Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2010

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission file number 001-12019

 

 

QUAKER CHEMICAL CORPORATION

(Exact name of Registrant as specified in its charter)

 

A Pennsylvania Corporation   No. 23-0993790
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)

One Quaker Park, 901 E. Hector Street,

Conshohocken, Pennsylvania

  19428-2380
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: (610) 832-4000

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

 

Title of each class

 

Name of each Exchange on which registered

Common Stock, $1.00 par value   New York Stock Exchange

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

None

 

 

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

Indicate by check mark 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 and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files)    Yes  ¨    No  ¨

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 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.  x

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨  (Do not check if smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

State the aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant. (The aggregate market value is computed by reference to the last reported sale on the New York Stock Exchange on June 30, 2010): $304,994,986

Indicate the number of shares outstanding of each of the Registrant’s classes of common stock as of the latest practicable date: 11,506, 450 shares of Common Stock, $1.00 Par Value, as of February 28, 2011.

 

 

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held on May 11, 2011 are incorporated by reference into Part III.

 

 

 


Table of Contents

PART I

As used in this Report, the terms “Quaker,” the “Company,” “we” and “our” refer to Quaker Chemical Corporation, its subsidiaries, and associated companies, unless the context otherwise requires.

 

Item 1. Business.

General Description

Quaker develops, produces, and markets a broad range of formulated chemical specialty products for various heavy industrial and manufacturing applications and, in addition, offers and markets chemical management services (“CMS”). Quaker’s principal products and services include: (i) rolling lubricants (used by manufacturers of steel in the hot and cold rolling of steel and by manufacturers of aluminum in the hot rolling of aluminum); (ii) corrosion preventives (used by steel and metalworking customers to protect metal during manufacture, storage, and shipment); (iii) metal finishing compounds (used to prepare metal surfaces for special treatments such as galvanizing and tin plating and to prepare metal for further processing); (iv) machining and grinding compounds (used by metalworking customers in cutting, shaping, and grinding metal parts which require special treatment to enable them to tolerate the manufacturing process, achieve closer tolerance, and improve tool life); (v) forming compounds (used to facilitate the drawing and extrusion of metal products); (vi) hydraulic fluids (used by steel, metalworking, and other customers to operate hydraulically activated equipment); (vii) technology for the removal of hydrogen sulfide in various industrial applications; (viii) chemical milling maskants for the aerospace industry and temporary and permanent coatings for metal and concrete products; (ix) construction products, such as flexible sealants and protective coatings, for various applications; (x) specialty greases; and (xi) programs to provide chemical management services. Individual product lines representing more than 10% of consolidated revenues for any of the past three years are as follows:

 

     2010     2009     2008  

Rolling lubricants

     21.2     20.8     19.7

Machining and grinding compounds

     20.3     18.1     17.7

Hydraulic fluids

     13.7     12.9     11.1

Corrosion preventives

     11.5     9.9     10.2

Chemical management services

     3.5     8.4     11.1

A substantial portion of Quaker’s sales worldwide are made directly through its own employees and its CMS programs with the balance being handled through value-added resellers and agents. Quaker employees visit the plants of customers regularly and, through training and experience, identify production needs which can be resolved or alleviated either by adapting Quaker’s existing products or by applying new formulations developed in Quaker’s laboratories. Quaker makes little use of advertising but relies heavily upon its reputation in the markets which it serves. Generally, separate manufacturing facilities of a single customer are served by different personnel. As part of the Company’s chemical management services, certain third-party product sales to customers are managed by the Company. Where the Company acts as principal, revenues are recognized on a gross reporting basis at the selling price negotiated with the customers. Where the Company acts as an agent, such revenue is recorded using net reporting as service revenues at the amount of the administrative fee earned by the Company for ordering the goods. Third-party products transferred under arrangements resulting in net reporting totaled $56.5 million, $27.5 million and $32.2 million for 2010, 2009 and 2008, respectively. The Company recognizes revenue in accordance with the terms of the underlying agreements, when title and risk of loss have been transferred, collectability is reasonably assured, and pricing is fixed or determinable. This generally occurs for product sales when products are shipped to customers or, for consignment arrangements, upon usage by the customer and when services are performed. License fees and royalties are recognized in accordance with agreed-upon terms, when performance obligations are satisfied, the amount is fixed or determinable, and collectability is reasonably assured, and are included in other income.

 

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In 2010, the Company completed the acquisition of D.A. Stuart’s U.S. aluminum hot rolling oil business from Houghton International for approximately $6.8 million. With this acquisition, Quaker became a leading player in the U.S. aluminum hot rolling market. The Company also completed the acquisition of Summit Lubricants Inc., a leading specialty grease manufacturer and distributor of specialty greases, for approximately $29.1 million. This acquisition is complementary to the Company’s existing business lines and the purchase price approximates expected 2011 sales.

Competition

The chemical specialty industry comprises a number of companies of similar size as well as companies larger and smaller than Quaker. Quaker cannot readily determine its precise position in every industry it serves. Based on information available to Quaker, however, it is estimated that Quaker holds a leading and significant global position (among a group in excess of 25 other suppliers) in the market for process fluids to produce sheet steel. It is also believed that Quaker holds significant global positions in the markets for process fluids in portions of the automotive and industrial markets. The offerings of many of our competitors differ from Quaker, with some who offer a broad portfolio of fluids including general lubricants to those who have a more specialized product range and all of whom provide different levels of technical services to individual customers. Competition in the industry is based primarily on the ability to provide products that meet the needs of the customer and render technical services and laboratory assistance to customers and, to a lesser extent, on price.

Major Customers and Markets

In 2010, Quaker’s five largest customers (each composed of multiple subsidiaries or divisions with semi-autonomous purchasing authority) accounted for approximately 20% of its consolidated net sales with the largest customer (Arcelor-Mittal Group) accounting for approximately 9% of consolidated net sales. A significant portion of Quaker’s revenues are realized from the sale of process fluids and services to manufacturers of steel, automobiles, appliances, and durable goods, and, therefore, Quaker is subject to the same business cycles as those experienced by these manufacturers and their customers. Furthermore, steel customers typically have limited manufacturing locations as compared to metalworking customers and generally use higher volumes of products at a single location. Accordingly, the loss or closure of a steel mill or other major customer site can have a material adverse effect on Quaker’s business.

Raw Materials

Quaker uses over 1,000 raw materials, including mineral oils and derivatives, animal fats and derivatives, vegetable oils and derivatives, ethylene derivatives, solvents, surface active agents, chlorinated paraffinic compounds, and a wide variety of other organic and inorganic compounds. In 2010, three raw material groups (mineral oils and derivatives, animal fats and derivatives, and vegetable oils and derivatives) each accounted for as much as 10% of the total cost of Quaker’s raw material purchases. The price of mineral oil can be affected by the price of crude oil and refining capacity. In addition, animal fat and vegetable oil prices are impacted by increased biodiesel consumption. Accordingly, significant fluctuations in the price of crude oil can have a material effect upon the Company’s business. Many of the raw materials used by Quaker are “commodity” chemicals, and, therefore, Quaker’s earnings can be affected by market changes in raw material prices. Reference is made to the disclosure contained in Item 7A of this Report.

Patents and Trademarks

Quaker has a limited number of patents and patent applications, including patents issued, applied for, or acquired in the United States and in various foreign countries, some of which may prove to be material to its business. Principal reliance is placed upon Quaker’s proprietary formulae and the application of its skills and experience to meet customer needs. Quaker’s products are identified by trademarks that are registered throughout its marketing area.

 

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Research and Development—Laboratories

Quaker’s research and development laboratories are directed primarily toward applied research and development since the nature of Quaker’s business requires continual modification and improvement of formulations to provide chemical specialties to satisfy customer requirements. Quaker maintains quality control laboratory facilities in each of its manufacturing locations. In addition, Quaker maintains in Conshohocken, Pennsylvania, Santa Fe Springs, California, Uithoorn, The Netherlands and Qingpu, China laboratory facilities that are devoted primarily to applied research and development.

Research and development costs are expensed as incurred. Research and development expenses during 2010, 2009 and 2008 were $15.7 million, $15.0 million and $16.9 million, respectively.

Most of Quaker’s subsidiaries and associated companies also have laboratory facilities. Although not as complete as the Conshohocken, Santa Fe Springs, Uithoorn or Qingpu laboratories, these facilities are generally sufficient for the requirements of the customers being served. If problems are encountered which cannot be resolved by local laboratories, such problems may be referred to the laboratory staff in Conshohocken or Uithoorn.

Regulatory Matters

In order to facilitate compliance with applicable Federal, state, and local statutes and regulations relating to occupational health and safety and protection of the environment, the Company has an ongoing program of site assessment for the purpose of identifying capital expenditures or other actions that may be necessary to comply with such requirements. The program includes periodic inspections of each facility by Quaker and/or independent experts, as well as ongoing inspections and training by on-site personnel. Such inspections address operational matters, record keeping, reporting requirements and capital improvements. In 2010, capital expenditures directed solely or primarily to regulatory compliance amounted to approximately $0.7 million compared to $0.7 million and $1.7 million in 2009 and 2008, respectively. In 2011, the Company expects to incur approximately $1.9 million for capital expenditures directed primarily to regulatory compliance.

Number of Employees

On December 31, 2010, Quaker’s consolidated companies had 1,385 full-time employees of whom 513 were employed by the parent company and its U.S. subsidiaries and 872 were employed by its non-U.S. subsidiaries. Associated companies of Quaker (in which it owns 50% or less) employed 225 people on December 31, 2010.

Product Classification

The Company organizes its segments by type of product sold. The Company’s reportable segments are as follows:

(1) Metalworking process chemicals—industrial process fluids for various heavy industrial and manufacturing applications.

(2) Coatings—temporary and permanent coatings for metal and concrete products and chemical milling maskants.

(3) Other chemical products—other various chemical products.

Incorporated by reference is the segment information contained in Note 17 of Notes to Consolidated Financial Statements included in Item 8 of this Report.

 

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Non-U.S. Activities

Since significant revenues and earnings are generated by non-U.S. operations, Quaker’s financial results are affected by currency fluctuations, particularly between the U.S. Dollar, the E.U. Euro, the Brazilian Real, and the Chinese Renminbi, and the impact of those currency fluctuations on the underlying economies. Incorporated by reference is (i) the foreign exchange risk information contained in Item 7A of this Report, (ii) the geographic information in Note 17 of Notes to Consolidated Financial Statements included in Item 8 of this Report, and (iii) information regarding risks attendant to foreign operations included in Item 1A of this Report.

Quaker on the Internet

Financial results, news and other information about Quaker can be accessed from the Company’s Web site at http://www.quakerchem.com. This site includes important information on products and services, financial reports, news releases, and career opportunities. The Company’s periodic and current reports on Forms 10-K, 10-Q and 8-K, including exhibits and supplemental schedules filed therewith, and amendments to those reports, filed with the Securities and Exchange Commission (“SEC”) are available on the Company’s Web site, free of charge, as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. Information contained on, or that may be accessed through, the Company’s Web site is not incorporated by reference in this Report and, accordingly, you should not consider that information part of this Report.

Factors that May Affect Our Future Results

(Cautionary Statements under the Private Securities Litigation Reform Act of 1995)

Certain information included in this Report and other materials filed or to be filed by Quaker with the SEC (as well as information included in oral statements or other written statements made or to be made by us) contain or may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements can be identified by the fact that they do not relate strictly to historical or current facts. We have based these forward-looking statements on our current expectations about future events. These forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, anticipations, intentions, financial condition, results of operations, future performance, and business, including:

 

   

statements relating to our business strategy;

 

   

our current and future results and plans; and

 

   

statements that include the words “may,” “could,” “should,” “would,” “believe,” “expect,” “anticipate,” “estimate,” “intend,” “plan” or similar expressions.

Such statements include information relating to current and future business activities, operational matters, capital spending, and financing sources. From time to time, oral or written forward-looking statements are also included in Quaker’s periodic reports on Forms 10-Q and 8-K, press releases, and other materials released to, or statements made to, the public.

Any or all of the forward-looking statements in this Report, in Quaker’s Annual Report to Shareholders for 2010, and in any other public statements we make may turn out to be wrong. This can occur as a result of inaccurate assumptions or as a consequence of known or unknown risks and uncertainties. Many factors discussed in this Report will be important in determining our future performance. Consequently, actual results may differ materially from those that might be anticipated from our forward-looking statements.

We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise. However, any further disclosures made on related subjects in Quaker’s subsequent reports on Forms 10-K, 10-Q and 8-K should be consulted. These forward-looking statements are subject to risks, uncertainties and assumptions about us and our operations that are subject to change based on various important factors, some of which are beyond our control. A major risk is that the demand for the Company’s

 

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products and services is largely derived from the demand for its customers’ products, which subjects the Company to uncertainties related to downturns in a customer’s business and unanticipated customer production shutdowns. Other major risks and uncertainties include, but are not limited to, significant increases in raw material costs, worldwide economic and political conditions, foreign currency fluctuations, and terrorist attacks such as those that occurred on September 11, 2001, each of which is discussed in greater detail in Item 1A of this Report. Furthermore, the Company is subject to the same business cycles as those experienced by steel, automobile, aircraft, appliance, and durable goods manufacturers. These risks, uncertainties, and possible inaccurate assumptions relevant to our business could cause our actual results to differ materially from expected and historical results. Other factors beyond those discussed in this Report could also adversely affect us. Therefore, we caution you not to place undue reliance on our forward-looking statements. This discussion is provided as permitted by the Private Securities Litigation Reform Act of 1995.

 

Item 1A. Risk Factors.

Changes to the industries and markets that Quaker serves could have a material adverse effect on the Company’s liquidity, financial position and results of operations.

The chemical specialty industry comprises a number of companies of similar size as well as companies larger and smaller than Quaker. It is estimated that Quaker holds a leading and significant global position in the markets for process fluids to produce sheet steel and significant global positions in portions of the automotive and industrial markets. The industry is highly competitive, and a number of companies with significant financial resources and/or customer relationships compete with us to provide similar products and services. Our competitors may be positioned to offer more favorable pricing and service terms, resulting in reduced profitability and loss of market share for us. Historically, competition in the industry has been based primarily on the ability to provide products that meet the needs of the customer and render technical services and laboratory assistance to the customer and, to a lesser extent, on price. Factors critical to the Company’s business include successfully differentiating the Company’s offering from its competition, operating efficiently and profitably as a globally integrated whole, and increasing market share and customer penetration through internally developed business programs and strategic acquisitions.

The business environment in which the Company operates remains uncertain. The Company is subject to the same business cycles as those experienced by steel, automobile, aircraft, appliance, and durable goods manufacturers. A major risk is that the Company’s demand is largely derived from the demand for its customers’ products, which subjects the Company to uncertainties related to downturns in our customers’ business and unanticipated customer production shutdowns or curtailments. The Company has limited ability to adjust its cost level contemporaneously with changes in sales and gross margins. Thus, a significant downturn in sales or gross margins due to weak end-user markets, loss of a significant customer, and/or rising raw material costs could have a material adverse effect on the Company’s liquidity, financial position, and results of operations.

Our business depends on attracting and retaining qualified management personnel.

The unanticipated departure of any key member of our management team could have an adverse effect on our business. Given the relative size of the Company and the breadth of its global operations, there are a limited number of qualified management personnel to assume the responsibilities of management level employees should there be management turnover. In addition, because of the specialized and technical nature of our business, our future performance is dependent on the continued service of, and our ability to attract and retain, qualified management, commercial and technical personnel. Competition for such personnel is intense, and we may be unable to continue to attract or retain such personnel.

Inability to obtain sufficient price increases or contract concessions to offset increases in the costs of raw material could have a material adverse effect on the Company’s liquidity, financial position and results of operations. Price increases implemented could result in the loss of sales.

Quaker uses over 1,000 raw materials, including mineral oils and derivatives, animal fats and derivatives, vegetable oils and derivatives, ethylene derivatives, solvents, surface active agents, chlorinated paraffinic

 

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compounds, and a wide variety of other organic and inorganic compounds. In 2010, three raw material groups (mineral oils and derivatives, animal fats and derivatives, and vegetable oils and derivatives) each accounted for as much as 10% of the total cost of Quaker’s raw material purchases. The price of mineral oil can be affected by the price of crude oil and refining capacity. In addition, many of the raw materials used by Quaker are “commodity” chemicals. Accordingly, Quaker’s earnings can be affected by market changes in raw material prices.

Over the past three years, Quaker has experienced significant volatility in its raw material costs, particularly crude oil derivatives. For example, the price of crude oil averaged $79 per barrel in 2010 versus $61 in 2009 and $100 in 2008 and is currently trading in the $100 per barrel range with market conditions that currently reflect the political instability in the Middle East. In addition, refining capacity has also been constrained by various factors, which further contributed to volatile raw material costs and negatively impacted margins. Animal fat and vegetable oil prices have been impacted by increased biodiesel consumption. In response, the Company has aggressively pursued price increases to offset the increased raw material costs. Although the Company has been successful in recovering a substantial amount of the raw material cost increases, it has experienced competitive as well as contractual constraints limiting pricing actions. In addition, as a result of the Company’s pricing actions, customers may become more likely to consider competitors’ products, some of which may be available at a lower cost. Significant loss of customers could result in a material adverse effect on the Company’s results of operations.

