**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, 2006**




**OR**




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





**For
      the transition period from _________________ to
      _______________**





**Commission
      File No. 000-33059**





**** **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.


512
      Kingsland Drive


Batavia,
      IL 60510-2299


630-845-4500


(Address
      and telephone number of principal executive offices)




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




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





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





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


**Yes** **o** **No** **x**





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


**Yes** **o** **No** **x**





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





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


**Yes** **x** **No
      o**





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


**Large
      Accelerated Filer** **o** **Accelerated
      Filer x** **Non-accelerated
      Filer o**





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


**Yes o** **No
      x**





**The
      aggregate market value of the voting stock held by non-affiliates of the
      registrant based on the average bid and asked prices of June 30, 2006 was
      $200,262,000. The aggregate market value of the voting stock held by
      non-affiliates of the registrant based on the average bid and asked prices
      of
      February 16, 2007 was $477,460,000.**





**Indicate
      number of shares outstanding of each of the registered classes of Common Stock
      at February 16, 2007: 22,086,728 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 2007 are incorporated by reference in Parts II, III, and IV
      hereof.**








**TABLE
      OF CONTENTS**




**Page****PART
                I**Item
                1.
            Business
            
            1Item
                1A.
            Risk
                Factors of the Business
            
            6Item
                1B.
            Unresolved
                Staff Comments
            
            7Item
                2.
            Properties
            
            7Item
                3.
            Legal
                Proceedings
            
            7Item
                4.
            Submission
                of Matters to Vote of Security Holders
            
            7**PART
                II**Item
                5.
            Market
                for Registrant’s Common Equity, Related Stockholder Matters and Issuer
                Purchase of Equity Securities
            
            8Item
                6.
            Selected
                Financial Data
            
            10Item
                7.
            Management's
                Discussion and Analysis of Financial Condition and Results of
                Operations
            
            11Item
                7A.
            Quantitative
                and Qualitative Disclosures about Market Risk
            
            18Item
                8.
            Financial
                Statements and Supplementary Data
            
            18Item
                9.
            Changes
                in and Disagreements with Accountants and Financial
                Disclosure
            
            44Item
                9A.
            Controls
                and Procedures
            
            44Item
                9B.
            Other
                Information
            
            44**PART
                III**Item
                10.
            Directors,
                Executive Officers and Corporate Governance
            
            45Item
                11.
            Executive
                Compensation
            
            46Item
                12.
            Security
                Ownership of Certain Beneficial Owners and Management
            
            46Item
                13.
            Certain
                Relationships and Related Transactions, and Director
                Independence
            
            46Item
                14.
            Principal
                Accounting Fees and Services
            
            46**PART
                IV**Item
                15.
            Exhibits
                and Financial Statement Schedules
            
            47Signatures
                and Certifications
            
            50





ii





**TABLE
      OF DEFINED TERMS**





**Term**
            
            **Definition**ABC
            
            American
                Bailey CorporationCAAA
            
            Clean
                Air Act Amendments of 1990CDT
            
            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 issuesFuel
                Tech
            
            Fuel
                Tech, Inc. and its subsidiariesInvestors
            
            The
                purchasers of Fuel Tech securities pursuant to a Securities Purchase
                Agreement as of March 23, 1998Loan
                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
                SCRNOxOUT®Process
            
            A
                trademark used to describe Fuel Tech’s SNCR process for the reduction of
                NOxNOxOUT-SCR®
            
            A
                trademark used to describe Fuel Tech’s direct injection of urea as a
                catalyst reagentNOxOUT
                ULTRA®
            
            A
                trademark used to describe Fuel Tech’s process for generating ammonia for
                use as SCR reagentRich
                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 boilersTIFITM
                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.





iii









iv




PART
      I





**Forward
      Looking Statements**





Statements
      in this Form 10-K that are not historical facts, so-called "forward-looking
      statements," are made pursuant to the safe harbor provisions of the Private
      Securities Litigation Reform Act of 1995. Investors are cautioned that all
      forward-looking statements involve risks and uncertainties, including those
      detailed in Fuel Tech's filings with the Securities and Exchange Commission.
      See
      "Risk Factors of the Business" in Item 1A.





**ITEM
      1. BUSINESS**





**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 512 Kingsland Drive, Batavia, Illinois,
      60510-2299. Fuel Tech maintains an Internet web site at www.ftek.com .





Fuel
      Tech's special focus is the worldwide marketing of its nitrogen oxide (“NOx”)
      reduction and FUEL CHEM ® processes. The NOx reduction technology segment, which includes the
      NOxOUT ® ,
      NOxOUT
      CASCADE ® ,
      NOxOUT
      ULTRA ® and
      NOxOUT-SCR ® processes, reduces NOx emissions in flue gas from boilers, incinerators,
      furnaces and other stationary combustion sources. The FUEL CHEM technology
      segment improves the efficiency, reliability and environmental status of
      combustion units by controlling slagging, fouling, corrosion, opacity, acid
      plume and loss on ignition, as well as the formation of sulfur trioxide,
      ammonium bisulfate, particulate matter (PM 2.5 ),
      carbon
      dioxide and NOx through the addition of chemicals into the fuel or via TIFITM
Targeted In-Furnace InjectionTM programs. Fuel Tech has other technologies, both
      commercial and in the development stage, which are related to the NOxOUT 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 of Fuel Tech, are shareholders of American Bailey Corporation
      (“ABC”). Please refer to Note 9 to the consolidated financial statements in this
      document. 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
      2007 Annual Meeting of Shareholders, which information is incorporated by
      reference.





**NOx
      Reduction**





*Regulations
      and Markets*





The
      U.S.
      air pollution control market is the primary driver in Fuel Tech’s NOx reduction
      technology segment. This market is dependent on air pollution regulations and their continued enforcement. These regulations are based on
      the
      Clean Air Act Amendments of 1990 (the “CAAA”), which require
      reductions in NOx emissions on varying timetables with respect to various
      sources of emissions. Under the SIP (State Implementation Plan) 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 are 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.




1





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.
      Under CAIR, additional annual NOx reduction requirements were extended to most
      SIP-affected units in 28 eastern states, commencing in 2009. The Company expects
      an additional 300 utility boilers to be affected by this rule, which allows
      a
      cap and trade format similar to the SIP Call. 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 the
      Company believes that CAVR will affect an additional 50 utility boilers and
      a
      large number of industrial units in multiple industries.





Outside
      the United States,
      Fuel Tech sells NOx control systems in Europe. Under European Union Directives,
      certain waste incinerators and cement plants must be in compliance with
      specified NOx reduction targets by 2008, while certain power plants must be
      in
      compliance by 2010.





Another
      foreign NOx control market representing attractive opportunities for Fuel Tech
      is the People's Republic of China (PRC). The Government's 11th Five-Year
      Economic Plan has set pollution control and energy efficiency and savings as
      the
      top two priorities. Fuel Tech has viable technologies to help achieve both
      objectives. While the PRC has taken an initial small step to reduce NOx
      emissions (by installing low NOx burners) on new electric utility units,
      on-going research and demonstration projects will generate cost performance
      data
      for use in tightening the standards in the near future. The PRC's dominant
      reliance on coal as an energy resource will not change in the foreseeable
      future. Clean air has been and will continue to be a pressing issue, especially
      with the PRC’s booming economy (8%-12% annual GDP increase), expected growth in
      power production (4%-5% average annual increase through 2020), and an
      increasingly expanded role in international events and organizations. The PRC
      is
      the host of the upcoming 2008 Beijing Summer Olympics and the 2010 Shanghai
      World Expo. Fuel Tech has gained an enviable market position in NOx control
      due
      to the national demonstration projects utilizing NOxOUT CASCADE technology
      at
      Jiangsu Kanshan (two new 600 megawatt units), NOxOUT SNCR technology at Jiangyin
      Ligang (four new 600 megawatt units), and NOxOUT ULTRA technology on two
      retrofit projects in Beijing. These projects are expected to showcase a wide
      spectrum of Fuel Tech capabilities for NOx emission control and help gain
      penetration within the market for new power units now as well as within the
      larger market for retrofit units later.





*Products*





Fuel
      Tech’s NOx reduction technologies are installed worldwide on over 400 combustion
      units, including utility, industrial and municipal solid waste applications.
      Products include customized NOx control systems and patented urea-to-ammonia
      conversion technology, which can provide safe reagent for use in Selective
      Catalytic Reduction (SCR) systems.





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





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





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





Fuel
      Tech’s NOxOUT ULTRA system is designed to convert urea to ammonia safely and
      economically for use as a reagent in the SCR process for NOx reduction. In
      this
      fashion, Fuel Tech intends to participate in the SCR segment of the U.S. SIP
      Call and CAIR driven markets. Recent local hurdles in the ammonia permitting
      process have raised concerns regarding the safety of ammonia storage in
      quantities sufficient to supply SCR. In addition, as new power plants are
      constructed in the PRC during the next several years with SCR systems, Fuel
      Tech’s NOxOUT ULTRA process is believed to be a leading candidate for the safe
      delivery of ammonia, particularly near densely populated cities, major
      waterways, harbors or islands, or where the transport of anhydrous ammonia
      is a
      safety concern.





Fuel
      Tech
      has sublicensed the Rich Reagent Injection Technology from Reaction Engineering
      International, which has a direct license from the Electric Power Research
      Institute. The technology has been proven in full-scale field studies on
      cyclone-fired units to reduce NOx by 25%-40%. The technology is a generic SNCR
      process, whose applicability is outside the temperature range of the NOxOUT
      process. The technology is seen as an add-on to Fuel Tech’s NOxOUT systems, thus
      potentially broadening the NOx reduction of the combined system to almost 55%
      with minimal additional capital requirement.





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




2





*NOx
      Reduction Competition*





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





Combustion
      modifications, including low NOx burners, can be fitted to most types of boilers
      with cost and effectiveness varying with specific boilers. Combustion
      modifications may effect 20-50% NOx reduction economically with capital costs
      ranging from $5 - $40/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 Alstom, Foster Wheeler Corporation, The Babcock & Wilcox
      Company and Babcock Power, Inc. are active competitors in the low-NOx burner
      business.





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





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





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





In
      addition to or in lieu of using the foregoing processes, certain customers
      will
      elect to close or derate 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.




3





**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, and
      waste-to-energy markets. FUEL CHEM programs are currently in place on over
      50
      combustion units, treating a wide variety of solid and liquid fuels, including
      coal, heavy oil, biomass and municipal waste.





Central
      to the FUEL CHEM approach is the introduction of chemical reagents, such as
      magnesium hydroxide, to combustion units via in-body fuel application
      (pre-combustion) or via direct injection (post-combustion) utilizing Fuel Tech’s
      proprietary TIFI technology. By attacking performance-hindering problems, such
      as slagging, fouling, corrosion, opacity, acid plume and loss on ignition (LOI),
      as well as the formation of sulfur trioxide (SO 3 ),
      ammonium bisulfate (ABS), particulate matter (PM 2.5 ),
      carbon
      dioxide (CO 2 )
      and
      NOx, the Company’s programs offer numerous operational, financial and
      environmental benefits to owners of boilers, furnaces and other combustion
      units.





