form10k.htm



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, 2012
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   x     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.   ¨

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 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, 2012): $593,424,846

Indicate the number of shares outstanding of each of the Registrant’s classes of common stock as of the latest practicable date: 13,096,116 shares of Common Stock, $1.00 Par Value, as of February 28, 2013.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held on May 8, 2013 are incorporated by reference into Part III.
 



 
 

 

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; (xi) die casting lubricants and (xii) 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:
 

     
2012 
   
2011 
   
2010 
   
 
Rolling Lubricants
 
20.7 
%
 
22.0 
%
 
21.2 
%
 
 
Machining and grinding compounds
 
17.6 
%
 
18.8 
%
 
20.3 
%
 
 
Hydraulic fluids
 
13.5 
%
 
12.9 
%
 
13.7 
%
 
 
Corrosion preventives
 
12.4 
%
 
11.5 
%
 
11.5 
%
 

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 distributors 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 $39.3 million, $50.9 million and $56.5 million for 2012, 2011 and 2010, respectively. The Company recognizes revenue in accordance with the terms of the underlying agreements, when title and risk of loss have been transferred, when collectability is reasonably assured, and when pricing is fixed or determinable. This generally occurs for product sales when products are shipped to customers or, for consignment-type arrangements, upon usage by the customer and, for services, when they are performed. License fees and royalties are included in other income when recognized in accordance with agreed-upon terms, when performance obligations are satisfied, when the amount is fixed or determinable, and when collectability is reasonably assured.
 
In July 2012, the Company acquired NP Coil Dexter Industries, S.r.l., for approximately $2.7 million.  NP Coil Dexter is a European manufacturer and supplier of metal surface treatment products.  In July 2011, the Company acquired the remaining 60% ownership interest in Tecniquimia Mexicana, S.A. de C.V., its Mexican affiliate, for approximately $10.5 million.  The acquisition of Tecniquimia allowed the Company to further capitalize on the growing Mexican market.  Also, in October 2011, the Company acquired G.W. Smith & Sons, Inc. for approximately $14.5 million.  G.W. Smith is a manufacturer and distributor of high quality die casting lubricants and metalworking fluids.
 
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 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.
 
 
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Major Customers and Markets
 
In 2012, Quaker’s five largest customers (each composed of multiple subsidiaries or divisions with semi-autonomous purchasing authority) accounted for approximately 19% 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 2012, 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.
 
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 facilities in Conshohocken, Pennsylvania, Santa Fe Springs, California, Batavia, New York, Uithoorn, The Netherlands, Rio De Janiero, Brazil and Qingpu, China that are devoted primarily to applied research and development.
 
Research and development costs are expensed as incurred. Research and development expenses during 2012, 2011 and 2010 were $20.0 million, $18.8 million and $15.7 million, respectively.
 
Most of Quaker’s subsidiaries and associated companies also have laboratory facilities. Although not as complete as the Conshohocken, Santa Fe Springs, Batavia, Uithoorn, Rio De Janiero 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. Capital expenditures directed solely or primarily to regulatory compliance amounted to approximately $1.0 million, $1.0 million and $0.7 million in 2012, 2011 and 2010, respectively. In 2013, the Company expects to incur approximately $1.4 million for capital expenditures directed primarily to regulatory compliance.
 
Number of Employees
 
On December 31, 2012, Quaker’s consolidated companies had 1,711 full-time employees of whom 546 were employed by the parent company and its U.S. subsidiaries and 1,165 were employed by its non-U.S. subsidiaries. Associated companies of Quaker (in which it owns less than 50% and has significant influence) employed 65 people on December 31, 2012.
 

 
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Product Classification
 
The Company organizes its segments by the nature of the product sold.  The Company’s reportable segments are as follows:
 
·  
Metalworking process chemicals — generally includes industrial process fluids for various heavy industrial and manufacturing applications.
 
·  
Coatings — generally includes temporary and permanent coatings for metal and concrete products and chemical milling maskants.
 
·  
Other chemical products—other various chemical products.
 
Incorporated by reference is the segment information contained in Note 15 of Notes to Consolidated Financial Statements included in Item 8 of this Report.
 
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 15 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-K, 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 2012, 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 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 products and services is largely derived from the demand for its customers’ products, which subjects

 
3

 
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, terrorist attacks and other acts of violence, 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.  In an effort to mitigate such risks, the Company utilizes retention bonuses, offers competitive pay and maintains continued succession planning, but there can be no assurance that these mitigating factors will be adequate to attract or retain qualified management 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 compounds, and a wide variety of other organic and inorganic compounds. In 2012, 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. 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 while retaining customers, there can be no assurance that the Company can continue to recover raw material costs or retain customers in the future. 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.
 

 
4

 

Availability of raw materials, including sourcing from some single suppliers and some suppliers in volatile economic environments, 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 and/or suppliers in economies that have experienced instability. 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.  In addition, the Company’s raw materials are subject to various regulatory laws, and a change in the ability to legally use such raw materials may impact Quaker’s 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 steel and automotive industries, including some of our larger customers, where a number of bankruptcies have occurred in the past 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 2012, our five largest customers (each composed of multiple subsidiaries or divisions with semi-autonomous purchasing authority) together accounted for approximately 19% of our consolidated net sales, with the largest customer (Arcelor-Mittal Group) accounting for approximately 9% of consolidated net sales.
 
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, 2012, the Company had $12.2 million outstanding under its credit facilities. The Company had, in previous years, 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, which matured during 2012.
 
Failure to generate taxable income could have a material adverse effect on our financial position and results of operations.
 
At December 31, 2012, the Company had net U.S. deferred tax assets totaling $13.9 million, excluding deferred tax assets relating to additional minimum pension liabilities. In addition, at that date, the Company had $12.6 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.
 

 
5

 

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 20 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 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.
 
An inability to capitalize on prior or future acquisitions may adversely affect the Company’s liquidity, financial position and results of operations.
 
 Quaker has completed several acquisitions in the past and may continue to seek acquisitions to grow business.  Success of the acquisitions depends on the Company’s ability to:
 
 
successfully execute the integration or consolidation of the acquired operations into existing businesses,
 
develop or modify the financial reporting and information systems of the acquired entity to ensure overall financial integrity and adequacy of internal control procedures,
 
identify and take advantage of cost reduction opportunities, and
 
further penetrate existing markets with the product capabilities acquired.
 
The Company may fail to derive significant benefits from such transactions, which could have a material adverse affect on liquidity, financial position and results of operations.  Also, if the Company fails to achieve sufficient financial performance from an acquisition, certain long-lived assets, such as property, plant and equipment and goodwill and other intangible assets, could become impaired and result in the recognition of an impairment loss.
 
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 60% 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 15 of Notes to Consolidated Financial Statements included in Item 8 of this Report.
 

 
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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.
 
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, similar to the recent instability in certain European economies,
  
 
changes in a country’s political condition, such as the current political unrest in the Middle East,
 
 
trade protection measures,
  
 
longer payment cycles,
   
 
licensing and other legal requirements,
  
 
restrictions on the repatriation of our assets, including 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.

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.    See Note 20 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, natural disasters, cybersecurity incidents or other uncommon global events may affect the markets in which we operate and our profitability.
 
Terrorist attacks, other acts of violence or war, natural disasters, cybersecurity incidents or other uncommon global events may negatively affect our operations. There can be no assurance that there will not be further terrorist attacks against the U.S. or other locations where we do business. Also, other uncommon global events, such as earthquakes, fires and tsunami, cannot be predicted.  Terrorist attacks, other acts of violence or armed conflicts, and natural disasters may directly impact our physical facilities or those of our suppliers or customers. Additional terrorist attacks or natural disasters 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.  Failure to effectively prevent, detect and recover from breaches in the Company’s cybersecurity infrastructure could also negatively impact the Company’s results of operation through the loss of Company assets, business disruptions or other adverse consequences resulting from other misuses of the Company’s information technology.  The consequences of terrorist attacks, other acts of violence or armed conflicts, natural disasters, cybersecurity incidents or other uncommon global events can be unpredictable, and we may not be able to foresee events, such as these, 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; Dayton, Ohio; Monterrey, N.L., Mexico; Uithoorn, The Netherlands; Santa Perpetua de Mogoda, Spain; Rio de Janeiro, Brazil; Tradate, Italy; Gorgonzola, Italy and Qingpu, China. All of the properties, except 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 Gorgonzola sites, which are leased, all of these principal facilities are owned by Quaker and, as of December 31, 2012, were mortgage free. Quaker also leases sales, laboratory, manufacturing, and warehouse facilities in other locations.
 

