $
                                                  1,794
                                                  
                                                  
                                                  $
                                                  3,388
                                                  
                                                  
                                                  $
                                                  683
                                                  
                                                  
                                                  $
                                                  -







The
following table summarizes Fuel Tech’s FIN 48 obligations as of December 31,
2008.  Please refer to Note 3to the consolidated
financial statements in this document for a description of our FIN 48
obligations.




Commitment
      expiration by period in thousands of dollarsCommercialCommitments
                                                  
                                                  Total
                                                  
                                                  
                                                  Less
      than 1 year
                                                  
                                                  
                                                  2-3
      years
                                                  
                                                  
                                                  4-5
      years
                                                  
                                                  
                                                  ThereafterFIN
      48 Obligations
                                                  
                                                  $
                                                  713
                                                  
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  713




Off-Balance-Sheet
Transactions





There
were no off-balance-sheet transactions during the two-year period ended Decmeber
31, 2008.




Subsequent
Events





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




21




ITEM
7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK





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





Fuel Tech
is also exposed to changes in interest rates primarily due to its long-term debt
arrangement (refer to Note 8 to the consolidated financial
statements).  A hypothetical 100 basis point adverse move in interest
rates along the entire interest rate yield curve would not have a materially
adverse effect on interest expense during the upcoming year ended December 31,
2009.




22




ITEM
8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA




Report
Of Independent Registered Public Accounting Firm
 
 The Board
of Directors and Stockholders
 Fuel
Tech, Inc.
 
 We have
audited Fuel Tech, Inc (a Delaware corporation) and Subsidiaries’ (the
“Company”) internal control over financial reporting as of December 31, 2008
based on criteria established in Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). The Company’s management is responsible for
maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting,
included the accompanying Management’s Report on Internal Control Over Financial
Reporting appearing under Item 9A.  Our responsibility is to express
an opinion on the Company’s internal control over financial reporting based on
our audit.
 
 We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, assessing the risk that a material weakness exists, testing
and evaluating the design and operating effectiveness of internal control based
on the assessed risk, and performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides a reasonable
basis for our opinion.
 
 A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial
statements.
 
 Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements.  Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
  In our
opinion, Fuel Tech and Subsidiaries maintained, in all material respects,
effective internal control over financial reporting as of December 31, 2008,
based on criteriaestablished in Internal Control – Integrated
Framework issued by COSO.
  We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of the Company
as of December 31, 2008 and 2007 and the related consolidated statements of
income, stockholders’ equity, and cash flows for each of the three years in the
period ended December 31, 2008, and our report dated March 5, 2009 expressed an
unqualified opinion on those financial statements.
  /s/ GRANT
THORNTON LLP
 
 Chicago,
Illinois
 March 5,
2009


23


Report
of Independent Registered Public Accounting Firm
 
 The Board
of Directors and Stockholders
 Fuel
Tech, Inc.
 
 We have
audited the accompanying consolidated balance sheets of Fuel Tech, Inc. (a
Delaware corporation) and Subsidiaries (the “Company”) as of December 31, 2008
and 2007, and the related consolidated statements of income, stockholders’
equity, and cash flows for each of the three years in the period ended December
31, 2008.  These financial statements are the responsibility of the
Company’s management. Our responsibility is to express an opinion on these
financial statements based on our audits.
 
 We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
 
 In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Fuel Tech, Inc. and
Subsidiaries as of December 31, 2008 and 2007 and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
2008, in conformity with accounting principles generally accepted in the United
States of America.
 
 We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of the Company’s internal
control over financial reporting as of December 31, 2008, based on the criteria
established in Internal
Control – Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) and our report dated March 5,
2009 expressed an unqualified opinion on the effective operation of internal
control over financial reporting.
 
 /s/ GRANT
THORNTON LLP
 
 Chicago,
Illinois
 March 5,
2009




24




Fuel
Tech, Inc.


Consolidated
Balance Sheets


(in
thousands of dollars, except share and per-share data)





2008
                
                
                2007December
      31ASSETSCurrent
      assets:Cash
      and cash equivalents
                
                $
                28,149
                
                
                $
                30,473Short-term
      investments
                
                
                -
                
                
                
                1,998Accounts
      receivable, net of allowance for doubtful accounts of $80 and $150,
      respectively
                
                
                23,365
                
                
                
                31,856Inventories
                
                
                1,014
                
                
                
                186Deferred
      income taxes
                
                
                767
                
                
                
                1,589Prepaid
      expenses and other current assets
                
                
                4,718
                
                
                
                1,761Total
      current assets
                
                
                58,013
                
                
                
                67,863Property
      and equipment, net of accumulated depreciation of $12,588 and $10,091,
      respectively
                
                
                17,515
                
                
                
                11,302Goodwill
                
                
                5,158
                
                
                
                2,119Other
      intangible assets, net of accumulated amortization of $1,504 and $1,320,
      respectively
                
                
                2,543
                
                
                
                1,088Deferred
      income taxes
                
                
                2,412
                
                
                
                2,552Other
      assets
                
                
                3,232
                
                
                
                2,290Total
      assets
                
                $
                88,873
                
                
                $
                87,214LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilities:Short-term
      debt
                
                $
                2,188
                
                
                $
                2,051Accounts
      payable
                
                
                8,196
                
                
                
                13,632Accrued
      liabilities:Employee
      compensation
                
                
                510
                
                
                
                2,304Other
      accrued liabilities
                
                
                2,773
                
                
                
                4,733Total
      current liabilities
                
                
                13,667
                
                
                
                22,720Other
      liabilities
                
                
                1,389
                
                
                
                1,255Total
      liabilities
                
                
                15,056
                
                
                
                23,975Stockholders'
      equity:Common
      stock, $.01 par value, 40,000,000 shares authorized, 24,110,967 and
      22,410,064 shares issued, respectively
                
                
                241
                
                
                
                224Additional
      paid-in capital
                
                
                118,588
                
                
                
                111,459Accumulated
      deficit
                
                
                (45,280
                )
                
                
                (48,882
                )Accumulated
      other comprehensive income
                
                
                187
                
                
                
                166Nil
      coupon perpetual loan notes
                
                
                81
                
                
                
                272Total
      stockholders' equity
                
                
                73,817
                
                
                
                63,239Total
      liabilities and stockholders' equity
                
                $
                88,873
                
                
                $
                87,214





See notes
to consolidated financial statements.




25




Fuel
Tech, Inc.


Consolidated
Statements of Income


(in
thousands of dollars, except share and per-share data)





2008
                  
                  
                  2007
                  
                  
                  2006For
      the years ended December 31Revenues
                  
                  $
                  81,074
                  
                  
                  $
                  80,297
                  
                  
                  $
                  75,115Costs
      and expenses:Cost
      of sales
                  
                  
                  44,345
                  
                  
                  
                  42,471
                  
                  
                  
                  38,429Selling,
      general and administrative
                  
                  
                  28,012
                  
                  
                  
                  24,950
                  
                  
                  
                  23,901Research
      and development
                  
                  
                  2,100
                  
                  
                  
                  2,137
                  
                  
                  
                  2,05274,457
                  
                  
                  
                  69,558
                  
                  
                  
                  64,382Operating
      income
                  
                  
                  6,617
                  
                  
                  
                  10,739
                  
                  
                  
                  10,733Interest
      expense
                  
                  
                  (135
                  )
                  
                  
                  (24
                  )
                  
                  
                  -Interest
      income
                  
                  
                  741
                  
                  
                  
                  1,634
                  
                  
                  
                  1,011Other
      income (expense)
                  
                  
                  (226
                  )
                  
                  
                  81
                  
                  
                  
                  24Income
      before taxes
                  
                  
                  6,997
                  
                  
                  
                  12,430
                  
                  
                  
                  11,768Income
      taxes
                  
                  
                  (3,395
                  )
                  
                  
                  (5,187
                  )
                  
                  
                  (4,942
                  )Net
      income
                  
                  $
                  3,602
                  
                  
                  $
                  7,243
                  
                  
                  $
                  6,826Net
      income per Common Share:Basic
                  
                  $
                  0.15
                  
                  
                  $
                  0.33
                  
                  
                  $
                  0.32Diluted
                  
                  $
                  0.15
                  
                  
                  $
                  0.29
                  
                  
                  $
                  0.28Weighted-average
      number of Common Shares outstanding:Basic
                  
                  
                  23,608,000
                  
                  
                  
                  22,280,000
                  
                  
                  
                  21,491,000Diluted
                  
                  
                  24,590,000
                  
                  
                  
                  24,720,000
                  
                  
                  
                  24,187,000





See notes
to consolidated financial statements.




26




Fuel
Tech, Inc.