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





The
      principal markets for this product line are electric power plants burning coals
      with slag- forming constituents. The slag-forming constituents are sodium,
      iron
      and high sulfur content. Sodium is typically found in the Powder River Basin
      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).





The
      combination of slagging coals and SO 3 -related
      issues, such as “blue plume” formation, air pre-heater fouling and corrosion,
      SCR fouling and the proclivity to suppress certain mercury removal processes,
      represents attractive market potential for Fuel Tech.





Internationally,
      market opportunities exist in Europe and in the Asia-Pacific region,
      particularly the PRC and India, where high-slagging coals are fueling a large
      and growing fleet of power plants. In addition, TIFI initiatives aimed at energy
      efficiency improvements often result in reduced CO 2 emissions,
      which can potentially be monetized under provisions of the Kyoto Protocol.





A
      potentially large fuel treatment market exists in Mexico, where high-sulfur,
      low-grade fuel oil containing vanadium and nickel is the primary source for
      electricity production. The presence of these metallic constituents promotes
      slag build-up, and the fuel properties may result in acid gas and particulate
      emissions in local combustion units. Fuel Tech has successfully treated such
      units with its TIFI technology.





Sales
      of
      the FUEL CHEM products were $28.7 million, $20.3 million and $16.2 million
      for
      the years ended December 31, 2006, 2005 and 2004, 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 SO 3 abatement, but there can be no assurance that such lack of substantive
      competition will continue.





**PLANT
      OPTIMIZATION SERVICES**





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




4





**INTELLECTUAL
      PROPERTY**





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





**EMPLOYEES**





Fuel
      Tech
      has 137 employees, 129 in North America and 8 in Europe. Fuel Tech enjoys good
      relations with its employees and is not a party to any labor management
      agreements.




5




**ITEM
      1A. RISK FACTORS OF THE BUSINESS**





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





(i)  Lack
      of
      Diversification





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


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





·
            The
                fuel treatment chemicals technology segment, which uses chemical
                processes, including TIFI Targeted In-Furnace Injection technology,
                to
                control slagging, fouling, corrosion, opacity, acid plume and loss
                on
                ignition, as well as the formation of sulfur trioxide, ammonium bisulfate,
                particulate matter (PM2.5),
                carbon dioxide and NOx in furnaces and boilers.


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





(ii)  Competition





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





Competition  in
      the
      FUEL CHEM markets includes chemicals sold by specialty chemical and combustion
      engineering companies, such as GE Infrastructure, Ashland Inc. and Environmental
      Energy Services, Inc. As noted previously, no substantive competition currently
      exists for Fuel Tech's TIFI technology, which is designed primarily for slag
      control and SO 3 abatement. However, there can be no assurance that such lack of substantive
      competition will continue.





(iii)  Dependence
      on Regulations and Enforcement





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





(iv)
      Protection of Patents and Proprietary Rights





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





6





**ITEM
      1B. UNRESOLVED STAFF COMMENTS**





None





**ITEM
      2. PROPERTIES**





Fuel
      Tech’s products are generally protected by U.S. and non-U.S. patents. Fuel Tech
      owns 88 granted patents worldwide and has seven patent applications pending
      in
      the United States and 20 pending in non-U.S. jurisdictions. These patents 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. These inventions represent significant
      enhancements of the application and performance of the technologies. Further,
      Fuel Tech believes that the protection provided by the numerous claims in the
      above referenced patents or patent applications is substantial, and affords
      Fuel
      Tech a significant competitive advantage in its business. Accordingly, any
      significant reduction in the protection afforded by these patents or any
      significant development in competing technologies could have a material adverse
      effect on Fuel Tech’s business.





Apart
      from its intellectual property, the property of Fuel Tech is not
      material.





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




·
            The
                Batavia, Illinois building lease term, for approximately 18,000 square
                feet, runs from June 1, 1999 to May 31, 2009. Fuel Tech has the option
                to
                extend the lease term for two successive terms of five years each
                at
                market rates to be agreed upon between Fuel Tech and the lessor.




·
            The
                Stamford, Connecticut building lease term, for approximately 7,000
                square
                feet, runs from February 1, 2004 to January 31, 2010. Fuel Tech has
                the
                option to extend the lease term for one successive term of five years
                at a
                market rate to be agreed upon between Fuel Tech and the
                lessor.




Please
      refer to Note 7 to the consolidated financial statements for a further
      discussion of these arrangements.





**ITEM
      3. LEGAL PROCEEDINGS**





Fuel
      Tech
      has no pending litigation material to its business.





**ITEM
      4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS**





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




7




**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.





*Prices*





The
      table
      below sets forth the high and low sales prices during each calendar quarter
      since January 2005.





**2006**
            
            **High**
            
            **Low**Fourth
                Quarter
            
            $
            27.44
            
            $
            14.40Third
                Quarter
            
            
            16.45
            
            
            10.07Second
                Quarter
            
            
            18.80
            
            
            11.15First
                Quarter
            
            
            16.75
            
            
            8.11**2005**Fourth
                Quarter
            
            $
            10.12
            
            $
            7.24Third
                Quarter
            
            
            10.13
            
            
            5.75Second
                Quarter
            
            
            7.20
            
            
            5.10First
                Quarter
            
            
            6.85
            
            
            4.60





*Dividends*





Fuel
      Tech
      has not to date paid dividends on its Common Shares and is not expected to
      do so
      in the foreseeable future.





*Holders*





Based
      on
      information from Fuel Tech’s Transfer Agent, as of February 16, 2006, there were
      305 registered holders of Fuel Tech’s Common Shares. Management believes that,
      on such date, there were approximately 15,924 beneficial holders of Fuel Tech’s
      Common Shares.





*Transfer
      Agent*





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





*Securities
      Authorized for Issuance Under Equity Compensation Plans*





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





**Plan
                Category**
            
            **Number
                of Securities to be issued upon exercise of outstanding options,
                warrants
                and rights**
            
            **Weighted-average
                exercise price of outstanding options, warrants and
                rights**
            
            **Number
                of securities remaining available for future issuance under equity
                compensation plans excluding securities listed in column
                (a)****(a)**
            
            **(b)**
            
            **(c)**Equity
                 compensation plans approved by security holders (1)
            
            
            2,414,200
            
            $
            13.02
            
            
            866,000




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




8


*Performance
      Graph*





The
      following line graph compares (i) Fuel Tech’s total return to shareholders per
      share of Common Stock for the five years ended December 31, 2006 to that of
      (ii)
      the NASDAQ Composite index, and (iii) the WilderHill Clean Energy Index for
      the
      period December 31, 2001 through December 31, 2006.




graph




9




**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, 2006. The selected financial
      data should be read in conjunction with the audited consolidated financial
      statements as of and for the year ended December 31, 2006, and “Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations.”




**For
                the years ended December 31****CONSOLIDATED
                STATEMENT of OPERATIONS DATA**
            
            2006
            
            2005
            
            2004
            
            2003
            
            2002(in
                thousands of U.S. dollars, except for share data)Net
                sales
            
            $
            75,115
            
            $
            52,928
            
            $
            30,832
            
            $
            35,736
            
            $
            32,627Selling,
                general and administrative and other costs and expenses
            
            
            25,953
            
            
            18,655
            
            
            14,130
            
            
            12,978
            
            
            11,777Operating
                income
            
            
            10,733
            
            
            7,155
            
            
            136
            
            
            969
            
            
            2,618Net
                income
            
            
            6,826
            
            
            7,588
            
            
            1,572
            
            
            1,120
            
            
            3,057Basic
                income per Common Share
            
            $
            0.32
            
            $
            0.38
            
            $
            0.08
            
            $
            0.06
            
            $
            0.16Diluted
                income per Common Share
            
            $
            0.28
            
            $
            0.33
            
            $
            0.07
            
            $
            0.05
            
            $
            0.14Weighted-average
                basic shares outstanding
            
            
            21,491,000
            
            
            20,043,000
            
            
            19,517,000
            
            
            19,637,000
            
            
            19,350,000Weighted-average
                diluted shares outstanding
            
            
            24,187,000
            
            
            23,066,000
            
            
            22,155,000
            
            
            22,412,000
            
            
            22,437,000




**December
                31****CONSOLIDATED
                BALANCE SHEET DATA**
            
            2006
            
            2005
            
            2004
            
            2003
            
            2002(in
                thousands of U.S. dollars, except for share data)Working
                capital
            
            $
            38,715
            
            $
            19,590
            
            $
            11,292
            
            $
            10,973
            
            $
            13,930Total
                assets
            
            
            65,660
            
            
            44,075
            
            
            23,828
            
            
            21,598
            
            
            25,869Long-term
                obligations
            
            
            500
            
            
            448
            
            
            505
            
            
            299
            
            
            2,059Total
                liabilities
            
            
            18,005
            
            
            14,939
            
            
            4,873
            
            
            4,287
            
            
            9,064Shareholders'
                equity
            
            
            47,655
            
            
            29,136
            
            
            18,955
            
            
            17,311
            
            
            16,805Net
                tangible book value per share
            
            $
            1.83
            
            $
            1.12
            
            $
            0.70
            
            $
            0.61
            
            $
            0.64





Notes:





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





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





(3)  Net
      tangible book value per share is defined as shareholders’ equity less intangible
      assets, divided by weighted average shares outstanding.




10





**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:





*Nitrogen
      Oxide (“NOx”) Reduction Technologies*





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





*Fuel
      Treatment Chemicals*





The
      fuel
      treatment chemicals technology segment uses chemical processes, including TIFI
      Targeted In-Furnace Injection technology, to control slagging, fouling,
      corrosion, opacity, acid plume and loss on ignition, as well as the formation
      of
      sulfur trioxide, ammonium bisulfate, particulate matter (PM 2.5 ),
      carbon
      dioxide and NOx in furnaces and boilers. Fuel Tech sells its fuel treatment
      chemicals through its direct sales force and agents to industrial and utility
      power-generation facilities.





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





**Critical
      Accounting Policies and Estimates**





The
      consolidated financial statements are prepared in accordance with accounting
      principles generally accepted in the United States of America, which require
      Fuel Tech to make estimates and assumptions. Fuel Tech believes that of its
      accounting policies (see Note 1 to the consolidated financial statements) the
      following involves a higher degree of judgment and complexity and are deemed
      critical. Fuel Tech discusses its critical accounting policies with the Audit
      Committee.





*Revenue
      Recognition*





Fuel
      Tech
      uses the percentage of completion method of accounting for certain long-term
      equipment construction and license contracts that are sold within the nitrogen
      oxide reduction business segment. Under the percentage of completion method,
      sales and gross profit are recognized as work is performed based on the
      relationship between actual construction costs incurred and total estimated
      costs at completion. Since the financial reporting of these contracts depends
      on
      estimates that are assessed continually during the term of the contract,
      recognized sales and profit are subject to revisions as the contract progresses
      to completion. Revisions in profit estimates are reflected in the period in
      which the facts that give rise to the revision become known.