 
7

 

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 2 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 non-U.S. associated companies (in which it owns a less than 50% interest and has significant influence) owns or leases a plant and/or sales facilities in various locations, with the exception of Primex, Ltd.

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 20 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.
Mine Safety Disclosures.

Not Applicable
 

 
8

 

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 Ms. Loebl) 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, 54
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 January 2004 through June 2005 and Vice President and Chief Financial Officer from 1998 to August 2004.
     
Margaret M. Loebl, 53
    Vice President, Chief Financial Officer
    and Treasurer
  
Ms. Loebl joined the Company on June 29, 2012 as Vice President, Chief Financial Officer and Treasurer.  Prior to joining the Company, Ms. Loebl, from August 2011 to December 2011, provided senior executive-level financial consulting services in Paris, France, for Constellium, a leader in the manufacturing of high-quality aluminum products and solutions.  Prior to joining Constellium, she served from October 2008 through December 2010 as Corporate Vice President, Chief Financial Officer and Treasurer of TechTeam Global, Inc., a provider of information technology and business process outsourcing services.  Ms. Loebl served as an Executive in Residence at the University of Illinois in support of the University’s Finance Academy from August 2007 to December 2008.  From November 2002 through August 2007, Ms. Loebl served as Group Vice President, Finance at Archer Daniels Midland Company, a leading agricultural processor.
 
     
D. Jeffry Benoliel, 54
    Vice President – Global Metalworking and Fluid
    Power and Corporate Secretary
  
Mr. Benoliel, who has been employed by the Company since 1995, has served as Vice-President – Global Metalworking and Fluid Power and Corporate Secretary since June 2011 and until March 15, 2012 also held the position of General Counsel.  He served as Vice President-Global Strategy, General Counsel and Corporate Secretary from October 2008 until June 2011 and as Vice President, Secretary and General Counsel from 2001 through September 2008.
     
Joseph A. Berquist, 41
    Vice President and Managing
    Director – North America
 
Mr. Berquist, who has been employed by the Company since 1997, has served as Vice President and Managing Director – North America since April 2010.  He served as Senior Director, North America Commercial from October 2008 through March 2010 and as Industry Business Director - Metalworking/Fluid Power from July 2006 through September 2008.
     
Ronald S. Ettinger, 60
Vice President – Human Resources
 
Mr. Ettinger, who has been employed by the Company since 2002, has served as Vice President-Human Resources since December 2011.  He served as Director-Global Human Resources from August 2005 to November 2011.

 
9

 


Name, Age, and Present
Position with the Company
  
Business Experience During Past Five
Years and Period Served as an Officer
     
George H. Hill, 38
Global Controller
 
Mr. Hill, who has been employed by the Company since 2002, has served in his current position since April 2007.
 
     
Dieter Laininger, 50
Vice President and Managing
Director – South America
and Global Primary Metals
 
Mr. Laininger, who has been employed by the Company since 1991, was appointed Vice President and Managing Director – South America, effective January 16, 2013, in addition to his position as Vice President-Global Primary Metals, to which he was appointed effective June 2011.  He served as Industry Business Manager for Steel and Metalworking – EMEA from March 2001 through July 2011.
 
     
Joseph F. Matrange, 71
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, 52
Vice President and Managing
Director – Asia/Pacific
  
Mr. Nieman, who has been employed by the Company since 1992, has served in his current position since February 2005.
     
Wilbert Platzer, 51
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.

 
10

 

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
 
Dividends
 
 
2012
 
2011
 
Declared
 
Paid
 
 
High
 
Low
 
High
 
Low
 
2012
 
2011
 
2012
 
2011
 
First quarter
$ 48.15   $ 35.82   $ 44.39   $ 35.00   $ 0.24   $ 0.235   $ 0.24   $ 0.235  
Second quarter
  46.59     37.86     46.02     38.57     0.245     0.24     0.24     0.235  
Third quarter
  50.55     40.21     44.98     25.31     0.245     0.24     0.245     0.24  
Fourth quarter
  54.00     45.07     40.87     24.11     0.245     0.24     0.245     0.24  

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, 2013, there were 1,003 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, 2013, 13,095,923 shares of Quaker common stock were issued and outstanding. Based on the information available to the Company on January 17, 2013, as of that date the holders of 770,844 shares of Quaker common stock would have been entitled to cast ten votes for each share, or approximately 38% of the total votes that would have been entitled to be cast as of that record date and the holders of 12,325,079 shares of Quaker common stock would have been entitled to cast one vote for each share, or approximately 62% 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, 2013 could be more than 20,033,519.
 
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.
 
 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
           
(c)
(d)
           
Total Number of
Maximum Number
 
(a)
 
(b)
 
Shares Purchased
of Shares that May
 
Total Number
 
Average
 
as part of Publicly
Yet Be Purchased
 
of Shares
 
Price Paid
 
Announced Plans
Under the Plans
Period
Purchased (1)
 
per Share (2)
 
or Programs (3)
or Programs (3)
October 1 - October 31
— 
 
$
— 
 
— 
252,600 
November 1 - November 30
5,378 
   
51.38 
 
— 
252,600 
December 1 - December 31
— 
   
— 
 
— 
252,600 
Total
5,378 
 
$
51.38 
 
— 
252,600 

(1)  
All of the 5,378 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 or, also, for the payment of taxes related to the exercise of employee stock options.
 

 
11

 

(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, in each case 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.
 
The following graph compares the cumulative total return (assuming reinvestment of dividends) from December 31, 2007 to December 31, 2012  for (i) Quaker’s common stock, (ii) the S&P SmallCap 600 Index (the “SmallCap Index”), (iii) the S&P 600 Specialty Chemicals Index (the “Specialty Chemicals Index”), and (iv) the S&P 600 Materials Group Index (the “Materials Group Index”).  We are replacing the Specialty Chemicals Index with the Materials Group Index in subsequent years, because the Materials Group Index is used as a market metric to determine the cash portion of the payouts earned under the Company’s Long-Term Performance Incentive Plan.  The graph assumes the investment of $100 on December 31, 2007 in each of Quaker’s common stock, the stocks comprising the SmallCap Index, the stocks comprising the Specialty Chemicals Index, and the stocks comprising the Materials Group Index.
 
 
 
   
12/31/2007
   
12/31/2008
   
12/31/2009
   
12/31/2010
   
12/31/2011
   
12/31/2012
 
Quaker
  $ 100.00     $ 77.75     $ 103.92     $ 216.94     $ 207.40     $ 293.34  
SmallCap Index
    100.00       68.93       86.55       109.32       110.43       128.46  
Specialty Chemicals Index
    100.00       62.81       98.39       121.63       113.69       146.36  
Materials Group Index
    100.00       52.15       77.28       91.40       83.85       105.06  

 
12

 

Item 6.
Selected Financial Data.

The following table sets forth selected financial data for the Company and its consolidated subsidiaries:
 
   
Year Ended December 31,
 
   
2012 (2)
   
2011 (3)
   
2010 (4)
   
2009 (5)
   
2008 (6)
 
         
(re-cast)
   
(re-cast)
   
(re-cast)
   
(re-cast)
 
Summary of Operations (1):
                             
Net sales
  $ 708,226     $ 683,231     $ 544,063     $ 451,490     $ 581,641  
Income before taxes and equity in net income of associated companies
    62,948       59,377       46,213       23,692       16,629  
Net income attribuatable to Quaker Chemical Corporation
    47,405       45,892       32,120       16,058       9,833  
Per share:
                                       
  Net income attributable to Quaker Chemical Corporation
                                       
Common Shareholders - basic
  $ 3.64     $ 3.71     $ 2.85     $ 1.46     $ 0.93  
  Net income attributable to Quaker Chemical Corporation
                                       
Common Shareholders - diluted
  $ 3.63     $ 3.66     $ 2.80     $ 1.45     $ 0.93  
  Dividends declared
    0.975       0.955       0.935       0.92       0.92  
  Dividends paid
    0.97       0.95       0.93       0.92       0.905  
Financial Position
                                       
Working capital
  $ 170,018     $ 152,900     $ 114,291     $ 98,994     $ 116,962  
Total assets
    536,634       511,152       452,868       398,183       387,957  
Long-term debt
    30,000       46,701       73,855       63,685       84,236  
Total equity
    289,676       261,357       190,537       159,186       132,393  

Following amounts in thousands
 
(1 )
The selected financial data for the years 2008 through 2011 has been re-cast in order to retrospectively apply the equity method of accounting for the Company’s investment in Primex, a captive insurance company.  For further information, see the Change in Accounting Method section included in Item 7 of this Report and Note 4 of Notes to Consolidated Financial Statements, included in Item 8 of this Report.
 
