STOCK-BASED COMPENSATION

Under our stock-based employee compensation plan, referred to as the Fuel Tech, Inc. 2014 Long-Term Incentive Plan (Incentive Plan), awards may be granted to participants in the form of Non-Qualified Stock Options, Incentive Stock Options, Stock Appreciation Rights, Restricted Stock, Restricted Stock Units (“RSUs”), Performance Awards, Bonuses or other forms of share-based or non-share-based awards or combinations thereof. Participants in the Incentive Plan may be our directors, officers, employees, consultants or advisors (except consultants or advisors in capital-raising transactions) as the directors determine are key to the success of our business. There are a maximum of 4,483,525 shares that may be issued or reserved for awards to participants under the Incentive Plan. At December 31, 2014, we had approximately 1,960,000 equity awards available for issuance under the Incentive Plan.

Stock-based compensation is included in selling, general and administrative costs in our consolidated statements of operations.

The components of stock-based compensation for the years ended December 31, 2014, 2013 and 2012 were as follows:



	For the Year Ended December 31,
	2014		2013		2012
Stock options	236		(245	)	(66	)
Restricted stock units	2,086		2,043		1,314
Deferred directors fees	—		—		58
Total stock-based compensation expense	2,322		1,798		1,306
Tax benefit of stock-based compensation expense	(892	)	(671	)	(472	)
After-tax effect of stock based compensation	1,430		1,127		834

As of December 31, 2014, there was $2,462 of total unrecognized compensation cost related to all non-vested share-based compensation arrangements granted under the Incentive Plan. That cost is expected to be recognized over the remaining requisite service period of 1.8 years.

Stock Options

The stock options granted to employees under the Incentive Plan have a 10-year life and they vest as follows: 50% after the second anniversary of the award date, 25% after the third anniversary, and the final 25% after the fourth anniversary of the award date. Fuel Tech calculates stock compensation expense for employee option awards based on the grant date fair value of the award, less expected annual forfeitures, and recognizes expense on a straight-line basis over the four-year service period of the award. Stock options granted to members of our Board of Directors vest immediately. Stock compensation for these awards is based on the grant date fair value of the award and is recognized in expense immediately.

Fuel Tech uses the Black-Scholes option pricing model to estimate the grant date fair value of employee stock options. The principal variable assumptions utilized in valuing options and the methodology for estimating such model inputs include: (1) risk-free interest rate – an estimate based on the yield of zero–coupon treasury securities with a maturity equal to the expected life of the option; (2) expected volatility – an estimate based on the historical volatility of Fuel Tech’s Common Stock for a period equal to the expected life of the option; and (3) expected life of the option – an estimate based on historical experience including the effect of employee terminations.

Based on the results of the model, the weighted-average fair value of the stock options granted during the 12-month periods ended December 31, 2014, 2013 and 2012, respectively, were $2.20, $1.79 and $1.72 per share using the following weighted average assumptions:



	2014		2013		2012
Expected dividend yield	—	%	—	%	—	%
Risk-free interest rate	1.55	%	1.01	%	0.67	%
Expected volatility	47.4	%	55.2	%	58.6	%
Expected life of option	4.9 years		4.7 years		4.8 years

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



	2014				2013				2012
	Number of Options		Weighted- Average Exercise Price		Number of Options		Weighted- Average Exercise Price		Number of Options		Weighted- Average Exercise Price
Outstanding at beginning of year	1,688,500		$	11.88	1,914,000		$	11.38	1,902,000		$	11.51
Granted	94,500		5.22		80,000		3.85		70,000		3.55
Exercised	(60,000	)	4.96		(195,000	)	4.16		—		—
Expired or forfeited	(176,500	)	13.01		(110,500	)	10.93		(58,000	)	6.33
Outstanding at end of year	1,546,500		$	11.62	1,688,500		$	11.88	1,914,000		$	11.38
Exercisable at end of year	1,546,500		$	11.62	1,678,500		$	11.92	1,833,500		$	11.48
Weighted-average fair value of options granted during the year			$	2.20			$	1.79			$	1.72

The following table provides additional information regarding our stock option activity for the 12 months ended December 31, 2014:



	Number of Options		Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Life	Aggregate Intrinsic Value
Outstanding on January 1, 2014	1,688,500		$	11.88
Granted	94,500		5.22
Exercised	(60,000	)	4.96
Expired or forfeited	(176,500	)	13.01
Outstanding on December 31, 2014	1,546,500		$	11.62	3.5 years	$	14
Exercisable on December 31, 2014	1,546,500		$	11.62	3.5 years	$	14

The aggregate intrinsic value in the preceding table represents the total pretax intrinsic value, based on our closing stock price of $3.83 as of December 31, 2014, which would have been received by the option holders had those options holders exercised their stock options as of that date.