Fuel
      Tech’s construction contracts are typically six to twelve months in length. A
      typical contract will have three or four critical milestones that serve as
      the
      basis for Fuel Tech to invoice the customer. At a minimum, the milestones will
      include the generation of engineering drawings, the shipment of equipment and
      the completion of a system performance test.




As
      part
      of most of its contractual project agreements, Fuel Tech will agree to
      customer-specific acceptance criteria that relate to the operational performance
      of the system that is being sold to the customer. These criteria are determined
      based on mathematical modeling that is performed by Fuel Tech personnel, which
      is based on operational inputs that are provided by the customer. The customer
      will warrant that these operational inputs are accurate as they are specified
      in
      the binding contractual agreement. Further, the customer is solely responsible
      for the accuracy of the operating condition information; all performance
      guarantees and equipment warranties granted by Fuel Tech are void if the
      operating condition information is inaccurate or is not met.




Fuel
      Tech
      has installed over 400 units with the technology and has never failed to meet
      a
      performance guarantee when the customer has provided the required operating
      conditions for the project. As part of the project implementation process,
      Fuel
      Tech will perform system start-up and optimization services that effectively
      serve as a test of actual project performance. Fuel Tech believes that this
      test, combined with the accuracy of the modeling that is performed, enables
      revenue to be recognized prior to the receipt of formal customer acceptance.




11





*Allowance
      for doubtful accounts*





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





*Assessment
      of potential impairments of goodwill and intangible
      assets*




Effective
      January 1, 2002, Fuel Tech adopted FASB (Financial Accounting Standards Board)
      Statement No. 142, “Goodwill and Other Intangible Assets.” 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 model (DCF) to determine the current fair
      value
      of its two reporting units. A number of significant assumptions and estimates
      are involved in the application of the DCF model to forecast operating cash
      flows, including markets and market share, sales volumes and prices, costs
      to
      produce and working capital changes. Management considers historical experience
      and all available information at the time the fair values of its reporting
      units
      are estimated. However, actual fair values that could be realized in an actual
      transaction may differ from those used to evaluate the impairment of
      goodwill.




Fuel
      Tech
      reviews other intangible assets, which include a customer list, a covenant
      not
      to compete and patent assets, 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.




*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, Fuel Tech 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 which can be readily implemented.





*Stock-Based
      Compensation*





Fuel
      Tech
      recognizes compensation expense for employee equity awards in which the expense
      (net of tax) is recognized ratably over the requisite service period of the
      award. Fuel Tech utilizes 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.





*Recently
      Adopted Accounting Standards*





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





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




12





*New
      Accounting Pronouncements*





In
      July
      2006, the Financial Accounting Standards Board (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,
      FIN 48 is effective for Fuel Tech on January 1, 2007. Management has determined
      that the adoption of FIN 48 will not have a material impact on Fuel Tech’s
      consolidated financial statements.





In
      September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” (SFAS
      157). SFAS 157 defines fair value, establishes a framework for measuring fair
      value in generally accepted accounting principles, and expands disclosures
      about
      fair value measurements. The provisions of this standard apply to other
      accounting pronouncements that require or permit fair value measurements. SFAS
      157 becomes effective for Fuel Tech on January 1, 2008. Upon adoption, the
      provisions of SFAS 157 are to be applied prospectively with limited exceptions.
      The adoption of SFAS 157 is not expected to have a material impact on Fuel
      Tech’s consolidated financial statements.




13





**2006
      versus 2005**





Net
      sales
      for the years ended December 31, 2006 and 2005 were $75,115,000 and $52,928,000,
      respectively. The year over year increase of $22,187,000, or 42%, reflects
      an
      increase of $13,804,000 from the nitrogen oxide (NOx) reduction technology
      segment and an increase of $8,389,000 from the fuel treatment chemical
      technology segment.





Revenues
      for the NOx reduction technology segment were $46,454,000 in 2006, an increase
      of $13,804,000, or 42%, over 2005. This segment continues to experience a high
      level of order activity as utilities and industrial facilities that are impacted
      by the Environmental Protection Agency’s (EPA) State Implementation Plan (SIP)
      Call regulation and other recently introduced regulatory mandates continue
      to
      utilize Fuel Tech’s technology as an important element of their ongoing
      regulatory compliance strategy.





Revenues
      for the Fuel Treatment Chemical business segment were $28,661,000 in 2006,
      an
      increase of $8,389,000, or 41%, over 2005. This segment’s growth is indicative
      of the continued market acceptance of Fuel Tech’s patented TIFITM Targeted
      In-Furnace InjectionTM technology, particularly on coal-fired units, which
      represent the largest market opportunity for the technology, both domestically
      and abroad. Fuel Tech’s oil-fired business was negatively impacted by the high
      price of oil during 2006.





Fuel
      Tech’s TIFI technology alleviates the slagging and fouling issues associated
      with burning coals that are high in low-melting-point ash constituents, such
      as
      sodium and iron. Powder River Basin (PRB) coal, which accounts for approximately
      42% of the coal burned in the United States today to generate electricity,
      and
      Illinois Basin coal, are two examples of coal sources that have high levels
      of
      low-melting-point ash constituents. There are coal seams across the country
      that
      provide utility units with slagging and fouling issues. Additionally,
      demonstrations have recently been performed on utility units that burn higher
      sulfur coals. High sulfur coals represent an additional market opportunity
      for
      Fuel Tech, particularly as environmental regulations require coal-fired utility
      units to install sulfur reduction technologies. When high-sulfur coal is used
      on
      a unit that has a Selective Catalytic Reduction (SCR) system, sulfur trioxide
      (SO 3 )
      and
      acid plume issues are created, which are a key concern in many utility and
      industrial operations today. Fuel Tech’s TIFI Targeted In-Furnace Injection
      technology provides a solution for these issues.





Cost
      of
      sales as a percentage of net sales for the years ended December 31, 2006 and
      2005 was 51%. The cost of sales percentage for 2006 for the NOx reduction
      segment increased to 57% from 51% in 2005. The increase is attributable to
      the
      mix of project business. For the fuel treatment chemical segment, the cost
      of
      sales percentage decreased to 42% in 2006 from 50% in 2005. The decrease is
      due
      to the timing of revenue recognition on cost-share demonstrations and to
      leveraging fixed costs on higher revenue-generating coal-fired utility units.





Selling,
      general and administrative expenses for
      the
      years ended December 31, 2006 and 2005 were
      $ 23,901,000
      and $17,414,000, respectively. The
      $6,487,000 year over year increase over 2005 is attributable to the
      following:


·
            Fuel
                Tech recorded $1,805,000 in stock compensation expense in accordance
                with
                Statement 123(R), as discussed in Note 6 to the consolidated financial
                statements.





·
            Fuel
                Tech realized an increase in revenue-related expenses in the amount
                of
                $1,500,000 as both technology segments had significantly improved
                revenue
                growth versus the comparable prior-year
                period.





·
            Fuel
                Tech recorded an increase in human resource-related expenses of
                approximately $1,800,000 as staffing levels were increased in several
                areas in response to overall business
                growth.





·
            Finally,
                Fuel Tech realized incremental expenses related to audit, tax, consulting
                and recruiting fees, all in support of achieving business growth.
                Of
                specific note are the costs that were incurred to domesticate Fuel
                Tech.





Research
      and development expenses were $2,052,000 and $1,241,000 for the years ended
      December 31, 2006 and 2005, 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 increase by almost $800,000 year over year, driven
      by
      higher average cash and short-term investment balances, and market interest
      rates versus those experienced in the prior year. The
      increase in other income is due largely to foreign exchange gains
      related to balances denominated in foreign currencies.





On
      a
      year-to-date basis, Fuel Tech recorded tax expense of $4,942,000. This amount
      primarily represents non-cash deferred tax expense related to taxable income
      recognized in 2006.





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





14





**2005
      versus 2004**





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





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





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





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





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





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





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





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





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





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





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




15





**Liquidity
      and Sources of Capital**





At
      December 31, 2006, Fuel Tech had cash and cash equivalents and short-term
      investments of $32,405,000 and working capital of $38,715,000 versus $16,375,000
      and $19,590,000 at the end of 2005, respectively. Operating activities provided
      $8,159,000 of cash during 2006, primarily due to the favorable operating results
      of the business segments. Investing activities used cash of $4,017,000 during
      2006, as short-term investments were increased by $2,000,000 and $2,017,000
      was
      utilized to support and enhance the operations of the business, principally
      for
      equipment related to the fuel treatment chemical technology segment. Fuel Tech
      generated cash related to the exercise of stock options in the amount of
      $9,770,000. Of this amount, $3,826,000 represents proceeds derived from the
      exercise price of options exercised in 2006, while $5,944,000 represents the
      excess tax benefits realized from the exercise of stock options in
      2006.





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





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





There
      were no interest payments made during the years ended December 31, 2006, 2005
      or
      2004.





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





16


**Contractual
      Obligations and Commitments**





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





**Payments
                due by period in thousands of U.S. dollars****Contractual
                Cash Obligations**
            
            **Total**
            
            **Less
                than 1 year**
            
            **2-3
                years**
            
            **4-5
                years**
            
            **Thereafter**Operating
                Leases
            
            $
            1,388
            
            $
            521
            
            $
            827
            
            $
            40
            
            $
            -





Fuel
      Tech
      has a sublease agreement that obligates the lessee to make future payments
      to
      Fuel Tech. The sublease obligations noted below are related to a sublease
      agreement between Fuel Tech and American Bailey Corporation (ABC). ABC will
      reimburse Fuel Tech for its share of lease and lease-related expenses under
      Fuel
      Tech’s January 29,  2004
      lease of its executive offices in Stamford, Connecticut. Please refer to Note
      9
      to the consolidated financial statements for a discussion of the relation
      between Fuel Tech and ABC.





**Rental
                payments due to Fuel Tech by period in thousands of U.S.
                dollars****Contractual
                Cash Obligations**
            
            **Total**
            
            **Less
                than 1 year**
            
            **2-3
                years**
            
            **4-5
                years**
            
            **Thereafter**Sublease
            
            $
            250
            
            $
            81
            
            $
            162
            
            $
            7
            
            $
            -





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





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





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





**Off-Balance-Sheet
      Transactions**




There
      were no off-balance-sheet transactions during
      the two year period ended December 31, 2006.