Availability of raw materials, including sourcing from some single suppliers, could have a material adverse effect on the Company’s liquidity, financial position and results of operations.

The chemical specialty industry can experience some tightness of supply of certain raw materials. In addition, in some cases, we choose to source from a single supplier. Any significant disruption in supply could affect our ability to obtain raw materials, which could have a material adverse effect on our liquidity, financial position and results of operations.

Loss of a significant manufacturing facility may materially and adversely affect the Company’s liquidity, financial position and results of operations.

Quaker has multiple manufacturing facilities throughout the world. In certain countries such as Brazil and China, there is only one such facility. If one of the Company’s facilities was damaged to such extent that production was halted for an extended period, the Company may not be able to timely supply affected customers. This could result in a loss of sales over an extended period or permanently. The Company does take steps to mitigate against this risk including contingency planning and procuring property and casualty insurance (including business interruption insurance). Nevertheless, the loss of sales in any one region over any extended period of time could have a significant material adverse effect on Quaker’s liquidity, financial position and results of operations.

Bankruptcy of a significant customer could have a material adverse effect on our liquidity, financial position and results of operations.

A significant portion of Quaker’s revenues is derived from sales to customers in the U.S. steel and automotive industries, including some of our larger customers, where a number of bankruptcies occurred during recent years and companies have experienced financial difficulties. As part of the bankruptcy process, the Company’s pre-petition receivables may not be realized, customer manufacturing sites may be closed or contracts voided. The bankruptcy of a major customer could have a material adverse effect on the Company’s liquidity, financial position, and results of operations. Steel customers typically have limited manufacturing locations as compared to metalworking customers and generally use higher volumes of products at a single location. The loss or closure of a steel mill or other major site of a significant customer could have a material adverse effect on Quaker’s business.

During 2010, our five largest customers (each composed of multiple subsidiaries or divisions with semi-autonomous purchasing authority) together accounted for approximately 20% of our consolidated net sales with the largest customer (Arcelor-Mittal Group) accounting for approximately 9% of consolidated net sales.

 

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Failure to comply with any material provision of our credit facility or other debt agreements could have a material adverse effect on our liquidity, financial position and results of operations.

The Company maintains a $175.0 million unsecured credit facility (the “Credit Facility”) with a group of lenders, which can be increased to $225.0 million at the Company’s option if lenders agree to increase their commitments and the Company satisfies certain conditions. The Credit Facility, which matures in 2014, provides the availability of revolving credit borrowings. In general, the borrowings under the Credit Facility bear interest at either a base rate or LIBOR rate plus a margin based on the Company’s consolidated leverage ratio.

The Credit Facility contains limitations on capital expenditures, investments, acquisitions and liens, as well as default provisions customary for facilities of its type. While these covenants and restrictions are not currently considered to be overly restrictive, they could become more difficult to comply with as our business or financial conditions change. In addition, deterioration in the Company’s results of operations or financial position could significantly increase borrowing costs.

Quaker is exposed to market rate risk for changes in interest rates, due to the variable interest rate applied to the Company’s borrowings under its Credit Facility. Accordingly, if interest rates rise significantly, the cost of debt to Quaker will increase, perhaps significantly, depending on the extent of Quaker’s borrowings under the Credit Facility. At December 31, 2010, the Company had $55.0 million outstanding under its credit facilities. The Company has entered into interest rate swaps in order to fix a portion of its variable rate debt and mitigate the risks associated with higher interest rates. The combined notional value of the swaps was $15.0 million at December 31, 2010.

Failure to generate taxable income could have a material adverse effect on our financial position and results of operations.

At December 31, 2010, the Company had net U.S. deferred tax assets totaling $14.8 million, excluding deferred tax assets relating to additional minimum pension liabilities. In addition, at that date, the Company had $2.1 million in operating loss carryforwards primarily related to certain of its foreign operations. The Company records valuation allowances when necessary to reduce its deferred tax assets to the amount that is more likely than not to be realized. The Company considers future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance. However, in the event the Company were to determine that it would not be able to realize all or part of its net deferred tax assets in the future, an adjustment to the deferred tax asset would be a non-cash charge to income in the period such determination was made, which could have a material adverse effect on the Company’s financial statements. The Company continues to closely monitor this situation as it relates to its net deferred tax assets and the assessment of valuation allowances.

Environmental laws and regulations and pending legal proceedings may materially and adversely affect the Company’s liquidity, financial position and results of operations.

The Company is a party to proceedings, cases, and requests for information from, and negotiations with, various claimants and Federal and state agencies relating to various matters, including environmental matters. An adverse result in one or more matters could materially and adversely affect the Company’s liquidity, financial position and results of operations. Incorporated herein by reference is the information concerning pending asbestos-related litigation against an inactive subsidiary and amounts accrued associated with certain environmental non-capital remediation costs in Note 22 of Notes to Consolidated Financial Statements which appears in Item 8 of this Report.

Climate change and greenhouse gas restrictions may materially affect the Company’s liquidity, financial position and results of operations.

The Company is subject to various regulations regarding its emission of greenhouse gases in its manufacturing facilities. In addition, a number of countries have adopted, or are considering the adoption of

 

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regulatory frameworks to reduce greenhouse gas emissions. These include adoption of cap and trade regimes, carbon taxes, increased efficiency standards and incentives or mandates for renewable energy. These requirements could make our products more expensive and reduce demand for our products. Current and pending greenhouse gas regulations may also increase our compliance costs.

We might not be able to timely develop, manufacture and gain market acceptance of new and enhanced products required to maintain or expand our business.

We believe that our continued success depends on our ability to continuously develop and manufacture new products and product enhancements on a timely and cost-effective basis, in response to customers’ demands for higher performance process chemicals, coatings and other chemical products. Our competitors may develop new products or enhancements to their products that offer performance, features and lower prices that may render our products less competitive or obsolete and, as a consequence, we may lose business and/or significant market share. The development and commercialization of new products require significant expenditures over an extended period of time, and some products that we seek to develop may never become profitable. In addition, we may not be able to develop and introduce products incorporating new technologies in a timely manner that will satisfy our customers’ future needs or achieve market acceptance.

The scope of our international operations subjects the Company to risks, including risks from changes in trade regulations, currency fluctuations, and political and economic instability.

Since significant revenues and earnings are generated by non-U.S. operations, Quaker’s financial results are affected by currency fluctuations, particularly between the U.S. Dollar, the E.U. Euro, the Brazilian Real, and the Chinese Renminbi, and the impact of those currency fluctuations on the underlying economies. During the past three years, sales by non-U.S. subsidiaries accounted for approximately 59% to 65% of our annual consolidated net sales. All of these operations use the local currency as their functional currency. The Company generally does not use financial instruments that expose it to significant risk involving foreign currency transactions; however, the size of non-U.S. activities has a significant impact on reported operating results and attendant net assets. Therefore, as exchange rates vary, Quaker’s results can be materially affected. Incorporated by reference is the foreign exchange risk information contained in Item 7A of this Report and the geographic information in Note 17 of Notes to Consolidated Financial Statements included in Item 8 of this Report.

Additional risks associated with the Company’s international operations include, but are not limited to, the following:

 

   

changes in economic conditions from country to country,

 

   

changes in a country’s political condition, such as the current political unrest in the Middle East,

 

   

trade protection measures,

 

   

licensing and other legal requirements,

 

   

longer payment cycles in certain foreign markets,

 

   

restrictions on the repatriation of our assets, including cash,

 

   

significant foreign and United States taxes on repatriated cash,

 

   

the difficulties of staffing and managing dispersed international operations,

 

   

less protective foreign intellectual property laws,

 

   

legal systems that may be less developed and predictable than those in the United States, and

 

   

local tax issues.

 

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The breadth of Quaker’s international operations subjects the Company to various local non-income taxes, including value-added-taxes (“VAT”). With VAT, the Company essentially operates as an agent for various jurisdictions by collecting VAT from customers and remitting those amounts to the taxing authorities on the goods it sells. The laws and regulations regarding VAT can be complex and vary widely among countries as well as among individual states within a given country for the same products, making full compliance difficult. As VAT is often charged as a percentage of the selling price of the goods sold, the amounts involved can be material. Should there be non-compliance by the Company, it may need to remit funds to the tax authorities prior to collecting the appropriate amounts from customers or jurisdictions which may have been incorrectly paid. In addition, the Company may choose for commercial reasons not to seek repayment from certain customers. This could have a material adverse affect on the Company’s liquidity, financial position and results of operations. Refer to Note 22 of Notes to Consolidated Financial Statements, included in Item 8 of this Report, which is incorporated herein by this reference, for further discussion.

Terrorist attacks, other acts of violence or war may affect the markets in which we operate and our profitability.

Terrorist attacks may negatively affect our operations. There can be no assurance that there will not be further terrorist attacks against the U.S. or U.S. businesses. Terrorist attacks, other acts of violence or armed conflicts may directly impact our physical facilities or those of our suppliers or customers. Additional terrorist attacks may disrupt the global insurance and reinsurance industries with the result that we may not be able to obtain insurance at historical terms and levels for all of our facilities. Furthermore, any of these events may make travel and the transportation of our supplies and products more difficult and more expensive and ultimately affect the sales of our products. The consequences of terrorist attacks, other acts of violence or armed conflicts can be unpredictable, and we may not be able to foresee events that could have an adverse effect on our business.

 

Item 1B. Unresolved Staff Comments.

None.

 

Item 2. Properties.

Quaker’s corporate headquarters and a laboratory facility are located in Conshohocken, Pennsylvania. Quaker’s other principal facilities are located in Detroit, Michigan; Middletown, Ohio; Santa Fe Springs, California; Batavia, New York; Uithoorn, The Netherlands; Santa Perpetua de Mogoda, Spain; Rio de Janeiro, Brazil; Tradate, Italy; and Qingpu, China. All of the properties except that in Santa Fe Springs, California are used by the metalworking process chemicals segment. The Santa Fe Springs, California property is used by the coatings segment. With the exception of the Conshohocken, Santa Fe Springs and Tradate sites, which are leased, all of these principal facilities are owned by Quaker and as of December 31, 2010 were mortgage free. Quaker also leases sales, laboratory, manufacturing, and warehouse facilities in other locations.

Quaker’s principal facilities (excluding Conshohocken) consist of various manufacturing, administrative, warehouse, and laboratory buildings. Substantially all of the buildings (including Conshohocken) are of fire-resistant construction and are equipped with sprinkler systems. All facilities are primarily of masonry and/or steel construction and are adequate and suitable for Quaker’s present operations. The Company has a program to identify needed capital improvements that are implemented as management considers necessary or desirable. Most locations have various numbers of raw material storage tanks ranging from 18 to 58 at each location with a capacity ranging from 1,000 to 82,000 gallons and processing or manufacturing vessels ranging in capacity from 7 to 16,000 gallons.

Each of Quaker’s 50% or less owned non-U.S. associated companies owns or leases a plant and/or sales facilities in various locations.

 

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Item 3. Legal Proceedings.

The Company is a party to proceedings, cases, and requests for information from, and negotiations with, various claimants and Federal and state agencies relating to various matters, including environmental matters. For information concerning pending asbestos-related litigation against an inactive subsidiary, amounts accrued associated with certain environmental non-capital remediation costs and the Company’s value-added-tax dispute settlements, reference is made to Note 22 of Notes to Consolidated Financial Statements, included in Item 8 of this Report, which is incorporated herein by this reference. The Company is a party to other litigation which management currently believes will not have a material adverse effect on the Company’s results of operations, cash flow, or financial condition.

 

Item 4. [Reserved]

 

Item 4(a). Executive Officers of the Registrant.

Set forth below is information regarding the executive officers of the Company, each of whom (with the exception of Mr. Claro) has been employed by the Company for more than five years, including the respective positions and offices with the Company held by each over the respected periods indicated. Each of the executive officers, with the exception of Mr. Hill, is elected annually to a one-year term. Mr. Hill is considered an executive officer in his capacity as principal accounting officer for purposes of this item.

 

Name, Age, and Present

Position with the Company

  

Business Experience During Past Five

Years and Period Served as an Officer

Michael F. Barry, 52

Chairman of the Board, Chief Executive Officer and President and Director

   Mr. Barry, who has been employed by the Company since 1998, has served as Chairman of the Board since May 13, 2009, in addition to his position as Chief Executive Officer and President held since October 2008. He served as Senior Vice President and Managing Director—North America from January 2006 to October 2008. He served as Senior Vice President and Global Industry Leader—Metalworking and Coatings from July 2005 through December 2005. He served as Vice President and Global Industry Leader—Industrial Metalworking and Coatings from July 2005 through December 2005 and Vice President and Chief Financial Officer from 1998 to August 2004.

Mark A. Featherstone, 49

Vice President, Chief Financial Officer and Treasurer

   Mr. Featherstone, who has been employed by the Company since 2001, has served as Chief Financial Officer and Treasurer since April 2007 and has served as Vice President since March 2005. He served as Global Controller from May 2001 to April 2007.

D. Jeffry Benoliel, 52

Vice President-Global Strategy,
General Counsel and Corporate Secretary

   Mr. Benoliel, who has been employed by the Company since 1995, has served as Vice President-Global Strategy, General Counsel and Corporate Secretary since October 2008. He served as Vice President, Secretary and General Counsel from 2001 through September 2008.

 

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Name, Age, and Present

Position with the Company

  

Business Experience During Past Five

Years and Period Served as an Officer

Joseph A. Berquist, 39

Vice President and Managing Director—North America

   Mr. Berquist, who has been employed by the Company since 1997, was elected as Vice President and Managing Director—North America on April 1, 2010. He served as Senior Director, North America Commercial from October 2008 through March 2010, as Industry Business Director—Metalworking/Fluid Power from July 2006 through September 2008 and as Industry Business Manager—Metalworking/Fluid Power from January 2006 until July 2006. He served as Regional Sales Manager—Metalworking from November 2004 through December 2005.

Jose Luiz Bregolato, 65

Vice President and Managing Director—
South America

   Mr. Bregolato, who has been employed by the Company since 1994, has served in his current position since 1994.

Carlos Claro, 49

Vice President

   Mr. Claro joined the Company on February 1, 2011 as Vice President. Prior to joining the Company, Mr. Claro was Americas Business Director at Cytec Industries, a specialty chemicals and materials technology company, responsible for the Powder Coating Resins business from April 2008 through January 2011. He served as Latin America Resins Commercial Director and Country Manager—Brazil at Cytec Industries from June 2005 until April 2008.

George H. Hill, 36

Global Controller

   Mr. Hill, who has been employed by the Company since 2002, has served in his current position since April 2007. He served as Assistant Global Controller from May 2004 until April 2007.

Joseph F. Matrange, 69

Vice President—Global Coatings

   Mr. Matrange, who has been employed by the Company since 2001, has served as Vice President—Global Coatings since October 2008. He has also served as President of AC Products, Inc., a California subsidiary, since October 2000, and Epmar Corporation, a California subsidiary, since April 2002.

Jan F. Nieman, 50

Vice President and Managing Director—
Asia/Pacific

   Mr. Nieman, who has been employed by the Company since 1992, has served as Vice President since February 2005, and has served in the position of Managing Director, Asia/Pacific since August 2003.

Wilbert Platzer, 49

Vice President and Managing Director—Europe

   Mr. Platzer, who has been employed by the Company since 1995, has served in his current position since January 2006. He served as Vice President—Global Industrial Metalworking from July 2005 through December 2005 and served as Vice President—Worldwide Operations from January 2001 through June 2005.

 

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PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

The Company’s common stock is listed on the New York Stock Exchange (“NYSE”) under the trading symbol KWR. The following table sets forth, for the calendar quarters during the past two most recent fiscal years, the range of high and low sales prices for the common stock as reported on the NYSE composite tape (amounts rounded to the nearest penny), and the quarterly dividends declared and paid:

 

     Price Range      Dividends
Declared
     Dividends
Paid
 
     2010      2009        
     High      Low      High      Low      2010      2009      2010      2009  

First quarter

   $ 27.71       $ 16.14       $ 16.53       $ 4.65       $ 0.23       $ —         $ 0.23       $ 0.23   

Second quarter

     36.49         22.55         15.25         7.60         0.235         0.46         0.23         0.23   

Third quarter

     38.16         24.64         23.20         11.97         0.235         0.23         0.235         0.23   

Fourth quarter

     45.80         32.30         23.82         17.18         0.235         0.23         0.235         0.23   

There are no restrictions that currently materially limit the Company’s ability to pay dividends or that the Company believes are likely to materially limit the future payment of dividends. If a default under the Company’s primary credit facility were to occur and continue, the payment of dividends would be prohibited. Reference is made to the “Liquidity and Capital Resources” disclosure contained in Item 7 of this Report.

As of January 17, 2011, there were 1,020 shareholders of record of the Company’s common stock, its only outstanding class of equity securities.

Every holder of Quaker common stock is entitled to one vote or ten votes for each share held of record on any record date depending on how long each share has been held. As of January 17, 2011, 11,494,448 shares of Quaker common stock were issued and outstanding. Based on the information available to the Company on January 17, 2011, as of that date the holders of 871,597 shares of Quaker common stock would have been entitled to cast ten votes for each share, or approximately 45% of the total votes that would have been entitled to be cast as of that record date and the holders of 10,622,851 shares of Quaker common stock would have been entitled to cast one vote for each share, or approximately 55% of the total votes that would have been entitled to be cast as of that date. The number of shares that are indicated as entitled to one vote includes those shares presumed to be entitled to only one vote. Because the holders of these shares may rebut this presumption, the total number of votes entitled to be cast as of January 17, 2011 could be more than 19,338,821.

