form10q.htm


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
 


FORM 10-Q
 


 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2013

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)
 

 
     
Pennsylvania
 
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
 
Not Applicable
Former name, former address and former fiscal year, if changed since last report.
 
 

 
 
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes    x     No    ¨
 
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 (§232.405 of this chapter) 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 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.
 
 
 
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 Exchange Act).    Yes  ¨   No  x    
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
     
Number of Shares of Common Stock
Outstanding on June 30, 2013
 
 
13,168,484
 



 
 

 

QUAKER CHEMICAL CORPORATION AND CONSOLIDATED SUBSIDIARIES
 
         
 
  
 
  
Page  
 PART I.
  
FINANCIAL INFORMATION
  
 
 Item 1.
  
Financial Statements (unaudited)
  
 
 
  
  
3
 
  
  
4
     
5
 
  
  
6
 
  
  
7
 Item 2.
  
  
21
 Item 3.
  
  
27
 Item 4.
  
  
28
 PART II.
  
  
29
 Item 1.
   
29
 Item 2.
   
29
 Item 6.
  
  
30
  
30


PART I
FINANCIAL INFORMATION

Item 1.                                Financial Statements (Unaudited).

Quaker Chemical Corporation
 
Condensed Consolidated Balance Sheet





   
Unaudited
 
   
(Dollars in thousands,
 
   
except par value
 
   
and share amounts)
 
   
June 30, 2013
   
December 31, 2012*
 
 
 
ASSETS
               
Current assets
               
        Cash and cash equivalents
 
$
38,546 
   
$
32,547 
 
        Accounts receivable, net
   
162,105 
     
154,197 
 
        Inventories
               
                Raw materials and supplies
   
39,363 
     
40,417 
 
                Work-in-process and finished goods
   
34,660 
     
32,054 
 
        Prepaid expenses and other current assets
   
17,722 
     
18,595 
 
                Total current assets
   
292,396 
     
277,810 
 
Property, plant and equipment, at cost
   
226,279 
     
225,177 
 
        Less accumulated depreciation
   
(141,137)
     
(140,065)
 
                Net property, plant and equipment
   
85,142 
     
85,112 
 
Goodwill
   
58,334 
     
59,169 
 
Other intangible assets, net
   
32,806 
     
32,809 
 
Investments in associated companies
   
16,554 
     
16,603 
 
Deferred income taxes
   
28,437 
     
30,673 
 
Other assets
   
35,824 
     
34,458 
 
                Total assets
 
$
549,493 
   
$
536,634 
 
                 
LIABILITIES AND EQUITY
               
Current liabilities
               
        Short-term borrowings and current portion of long-term debt
 
$
1,337 
   
$
1,468 
 
        Accounts and other payables
   
76,191 
     
70,794 
 
        Accrued compensation
   
13,013 
     
16,842 
 
        Other current liabilities
   
25,618 
     
18,688 
 
               Total current liabilities
   
116,159 
     
107,792 
 
Long-term debt
   
22,550 
     
30,000 
 
Deferred income taxes
   
6,147 
     
6,383 
 
Other non-current liabilities
   
92,280 
     
102,783 
 
               Total liabilities
   
237,136 
     
246,958 
 
Equity
               
         Common stock $1 par value; authorized 30,000,000 shares; issued and outstanding
               
            2013 – 13,168,484 shares; 2012 – 13,094,901 shares
   
13,168 
     
13,095 
 
         Capital in excess of par value
   
97,085 
     
94,470 
 
         Retained earnings
   
238,580 
     
215,390 
 
         Accumulated other comprehensive loss
   
(45,252)
     
(41,855)
 
               Total Quaker shareholders’ equity
   
303,581 
     
281,100 
 
Noncontrolling interest
   
8,776 
     
8,576 
 
Total equity
   
312,357 
     
289,676 
 
         Total liabilities and equity
 
$
549,493 
   
$
536,634 
 


 
*
Condensed from audited financial statements

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


Quaker Chemical Corporation
 
Condensed Consolidated Statement of Income

   
Unaudited
 
   
(Dollars in thousands, except per share amounts)
 