(2 )
The results of operations for 2012 include an increase to other income of $1,737 related to a change in the fair value of a contingent consideration liability;  an increase to other income of  $1,033 related to a change in the fair value of an acquisition-related liability; and a $2,216 tax benefit from the derecognition of various uncertain tax positions due to the expiration of applicable statutes of limitations; partially offset by a pre-tax charge of $1,254 related to the bankruptcy of certain customers in the U.S.; a pre-tax charge of $609 related to CFO transition costs; and certain uncommon charges of $1,936, pre-tax, that largely consist of severance and related items and costs associated with the launch of the Company's new revitalized Brand.
 
(3 )
The results of operations for 2011 include an increase to other income of $2,718 related to the revaluation of the Company’s previously held ownership interest in Tecniquimia Mexicana S.A de C.V. to its fair value; an increase to other income of $595 related to a change in the fair value of a contingent consideration liability; and a $1,972 tax benefit from the derecognition of various uncertain tax positions due to the expiration of applicable statutes of limitations.
 
(4 )
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; and a $564 charge related to an out-of-period adjustment at the Company’s 40% owned affiliate in Mexico; partially 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.
 
(5 )
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; partially 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.
 
(6 )
The results of operations for 2008 include a pre-tax charge for restructuring and related activities of $2,916; and a pre-tax charge of $3,505 for the incremental charges related to the retirement of the Company’s Chief Executive Officer; partially 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.
 

 
13

 

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 fluids, chemical specialties, and technical expertise to a wide range of industries, including steel, aluminum, automotive, mining, aerospace, tube and pipe, cans, and others.  For nearly 100 years, Quaker has helped customers around the world achieve production efficiency, improve product quality, and lower costs through a combination of innovative technology, process knowledge, and customized services. Headquartered in Conshohocken, Pennsylvania USA, Quaker serves businesses worldwide with a network of dedicated and experienced professionals whose mission is to make a difference.
 
The Company’s 2012 record revenue of $708.2 million grew 4% compared to 2011 on an increase in product volumes, including acquisitions, of 5%, and an increase in price and selling mix of 3%, which were partially offset by a decrease from foreign exchange rate translation of approximately $26.8, million or 4%.  Gross profit increased $16.1 million, or 7%, from 2011 with gross margin improving to 33.7% from 32.6% for 2011, reflecting some stabilization in raw material costs experienced primarily at the end of 2012, allowing margins to return to more acceptable levels.  Selling, general and administrative expenses (“SG&A”) increased $10.7 million, or 7%, from 2011 primarily due to acquisitions and higher selling, inflationary and other costs on increased business activity, which were partially offset by decreases due to foreign exchange rate translation and lower incentive compensation.  Included in SG&A for 2012 were charges of $0.06 per diluted share for certain customer bankruptcies in the U.S., $0.03 per diluted share related to CFO transition costs and certain other charges of $0.11 per diluted share that largely consist of severance and related items and costs associated with the launch of the Company's new revitalized Brand.  As a result, SG&A, as a percentage of sales, increased slightly to 24.8% from 24.1% in 2011.  In addition, changes in foreign exchange rates negatively impacted the 2012 net income by approximately $1.7 million, or $0.13 per diluted share.
 
During 2012, the Company’s results reflect certain uncommon items.  There was an increase in other income of $1.7 million, or $0.09 per diluted share, due to a change in the fair value of a contingent consideration liability and, also, a separate increase in other income of approximately $1.0 million due to a change in the fair value of an acquisition-related liability.  The effective tax rate for 2012 includes approximately $2.2 million, or approximately $0.17 per diluted share, of benefit from the derecognition of several uncertain tax positions due to the expiration of applicable statutes of limitations and resolution of tax audits for certain tax years.  In 2011, the Company completed an equity offering of approximately 1.3 million shares, raising approximately $48.1 million of net cash proceeds, which caused an approximate $0.11 dilutive effect on the 2012 earnings per diluted share.
 
The full year 2011 results also include other atypical items.  An increase, similar to the one noted above, was recognized in other income due to a change in the fair value of the contingent consideration liability of $0.6 million, or $0.03 per diluted share, and, also,  there was an increase of $2.7 million, or $0.22 per diluted share, to other income resulting from the revaluation of the Company’s previously held ownership interest in its Mexican affiliate to its fair value, which was related to the Company’s 2011 purchase of the remaining ownership interest in this entity.   The effective tax rate for 2011 includes approximately $2.0 million, or approximately $0.16 per diluted share, of benefit from the derecognition of several uncertain tax positions due to the expiration of applicable statutes of limitations and resolution of tax audits for certain tax years.
 
The results for 2011 and 2010 have been re-cast in order to retrospectively apply the equity method of accounting for the Company’s investment in Primex, a captive insurance company.  The results for 2012 also reflect the Company’s equity earnings attributable to its investment in Primex.  As a result, the Company's earnings per diluted share wre $3.63 for the full year 2012 compared to $3.66 for the full year 2011, which incluude earnings per diluted share from Primex of $0.14 and $0.19 in 2012 and 2011, respectively.  For further information, see the Change in Accounting Method section below, and Note 4 of Notes to Consolidated Financial Statements included in Item 8, of this Report.
 
For 2012, net cash provided by operating activities was a record $62.9 million.  Net cash provided by operating activities increased approximately $43.2 million from 2011, primarily led by improved working capital management and higher net income.
 
For the Company, 2012 was a record year in terms of revenue, net income, and net operating cash flow.  The Company achieved such levels despite a challenging global environment, including a strengthening dollar and weaker demand experienced in several geographical areas, by continuing to grow through additional new business and recent acquisitions. The Company’s shareholder appreciation increased approximately 41% in 2012 as we continued with both dividend and share price appreciation.  Also, the Company’s balance sheet and cash flow generation remains very strong, as its cash position exceeded its debt at December 31, 2012, which provides financial flexibility for the Company to be able to invest in strategic growth opportunities, such as the recent NP Coil Dexter Industries S.r.l acquisition.  This was the Company’s fifth acquisition in the last two years, as the Company continues to add new adjacent product lines which can be leveraged on a global platform. Further, the Company launched a new revitalized Brand during 2012, which the Company believes will build on its 94-year history and take the Company to the next level.  Going into 2013, the Company will continue to face challenging economic environments in various parts of the world, especially Europe.  In addition, the Company will likely experience higher raw material costs from current levels due to increasing crude oil pricing.  However, the Company also expects a continued recovery in North America and China, as well as growth due to its strategic initiatives and further leverage from its acquisitions.  In summary, the Company remains confident in its future and expects 2013 to be another good year for Quaker.

 
14

 

Change in Accounting Method
 
In 1986, the market for general liability insurance became highly volatile and there was limited product liability insurance for chemical companies to purchase.  In response, the Company joined together with fifteen other chemical companies, each putting forward $0.5 million as capital, to form a captive insurance company, Primex, Ltd. (“Primex”).  Primex was incorporated in Barbados and operates under the provisions of the Exempt Insurance Act of 1983, and provides excess liability insurance coverage only to its shareholders who are in chemical and chemical related manufacturing industries.  Primex utilizes leading service providers for insurance, actuarial, accounting and legal services.
 
Since 1986, many of the original investors have exited Primex, either through acquisitions or divestitures.  To date, companies that have ceased to purchase insurance from Primex have sold their shares back to Primex.  Each current shareholder has one representative on Primex’s board of directors, each with an equal vote on operational and financial matters.   As a result of one of those shareholders exiting Primex in 2012, the Company reassessed its ability to significantly influence the operating and financial policies of Primex.  Based on its ownership percentage and other factors, the Company determined that during 2012 the Company obtained the ability to significantly influence Primex and, as a result, needed to change its method of accounting for Primex from the cost method to the equity method.   In accordance with the guidance of the Financial Accounting Standards Board (“FASB”), the equity method of accounting must be applied on a retrospective basis, and all periods presented must be recast to reflect the change in the method of accounting.
 