Reference is made to the information in Item 12 of this Report under the caption “Equity Compensation Plans,” which is incorporated herein by this reference.

 

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The following table sets forth information concerning shares of the Company’s common stock acquired by the Company during the fourth quarter of the fiscal year covered by this Report, all of which were acquired from employees in payment of the exercise price of employee stock options exercised during the period.

Issuer Purchases of Equity Securities

 

Period

  (a)
Total Number  of
Shares
Purchased (1)
    (b)
Average
Price Paid
per Share (2)
    (c)
Total Number  of Shares
Purchased as Part of

Publicly Announced Plans
or Programs (3)
    (d)
Maximum
Number of Shares that May
Yet

Be Purchased Under the Plans
or

Programs (3)
 

October 1 – October 31

    —        $ —          —          252,600   

November 1 – November 30

    30,039      $ 38.06        —          252,600   

December 1 – December 31

    —        $ —          —          252,600   
                               

Total

    30,039      $ 38.06        —          252,600   

 

(1) All of the 30,039 shares acquired by the Company during the period covered by this report were acquired from employees upon their surrender of previously owned shares in payment of the exercise price of employee stock options.
(2) The price paid per share, in each case, represents either a) the average of the high and low price of the Company’s common stock on the date of exercise; or b) the closing price of the Company’s common stock on date of exercise, as specified by the plan pursuant to which the applicable option was granted.
(3) On February 15, 1995, the Board of Directors of the Company authorized a share repurchase program authorizing the repurchase of up to 500,000 shares of Quaker common stock, and, on January 26, 2005, the Board authorized the repurchase of up to an additional 225,000 shares. Under the 1995 action of the Board, 27,600 shares may yet be purchased. Under the 2005 action of the Board, none of the shares authorized has been purchased and, accordingly, all of those shares may yet be purchased. Neither of the share repurchase authorizations has an expiration date.

 

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The following graph compares the cumulative total return (assuming reinvestment of dividends) from December 31, 2005 to December 31, 2010 for (i) Quaker’s common stock, (ii) the S&P SmallCap 600 Stock Index (the “SmallCap Index”) and (iii) the S&P Chemicals (Specialty) Index-SmallCap (the “Chemicals Index”). The graph assumes the investment of $100 on December 31, 2005 in each of Quaker’s common stock, the stocks comprising the SmallCap Index, and the stocks comprising the Chemicals Index.

COMPARISON OF CUMULATIVE FIVE–YEAR TOTAL RETURN

LOGO

 

     12/31/2005      12/31/2006      12/31/2007      12/31/2008      12/31/2009      12/31/2010  

Quaker

   $ 100.00       $ 119.89       $ 124.06       $ 96.46       $ 128.93       $ 269.14   

SmallCap Index

     100.00         115.12         114.78         79.11         99.34         125.47   

Chemicals Index

     100.00         138.28         142.16         89.29         139.86         172.90   

 

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Item 6. Selected Financial Data.

The following table sets forth selected financial information for the Company and its consolidated subsidiaries:

 

    Year Ended December 31,  
    2010 (1)     2009 (2)     2008 (3)     2007 (4)     2006  
    (In thousands, except per share amounts)  

Summary of Operations:

         

Net sales

  $ 544,063      $ 451,490      $ 581,641      $ 545,597      $ 460,451   

Income before taxes, equity income and noncontrolling interest

    46,213        23,692        16,629        22,735        18,440   

Net income attributable to Quaker Chemical Corporation

    31,807        16,220        11,132        15,471        11,667   

Per share:

         

Net income attributable to Quaker Chemical Corporation Common Shareholders—basic

  $ 2.82      $ 1.48      $ 1.06      $ 1.53      $ 1.18   

Net income attributable to Quaker Chemical Corporation Common Shareholders—diluted

  $ 2.77      $ 1.47        1.05        1.52        1.18   

Dividends declared

    0.935        0.92        0.92        0.86        0.86   

Dividends paid

    0.93        0.92        0.905        0.86        0.86   

Financial Position:

         

Working capital

  $ 114,291      $ 98,994      $ 116,962      $ 107,150      $ 96,062   

Total assets

    449,430        395,292        385,439        399,049        357,382   

Long-term debt

    73,855        63,685        84,236        78,487        85,237   

Equity

    187,099        156,295        129,875        134,906        114,866   

Following amounts in thousands

 

(1) The results of operations for 2010 include a pre-tax final charge of $1,317 related to the retirement of the Company’s former Chief Executive Officer in 2008; a net pre-tax charge of $4,132 related to a Non-Income tax contingency; a $322 charge related to a currency devaluation at the Company’s 50% owned affiliate in Venezuela; a $564 charge related to an out-of-period adjustment at the Company’s 40% owned affiliate in Mexico; offset by a $2,441 tax benefit from the derecognition of various uncertain tax positions due to the expiration of applicable statutes of limitations and resolution of tax audits for certain tax years.
(2) The results of operations for 2009 include a pre-tax charge for restructuring and related activities of $2,289; a pre-tax charge of $2,443 related to the retirement of the Company’s former Chief Executive Officer in 2008; offset by a gain of $1,193 on the disposition of land in Europe and a $583 tax benefit from the derecognition of various uncertain tax positions due to the expiration of applicable statutes of limitations and resolution of tax audits for certain tax years.
(3) The results for operations for 2008 include a pre-tax charge for restructuring and related activities of $2,916; a pre-tax charge of $3,505 for the incremental charges related to the retirement of the Company’s Chief Executive Officer; offset by a net arbitration award of $956 related to litigation with one of the former owners of the Company’s Italian subsidiary; a tax refund of $460 relating to the Company’s increased investment in China; and a $1,508 tax benefit from the derecognition of various uncertain tax positions due to the expiration of applicable statutes of limitations and resolution of tax audits for certain tax years.
(4) The results of operations for 2007 include a pre-tax environmental charge of $3,300 for the settlement of the AC Products, Inc. litigation and ongoing remediation activities at the site; a pre-tax charge of $701 related to a discontinued strategic initiative; a pre-tax charge of $487 related to certain customer bankruptcies; a tax refund of $665 related to the Company’s increased investment in China; a non-cash out-of-period tax benefit adjustment of $993 primarily related to deferred tax accounting for the Company’s foreign pension plans; and a $391 tax charge related to the revaluation of deferred tax assets as a result of a tax law change.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Executive Summary

Quaker Chemical Corporation is a leading global provider of process chemicals, chemical specialties, services and technical expertise to a wide range of industries—including steel, aluminum, automotive, mining, aerospace, tube and pipe, coatings and construction materials. Our products, technical solutions and chemical management services (“CMS”) enhance our customers’ processes, improve their product quality and lower their costs.

The 21% growth in revenue during 2010 compared to 2009 was principally due to double-digit volume increases experienced across the globe as the Company continued to recover from the global economic downturn. These volume increases were partially offset by lower CMS revenue reported on a gross basis as a result of contract renegotiations. While the Company’s gross margin improved from 34.7% in 2009 to 35.4% in 2010, the Company experienced significantly higher raw material costs as 2010 progressed, only a portion of which were recovered through price increases in 2010. Additional price increases are being implemented in early 2011 as part of the Company’s efforts to recover margins. The Company’s selling, general and administrative expenses (“SG&A”) increased 10% during 2010 due to higher selling costs with increased business activity, inflationary costs, increased incentive compensation costs as well as higher professional fees related to acquisitions. However, SG&A as a percentage of sales decreased from 28% in 2009 to 26% in 2010.

In 2010, the Company completed the acquisition of D.A. Stuart’s U.S. aluminum hot rolling oil business from Houghton International for approximately $6.8 million. With this acquisition, Quaker became a leading player in the U.S. aluminum hot rolling market. The Company also completed the acquisition of Summit Lubricants Inc., a leading specialty grease manufacturer and distributor of specialty greases, for approximately $29.1 million. This acquisition is complementary to the Company’s existing business.

The full year 2010 results include some unusual items. The 2010 results include a $4.1 million charge related to a non-income tax contingency discussed below. The Company incurred a final charge related to the former CEO’s supplemental retirement plan of approximately $1.3 million. Equity in net income of associated companies includes charges totaling $0.9 million related to the devaluation of the Venezuelan Bolivar Fuerte and an out-of-period charge related to shortfalls in reserves for pensions and other items. The effective tax rate for 2010 includes approximately $2.4 million of benefit from the derecognition of various uncertain tax positions due to the expiration of applicable statutes of limitations.

The full year 2009 results included some unusual items as well. A $2.3 million restructuring charge was taken in an effort to reduce operating costs as volume declines continued in the U.S. and Europe and extended to other regions. The Company also incurred charges related to the former CEO’s supplemental retirement plan of approximately $2.4 million. Other income for 2009 includes a $1.2 million gain related to the disposition of excess land in Europe. The effective tax rate for 2009 reflected no tax expense being provided on the land sale gain due to the utilization of net operating losses which were previously not benefited and included approximately $0.6 million of benefit from the derecognition of various uncertain tax positions due to the expiration of applicable statutes of limitations and resolution of tax audits for certain tax years.

The net result was earnings per diluted share of $2.77, up 88% compared to $1.47 for 2009, with 2010 net income surpassing that of any year in the Company’s history. In addition, the Company raised its dividend in 2010, made two strategic acquisitions and enhanced its financial flexibility for future growth by amending its primary credit facility. The Company expects to have good growth in 2011 due to its leadership positions in faster growing economies like China, Brazil and India, as well as continued recovery in the more mature markets such as the U.S. and Europe. The Company will also be investing in additional resources to support that growth, especially in the emerging markets. While the current Middle East tensions put greater uncertainty on raw material pricing, the Company’s goal is to continue its profit growth and build upon the record profits achieved in 2010. In addition, the Company expects to continue to make strategic acquisitions and is currently evaluating several opportunities.

 

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Critical Accounting Policies and Estimates

Quaker’s discussion and analysis of its financial condition and results of operations are based upon Quaker’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires Quaker to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, Quaker evaluates its estimates, including those related to customer sales incentives, product returns, bad debts, inventories, property, plant, and equipment, investments, goodwill, intangible assets, income taxes, financing operations, restructuring, incentive compensation plans (including equity-based compensation), pensions and other postretirement benefits, and contingencies and litigation. Quaker bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Quaker believes the following critical accounting policies describe the more significant judgments and estimates used in the preparation of its consolidated financial statements:

1. Accounts receivable and inventory reserves and exposures—Quaker establishes allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. If the financial condition of Quaker’s customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. As part of its terms of trade, Quaker may custom manufacture products for certain large customers and/or may ship product on a consignment basis. Further, a significant portion of Quaker’s revenues is derived from sales to customers in the U.S. steel and automotive industries, where a number of bankruptcies have occurred during recent years and companies have experienced financial difficulties. When a bankruptcy occurs, Quaker must judge the amount of proceeds, if any, that may ultimately be received through the bankruptcy or liquidation process. These matters may increase the Company’s exposure should a bankruptcy occur, and may require write down or disposal of certain inventory due to its estimated obsolescence or limited marketability. Reserves for customers filing for bankruptcy protection are generally dependent on the Company’s evaluation of likely proceeds from the bankruptcy process. Large and/or financially distressed customers are generally reserved for on a specific review basis while a general reserve is established for other customers based on historical experience. The Company’s consolidated allowance for doubtful accounts was $4.3 million and $4.0 million at December 31, 2010 and 2009, respectively. Further, the Company recorded provisions for doubtful accounts of $0.9 million, $1.4 million and $1.1 million in 2010, 2009 and 2008, respectively. An increase of 10% to the recorded provisions would have decreased the Company’s pre-tax earnings by approximately $0.1 million in 2010, 2009 and 2008, respectively.

2. Environmental and litigation reserves—Accruals for environmental and litigation matters are recorded when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated. Accrued liabilities are exclusive of claims against third parties and are not discounted. Environmental costs and remediation costs are capitalized if the costs extend the life, increase the capacity or improve the safety or efficiency of the property from the date acquired or constructed, and/or mitigate or prevent contamination in the future. Estimates for accruals for environmental matters are based on a variety of potential technical solutions, governmental regulations and other factors, and are subject to a large range of potential costs for remediation and other actions. A considerable amount of judgment is required in determining the most likely estimate within the range, and the factors determining this judgment may vary over time. Similarly, reserves for litigation and similar matters are based on a range of potential outcomes and require considerable judgment in determining the most probable outcome. If no amount within the range is considered more probable than any other amount, the Company accrues the lowest amount in the range in accordance with generally accepted accounting principles. See Note 22 of Notes to Consolidated Financial Statements which appears in Item 8 of this Report.

3. Realizability of equity investments—Quaker holds equity investments in various foreign companies, whereby it has the ability to influence, but not control, the operations of the entity and its future results. Quaker

 

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records an investment impairment charge when it believes an investment has experienced a decline in value that is other than temporary. Future adverse changes in market conditions, poor operating results of underlying investments, or devaluation of foreign currencies could result in losses or an inability to recover the carrying value of the investments that may not be reflected in an investment’s current carrying value. These factors may result in an impairment charge in the future. The carrying amount of the Company’s equity investments at December 31, 2010 was $9.2 million and was comprised of four investments totaling $5.8 million in Nippon Quaker Chemical, Ltd. (Japan) at 50%, $1.7 million in TecniQuimia Mexicana S.A. de C.V. (Mexico) at 40%, $1.5 million in Kelko Quaker Chemical, S.A. (Venezuela) at 50% and $0.2 million in Kelko Quaker Chemical, S.A. (Panama) at 50%, respectively. See Note 6 of Notes to Consolidated Financial Statements which appears in Item 8 of this Report.

4. Tax exposures, valuation allowances and uncertain tax positions—Quaker records expenses and liabilities for taxes based on estimates of amounts that will be ultimately determined to be deductible in tax returns filed in various jurisdictions. The filed tax returns are subject to audit, often several years subsequent to the date of the financial statements. Disputes or disagreements may arise during audits over the timing or validity of certain items or deductions, which may not be resolved for extended periods of time. Quaker applies the provisions of FASB’s guidance regarding uncertain tax positions. The guidance applies to all income tax positions taken on previously filed tax returns or expected to be taken on a future tax return. The guidance prescribes a benefit recognition model with a two-step approach, a more-likely-than-not recognition criterion, and a measurement attribute that measures the position as the largest amount of tax benefit that is greater than 50% likely of being realized upon effective settlement. The guidance further requires that the amount of interest expense and income to be recognized related to uncertain tax positions be computed by applying the applicable statutory rate of interest to the difference between the tax position recognized in accordance with the guidance, including timing differences, and the amount previously taken or expected to be taken in a tax return. Quaker also records valuation allowances when necessary to reduce its deferred tax assets to the amount that is more likely than not to be realized. While Quaker has considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event Quaker were to determine that it would be able to realize its deferred tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made. Likewise, should Quaker determine that it would not be able to realize all or part of its net deferred tax assets in the future, an adjustment to the deferred tax asset would be charged to income in the period such determination was made which could have a material adverse impact on the Company’s financial statements. U.S. income taxes have not been provided on the undistributed earnings of non-U.S. subsidiaries since it is the Company’s intention to continue to reinvest these earnings in those subsidiaries for working capital needs and growth initiatives. U.S. and foreign income taxes that would be payable if such earnings were distributed may be lower than the amount computed at the U.S. statutory rate due to the availability of foreign tax credits.

5. Restructuring liabilities—Restructuring charges may consist of charges for employee severance, rationalization of manufacturing facilities and other items. The Company applies FASB’s guidance regarding exit or disposal cost obligations. The guidance requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred.

6. Goodwill and other intangible assets—The Company records goodwill and intangible assets at fair value as of the acquisition date and amortizes intangible assets which do not have indefinite lives on a straight-line basis over the lives of the intangible assets based on third-party valuations of the assets. Goodwill and intangible assets, which have indefinite lives, are not amortized and are required to be assessed at least annually for impairment. The Company compares the assets’ fair value to their carrying value primarily based on future discounted cash flows in order to determine if an impairment charge is warranted. The estimates of future cash flows involve considerable management judgment and are based upon assumptions about expected future operating performance. Assumptions used in these forecasts are consistent with internal planning. The actual cash flows could differ from management’s estimates due to changes in business conditions, operating performance, and economic conditions. The Company completed its annual impairment assessment as of the end

 

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of the third quarter 2010, and no impairment charge was warranted. The Company’s consolidated goodwill and indefinite-lived intangible assets at December 31, 2010 and 2009 were $53.9 million and $47.1 million, respectively. The Company’s assumption of weighted average cost of capital and estimated future net operating profit after tax (NOPAT) are particularly important in determining whether an impairment charge has been incurred. The Company currently uses a weighted average cost of capital of 12% and, at September 30, 2010, this assumption would have had to increase by more than 6.75 percentage points before any of the Company’s reporting units would fail step one of the impairment analysis. Further, at September 30, 2010, the Company’s estimate of future NOPAT would have had to decrease by more than 36% before any of the Company’s reporting units would be considered potentially impaired. As a result, the estimated fair value of each of the Company’s reporting units substantially exceeds their carrying value.