   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2013
   
2012
   
2013
   
2012
 
Net sales
  $ 184,846     $ 176,797     $ 361,039     $ 354,435  
Cost of goods sold
    117,532       116,161       231,117       234,004  
Gross profit
    67,314       60,636       129,922       120,431  
Selling, general and administrative expenses
    47,521       43,653       92,718       86,746  
Operating income
    19,793       16,983       37,204       33,685  
Other income (expense), net
    2,301       (134 )     2,647       207  
Interest expense
    (762 )     (1,151 )     (1,506 )     (2,325 )
Interest income
    229       137       398       260  
Income before taxes and equity in net income of associated companies
    21,561       15,835       38,743       31,827  
Taxes on income before equity in net income of associated companies
    6,828       4,874       10,961       8,319  
Income before equity in net income of associated companies
    14,733       10,961       27,782       23,508  
Equity in net income of associated companies
    1,942       777       3,084       1,342  
Net income
    16,675       11,738       30,866       24,850  
Less: Net income attributable to noncontrolling interest
    592       630       1,164       1,377  
Net income attributable to Quaker Chemical Corporation
  $ 16,083     $ 11,108     $ 29,702     $ 23,473  
Per share data:
                               
Net income attributable to Quaker Chemical Corporation Common
                               
Shareholders – basic
  $ 1.22     $ 0.86     $ 2.26     $ 1.81  
Net income attributable to Quaker Chemical Corporation Common
                               
Shareholders – diluted
  $ 1.22     $ 0.85     $ 2.26     $ 1.80  
Dividends declared
  $ 0.25     $ 0.245     $ 0.495     $ 0.485  
                                 

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


Quaker Chemical Corporation
 
Condensed Consolidated Statement of Comprehensive Income


   
Unaudited
   
(Dollars in thousands, except per share amounts)
   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2013
   
2012
   
2013
   
2012
 
Net income
  $ 16,675     $ 11,738     $ 30,866     $ 24,850  
                                 
Other comprehensive loss, net of tax
                               
Currency translation adjustments
    (4,183 )     (7,709 )     (5,946 )     (3,661 )
Defined benefit retirement plans
    562       997       1,868       1,054  
Current period change in fair value of derivatives
          103             199  
Unrealized (loss) gain on available-for-sale securities
    (715 )     (373 )     (283 )     705  
Other comprehensive loss
    (4,336 )     (6,982 )     (4,361 )     (1,703 )
                                 
Comprehensive income
    12,339       4,756       26,505       23,147  
Less: comprehensive loss (income) attributable to noncontrolling interest
    239       (205 )     (200 )     (1,243 )
Comprehensive income attributable to Quaker Chemical Corporation
  $ 12,578     $ 4,551     $ 26,305     $ 21,904  

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



Quaker Chemical Corporation
 
Condensed Consolidated Statement of Cash Flows

   
Unaudited
 
   
(Dollars in thousands)
 
   
For the Six Months Ended
 
   
June 30,
 
   
2013
   
2012
 
Cash flows from operating activities
           
Net income
  $ 30,866     $ 24,850  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation
    6,125       5,969  
Amortization
    1,763       1,465  
Equity in undistributed earnings of associated companies, net of dividends
    (1,021 )     (1,158 )
Deferred compensation and other, net
    (1,080 )     1,332  
Stock-based compensation
    2,152       2,078  
Gain on disposal of property, plant and equipment
    (224 )     (13 )
Insurance settlement realized
    (384 )     (808 )
Pension and other postretirement benefits
    (1,884 )     (1,951 )
(Decrease) increase in cash from changes in current assets and current liabilities, net of acquisitions:
               
