Note I - Stock-Based Compensation

6 Months Ended

Jun. 30, 2011

Disclosure of Compensation Related Costs, Share-based Payments [Text Block]

Note I:                      Stock-Based Compensation

Fuel Tech has a stock-based employee compensation plan, referred to as the Fuel Tech, Inc. Incentive Plan (Incentive Plan), under which awards may be granted to participants in the form of Non-Qualified Stock Options, Incentive Stock Options, Stock Appreciation Rights, Restricted Stock, Restricted Stock Units (RSUs), Performance Awards, Bonuses or other forms of share-based or non-share-based awards or combinations thereof.  Participants in the Incentive Plan may be Fuel Tech’s directors, officers, employees, consultants or advisors (except consultants or advisors in capital-raising transactions) as the directors determine are key to the success of Fuel Tech’s business.  The amount of shares that may be issued or reserved for awards to participants under a 2004 amendment to the Incentive Plan is 12.5% of outstanding shares calculated on a diluted basis.  At June 30, 2011, Fuel Tech had approximately 970,000 equity awards available for issuance under the Incentive Plan.

Stock-based compensation is included in selling, general, and administrative costs in our consolidated statements of operations. The components of stock-based compensation for the three and six month periods ended June 30, 2011 and 2010 were as follows:

	Three Months Ended						Six Months Ended
	June 30						June 30
	2011			2010			2011			2010
Stock options	$	869		$	1,352		$	1,405		$	2,519
Restricted stock units		173			-			254			-
Deferred directors fees		17			22			37			50
Total stock-based compensation expense		1,059			1,374			1,696			2,569
Tax benefit of stock-based compensation expense		(355	)		(469	)		(550	)		(868	)
After-tax effect of stock based compensation	$	704		$	905		$	1,146		$	1,701

As of June 30, 2011, there was $4,198 of total unrecognized compensation cost related to all non-vested share-based compensation arrangements granted under the Incentive Plan.

Stock Option Exchange Program

On June 1, 2011 the Company commenced an exchange offer that offered to certain employees the right to exchange eligible options to purchase shares of common stock of the Company for a lesser number of replacement awards of restricted stock units.  The exchange offer expired on June 29, 2011.  Pursuant to the exchange offer, 814,500 eligible options were tendered and the Company granted 267,372 restricted stock units in exchange for those options. As a result of the exchange, which is deemed a modification of the original stock option awards under generally accepted accounting principles, additional stock-based compensation of approximately $251 will be recognized over the two year vesting period associated with the replacement awards commencing June 30, 2011.  Additional information regarding the stock option exchange program may be found on the Company’s Tender Offer Statement on Schedule TO filed with the SEC on June 1, 2011.

Stock Options

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

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

Based on the results of the model, the weighted-average fair value of the stock options granted during the six-month period ended June 30, 2011 was $4.08 per option using the following assumptions:

Expected dividend yield	0.0%
Risk-free interest rate	1.8%
Expected volatility	57.2%
Expected life of option	5.0 years

Stock option activity for Fuel Tech’s Incentive Plan for the six months ended June 30, 2011 was as follows:

	Number of Options			Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Term	Aggregate Intrinsic Value
Outstanding on January 1, 2011		2,856,125		$	14.68
Granted		60,000			8.16
Converted to RSUs		(814,500	)		22.06
Exercised		(70,000	)		4.47
Expired or forfeited		(79,625	)		20.51
Outstanding on June 30, 2011		1,952,000		$	11.53	5.4 years	$984
Exercisable on June 30, 2011		1,692,375		$	11.59	5.0 years	$962

Non-vested stock option activity for the three months ended June 30, 2011 was as follows:

	Non-Vested Stock Options Outstanding				Weighted-Average Grant Date Fair Value
Outstanding on January 1, 2011		578,500		$	7.50
Granted		60,000			4.08
Vested		(272,500	)		7.03
Converted to RSUs		( 91,500	)		9.97
Forfeited		(14,875	)		7.04
Outstanding on June 30, 2011		259,625		$	6.36

As of June 30, 2011, there was $2,129 of total unrecognized compensation cost related to non-vested stock options granted under the Incentive Plan.  That cost is expected to be recognized over a weighted average period of 1.4 years.