7. Postretirement benefits—The Company provides certain pension and other postretirement benefits to employees and retirees. Independent actuaries, in accordance with accounting principles generally accepted in the United States, perform the required valuations to determine benefit expense and, if necessary, non-cash charges to equity for additional minimum pension liabilities. Critical assumptions used in the actuarial valuation include the weighted average discount rate, rates of increase in compensation levels, and expected long-term rates of return on assets. If different assumptions were used, additional pension expense or charges to equity might be required. The Company’s U.S. pension plan year-end is November 30, and the measurement date is December 31. The following table highlights the potential impact on the Company’s pre-tax earnings due to changes in assumptions with respect to the Company’s pension plans, based on assets and liabilities at December 31, 2010:

 

     1/2 Percentage Point
Increase
    1/2 Percentage Point
Decrease
 
     Foreign     Domestic     Total     Foreign      Domestic      Total  
     (Dollars in millions)  

Discount rate

   $ (0.2   $ (0.1   $ (0.3   $ 0.3       $ 0.1       $ 0.4   

Expected rate of return on plan assets

   $ (0.2   $ (0.2   $ (0.4   $ 0.2       $ 0.2       $ 0.4   

Recently Issued Accounting Standards

The FASB updated its guidance regarding a vendor’s multiple-deliverable arrangements in October 2009. The updated guidance establishes a selling price hierarchy to be followed in determining the selling price for each deliverable in multiple-deliverable arrangements, eliminates the residual method of allocation and requires that arrangement consideration be allocated at the inception of the arrangement using the relative selling price method and requires enhanced disclosure regarding multiple-deliverable arrangements. The guidance is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning after June 15, 2010. The Company is currently assessing the impact of this guidance on its financial statements.

Liquidity and Capital Resources

Quaker’s cash and cash equivalents increased to $25.8 million at December 31, 2010 from $25.1 million at December 31, 2009. The $0.7 million increase resulted primarily from $37.5 million of cash provided by operating activities, $41.0 million of cash used in investing activities, $4.3 million of cash provided by financing activities and a $0.1 million decrease from the effect of exchange rates on cash.

Net cash flows provided by operating activities were $37.5 million in 2010, compared to $41.6 million provided by operating activities in 2009. The Company’s improvement in net income was more than offset by increased investment in working capital. During 2009, the Company experienced significantly lower business activity as it was still recovering from the global economic downturn, which in turn greatly reduced the Company’s investment in working capital. As business volumes began to recover later in 2009 and continued to increase in 2010, the Company’s need for working capital investment correspondingly increased. The Company’s first quarter 2009 disposition of land in Europe, reduced pension contributions compared to 2009, and the 2009 completion of restructuring activities also impacted the operating cash flow comparisons.

 

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Net cash flows used in investing activities were $41.0 million in 2010, compared to $6.6 million of cash used in investing activities in 2009. Payments related to acquisitions were the primary driver in the change in cash flows used in investing activities. During the third quarter of 2010, the Company completed the acquisition of D.A. Stuart’s U.S. aluminum hot rolling business from Houghton International for $6.8 million and, in the fourth quarter of 2010, the Company completed the acquisition of Summit Lubricants, Inc. for $29.1 million. Cash paid for acquisitions in 2009 included the final $1.0 million payment related to the 2005 acquisition of the remaining 40% interest in the Company’s Brazilian joint venture and the final payment related to the 2006 acquisition of the remaining minority interest in its China joint venture for approximately $1.0 million. In addition, the 2009 proceeds from the disposition of land in Europe were offset by lower capital expenditures in 2010 as the Company completed its Middletown, Ohio expansion project. Reductions in the use of restricted cash related to the expansion project also affected the investing cash flow comparisons.

In the first quarter of 2007, an inactive subsidiary of the Company reached a settlement agreement and release with one of its insurance carriers for $20.0 million. The proceeds of the settlement are restricted and can only be used to pay claims and costs of defense associated with this subsidiary’s asbestos litigation. The payments were structured to be received over a four-year period with annual installments of $5.0 million, the final installment of which was received in the first quarter of 2010. During the third quarter of 2007, the same inactive subsidiary and another of its insurance carriers entered into a Claim Handling and Funding Agreement under which the carrier will pay 27% of the defense and indemnity costs incurred by or on behalf of the subsidiary in connection with asbestos bodily injury claims for a minimum of five years beginning July 1, 2007. See Notes 20, 21, and 22 of Notes to Consolidated Financial Statements which appear in Item 8 of this Report.

Net cash flows provided by financing activities were $4.3 million in 2010, compared to $32.8 million of cash used in financing activities in 2009. The majority of the change was the result of debt repayments in 2009 compared to debt borrowings in 2010. In 2009, the cash flow generated from reduced working capital investments as a result of significantly curtailed business volumes enabled the debt repayments. In 2010, debt borrowings were needed to supplement the Company’s cash flow from operations for its acquisition activity, noted above. In addition, a significantly higher number of stock options were exercised in 2010, which impacted the change in cash flows.

In June 2010, the Company amended its primary credit facility to increase the maximum principal amount available for revolving credit borrowings from $125.0 million to $175.0 million. This amount can be increased to $225.0 million at the Company’s option if the lenders agree to increase their commitments and the Company satisfies certain conditions. At December 31, 2010 and December 31, 2009, the Company had approximately $55.0 million and $46.4 million, respectively, outstanding under its credit facilities. The amendment also extended the maturity date of the Company’s credit line from August 2012 to June 2014 and amended certain acquisition and other covenants, including a reduced interest rate spread and a new interest rate tier for leverage ratios below one times EBITDA that would allow for a further interest rate spread reduction. The Company’s access to this credit is largely dependent on its consolidated leverage ratio covenant, which cannot exceed 3.5 to 1, and at December 31, 2010 and December 31, 2009, the consolidated leverage ratio was below 2.0 to 1. Under this covenant, the Company could have borrowed an additional $120.0 million at December 31, 2010. The Company has entered into interest rate swaps with a combined notional value of $15.0 million as of December 31, 2010, in order to fix the interest rate on a portion of its variable rate debt. Outstanding financial derivative instruments may expose the Company to credit loss in the event of nonperformance by the counterparties to the agreements. To manage credit risk, the Company limits its exposure to any single counterparty. However, the Company does not expect any of the counterparties to fail to meet their obligations.

In 2009, the Company filed a shelf registration statement on Form S-3 with the Securities and Exchange Commission (the “SEC”). The registration statement was declared effective on January 29, 2010 and permits the Company to offer and sell from time to time in one or more public offerings up to $100.0 million aggregate dollar amount of its securities, which may be shares of preferred stock (either separately or represented by depositary shares), common stock, debt securities and warrants to purchase our debt or equity securities, as well

 

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as units that include any of these securities, on terms, in each case, established at the time of the offering. This registration statement provides the Company with the ability to issue registered debt or equity securities on an accelerated basis.

At December 31, 2010, the Company’s gross liability for uncertain tax positions, including accrued interest and penalties, was $13.1 million. The Company cannot determine a reliable estimate of the timing of cash flows by period related to its uncertain tax position liability. However, should the entire liability be paid, the amount of the payment may be reduced by $7.0 million as a result of offsetting benefits in other tax jurisdictions.

The Company believes it is capable of supporting its operating requirements, including pension plan contributions, payments of dividends to shareholders, possible acquisitions and business opportunities, capital expenditures and possible resolution of contingencies through internally generated funds supplemented with debt or equity as needed.

The following table summarizes the Company’s contractual obligations at December 31, 2010, and the effect such obligations are expected to have on its liquidity and cash flow in future periods. Pension and other postretirement plan contributions beyond 2011 are not determinable since the amount of any contribution is heavily dependent on the future economic environment and investment returns on pension trust assets. The timing of payments related to other long-term liabilities, which consist primarily of deferred compensation agreements cannot be readily determined due to their uncertainty. Interest obligations on the Company’s short and long-term debt are included assuming the debt levels will be outstanding for the entire period and assuming the interest rates in effect at December 31, 2010. Interest obligations on the contingent acquisition consideration is included assuming the discount rate in effect at the time of acquisition.

 

     Payments due by period  

Contractual Obligations (Amounts in millions)

   Total      2011      2012      2013      2014      2015      2016 and
Beyond
 

Short-term debt

   $ 0.077       $ 0.077       $ —         $ —         $ —         $ —         $ —     

Long-term debt

     89.868         2.695         2.423         1.999         56.567         1.175         25.009   

Capital lease obligations

     1.471         0.570         0.404         0.246         0.064         0.064         0.123   

Non-cancelable operating leases

     20.189         4.937         4.270         3.195         2.483         2.210         3.094   

Purchase obligations

     5.915         5.415         0.500         —           —           —           —     

Pension and other postretirement plan contributions

     9.220         9.220         —           —           —           —           —     

Contingent acquisition consideration

     8.031         —           —           8.031         —           —           —     

Other long-term liabilities (see Note 21 of Notes to Consolidated Financial Statements)

     3.359         —           —           —           —           —           3.359   
                                                              

Total contractual cash obligations

   $ 138.130       $ 22.914       $ 7.597       $ 13.471       $ 59.114       $ 3.449       $ 31.585   
                                                              

Operations

CMS Discussion

The Company currently has more than 40 CMS contracts in North America, as well as additional CMS contracts in other areas of the world. Under its traditional CMS approach, the Company effectively acts as an agent, and the revenues and costs from these sales are reported on a net sales or “pass-through” basis. Under certain of its CMS contracts, the contracts are structured differently in that the Company’s revenue received from the customer is a fee for products and services provided to the customer, which are indirectly related to the actual costs incurred. Profit is dependent on how well the Company controls product costs and achieves product conversions from other third-party suppliers to its own products. As a result, under the alternative structure, the

 

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Company recognizes in reported revenue the gross revenue received from the CMS site customer, and in cost of goods sold the third-party product purchases, which substantially offset each other until the Company achieves significant product conversions, which may result in a decrease in reported gross margin as a percentage of sales.

In 2009, the Company had a mix of contracts with both the traditional product pass-through structure and fixed price contracts covering all services and products. As a result of the global economic downturn and its impact in the automotive sector, during 2009 and early 2010, the Company experienced a shift in customer requirements and business circumstances where almost all of CMS contracts have reverted to the traditional product pass-through structure. However, the Company’s offerings will continue to include both approaches to CMS.

Comparison of 2010 with 2009

Net sales for 2010 were $544.1 million, an increase of $92.6 million, or approximately 21%, compared to $451.5 million in 2009. The increase in sales was driven by significant increases in volume across the globe, as the comparisons to the prior year continue to reflect recovery from the global economic downturn. The volume increases were partially offset by lower CMS revenue reported on a gross basis, which decreased revenues by approximately 4%. Changes in price/mix and foreign exchange rate translation each increased revenues by approximately 1%.

Gross profit increased $36.0 million, or 23%, compared to 2009, largely as a result of increased volumes. The gross margin increased to 35.4% in 2010 from 34.7% in 2009. Raw material costs did not begin to significantly increase until the middle of the second quarter of 2010 and continued through the end of 2010. Only a portion of these higher costs were recovered through price increases in 2010. Additional price increases are being implemented in early 2011 as part of the Company’s effort to recover margins. However, the reduction in gross margin from higher raw material costs was tempered by reduced automotive CMS revenues reported on a gross basis which increased the gross margin by approximately 1 percentage point.

SG&A increased $13.2 million, or 10%, compared to 2009. Higher selling costs with increased business activity, inflationary costs as well as increased incentive compensation were the primary drivers of the increase, representing 66% of the increase. Differences in foreign exchange rates, higher professional fees related to acquisitions and other costs accounted for the remainder of the increase. SG&A as a percentage of sales decreased from 28% in 2009 to 26% in 2010.

As initially disclosed in the Company’s second quarter Form 10-Q, one of the Company’s subsidiaries may have paid certain value-added-taxes (“VAT”) incorrectly and, in certain cases, may not have collected sufficient VAT from certain customers. The VAT rules and regulations at issue are complex, vary among the jurisdictions and can be contradictory, in particular as to how they relate to the subsidiary’s products and to sales between jurisdictions.

Since its inception, the subsidiary had been consistent in its VAT collection and remittance practices and had never been contacted by any tax authority relative to VAT. Now the subsidiary has determined that for certain products, a portion of the VAT was incorrectly paid and that the total VAT due exceeds the amount originally collected and remitted by the subsidiary. In 2010, several jurisdictions contacted the subsidiary requesting information, but no tax assessments were received. In two jurisdictions, the subsidiary has either participated in an amnesty program or entered into a settlement whereby it paid a reduced portion of the amounts owed in resolution of those jurisdictions’ claims. At this time, the subsidiary has either modified or is in the process of modifying its VAT invoicing and payment procedures to eliminate or mitigate future exposure.

In analyzing the subsidiary’s exposure, it is difficult to estimate both the probability and the amount of any potential liabilities due to a number of factors, including: the decrease in exposure over time due to applicable

 

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statutes of limitations and actions taken by the subsidiary, the joint liability of customers and suppliers for a portion of the VAT, the availability of a VAT refund for VAT incorrectly paid through an administrative process, any amounts which may have already been, or will be paid by customers, as well as the timing and structure of any tax amnesties or settlements. In addition, interest and penalties on any VAT due can be a multiple of the base tax. The subsidiary may contest any tax assessment administratively and/or judicially for an extended period of time, but may ultimately resolve its disputes through participation in tax amnesty programs, which are a common practice for settling tax disputes in the jurisdictions in question and which have historically occurred on a regular basis resulting in significant reductions of interest and penalties. Also, the timing of payments and refunds of VAT may not be contemporaneous, and, if additional VAT is owed, it may not be fully recoverable from customers. As a result, this matter has the potential to have a material adverse impact on the Company’s financial position, liquidity and capital resources and the results of operations.

Included in the 2010 results is a net charge of $4.1 million, which consists of a net $3.9 million charge related to two tax dispute settlements entered into by the subsidiary, as well as a net $0.2 million charge representing management’s best estimate, based on the information available to it, including the factors noted above, of the amount that ultimately may be paid related to the other jurisdiction that has made inquiries. These charges assume a successful recovery of the VAT incorrectly paid, as well as reductions in interest and penalties from anticipated future amnesty programs or settlements. On a similar basis, if all other potentially impacted jurisdictions were to initiate audits and issue assessments, the range of the remaining exposure, net of refunds, could be from $0 to $22.0 million, with one jurisdiction representing approximately 82 percent of this additional exposure, assuming the continued availability of future amnesty programs or settlements to reduce the interest and penalties. If there are future assessments but no such future amnesty programs or settlements, the potential exposure could be higher.

In 2009, the Company implemented and completed a restructuring program totaling $2.3 million, or approximately $0.14 per diluted share. The Company incurred a final charge related to the former CEO’s supplemental retirement plan of approximately $1.3 million, or $0.08 per diluted share, in 2010, compared to a charge of $2.4 million, or $0.14 per diluted share, in 2009.

Other income for 2010 includes higher license fees from increased business activities as well as foreign exchange rate gains versus losses in 2009, which partially offset a gain related to the disposition of land in Europe of approximately $0.11 per diluted share in 2009. Net interest expense decreased due to lower interest rates, lower average debt balances as well as higher interest income.

The Company’s effective tax rate for 2010 was 27.3% compared to 29.8% in 2009. The 2010 effective tax rate includes a benefit of approximately $0.21 per diluted share, while 2009 includes a benefit of approximately $0.05 per diluted share, due to the expiration of applicable statutes of limitations for uncertain tax positions. In addition, the 2010 effective tax rate was impacted by significantly improved profitability in certain higher rate jurisdictions, which has also allowed for the utilization of the domestic production activities deduction for the first time in the Company’s history. The effective tax rate for 2009 reflects no tax provided for the land sale gain, due to the utilization of net operating losses, which were previously not benefited. The Company has experienced, and expects to experience, further volatility in its quarterly effective tax rates due to the varying timing of tax audits and the expiration of applicable statutes of limitations as they relate to uncertain tax positions. During 2010, the Company recorded $2.6 million of excess tax benefits in capital in excess of par on its Consolidated Balance Sheet and in its Consolidated Statement of Cash Flows, related to stock option exercises, which occurred over the current and prior years. Previously, the Company’s actual taxable income in affected jurisdictions was not sufficient to recognize these benefits, while the Company’s 2010 taxable income was sufficient to recognize these benefits. At the end of 2010, the Company had net U.S. deferred tax assets totaling $14.8 million, excluding deferred tax assets relating to additional minimum pension liabilities. The Company records valuation allowances when necessary to reduce its deferred tax assets to the amount that is more likely than not to be realized. The Company considers future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance. However, in the event the

 

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Company were to determine that it would not be able to realize all or part of its net deferred tax assets in the future, an adjustment to the deferred tax assets would be a non-cash charge to income in the period such determination was made, which could have a material adverse impact on the Company’s financial statements. The global economic downturn has been negatively impacting profitability in certain taxing jurisdictions. The Company continues to closely monitor this situation as it relates to its net deferred tax assets and the assessment of valuation allowances. The Company is continuing to evaluate alternatives that could positively impact taxable income in these jurisdictions.