Consolidated
Statements of Stockholders’ Equity


(in
thousands of dollars or thousand of shares, as appropriate)


Common
      Stock
                                
                                
                                Additional
                                  Paid-in
                                
                                
                                Accumulated
                                
                                
                                Accumulated
                                  Other
                                  Comprehensive
                                
                                
                                Treasury
      Stock
                                
                                
                                Nil Coupon
                                  PerpetualShares
                                
                                
                                Amount
                                
                                
                                Capital
                                
                                
                                Deficit
                                
                                
                                Income
      (Loss)
                                
                                
                                Shares
                                
                                
                                Amount
                                
                                
                                Loan Notes
                                
                                
                                TotalBalance
      at January 1, 2006
                                
                                
                                20,424
                                
                                
                                $
                                204
                                
                                
                                $
                                91,559
                                
                                
                                $
                                (62,870
                                )
                                
                                $
                                (39
                                )
                                
                                
                                -
                                
                                
                                $
                                -
                                
                                
                                $
                                282
                                
                                
                                $
                                29,136Comprehensive
      income:Net
      income
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                6,826
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                6,826Foreign  currency
      translation adjustments
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                118
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                118Comprehensive
      income
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                6,944Exercise
      of stock options and warrants
                                
                                
                                1,662
                                
                                
                                
                                17
                                
                                
                                
                                3,809
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                3,826Conversion
      of nil coupon perpetual loan notes into Common Shares
                                
                                
                                1
                                
                                
                                
                                
                                
                                
                                
                                5
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                (5
                                )
                                
                                
                                -Tax
      benefit from stock compensation expense
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                5,944
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                5,944Stock
      compensation expense
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                1,805
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                1,805Balance
      at December 31, 2006
                                
                                
                                22,087
                                
                                
                                $
                                221
                                
                                
                                $
                                103,122
                                
                                
                                $
                                (56,044
                                )
                                
                                $
                                79
                                
                                
                                
                                -
                                
                                
                                $
                                -
                                
                                
                                $
                                277
                                
                                
                                $
                                47,655Comprehensive
      income:Net
      income
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                7,243
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                7,243Foreign  currency
      translation adjustments
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                87
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                87Comprehensive
      income
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                7,330Exercise
      of stock options and warrants
                                
                                
                                322
                                
                                
                                
                                3
                                
                                
                                
                                909
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                912Conversion
      of nil coupon perpetual loan notes into Common Shares
                                
                                
                                1
                                
                                
                                
                                
                                
                                
                                
                                5
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                (5
                                )
                                
                                
                                -Effect
      of FIN 48 adoption
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                (81
                                )
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                (81
                                )Tax
      benefit from stock compensation expense
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                1,482
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                1,482Stock
      compensation expense
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                4,791
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                4,791Issuance
      of deferred shares of stock
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                1,150
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                1,150Balance
      at December 31, 2007
                                
                                
                                22,410
                                
                                
                                $
                                224
                                
                                
                                $
                                111,459
                                
                                
                                $
                                (48,882
                                )
                                
                                $
                                166
                                
                                
                                
                                -
                                
                                
                                $
                                -
                                
                                
                                $
                                272
                                
                                
                                $
                                63,239Comprehensive
      income:Net
      income
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                3,602
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                3,602Foreign  currency
      translation adjustments
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                21
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                21Comprehensive
      income
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                3,623Exercise
      of stock  options and warrants
                                
                                
                                1,657
                                
                                
                                
                                17
                                
                                
                                
                                602
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                619Conversion
      of nil coupon perpetual loan notes into Common Shares
                                
                                
                                44
                                
                                
                                
                                
                                
                                
                                
                                191
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                (191
                                )
                                
                                
                                -Tax
      benefit from stock compensation expense
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                548
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                548Stock
      compensation expense
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                5,815
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                5,815Issuance
      of deferred shares of stock
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                73
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                73Reclassification
      of liability award
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                (100
                                )
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                (100
                                )Balance
      at December 31, 2008
                                
                                
                                24,111
                                
                                
                                $
                                241
                                
                                
                                $
                                118,588
                                
                                
                                $
                                (45,280
                                )
                                
                                $
                                187
                                
                                
                                
                                -
                                
                                
                                $
                                -
                                
                                
                                $
                                81
                                
                                
                                $
                                73,817




See notes
to consolidated financial statements.




27




Fuel
Tech, Inc.


Consolidated
Statements of Cash Flows


(in
thousands of dollars)





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





See notes
to consolidated financial statements.




28




Notes to
Consolidated Financial Statements


(in
thousands of dollars, except share and per-share data)





1.
              ORGANIZATION
      AND SIGNIFICANT ACCOUNTING
POLICIES





Organization





Fuel Tech
is a company that provides advanced engineering solutions for the optimization
of combustion systems in utility and industrial applications.  Fuel
Tech’s primary focus is on the worldwide marketing and sale of its NOx reduction
technologies as well as its FUEL CHEM program.  The Company’s NOx
reduction technologies reduce nitrogen oxide emissions from boilers, furnaces
and other stationary combustion sources.  Our FUEL CHEM program is
based on proprietary TIFI Targeted In-Furnace Injection technology in the unique
application of specialty chemicals to improve the efficiency, reliability and
environmental status of combustion units by controlling slagging, fouling,
corrosion, opacity and acid plume, as well as the formation of sulfur trioxide,
ammonium bisulfate, particulate matter (PM2.5), carbon
dioxide, NOx and unburned carbon in fly ash via the addition of chemicals into
the boiler.  Our business is materially dependent on the continued
existence and enforcement of air quality regulations, particularly in the United
States.  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.





International
revenues were $12,641, $12,763 and $17,487 for the years ended December 31,
2008, 2007 and 2006, respectively.  These amounts represented 16%, 16%
and 23% of Fuel Tech’s total revenues for the respective periods of
time.  Foreign currency changes did not have a material impact on the
calculation of these percentages.   Fuel Tech has foreign offices
in Beijing, China and in Gallarate, Italy.





Basis
of Presentation





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





Use
of Estimates





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





Fair
Value of Financial Instruments





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





Cash
Equivalents and Short-Term Investments





Fuel Tech
includes cash and investments having an original maturity of three months or
less at the time of acquisition in cash and cash
equivalents.  Short-term investments consist of highly liquid
investments having an original maturity of greater than three months which are
recorded at cost, and have been classified as available for sale
securities.  Fuel Tech has never incurred realized or unrealized
holding gains or losses on these securities.  Income resulting from
short-term investments is recorded as interest income.





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 or into foreign currency option contracts to manage
this risk due to the immaterial nature of the transactions
involved.





Accounts
Receivable





Accounts
receivable includes unbilled receivables, representing costs and estimated
earnings in excess of billings on uncompleted contracts under the percentage of
completion method.   At December 31, 2008 and 2007, unbilled
receivables were approximately $5,552 and $16,813 respectively.




29




Allowance
for Doubtful Accounts





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





Year
                        
                        Balance
      at
                          January
      1
                        
                        
                        Charged
      to costs
                          and
      expenses
                        
                        
                        (Deductions)/Other
                        
                        
                        Balance
      at
                          December
      312006
                        
                        $
                        150
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        $
                        1502007
                        
                        $
                        150
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        $
                        1502008
                        
                        $
                        150
                        
                        
                        
                        -
                        
                        
                        $
                        (70
                        )
                        
                        $
                        80




Translation
of Foreign Currency





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





Comprehensive
Income





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





Research
and Development





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





Product/System
Warranty





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





Goodwill
and Other Intangibles




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 the
business to the carrying value.  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.




Fuel Tech
allocates goodwill to reporting units based on the relative excess of fair value
over carrying value of the reporting units.  Fair value is determined
as noted above.  The ratio of each reporting unit’s excess of fair
value over carrying value, to the total excess of fair value over carrying
value, is used as the basis for the allocation of the goodwill
balance.  Our fair value measurement test, performed annually as of
October 1, revealed no indications of impairment.




Included
with other intangible assets on the consolidated balance sheet are third-party
costs related to the development of patents.  As of December 31, 2008
and 2007, the net patent asset balance was $249 and $199,
respectively.  The third-party costs capitalized during the years
ended December 31, 2008 and 2007 were $60 and $53,
respectively.  Third-party costs are comprised of legal fees that
relate to the review and preparation of patent disclosures and filing fees
incurred to present the patents to the required governing body.




30




Fuel
Tech’s intellectual property has been the primary building block for the Air
Pollution Control and FUEL CHEM technology segments.  The patents are
essential to the generation of revenue for our businesses and are essential to
protect us from competition in the markets in which it serves.  These
costs are being amortized on the straight-line method over a period of 10 years
from the date of patent issuance.  Patent maintenance fees are charged
to operations as incurred.




Fuel Tech
reviews other intangible assets, which include customer lists and relationships,
covenants not to compete, patent assets and acquired technologies, for
impairment on a recurring basis or when events or changes in circumstances
indicate the carrying amount of an asset may not be recoverable.  In
the event the sum of the expected undiscounted future cash flows resulting from
the use of the asset is less than the carrying amount of the asset, an
impairment loss equal to the excess of the asset’s carrying value over its fair
value is recorded.  Management considers historical experience and all
available information at the time the estimates of future cash flows are made,
however, the actual cash values that could be realized may differ from those
that are estimated.  For the years ended December 31, 2008, 2007 and
2006 the impact of impairment losses was $0, $7 and $0,
respectively.  Such amounts are recorded in the “Research and
development” line item in the consolidated statements of income.




The table
below shows the amortization period and other intangible asset cost by
intangible asset as of December 31, 2008 and 2007, and the accumulated
amortization and net intangible asset value in total for all other intangible
assets.