Consequently, the Company has recast its Consolidated Balance Sheet as of December 31, 2011, the Consolidated Statements of Income, Other Comprehensive Income and Cash Flows for the years ending December 31, 2010 and December 31, 2011 and the Consolidated Statement of Changes in Equity for the years ended December 31, 2009, December 31, 2010 and December 31, 2011 and the Notes to the Consolidated Financial Statements included in Item 8 of this report.  In addition, the Selected Financial Data for the years ended December 31, 2008, December 31, 2009, December 31, 2010 and December 31, 2011 included in Item 6 of this Report and Management’s Discussion and Analysis for the years ended December 31, 2010 and December 31, 2011 included in Item 7 of this Report have been updated to reflect the change in method of accounting.
 
The change in method of accounting results in an increase of previously reported net income and earnings per share for the years ending December 31, 2011 and December 31, 2010 of $2.3 million, or $0.19 per diluted share, and $0.3 million, or $0.03 per diluted share, respectively.
 
The following table sets forth the impact, by line item on each financial statement, of the retrospective application of the change in method of accounting (amounts in thousands, except per share data):
 

Consolidated Statement of Income
 
2011
   
2010
 
Equity in net income of associated companies
  $ 2,323     $ 313  
Net income attributable to Quaker Chemical Corporation
  $ 2,323     $ 313  
Net income attributable to Quaker Chemical Corporation Common Shareholders - Diluted
  $ 0.19     $ 0.03  
                 
Consolidated Balance Sheet
               
Investments in associated companies
  $ 6,131     $ 3,938  
Other assets
    (500 )     (500 )
Total assets
  $ 5,631     $ 3,438  
                 
Retained earnings
  $ 4,778     $ 2,455  
Accumulated other comprehensive loss
    853       983  
Total equity
  $ 5,631     $ 3,438  

For further information, see Note 4 of the Notes to Consolidated Financial Statements included in Item 8 of this Report.
 
The Company determined that the ability to significantly influence the operating and financial policies of Primex was obtained during the first quarter of 2012.  The Company did not amend and restate any of its Quarterly Reports on Form 10-Q for 2012 because the errors identified were not deemed to be material to any individual period.
 


 
15

 

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 a write down or a disposal of certain inventory due to its estimated obsolescence or limited marketability. Reserves for customers filing for bankruptcy protection are generally established at 75-100% of the amount outstanding at the bankruptcy filing date, 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 maintained for other customers based on historical experience. The Company’s consolidated allowance for doubtful accounts was $6.4 million and $4.6 million at December 31, 2012 and December 31, 2011, respectively. Further, the Company recorded provisions for doubtful accounts of $2.1 million, $0.9 million and $0.9 million in 2012, 2011 and 2010, respectively. An increase of 10% to the recorded provisions would have decreased the Company’s pre-tax earnings by approximately $0.2 million, $0.1 million and $0.1 million in 2012, 2011 and 2010, 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 of total costs, 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 that range in accordance with generally accepted accounting principles. See Note 20 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 records an impairment charge to an investment when it believes a decline in value that is other than temporary has occurred. Future adverse changes in market conditions, poor operating results of underlying investments, devaluation of foreign currencies or other events or circumstances could result in losses or an inability to recover the carrying value of the investments.  These indicators may result in an impairment charge in the future. The carrying amount of the Company’s equity investments at December 31, 2012 was $16.6 million, which comprised four investments of $8.8 million, or a 32.3% interest, in Primex, Ltd (Barbados), $5.9 million, or a 50% interest, in Nippon Quaker Chemical, Ltd. (Japan), $1.7 million, or a 50% interest, in Kelko Quaker Chemical, S.A. (Venezuela) and $0.2 million, or a 50% interest, in Kelko Quaker Chemical, S.A. (Panama), respectively.  See Note 4 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, which often occur 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 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
 

 
16

 

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 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.  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.  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 employs prudent and feasible tax planning strategies in assessing the need for a 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. Both determinations 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 foreign 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. To account for such charges, the Company applies FASB’s guidance regarding exit or disposal cost obligations.  This 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 definite-lived intangible assets on a straight-line basis over the useful 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 of the third quarter 2012, and no impairment charge was warranted. The Company’s consolidated goodwill and indefinite-lived intangible assets at December 31, 2012 and December 31, 2011 were $60.3 million and $59.3 million, respectively. The Company’s assumption of weighted average cost of capital (“WACC”) 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 WACC of 12% and, at September 30, 2012, this assumption would have had to increase by more than 11.26 percentage points before any of the Company’s reporting units would fail step one of the impairment analysis. Further, at September 30, 2012, the Company’s estimate of future NOPAT would have had to decrease by more than 48.4% 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, 2012:

 
1/2 Percentage Point Increase
   
1/2 Percentage Point Decrease
 
 
Foreign
   
Domestic
   
Total
   
Foreign
 
Domestic
 
Total
 
 
(Dollars in millions)
 
Discount rate
$ (0.5 )   $ (0.1 )   $ (0.6 )   $ 0.5   $ 0.1   $ 0.6  
Expected rate of return on plan assets
  (0.3 )     (0.2 )     (0.5 )     0.3     0.2     0.5  


 
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Recently Issued Accounting Standards
 
The FASB updated its guidance in July 2012 regarding indefinite-lived intangible asset impairment testing.  The updated guidance permits a Company to first assess qualitative factors to determine whether it is more likely than not that the fair value of the indefinite-lived intangible asset is less than its carrying value.  If the Company determines that the fair value is more likely than not above its carrying value, no further impairment testing is required.  However, if the Company concludes otherwise, then the first step of the traditional two-step impairment test is required to be performed.  The guidance is effective for annual and interim fiscal periods beginning after September 15, 2012, with early adoption permitted if an entity’s financial statements have not been issued as of the date of the entity’s interim or annual impairment test.  The Company elected to test its indefinite-lived intangible assets for impairment under the traditional two-step method during the current year but is currently evaluating the effect of this guidance for future applicability.
 
The FASB updated its guidance in December 2011 regarding disclosures pertaining to the netting and offsetting of derivatives and financial instruments on an entity’s Consolidated Balance Sheet.  Disclosures required under the updated guidance include presenting gross amounts of assets and liabilities related to financial instruments that may have been historically offset on the Consolidated Balance Sheet.  The guidance is effective for annual and interim fiscal periods beginning on or after January 1, 2013.   The Company is currently evaluating the effect of this guidance.
 
Liquidity and Capital Resources
 
Quaker’s cash and cash equivalents increased to $32.5 million at December 31, 2012 from $16.9 million at December 31, 2011.  The $15.6 million increase was primarily the result of a record amount of cash provided by operating activities of $62.9 million, net of cash used in investing activities of $16.7 million and cash used in financing activities of $30.6 million.
 
Net cash flows provided by operating activities were $62.9 million in 2012, compared to $19.7 million provided by operating activities in 2011.  The $43.2 million increase in operating cash flow was primarily driven by improved working capital levels and higher net income.  The largest contributors to the improved working capital levels were changes in accounts receivable and inventory.  The increase in the Company’s working capital investment in 2011 was largely due to increasing sales volumes and raw material costs, which in turn necessitated higher selling prices to restore the Company’s margins to more historically acceptable levels.  In 2012, the Company was able to leverage consistent working capital levels compared to 2011, despite record sales volumes.
 
 Net cash flows used in investing activities decreased $18.7 million from $35.4 million in 2011 to $16.7 million in 2012, which was primarily driven by lower payments for acquisitions.  In 2012, the Company acquired NP Coil Dexter Industries, S.r.l. for approximately $2.7 million and settled hold-back of consideration liabilities assumed in the acquisitions of Tecniquimia Mexicana, S.A. de C.V. and G.W. Smith and Sons, Inc. for approximately $3.0 million. In 2011, the Company acquired G.W. Smith & Sons, Inc. for approximately $14.5 million and acquired the remaining 60% ownership interest in Tecniquimia Mexicana, S.A. de C.V. for approximately $10.5 million.  This decrease in cash paid for acquisitions from 2011 was partially offset by higher investments in property plant and equipment during 2012, as the Company continued to invest in the expansion of its Asia/Pacific facilities and in its information technology infrastructure. Also, changes in the Company’s restricted cash, as discussed below, 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 one 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.  The agreement continues until terminated and can only be terminated by either party by providing the other party with a minimum of two years prior written notice.  As of December 31, 2012, no notice of termination has been given under this agreement.
 