Equity in net income of associated companies includes charges totaling approximately $0.08 per diluted share related to the first quarter 2010 devaluation of the Venezuelan Bolivar Fuerte and an out-of-period charge relating to errors the Company identified for shortfalls in reserves for pensions and other items at the Company’s Mexican affiliate. The affiliate adjusted for these items in the fourth quarter of 2010, and the Company does not believe these adjustments are material to the Company’s consolidated financial statements for the years ended December 31, 2007, 2008, 2009 or 2010 and, therefore has not restated any prior period amounts.

The increase in net income attributable to noncontrolling interests reflects improved profitability from these affiliates, as the prior year comparisons are affected by the global economic downturn.

Segment Reviews—Comparison of 2010 with 2009

Metalworking Process Chemicals:

Metalworking Process Chemicals consists of industrial process fluids for various heavy industrial and manufacturing applications and represented approximately 94% of the Company’s net sales in 2010. Net sales were up $92.1 million, or 22%, compared to 2009. Foreign currency translation positively impacted net sales by approximately 1%, driven by the Brazilian Real to U.S. Dollar exchange rate offset by the E.U. Euro to U.S. Dollar exchange rate. The average U.S. Dollar to Brazilian Real exchange rate was 0.57 in 2010 compared to 0.51 in 2009, while the average E.U. Euro to U.S. Dollar exchange rate was 1.33 in 2010 compared to 1.39 in 2009. Net sales were positively impacted by increases of 15% in North America, 19% in Europe, 28% in Asia/Pacific and 30% in South America, all on a constant currency basis. The increase in this segment’s sales was primarily attributable to increased volumes of 24% with double-digit increases in all regions, as the prior year results continued to reflect the global economic downturn. The product volume increases were partially offset by a reduction in automotive CMS revenue, which was due, in part, to the renegotiation of certain contracts now reported on a pass-through versus gross basis. Consistent with the significant volume increases, this segment’s operating income increased $26.0 million over 2009.

Coatings:

The Company’s coatings segment, which represented approximately 6% of the Company’s net sales in 2010, contains products that provide temporary and permanent coatings for metal and concrete products and chemical milling maskants. Net sales for this segment were up $0.6 million, or 2% for 2010 compared with the prior year, primarily due to higher encapsulant coatings sales. This segment’s operating income was up $0.3 million, consistent with the noted volume increases.

Other Chemical Products:

Other Chemical Products, which represented less than 1% of the Company’s net sales in 2010, consists of sulfur removal products for industrial gas streams sold by the Company’s Q2 Technologies joint venture. Net sales were down $0.1 million and operating income was at a slight loss due to reduced volumes with the downturn in the oil and gas markets.

 

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Comparison of 2009 with 2008

Net sales for 2009 were $451.5 million, a decline of $130.2 million, or approximately 22%, compared to $581.6 million for 2008. Volumes declined approximately 20%, reflective of the global economic downturn. Changes in foreign exchange rates also decreased revenue by approximately 2%.

Gross profit decreased by $6.2 million, or 4%, compared to 2008, reflective of the above noted volume declines which were tempered by gross margin expansion. The gross margin increased to 34.7% in 2009, compared to 28.0% in 2008, primarily due to cost reduction actions taken, a more favorable raw material cost environment and reduced automotive chemical management services revenue reported on a gross basis.

SG&A decreased $10.7 million, or 8%, compared to 2008. Savings from cost reduction programs, lower travel and entertainment expenses and lower commissions, partially offset by higher incentive compensation accruals, accounted for 64% of the decline. Changes in foreign exchange rates accounted for the remainder.

In response to the global economic downturn, the Company initiated restructuring programs and incurred charges of approximately $2.3 million, or approximately $0.14 per diluted share in 2009, and $2.9 million, or approximately $0.18 per diluted share in 2008. The Company completed both initiatives in 2009.

The Company incurred charges related to the former CEO’s supplemental retirement plan of approximately $2.4 million in 2009, or approximately $0.14 per diluted share. The CEO transition costs incurred in 2008 were approximately $3.5 million, or approximately $0.22 per diluted share.

Other income for 2009 included a $1.2 million gain related to the disposition of excess land in Europe, while other income for 2008 included a net arbitration award of approximately $1.0 million related to litigation with one of the former owners of the Company’s Italian subsidiary. Lower foreign exchange rate losses in 2009 compared to 2008 also contributed to the change in other income in 2009. The increase in net interest expense was primarily due to lower interest income, as lower average debt balances were offset by higher interest rates. The increase in equity in net income of associated companies and net income attributable to noncontrolling interests was due to stronger financial performances from those affiliates as they began to recover from the global economic downturn.

The Company’s effective tax rate for 2009 was 29.8%, compared to 29.9% in 2008. The 2009 effective tax rate reflected no tax expense being provided for the land sale gain due to the utilization of net operating losses, which were previously not benefited, while the 2008 effective tax rate included a tax refund of $0.5 million related to the Company’s increased investment in China.

Segment Reviews—Comparison of 2009 with 2008

Metalworking Process Chemicals:

Metalworking Process Chemicals consists of industrial process fluids for various heavy industrial and manufacturing applications and represented approximately 93% of the Company’s net sales in 2009. Net sales were down $120.9 million, or 22%, compared to 2008. Foreign currency translation negatively impacted net sales by approximately 2%, driven by the E.U. Euro to U.S. Dollar, and Brazilian Real to U.S. Dollar exchange rates. The average Euro to U.S. Dollar exchange rate was 1.39 in 2009 compared to 1.47 in 2008, and the average Brazilian Real exchange rate was 0.51 in 2009 compared to 0.55 in 2008. Net sales were negatively impacted by declines of 32% in North America, 22% in Europe, 3% in Asia/Pacific and 14% in South America, all on a constant currency basis. The decline in this segment’s sales was primarily attributable to volume declines of approximately 20% impacting all regions, reflective of the global economic downturn. Part of this segment’s volume decline was due to reduced automotive CMS revenue reported on a gross versus pass-through basis. Despite the significant volume declines, this segment’s operating income increased $11.3 million reflective of savings from the Company’s restructuring programs and reduced discretionary spending as well as a more favorable raw material environment.

 

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Coatings:

The Company’s coatings segment, which represented approximately 7% of the Company’s net sales in 2009, contains products that provide temporary and permanent coatings for metal and concrete products and chemical milling maskants. Net sales for this segment were down $7.0 million, or 19%, for 2009 compared with the prior year, primarily due to reduced volumes of chemical milling maskants sold to the aerospace industry as well as reduced coating sales to the construction industry. This segment’s operating income was down $1.9 million, consistent with the volume decline noted above.

Other Chemical Products:

Other Chemical Products, which represented less than 1% of the Company’s net sales in 2009, consists of sulfur removal products for industrial gas streams sold by the Company’s Q2 Technologies joint venture. Net sales were down $2.3 million as a result of reduced volumes due to the downturn in the oil and gas market. Operating income was a slight loss for 2009, reflective of the above noted volume declines.

Restructuring and Related Activities

In the fourth quarter of 2008, Quaker’s management approved restructuring plans (the 2008 4th Quarter Program) to reduce operating costs, primarily in North America and Europe. Included in restructuring plans were provisions for severance for 57 employees. The Company recognized a $2.9 million restructuring charge in the fourth quarter of 2008. Employee separation benefits varied depending on local regulations within certain foreign countries and included severance and other benefits. The Company implemented an additional restructuring program in the first quarter of 2009 (the 2009 1st Quarter Program) which included provisions for severance for 60 employees totaling approximately $2.3 million. The Company completed the initiatives contemplated under these programs during 2009.

Environmental Clean-up Activities

The Company is involved in environmental clean-up activities in connection with an existing plant location and former waste disposal sites. In April of 1992, the Company identified certain soil and groundwater contamination at AC Products, Inc. (“ACP”), a wholly owned subsidiary. In voluntary coordination with the Santa Ana California Regional Water Quality Board, ACP is remediating the contamination. Effective October 17, 2007, ACP agreed to operate the two existing groundwater treatment systems associated with the extraction wells P-2 and P-3 so as to hydraulically contain groundwater contamination emanating from ACP’s site until such time as the concentrations of contaminants are below the current Federal maximum contaminant level for four consecutive quarterly sampling events. At December 31, 2010, the Company believes that the remaining potential-known liabilities associated with the ACP contamination, namely estimated future cost of the soil and water remediation program, is approximately $1.3 million to $2.3 million, for which the Company has sufficient reserves. Notwithstanding the foregoing, the Company cannot be certain that liabilities in the form of remediation expenses and damages will not be incurred in excess of the amount reserved. See Note 22 of Notes to Consolidated Financial Statements which appears in Item 8 of this Report.

General

The Company generally does not use financial instruments that expose it to significant risk involving foreign currency transactions; however, the size of non-U.S. activities has a significant impact on reported operating results and the attendant net assets. During the past three years, sales by non-U.S. subsidiaries accounted for approximately 59% to 65% of our consolidated net annual sales. See Note 17 of Notes to Consolidated Financial Statements which appears in Item 8 of this Report.

 

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Factors that May Affect Our Future Results

(Cautionary Statements Under the Private Securities Litigation Reform Act of 1995)

Certain information included in this Report and other materials filed or to be filed by Quaker with the SEC (as well as information included in oral statements or other written statements made or to be made by us) contain or may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements can be identified by the fact that they do not relate strictly to historical or current facts. We have based these forward-looking statements on our current expectations about future events. These forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, anticipations, intentions, financial condition, results of operations, future performance, and business, including:

 

   

statements relating to our business strategy;

 

   

our current and future results and plans; and

 

   

statements that include the words “may,” “could,” “should,” “would,” “believe,” “expect,” “anticipate,” “estimate,” “intend,” “plan” or similar expressions.

Such statements include information relating to current and future business activities, operational matters, capital spending, and financing sources. From time to time, oral or written forward-looking statements are also included in Quaker’s periodic reports on Forms 10-Q and 8-K, press releases and other materials released to, or statements made to, the public.

Any or all of the forward-looking statements in this Report, in Quaker’s Annual Report to Shareholders for 2010 and in any other public statements we make may turn out to be wrong. This can occur as a result of inaccurate assumptions or as a consequence of known or unknown risks and uncertainties. Many factors discussed in this Report will be important in determining our future performance. Consequently, actual results may differ materially from those that might be anticipated from our forward-looking statements.

We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise. However, any further disclosures made on related subjects in Quaker’s subsequent reports on Forms 10-K, 10-Q and 8-K should be consulted. These forward-looking statements are subject to risks, uncertainties and assumptions about us and our operations that are subject to change based on various important factors, some of which are beyond our control. A major risk is that the Company’s demand is largely derived from the demand for its customers’ products, which subjects the Company to uncertainties related to downturns in a customer’s business and unanticipated customer production shutdowns. Other major risks and uncertainties include, but are not limited to, significant increases in raw material costs, worldwide economic and political conditions, foreign currency fluctuations, and terrorist attacks such as those that occurred on September 11, 2001, each of which is discussed in greater detail in Item 1A of this Report. Furthermore, the Company is subject to the same business cycles as those experienced by steel, automobile, aircraft, appliance, and durable goods manufacturers. These risks, uncertainties, and possible inaccurate assumptions relevant to our business could cause our actual results to differ materially from expected and historical results. Other factors beyond those discussed in this Report could also adversely affect us. Therefore, we caution you not to place undue reliance on our forward-looking statements. This discussion is provided as permitted by the Private Securities Litigation Reform Act of 1995.

 

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Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

Quaker is exposed to the impact of interest rates, foreign currency fluctuations, changes in commodity prices, and credit risk.

Interest Rate Risk. Quaker’s exposure to market rate risk for changes in interest rates relates primarily to its short and long-term debt. Most of Quaker’s debt is negotiated at market rates. Accordingly, if interest rates rise significantly, the cost of debt to Quaker will increase. This can have an adverse effect on Quaker, depending on the extent of Quaker’s borrowings. As of December 31, 2010, Quaker had approximately $55.0 million in borrowings under its credit facility at a weighted average borrowing rate of approximately 2.02% (LIBOR plus a spread). If interest rates were to change by 10%, the Company’s interest expense would correspondingly increase or decrease approximately $0.1 million. The Company uses derivative financial instruments primarily for the purposes of hedging exposures to fluctuations in interest rates. The Company does not enter into derivative contracts for trading or speculative purposes. The Company has entered into interest rate swaps in order to fix a portion of its variable rate debt. The swaps had a combined notional value of $15.0 million and a fair value of $(1.0) million at December 31, 2010, and a combined notional value of $40.0 million and a fair value of $(2.2) million at December 31, 2009. As of December 31, 2010, the Company is currently receiving a LIBOR rate and paying an additional average fixed rate of approximately 5% on its interest rate swaps. The Company’s remaining three swaps mature in 2012. The counterparties to the swaps are major financial institutions. Outstanding financial derivative instruments expose the Company to credit loss in the event of nonperformance by the counterparties to the agreements. To manage credit risk, the Company limits its exposure to any single counterparty. However, the Company does not expect any of the counterparties to fail to meet their obligations. See the information included under the caption “Derivatives” in Note 1 and the information in Note 5 of Notes to Consolidated Financial Statements which appears in Item 8 of this Report and is incorporated herein by reference.

Foreign Exchange Risk. A significant portion of Quaker’s revenues and earnings is generated by its foreign operations. These foreign operations also represent a significant portion of Quaker’s assets and liabilities. All such operations use the local currency as their functional currency. Accordingly, Quaker’s financial results are affected by risks typical of global business such as currency fluctuations, particularly between the U.S. Dollar, the Brazilian Real, the Chinese Renminbi and the E.U. Euro. As exchange rates vary, Quaker’s results can be materially affected. If the Brazilian Real, the E.U. Euro and the Chinese Renminbi were each to change by 10% against the U.S. Dollar, the Company’s 2010 revenues and pre-tax earnings would correspondingly have increased or decreased approximately $28.0 million and $4.0 million, respectively.

The Company generally does not use financial instruments that expose it to significant risk involving foreign currency transactions; however, the size of non-U.S. activities has a significant impact on reported operating results and the attendant net assets. During the past three years, sales by non-U.S. subsidiaries accounted for approximately 59% to 65% of consolidated net annual sales.

In addition, the Company often sources inventory among its worldwide operations. This practice can give rise to foreign exchange risk resulting from the varying cost of inventory to the receiving location, as well as from the revaluation of intercompany balances. The Company mitigates this risk through local sourcing efforts.

Commodity Price Risk. Many of the raw materials used by Quaker are commodity chemicals, and, therefore, Quaker’s earnings can be materially affected by market changes in raw material prices. In certain cases, Quaker has entered into fixed-price purchase contracts having a term of up to two years. These contracts provide for protection to Quaker if the price for the contracted raw materials rises, however, in certain limited circumstances, Quaker will not realize the benefit if such prices decline. If the Company’s gross margin were to change by one percentage point, the Company’s 2010 pretax earnings would have correspondingly increased or decreased by approximately $5.5 million.

Credit Risk. Quaker establishes allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. If the financial condition of Quaker’s customers were to

 

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deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Downturns in the overall economic climate may also exacerbate specific customer financial issues. A significant portion of Quaker’s revenues is derived from sales to customers in the U.S. steel and automotive industries, including some of our larger customers, where a number of bankruptcies occurred during recent years and companies have experienced financial difficulty. When a bankruptcy occurs, Quaker must judge the amount of proceeds, if any, that may ultimately be received through the bankruptcy or liquidation process. In addition, as part of its terms of trade, Quaker may custom manufacture products for certain large customers and/or may ship product on a consignment basis. These practices may increase the Company’s exposure should a bankruptcy occur, and may require write-down or disposal of certain inventory due to its estimated obsolescence or limited marketability. Customer returns of products or disputes may also result in similar issues related to the realizability of recorded accounts receivable or returned inventory. The Company recorded provisions for doubtful accounts of $0.9 million, $1.4 million and $1.1 million in 2010, 2009 and 2008, respectively. A change of 10% to the recorded provisions would have increased or decreased the Company’s pre-tax earnings by approximately $0.1 million in 2010, 2009 and 2008, respectively.

 

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Item 8. Financial Statements and Supplementary Data.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

     Page  

Financial Statements:

  

Report of Independent Registered Public Accounting Firm

     31   

Consolidated Statement of Income

     32   

Consolidated Balance Sheet

     33   

Consolidated Statement of Cash Flows

     34   

Consolidated Statement of Comprehensive (Loss) Income and Changes in Equity

     35   

Notes to Consolidated Financial Statements

     36   

 

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Report of Independent Registered Public Accounting Firm

To the Shareholders and Board of Directors

of Quaker Chemical Corporation:

In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Quaker Chemical Corporation and its subsidiaries at December 31, 2010 and December 31, 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements and on the Company’s internal control over financial reporting based on our integrated 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 audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

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 (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) 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 (iii) 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.

As described in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A, management has excluded Summit Lubricants, Inc. from its assessment of internal control over financial reporting as of December 31, 2010 because it was acquired by the Company in a purchase business combination on December 31, 2010. We have also excluded Summit Lubricants, Inc. from our audit of internal control over financial reporting. Summit Lubricants, Inc. is a wholly-owned subsidiary whose total assets and total revenues represent 8% and 0%, respectively, of the related consolidated financial statement amounts as of and for the year ended December 31, 2010.