AmortizationDescription
      of Other Intangible
                                
                                period
                                
                                2008
                                
                                
                                2007Customer
      list
                                
                                3-15
      years
                                
                                $
                                1,548
                                
                                
                                $
                                1,198Patent
      asset
                                
                                10
      years
                                
                                
                                1,170
                                
                                
                                
                                1,110Covenant
      not to compete
                                
                                5-6
      years
                                
                                
                                336
                                
                                
                                
                                100Technologies
                                
                                3-8
      years
                                
                                
                                603
                                
                                
                                
                                -Miscellaneous
                                
                                3-7
      years
                                
                                
                                390
                                
                                
                                
                                -Total
      cost
                                
                                
                                
                                
                                4,047
                                
                                
                                $
                                2,408Less
      accumulated amortization
                                
                                
                                
                                
                                (1,504
                                )
                                
                                
                                (1,320
                                )Total
      net intangible asset value
                                
                                
                                
                                $
                                2,543
                                
                                
                                $
                                1,088





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





Property
and Equipment





Equipment
is stated at historical cost.  Provisions for depreciation are
computed by the straight-line method, using estimated useful
lives.  The table below shows the depreciable life and cost by asset
class as of December 31, 2008 and 2007, and the accumulated depreciation and net
book value in total for all classes of assets.





Description
      of Property and
                                Equipment
                              
                              Depreciable
                                life
                              
                              2008
                                Cost
                              
                              
                              2007
                                CostLand
                              
                              
                              
                              $
                              1,440
                              
                              
                              $
                              1,440Building
                              
                              39
      years
                              
                              
                              4,857
                              
                              
                              
                              4,857Leasehold
      Improvements
                              
                              3-39 years
                              
                              
                              4,719
                              
                              
                              
                              -Field
      equipment
                              
                              3-4
      years
                              
                              
                              13,714
                              
                              
                              
                              10,405Computer
      equipment and software
                              
                              2-3
      years
                              
                              
                              3,527
                              
                              
                              
                              2,996Furniture
      and fixtures
                              
                              3-10
      years
                              
                              
                              1,823
                              
                              
                              
                              1,673Vehicles
                              
                              3
      years
                              
                              
                              22
                              
                              
                              
                              22Total
      cost
                              
                              
                              
                              $
                              30,102
                              
                              
                              $
                              21,393Less
      accumulated depreciation
                              
                              
                              
                              
                              (12,587
                              )
                              
                              
                              (10,091
                              )Total
      net book value
                              
                              
                              
                              $
                              17,515
                              
                              
                              $
                              11,302




31




Revenue
Recognition





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





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





Distribution
Costs





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





Income
Taxes





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





At the
end of each reporting period, for financial statement purposes, Fuel Tech
reviews the realizability of the deferred tax assets.  As part of this
review, we will consider if there are taxable temporary differences that could
generate taxable income in the future, if there is the ability to carryback the
net operating losses or credits, if there is a projection of future taxable
income, and if there are any tax planning strategies that can be readily
implemented.  The table below sets forth the components of the
Valuation Allowance for Deferred Tax Assets for the years ended December
31.




Year
                        
                        Balance
      at
                          January
      1
                        
                        
                        Charged
      to costs and expenses
                        
                        
                        (Deductions)/Other
                        
                        
                        Balance
      at
                          December
      312006
                        
                        $
                        45
                        
                        
                        $
                        215
                        
                        
                        
                        -
                        
                        
                        $
                        2602007
                        
                        $
                        260
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        $
                        2602008
                        
                        $
                        260
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        $
                        260








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, 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 our 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.  In 2008, 2007
and 2006, 757,250, 310,500 and 1,094,000 options, respectively, were granted to
employees and directors.  At December 31, 2008, Fuel Tech had 471,712
stock options available for issuance under the Incentive Plan.





Effective
January 1, 2006, Fuel Tech adopted the fair value recognition provisions of FASB
Statement No. 123(R), “Share-Based Payment” (SFAS 123R) using the
modified-prospective transition method.  Under that transition method,
compensation cost recognized for the year ended December 31, 2008 includes: (a)
compensation cost for all share-based payments granted prior to, but not yet
vested as of January 1, 2006, based on the grant date fair value estimated in
accordance with the original provisions of Statement 123, and (b) compensation
cost for all share-based payments granted subsequent to January 1, 2006, based
on the grant-date fair value estimated in accordance with the provisions of SFAS
123R.  Accordingly, results for prior periods have not been
restated.





Basic
and Diluted Earnings per Common Share





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




32




2008
                        
                        
                        2007
                        
                        
                        2006Basic
      weighted-average shares
                        
                        
                        23,608,000
                        
                        
                        
                        22,280,000
                        
                        
                        
                        21,491,000Conversion
      of unsecured loan notes
                        
                        
                        43,000
                        
                        
                        
                        45,000
                        
                        
                        
                        46,000Unexercised
      options and warrants
                        
                        
                        939,000
                        
                        
                        
                        2,395,000
                        
                        
                        
                        2,650,000Diluted
      weighted-average shares
                        
                        
                        24,590,000
                        
                        
                        
                        24,720,000
                        
                        
                        
                        24,187,000




Recently
Adopted Accounting Standards


In
September 2006, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standard No. 157, “Fair Value Measurements” (SFAS
157), which defines fair value, establishes a framework for measuring fair value
in generally accepted accounting principles, and expands disclosures about fair
value measurements.  SFAS 157 does not require any new fair value
measurements, but provides guidance on how to measure fair value by providing a
fair value hierarchy used to classify the source of the information.  This
statement is effective for fiscal years beginning after November 15, 2007.
 On February 14, 2008, the FASB issued FSP FAS No. 157-1
“Application of FASB Statement No. 157 to FASB Statement 13 and Other
Accounting Pronouncements That Address Fair Value Measurements for Purposes of
Lease Classification or Measurement Under Statement 13” (SFAS 157-1) that amends
SFAS 157 to exclude its application for purposes of lease classification or
measurement under SFAS 13.  On February 12, 2008, the FASB issued
Staff Position Financial Accounting Standard (FSP FAS) No. 157-2 “Effective
Date of FASB Statement No. 157” (FSP 157-2) that amends SFAS 157 to
delay the effective date for all non-financial assets and non-financial
liabilities, except those that are recognized or disclosed at fair value in the
financial statements on a recurring basis to fiscal years beginning after
November 15, 2008.  The Company adopted the required provisions of
SFAS 157-1 effective January 1, 2008 and there was no material effect
on its consolidated financial statements. The Company has adopted FSP 157-2
to delay the adoption effects related to non-financial assets and does not
anticipate there will be a material effect on its consolidated financial
statements.  In October 2008, the FASB issued FSP 157-3, “Determining
the Fair Value of a Financial Asset in a Market That Is Not Active.”  The
FSP was effective upon issuance, including periods for which financial
statements have not been issued. The FSP clarified the application of
SFAS 157 in an inactive market and provided an illustrative example to
demonstrate how the fair value of a financial asset is determined when the
market for that financial asset is inactive.  The adoption of this FSP
FAS 157-3 did not have a material impact on the Company’s consolidated
financial statements.
 
 In
December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business
Combinations” (SFAS 141R). SFAS 141R establishes principles and
requirements for how an acquirer recognizes and measures in its financial
statements the identifiable assets acquired, the liabilities assumed, any
noncontrolling interest in the acquiree and the goodwill acquired.
 SFAS 141R also establishes disclosure requirements to enable the
evaluation of the nature and financial effects of the business combination.
 SFAS 141R is effective for financial statements issued for fiscal
years beginning after December 15, 2008.  The Company is currently
evaluating the potential impact of adoption of SFAS 141R on its
consolidated financial statements.  However, the Company does not expect
the adoption of SFAS 141R to have a material effect on its consolidated
financial statements.
 
 In April
2008, the FASB issued FASB Staff Position No. FAS 142-3, Determination of the Useful Life of
Intangible Assets(“FSP No. FAS 142-3”). FSP
No. FAS 142-3 requires companies estimating the useful life of a
recognized intangible asset to consider their historical experience in renewing
or extending similar arrangements or, in the absence of historical experience,
to consider assumptions that market participants would use about renewal or
extension as adjusted for SFAS 142’s, Goodwill and Other Intangible
Assets, entity-specific factors. FSP No. FAS 142-3 will be
effective for fiscal years beginning after December 15, 2008.  The
Company is currently evaluating the potential impact of adoption of FSP
No. FAS 142-3 on its consolidated financial statements. However, the
Company does not expect the adoption of FSP No. FAS 142-3 to have a
material effect on its consolidated financial statements.
 In May
2008, the FASB issued Statement of Financial Accounting Standards No. 162,
“The Hierarchy of Generally Accepted Accounting Principles” (SFAS
162).  SFAS 162 identifies the sources of accounting principles
and the framework for selecting the principles used in the preparation of
financial statements that are presented in conformity with generally accepted
accounting principles. SFAS 162 becomes effective 60 days following
the SEC’s approval of the Public Company Accounting Oversight Board amendments
to AU Section 411, “The Meaning of Present Fairly in Conformity With
Generally Accepted Accounting Principles.”  The Company does not expect
that the adoption of SFAS 162 to have a material effect on its consolidated
financial statements.