Net cash flows used by financing activities were $30.6 million in 2012 compared with $9.1 million provided by financing activities in 2011.  The Company’s second quarter 2011 offering of approximately 1.3 million shares of its common stock resulted in net cash proceeds of approximately $48.1 million, which were used to repay a portion of the outstanding borrowings on the Company’s revolving credit line in 2011.  In 2012, the Company was able to fund its investing and financing activities through strong net operating cash flow and, also, repay a further portion of its revolving credit line.  During 2012, the Company recorded $2.0 million of excess tax benefits related to stock options exercises in capital in excess of par on its Condensed Consolidated Balance Sheet and as a cash flow from financing activities in its Condensed Consolidated Statement of Cash Flows, compared to approximately $0.1 million of these benefits recorded in 2011.  Higher dividend payments, primarily due to the Company’s prior year equity offering, and a change in stock option exercise and other activity also affected the financing cash flow comparisons.
 
The Company completed its annual goodwill impairment assessment as of the end of the third quarter of 2012 and the estimated fair value of each of the Company’s reporting units substantially exceeded their carrying value, so no impairment charge was warranted.
 

 
18

 

The Company’s primary credit line is a $175.0 million syndicated multicurrency credit agreement with Bank of America, N.A. (administrative agent) and certain other major financial institutions, which expires in June 2014. At the Company’s option, the principal amount available can be increased to $225.0 million if the lenders agree to increase their commitments and the Company satisfies certain conditions.  At December 31, 2012 and December 31, 2011, the Company had approximately $12.2 million and $28.5 million, respectively, outstanding under this facility.  The Company’s access to this credit is largely dependent on its consolidated leverage ratio covenant, which cannot exceed 3.50 to 1. At December 31, 2012 and December 31, 2011, the Company’s consolidated leverage ratio was below 1.0 to 1.  Under this covenant and the borrowing capacity available on the Company’s primary credit line, approximately $160.0 million of additional borrowings could have been borrowed as of December 31, 2012. The Company had previously entered into interest rate swaps with a combined notional value of $15.0 million to fix the interest rate on that amount of its variable rate debt, which matured during the third quarter of 2012.
 
The Company filed a shelf registration statement on Form S-3 with the Securities and Exchange Commission (the “SEC”) in 2009.  The registration statement was declared effective on January 29, 2010 and permitted the Company to offer and sell, from time to time and in one or more public offerings, up to $100.0 million aggregate dollar amount of its securities, including 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 as units that include any of these securities, on terms, in each case, established at the time of the offering.  This registration statement provided the Company with the ability to issue registered debt or equity securities on an accelerated basis.  During 2011, the Company sold approximately 1.3 million shares of common stock for gross proceeds of approximately $51.2 million utilizing this shelf registration.  In early 2013, this shelf registration expired.
 
At December 31, 2012, the Company’s gross liability for uncertain tax positions, including interest and penalties, was $16.3 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 up to $10.8 million as a result of offsetting benefits in other tax jurisdictions.
 
As of December 31, 2012, the Company held an equity investment in Primex, a captive insurance company, which is accounted for under the equity method of accounting.  Subsequent to December 31, 2012, the Company received its first dividend distribution of approximately $2.0 million from Primex Ltd., which will be accounted for as a reduction to the Company’s investment balance in this associated company.  For further information, see the Change in Accounting Method section above and Note 4 of Notes to Consolidated Financial Statements included in Item 8 of this Report.
 
 The Company believes it is capable of supporting its operating requirements, including pension plan contributions, payments of dividends to shareholders, possible acquisitions and other 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, 2012, and the effect such obligations are expected to have on its liquidity and cash flows in future periods. Pension and other postretirement plan contributions beyond 2012 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, also cannot be readily determined due to their uncertainty. Interest obligations on the Company’s short and long-term debt are included and assume the debt levels will be outstanding for the entire respective period and apply the interest rates in effect at December 31, 2012. The contingent acquisition consideration is included based on management’s estimate of the probability of the earnout being ultimately met/paid and the discount rate in effect at the time of acquisition:

   
Payments due by period
 
                                       
2018 and
 
Contractual Obligations (Amounts in millions)
 
Total
   
2013
   
2014
   
2015
   
2016
   
2017
   
Beyond
 
Short-term debt
  $ 0.867     $ 0.867     $     $     $     $     $  
Long-term debt
    40.917       1.680       13.633       1.277       1.241       1.230       21.856  
Capital lease obligations
    0.660       0.291       0.147       0.099       0.065       0.058        
Non-cancelable operating leases
    16.811       4.927       4.003       3.472       2.941       1.466       0.002  
Purchase obligations
    8.459       7.193       1.266                          
Pension and other postretirement plan
                                                       
contributions
    7.329       7.329                                
Contingent acquisition consideration
    5.149             5.149                          
Other long-term liabilities (See Note 19 of Notes
                                                       
to Consolidated Financial Statements)
    5.034                                     5.034  
Total contractual cash obligations
  $ 85.226     $ 22.287     $ 24.198     $ 4.848     $ 4.247     $ 2.754     $ 26.892  


 
19

 

Operations
 
CMS Discussion
 
The Company currently has numerous CMS contracts around 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 an alternative structure for certain 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’ products to its own products.  As a result, under the alternative structure, the 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. This may result in a decrease in reported gross margin as a percentage of sales.
 
The Company has maintained a mix of CMS contracts with both the traditional product pass-through structure and the alternative structure, including fixed price contracts that cover all services and products.  Since the global economic downturn and its impact on the automotive sector, the Company has experienced shifts in customer requirements and business circumstances, but the Company’s offerings continue to include both approaches to CMS.
 
Comparison of 2012 with 2011
 
Net sales for 2012 were $708.2 million, an increase of 4% from $683.2 million in 2011.  Product volumes, including acquisitions, increased revenues by approximately 5% and selling and price mix increased revenues by approximately 3%, while foreign exchange rate translation decreased revenues by approximately $26.8 million, or 4%.
 
Gross profit increased by approximately $16.1 million, or 7%, from 2011, with gross margin improving to 33.7% from 32.6%, for 2011, reflecting some stabilization in raw material costs experienced primarily at the end of 2012, allowing margins to return to more acceptable levels.
 
SG&A increased by approximately $10.7 million, or 7%, compared to 2011, primarily related to acquisitions and higher selling, inflationary and other costs on increased business activity, which were partially offset by decreases due to foreign exchange rate translation and lower incentive compensation.  Also, SG&A for 2012 includes charges of $0.06 per diluted share for certain customer bankruptcies in the U.S., $0.03 per diluted share related to CFO transition costs and certain uncommon charges of $0.11 per diluted share that largely consists of severance and related items and costs associated with the launch of the Company's new revitalized Brand.  As a result, SG&A, as a percentage of sales, slightly increased to 24.8% from 24.1% in 2011.
 
The decrease in interest expense was primarily due to lower average borrowings and lower interest rates in 2012 as compared to 2011, and the decrease in interest income from 2011 to 2012 was primarily caused by lower cash levels invested in higher interest rate jurisdictions.
 
Other income for 2012 included increases due to changes in the fair value of a contingent consideration liability of $1.7 million, or $0.09 per diluted share, and a separate acquisition-related liability of $1.0 million, or $0.08 per diluted share, noted above.  Other income for 2011 included a lower increase related to the adjustment of the contingent consideration liability of $0.6 million, or $0.03 per diluted share, noted above, and, also, other income for 2011 increased $2.7 million, or $0.22 per diluted share, related to the revaluation of the Company’s previously held ownership interest in its Mexican affiliate to its fair value, which was related to the Company’s 2011 purchase of the remaining ownership interest in this entity. In addition, the Company experienced higher foreign exchange losses in 2012 and, also, received lower third party license fees in 2012, primarily as a result of the prior year purchase of the remaining ownership interest in the Company’s Mexican affiliate.
 
The Company’s 2012 and 2011 effective tax rates of 24.7% and 24.0%, respectively, reflect decreases in reserves for uncertain tax positions due to the expiration of applicable statutes of limitations for certain tax years of approximately $0.17 and $0.16 per diluted share, respectively.  The Company has experienced and expects to further experience volatility in its 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, among other factors.   At the end of 2012, the Company had net U.S. deferred tax assets totaling $13.9 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 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 uncertain global economic environment 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.   During 2012, the Company recorded $2.0 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.
 

 
20

 

The decrease in equity in net income of associated companies was caused by lower income from the Company’s equity investment in a captive insurance company, partially offset by improved performance over the majority of the Company’s equity affiliates in 2012 as compared to 2011, in particular in our Japanese affiliate.
 
Earnings per diluted share for 2012 of $3.63 reflect an approximate $0.11 per share dilutive effect as a result of the Company’s equity offering in May of 2011.  Changes in foreign exchange rates negatively impacted the 2012 net income by approximately $1.7 million or $0.13 per diluted share.
 