/s/ PricewaterhouseCoopers LLP

Philadelphia, PA

March 2, 2011

 

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QUAKER CHEMICAL CORPORATION

CONSOLIDATED STATEMENT OF INCOME

 

     Year Ended December 31,  
     2010     2009     2008  
    

(In thousands, except

per share amounts)

 

Net sales

   $ 544,063      $ 451,490      $ 581,641   
                        

Costs and expenses:

      

Cost of goods sold

     351,274        294,652        418,580   

Selling, general, and administrative expenses

     139,209        126,018        136,697   

Non-income tax contingency charge

     4,132        —          —     

CEO transition costs

     1,317        2,443        3,505   

Restructuring and related activities

     —          2,289        2,916   
                        
     495,932        425,402        561,698   
                        

Operating income

     48,131        26,088        19,943   

Other income, net

     2,106        2,409        1,095   

Interest expense

     (5,225     (5,533     (5,509

Interest income

     1,201        728        1,100   
                        

Income before taxes and equity in net income of associated companies

     46,213        23,692        16,629   

Taxes on income before equity in net income of associated companies

     12,616        7,065        4,977   
                        

Income before equity in net income of associated companies

     33,597        16,627        11,652   

Equity in net income of associated companies

     494        863        388   
                        

Net income

     34,091        17,490        12,040   

Less: Net income attributable to noncontrolling interest

     2,284        1,270        908   
                        

Net income attributable to Quaker Chemical Corporation

   $ 31,807      $ 16,220      $ 11,132   
                        

Earnings per common share data:

      

Net income attributable to Quaker Chemical Corporation Common shareholders—basic

   $ 2.82      $ 1.48      $ 1.06   

Net income attributable to Quaker Chemical Corporation Common shareholders—diluted

   $ 2.77      $ 1.47      $ 1.05   

The accompanying notes are an integral part of these consolidated financial statements.

 

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QUAKER CHEMICAL CORPORATION

CONSOLIDATED BALANCE SHEET

 

     December 31,  
     2010     2009  
    

(In thousands, except

par value and

share amounts)

 

ASSETS

    

Current assets

    

Cash and cash equivalents

   $ 25,766      $ 25,051   

Construction fund (restricted cash)

     —          2,358   

Accounts receivable, net

     116,266        108,793   

Inventories

     60,841        50,040   

Current deferred tax assets

     4,624        5,523   

Prepaid expenses and other current assets

     7,985        7,409   
                

Total current assets

     215,482        199,174   
                

Property, plant and equipment, net

     76,535        67,426   

Goodwill

     52,758        46,515   

Other intangible assets, net

     24,030        5,579   

Investments in associated companies

     9,218        8,824   

Non-current deferred tax assets

     28,846        28,237   

Other assets

     42,561        39,537   
                

Total assets

   $ 449,430      $ 395,292   
                

LIABILITIES AND EQUITY

    

Current liabilities

    

Short-term borrowings and current portion of long-term debt

   $ 890      $ 2,431   

Accounts payable

     61,192        58,389   

Dividends payable

     2,701        2,550   

Accrued compensation

     17,140        16,656   

Accrued pension and postretirement benefits

     1,672        4,717   

Current deferred tax liabilities

     181        213   

Other current liabilities

     17,415        15,224   
                

Total current liabilities

     101,191        100,180   
                

Long-term debt

     73,855        63,685   

Non-current deferred tax liabilities

     6,108        5,213   

Accrued pension and postretirement benefits

     30,016        27,602   

Other non-current liabilities

     51,161        42,317   
                

Total liabilities

     262,331        238,997   
                

Commitments and contingencies

     —          —     

Equity

    

Common stock, $1 par value; authorized 30,000,000 shares;
Issued: 2010-11,492,142 shares, 2009-11,085,549 shares

     11,492        11,086   

Capital in excess of par value

     38,275        27,527   

Retained earnings

     144,347        123,140   

Accumulated other comprehensive loss

     (13,736     (10,439
                

Total Quaker shareholders’ equity

     180,378        151,314   

Noncontrolling interest

     6,721        4,981   
                

Total equity

     187,099        156,295   
                

Total liabilities and equity

   $ 449,430      $ 395,292   
                

The accompanying notes are an integral part of these consolidated financial statements.

 

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QUAKER CHEMICAL CORPORATION

CONSOLIDATED STATEMENT OF CASH FLOWS

 

     Year Ended December 31,  
     2010     2009     2008  
     (In thousands)  

Cash flows from operating activities

      

Net income

   $ 34,091      $ 17,490      $ 12,040   

Adjustments to reconcile net income to net cash provided by operating activities:

      

Depreciation

     9,867        9,525        10,879   

Amortization

     988        1,078        1,177   

Equity in net income of associated companies, net of dividends

     19        (833     (275

Deferred income taxes

     1,849        (505     1,014   

Uncertain tax positions (non-deferred portion)

     (1,130     1,266        211   

Deferred compensation and other, net

     (628     652        819   

Stock-based compensation

     3,096        2,130        3,901   

Restructuring and related activities

     —          2,289        2,916   

Loss (gain) on disposal of property, plant and equipment

     32        (1,202     (10

Insurance settlement realized

     (1,640     (1,608     (1,556

Pension and other postretirement benefits

     (2,636     (7,929     (3,527

Increase (decrease) in cash from changes in current assets and current liabilities, net of acquisitions:

      

Accounts receivable

     (4,469     (6,816     15,582   

Inventories

     (7,153     9,765        (73

Prepaid expenses and other current assets

     (814     (129     (181

Accounts payable and accrued liabilities

     5,511        16,540        (27,892

Change in restructuring liabilities

     —          (4,473     (749

Estimated taxes on income

     564        4,363        (885
                        

Net cash provided by operating activities

     37,547        41,603        13,391   
                        

Cash flows from investing activities

      

Capital expenditures

     (9,354     (13,834     (11,742

Payments related to acquisitions, net of cash acquired

     (35,909     (1,975     (1,859

Proceeds from disposition of assets

     229        1,666        177   

Insurance settlement received and interest earned

     5,122        5,204        5,306   

Change in restricted cash, net

     (1,124     2,327        (12,031
                        

Net cash used in investing activities

     (41,036     (6,612     (20,149
                        

Cash flows from financing activities

      

Net (decrease) increase in short-term borrowings

     (1,456     (1,755     743   

Proceeds from long-term debt

     9,841        3,500        10,000   

Repayment of long-term debt

     (636     (23,973     (3,401

Dividends paid

     (10,449     (10,111     (9,503

Stock options exercised, other

     5,500        412        11,919   

Excess tax benefit related to stock option exercises

     2,558        —          —     

Distributions to noncontrolling shareholders

     (1,021     (890     (404
                        

Net cash provided by (used in) financing activities

     4,337        (32,817     9,354   
                        

Effect of exchange rate changes on cash

     (133     1,985        (1,899

Net increase in cash and cash equivalents

     715        4,159        697   

Cash and cash equivalents at beginning of the period

     25,051        20,892        20,195   
                        

Cash and cash equivalents at end of the period

   $ 25,766      $ 25,051      $ 20,892   
                        

Supplemental cash flow disclosures

      

Cash paid during the year for:

      

Income taxes

   $ 7,799      $ 180      $ 4,561   

Interest

     4,884        5,113        5,314   

Non-cash activities:

      

Restricted insurance receivable (See also Note 20 of Notes to Consolidated Financial Statements)

   $ 5,000      $ 5,000      $ 5,000   

Property, plant and equipment acquired by capital lease

     848        432        —     

The accompanying notes are an integral of these consolidated financial statements

 

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QUAKER CHEMICAL CORPORATION

CONSOLIDATED STATEMENT OF COMPREHENSIVE (LOSS) INCOME AND CHANGES IN EQUITY

 

(In thousands)   Common
stock
    Capital in
excess  of
par value
    Retained
earnings
    Accumulated
other
comprehensive
loss
    Noncontrolling
Interest
    Comprehensive
Income (Loss)
    Total  

Balance at December 31, 2007

  $ 10,147      $ 10,104      $ 115,767      $ (5,625   $ 4,513        $ 134,906   

Net income

    —          —          11,132          908      $ 12,040     

Currency translation adjustments

    —          —          —          (10,110     (1,065     (11,175  

Defined benefit retirement plans:

             

Net gain (loss) arising during the period, other

    —          —          —          (10,238     —          (10,238  

Amortization of actuarial (gain) loss

    —          —          —          888        —          888     

Amortization of prior service cost (credit)

    —          —          —          (477     —          (477  

Amortization of initial net asset

    —          —          —          (148     —          (148  

Current period changes in fair value of derivatives

    —          —          —          (1,302     —          (1,302  

Unrealized gain on available-for-sale securities

    —          —          —          (255     —          (255  
                         

Comprehensive loss

    —          —          —          —          —          (10,667     (10,667
                   

Comprehensive income attributable to noncontrolling interest

              157     
                   

Comprehensive loss attributable to Quaker Chemical Corporation

            $ (10,510  
                   

Effects of adjustment to apply change of measurement date provisions of defined benefit retirement plans guidance:

             

Service cost, interest cost and expected return on plan assets for December 1, 2007 – December 31, 2007, net of tax

    —          —          7        —          —            7   

Amortization of prior service cost for December 1, 2007 – December 31, 2007, net of tax

    —          —          —          30        —            30   

Dividends ($0.92 per share)

    —          —          (9,817     —          —            (9,817

Dividends paid to noncontrolling interests

    —          —          —          —          (404       (404

Shares issued upon exercise of options and other

    590        11,066        —          —          —            11,656   

Shares issued for employee stock purchase plan

    13        250        —          —          —            263   

Equity-based compensation plans

    83        3,818        —          —          —            3,901   
                                                 

Balance at December 31, 2008

    10,833        25,238        117,089        (27,237     3,952          129,875   

Net income

    —          —          16,220          1,270      $ 17,490     

Currency translation adjustments

    —          —          —          10,497        649        11,146     

Defined benefit retirement plans:

             

Net gain (loss) arising during the period, other

    —          —          —          3,075        —          3,075     

Amortization of actuarial (gain) loss

    —          —          —          2,633        —          2,633     

Amortization of prior service cost (credit)

    —          —          —          65        —          65     

Amortization of initial net asset

    —          —          —          (140     —          (140  

Current period changes in fair value of derivatives

    —          —          —          642        —          642     

Unrealized gain on available-for-sale securities

    —          —          —          26        —          26     
                         

Comprehensive income

    —          —          —          —          —          34,937        34,937   
                   

Comprehensive loss attributable to noncontrolling interest

              (1,919  
                   

Comprehensive income attributable to Quaker Chemical Corporation

            $ 33,018     
                   

Dividends ($0.92 per share)

    —          —          (10,169     —          —            (10,169

Dividends paid to noncontrolling interests

    —          —          —          —          (890       (890

Shares issued upon exercise of options and other

    10        120        —          —          —            130   

Shares issued for employee stock purchase plan

    26        256        —          —          —            282   

Equity-based compensation plans

    217        1,913        —          —          —            2,130   
                                                 

Balance at December 31, 2009

  $ 11,086      $ 27,527      $ 123,140      $ (10,439   $ 4,981        $ 156,295   

Net income

    —          —          31,807          2,284      $ 34,091     

Currency translation adjustments

    —          —          —          328        477        805     

Defined benefit retirement plans:

             

Net gain (loss) arising during the period, other

    —          —          —          (6,267     —          (6,267  

Amortization of actuarial (gain) loss

    —          —          —          1,832        —          1,832     

Amortization of prior service cost (credit)

    —          —          —          91        —          91     

Amortization of initial net asset

    —          —          —          (3     —          (3  

Current period changes in fair value of derivatives

    —          —          —          708        —          708     

Unrealized gain on available-for-sale securities

    —          —          —          14        —          14     
                         

Comprehensive income

    —          —          —          —          —          31,271        31,271   
                   

Comprehensive loss attributable to noncontrolling interest

              (2,761  
                   

Comprehensive income attributable to Quaker Chemical Corporation

            $ 28,510     
                   

Dividends ($0.935 per share)

    —          —          (10,600     —          —            (10,600

Dividends paid to noncontrolling interests

    —          —          —          —          (1,021       (1,021

Shares issued upon exercise of options and other

    297        4,965        —          —          —            5,262   

Shares issued for employee stock purchase plan

    10        228        —          —          —            238   

Equity-based compensation plans

    99        2,997        —          —          —            3,096   

Excess tax benefit from stock option exercises

    —          2,558        —          —          —            2,558   
                                                 

Balance at December 31, 2010

  $ 11,492      $ 38,275      $ 144,347      $ (13,736   $ 6,721        $ 187,099   
                                                 

The accompanying notes are an integral part of these consolidated financial statements

 

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QUAKER CHEMICAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands except per share amounts)

Note 1—Significant Accounting Policies

Principles of consolidation: All majority-owned subsidiaries are included in the Company’s consolidated financial statements, with appropriate elimination of intercompany balances and transactions. Investments in associated (less than majority-owned) companies are accounted for under the equity method. The Company’s share of net income or losses of investments is included in the consolidated statement of income. The Company periodically reviews these investments for impairments and, if necessary, would adjust these investments to their fair value when a decline in market value is deemed to be other than temporary.

The Financial Accounting Standards Board’s (“FASB’s”) guidance regarding the consolidation of certain Variable Interest Entities (“VIEs”) generally requires that assets, liabilities and results of the activities of a VIE be consolidated into the financial statements of the enterprise that is considered the primary beneficiary. The consolidated financial statements include the accounts of the Company and all of its subsidiaries in which a controlling interest is maintained and would include any VIEs if the Company was the primary beneficiary pursuant to the provisions of the guidance.

Reclassifications: Certain reclassifications of prior years’ data have been made to improve comparability.

Translation of foreign currency: Assets and liabilities of non-U.S. subsidiaries and associated companies are translated into U.S. Dollars at the respective rates of exchange prevailing at the end of the year. Income and expense accounts are translated at average exchange rates prevailing during the year. Translation adjustments resulting from this process are recorded directly in equity and will be included in income only upon sale or liquidation of the underlying investment. All non-U.S. subsidiaries use their local currency as its functional currency.

Cash and cash equivalents: The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents.

Inventories: Inventories are valued at the lower of cost or market value. Inventories are valued using the first-in, first-out (“FIFO”) method. See also Note 8 of Notes to Consolidated Financial Statements.

Long-lived assets: Property, plant and equipment are stated at cost. Depreciation is computed using the straight-line method on an individual asset basis over the following estimated useful lives: buildings and improvements, 10 to 45 years; and machinery and equipment, 3 to 15 years. The carrying value of long-lived assets is periodically evaluated whenever changes in circumstances or current events indicate the carrying amount of such assets may not be recoverable. An estimate of undiscounted cash flows produced by the asset, or the appropriate group of assets, is compared with the carrying value to determine whether impairment exists. If necessary, the Company recognizes an impairment loss for the difference between the carrying amount of the assets and their estimated fair value. Fair value is based on current and anticipated future undiscounted cash flows. Upon sale or other dispositions of long-lived assets, the applicable amounts of asset cost and accumulated depreciation are removed from the accounts and the net amount, less proceeds from disposals is recorded to income. Expenditures for renewals and betterments, which increase the estimated useful life or capacity of the assets, are capitalized; expenditures for repairs and maintenance are expensed when incurred.

Capitalized software: The Company capitalizes certain costs incurred in connection with developing or obtaining software for internal use. In connection with the upgrade and implementations of the Company’s global transaction and consolidation systems, approximately $2,338 and $1,319 of net costs were capitalized at December 31, 2010 and 2009, respectively. These costs are amortized over a period of five years once the assets are ready for their intended use.

 

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QUAKER CHEMICAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Dollars in thousands except per share amounts)

 

Goodwill and other intangible assets: The Company records goodwill and indefinite-lived intangible assets at fair value at acquisition. Goodwill and indefinite-lived intangible assets are not amortized, but tested for impairment at least annually. These tests will be performed more frequently if there are triggering events. Definite-lived intangible assets are amortized over their estimated useful lives, generally for periods ranging from 5 to 20 years. The Company continually evaluates the reasonableness of the useful lives of these assets. See also Note 19 of Notes to Consolidated Financial Statements.

Revenue recognition: The Company recognizes revenue in accordance with the terms of the underlying agreements, when title and risk of loss have been transferred, collectability is reasonably assured, and pricing is fixed or determinable. This generally occurs for product sales when products are shipped to customers or, for consignment arrangements, upon usage by the customer and when services are performed. License fees and royalties are recognized in accordance with agreed-upon terms, when performance obligations are satisfied, the amount is fixed or determinable, and collectability is reasonably assured, and are included in other income. As part of the Company’s chemical management services, certain third-party product sales to customers are managed by the Company. Where the Company acts as principal, revenues are recognized on a gross reporting basis at the selling price negotiated with customers. Where the Company acts as an agent, such revenue is recorded using net reporting as service revenue at the amount of the administrative fee earned by the Company for ordering the goods. Third-party products transferred under arrangements resulting in net reporting totaled $56,528, $27,483 and $32,194 for 2010, 2009 and 2008, respectively.