33




2.
              CONSTRUCTION
      CONTRACTS IN PROGRESS





The
status of contracts in progress as of December 31, 2008 and 2007 is as
follows:





2008
                              
                              2007Costs
      incurred on uncompleted contracts
                              
                              $
                              18,220
                              
                              
                              $
                              17,050Estimated
      earnings
                              
                              
                              14,882
                              
                              
                              
                              15,247Earned
      revenue
                              
                              
                              33,102
                              
                              
                              
                              32,296Less
      billings to date
                              
                              
                              (28,773)
                              
                              
                              
                              (16,303)Total
                              
                              $
                              4,330
                              
                              
                              $
                              15,993Classified
      as follows:Costs
      and estimated earnings in excess of billings on uncompleted
      contracts
                              
                              $
                              5,552
                              
                              
                              $
                              16,813Billings
      in excess of costs and estimated earnings on  uncompleted
      contracts
                              
                              
                              (1,223)
                              
                              
                              
                              (821)Total
                              
                              $
                              4,330
                              
                              
                              $
                              15,993





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





As of
December 31, 2008 and 2007, Fuel Tech had no construction contracts in progress
that were identified as loss contracts.




3.
              TAXATION





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





Origin
      of income (loss) before taxes
                          
                          2008
                          
                          
                          2007
                          
                          
                          2006United
      States
                          
                          $
                          8,353
                          
                          
                          $
                          13,242
                          
                          
                          $
                          13,279Foreign
                          
                          
                          (1,356
                          )
                          
                          
                          (812
                          )
                          
                          
                          (1,511
                          )Income
      before taxes
                          
                          $
                          6,997
                          
                          
                          $
                          12,430
                          
                          
                          $
                          11,768





Significant
components of income tax expense for the years ended December 31 are as
follows:





2008
                            
                            
                            2007
                            
                            
                            2006Current:Federal
                            
                            $
                            1,395
                            
                            
                            $
                            1,401
                            
                            
                            $
                            144State
                            
                            
                            411
                            
                            
                            
                            588
                            
                            
                            
                            29Other
                            
                            
                            (84
                            )
                            
                            
                            -
                            
                            
                            
                            60Total
      current
                            
                            $
                            1,722
                            
                            
                            $
                            1,989
                            
                            
                            $
                            233Deferred:Federal
                            
                            
                            1,612
                            
                            
                            
                            3,183
                            
                            
                            
                            4,314State
                            
                            
                            61
                            
                            
                            
                            15
                            
                            
                            
                            180Change
      in valuation allowance
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            215Total
      deferred
                            
                            
                            1,673
                            
                            
                            
                            3,198
                            
                            
                            
                            4,709Income
      tax expense
                            
                            $
                            3,395
                            
                            
                            $
                            5,187
                            
                            
                            $
                            4,942




A
reconciliation between the provision for income taxes calculated at the U.S.
federal statutory income tax rate and the consolidated income tax benefit in the
consolidated statements of income for the years ended December 31 is as
follows:




34




2008
                        
                        
                        2007
                        
                        
                        2006Provision
      at the U.S. federal statutory rate
                        
                        $
                        2,449
                        
                        
                        $
                        4,351
                        
                        
                        $
                        4,119State
      taxes, net of federal benefit
                        
                        
                        311
                        
                        
                        
                        405
                        
                        
                        
                        187Foreign
      losses without tax benefit
                        
                        
                        391
                        
                        
                        
                        284
                        
                        
                        
                        588Research
      credits
                        
                        
                        (77
                        )
                        
                        
                        (63
                        )
                        
                        
                        (229
                        )Other
                        
                        
                        321
                        
                        
                        
                        210
                        
                        
                        
                        62Valuation
      allowance adjustment
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        215Income
      tax expense
                        
                        $
                        3,395
                        
                        
                        $
                        5,187
                        
                        
                        $
                        4,942





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





2008
                        
                        
                        2007
                        
                        
                        2006Provision
      at the U.S. federal statutory rate
                        
                        
                        35.0
                        %
                        
                        
                        35.0
                        %
                        
                        
                        35.0
                        %State
      taxes, net of federal benefit
                        
                        
                        4.4
                        %
                        
                        
                        3.3
                        %
                        
                        
                        1.6
                        %Foreign
      losses without tax benefit
                        
                        
                        5.6
                        %
                        
                        
                        2.3
                        %
                        
                        
                        5.0
                        %Research
      credits
                        
                        
                        (1.1
                        )%
                        
                        
                        (.5
                        )%
                        
                        
                        (1.9
                        )%Other
                        
                        
                        4.6
                        %
                        
                        
                        1.6
                        %
                        
                        
                        .5
                        %Valuation
      allowance adjustment
                        
                        
                        -
                        %
                        
                        
                        -
                        %
                        
                        
                        1.8
                        %Income
      tax expense
                        
                        
                        48.5
                        %
                        
                        
                        41.7
                        %
                        
                        
                        42.0
                        %





The
deferred tax assets and liabilities at December 31 are as follows:





2008
                              
                              
                              2007Deferred
      tax assets:Stock
      compensation expense
                              
                              $
                              4,238
                              
                              
                              $
                              2,306Research
      and development credit
                              
                              
                              492
                              
                              
                              
                              1,302Equipment
                              
                              
                              -
                              
                              
                              
                              648Alternative
      minimum tax credit
                              
                              
                              275
                              
                              
                              
                              275Warranty
      reserve
                              
                              
                              101
                              
                              
                              
                              176Accounts
      receivable
                              
                              
                              30
                              
                              
                              
                              57Vacation
      accrual
                              
                              
                              45
                              
                              
                              
                              40Deferred
      rent liability
                              
                              
                              49
                              
                              
                              
                              33Effect
      of FIN 48 adoption
                              
                              
                              13
                              
                              
                              
                              7Intangible
      assets
                              
                              
                              11
                              
                              
                              
                              -Net
      operating loss carryforwards
                              
                              
                              84
                              
                              
                              
                              -Total
      deferred tax assets
                              
                              
                              5,338
                              
                              
                              
                              4,844Deferred
      tax liabilities:Equipment
                              
                              
                              (975
                              )
                              
                              
                              -Prepaid
      expenses
                              
                              
                              (361
                              )
                              
                              
                              -Patents
                              
                              
                              (94
                              )
                              
                              
                              (76
                              )Goodwill
                              
                              
                              (469
                              )
                              
                              
                              (367
                              )Total
      deferred tax liabilities
                              
                              
                              (1,899
                              )
                              
                              
                              (443
                              )Net
      deferred tax asset before valuation allowance
                              
                              $
                              3,349
                              
                              
                              $
                              4,401Valuation
      allowances for deferred tax assets
                              
                              
                              (260
                              )
                              
                              
                              (260
                              )Net
      deferred tax asset
                              
                              $
                              3,179
                              
                              
                              $
                              4,141





Net
deferred tax assets and liabilities are recorded as follows within the
consolidated balance sheets:





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





For the
years ended December 31, 2008 and 2007, Fuel Tech recorded tax benefits from the
exercise of stock options in the amount of $548 and $1,482,
respectively.  The amounts were recorded as an increase in additional
paid-in capital on the consolidated balance sheets and as cash from financing
activities on the consolidated statements of cash flows.  With our
adoption of SFAS 123R on January 1, 2006, all subsequent tax benefits from the
exercise of stock options were recorded as cash flows from financing
activities.




35




State and
Federal income tax payments during the years ended December 31, 2008, 2007 and
2006 were $5,905, $173 and $217, respectively.




In July
2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in
Income Taxes - an interpretation of FASB Statement No. 109,” (FIN
48).  FIN 48 prescribes a comprehensive model for how a company should
recognize, measure, present and disclose in its financial statements uncertain
tax positions that it has taken or expects to take on a tax
return.  On January 17, 2007, the FASB affirmed its previous decision
to make FIN 48 effective for fiscal years beginning after December 15,
2006.  Accordingly, Fuel Tech adopted the provisions of FIN 48 on
January 1, 2007.





Previously,
Fuel Tech had accounted for tax contingencies in accordance with Statement of
Financial Accounting Standards 5, Accounting for Contingencies.  As
required by FIN 48, which clarifies Statement 109, Accounting for Income Taxes,
Fuel Tech recognizes the financial statement benefit of a tax position only
after determining that the relevant tax authority would more likely than not
sustain the position following an audit.  For tax positions meeting
the more-likely-than-not threshold, the amount recognized in the financial
statements is the largest benefit that has a greater than 50% likelihood of
being realized upon ultimate settlement with the relevant tax
authority.  At the adoption date, we applied FIN 48 to all tax
positions for which the statute of limitations remained open.  As a
result of the implementation of FIN 48, we recognized an increase of
approximately $86 in the liability for unrecognized tax benefits, of which $81
was accounted for as a reduction to the January 1, 2007 balance of retained
earnings.




The
following table summarizes Fuel Tech’s unrecognized tax benefit activity during
2008:




Description
                            
                            BalanceBalance
      at January 1, 2008
                            
                            $
                            678Increases
      in positions taken in a prior period
                            
                            
                            -Decreases
      in positions taken in a prior period
                            
                            
                            -Increases
      in positions taken in a current period
                            
                            
                            35Decreases
      in positions taken in a current period
                            
                            
                            -Decreases
      due to settlements
                            
                            
                            -Decreases
      due to lapse of statute of limitations
                            
                            
                            -Balance
      at December 31, 2008
                            
                            $
                            713





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





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





Fuel Tech
recognizes interest and penalties accrued related to unrecognized tax benefits
in income tax expense for all periods presented.  Fuel Tech had
accrued approximately $68 for the payment of interest and penalties at December
31, 2008.