Fuel Tech received proceeds from the exercise of stock options of $313 in the six month period ended June 30, 2011.  The intrinsic value of options exercised in the six month period ended June 30, 2011 was $249.  It is our policy to issue new shares upon option exercises, loan conversions, and vesting of restricted stock units.  We have not used cash and do not anticipate any future use of cash to settle equity instruments granted under share-based payment arrangements.

Restricted Stock Units

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

In addition to the time vested RSUs described above, in March 2011 the Company entered into a performance-based RSU agreement (the Agreement) with each of the Company’s President/Chief Executive Officer, Treasurer/Chief Financial Officer, Executive Vice President, Marketing & Sales and Executive Vice President, Worldwide Operations.  The Agreement provides each participating executive the opportunity to earn three types of awards with each award type specifying a targeted number of RSUs that may be granted to each executive based on either the individual performance of the executive or the Company’s relative performance compared to a peer group, as determined by the award type.  The Compensation and Nominating Committee of our Board of Directors (the Committee) determines the extent to which, if any, RSUs will be granted based on the achievement of the applicable performance criteria specified in the Agreement.  This determination will be made following the completion of the applicable performance period (each a “Determination Date”).  Such performance based awards include the following:

· The first type of award is based on individual performance during the 2011 calendar year as determined by the Committee based on performance criteria specified in the Agreement.  These awards will vest over a three year period beginning on the Determination Date.  We estimated the fair value of these performance-based RSU awards on the date of the Agreement using the intrinsic value method and our estimate of the probability that the specified performance criteria will be met.  The fair value measurement and probability estimate will be re-measured each reporting date until the Determination Date, at which time the final award amount will be known.  For these job performance-based awards, we amortize compensation costs over the requisite service period, adjusted for estimated forfeitures, for each separately vesting tranche of the award.

· The second type of RSU award contains a targeted number of RSUs to be granted based on the Company’s revenue growth relative to a specified peer group during the 2011 and 2012 calendar years.  These awards vest 67% on the second anniversary of the Agreement date and 33% on the third anniversary of the Agreement date.  We estimated the fair value of these performance-based RSU awards on the Agreement date using the intrinsic value method and our estimate of the probability that the specified performance criteria will be met.  For these revenue growth performance-based awards, we amortize compensation costs over the requisite service period, adjusted for estimated forfeitures, for each separately vesting tranche of the award.

· The third type of RSU award contains a targeted number of RSUs to be granted based on the total shareholder return (TSR) of the Company’s common stock relative to a specified peer group during the 2011 and 2012 calendar years. These awards vest 67% on the second anniversary of the Agreement date and 33% on the third anniversary of the Agreement date. We estimated the fair value of these market-based RSU awards on the Agreement date using a Monte Carlo valuation methodology and amortize the fair value over the requisite service period for each separately vesting tranche of the award.

At June 30, 2011 there is $1,818 of unrecognized compensation costs related to restricted stock unit awards to be recognized over a weighted average period of 3.8 years.

A summary of restricted stock unit activity for the six month period ended June 30, 2011 is as follows:

	Shares			Weighted Average Grant Date Fair Value
Unvested restricted stock units at December 31, 2010		149,000		$	8.63
Granted		-			-
Converted from stock options		267,372			6.53
Forfeited		(1,000	)		8.63
Vested		-			-
Unvested restricted stock units at June 30, 2011		415,372		$	7.28

Deferred Directors Fees

In addition to the Incentive Plan, Fuel Tech has a Deferred Compensation Plan for Directors (Deferred Plan).  Under the terms of the Deferred Plan, Directors can elect to defer Directors’ fees for shares of Fuel Tech Common Stock that are issuable at a future date as defined in the agreement.  In accordance with ASC 718, Fuel Tech accounts for these awards as equity awards as opposed to liability awards.  In the periods ended June 30, 2011 and 2010, Fuel Tech recorded $37 and $28, respectively, of stock-based compensation expense under the Deferred Plan.

At June 30, 2011, Fuel Tech had 1,924,000 weighted average stock awards outstanding that were not dilutive for the purpose of inclusion in the calculation of diluted earnings per share but could potentially become dilutive in future periods.