**Forward-Looking
      Information**





From
      time
      to time, information provided by Fuel Tech, statements made by its employees
      or
      information included in its filings with the Securities and Exchange Commission
      (including this Annual Report) may contain statements that are not historical
      facts, so-called “forward-looking statements.” These forward-looking statements
      are made pursuant to the safe harbor provisions of the Private Securities
      Litigation Reform Act of 1995. Fuel Tech’s actual future results may differ
      significantly from those stated in any forward-looking statements.
      Forward-looking statements involve a number of risks and uncertainties,
      including, but not limited to, product demand, pricing, market acceptance,
      litigation, risk of dependence on significant customers, third-party suppliers
      and intellectual property rights, risks in product and technology development
      and other risk factors detailed in the text under the caption “Risk Factors of
      the Business” in Item 1 “Business” under Part I of this Annual Report and in
      Fuel Tech’s Securities and Exchange Commission filings.




17





**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. Fuel Tech does not enter into foreign currency
      forward contracts or into foreign currency option contracts to manage this
      risk
      due to the immaterial nature of the transactions involved.





Fuel
      Tech
      is also exposed to changes in interest rates primarily due to its long-term
      debt
      arrangement (refer to Note 8 to the consolidated financial statements). A
      hypothetical 100 basis point adverse move in interest rates along the entire
      interest rate yield curve would not have a materially adverse effect on interest
      expense during the upcoming year ended December 31, 2007.





**ITEM
      8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**





**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, 2006, based on
      criteria in “Internal Control—Integrated Framework” ** issued
      by
      the COSO.




Management’s
      assessment of the effectiveness of internal control over financial reporting
      as
      of December 31, 2006, has been audited by Grant Thornton LLP, an independent
      registered public accounting firm, as stated in their report, which is included
      elsewhere herein.




18







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





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





We
      have
      audited management’s assessment, included in the accompanying Management’s
      Report on Internal Control Over Financial Reporting, that Fuel Tech, Inc.
      maintained effective internal control over financial reporting as of December
      31, 2006 based on criteria established in Internal Control—Integrated Framework
      issued by the Committee of Sponsoring Organizations of the Treadway Commission
      (the COSO criteria). Fuel Tech, Inc.’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. Our
      responsibility is to express an opinion on management’s assessment and an
      opinion on the effectiveness of 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, evaluating management’s assessment, testing and evaluating
      the design and operating effectiveness of internal control, and performing
      such
      other procedures as we considered necessary in the circumstances. We believe
      that our audit provides a reasonable basis for our opinion.





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





Because
      of its inherent limitations, internal control over financial reporting may
      not
      prevent or detect misstatements. Also, projections of any evaluation of
      effectiveness to future periods are subject to the risk that controls may become
      inadequate because of changes in conditions, or that the degree of compliance
      with the policies or procedures may deteriorate.




In
      our
      opinion, management’s assessment that Fuel Tech, Inc. maintained effective
      internal control over financial reporting as of December 31, 2006, is fairly
      stated, in all material respects, based on the COSO criteria. Also, in our
      opinion, Fuel Tech, Inc. has maintained, in all material respects, effective
      internal control over financial reporting as of December 31, 2006, based
      on **** the
      COSO
      criteria .




We
      also
      have audited, in accordance with the standards of the Public Company Accounting
      Oversight Board (United States), the consolidated balance sheets of Fuel Tech,
      Inc. as of December 31, 2006 and the related consolidated statements of income,
      shareholders’ equity, and cash flows for the year ended December 31, 2006 of
      Fuel Tech, Inc. and our report dated March 5, 2007 expressed an unqualified
      opinion on those financial statements and included an explanatory paragraph
      regarding the Company's adoption of Statement of Financial Accounting Standards
      ("SFAS") No. 123(R), Share Based Payment, in 2006.


/s/
                GRANT THORNTON, LLP


Chicago,
      Illinois


March
      5,
      2007


19
 **Report
        of Independent Registered Public Accounting Firm**
 
 The
        Board
        of Directors and Stockholders’
 Fuel
        Tech, Inc.:
 
 We
        have
        audited the accompanying consolidated balance sheet of Fuel Tech, Inc. and
        subsidiaries as of December 31, 2006, and the related consolidated statements
        of
        income, shareholders’ equity and cash flows for the year then ended. These
        financial statements are the responsibility of the Company’s management. Our
        responsibility is to express an opinion on these financial statements based
        on
        our audit.
 
 We
        conducted our audit in accordance with the standards of the Public Company
        Accounting Oversight Board (United States). Those standards require that
        we plan
        and perform the audit to obtain reasonable assurance about whether the financial
        statements are free of material misstatement. An audit includes examining,
        on a
        test basis, evidence supporting the amounts and disclosures in the financial
        statements. An audit also includes assessing the accounting principles used
        and
        significant estimates made by management, as well as evaluating the overall
        financial statement presentation. We believe that our audit provides a
        reasonable basis for our opinion.
 
 In
        our
        opinion, the consolidated financial statements referred to above present
        fairly,
        in all material respects, the financial position of Fuel Tech, Inc. as of
        December 31, 2006 and the results of their operations and cash flows for
        the
        year ended December 31, 2006, in conformity with accounting principles generally
        accepted in the United States of America.
 
 As
        discussed in Note 6 to the consolidated financial statements, effective January
        1, 2006 the Company changed the manner in which it accounts for share-based
        payments as a result of adopting the provisions of Statement of Financial
        Accounting Standards No. 123 (revised 2004), Share-Based Payment.
 
 Our
        audit
        was conducted for the purpose of forming an opinion on the basic financial
        statements taken as a whole. The accompanying Schedule II is presented to
        comply
        with SEC reporting requirements and is not a required part of the basic
        financial statements. This schedule has been subjected to the auditing
        procedures applied in the audit of the basic financial statements and, in
        our
        opinion, is fairly stated in all material respects in relation to the basic
        financial statements taken as a whole.
 
 We
        also
        have audited, in accordance with the standards of the Public Company Accounting
        Oversight Board (United States), the effectiveness of Fuel Tech Inc.’s internal
        control over financial reporting as of December 31, 2006, based on the criteria
        established in Internal Control - Integrated Framework issued by the Committee
        of Sponsoring Organizations of the Treadway Commission (COSO) and our report
        dated March 5, 2007 expressed an unqualified opinion on management’s assessment
        and an unqualified opinion on the effectiveness of Fuel Tech Inc.’s internal
        control over financial reporting.
 /s/
                GRANT THORNTON, LLP
 Chicago,
        Illinois
 March
        5,
        2007


20





**Report
      of Independent Registered Public Accounting Firm**





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





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





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





In
      our
      opinion, the financial statements referred to above present fairly, in all
      material respects, the consolidated financial position of Fuel Tech, Inc. at
      December 31, 2005, and the consolidated results of its operations and its cash
      flows for each of the two years in the period ended December 31, 2005, in
      conformity with U.S. generally accepted accounting principles. Also, in our
      opinion, the related financial statement schedule for each of the two years
      ended December 31, 2005, when considered in relation to the basic financial
      statements taken as a whole, presents fairly in all material respects the
      information set forth therein.


/s/
                Ernst & Young LLP


Chicago,
      Illinois


March
      8,
      2006





21





Fuel
      Tech, Inc.


Consolidated
      Balance Sheets





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





2006
            
            2005**December
                31****ASSETS**Current
                assets:Cash
                and cash equivalents
            
            $
            24,405
            
            $
            10,375Short-term
                investments
            
            
            8,000
            
            
            6,000Accounts
                receivable, net of allowances for doubtful accounts of $150 and $150,
                respectively
            
            
            16,724
            
            
            13,233Inventories
            
            
            203
            
            
            358Deferred
                income taxes
            
            
            4,972
            
            
            3,043Prepaid
                expenses and other current assets
            
            
            1,916
            
            
            1,072Total
                current assets
            
            
            56,220
            
            
            34,081Equipment,
                net of accumulated depreciation of $8,845 and $7,900,
                respectively
            
            
            4,051
            
            
            4,045Goodwill
            
            
            2,119
            
            
            2,119Other
                intangible assets, net of accumulated amortization of $1,205 and
                $1,087,
                respectively
            
            
            1,156
            
            
            1,224Deferred
                income taxes
            
            
            885
            
            
            1,579Other
                assets
            
            
            1,229
            
            
            1,027Total
                assets
            
            $
            65,660
            
            $
            44,075**LIABILITIES
                AND SHAREHOLDERS’ EQUITY**Current
                liabilities:Accounts
                payable
            
            $
            7,632
            
            $
            6,493Accrued
                liabilities:Employee
                and director compensation
            
            
            4,457
            
            
            2,331Other
                accrued liabilities
            
            
            5,416
            
            
            5,667Total
                current liabilities
            
            
            17,505
            
            
            14,491Other
                liabilities
            
            
            500
            
            
            448Total
                liabilities
            
            
            18,005
            
            
            14,939Shareholders'
                equity:Common
                stock, $.01 par value, 40,000,000 sharesauthorized,
                22,086,728 and 20,424,133 shares issued, respectively
            
            
            221
            
            
            204Additional
                paid-in capital
            
            
            103,122
            
            
            91,559Accumulated
                deficit
            
            
            (56,044
            )
            
            (62,870
            )Accumulated
                other comprehensive income (loss)
            
            
            79
            
            
            (39
            )Nil
                coupon perpetual loan notes
            
            
            277
            
            
            282Total
                shareholders' equity
            
            
            47,655
            
            
            29,136Total
                liabilities and shareholders' equity
            
            $
            65,660
            
            $
            44,075





See
      notes
      to consolidated financial statements.




22





Fuel
      Tech, Inc.


Consolidated
      Statements of Income





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





2006
            
            2005
            
            2004**For
                the years ended December 31****Net
                sales**
            
            $
            75,115
            
            $
            52,928
            
            $
            30,832**Costs
                and expenses:**Cost
                of sales
            
            
            38,429
            
            
            27,118
            
            
            16,566Selling,
                general and administrative
            
            
            23,901
            
            
            17,414
            
            
            12,775Research
                and development
            
            
            2,052
            
            
            1,241
            
            
            1,35564,382
            
            
            45,773
            
            
            30,696**Operating
                income**
            
            
            10,733
            
            
            7,155
            
            
            136Interest
                income
            
            
            1,011
            
            
            244
            
            
            65Other
                income (expense)
            
            
            24
            
            
            (230
            )
            
            (35
            )**Income
                before taxes**
            
            
            11,768
            
            
            7,169
            
            
            166Income
                tax (expense) benefit
            
            
            (4,942
            )
            
            419
            
            
            1,406**Net
                income**
            
            $
            6,826
            
            $
            7,588
            
            $
            1,572**Net
                income per Common Share:**Basic
            
            $
            0.32
            
            $
            0.38
            
            $
            0.08Diluted
            
            $
            0.28
            
            $
            0.33
            
            $
            0.07**Weighted-average
                number of Common Shares outstanding:**Basic
            
            
            21,491,000
            
            
            20,043,000
            
            
            19,517,000Diluted
            
            
            24,187,000
            
            
            23,066,000
            
            
            22,155,000




See
      notes
      to consolidated financial statements.




23


Fuel
      Tech, Inc.


Consolidated
      Statements of Shareholders’ Equity





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


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




See
      notes
      to consolidated financial statements.