The
management of Fuel Tech periodically estimates the probable tax obligations of
the Company using historical experience in tax jurisdictions and informed
judgments.  There are inherent uncertainties related to the
interpretation of tax regulations in the jurisdictions in which we transact
business. The judgments and estimates made at a point in time may change based
on the outcome of tax audits, as well as changes to or further interpretations
of regulations.  If such changes take place, there is a risk that the
tax rate may increase or decrease in any period.  Tax accruals for tax
liabilities related to potential changes in judgments and estimates for both
federal and state tax issues are included in current liabilities on the
consolidated balance sheet.




At
December 31, 2008, Fuel Tech has tax losses of $4,035 available to offset
foreign income.  The foreign loss carryforwards began to expire in
2008 and at December 31, 2008 a valuation allowance of $3,699 is recorded
against this amount.




4.
              COMMON
      SHARES





At
December 31, 2008, Fuel Tech had 24,110,967 Common Shares issued, with an
additional 7,485 shares reserved for issuance upon conversion of the nil coupon
non-redeemable convertible unsecured loan notes (see Note 5) and 2,905,325
shares reserved for issuance upon the exercise of stock options, 1,461,700 of
which are currently exercisable (see Note 6).




36




5.
            NIL
      COUPON NON-REDEEMABLE CONVERTIBLE UNSECURED LOAN
  NOTES




At
December 31, 2008, 2007 and 2006, respectively, Fuel Tech had principal amounts
of $81, $272 and $277 of nil coupon non-redeemable convertible unsecured
perpetual loan notes (the “Loan Notes”) outstanding.  The Loan Notes
are convertible at any time into Common Shares at rates of $6.50 or $11.43 per
share, as appropriate.  The Loan Notes bear no interest and have no
maturity date.  They are repayable in the event of Fuel Tech’s
dissolution and, accordingly, have been classified within stockholders’ equity
in the accompanying balance sheet.




In 2008,
Loan Notes in the principal amount of $191 were converted into 43,845 Common
Shares.  In 2007 and 2006, Loan Notes in the principal amount of $5
and $5, respectively, were converted into 769 and 769 Common Shares,
respectively.




6.
            STOCK-BASED
      COMPENSATION AND WARRANTS




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,
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.  In 2008, 2007 and
2006, 757,000, 311,000, 1,094,000 options, respectively, were granted to
employees and directors.  At December 31, 2008, Fuel Tech had 472,000
stock options available for issuance under the Incentive Plan.




Fuel Tech
uses the Black-Scholes options-pricing model to estimate the fair value of
employee stock options for the required pro forma disclosure under Statement
123(R).  For the year ended December 31, 2008, Fuel Tech recorded
stock-based compensation expense of $5,815 ($3,882 after tax).  The
Company recorded $4,791 ($3,105 after tax) in stock-based compensation expense
for the comparable period in 2007.




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





The
awards granted under the 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 based on the
grant date fair value of the award and recognizes expense on a straight-line
basis over the four-year service period of the award.




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 to the expected life of the option; and (3) expected life of the option –
an estimate based on historical experience including the effect of employee
terminations.





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





2008
                    
                    
                    2007
                    
                    
                    2006Expected
      dividend yield
                    
                    
                    0.00
                    %
                    
                    
                    0.00
                    %
                    
                    
                    0.00
                    %Risk-free
      interest rate
                    
                    
                    2.85
                    %
                    
                    
                    4.39
                    %
                    
                    
                    4.64
                    %Expected
      volatility
                    
                    
                    59.3
                    %
                    
                    
                    57.4
                    %
                    
                    
                    60.7
                    %Expected
      life of option
                    
                    5.2
      years
                    
                    
                    5.2
      years
                    
                    
                    5.2
      years




37






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




2008
                                      
                                      
                                      2007
                                      
                                      
                                      2006Number
                                        of
                                        Options
                                      
                                      
                                      Weighted-
                                        Average
                                        Exercise Price
                                      
                                      
                                      Number
                                        of
                                        Options
                                      
                                      
                                      Weighted-
                                        Average
                                        Exercise Price
                                      
                                      
                                      Number
                                        of
                                        Options
                                      
                                      
                                      Weighted-
                                        Average
                                        Exercise PriceOutstanding
      at beginning of year
                                      
                                      
                                      2,464,325
                                      
                                      
                                      $
                                      15.03
                                      
                                      
                                      
                                      2,414,200
                                      
                                      
                                      $
                                      13.02
                                      
                                      
                                      
                                      2,799,000
                                      
                                      
                                      $
                                      4.29Granted
                                      
                                      
                                      757,250
                                      
                                      
                                      
                                      18.05
                                      
                                      
                                      
                                      310,500
                                      
                                      
                                      
                                      25.80
                                      
                                      
                                      
                                      1,094,000
                                      
                                      
                                      
                                      22.06Exercised
                                      
                                      
                                      (171,125
                                      )
                                      
                                      
                                      3.61
                                      
                                      
                                      
                                      (188,875
                                      )
                                      
                                      
                                      4.83
                                      
                                      
                                      
                                      (1,332,925
                                      )
                                      
                                      
                                      2.88Expired
      or forfeited
                                      
                                      
                                      (145,125
                                      )
                                      
                                      
                                      18.69
                                      
                                      
                                      
                                      (71,500
                                      )
                                      
                                      
                                      20.82
                                      
                                      
                                      
                                      (145,875
                                      )
                                      
                                      
                                      5.91Outstanding
      at end of year
                                      
                                      
                                      2,905,325
                                      
                                      
                                      $
                                      16.30
                                      
                                      
                                      
                                      2,464,325
                                      
                                      
                                      $
                                      15.03
                                      
                                      
                                      
                                      2,414,200
                                      
                                      
                                      $
                                      13.02Exercisable
      at end of year
                                      
                                      
                                      1,461,700
                                      
                                      
                                      $
                                      12.92
                                      
                                      
                                      
                                      955,825
                                      
                                      
                                      $
                                      7.11
                                      
                                      
                                      
                                      711,450
                                      
                                      
                                      $
                                      5.22Weighted-average
      fair value of options granted during the year
                                      
                                      
                                      
                                      
                                      
                                      $
                                      9.65
                                      
                                      
                                      
                                      
                                      
                                      
                                      $
                                      14.01
                                      
                                      
                                      
                                      
                                      
                                      
                                      $
                                      12.53





The
following table provides additional information regarding Fuel Tech’s stock
option activity for the 12 months ended December 31, 2008.





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




38





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





Options Outstanding
                    
                    
                    Options ExercisableRange of
                    
                    
                    Number of
                    
                    Weighted-Average
                      Remaining
                    
                    Weighted-
                      Average
                    
                    
                    Number of
                    
                    
                    Weighted-AverageExercise Prices
                    
                    
                    Options
                    
                    Contractual Life
                    
                    Exercise Price
                    
                    
                    Options
                    
                    
                    Exercise Price$
                    1.47 -
      $ 5.51
                    
                    
                    
                    451,700
                    
                    4.89
      years
                    
                    $
                    4.19
                    
                    
                    
                    446,200
                    
                    
                    $
                    4.17$
                    5.52 -
      $ 11.03
                    
                    
                    
                    536,125
                    
                    6.40
      years
                    
                    $
                    7.96
                    
                    
                    
                    380,250
                    
                    
                    $
                    7.56$
                    11.04 -
      $ 22.06
                    
                    
                    
                    792,000
                    
                    8.57
      years
                    
                    $
                    16.19
                    
                    
                    
                    167,500
                    
                    
                    $
                    14.09$
                    22.07 -
      $ 27.57
                    
                    
                    
                    1,125,500
                    
                    8.31
      years
                    
                    $
                    25.22
                    
                    
                    
                    467,750
                    
                    
                    $
                    25.20$
                    1.47
      - $ 27.57
                    
                    
                    
                    2,905,325
                    
                    7.49
      years
                    
                    $
                    16.30
                    
                    
                    
                    1,461,700
                    
                    
                    $
                    12.92





The
weighted-average exercise price per non-vested stock award at grant date was
$17.55 per share for the non-vested stock awards granted in
2008.  Non-vested stock award activity for all plans for the 12 months
ended December 31, 2008 was as follows:





Non-Vested Stock
                                    Outstanding
                                  
                                  
                                  Weighted-AverageGrantDate
                                    Fair ValueOutstanding
      on January 1, 2008
                                  
                                  
                                  1,508,500
                                  
                                  
                                  $
                                  11.08Granted
                                  
                                  
                                  757,250
                                  
                                  
                                  
                                  9.65Released
                                  
                                  
                                  (682,000
                                  )
                                  
                                  
                                  10.36Expired
      or forfeited
                                  
                                  
                                  (140,125
                                  )
                                  
                                  
                                  10.36Outstanding
      on December 31, 2008
                                  
                                  
                                  1,443,625
                                  
                                  
                                  $
                                  10.75





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





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





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





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


39





7.      COMMITMENTS





Operating
Leases





Fuel Tech
leases office space, autos and certain equipment under agreements expiring on
various dates through 2014. Future minimum lease payments under non-cancellable
operating leases that have initial or remaining lease terms in excess of one
year as of December 31, 2008 are as follows:





Year
      of Payment
                        
                        Amount2009
                        
                        $
                        6632010
                        
                        
                        2792011
                        
                        
                        2492012
                        
                        
                        251Thereafter
                        
                        
                        278





For the
years ended December 31, 2008, 2007 and 2006, rent expense approximated $1,300,
$852 and $829, respectively.