Segment Reviews—Comparison of 2012 with 2011
 
Metalworking Process Chemicals:
 
Metalworking Process Chemicals generally consists of industrial process fluids for various heavy industrial and manufacturing applications.  This segment represented approximately 93% of the Company’s net sales in 2012, which were up approximately $20.5 million, or 3%, compared to 2011.   Net sales for this reportable segment increased approximately 4% from acquisition activity and approximately 3% from increases in volume and price and selling mix primarily in North America and Asia/Pacific, which were partially offset by decreases due to foreign currency translation of approximately 4%.   The foreign currency translation impacts were primarily driven by the average E.U. Euro to U.S. Dollar exchange rate being 1.29 in 2012 compared to 1.39 in 2011 and the average Brazilian Real to U.S. Dollar exchange rate being 0.51 in 2012 compared to 0.60 in 2011.   The 2012 operating income for this reportable segment increased approximately $5.9 million from 2011, primarily driven by the sales increases noted above and improved margins, reflecting some stabilization in raw material costs experienced primarily at the end of 2012, allowing margins to improve to more acceptable levels.
 
Coatings:
 
The Company’s coatings segment, which represented approximately 6% of the Company’s net sales in 2012, generally contains products that provide temporary and permanent coatings for metal and concrete products and chemical milling maskants.  Net sales for this reportable segment in 2012 were up approximately $3.6 million, or 9%, compared to 2011, which was primarily due to increased sales of chemical milling maskants to the aerospace industry.  The 2012 operating income for this reportable segment increased approximately $1.4 million from 2011, consistent with the sales increase noted above.
 
Other Chemical Products:
 
Other Chemical Products, which represented approximately 1% of the Company’s net sales in 2012, generally consists of sulfur removal products for industrial gas streams sold by the Company’s Q2 Technologies joint venture.  For 2012, net sales and operating income for this reportable segment increased approximately $0.9 million and approximately $0.2 million, respectively, compared to 2011, due to increased activity in the oil and gas market.
 
Comparison of 2011 with 2010
 
Net sales for 2011 were approximately $683.2 million, an increase of $139.2 million, or 26%, from 2010.  Product volumes were approximately 13% higher, including acquisitions.  Selling prices and mix increased revenues by approximately 10%, as the Company increased prices to help offset higher raw material costs.  Foreign exchange rates increased revenues by approximately 3%.
 
Gross profit increased by approximately $29.9 million, or 15%, compared to 2010, largely as a result of increased volumes. Gross margin decreased from 35.4% in 2010 to 32.6%, as the increases in raw material costs that began in the second half of 2010 continued to escalate throughout 2011.  Price increases were implemented during 2011 to help recover margins, but the significant raw material cost increase was only partially offset as the Company typically experiences a lag effect in recovering its margins.
 
SG&A increased approximately $25.5 million, or 18%, compared to 2010.  Higher selling, inflationary and other costs as a result of increased business activity and investment in growth, acquisition-related activity and foreign exchange rate translation accounted for the majority of the increase while overall incentive compensation costs were lower.  SG&A as a percentage of sales decreased from 25.6% in 2010 to 24.1% in 2011.
 
Included in the 2010 results is a non-income tax contingency charge of approximately $4.1 million, or approximately $0.26 per diluted share.  See Note 20 to Consolidated Financial Statements in Item 8 of this Report.  Also included in the 2010 results was a final charge related to the Company’s former CEO’s supplemental retirement plan of approximately $1.3 million, or approximately $0.08 per diluted share.
 
Other income for 2011 increased $0.6 million, or $0.03 per diluted share, due to a change in the fair value of a contingent consideration liability, noted above, and, also, increased $2.7 million, or approximately $0.22 per diluted share, related to the revaluation of the Company’s previously held ownership interest in its Mexican equity affiliate to its fair value related to the July 2011 purchase of the remaining interest in this entity. Partially offsetting these increases to other income were foreign exchange rate losses versus gains in 2010.
 
Interest expense decreased due to lower average borrowings, primarily caused by the repayment of outstanding borrowings from the proceeds of the second quarter 2011 equity offering.

 
21

 
 
The Company’s effective tax rate for 2011 was 24.0% compared to 27.3% in 2010.  The 2011 effective tax rate includes a benefit of approximately $0.16 per diluted share, while 2010 includes a benefit of approximately $0.21 per diluted share, due to the expiration of applicable statutes of limitations for uncertain tax positions.  The 2011 effective tax rate was impacted by a changing mix of income from higher rate jurisdictions to lower rate jurisdictions. In addition, the fair value adjustment related to the Company’s purchase of the remaining 60% ownership interest in its Mexican equity affiliate was not taxable.  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.
 
Equity in net income of associated companies in 2011 includes higher income from the Company’s equity investment in a captive insurance company of $2.3 million compared to $0.3 million in 2010.  Also, equity in net income of associated companies in 2010 reflects an equity affiliate charge of approximately $0.05 per diluted share, related to an out-of-period adjustment, as well as a $0.03 per diluted share charge related to the first quarter 2010 devaluation of the Venezuelan Bolivar Fuerte.  See 4 of Notes to Consolidated Financial Statements in Item 8 of this Report.
 
Segment Reviews—Comparison of 2011 with 2010
 
Metalworking Process Chemicals:
 
Metalworking Process Chemicals consists of industrial process fluids for various heavy industrial and manufacturing applications.  This segment represented approximately 94% of the Company’s net sales in 2011, which were up approximately $130.0 million, or 25%, compared to 2010.   Net sales for this reportable segment increased approximately 8% from acquisition activity, approximately 3% from foreign currency translation, approximately 5% from increases in volume, and approximately 9% from price and selling mix across the Company’s North American, Asia Pacific and European regions, as price increases were implemented in this segment during 2011 to help recover rising raw material costs.   The foreign currency translation impacts were primarily driven by the average E.U. Euro to U.S. Dollar exchange rate being 1.39 in 2011 compared to 1.33 in 2010 and the average U.S. Dollar to Brazilian Real exchange rate being 0.60 in 2011 compared to 0.57 in 2010.  The 2011 operating income for this reportable segment increased approximately $11.7 million over 2010, reflecting the Company’s acquisition activity and the volume and sales price increases noted above, which were partially offset by higher raw material costs and higher SG&A on increased business activity.
 
Coatings:
 
The Company’s coatings segment, which represented approximately 6% of the Company’s net sales in 2011, contains products that provide temporary and permanent coatings for metal and concrete products and chemical milling maskants.  Net sales for this reportable segment were up approximately $8.2 million, or 26% for 2011 compared with the prior year, primarily due to increased sales in chemical milling maskants sold to the aerospace industry.  The 2011 operating income for this reportable segment was up approximately $2.2 million, consistent with the volume increases noted above.
 
Other Chemical Products:
 
Other Chemical Products, which represented less than 1% of the Company’s net sales in 2011, consists of sulfur removal products for industrial gas streams sold by the Company’s Q2 Technologies joint venture.  For 2011, net sales and operating income for this reportable segment were up approximately $1.0 million and $0.2 million, respectively, which was caused by increased activity in the oil and gas market in 2011 as compared to 2010.
 
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 (“SACRWQB”), 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. On September 11, 2012, ACP received a letter from the SACRWQB advising that no further action is required to remediate the soil contamination on site.  At December 31, 2012, the Company believes that the remaining potential-known liabilities associated with the ACP contamination, namely estimated future cost of the water remediation program, is approximately $0.7 million to $1.2 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 20 of Notes to Consolidated Financial Statements which appears in Item 8 of this Report.
 

 
22

 

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 60% to 65% of our consolidated net annual sales. See Note 15 of Notes to Consolidated Financial Statements which appears in Item 8 of this Report and the Foreign Exchange Risk section in Item 7A 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 2012 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 and other acts of violence, 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.
 