24


Fuel
      Tech, Inc.


Consolidated
      Statements of Cash Flows


(in
      thousands of U.S. dollars)


2006
              
              2005
              
              2004**For
                    the years ended December 31****OPERATING
                  ACTIVITIES**Net
                  income
              
              $
              6,826
              
              $
              7,588
              
              $
              1,572Adjustments
                  to reconcile net income to net cashprovided
                  by operating activities:Depreciation
              
              
              1,961
              
              
              1,566
              
              
              1,225Amortization
              
              
              118
              
              
              127
              
              
              137Provision
                  for doubtful accounts
              
              
              -
              
              
              26
              
              
              92Loss
                  on equipment disposals/impaired assets
              
              
              -
              
              
              32
              
              
              109Deferred
                  income tax
              
              
              (1,235
              )
              
              (2,978
              )
              
              (1,520
              )Current
                  stock compensation expense
              
              
              1,805
              
              
              -
              
              
              -Changes
                  in operating assets and liabilities:Accounts
                  receivable
              
              
              (3,491
              )
              
              (5,901
              )
              
              (1,355
              )Inventories
              
              
              155
              
              
              (47
              )
              
              -Prepaid
                  expenses, other current assetsand
                  other noncurrent assets
              
              
              (1,046
              )
              
              (439
              )
              
              (197
              )Accounts
                  payable
              
              
              1,139
              
              
              3,788
              
              
              461Accrued
                  liabilities and othernoncurrent
                  liabilities
              
              
              1,927
              
              
              6,278
              
              
              125Other
              
              
              -
              
              
              3
              
              
              65Net
                  cash provided by operating activities
              
              
              8,159
              
              
              10,043
              
              
              714**INVESTING
                  ACTIVITIES**Proceeds
                  from sale of equipment
              
              
              -
              
              
              -
              
              
              13Purchases
                  of short-term investments
              
              
              (2,000
              )
              
              (3,500
              )
              
              -Purchases
                  of equipment and patents
              
              
              (2,017
              )
              
              (2,792
              )
              
              (2,080
              )Net
                  cash used in investing activities
              
              
              (4,017
              )
              
              (6,292
              )
              
              (2,067
              )**FINANCING
                  ACTIVITIES**Proceeds
                  from exercise of stock options and warrants
              
              
              3,826
              
              
              1,230
              
              
              34Income
                  tax benefit from exercise of stock options
              
              
              5,944
              
              
              1,488
              
              
              -Net
                  cash provided by financing activities
              
              
              9,770
              
              
              2,718
              
              
              34Effect
                  of exchange rate fluctuations on cash
              
              
              118
              
              
              (125
              )
              
              38Net
                  increase (decrease) in cash and cash equivalents
              
              
              14,030
              
              
              6,344
              
              
              (1,281
              )Cash
                  and cash equivalents at beginning of year
              
              
              10,375
              
              
              4,031
              
              
              5,312Cash
                  and cash equivalents at end of year
              
              $
              24,405
              
              $
              10,375
              
              $
              4,031





See
      notes
      to consolidated financial statements.




25


Notes
      to
      Consolidated Financial Statements





**1.** **ORGANIZATION
        AND SIGNIFICANT ACCOUNTING POLICIES**





**Organization**





Fuel
      Tech, Inc. (“Fuel Tech”) is a company that provides advanced engineering
      solutions for the optimization of combustion systems in utility and industrial
      applications. Fuel Tech’s primary focus is on the worldwide marketing and sale
      of its NOxOUT ® Process
      and related technologies as well as its FUEL CHEM ® fuel
      treatment chemical product line. The NOxOUT Process reduces nitrogen oxide
      (“NOx”) emissions from boilers, furnaces and other stationary combustion
      sources. Fuel Tech’s FUEL CHEM program is based on proprietary TIFITM Targeted
      In-Furnace InjectionTM technology in the unique application of specialty
      chemicals to improve the performance of combustion units. Fuel Tech’s business
      is materially dependent on the continued existence and enforcement of air
      quality regulations, particularly in the United States. Fuel Tech has expended
      significant resources in the research and development of new technologies in
      building its proprietary portfolio of air pollution control, fuel treatment
      chemicals, computer modeling and advanced visualization technologies.





International
      revenues were $17.5 million, $11.2 million and $4.7 million for the years ended
      December 31, 2006, 2005 and 2004, respectively. These amounts represented 23%,
      21% and 15% 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.





**Basis
      of Presentation**





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





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





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





**Reclassifications**





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





**Use
      of Estimates**





The
      preparation of the financial statements in conformity with generally accepted
      accounting principles requires management to make estimates and assumptions
      that
      affect the amounts reported in the financial statements and accompanying notes.
      Actual results could differ from those estimates.





**Cash
      Equivalents and Financial Instruments**





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





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




26





**Foreign
      Currency Risk Management**





Fuel
      Tech's earnings and cash flow are subject to fluctuations due to changes in
      foreign currency exchange rates. Fuel Tech does 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, 2006 and 2005, unbilled receivables were
      approximately $3,615,000 and $2,272,000, respectively. The allowance for
      doubtful accounts is established based on Fuel Tech’s historical level of
      write-off activity and management’s review of specific accounts at each
      reporting date.





**Allowance
      for Doubtful Accounts**





Fuel
      Tech, in order to control and monitor the credit risk associated with its
      customer base, reviews the credit worthiness of customers on a recurring basis.
      Factors influencing the level of scrutiny include the level of business the
      customer has with Fuel Tech, the customer’s payment history and the customer’s
      financial stability. Representatives of Fuel Tech’s 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.





**Goodwill
      and Other Intangibles**




Effective
      January 1, 2002, Fuel Tech adopted Financial Accounting Standards Board (FASB)
      Statement No. 142, “Goodwill and Other Intangible Assets.” Under the guidance of
      this statement, 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 recorded value. Fuel
      Tech uses a discounted cash flow model (DCF) to determine the current fair
      value
      of its reporting units. A number of significant assumptions and estimates are
      involved in the application of the DCF model to forecast operating cash flows,
      including markets and market share, sales volumes and prices, costs to produce
      and working capital changes. Management considers historical experience and
      all
      available information at the time the fair values of its reporting units are
      estimated. However, actual fair values that could be realized in an actual
      transaction may differ from those used to evaluate the impairment of
      goodwill.




Fuel
      Tech
      allocates goodwill to reporting units based on the relative excess of fair
      value
      over carrying value of the reporting units. Fair value is determined as noted
      above. The ratio of each reporting unit’s excess of fair value over carrying
      value, to the total excess of fair value over carrying value, is used as the
      basis for the allocation of the goodwill balance. Fuel Tech’s annual fair value
      measurement test revealed no evidence 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, 2006 and 2005,
      the net patent asset balance was $172,000 and $144,000, respectively. The
      third-party costs capitalized during the years ended December 31, 2006 and
      2005
      were $50,000 and $38,000, 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.




Fuel
      Tech’s intellectual property has been the primary building block for the Air
      Pollution Control and Fuel treatment chemical product lines. The patents are
      essential to the generation of revenue for Fuel Tech’s businesses and are
      essential to protect Fuel Tech from competition in the markets in which it
      serves. These costs are being amortized on the straight-line method over a
      period of 10 years from the date of patent issuance. Patent maintenance fees
      are
      charged to operations as incurred. Further, the estimated amortization expense
      related to Fuel Tech’s intangible patent assets is expected to approximate
      $20,000 per year for the five-year period ending December 31, 2011.




27




Fuel
      Tech
      reviews other intangible assets, which include a customer list, a covenant
      not
      to compete and patent assets, for impairment on a recurring basis or when events
      or changes in circumstances indicate the carrying amount of an asset may not
      be
      recoverable. In the event the sum of the expected undiscounted future cash
      flows
      resulting from the use of the asset is less than the carrying amount of the
      asset, an impairment loss equal to the excess of the asset’s carrying value over
      its fair value is recorded. Management considers historical experience and
      all
      available information at the time the estimates of future cash flows are made,
      however, the actual cash values that could be realized may differ from those
      that are estimated. Fuel Tech did not record an impairment loss in 2006, while
      the impact of impairment
      losses on Fuel Tech was $30,000 and $113,000 for the years ended December 31,
      2005, 2004, 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, 2006 and
      2005, and the accumulated amortization and net intangible assset value in total
      for all other intangible assets.




Description
                  of Other Intangible
              
              Amortization
                  period
              
              (in
                  thousands)2066
              
              2005Customer
                  list
              
              
              15
                  years
              
              
              $
              1,198
              
              $
              1,198Patent
                  asset
              
              
              10
                  years
              
              
              
              1,063
              
              
              1,013Covenant
                  not to compete
              
              
              6
                  years
              
              
              
              100
              
              
              100Total
                  cost
              
              
              
              
              $
              2,361
              
              $
              2,311Less
                  accumulated amortization
              
              
              
              
              
              1,205
              
              
              1,087Total
                  net intangible asset value
              
              
              
              
              $
              1,156
              
              $
              1,224




28




**Equipment**





Equipment
      is stated on the basis of cost. Provisions for depreciation are computed by
      the
      straight-line method, using estimated useful lives. The table below shows the
      depreciable life and equipment cost by asset class as of December 31, 2006
      and
      2005, and the accumulated depreciation and net book value in total for all
      classes of assets.





Description
                of Equipment
            
            Depreciable
                life
            
            (in
                thousands)2006
              Equipment
              Cost
            
            2005
              Equipment
              CostField
                equipment
            
            
            3-4
                years
            
            $
            8,365
            
            $
            7,487Computer
                equipment and software
            
            
            2-3
                years
            
            
            2,857
            
            
            2,805Furniture
                and fixtures
            
            
            3-10
                years
            
            
            1,652
            
            
            1,631Vehicles
            
            
            3
                years
            
            
            22
            
            
            22Total
                cost
            
            
            
            
            $
            12,896
            
            $
            11,945Less
                accumulated depreciation
            
            
            
            
            
            8,845
            
            
            7,900Total
                net book value
            
            
            
            
            $
            4,051
            
            $
            4,045





**Revenue
      Recognition**




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




**Distribution
      Costs**





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





**Income
      Taxes**





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





At
      the
      end of each reporting period, for financial statement purposes, Fuel Tech
      reviews the realizability of the deferred tax assets. As part of this review,
      Fuel Tech 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.





**Stock-Based
      Compensation**





Fuel
      Tech
      has one stock-based employee compensation plan, referred to as the 1993
      Incentive Plan (1993 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 1993 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 1993 Plan
      is
      12.5% of outstanding shares calculated on a diluted basis. At December 31,
      2006,
      Fuel Tech has 866,000 stock options available for issuance under the 1993
      Plan.