Fuel Tech
has a sublease agreement with American Bailey Corporation (ABC) that obligates
the lessee to make future payments.  ABC will reimburse Fuel Tech for
its share of lease and lease-related expenses under Fuel Tech’s January 29,2004
lease of its executive offices in Stamford, Connecticut.  Please refer
to Note 9 to the consolidated financial statements for a discussion of the
relationship between Fuel Tech and ABC.  The future minimum lease
income under this noncancellable sublease as of December 31, 2008 is as
follows:





Year
      of Payment
                          
                          Amount2009
                          
                          $
                          812010
                          
                          
                          72011
                          
                          
                          -2012
                          
                          
                          -Thereafter
                          
                          
                          -




The terms
of the three primary lease arrangements are as follows:




-
            The
      Stamford, Connecticut building lease term, for approximately 7,000 square
      feet, runs from February 1, 2004 to January 31, 2010.  The
      facility houses certain administrative functions such as Investor
      Relations, Benefit Plan Administration and certain APC sales
      functions.




-
            The
      Beijing, China building lease term, for approximately 4,000 square feet,
      runs from September 1, 2007 to August 31, 2009.  This facility
      serves as the operating headquarters for our Beijing Fuel Tech
      operation.  Fuel Tech has the option to extend the lease term at
      a market rate to be agreed upon between Fuel Tech and the
      lessor.




-
            The
      Durham, North Carolina building lease term, for approximately 16,000
      square feet, runs from November 1, 2005 to April 30, 2014.  This
      facility houses the former Tackticks and FlowTack
      operations.  Fuel Tech has no option to extend the
      lease.




In
addition to the above, on November 30, 2007, Fuel Tech purchased an office
building in Warrenville, Illinois, which has served as our corporate
headquarters since June 23, 2008.  Our prior headquarters, an 18,000
square foot location in Batavia, Illinois, remains under an operating lease
until May 31, 2009.  We have no plans to renew this
lease.




Performance
Guarantees





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





-
            in
      support of the warranty period defined in the contract;
  or


-
            in
      support of the system performance criteria that are defined in the
      contract.




40


As of
December 31, 2008, Fuel Tech has outstanding bank performance guarantees and
letters of credit in the amount of $5,765 in support of equipment construction
contracts that have not completed their final acceptance test or that are still
operating under a warranty period.  Fuel Tech’s management believes
that these projects will be successfully completed and that there will not be a
materially adverse impact on Fuel Tech’s operations from these bank performance
guarantees and letters of credit.





Product
Warranties




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 experience in the preceding years.  Changes in the warranty
liability in 2008, 2007 and 2006 are summarized below:




2008
                        
                        
                        2007
                        
                        
                        2006Aggregate
      product warranty liability at beginning of year
                        
                        $
                        464
                        
                        
                        $
                        472
                        
                        
                        $
                        247Net
      aggregate accruals related to product warranties
                        
                        
                        (45
                        )
                        
                        
                        88
                        
                        
                        
                        280Aggregate
      reductions for payments
                        
                        
                        (154
                        )
                        
                        
                        (96
                        )
                        
                        
                        (55
                        )Aggregate
      product warranty liability at end of year
                        
                        $
                        265
                        
                        
                        $
                        464
                        
                        
                        $
                        472





8.      DEBT
FINANCING





Fuel Tech
has a domestic $25.0 million revolving credit facility expiring July 31,
2009.  The facility is unsecured and bears interest at a rate of LIBOR
plus 75 basis points.   The Company can use this facility for
cash advances and standby letters of credit.  As of December 31, 2008
and 2007, there were no outstanding borrowings on this facility.





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





During
2008 and 2007, under the domestic $25.0 million facility, the Company requested
and received a waiver to enable us to exceed the capital spending covenant
specified in the facility agreement to accommodate our purchase of land and
building for our new corporate headquarters and the subsequent build out and
furnishing of the premises.  During 2008, the Company also requested
and received a waiver to enable us to exceed the allowable acquisition spending
covenant specified in the facility agreement to accommodate our strategic
acquisitions.




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





Interest
payments in the amount of $135 and $24 were made during the years ended December
31, 2008 and 2007, respectively.  No payments were made during the
year ended December 31, 2006.





9.      RELATED
PARTY TRANSACTIONS





As of
December 31, 2008, Fuel Tech had a 4.5% common stock ownership interest in Clean
Diesel Technologies, Inc. (CDT), which is being accounted for using the cost
method.  Fuel Tech is precluded from selling its interest in CDT
except pursuant to a registration statement, or in a broker/dealer transaction
within the limitations of Rule 144 of the Securities and Exchange Commission
(SEC), or in an exempt private placement within the limitations of Rule 144 of
the SEC.  Fuel Tech’s investment in CDT, whose shares are publicly
traded on The NASDAQ Stock Market and the London Stock Exchange, had a market
value of $1,004 at December 31, 2008.  Fuel Tech also owns 5,000
warrants to purchase CDT common stock.  The warrants have an exercise
price of $10.00 and can be exercised on or before November 14,
2010.




41


On August
3, 1995, Fuel Tech signed a Management and Services Agreement with
CDT.  According to the agreement, CDT is to reimburse Fuel Tech for
management, services and administrative expenses incurred by Fuel Tech on behalf
of CDT.  Additionally, Fuel Tech charges CDT an additional 3% of such
costs annually.  For the years ended December 31, 2008, 2007 and 2006,
$72, $72 and $71, respectively, was charged to CDT as a management
fee.





Pursuant
to an assignment agreement of certain technology to CDT, Fuel Tech is due
royalties from CDT of 2.5% of CDT’s annual revenue from sales of CDT’s Platinum
Fuel Catalyst, commencing in 1998.  The royalty obligation expired in
2008.  Over the life of the royalty agreement, Fuel Tech received
approximately $61 in royalties.





Persons
now or formerly associated with American Bailey Corporation (ABC) currently own
approximately 25% of Fuel Tech’s Common Shares.  On April 30, 1998,
Fuel Tech entered into an agreement with ABC for it to provide certain
management and consulting services to Fuel Tech.  Effective January 1,
2004, this agreement was revised whereby ABC reimburses Fuel Tech for services
that certain employees of Fuel Tech provide to ABC.  In addition, ABC
is a sub-lessee under Fuel Tech’s January 29,2004
lease of its offices in Stamford, Connecticut.  ABC reimburses Fuel
Tech for its share of lease and lease-related expenses under the sublease
agreement.  Please refer to Note 7 to the consolidated financial
statements for a further discussion of this topic.  At December 31,
2008, $23 is due from ABC related to the compensation and sublease
agreements.




10.    DEFINED
CONTRIBUTION PLAN





Fuel Tech
has a retirement savings plan available for all U.S. employees who have met
minimum length-of-service requirements. Our contributions are determined based
upon amounts contributed by Fuel Tech’s employees with additional contributions
made at the discretion of Fuel Tech’s Board of Directors.  Costs
related to this plan were $851, $802 and $612 in 2008, 2007 and 2006,
respectively.





11.    BUSINESS
SEGMENT, GEOGRAPHIC AND QUARTERLY FINANCIAL DATA





Business
Segment Financial Data





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





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





-
            The
      FUEL CHEM technology segment, which uses chemical processes for the
      control of slagging, fouling, corrosion, opacity, acid plume and sulfur
      trioxide-related issues in furnaces and boilers through the addition of
      chemicals into the fuel using TIFITM Targeted In-Furnace InjectionTM
      technology.





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





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




Information
about reporting segment net sales and gross margin are provided
below:





For the year ended
                  December 31, 2008
                
                Air Pollution Control
                  Segment
                
                
                FUEL CHEM
                  Segment
                
                
                Other
                
                
                TotalRevenues
      from external customers
                
                $
                44,393
                
                
                $
                36,681
                
                
                $
                -
                
                
                $
                81,074Cost
      of sales
                
                
                24,365
                
                
                
                19,979
                
                
                
                1
                
                
                
                44,345Gross
      margin
                
                
                20,028
                
                
                
                16,702
                
                
                
                (1
                )
                
                
                36,729Selling,
      general and administrative
                
                
                -
                
                
                
                -
                
                
                
                28,012
                
                
                
                28,012Research
      and development
                
                
                -
                
                
                
                -
                
                
                
                2,100
                
                
                
                2,100Operating
      income (loss)
                
                $
                20,028
                
                
                $
                16,702
                
                
                $
                (30,113
                )
                
                $
                6,617




42





For the year ended
                  December 31, 2007
                
                Air Pollution Control
                  Segment
                
                
                FUEL CHEM
                  Segment
                
                
                Other
                
                
                TotalRevenues
      from external customers
                
                $
                47,750
                
                
                $
                32,547
                
                
                $
                -
                
                
                $
                80,297Cost
      of sales
                
                
                25,775
                
                
                
                16,619
                
                
                
                77
                
                
                
                42,471Gross
      margin
                
                
                21,975
                
                
                
                15,928
                
                
                
                (77
                )
                