Research and development costs: Research and development costs are expensed as incurred. Research and development expenses are included in selling, general and administrative expenses, and during 2010, 2009 and 2008 were $15,690, $14,991 and $16,877, respectively.

Concentration of credit risk: Financial instruments, which potentially subject the Company to a concentration of credit risk, principally consist of cash equivalents, short-term investments, and trade receivables. The Company invests temporary and excess funds in money market securities and financial instruments having maturities typically within 90 days. The Company has not experienced losses from the aforementioned investments. See also Note 7 of Notes to Consolidated Financial Statements.

Environmental liabilities and expenditures: Accruals for environmental matters are recorded when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated. If no amount in the range is considered more probable than any other amount, the Company records the lowest amount in the range in accordance with generally accepted accounting principles. Accrued liabilities are exclusive of claims against third parties and are not discounted. Environmental costs and remediation costs are capitalized if the costs extend the life, increase the capacity or improve safety or efficiency of the property from the date acquired or constructed, and/or mitigate or prevent contamination in the future.

Comprehensive income (loss): The Company presents comprehensive income (loss) in its Statement of Comprehensive (Loss) Income and Changes in Equity. The components of accumulated other comprehensive loss at December 31, 2010 include: accumulated foreign currency translation adjustments of $13,368, minimum pension liability of $(26,448), unrealized holding gains on available-for-sale securities of $11, and the fair value of derivative instruments of $(667). The components of accumulated other comprehensive loss at December 31, 2009 include: accumulated foreign currency translation adjustments of $13,232, minimum pension liability of $(22,293), unrealized holding losses on available-for-sale securities of $(3), and the fair value of derivative instruments of $(1,375).

 

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QUAKER CHEMICAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Dollars in thousands except per share amounts)

 

Income taxes and uncertain tax positions: The provision for income taxes is determined using the asset and liability approach of accounting for income taxes. Under this approach, deferred taxes represent the future tax consequences expected to occur when the reported amounts of assets and liabilities are recovered or paid. The provision for income taxes represents income taxes paid or payable for the current year plus the change in deferred taxes during the year. Deferred taxes result from differences between the financial and tax bases of the Company’s assets and liabilities and are adjusted for changes in tax rates and tax laws when changes are enacted. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized. The Company applies the FASB’s guidance regarding uncertain tax positions to all income tax positions taken on previously filed tax returns or expected to be taken on a future tax return. The guidance prescribes a benefit recognition model with a two-step approach, a more-likely-than-not recognition criterion, and a measurement attribute that measures the position as the largest amount of tax benefit that is greater than 50% likely of being realized upon effective settlement. The guidance also requires that the amount of interest expense and income to be recognized related to uncertain tax positions be computed by applying the applicable statutory rate of interest to the difference between the tax position recognized, including timing differences, and the amount previously taken or expected to be taken in a tax return. The Company’s continuing practice is to recognize interest and/or penalties related to income tax matters in income tax expense.

Derivatives: The Company uses derivative financial instruments primarily for purposes of hedging exposures to fluctuations in interest rates. The Company does not enter into derivative contracts for trading or speculative purposes. The Company recognizes all derivatives on the balance sheet at fair value. For derivative instruments designated as cash flow hedges, the effective portion of any hedge is reported in Accumulated Other Comprehensive Income (Loss) until it is cleared to earnings during the same period in which the hedged item affects earnings. The Company uses no derivative instruments designated as fair value hedges.

The Company has entered into interest rate swaps in order to fix a portion of its variable rate debt. The swaps had a combined notional value of $15,000 and $40,000 and a fair value of $(1,026) and $(2,160) at December 31, 2010 and December 31, 2009, respectively. The counterparties to the swaps are major financial institutions. Refer to Note 5—Hedging Activities for more information.

Recently issued accounting standards:

The FASB updated its guidance regarding a vendor’s multiple-deliverable arrangements in October 2009. The updated guidance establishes a selling price hierarchy to be followed in determining the selling price for each deliverable in multiple-deliverable arrangements, eliminates the residual method of allocation and requires that arrangement consideration be allocated at the inception of the arrangement using the relative selling price method and requires enhanced disclosure regarding multiple-deliverable arrangements. The guidance is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning after June 15, 2010. The Company is currently assessing the impact of this guidance on its financial statements.

Accounting estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, and disclosure of contingencies at the date of the financial statements and the reported amounts of net sales and expenses during the reporting period. Actual results could differ from such estimates.

Note 2—Restructuring and Related Activities

In the fourth quarter of 2008, Quaker’s management approved a restructuring plan (2008 4th Quarter Program) to reduce operating costs, primarily in North America and Europe. Included in the restructuring plans were provisions for severance for 57 employees. The Company recognized a $2,916 restructuring charge in the fourth

 

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QUAKER CHEMICAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Dollars in thousands except per share amounts)

 

quarter of 2008. Employee separation benefits varied depending on local regulations within certain foreign countries and included severance and other benefits. The Company completed the initiatives under this program during 2009.

In the first quarter of 2009, Quaker’s management implemented an additional restructuring program (2009 1st Quarter Program) which included provisions for severance for 60 employees totaling $2,289. The Company completed the initiatives under this program during 2009.

Note 3—Fair Value Measures

The FASB’s guidance regarding fair value measurements establishes a common definition for fair value to be applied to guidance requiring use of fair value, establishes a framework for measuring fair value, and expands disclosure about such fair value measurements. The guidance does not require any new fair value measurements, but rather applies to all other accounting guidance that requires or permits fair value measurements.

The guidance utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The following is a brief description of those three levels:

 

   

Level 1: Observable inputs such as quoted prices (unadjusted) in active markets for identical assets or liabilities.

 

   

Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.

 

   

Level 3: Unobservable inputs that reflect the reporting entity’s own assumptions.

The Company values its interest rate swaps, company-owned life insurance policies, various deferred compensation assets and liabilities at fair value and acquisition related contingent consideration at fair value. The Company’s assets and liabilities subject to fair value measurement are as follows (in thousands):

 

     Fair Value
as of
December 31,
2010
     Fair Value Measurements at December 31, 2010
Using Fair Value Hierarchy
 
       
            Level 1                  Level 2                  Level 3        

Assets

           

Company-owned life insurance

   $ 2,033       $ —         $ 2,033       $ —     

Company-owned life insurance—Deferred compensation assets

     593         —           593         —     

Other deferred compensation assets

           

Large capitalization registered investment companies

     69         69         —           —     

Mid capitalization registered investment companies

     4         4         —           —     

Small capitalization registered investment companies

     8         8         —           —     

International developed and emerging markets registered investment companies

     40         40         —           —     

Fixed income registered investment companies

     10         10         —           —     
                                   

Total

   $ 2,757       $ 131       $ 2,626       $ —     
                                   

 

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QUAKER CHEMICAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Dollars in thousands except per share amounts)

 

     Fair Value
as of
December 31,
2010
     Fair Value Measurements at December 31, 2010
Using Fair Value Hierarchy
 
       
      Level 1      Level 2      Level 3  

Liabilities

           

Deferred compensation liabilities

           

Large capitalization registered investment companies

   $ 347       $ 347       $ —         $ —     

Mid capitalization registered investment companies

     88         88         —           —     

Small capitalization registered investment companies

     71         71         —           —     

International developed and emerging markets registered investment companies

     213         213         —           —     

Fixed income registered investment companies

     52         52         —           —     

Fixed general account

     182         —           182         —     

Interest rate derivatives

     1,026         —           1,026         —     

Acquisition related contingent consideration

     5,350         —           —           5,350   
                                   

Total

   $ 7,329       $ 771       $ 1,208       $ 5,350   
                                   
     Fair Value
as of
December 31,
2009
     Fair Value Measurements at December 31, 2009
Using Fair Value Hierarchy
 
     
            Level 1                  Level 2                  Level 3        

Assets

           

Company-owned life insurance

   $ 1,869       $ —         $ 1,869       $ —     

Company-owned life insurance—Deferred compensation assets

     622         —           622         —     

Other deferred compensation assets

           

Large capitalization registered investment companies

     64         64         —           —     

Mid capitalization registered investment companies

     4         4         —           —     

Small capitalization registered investment companies

     7         7         —           —     

International developed and emerging markets registered investment companies

     39         39         —           —     

Fixed income registered investment companies

     11         11         —           —     
                                   

Total

   $ 2,616       $ 125       $ 2,491       $ —     
                                   

 

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QUAKER CHEMICAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Dollars in thousands except per share amounts)

 

     Fair Value
as of
December 31,
2009
     Fair Value Measurements at December 31, 2009
Using Fair Value Hierarchy
 
            Level 1                  Level 2                  Level 3        

Liabilities

           

Deferred compensation liabilities

           

Large capitalization registered investment companies

   $ 557       $ 557       $ —         $ —     

Mid capitalization registered investment companies

     98         98         —           —     

Small capitalization registered investment companies

     108         108         —           —     

International developed and emerging markets registered investment companies

     205         205         —           —     

Fixed income registered investment companies

     64         64         —           —     

Fixed general account

     184         —           184         —     

Interest rate derivatives

     2,160         —           2,160         —     
                                   

Total

   $ 3,376       $ 1,032       $ 2,344       $ —     
                                   

The fair values of Company-owned life insurance (“COLI”) and COLI deferred compensation assets are based on quotes for like instruments with similar credit ratings and terms. The fair values of Other deferred compensation assets and liabilities are based on quoted prices in active markets. The fair values of interest rate derivatives are based on quoted market prices from various banks for similar instruments. Upon review of the underlying assets upon which the deferred compensation liabilities are based, the Company reclassified the fixed general account from Level 1 to Level 2 as of December 31, 2009. The fair value of the acquisition related contingent consideration is based on unobservable inputs and is classified as Level 3. Significant inputs and assumptions are management’s estimate of the probability of the earnout ultimately being met/paid and the discount rate used to present value the liability.

Changes in the fair value of the Level 3 liability during the year ended December 31, 2010 was as follows:

 

     Contingent
Consideration
 

Balance at December 31, 2009

   $ —     

Purchases, sales, acquisitions and settlements, net

     5,350   

Realized gains

     —     

Unrealized gains

     —     
        

Balance at December 31, 2010

   $ 5,350   
        

Note 4—Uncertain Tax Positions

The FASB’s guidance regarding accounting for uncertainty in income taxes prescribes the recognition threshold and measurement attributes for financial statement recognition and measurement of tax positions taken or expected to be taken on a tax return. The guidance further requires the determination of whether the benefits of tax positions will be more likely than not sustained upon audit based upon the technical merits of the tax position. For tax positions that are determined to be more likely than not sustained upon audit, a company recognizes the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement in the financial

 

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QUAKER CHEMICAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Dollars in thousands except per share amounts)

 

statements. For tax positions that are not determined to be more likely than not sustained upon audit, a company does not recognize any portion of the benefit in the financial statements. Additionally, the guidance provides for derecognition, classification, penalties and interest, accounting in interim periods, disclosure and transition.

As of December 31, 2010, the Company’s cumulative liability for gross unrecognized tax benefits was $10,464. The Company had accrued $857 for cumulative penalties and $1,824 for cumulative interest at December 31, 2010.

The Company continues to recognize interest and penalties associated with uncertain tax positions as a component of Taxes on Income in its Consolidated Statement of Income. The Company has recognized $(12) for penalties and $80 for interest (net of expirations and settlements) on its Consolidated Statement of Income for the twelve-month period ended December 31, 2010.

The Company estimates that during the year ending December 31, 2011 it will reduce its cumulative liability for gross unrecognized tax benefits by approximately $1,400 to $1,600 due to the expiration of the statute of limitations with regard to certain tax positions. This estimated reduction in the cumulative liability for unrecognized tax benefits does not consider any increase in liability for unrecognized tax benefits with regard to existing tax positions or any increase in cumulative liability for unrecognized tax benefits with regard to new tax positions for the year ended December 31, 2011.

The Company and its subsidiaries are subject to U.S. Federal income tax, as well as the income tax of various state and foreign tax jurisdictions. Tax years that remain subject to examination by major tax jurisdictions include the Netherlands from 2004, United Kingdom, Brazil, Italy and Spain from 2006, China and the United States from 2007 and various domestic state tax jurisdictions from 1993.

During 2010, the Company derecognized several uncertain tax positions due to expiration of the applicable statutes of limitations for certain tax years. As a result, the Company recognized a $1,828 decrease in its cumulative liability for gross unrecognized tax benefits.

A reconciliation of the beginning and ending amounts of unrecognized tax benefits for the years ended December 31, 2010, 2009 and 2008, respectively, is as follows:

 

    2010     2009     2008  

Unrecognized tax benefits at January 1

  $ 10,686      $ 10,012      $ 10,861   

Increase unrecognized tax benefits taken in prior periods

    —          14        —     

(Decrease) unrecognized tax benefits taken in prior periods

    —          —          (115

Increase unrecognized tax benefits taken in current period

    2,249        1,272        1,824   

(Decrease) unrecognized tax benefits taken in current period

    —          —          —     

Increase unrecognized tax benefits due to settlements

    —          —          —     

(Decrease) unrecognized tax benefits due to settlements

    —          (402     (1,030

(Decrease) in unrecognized tax benefits due to lapse of statute of limitations

    (1,828     (422     (1,114

Increase (decrease)—foreign exchange rates

    (643     212        (414
                       

Unrecognized tax benefits at December 31

  $ 10,464      $ 10,686      $ 10,012   
                       

 

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QUAKER CHEMICAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Dollars in thousands except per share amounts)

 

Note 5—Hedging Activities

Effective January 1, 2009, the Company adopted FASB’s guidance regarding disclosure of derivative instruments and hedging activities. The guidance requires additional disclosure about the Company’s derivative activities, but does not require any new accounting related to derivative activities. The Company has applied the requirements of the guidance on a prospective basis. Accordingly, disclosures related to periods prior to the date of adoption have not been presented.

The Company is exposed to the impact of changes in interest rates, foreign currency fluctuations, changes in commodity prices and credit risk. The Company does not use derivative instruments to mitigate the risks associated with foreign currency fluctuations, changes in commodity prices or credit risk. Quaker uses interest rate swaps to mitigate the impact of changes in interest rates. The swaps are designated as cash flow hedges and reported on the Consolidated Balance Sheet at fair value. The effective portions of the hedges are reported in Other Comprehensive Income (“OCI”) until reclassified to earnings during the same period the hedged item affects earnings. The Company has no derivatives designated as fair value hedges and only has derivatives designated as hedging instruments under the FASB’s authoritative guidance. The notional amount of the Company’s interest rate swaps was $15,000 as of December 31, 2010, and $40,000 as of December 31, 2009.

Information about the Company’s interest rate derivatives is as follows:

 

          Fair Value  
    

Consolidated Balance Sheet
Location

   December 31,
2010
     December 31,
2009
 

Derivatives designated as cash flow hedges:

        

Interest rate swaps

   Other current liabilities    $ —         $ 1,006   

Interest rate swaps

   Other non-current liabilities      1,026         1,154   
                    
      $ 1,026       $ 2,160   
                    

Cash Flow Hedges

Interest Rate Swaps

 

          For the Years Ended
December 31,
 
          2010     2009  

Amount of Gain (Loss) Recognized in Accumulated OCI on Derivative (Effective Portion)

      $ 708      $ 642   
                   

Amount and Location of Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion)

   Interest Expense    $ (1,590   $ (1,594
                   

Amount and Location of Gain (Loss) Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing)

   Other Income    $ —        $ —     
                   

 

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QUAKER CHEMICAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Dollars in thousands except per share amounts)

 

Note 6—Investments in Associated Companies

Investments in associated (less than majority-owned) companies are accounted for under the equity method. The Company has a 50% investment in Kelko Quaker Chemical, S.A. (Venezuela), a 50% investment in Nippon Quaker Chemical, Ltd. (Japan), a 40% investment in TecniQuimia Mexicana S.A. de C.V. (Mexico) and a 50% investment in Kelko Quaker Chemical S.A. (Panama).

Effective January 1, 2010, Venezuela’s economy was considered to be highly inflationary under U.S. generally accepted accounting principles since it has experienced a rate of general inflation in excess of 100% over the latest three-year period, based upon the blended Consumer Price Index and National Consumer Price Index. Accordingly, all gains and losses resulting from the remeasurement of the Company’s Venezuelan 50% owned equity affiliate (Kelko Quaker Chemical, S.A.) are required to be recorded directly in the Consolidated Statement of Income. On January 8, 2010, the Venezuelan government announced the devaluation of the Bolivar Fuerte and the establishment of a two-tier exchange structure. The Company recorded a charge in the first quarter of 2010 of approximately $0.03 per diluted share to reflect the devaluation.

During the fourth quarter of 2010, the Company identified errors in reserves for pension and certain other items at its TecniQuimia Mexicana S.A. de C.V. affiliate. The affiliate adjusted for these items in the fourth quarter of 2010, which had the effect of reducing Equity Income and Net Income by $564 in the fourth quarter and year-to-date periods of 2010. The Company does not believe this adjustment is material to the Consolidated Financial Statements for the years ended December 31, 2007, 2008, 2009 or 2010 and, therefore, has not restated any prior period amounts.