 
23

 


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, 2012, Quaker had approximately $12.2 million in borrowings under its credit facility at a weighted average borrowing rate of approximately 1.96% (LIBOR plus a spread). If interest rates had changed by 10%, the Company’s interest expense would have correspondingly increased or decreased approximately $0.1 million. The Company previously used derivative financial instruments primarily for the purposes of hedging exposures to fluctuations in interest rates. Specifically, the Company had previously 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 $(0.4) million at December 31, 2011, but matured during 2012.  The Company does not enter into derivative contracts for trading or speculative purposes.  See the information included under the caption “Derivatives” in Note 1, and the information in Note 3, 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 had each changed by 10% against the U.S. Dollar, the Company’s 2012 revenues and pre-tax earnings would have correspondingly increased or decreased approximately $31.2 million and $3.7 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 60% 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 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 had changed by one percentage point, the Company’s 2012 pretax earnings would have correspondingly increased or decreased by approximately $7.1 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 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 a 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 $2.1 million, $0.9 million and $0.9 million in 2012, 2011 and 2010, respectively. A change of 10% to the recorded provisions would have increased or decreased the Company’s pre-tax earnings by approximately $0.2 million, $0.1 million and $0.1 million in 2012, 2011 and 2010, respectively.

 
24

 

Item 8.
Financial Statements and Supplementary Data.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
  
Page
Financial Statements:
  
 
  
26
  
27
 
28
  
29
  
30
  
31
 
32
 

 
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Table of Contents

Report of Independent Registered Public Accounting Firm

 
To the Shareholders and Board of Directors
of Quaker Chemical Corporation:
 
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, comprehensive income, changes in equity, and cash flows present fairly, in all material respects, the financial position of Quaker Chemical Corporation and its subsidiaries at December 31, 2012 and December 31, 2011, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2012 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, 2012, 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 NP Coil Dexter Industries, S.r.l. from its assessment of internal control over financial reporting as of December 31, 2012 because this entity was acquired by the Company in purchase business combinations on July 2, 2012. We have also excluded NP Coil Dexter Industries, S.r.l. from our audit of internal control over financial reporting. This entity represents total assets and total revenues of 2% and less than 1%, respectively, of the related consolidated financial statement amounts as of and for the year ended December 31, 2012.
 
As discussed in Note 4 to the consolidated financial statements, the Company changed its accounting method for one of its long term investments.
 
/s/ PricewaterhouseCoopers LLP
Philadelphia, PA
March 6, 2013

 
26

 
Table of Contents

QUAKER CHEMICAL CORPORATION
 
CONSOLIDATED STATEMENT OF INCOME

   
Year Ended December 31,
 
   
2012
   
2011
   
2010
 
         
(re-cast)
   
(re-cast)
 
   
(In thousands, except per share amounts)
 
Net sales
  $ 708,226     $ 683,231     $ 544,063  
Costs and expenses
                       
Cost of goods sold
    469,515       460,581       351,274  
Selling, general and administrative expenses
    175,487       164,738       139,209  
Non-income tax contingency charge
                4,132  
CEO transition costs
                1,317  
      645,002       625,319       495,932  
Operating income
    63,224       57,912       48,131  
Other income, net
    3,415       5,050       2,106  
Interest expense
    (4,283 )     (4,666 )     (5,225 )
Interest income
    592       1,081       1,201  
Income before taxes and equity in net income of associated companies
    62,948       59,377       46,213  
Taxes on income before equity in net income of associated companies
    15,575       14,256       12,616  
Income before equity in net income of associated companies
    47,373       45,121       33,597  
Equity in net income of associated companies
    2,867       3,102       807  
Net income
    50,240       48,223       34,404  
Less: Net income attributable to noncontrolling interest
    2,835       2,331       2,284  
Net income attributable to Quaker Chemical Corporation
  $ 47,405     $ 45,892     $ 32,120  
Earnings per common share data:
                       
Net income attributable to Quaker Chemical Corporation Common Shareholders – basic
  $ 3.64     $ 3.71     $ 2.85  
Net income attributable to Quaker Chemical Corporation Common Shareholders – diluted
  $ 3.63     $ 3.66     $ 2.80  


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

 
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Table of Contents

QUAKER CHEMICAL CORPORATION
 
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME


                   
   
Year Ended December 31,
 
   
2012
   
2011
   
2010
 
         
(re-cast)
   
(re-cast)
 
   
(In thousands)
 
                   
Net income
  $ 50,240     $ 48,223     $ 34,404  
                         
Other comprehensive loss, net of tax
                       
Currency translation adjustments
    (2,111 )     (9,155 )     805  
Defined benefit retirement plans
                       
  Net loss arising during the period, other
    (13,980 )     (9,698 )     (6,267 )
  Amortization of actuarial loss
    1,852       1,230       1,832  
  Amortization of prior service cost
    76       77       91  
  Amortization of initial net asset
                (3 )
Current period change in fair value of derivatives
    272       395       708  
Unrealized gain (loss) on available-for-sale securities
    866       (138 )     248  
  Other comprehensive loss
    (13,025 )     (17,289 )     (2,586 )
                         
Comprehensive income
    37,215       30,934       31,818  
Less: comprehensive income attributable to noncontrolling interest
    (2,698 )     (1,256 )     (2,761 )
Comprehensive income attributable to Quaker Chemical Corporation
  $ 34,517     $ 29,678     $ 29,057  


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

 
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QUAKER CHEMICAL CORPORATION
 
CONSOLIDATED BALANCE SHEET

   
December 31,
 
   
2012 
     
2011 
           
(re-cast)
 
   
(In thousands, except par value
and share amounts)
 
ASSETS
               
Current assets
               
        Cash and cash equivalents
 
$
32,547 
   
$
16,909 
 
        Accounts receivable, net
 
 
154,197 
     
150,676 
 
        Inventories
 
 
72,471 
     
74,758 
 
        Current deferred tax assets
 
 
6,401 
     
6,338 
 
        Prepaid expenses and other current assets
 
 
12,194 
     
10,868 
 
                Total current assets
 
 
277,810 
 
 
 
259,549 
 
Property, plant and equipment, net
 
 
85,112 
     
82,916 
 
Goodwill
 
 
59,169 
     
58,152 
 
Other intangible assets, net
 
 
32,809 
     
31,783 
 
Investments in associated companies
 
 
16,603 
     
14,073 
 
Non-current deferred tax assets
 
 
30,673 
     
29,823 
 
Other assets
 
 
34,458 
     
34,856 
 
                Total assets
 
$
536,634 
 
 
$
511,152 
 
 
 
 
   
 
 
   
LIABILITIES AND EQUITY
 
 
   
 
 
   
Current liabilities
 
 
   
 
 
   
        Short-term borrowings and current portion of long-term debt
 
$
1,468 
 
 
$
636 
 
        Accounts payable
 
 
67,586 
 
 
 
65,026 
 
        Dividends payable
   
3,208 
     
3,099 
 
        Accrued compensation
 
 
16,842 
 
 
 
16,987 
 
        Accrued pension and postretirement benefits
   
2,188 
     
2,038 
 
        Current deferred tax liabilities
   
253 
     
238 
 
        Other current liabilities
 
 
16,247 
 
 
 
18,625 
 
               Total current liabilities
 
 
107,792 
 
 
 
106,649 
 
Long-term debt
 
 
30,000 
 
 
 
46,701 
 
Non-current deferred tax liabilities
   
6,383 
     
7,094 
 
Accrued pension and postretirement benefits
 
 
49,916 
 
 
 
34,533 
 
Other non-current liabilities
 
 
52,867 
 
 
 
54,818 
 
               Total liabilities
 
 
246,958 
 
 
 
249,795 
 
Equity
 
 
   
 
 
   
         Common stock $1 par value; authorized 30,000,000 shares; issued and outstanding
 
 
   
 
 
   
            2012 – 13,094,901 shares; 2011 – 12,911,508 shares
   
13,095 
     
12,912 
 
         Capital in excess of par value
 
 
94,470 
 
 
 
89,725 
 
         Retained earnings
 
 
215,390 
 
 
 
180,710 
 
         Accumulated other comprehensive loss
 
 
(41,855)
   
 
(28,967)
 
               Total Quaker shareholders’ equity
 
 
281,100 
 
 
 
254,380 
 
               Noncontrolling interest
   
8,576 
     
6,977 
 
               Total equity
   
289,676 
     
261,357 
 
                       Total liabilities and equity
 
$
536,634 
 
 
$
511,152 
 


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,
 
   
2012
   
2011
   
2010
 
         
(re-cast)
   
(re-cast)
 
   
(In thousands)
 
Cash flows from operating activities
 
 
   
 
   
 
 
Net income
  $ 50,240     $ 48,223     $ 34,404  
Adjustments to reconcile net income to net cash provided by operating activities:
                       