                
                37,826Selling,
      general and administrative
                
                
                -
                
                
                
                -
                
                
                
                24,950
                
                
                
                24,950Research
      and development
                
                
                -
                
                
                
                -
                
                
                
                2,137
                
                
                
                2,137Operating
      income (loss)
                
                $
                21,975
                
                
                $
                15,928
                
                
                $
                (27,164
                )
                
                $
                10,739





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





Geographic
Segment Financial Data





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





For
      the years ended December 31
                              
                              2008
                              
                              
                              2007
                              
                              
                              2006Revenues:United
      States
                              
                              $
                              68,433
                              
                              
                              $
                              67,534
                              
                              
                              $
                              57,628Foreign
                              
                              
                              12,641
                              
                              
                              
                              12,763
                              
                              
                              
                              17,487$
                              81,074
                              
                              
                              $
                              80,297
                              
                              
                              $
                              75,115
 
 December
      31,
                            
                            2008
                            
                            
                            2007
                            
                            
                            2006Assets:United
      States
                            
                            $
                            81,241
                            
                            
                            $
                            79,132
                            
                            
                            $
                            62,190Foreign
                            
                            
                            7,632
                            
                            
                            
                            8,082
                            
                            
                            
                            3,470$
                            88,873
                            
                            
                            $
                            87,214
                            
                            
                            $
                            65,660





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





For the
year ended December 31, 2007, Fuel Tech had two customers that individually
represented greater than 10% of revenues.  In total, these two
customers represented 23% of revenues and utilized the product line offered by
Fuel Tech’s APC technology segment.





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




43





Quarterly
Financial Data





Set forth
below are the unaudited quarterly financial data for the fiscal years ended
December 31, 2008 and 2007.





For the quarters ended:
                
                March 31
                
                
                June 30
                
                
                September 30
                
                
                December 312008
      (a)Revenues
                
                $
                20,467
                
                
                $
                18,791
                
                
                $
                23,703
                
                
                $
                18,113Cost
      of sales
                
                
                10,669
                
                
                
                9,833
                
                
                
                13,019
                
                
                
                10,824Net
      income
                
                
                1,633
                
                
                
                447
                
                
                
                2,102
                
                
                
                (580
                )Net
      income (loss) per Common Share:Basic
                
                $
                0.07
                
                
                $
                0.02
                
                
                $
                0.09
                
                
                $
                (0.02
                )Diluted
                
                $
                0.07
                
                
                $
                0.02
                
                
                $
                0.09
                
                
                $
                (0.02
                )2007
      (b)Revenues
                
                $
                16,262
                
                
                $
                16,210
                
                
                $
                15,246
                
                
                $
                32,579Cost
      of sales
                
                
                8,957
                
                
                
                9,083
                
                
                
                8,018
                
                
                
                16,413Net
      income
                
                
                792
                
                
                
                282
                
                
                
                927
                
                
                
                5,242Net  income
      per Common Share:Basic
                
                $
                0.04
                
                
                $
                0.01
                
                
                $
                0.04
                
                
                $
                0.23Diluted
                
                $
                0.03
                
                
                $
                0.01
                
                
                $
                0.04
                
                
                $
                0.21





(a) The
total of the basic and diluted net income amounts per share for the four
quarters ending December 31, 2008 does not sum to the amounts presented on the
consolidated statement of income for the year ending December 31, 2008 due to
rounding.





(b) The
total of the basic net income amounts per share for the four quarters ending
December 31, 2007 does not sum to the amounts presented on the consolidated
statement of income for the year ending December 31, 2007 due to
rounding.





12.    BUSINESS
ACQUISITIONS





Fuel Tech
accounts for its acquisitions as purchases.  Accordingly, in
connections with each acquisition, the purchase price is allocated to the
estimated fair values of all acquired tangible and intangible assets and assumed
liabilities as of the date of the acquisition.




Tackticks,
LLC & FlowTack, LLC




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





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


44




Advanced
Combustion Technology, Inc.




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





13.    SUBSEQUENT
EVENTS





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





ITEM 9 -CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE





None





ITEM
9A - CONTROLS AND PROCEDURES





Disclosure
Controls and Procedures





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





Change in
Internal Controls





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





Management’s
Report on Internal Control Over Financial Reporting





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




Fuel
Tech’s system of internal control over financial reporting is designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles.  Because of its
inherent limitations, internal control over financial reporting may not prevent
or detect misstatements.  Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.




Based on
its assessment, management has concluded that Fuel Tech maintained effective
internal control over financial reporting as of December 31, 2008, based on
criteria in “Internal Control - Integrated Framework”issued by the
COSO.





Grant
Thornton, LLP, our independent registered public accounting firm, who audited
and reported on the consolidated financial statements included in this Annual
Report on Form 10-K, has issued an attestation report on the effectiveness of
our internal control over financial reporting.  This attestation
report is included on page 23 of this Annual Report on
Form 10-K.





ITEM
9B - OTHER INFORMATION





None


45


PART
III





ITEM
10 – DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE





Information
required by this Item will be set forth under the captions “Election of
Directors,” “Directors and Executive Officers of Fuel Tech,” “Compensation
Committee,” “Audit Committee,” and “Financial Experts” in Fuel Tech’s Proxy
Statement related to the 2009 Annual Meeting of Stockholders (the “Proxy
Statement”) and is incorporated by reference.





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





The
identities of the Fuel Tech directors and other information concerning the
directors and executive officers of Fuel Tech and relating to corporate
governance will be set forth under the captions “Election of Directors,” “Audit
Committee,” “Compensation and Nominating Committee,” “Financial Experts,”
“Corporate Governance” and “General” in Fuel Tech’s Proxy Statement related to
its 2009 Annual Meeting of Stockholders and is incorporated by
reference.





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





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





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





Stephen
P. Brady, 52, has been Senior Vice President, Fuel Chem Sales since January,
2009; previously he had been Senior Vice President, Sales and Marketing since
April, 2006; Senior Vice President, Fuel Chem since January, 2002; and Vice
President, Fuel Chem since February, 1998.





William
E. Cummings, Jr., 52, has been Senior Vice President, APC Sales since January,
2009; previously he had been Vice President, Sales since April, 2006; Vice
President, Air Pollution Control Sales since May, 2000; Director, Utility Sales
since April, 1998; and Director, Eastern Region since 1994.





Kevin R.
Dougherty, 46, has been Vice President, Business Development and Marketing since
April, 2006; previously he had been Vice President, Corporate Marketing and
Procurement since December, 2005; Director, Marketing and Sales Administration,
Air Pollution Control since November, 2000; and Manager, Contracts
Administration, Air Pollution Control since 1999.





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





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





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





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





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





Dr. M.
Linda Lin, 60, has been Senior Vice President, China/Pacific Rim since August,
2008; previously she had been Vice President, China/Pacific Rim since December,
2006; Vice President Asia/Pacific since April, 2006; Marketing Manager since
1992; and Research Associate/Research Manager since 1990.


46




Michael
P. Maley, 50, prior to his resignation from Fuel Tech effective February 13,
2009, had been Senior Vice President, International Business Development and
Project Execution since joining the Company in April, 2006; previously he had
been employed as President and Chief Operating Officer of Alliant Energy
Generation from 2001 to 2005; Vice President of Business Development of Calpine
Corporation since 1998; and Vice President of Project Development of Cogentrix
Energy LLC since 1993.





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





Nolan R.
Schwartz, 57, has been Vice President, Strategic Business Development since
August, 2008; he had been Vice President, Corporate Development since January,
2004 and a director of Fuel Tech, Inc., a former subsidiary of Fuel Tech, since
1998; and, prior to that, a principal of American Bailey
Corporation.





Christopher
R. Smyrniotis, 56, has been Vice President, Fuel Chem Technologies since April
5, 2006; previously he had been Vice President, Fuel Chem Technology and Market
Development since December, 2003; Director of Marketing and Technology, Fuel
Chem since October, 1998; and Market Development manager since
1993.





Dr.
William H. Sun, 51, has been Vice President, Europe, India and Latin
America since February 9, 2009; he had been Vice President, Air Pollution
Technologies since April, 2006; Vice President and Chief Technology Officer
since December, 2003; Vice President, Engineering and Technology since April,
1998; and Director of Process Engineering since 1990.





ITEM
11 - EXECUTIVE COMPENSATION





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





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





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





Plan Category
                        
                        Number of Securities to beissuedupon exercise ofoutstandingoptions, warrantsand rights
                        
                        
                        Weighted-averageexerciseprice ofoutstandingoptions,warrants andrights
                        
                        
                        Number of securitiesremaining available forfutureissuance under equitycompensation plansexcludingsecurities listed incolumn (a)(a)
                        
                        
                        (b)
                        
                        
                        (c)Equity
      compensation plans approved by security holders (1)
                        
                        
                        2,905,325
                        
                        
                        $
                        16.31
                        
                        
                        
                        471,712





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





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





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





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





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





ITEM
14 - PRINCIPAL ACCOUNTANT FEES AND SERVICES





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




47


PART
IV








ITEM
15 - EXHIBITS AND FINANCIAL STATEMENT SCHEDULES


(a)
                (1)
      Financial Statements
 
 The
financial statements identified below and required by Part II, Item 8 of this
Form 10-K are set forth above.
 