Summarized financial information of the associated companies, in the aggregate, is as follows:

 

     December 31,  
     2010      2009  

Current assets

   $ 34,830       $ 29,739   

Noncurrent assets

     5,689         5,072   

Current liabilities

     17,581         14,572   

Noncurrent liabilities

     4,333         494   

 

     Year Ended December 31,  
     2010      2009      2008  

Net sales

   $ 65,592       $ 52,099       $ 60,407   

Gross margin

     24,810         20,215         20,072   

Operating income

     5,211         4,508         3,456   

Net income

     1,071         1,856         806   

Note 7—Accounts Receivable and Allowance for Doubtful Accounts

Trade accounts receivable are recorded at the invoiced amount and generally do not bear interest. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in existing accounts receivable. Reserves for customers filing for bankruptcy protection are dependent on the Company’s evaluation of likely proceeds from the bankruptcy process. Large and/or financially distressed customers are generally reserved for on a specific review basis while a general reserve is established for other customers based on historical experience. The Company performs a formal review of its allowance for doubtful accounts quarterly. Account balances are charged off against the allowance when the Company feels it is

 

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QUAKER CHEMICAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Dollars in thousands except per share amounts)

 

probable the receivable will not be recovered. The Company does not have any off-balance-sheet credit exposure related to its customers. During 2010, the Company’s five largest customers accounted for approximately 20% of its consolidated net sales with the largest customer (Arcelor-Mittal Group) accounting for approximately 9% of consolidated net sales.

At December 31, 2010 and 2009, the Company had gross trade accounts receivable totaling $120,544 and $112,795 with trade accounts receivable greater than 90 days past due of $4,924 and $4,928, respectively. Following are the changes in the allowance for doubtful accounts during the years ended December 31, 2010, 2009 and 2008.

 

     Balance at
Beginning
of Period
     Charged
to Costs
and
Expenses
     Write-Offs
Charged  to
Allowance
    Effect of
Exchange
Rate
Changes
    Balance
at End
of Period
 

ALLOWANCE FOR DOUBTFUL ACCOUNTS

               

Year ended December 31, 2010

   $ 4,002       $ 860       $ (538   $ (46      $ 4,278   

Year ended December 31, 2009

   $ 3,508       $ 1,389       $ (918   $ 23         $ 4,002   

Year ended December 31, 2008

   $ 3,072       $ 1,087       $ (505   $ (146      $ 3,508   

Note 8—Inventories

Total inventories comprise:

 

     December 31,  
     2010      2009  

Raw materials and supplies

   $ 31,909       $ 23,495   

Work in process and finished goods

     28,932         26,545   
                 
   $ 60,841       $ 50,040   
                 

Note 9—Other Current Liabilities

Other current liabilities comprise:

 

     December 31,  
     2010      2009  

Non-income taxes

   $ 6,100       $ 3,866   

Current portion of uncertain tax positions

     2,161         2,767   

Income taxes payable

     1,693         595   

Professional fees

     1,615         1,304   

Freight

     1,229         1,099   

Legal

     1,211         1,051   

Current portion of interest rate swaps

     —           1,006   

Selling expenses

     1,110         947   

Other

     2,296         2,589   
                 

Total

   $ 17,415       $ 15,224   
                 

 

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QUAKER CHEMICAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Dollars in thousands except per share amounts)

 

Note 10—Property, Plant and Equipment

Property, plant and equipment comprise:

 

     December 31,  
     2010     2009  

Land

   $ 6,458      $ 6,185   

Building and improvements

     69,233        52,227   

Machinery and equipment

     124,043        117,527   

Construction in progress

     5,625        15,041   
                
     205,359        190,980   

Less accumulated depreciation

     (128,824     (123,554
                
   $ 76,535      $ 67,426   
                

The Company leases certain equipment under capital leases in Europe, South America and the U.S., including its manufacturing facility in Tradate, Italy. Gross property, plant and equipment includes $4,454 and $3,938 of capital leases with $1,020 and $807 of accumulated depreciation at December 31, 2010 and 2009, respectively. The following is a schedule by years of future minimum lease payments:

 

For the year ended December 31,

      

2011

   $ 570   

2012

     404   

2013

     246   

2014

     64   

2015

     64   

2016 and beyond

     123   
        

Total net minimum lease payments

     1,471   

Less amount representing interest

     (198
        

Present value of net minimum lease payments

   $ 1,273   
        

Note 11—Asset Retirement Obligations

The FASB’s guidance regarding asset retirement obligations addresses the accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated retirement costs. The FASB issued further guidance which clarified that the term conditional asset retirement obligation (“CARO”) refers to a legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the entity. A liability is recorded when there is enough information regarding the timing of the CARO to perform a probability weighted discounted cash flow analysis.

The Company’s CAROs consist primarily of asbestos contained in certain manufacturing facilities and decommissioning costs related to its aboveground storage tanks and had an accrued CARO of $320 and $306 at December 31, 2010 and 2009, respectively. The Company accrued interest of $14 on this liability, which is included in other non-current liabilities, during each of the years 2010 and 2009.

 

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QUAKER CHEMICAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Dollars in thousands except per share amounts)

 

Note 12—Taxes on Income

Taxes (benefit) on income consist of the following:

 

     Year Ended December 31,  
     2010      2009     2008  

Current:

       

Federal

   $ 1,429       $ 1,266      $ 211   

State

     195         133        20   

Foreign

     9,143         6,171        3,732   
                         
     10,767         7,570        3,963   

Deferred:

       

Federal

     1,204         (948     355   

Foreign

     645         443        659   
                         

Total

   $ 12,616       $ 7,065      $ 4,977   
                         

The components of earnings (losses) before income taxes were as follows:

 

     2010      2009     2008  

Domestic

   $ 9,482       $ (1,920   $ 1,960   

Foreign

     36,731         25,612        14,669   
                         

Total

   $ 46,213       $ 23,692      $ 16,629   
                         

Total deferred tax assets and liabilities are composed of the following at December 31:

 

     2010     2009 *  
     Current     Non-current     Current     Non-current  

Retirement benefits

   $ 534      $ 7,720      $ 1,599      $ 5,865   

Allowance for doubtful accounts

     550        —          481        —     

Insurance and litigation reserves

     574        395        484        541   

Postretirement benefits

     —          2,447        —          2,110   

Supplemental retirement benefits

     —          1,811        —          2,408   

Performance incentives

     3,041        418        2,562        335   

Equity-based compensation

     185        411        248        888   

Alternative minimum tax carryforward

     —          2,092        —          2,092   

Insurance settlement

     —          10,314        —          9,096   

Operating loss carryforward

     —          3,837        —          5,972   

Foreign tax credit

     —          3,395        —          3,801   

Uncertain tax positions

     163        3,871        —          4,034   

Interest rate swaps and other

     —          511        786        352   
                                
     5,047        37,222        6,160        37,494   

Valuation allowance

     (393     (4,530     (612     (5,054
                                

Total deferred income tax assets, net

   $ 4,654      $ 32,692      $ 5,548      $ 32,440   
                                

Depreciation

   $ —        $ 1,798      $ —        $ 2,110   

Europe pension and other

     —          2,472        —          2,394   

Amortization and other

     211        5,684        238       4,912   
                                

Total deferred income tax liabilities

   $ 211      $ 9,954      $ 238     $ 9,416   
                                

 

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QUAKER CHEMICAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Dollars in thousands except per share amounts)

 

Following are the changes in the Company’s deferred tax asset valuation allowance for the years ended December 31, 2010, 2009 and 2008:

 

     Balance at
Beginning
of Period
     Additional
Valuation
Allowance
     Allowance
Utilization
and Other
    Effect of
Exchange
Rate
Changes
    Balance
at End
of Period
 

VALUATION ALLOWANCE

               

Year ended December 31, 2010

   $ 5,666       $ 38       $ (769   $ (12      $ 4,923   

Year ended December 31, 2009

   $ 5,228       $ 1,397       $ (1,188   $ 229         $ 5,666   

Year ended December 31, 2008

   $ 4,161       $ 1,273       $ (2   $ (204      $ 5,228   

The Company’s net deferred tax assets and liabilities are classified in the Consolidated Balance Sheet as follows:

 

     2010      2009 *  

Current deferred tax assets

   $ 4,624       $ 5,523   

Non-current deferred tax assets

     28,846         28,237   

Current deferred tax liabilities

     181         213   

Non-current deferred tax liabilities

     6,108         5,213   
                 

Net deferred tax asset

   $ 27,181       $ 28,334   
                 

The following is a reconciliation of income taxes at the Federal statutory rate with income taxes recorded by the Company for the years ended December 31:

 

     2010     2009 *     2008  

Income tax provision at the Federal statutory tax rate

   $ 16,175      $ 8,292      $ 5,820   

Differences in tax rates on foreign earnings and remittances

     (2,546     (2,106     (132

Foreign dividends

     15,645        159        —     

Excess foreign tax credit utilization

     (15,198     —          —     

Foreign tax refunds

     —          —          (460

Uncertain tax positions

     (1,130     457        (494

Domestic production activities deduction

     (932     —          —     

State income tax provisions, net

     127        86        13   

Non-deductible entertainment and business meals expense

     152        118        192   

Miscellaneous items, net

     323        59        38   
                        

Taxes on income

   $ 12,616      $ 7,065      $ 4,977   
                        

 

* During the fourth quarter of 2010, the Company identified errors in the methodology of recording its net deferred tax assets and liabilities on its Consolidated Balance Sheet. The Company corrected for this item in the fourth quarter of 2010, and reclassified its prior year deferred tax balances to conform to the current year presentation. The Company does not believe this adjustment is material to the Consolidated Financial Statements for the years ended 2009 or 2010.

At December 31, 2010, the Company domestically had a net deferred tax asset of $14,835 inclusive of alternative minimum tax (AMT) credits of $2,092. Additionally, the Company has foreign tax credit carryovers

 

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QUAKER CHEMICAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Dollars in thousands except per share amounts)

 

of $3,395 which have the following expiration dates: $129 in 2014, $730 in 2016, $1,023 in 2017, $594 in 2018 and $919 in 2019. A full valuation allowance has been taken against these foreign tax credits. Finally, the Company has foreign tax loss carryforwards of $13,646 of which $330 expires in 2011, $460 in 2014, $351 in 2015, $3,157 in 2018, $184 in 2019, $102 in 2020 and $1,067 in 2023; the remaining foreign tax losses have no expiration dates. A partial valuation allowance has been established with respect to the tax benefit of these losses for $1,528.

U.S. income taxes have not been provided on the undistributed earnings of non-U.S. subsidiaries because it is the Company’s intention to continue to reinvest these earnings in those subsidiaries to support growth initiatives. U.S. and foreign income taxes that would be payable if such earnings were distributed may be lower than the amount computed at the U.S. statutory rate due to the availability of tax credits. The amount of such undistributed earnings at December 31, 2010 was approximately $91,000. Any income tax liability which might result from ultimate remittance of these earnings is expected to be substantially offset by foreign tax credits.

Note 13—Pension and Other Postretirement Benefits

The Company maintains various noncontributory retirement plans, the largest of which is in the U.S., covering substantially all of its employees in the U.S. and certain other countries. The plans of the Company’s subsidiaries in The Netherlands and in the United Kingdom are subject to the provisions of FASB’s guidance regarding employers’ accounting for pension plans. The plans of the remaining non-U.S. subsidiaries are, for the most part, either fully insured or integrated with the local governments’ plans and are not subject to the provisions of the guidance. The guidance requires that employers recognize on a prospective basis the funded status of their defined benefit pension and other postretirement plans on their consolidated balance sheet and recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost. The Company’s U.S. pension plan year ends on November 30 and the measurement date is December 31. The measurement date for the Company’s other postretirement benefits plan is December 31.

 

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QUAKER CHEMICAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Dollars in thousands except per share amounts)

 

The following table shows the Company plans’ funded status reconciled with amounts reported in the consolidated balance sheet as of December 31:

 

    Pension Benefits     Other
Postretirement
Benefits
 
    2010     2009     2010     2009  
    Foreign     Domestic     Total     Foreign     Domestic     Total     Domestic     Domestic  

Change in benefit obligation

               

Benefit obligation at beginning of year

  $ 47,444      $ 62,432      $ 109,876      $ 43,577      $ 66,808      $ 110,385      $ 7,576      $ 9,648   

Service cost

    1,606        368        1,974        1,776        342        2,118        16        15   

Interest cost

    2,587        3,385        5,972        2,545        3,848        6,393        401        445   

Employee contributions

    89        —          89        84        —          84        —          —     

Curtailment (gain)/loss

    —          (5     (5     (12     —          (12     —          —     

Benefits paid

    (1,407     (7,384     (8,791     (1,338     (10,884     (12,222     (924     (966

Plan expenses and premiums paid

    (356     (175     (531     (382     (175     (557     —          —     

Actuarial (gain)/loss

    6,310        4,504        10,814        (526     2,493        1,967        746        (1,566

Translation difference

    (3,023     —          (3,023     1,720        —          1,720        —          —     
                                                               

Benefit obligation at end of year

  $ 53,250      $ 63,125      $ 116,375      $ 47,444      $ 62,432      $ 109,876      $ 7,815      $ 7,576   
                                                               

Change in plan assets

               

Fair value of plan assets at beginning of year

  $ 50,176      $ 41,690      $ 91,866      $ 43,432      $ 34,716      $ 78,148      $ —        $ —     

Actual return on plan assets

    4,344        4,601        8,945        2,993        6,732        9,725        —          —     

Employer contributions

    3,362        4,371        7,733        3,786        11,301        15,087        924        966   

Employee contributions

    89        —          89        84        —          84        —          —     

Benefits paid

    (1,407     (7,384     (8,791     (1,338     (10,884     (12,222     (924     (966

Plan expenses and premiums paid

    (356     (175     (531     (382     (175     (557     —          —     

Translation difference

    (3,335     —          (3,335     1,601        —          1,601        —          —     
                                                               

Fair value of plan assets at end of year

  $ 52,873      $ 43,103      $ 95,976      $ 50,176      $ 41,690      $ 91,866      $ —        $ —     
                                                               

Net amount recognized

  $ (377   $ (20,022   $ (20,399   $ 2,732      $ (20,742   $ (18,010   $ (7,815   $ (7,576
                                                               

Amounts recognized in the balance sheet consist of:

               

Non-current asset

  $ 3,474      $ —        $ 3,474      $ 6,733      $ —        $ 6,733      $ —        $ —     

Current liabilities

    (262     (587     (849     (240     (3,675     (3,915     (823     (802

Non-current liabilities

    (3,589     (19,435     (23,024     (3,761     (17,067     (20,828     (6,992     (6,774
                                                               

Net amount recognized

  $ (377   $ (20,022   $ (20,399   $ 2,732      $ (20,742   $ (18,010   $ (7,815   $ (7,576
                                                               

Amounts not yet reflected in net periodic benefit costs and included in accumulated other comprehensive income:

               

Transition asset (obligation)

  $ —        $ —        $ —        $ 4      $ —        $ 4      $ —        $ —     

Prior service credit (cost)

    (123     (624     (747     (165     (728     (893     —          —     

Accumulated gain (loss)

    (8,725     (27,121     (35,846     (4,882     (26,664     (31,546     (1,951     (1,266
                                                               

Accumulated other comprehensive income (AOCI)

    (8,848     (27,745     (36,593     (5,043     (27,392     (32,435     (1,951     (1,266

Cumulative employer contributions in excess of net period benefit cost

    8,471        7,723        16,194        7,775        6,650        14,425        (5,864     (6,310
                                                               

Net amount recognized

  $ (377   $ (20,022   $ (20,399   $ 2,732      $ (20,742   $ (18,010   $ (7,815   $ (7,576
                                                               

 

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QUAKER CHEMICAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Dollars in thousands except per share amounts)

 

The accumulated benefit obligation for all defined benefit pension plans was $112,505 ($62,755 Domestic, $49,750 Foreign) and $105,447 ($62,072 Domestic, $43,375 Foreign) at December 31, 2010 and 2009, respectively.

Information for pension plans with accumulated benefit obligation in excess of plan assets:

 

     2010      2009  
     Foreign      Domestic      Total      Foreign      Domestic      Total  

Projected benefit obligation

   $ 11,390       $ 63,125       $ 74,515       $ 10,855       $ 62,432       $ 73,287   

Accumulated benefit obligation

     10,007         62,755         72,762         9,237         62,072         71,309   

Fair value of plan assets

     7,540         43,103         50,643         6,854         41,690         48,544   

Information for pension plans with a projected benefit obligation in excess of plan assets:

 

     2010      2009  
     Foreign      Domestic      Total      Foreign      Domestic      Total  

Projected benefit obligation

   $ 11,390       $ 63,125       $ 74,515       $ 10,855       $ 62,432       $ 73,287   

Fair value of plan assets

     7,540         43,103         50,643         6,854         41,690         48,544   

Components of net periodic benefit cost—pension plans:

 

     2010     2009  
     Foreign     Domestic     Total     Foreign     Domestic     Total  

Service cost

   $ 1,606      $ 368      $ 1,974      $ 1,776      $ 342      $ 2,118   

Interest cost

     2,587        3,385        5,972        2,545        3,848        6,393   

Expected return on plan assets

     (2,135     (3,307     (5,442     (1,969     (2,886     (4,855

Settlement charge

     —          1,317        1,317        —          2,443        2,443   

Curtailment charge

     —          19        19        —          —          —