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





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




29





**Basic
      and Diluted Earnings Per Common Share**





Basic
      earnings per share excludes the dilutive effects of stock options and 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 stock options and
      warrants. The following table sets forth the weighted-average shares used at
      December 31 in calculating earnings per share (in thousands):





2006
            
            2005
            
            2004Basic
                weighted-average shares
            
            
            21,491
            
            
            20,043
            
            
            19,517Conversion
                of unsecured loan notes
            
            
            46
            
            
            59
            
            
            85Unexercised
                options and warrants
            
            
            2,650
            
            
            2,964
            
            
            2,553Diluted
                weighted-average shares
            
            
            24,187
            
            
            23,066
            
            
            22,155




**New
      Accounting Pronouncements**





In
      July
      2006, the Financial Accounting Standards Board (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 it previous
      decision to make FIN 48 effective for fiscal years beginning after December
      15,
      2006. Accordingly, FIN 48 is effective for Fuel Tech on January 1, 2007.
      Management has determined that the adoption of FIN 48 will not have a material
      impact on Fuel Tech’s consolidated financial statements.





In
      September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” (SFAS
      157). SFAS 157 defines fair value, establishes a framework for measuring fair
      value in generally accepted accounting principles, and expands disclosures
      about
      fair value measurements. The provisions of this standard apply to other
      accounting pronouncements that require or permit fair value measurements. SFAS
      157 becomes effective for Fuel Tech on January 1, 2008. Upon adoption, the
      provisions of SFAS 157 are to be applied prospectively with limited exceptions.
      The adoption of SFAS 157 is not expected to have a material impact on Fuel
      Tech’s consolidated financial statements.




30




**2.**  **CONSTRUCTION
      CONTRACTS IN PROGRESS**





The
      status of contracts in progress as of December 31, 2006 and 2005, is as
      follows:





(in
                thousands)
            
            2006
            
            2005Costs
                incurred on uncompleted contracts
            
            $
            18,696
            
            $
            12,020Estimated
                earnings
            
            
            13,810
            
            
            11,442Earned
                revenue
            
            
            32,506
            
            
            23,462Less
                billings to date
            
            
            31,524
            
            
            25,179Total
            
            $
            982
            
            $
            (1,717
            )Classified
                as follows:Costs
                and estimated earnings in excess of billings
                on   uncompleted contracts
            
            $
            3,615
            
            $
            2,272Billings
                in excess of costs and estimated earnings on    uncompleted
                contracts
            
            
            (2,633
            )
            
            (3,989
            )Total
            
            $
            982
            
            $
            (1,717
            )





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, 2006 and 2005 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 (in thousands):





**Origin
                of income (loss) before taxes**
            
            **2006**
            
            **2005**
            
            **2004**United
                States
            
            $
            13,279
            
            $
            7,823
            
            $
            1,218Foreign
            
            
            (1,511
            )
            
            (654
            )
            
            (1,052
            )Income
                before taxes
            
            $
            11,768
            
            $
            7,169
            
            $
            166





Significant
      components of the income tax benefit for the years ended December 31 are as
      follows (in thousands):




**2006**
            
            **2005**
            
            **2004**Current:Federal
            
            $
            144
            
            $
            582
            
            $
            20State
            
            
            29
            
            
            455
            
            
            94Other
            
            
            60
            
            
            34
            
            
            -Total
                current
            
            $
            233
            
            
            1,071
            
            
            114Deferred:Federal
            
            
            4,314
            
            
            2,179
            
            
            1,512State
            
            
            180
            
            
            630
            
            
            204Change
                in valuation allowance
            
            
            215
            
            
            (4,299
            )
            
            (3,236
            )Total
                deferred
            
            
            4,709
            
            
            (1,490
            )
            
            (1,520
            )Income
                tax expense (benefit)
            
            $
            4,942
            
            $
            (419
            )
            $
            (1,406
            )





31





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







**2006**
            
            **2005**
            
            **2004**Provision
                at the U.S. federal statutory rate
            
            $
            4,119
            
            $
            2,509
            
            $
            58State
                taxes, net of federal benefit
            
            
            187
            
            
            369
            
            
            94Foreign
                losses without tax benefit
            
            
            588
            
            
            263
            
            
            368Research
                credits
            
            
            (229
            )
            
            (339
            )
            
            -Other
            
            
            62
            
            
            1,078
            
            
            -Valuation
                allowance adjustment
            
            
            215
            
            
            (4,299
            )
            
            (1,926
            )Income
                tax benefit
            
            $
            4,942
            
            $
            (419
            )
            $
            (1,406
            )





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





**2006**
            
            **2005**
            
            **2004**Provision
                at the U.S. federal statutory rate
            
            
            35.0
            %
            
            35.0
            %
            
            35.0
            %State
                taxes, net of federal benefit
            
            
            1.6
            %
            
            5.1
            %
            
            56.6
            %Foreign
                losses without tax benefit
            
            
            5.0
            %
            
            3.7
            %
            
            221.7
            %Research
                credits
            
            
            (1.9
            )%
            
            (4.7
            )%
            
            -
            %Other
            
            
            .5
            %
            
            15.1
            %
            
            -
            %Valuation
                allowance adjustment
            
            
            1.8
            %
            
            (60.0
            )%
            
            (1,160.3
            )%Income
                tax benefit
            
            
            42.0
            %
            
            (5.8
            )%
            
            (847.0
            )%




32


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





2006
            
            2005Deferred
                tax assets:Research
                and development credit
            
            $
            2,296
            
            $
            1,663Net
                operating loss carryforwards
            
            
            2,116
            
            
            2,268Accrued
                liability for compensation
            
            
            537
            
            
            344Stock
                compensation expense
            
            
            526
            
            
            -Equipment
            
            
            379
            
            
            159Alternative
                minimum tax credit
            
            
            284
            
            
            261Warranty
                reserve
            
            
            180
            
            
            94Accounts
                receivable
            
            
            57
            
            
            57Deferred
                rent liability
            
            
            37
            
            
            42Vacation
                accrual
            
            
            33
            
            
            28Charitable
                contribution
            
            
            14
            
            
            8Research
                and development asset
            
            
            9
            
            
            -Total
                deferred tax assets
            
            
            6,468
            
            
            4,924Valuation
                allowances for deferred tax assets
            
            
            (260
            )
            
            (45
            )Deferred
                tax assets net of valuation allowances
            
            $
            6,208
            
            $
            4,879Deferred
                tax liabilities:Patents
            
            
            (65
            )
            
            (54
            )Goodwill
            
            
            (286
            )
            
            (203
            )Total
                deferred tax liabilities
            
            
            (351
            )
            
            (257
            )Net
                deferred tax asset
            
            $
            5,857
            
            $
            4,622Net
                deferred tax assets and liabilities are recorded as follows within
                the
                consolidated balance sheets:Current
                assets
            
            $
            4,972
            
            $
            3,043Long-term
                assets
            
            
            885
            
            
            1,579Net
                deferred tax asset
            
            $
            5,857
            
            $
            4,622





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





For
      the
      years ended December 31, 2006 and 2005 Fuel Tech recorded tax benefits from
      the
      exercise of stock options in the amount of $5,944,000 and $1,488,000
      respectively. The amounts were recorded as an increase in additional paid-in
      capital on the consolidated balance sheets.




State
      and
      Federal Tax payments during the years ended December 31, 2006, 2005 and 2004
      were $217,000, $326,000, and $76,000, respectively.





33




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




At
      December 31, 2006, Fuel Tech has tax losses in the amount of $6,045,000
      available in the United States to offset federal taxable income, and tax losses
      in the amount of $1,574,000 available to offset foreign income. The foreign
      loss
      carryforwards begin to expire in 2008 and at December 31, 2006 a full valuation
      allowance is recorded against this amount. The remaining domestic tax loss
      carryforwards expire as follows (in thousands):





2007
            
            $
            2,3252008
            
            
            1,4802009
            
            
            2202010
            
            
            3092011
            
            
            8842012
            
            
            402021
            
            
            1172025
            
            
            670$
            6,045




**4.**  **COMMON
      SHARES**





At
      December 31, 2006, Fuel Tech had 22,086,728 Common Shares issued, with an
      additional 45,556 shares reserved for issuance upon conversion of the nil coupon
      non-redeemable convertible unsecured loan notes (see Note 5) and 2,414,200
      shares reserved for issuance upon the exercise of stock options, 711,450 of
      which are currently exercisable (see Note 6).




**5.**  **NIL
      COUPON NON-REDEEMABLE CONVERTIBLE UNSECURED LOAN NOTES**




At
      December 31, 2006, 2005 and 2004, Fuel Tech had $277,000, $282,000, and $532,000
      principal amount 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. The Loan Notes
      bear no interest and have no maturity date. They are generally repayable only
      in
      the event of Fuel Tech’s dissolution and, accordingly, have been classified
      within shareholders’ equity in the accompanying balance sheet.




In
      2006,
      Loan Notes in the principal amount of $5,000 were converted into 769 Common
      Shares, while in 2005 Loan Notes in the principal amount of $250,000 were
      converted into 38,461 Common Shares. There were no conversions in 2004.




**6.**  **STOCK
      OPTIONS AND WARRANTS**




Fuel
      Tech
      has one stock-based employee compensation plan, referred to as the 1993
      Incentive Plan (1993 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 1993 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 1993 Plan
      is
      12.5% of outstanding shares calculated on a diluted basis. In
      2006,
      2005 and 2004, 1,094,000, 557,000, and 408,000 options, respectively, were
      granted to employees and directors. At
      December 31, 2006, Fuel Tech has 866,000 stock options available for issuance
      under the 1993 Plan.





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





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




34





As
      a
      result of adopting Statement 123(R) on January 1, 2006, Fuel Tech recorded
      stock-based compensation expense of $1,805,000 ($1,268,000 after-tax) for the
      year ended December 31, 2006.





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





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





As
      of
      December 31, 2006, there was $12.1 million of total unrecognized compensation
      cost related to nonvested 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 1993 Plan have a 10-year life and they vest as follows:
      50% after the second anniversary of the award date, 25% after the third
      anniversary, and the final 25% after the fourth anniversary of the award date.
      Fuel Tech calculates stock compensation expense based on the grant date fair
      value of the award and recognizes expense on a straight-line basis over the
      four-year service period of the award.




Prior
      to
      January 1, 2006, Fuel Tech used the Black-Scholes option-pricing model to
      estimate the fair value of employee stock options for the required pro forma
      disclosure under Statement 123. This model was developed for use in estimating
      the fair value of traded options that have no vesting restrictions and are
      fully
      transferable. With the adoption of Statement 123(R) as of January 1, 2006,
      Fuel
      Tech has continued to use the Black-Scholes option-pricing model to estimate
      the
      fair value of stock option grants.




The
      principal variable assumptions utilized in valuing options and the methodology
      for estimating such model inputs include: (1) risk-free interest rate - an
      estimate based on the yield of zero-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 period ended December 31, 2006 was $12.53 per share
      using the following assumptions:





**2006**
            
            **2005**
            
            **2004**Expected
                dividend yield
            
            
            0.00
            %
            
            0.00
            %
            
            0.00
            %Risk-free
                interest rate
            
            
            4.64
            %
            
            4.38
            %
            
            3.60
            %Expected
                volatility
            
            
            60.7
            %
            
            48.0
            %
            
            62.3
            %Expected
                life of option
            
            
            5.2
                years
            
            
            4.0
                years
            
            
            4.0
                years




35





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





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





The
      following table provides additional information regarding Fuel Tech’s stock
      option activity for the 12 months ended December 31, 2006.