 Management’s
      Report on Internal Control Over Financial ReportingReport
      of Independent Registered Public Accounting Firm on Internal Control Over
      Financial ReportingReport
      of Independent Registered Public Accounting FirmReport
      of Independent Registered Public Accounting FirmConsolidated
      Balance Sheets as of December 31, 2008 and 2007Consolidated
      Statements of Income for Years Ended December 31, 2008, 2007 and
      2006Consolidated
      Statements of Stockholders’ Equity for the Years Ended December 31, 2008,
      2007 and 2006Consolidated
      Statements of Cash Flows for the Years Ended December 31, 2008, 2007 and
      2006Notes
      to Consolidated Financial
Statements
 
 (2)
      Financial Statement Schedules


All other
schedules have been omitted because of the absence of the conditions under which
they are required or because the required information, where material, is shown
in the financial statements or the notes thereto.




48




(3) ExhibitsIncorporated by referenceExhibit
                                                      
                                                      Description
                                                      
                                                      Filed
                                                        herewith
                                                      
                                                      Form
                                                      
                                                      Period
                                                        ending
                                                      
                                                      Exhibit
                                                      
                                                      Filing date3.1
                                                      
                                                      Certificate
      of Incorporation of Fuel Tech, Inc.
                                                      
                                                      
                                                      
                                                      8-K
                                                      
                                                      
                                                      
                                                      3.2
                                                      
                                                      10/05/063.2
                                                      
                                                      Certificate
      of Conversion of Fuel Tech, Inc.
                                                      
                                                      
                                                      
                                                      8-K
                                                      
                                                      
                                                      
                                                      3.1
                                                      
                                                      10/05/063.3
                                                      
                                                      By-Laws
      of Fuel Tech, Inc.
                                                      
                                                      
                                                      
                                                      8-K
                                                      
                                                      
                                                      
                                                      3.3
                                                      
                                                      10/05/064.1
                                                      
                                                      Instrument
      Constituting US $19,200 Nil Coupon Non-Redeemable Convertible Unsecured
      Loan Notes of Fuel-Tech N.V., dated December 21, 1989
                                                      
                                                      
                                                      
                                                      20-F
                                                      
                                                      
                                                      
                                                      4.1
                                                      
                                                      08/26/934.2
                                                      
                                                      First
      Supplemental Instrument Constituting US $3,000 Nil Coupon Non-Redeemable
      Convertible Unsecured Loan Notes of Fuel-Tech N.V., dated July 10,
      1990
                                                      
                                                      
                                                      
                                                      20-F
                                                      
                                                      
                                                      
                                                      4.2
                                                      
                                                      08/26/934.3
                                                      
                                                      Instrument
      Constituting US $6,000 Nil Coupon Non-Redeemable Convertible Unsecured
      Loan Notes of Fuel-Tech N.V., dated March 12, 1993
                                                      
                                                      
                                                      
                                                      6-K
                                                      
                                                      03/31/93
                                                      
                                                      4.3
                                                      
                                                      04/01/934.4*
                                                      
                                                      Fuel
      Tech, Inc. Incentive Plan as amended through June 3, 2004
                                                      
                                                      
                                                      
                                                      S-8
                                                      
                                                      
                                                      
                                                      4.5
                                                      
                                                      10/02/064.5*
                                                      
                                                      Fuel
      Tech, Inc. Form of Non-Executive Director Stock Option
      Agreement
                                                      
                                                      
                                                      
                                                      10-K
                                                      
                                                      12/31/06
                                                      
                                                      4.6
                                                      
                                                      03/06/074.6*
                                                      
                                                      Fuel
      Tech, Inc. Form of Non-Qualified Stock Option Agreement
                                                      
                                                      
                                                      
                                                      10-K
                                                      
                                                      12/31/06
                                                      
                                                      4.7
                                                      
                                                      03/06/074.7*
                                                      
                                                      Fuel
      Tech, Inc. Form of Incentive Stock Option Agreement
                                                      
                                                      
                                                      
                                                      10-K
                                                      
                                                      12/31/06
                                                      
                                                      4.8
                                                      
                                                      03/06/074.8
                                                      
                                                      Business
      Loan Agreement, dated as of July 31, 2006, between Wachovia Bank N.A. and
      Fuel Tech, Inc.
                                                      
                                                      
                                                      
                                                      8-K
                                                      
                                                      
                                                      
                                                      99.1
                                                      
                                                      08/10/06




49




Incorporated by referenceExhibit
                                                    
                                                    Description
                                                    
                                                    Filed
                                                      herewith
                                                    
                                                    Form
                                                    
                                                    Period
                                                      ending
                                                    
                                                    Exhibit
                                                    
                                                    Filing date10.1
                                                    
                                                    Securities
      Purchase Agreement dated as of March 23, 1998, between Fuel-Tech N.V., and
      the several Investors signatory thereto, including
    exhibits.
                                                    
                                                    
                                                    
                                                    6-K
                                                    
                                                    03/31/98
                                                    
                                                    10.1
                                                    
                                                    04/01/9810.2
                                                    
                                                    License
      Agreement dated November 18, 1998 between The Gas Technology Institute and
      Fuel Tech, Inc. relating to the FLGR Process (Certain confidential
      information removed and filed separately).
                                                    
                                                    
                                                    
                                                    10-K
                                                    
                                                    12/31/99
                                                    
                                                    3.28
                                                    
                                                    03/30/0010.3
                                                    
                                                    Amendment
      No. 1, dated February 28, 2000, to License Agreement dated November 18,
      1998 between The Gas Technology Institute and Fuel Tech, Inc. relating to
      the FLGR Process (Certain confidential information removed and filed
      separately).
                                                    
                                                    
                                                    
                                                    10-K
                                                    
                                                    12/31/99
                                                    
                                                    3.29
                                                    
                                                    03/30/0010.4
                                                    
                                                    Employment
      Agreement as of February 28, 2006 between John (Johnny) F. Norris Jr. and
      Fuel Tech, Inc.
                                                    
                                                    
                                                    
                                                    10-K
                                                    
                                                    12/31/05
                                                    
                                                    3.18
                                                    
                                                    03/10/0610.5
                                                    
                                                    Amendment
      to Employment Agreement as of February 28, 2007  between John
      (Johnny) F. Norris Jr. and Fuel Tech, Inc.
                                                    
                                                    
                                                    
                                                    10-K
                                                    
                                                    12/31/07
                                                    
                                                    10.5
                                                    
                                                    03/05/0810.6
                                                    
                                                    Form
      of Indemnity Agreement between Fuel Tech, Inc. and its Directors and
      Officers.
                                                    
                                                    
                                                    
                                                    8-K
                                                    
                                                    
                                                    
                                                    99.1
                                                    
                                                    02/07/0710.7
                                                    
                                                    Restated
      Supply Agreement, dated March 4, 2009, between Fuel Tech, Inc. and Martin
      Marietta Magnesia Specialties, LLC (Certain confidential information
      removed and filed separately).
                                                    
                                                    X10.8
                                                    
                                                    Asset
      Purchase Agreement, dated December 5, 2008, among Fuel Tech, Inc.,
      Advanced Combustion Technology, Inc., Peter D. Marx, Robert W. Pickering
      and Charles E. Trippel.
                                                    
                                                    X23.1
                                                    
                                                    Consent
      of Independent Registered Public Accounting Firm
                                                    
                                                    X31.1
                                                    
                                                    Certifications
      of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002.
                                                    
                                                    X31.2
                                                    
                                                    Certifications
      of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002.
                                                    
                                                    X31.3
                                                    
                                                    Certification
      of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002.
                                                    
                                                    X31.4
                                                    
                                                    Certification
      of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002.
                                                    
                                                    X
 
 *
                
                Indicates
      a management contract or compensatory plan or
  arrangement.




50




SIGNATURES
AND CERTIFICATIONS




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





FUEL
      TECH, INC.Date:  March
      5, 2009
                
                By:
                /s/ John F. Norris Jr.John F. Norris Jr.Chief Executive Officer(Principal Executive Officer)Date:  March
      5, 2009
                
                By:
                /s/ John P. GrahamJohn P. GrahamChief Financial Officer(Principal Financial
Officer)




51


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





Date:
March 5, 2009





Signature
                
                Title/s/ Ralph E. Bailey
                
                Executive
      Chairman and DirectorRalph E. Bailey/s/ Douglas G. Bailey
                
                Deputy
      Chairman and DirectorDouglas G. Bailey/s/ Miguel Espinosa
                
                DirectorMiguel Espinosa/s/ Charles W. Grinnell
                
                DirectorCharles W. Grinnell/s/ Thomas L. Jones
                
                DirectorThomas L. Jones/s/ John D. Morrow
                
                DirectorJohn D. Morrow/s/ John F. Norris Jr.
                
                Director,
      President and Chief Executive OfficerJohn F. Norris Jr.
                
                (Principal
      Executive Officer)/s/ Thomas S. Shaw, Jr.
                
                DirectorThomas S. Shaw, Jr./s/ Delbert L. Williamson
                
                DirectorDelbert L. Williamson/s/ Ellen T. Albrecht
                
                Vice
      President and ControllerEllen T. Albrecht
                
                (Controller)/s/ John P. Graham
                
                Sr.
      Vice President, Chief Financial Officer and TreasurerJohn P. Graham
                
                (Principal
      Financial Officer)




52