The following table summarizes information about stock options outstanding at December 31, 2014:



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 Price
$ 3.55 - $ 5.51	296,500	7.6 years	$	4.57	296,500	$	4.57
$ 5.52 - $11.03	735,875	3.1 years	8.94		735,875	8.94
$11.04 - $22.06	267,250	1.2 years	14.57		267,250	14.57
$22.07 - $27.57	246,875	1.9 years	24.87		246,875	24.87
$ 3.55 - $27.57	1,546,500	3.5 years	$	11.62	1,546,500	$	11.62

Non-vested stock option activity for the 12 months ended December 31, 2014 was as follows:



	Non-Vested Stock Options Outstanding		Weighted-Average Grant Date Fair Value
Outstanding on January 1, 2014	10,000		$	3.58
Granted	94,500		2.20
Vested	(104,500	)	2.33
Forfeited	—		—
Outstanding on December 31, 2014	—		—

As of December 31, 2014, there was $0 of total unrecognized compensation cost related to non-vested stock options granted under the Incentive Plan. Fuel Tech received proceeds from the exercise of stock options of $297, $811 and $0 in the years ended December 31, 2014, 2013 and 2012, respectively. The intrinsic value of options exercised in the years ended December 31, 2014, 2013 and 2012 was $103, $520 and $0, respectively. It is our policy to issue new shares upon option exercises, loan conversions, and vesting of restricted stock units. We have not used cash and do not anticipate any future use of cash to settle equity instruments granted under share-based payment arrangements.

Restricted Stock Units

Restricted stock units (RSUs) granted to employees vest over time based on continued service (typically vesting over a period between two and four years). Such time-vested RSUs are valued at the date of grant using the intrinsic value method based on the closing price of the Common Shares on the grant date. Compensation cost, adjusted for estimated forfeitures, is amortized on a straight-line basis over the requisite service period.

In addition to the time vested RSUs described above, performance-based RSU agreements (the Agreements) are issued annually to our President/Chief Executive Officer, Chief Operating Officer, Chief Financial Officer/Treasurer, Executive Vice President of Marketing & Sales, and Senior Vice President/General Counsel/Secretary. The Agreements provide each participating executive the opportunity to earn three types of awards with each award type specifying a targeted number of RSUs that may be granted to each executive based on either the individual performance of the executive or our relative performance compared to a peer group, as determined by the award type. The Compensation Committee of our Board of Directors (the Committee) determines the extent to which, if any, RSUs will be granted based on the achievement of the applicable performance criteria specified in the Agreement. This determination will be made following the completion of the applicable performance period (each a Determination Date). Such performance based awards include the following:

•

The first type of award is based on individual performance during the respective calendar year as determined by the Committee based on performance criteria specified in the Agreement. These awards will vest over a three-year period beginning on the Determination Date. We estimated the fair value of these performance-based RSU awards on the date of the Agreement using the trading price of the Company’s stock and our estimate of the probability that the specified performance criteria will be met. The fair value measurement and probability estimate will be re-measured each reporting date until the Determination Date, at which time the final award amount will be known. For these job performance-based awards, we amortize compensation costs over the requisite service period, adjusted for estimated forfeitures, for each separately vesting tranche of the award.

•

The second type of RSU award contains a targeted number of RSUs to be granted based on our revenue growth relative to a specified peer group during a period of two calendar years. These awards vest 67% on the second anniversary of the Agreement date and 33% on the third anniversary of the Agreement date. We estimated the fair value of these performance-based RSU awards on the Agreement date using the trading price of the Company’s stock and our estimate of the probability that the specified performance criteria will be met. For these revenue growth performance-based awards, we amortize compensation costs over the requisite service period, adjusted for estimated forfeitures, for each separately vesting tranche of the award.

•

The third type of RSU award contains a targeted number of RSUs to be granted based on the total shareholder return (TSR) of our Common Shares relative to a specified peer group during a period of two calendar years. These awards vest 67% on the second anniversary of the Agreement date and 33% on the third anniversary of the Agreement date. We estimated the fair value of these market-based RSU awards on the Agreement date using a Monte Carlo valuation methodology and amortize the fair value over the requisite service period for each separately vesting tranche of the award. The principal variable assumptions utilized in valuing these RSUs under this valuation methodology include the risk-free interest rate, stock volatility and correlations between our stock price and the stock prices of the peer group of companies.

We recorded expense of approximately $2,086, $2,043 and $1,314 associated with our restricted stock unit awards in 2014, 2013 and 2012, respectively. At December 31, 2014 there was $2,462 of unrecognized compensation costs related to restricted stock unit awards to be recognized over a weighted average period of 1.8 years. During the years ended December 31, 2014 and 2013, there were 266,091 and 394,938 restricted stock units that vested with a fair value of $1,553 and $1,728, respectively.

A summary of restricted stock unit activity for the years ended December 31, 2014, 2013 and 2012 is as follows:



	Shares		Weighted Average Grant Date Fair Value
Unvested restricted stock units at January 1, 2012	487,165		$	7.59
Granted	349,000		4.82
Forfeited	(11,891	)	7.15
Vested	(72,250	)	8.63
Unvested restricted units at December 31, 2012	752,024		6.21
Granted	485,000		4.62
Forfeited	(70,070	)	5.58
Vested	(394,938	)	2.94
Unvested restricted stock units at December 31, 2013	772,016		5.35
Granted	484,450		5.63
Forfeited	(13,306	)	5.27
Vested	(266,091	)	5.84
Unvested restricted stock units at December 31, 2014	977,069		5.36

Deferred Directors Fees

In addition to the Incentive Plan, Fuel Tech has a Deferred Compensation Plan for Directors (Deferred Plan). Under the terms of the Deferred Plan, Directors can elect to defer Directors’ fees for shares of Fuel Tech Common Stock that are issuable at a future date as defined in the agreement. In accordance with ASC 718, Fuel Tech accounts for these awards as equity awards as opposed to liability awards. In 2014, 2013 and 2012, we recorded $0, $0 and $58 respectively, of stock-based compensation expense under the Deferred Plan.