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





36





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





**Options
                Outstanding**
            
            **Options
                Exercisable****Range
                  of**
                  **Exercise
                    Prices**
            
            **Number
                  of**
                  **Options**
            
            **Weighted-Average**
                **Remaining**Contractual
                  Life****
            
            **Weighted-Average**
                  **Exercise
                    Price**
            
            **Number
                  of**
                  **Options**
            
            **Weighted-Average**
                  **Exercise
                    Prices**$2.55
                - $5.10
            
            
            709,200
            
            
            6.39
                years
            
            $
            3.87
            
            
            485,450
            
            $
            3.64$5.11
                - $10.20
            
            
            611,000
            
            
            8.09
                years
            
            $
            7.44
            
            
            166,000
            
            $
            5.98$10.21
                - $17.84
            
            
            317,500
            
            
            9.31
                years
            
            $
            13.66
            
            
            60,000
            
            $
            15.95$17.85
                - $25.49
            
            
            776,500
            
            
            9.94
                years
            
            $
            25.49$2.55
                - $25.49
            
            
            2,414,200
            
            
            8.35
                years
            
            $
            13.02
            
            
            711,450
            
            $
            5.22





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





**Nonvested
                Stock Outstanding**
            
            **Weighted-Average**
              **Fair
                Value**Outstanding
                on January 1, 2006
            
            
            1,111,625
            
            $
            2.82Granted
            
            
            1,094,000
            
            
            12.53Released
            
            
            (362,500
            )
            
            3.59Expired
                or forfeited
            
            
            (140,375
            )
            
            2.75Outstanding
                on December 31, 2006
            
            
            1,702,750
            
            $
            8.90





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





In
      addition to the above, Fuel Tech has 1,742,000 warrants outstanding to purchase
      Common Shares at an exercise price of $1.75. The warrants expire on April 30,
      2008.





**7.**  **COMMITMENTS**





**Operating
      Leases**





Fuel
      Tech
      leases office space, autos and certain equipment under agreements expiring
      on
      various dates through 2011. Future minimum lease payments under noncancellable
      operating leases that have initial or remaining lease terms in excess of one
      year as of December 31, 2006 are as follows (in thousands):





**Year
                of Payment**
            
            **Amount**2007
            
            $
            5212008
            
            
            4662009
            
            
            3612010
            
            
            342011
            
            
            6Thereafter
            
            
            0





For
      the
      years ended December 31, 2006, 2005 and 2004, rent expense approximated $829,000
      $778,000 and $640,000, respectively.




37





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





Year
                of Payment
            
            Amount2007
            
            $
            812008
            
            
            812009
            
            
            812010
            
            
            72011
            
            
            -Thereafter
            
            
            -




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




·
      The Batavia, Illinois building lease term
      runs from June 1, 1999 to May 31, 2009. Fuel Tech has the option to extend
      the
      lease term for two successive terms of five years each at market rates to be
      agreed upon between Fuel Tech and the lessor.




·
      The Stamford, Connecticut building lease
      term runs from February 1, 2004 to January 31, 2010. Fuel Tech has the option
      to
      extend the lease term for one successive term of five years at a market rate
      to
      be agreed upon between Fuel Tech and the lessor. Fuel Tech was provided with
      a
      10 month “free rent” period under this lease, and the total minimum lease
      payments are being amortized over the lease term. The deferred rent liability
      is
      $158,000 at December 31, 2006, of which $20,000 and $138,000 are recorded in
      current “Other accrued liabilities” and long-term “Other liabilities,”
respectively, on the consolidated balance sheet. Under the sublease noted above,
      ABC was also provided with a 10-month “free rent” period, and the total minimum
      lease rentals are also being amortized over the lease term. The deferred rent
      receivable is $59,000 at December 31, 2006, of which $8,000 and $51,000 are
      recorded in current “Prepaid expenses and other current assets” and long-term
“Other assets”, respectively, on the consolidated balance sheet.




None
      of
      Fuel Tech’s lease arrangements are adjusted based on an index
      feature.





**Performance
      Guarantees**





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





·
            in
                support of the warranty period defined in the contract, or


·
            in
                support of the system performance criteria that are defined in the
                contract





As
      of
      December 31, 2006, Fuel Tech has outstanding bank performance guarantees and
      letters of credit in the amount of $1,077,000 in support of equipment
      construction contracts that have not completed their final acceptance test
      or
      that are still operating under a warranty period. Management of Fuel Tech
      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.




38





**Product
      Warranties**




Fuel
      Tech
      issues a standard product warranty with the sale of its products to customers.
      Fuel Tech’s recognition of warranty liability is based, generally, on analyses
      of warranty claims experience in the preceding years. Changes in the warranty
      liability in 2006, 2005 and 2004 are summarized below:




(in
                thousands)
            
            2006
            
            2005
            
            2004Aggregate
                product warranty liability at beginning of year
            
            $
            247
            
            $
            137
            
            $
            176Aggregate
                accruals related to product warranties
            
            
            280
            
            
            160
            
            
            663Aggregate
                reductions for payments
            
            
            (55
            )
            
            (50
            )
            
            (701
            )Aggregate
                product warranty liability at end of year
            
            $
            472
            
            $
            247
            
            $
            137




**8.**  **DEBT
      FINANCING**





Fuel
      Tech
      has a $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. As of December 31, 2006 and 2005, there were no outstanding borrowings
      on this facility.





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





There
      were no interest payments made during the years ended December 31, 2006, 2005,
      or 2004.





**9.**  **RELATED
      PARTY TRANSACTIONS**





As
      of
      December 31, 2006, Fuel Tech has a 6% common stock ownership interest in Clean
      Diesel Technologies, Inc. (CDT), which is being accounted for using the cost
      method. Fuel Tech is precluded from selling its interest in CDT except pursuant
      to a registration statement, or in a broker/dealer transaction within the
      limitations of Rule 144 of the Securities and Exchange Commission (SEC), or
      in
      an exempt private placement within the limitations of Rule 144 of the SEC.
      Fuel
      Tech’s investment in CDT, whose shares are publicly traded on the OTC Bulletin
      Board and the Alternative Investment Market of the London Stock Exchange, had
      a
      market value of $3.3 million at December 31, 2006 Fuel Tech also owns 25,000
      warrants to purchase CDT common stock. The warrants have an exercise price
      of
      $2.00 and can be exercised on or before November 14, 2010. The value assigned
      to
      the warrants on the consolidated balance sheet at December 31, 2006 and 2005
      is
      not significant.





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, 2006, 2005 and 2004, $71,000, $71,000 and $70,000,
      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 expires in 2008.
      CDT
      may terminate the royalty obligation to Fuel Tech by payment of $12 million
      commencing in 1998 and declining annually to $1,090,910 in 2008. CDT as assignee
      and owner will maintain the technology at its own expense. To date, Fuel Tech
      has received approximately $31,000 in royalties.





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




39





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





**10.**  **DEFINED
      CONTRIBUTION PLAN**





Fuel
      Tech
      has a retirement savings plan available for all U.S. employees who have met
      minimum length-of-service requirements. Fuel Tech’s contributions are determined
      based upon amounts contributed by Fuel Tech’s employees with additional
      contri butions
      made at the discretion of Fuel Tech’s Board of Directors. Costs related to this
      plan were $612,000, $285,000 and $300,000 in 2006, 2005 and 2004,
      respectively.




40





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





·
      The fuel treatment chemicals technology
      segment, which uses chemical processes for the control of slagging, fouling,
      corrosion, opacity, acid plume, loss on ignition and sulfur trioxide-related
      issues in furnaces and boilers through the addition of chemicals into the fuel
      using 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:





(in
      thousands)




For
                the year ended
              December
                31, 2006
            
            Nitrogen
                Oxide Reduction
            
            Fuel
                Treatment Chemical
            
            Other
            
            TotalNet
                sales 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





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





For
                the year ended
              December
                31, 2004
            
            Nitrogen
                Oxide Reduction
            
            Fuel
                Treatment Chemical
            
            Other
            
            TotalNet
                sales from external customers
            
            $
            14,602
            
            $
            16,216
            
            $
            14
            
            $
            30,832Cost
                of sales
            
            
            8,458
            
            
            7,797
            
            
            311
            
            
            16,566Gross
                margin
            
            
            6,144
            
            
            8,419
            
            
            (297
            )
            
            14,266Selling,
                general and administrative
            
            
            -
            
            
            -
            
            
            12,775
            
            
            12,775Research
                and development
            
            
            -
            
            
            -
            
            
            1,355
            
            
            1,355Operating
                income (loss)
            
            $
            6,144
            
            $
            8,419
            
            $
            (14,427
            )
            $
            136




41




GEOGRAPHIC
      SEGMENT FINANCIAL DATA





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





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





During
      2006 and 2005, Fuel Tech realized 24.5% and 13.1%, respectively, of its revenues
      from one customer. This customer utilized the product line offered by Fuel
      Tech’s Nitrogen Oxide Reduction business segment.




42


QUARTERLY
      FINANCIAL DATA





Set
      forth
      below are the unaudited quarterly financial data for the fiscal years ended
      December 31, 2006 and 2005.





**For
                the quarters ended:**
            
            March
                31
            
            June
                30
            
            September
                30
            
            December
                31(in
                thousands, except share data)**2006
                (a)**Net
                sales
            
            $
            17,121
            
            $
            19,759
            
            $
            20,173
            
            $
            18,062Cost
                of sales
            
            
            9,056
            
            
            10,112
            
            
            10,042
            
            
            9,219Net
                income
            
            
            1,350
            
            
            1,958
            
            
            2,060
            
            
            1,458Net
                income per Common Share:Basic
            
            $
            0.07
            
            $
            0.09
            
            $
            0.09
            
            $
            0.07Diluted
            
            $
            0.06
            
            $
            0.08
            
            $
            0.09
            
            $
            0.06**2005
                (b)**Net
                sales
            
            $
            12,051
            
            $
            11,780
            
            $
            12,821
            
            $
            16,276Cost
                of sales
            
            
            6,397
            
            
            6,053
            
            
            6,467
            
            
            8,201Net
                (loss) income
            
            
            753
            
            
            3,172
            
            
            1,048
            
            
            2,615Net
                (loss) income per Common Share:Basic
            
            $
            0.04
            
            $
            0.16
            
            $
            0.05
            
            $
            0.13Diluted
            
            $
            0.03
            
            $
            0.14
            
            $
            0.05
            
            $
            0.11





(a)
      The
      total of the diluted net income amounts per share for the four quarters ending
      December 31, 2006 does not sum to the amounts presented on the consolidated
      statement of income for the year ending December 31, 2006 due to
      rounding.