Depreciation
    12,252       11,455       9,867  
Amortization
    3,106       2,338       988  
Equity in undistributed earnings of associated companies, net of dividends
    (2,350 )     (2,365 )     (294 )
Deferred income taxes
    2,354       2,431       1,849  
Uncertain tax positions (non-deferred portion)
    (1,407 )     3,673       (1,130 )
Acquisition-related fair value adjustments
    (1,909 )     (2,624 )      
Deferred compensation and other, net
    (156 )     566       (628 )
Stock-based compensation
    3,807       3,513       3,096  
(Gain) loss on disposal of property, plant and equipment
    (108 )     (86 )     32  
Insurance settlement realized
    (1,391 )     (1,840 )     (1,640 )
Pension and other postretirement benefits
    (1,427 )     (4,239 )     (2,636 )
Increase (decrease) in cash from changes in current assets and current liabilities, net of acquisitions:
                       
Accounts receivable
    779       (31,558 )     (4,469 )
Inventories
    3,228       (9,281 )     (7,153 )
Prepaid expenses and other current assets
    504       (2,505 )     (814 )
Accounts payable and accrued liabilities
    (2,562 )     4,442       5,511  
Estimated taxes on income
    (2,067 )     (2,477 )     564  
Net cash provided by operating activities
    62,893       19,666       37,547  
                         
Cash flows from investing activities
                       
Capital expenditures
    (12,735 )     (12,117 )     (9,354 )
Payments related to acquisitions, net of cash acquired
    (5,635 )     (25,477 )     (35,909 )
Proceeds from disposition of assets
    245       393       229  
Insurance settlement received and interest earned
    69       80       5,122  
Change in restricted cash, net
    1,322       1,760       (1,124 )
Net cash used in investing activities
    (16,734 )     (35,361 )     (41,036 )
                         
Cash flows from financing activities
                       
Net decrease in short-term borrowings
    (315 )     (254 )     (1,456 )
Proceeds from long-term debt
                9,841  
Repayment of long-term debt
    (17,632 )     (27,364 )     (636 )
Dividends paid
    (12,616 )     (11,586 )     (10,449 )
Stock options exercised, other
    (924 )     1,105       5,500  
Excess tax benefit related to stock option exercises
    2,045       109       2,558  
Proceeds from sale of common stock, net of related expenses
          48,143        
Distributions to noncontrolling shareholders
    (1,099 )     (1,000 )     (1,021 )
Net cash (used in) provided by financing activities
    (30,541 )     9,153       4,337  
         Effect of exchange rate changes on cash
    20       (2,315 )     (133 )
       Net increase (decrease) in cash and cash equivalents
    15,638       (8,857 )     715  
       Cash and cash equivalents at beginning of period
    16,909       25,766       25,051  
       Cash and cash equivalents at end of period
  $ 32,547     $ 16,909     $ 25,766  
                         
Supplemental cash flow disclosures:
                       
        Cash paid during the year for:
                       
    Income taxes
  $ 13,190     $ 9,110     $ 7,799  
    Interest
    2,809       3,298       4,884  
         Non-cash activities:
                       
    Restricted insurance receivable (See also Note 18 of Notes to Consolidated Financial Statements)
  $     $     $ 5,000  
    Property, plant and equipment acquired by capital lease
                848  


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

 
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Table of Contents

QUAKER CHEMICAL CORPORATION
 
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

                     
Accumulated
             
         
Capital in
         
other
   
Non-
       
   
Common
   
excess of
   
Retained
   
comprehensive
   
controlling
       
   
stock
   
par value
   
earnings
   
loss
   
interest
   
Total
 
Balance at December 31, 2009 (re-cast)
  $ 11,086     $ 27,527     $ 125,282     $ (9,690 )   $ 4,981     $ 159,186  
Net income (re-cast)
                32,120             2,284       34,404  
Currency translation adjustments
                      328       477       805  
Defined benefit retirement plans:
                                               
Net loss arising during the period, other
                      (6,267 )           (6,267 )
Amortization of actuarial loss
                      1,832             1,832  
Amortization of prior service cost
                      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 (re-cast)
                      248             248  
Dividends ($0.935 per share)
                (10,600 )                 (10,600 )
Dividends paid to noncontrolling interests
                            (1,021 )     (1,021 )
Shares issued upon exercise of stock 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 (re-cast)
    11,492       38,275       146,802       (12,753 )     6,721       190,537  
Net income (re-cast)
                45,892             2,331       48,223  
Currency translation adjustments
                      (8,080 )     (1,075 )     (9,155 )
Defined benefit retirement plans:
                                               
Net loss arising during the period, other
                      (9,698 )           (9,698 )
Amortization of actuarial loss
                      1,230             1,230  
Amortization of prior service cost
                      77             77  
Current period changes in fair value of derivatives
                      395             395  
Unrealized loss on available-for-sale securities (re-cast)
                      (138 )           (138 )
Dividends ($0.95 per share)
                (11,984 )                 (11,984 )
Dividends paid to noncontrolling interests
                            (1,000 )     (1,000 )
Stock offering, net of related expenses
    1,265       46,878                         48,143  
Shares issued upon exercise of stock options and other
    47       811                         858  
Shares issued for employee stock purchase plan
    8       239                         247  
Equity based compensation plans
    100       3,413                         3,513  
Excess tax benefit from stock option exercises
          109                         109  
Balance at December 31, 2011 (re-cast)
    12,912       89,725       180,710       (28,967 )     6,977       261,357  
Net income
                47,405             2,835       50,240  
Currency translation adjustments
                      (1,974 )     (137 )     (2,111 )
Defined benefit retirement plans:
                                               
Net loss arising during the period, other
                      (13,980 )           (13,980 )
Amortization of actuarial loss
                      1,852             1,852  
Amortization of prior service cost
                      76             76  
Current period changes in fair value of derivatives
                      272             272  
Unrealized gain on available-for-sale securities
                      866             866  
Dividends ($0.975 per share)
                (12,725 )                 (12,725 )
Dividends paid to noncontrolling interests
                            (1,099 )     (1,099 )
Shares issued upon exercise of stock options and other
    102       (1,296 )                       (1,194 )
Shares issued for employee stock purchase plan
    7       263                         270  
Equity based compensation plans
    74       3,733                         3,807  
Excess tax benefit from stock option exercises
          2,045                         2,045  
Balance at December 31, 2012
  $ 13,095     $ 94,470     $ 215,390     $ (41,855 )   $ 8,576     $ 289,676  


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

 
31

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 companies (less than majority-owned and in which the Company has significant influence) are accounted for under the equity method.  The Company’s share of net income or losses in these investments in associated companies 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 or other impairment indicators are deemed to be other than temporary.  As described in Note 4 of Notes to Consolidated Financial Statements, during 2012 the Company acquired an increased ownership percentage in Primex, Ltd. (“Primex”), a captive insurance company.  Due to the increased ownership percentage and other factors, the Company changed its method of accounting for its investment in Primex from the cost method to the equity method of accounting.  As a result, the Company recast its Consolidated Balance Sheet as of December 31, 2011, the Consolidated Statements of Income, Other Comprehensive Income and Cash Flows for the years ending December 31, 2010 and December 31, 2011 and the Consolidated Statement of Changes in Equity for the years ending December 31, 2009, December 31, 2010 and December 31, 2011 and the Notes to Consolidated Financial Statements to reflect the change in method of accounting.  See also Note 4 to Notes to Consolidated Financial Statements.
 
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 applicable guidance.
 
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 as accumulated other comprehensive income (loss) and will be included as income or expense only upon sale or liquidation of the underlying investment.  All non-U.S. subsidiaries use their local currency as their 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, and are valued using the first-in, first-out (“FIFO”) method. See also Note 6 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, 1 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 in income.  Expenditures for renewals or improvements that increase the estimated useful life or capacity of the assets are capitalized, whereas 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 $2,395 and $2,800 of net costs were capitalized at December 31, 2012 and December 31, 2011, respectively. These costs are amortized over a period of three to five years once the assets are ready for their intended use.
 
Goodwill and other intangible assets:    The Company records goodwill, definite-lived intangible assets 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 triggering events indicate potential impairment. 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 Note 17 of Notes to Consolidated Financial Statements.
 
 
32

QUAKER CHEMICAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
(Dollars in thousands except per share amounts)

 
Revenue recognition:    The Company recognizes revenue in accordance with the terms of the underlying agreements, when title and risk of loss have been transferred, when collectability is reasonably assured, and when pricing is fixed or determinable. This generally occurs when products are shipped to customers or, for consignment-type arrangements, upon usage by the customer and when services are performed. License fees and royalties are included in other income when recognized in accordance with their agreed-upon terms, when performance obligations are satisfied, when the amount is fixed or determinabl