(b)
      Based
      on a review of both historical and projected taxable income, at June 30, 2005
      Fuel Tech concluded that it was more likely than not that some portion of its
      net operating losses would be utilized in subsequent years and that a reduction
      in the deferred tax asset valuation allowance needed to be recorded. Fuel Tech
      recorded a reduction in the deferred tax asset valuation allowance of $2,200,000
      in the second quarter of 2005 representing the anticipated utilization of net
      operating loss carryforwards in subsequent years.





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





43





**ITEM
      9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL
      DISCLOSURE**





None





**ITEM
      9A. CONTROLS AND PROCEDURES**





*Disclosure
      Controls and Procedures* **





As
      required by Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended
      (the “Exchange Act”), Fuel Tech’s management carried out an evaluation, with the
      participation of Fuel Tech’s Chief Executive Officer and Chief Financial
      Officer, of the effectiveness of Fuel Tech’s disclosure controls and procedures,
      as of the end of the last fiscal quarter.





Based
      upon that evaluation, the Chief Executive Officer and Chief Financial Officer
      concluded that, as of December 31, 2006, Fuel Tech’s disclosure controls and
      procedures were operating effectively to ensure that information required to
      be
      disclosed by Fuel Tech in the reports that Fuel Tech files or submits under
      the
      Exchange Act is recorded, processed, summarized and reported, within the time
      periods specified in the SEC’s rules and forms.





*Internal
      Control Over Financial Reporting* **





Management’s
      Report on Internal Control over Financial Reporting and our Independent
      Registered Public Accounting Firm’s Attestation Report are included at Item
      8.





*Change
      in Internal Control Over Financial Reporting* **





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





**ITEM
      9B. OTHER INFORMATION**




None




44




**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 2007 Annual Meeting of Shareholders (the “Proxy
      Statement”) and is incorporated by reference.





Fuel
      Tech
      has adopted a Code of Ethics and Business Conduct (the “Code”) that applies to
      all employees, officers and directors, including the Chief Executive Officer,
      Chief Financial Officer and Controller. A copy of the Code is available free
      of
      charge to any person on written or telephone request to Fuel Tech’s Investor
      Relations at the address or telephone number set out in Fuel Tech’s Annual
      Report to Shareholders. 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 2007 Annual Meeting of Stockholders and is incorporated by reference.





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





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





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





Vincent
      J. Arnone, 43, has been Senior Vice President, Treasurer and Chief Financial
      Officer since February 28, 2006; previously he had been Vice President,
      Treasurer and Chief Financial Officer since December, 2003; and Controller
      since
      May, 1999.





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





William
      E. Cummings, Jr., 50, became Vice President, Sales on April 5, 2006; previously
      he had been Vice President, Air Pollution Control Sales since May, 2000;
      Director, Utility Sales since April, 1998; and Director, Eastern Region since
      1994.





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





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





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





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





Michael
      P. Maley, 49, became Senior Vice President, International Business Development
      and Project Execution on April 5, 2006; previously he had been 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.




Nolan
      R.
      Schwartz, 56, became Vice President, Corporate Development on January 1, 2004;
      previously he had been a director of Fuel Tech, Inc., a former subsidiary of
      Fuel Tech, since 1998; and, prior to that, a principal of American Bailey
      Corporation.





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




45





William
      H. Sun, 50, became Vice President, Air Pollution Technologies on April 5, 2006;
      previously he had been Vice President and Chief Technology Officer since
      December, 2003; Vice President, Engineering and Technology since April , 1998;
      and Director of Process Engineering since 1990.




**ITEM
      11. 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**





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





**ITEM
      13. CERTAIN RELATIONSHIPS,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 ACCOUNTING 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.




46




**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 Reporting


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


Report
      of
      Independent Registered Public Accounting Firm


Report
      of
      Independent Registered Public Accounting Firm


Consolidated
      Balance Sheets as of December 31, 2006 and 2005


Consolidated
      Statements of Income for Years Ended December 31, 2006, 2005 and
      2004


Consolidated
      Statements of Shareholders’ Equity for the Years Ended December 31, 2006, 2005
      and 2004


Consolidated
      Statements of Cash Flows for the Years Ended December 31, 2006, 2005 and
      2004


Notes
      to
      Consolidated Financial Statements





**(2)
      Financial Statement Schedules**





**Schedule
      II - Valuation and Qualifying Accounts**





Fuel
      Tech, Inc. - Allowance for Doubtful Accounts:





Year
            
            Balance
                at
              January
                1
            
            Charged
                to costs and expenses
            
            (Deductions)/Other
            
            Balance
                at
              December
                312004
            
            $
            311,000
            
            
            92,000
            
            
            (329,000
            )
            $
            74,0002005
            
            $
            74,000
            
            
            26,000
            
            
            50,000
            
            $
            150,0002006
            
            $
            150,000
            
            
            -
            
            
            -
            
            $
            150,000




Fuel
      Tech, Inc. - Valuation Allowance for Deferred Tax Assets:




Year
              
              Balance
                  at
                January
                  1
              
              Charged
                  to costs and expenses
              
              (Deductions)/Other
              
              Balance
                  at
                December
                  312004
              
              $
              7,580,000
              
              
              -
              
              
              (3,236,000
              )
              $
              4,344,0002005
              
              $
              4,344,000
              
              
              -
              
              
              (4,299,000
              )
              $
              45,0002006
              
              $
              45,000
              
              
              215,000
              
              
              -
              
              $
              260,000


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




47


**(3)
      Exhibits**





^^
            3.1
            Certificate
                of Incorporation of Fuel Tech, Inc. filed September 30,
                2006^^
            3.2
            Certificate
                of Conversion of Fuel Tech, Inc. filed September 30,
                2006^^
            3.3
            By-Laws
                of Fuel Tech, Inc. adopted September 30, 2006*
            4.1
            Instrument
                Constituting US $19,200,000 Nil Coupon Non-Redeemable Convertible
                Unsecured Loan Notes of Fuel-Tech N.V., dated December 21,
                1989*
            4.2
            First
                Supplemental Instrument Constituting US $3,000,000 Nil Coupon
                Non-Redeemable Convertible Unsecured Loan Notes of Fuel-Tech N.V.,
                dated
                July 10, 1990**
            4.3
            Instrument
                Constituting US $6,000,000 Nil Coupon Non-Redeemable Convertible
                Unsecured
                Loan Notes of Fuel-Tech N.V., dated March 12, 1993**
            4.4
            Form
                of Warrants issued April 30, 1998 evidencing right to purchase 3
                million
                shares of Fuel-Tech N.V. Common Stock.^^^
            4.5
            Fuel
                Tech, Inc. Incentive Plan as amended through June 3,
                2004o
            4.6
            Fuel
                Tech, Inc. Form of Non-Executive Director Stock Option
                Agreement.o
            4.7
            Fuel
                Tech, Inc. Form of Non-Qualified Stock Option
                Agreement.o
            4.8
            Fuel
                Tech, Inc. Form of Incentive Stock Option Agreement.^
            4.9
            The
                Business Loan Agreement dated as of July 31, 2006 between Wachovia
                Bank
                N.A. and Fuel Tech, Inc.**
            10.1
            Securities
                Purchase Agreement dated as of March 23, 1998, between Fuel-Tech
                N.V., and
                the several Investors signatory thereto, including
                exhibits.#&
            10.2
            License
                Agreement dated November 18, 1998 between The Gas Technology Institute
                and
                Fuel Tech, Inc. relating to the FLGR Process#&
            10.3
            Amendment
                No. 1, dated February 28, 2000, to License Agreement of November
                18, 1998
                between The Gas Technology Institute and Fuel Tech,
                Inc.oooo
            10.4
            Employment
                Agreement as of February 28, 2006 between John (Johnny) F. Norris,
                Jr. and
                Fuel Tech, Inc.^^^^
            10.5
            Form
                of Indemnity Agreement between Fuel Tech, Inc. and its Directors
                and
                Officersoo
            19.0
            Those
                portions of the Proxy Statement to be distributed to Shareholders
                of Fuel
                Tech for the 2007 Annual Meeting of Shareholders of Fuel Tech, Inc.
                specifically incorporated by reference into this Annual Report on
                Form10-K.o
            23.1
            Consent
                of Independent Registered Public Accounting Firmo
            23.2
            Consent
                of Independent Registered Public Accounting Firmo
            31.1
            Certification
                Pursuant to Section 302 of the Sarbanes-Oxley Act of
                2002o
            31.2
            Certification
                Pursuant to Section 302 of the Sarbanes-Oxley Act of
                2002o
            32.0
            Certification
                Pursuant to Section 906 of the Sarbanes-Oxley Act of
                2002





48




The
      following are incorporated by reference from the documents
      indicated.




*
            Filed
                with Registration Statement on Form 20-F, No. 000-21724 on August
                26,
                1993, as amended**
            Filed
                with Registrant’s Report on Form 6-K for the month of March
                1998†
            Filed
                with Registrant’s Report on Form 20-F for the year 1997o
            Filed
                herewithoo
            Filed
                with the Registrant’s definitive proxy material for its 2007 Annual
                Meetingoooo
            Filed
                with Registrant’s report on Form 10-K for the year 2006#
            Confidential
                information removed and filed separately&
            Filed
                with Registrant’s report on Form 10-K for the year 1999^
            Filed
                with Registrant’s Form 8-K on August 10, 2006^^
            Filed
                with Registrant’s Form 8-K on September 30, 2006^^^
            Filed
                with Registration Statement on Form S-8 No. 333-137735 on October
                2nd
                2006^^^^
            Filed
                with Registrant’s Form 8-K on February 7,
                2007




49




**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.





Date:
              March 6, 2007
            By:
            /s/
              John
              F. Norris Jr.John
              F. Norris Jr.Chief
                Executive Officer, President and
                Director




Date:
              March 6, 2007
            By:
            /s/
              Vincent J. ArnoneVincent
                J. ArnoneChief
                  Financial Officer,Sr. Vice President and
                  Treasurer




50


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





Date:
      March 6, 2007


/s/
                  Ralph E. Bailey
              
              Executive
                  Chairman and DirectorRalph
                  E. Bailey/s/
                  Douglas G. Bailey
              
              Deputy
                  Chairman and DirectorDouglas
                  G. Bailey/s/
                  Thomas J. Shaw
              
              DirectorThomas
                  J. Shaw/s/
                  Miguel Espinosa
              
              DirectorMiguel
                  Espinosa/s/
                  Samer S. Khanachet
              
              DirectorSamer
                  S. Khanachet/s/
                  John D. Morrow
              
              DirectorJohn
                  D. Morrow/s/
                  Thomas L. Jones
              
              DirectorThomas
                  L. Jones/s/
                  Charles W. Grinnell
              
              Director,
                  Vice President, General Counsel and Corporate SecretaryCharles
                W.
                Grinnell




51