Accounts receivable
    (9,913 )     (7,031 )
Inventories
    (2,269 )     (3,871 )
Prepaid expenses and other current assets
    (286 )     (1,946 )
Accounts payable and accrued liabilities
    3,650       3,025  
Net cash provided by operating activities
    27,495       21,941  
                 
Cash flows from investing activities
               
Investments in property, plant and equipment
    (5,202 )     (6,423 )
Proceeds from disposition of assets
    345       84  
Payments related to acquisitions, net of cash acquired
    (2,478 )      
Insurance settlement interest earned
    28       35  
Change in restricted cash, net
    356       773  
Net cash used in investing activities
    (6,951 )     (5,531 )
                 
Cash flows from financing activities
               
Repayment of long-term debt
    (7,563 )     (1,754 )
Dividends paid
    (6,428 )     (6,213 )
Stock options exercised, other
    84       (925 )
Excess tax benefit related to stock option exercises
    452       1,420  
Distributions to noncontrolling shareholders
          (30 )
Net cash used in financing activities
    (13,455 )     (7,502 )
Effect of exchange rate changes on cash
    (1,090 )     (565 )
Net increase in cash and cash equivalents
    5,999       8,343  
Cash and cash equivalents at beginning of period
    32,547       16,909  
Cash and cash equivalents at end of period
  $ 38,546     $ 25,252  
                 
Supplemental cash flow disclosures:
               
Non-cash activities:
               
Accrued property, plant and equipment purchases
  $ 1,159     $  

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

 
6

Quaker Chemical Corporation
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
(Unaudited)


Note 1 – Condensed Financial Information
 
The condensed consolidated financial statements included herein are unaudited and have been prepared in accordance with generally accepted accounting principles in the United States for interim financial reporting and the United States Securities and Exchange Commission regulations. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the financial statements reflect all adjustments (consisting only of normal recurring adjustments, except as discussed below) which are necessary for a fair statement of the financial position, results of operations and cash flows for the interim periods. Certain reclassifications of prior year data have been made to improve comparability.  The results for the three and six months ended June 30, 2013 are not necessarily indicative of the results to be expected for the full year. These financial statements should be read in conjunction with the Company’s Annual Report filed on Form 10-K for the year ended December 31, 2012.
 
During the first quarter of 2013, the Company adopted the Financial Accounting Standards Board’s (“FASB’s”) guidance regarding the disclosure of reclassifications from Accumulated Other Comprehensive Income (Loss) (“AOCI”).  The guidance requires the disclosure of significant amounts reclassified from each component of AOCI, the related tax amounts and the income statement line items affected by the reclassifications, either parenthetically on the Condensed Consolidated Statement of Comprehensive Income or in the Notes to the Condensed Consolidated Financial Statements.  The Company elected to present the information in the Notes to the Condensed Consolidated Financial Statements, and the adoption of this guidance did not have a material impact on the Company’s results or financial condition.  See Note 9 of Notes to Condensed Consolidated Financial Statements.
 
Effective January 1, 2010, Venezuela’s economy was considered to be hyperinflationary under generally accepted accounting principles in the United States, as it had experienced a rate of general inflation in excess of 100% over the latest three-year period, based upon the blended Consumer Price Index and National Consumer Price Index.  Accordingly, all gains and losses resulting from the remeasurement of the Company’s Venezuelan 50% owned equity affiliate (Kelko Quaker Chemical, S.A.) were required to be recorded directly to the Condensed Consolidated Statement of Income.  On January 8, 2010, the Venezuelan government announced the devaluation of the Bolivar Fuerte and the establishment of a two-tiered exchange structure.  In February 2013, the Venezuelan Government announced a further devaluation of the Bolivar Fuerte.  Accordingly, the Company recorded a charge of approximately $0.03 per diluted share during the first quarter of 2013.
 
During 2002 and 2003, the Company’s Netherlands and Italian subsidiaries paid excise taxes on mineral oil sales in Italy for a total amount of approximately $2,000.  Alleging that the mineral oil excise tax was contrary to European Union directives, the subsidiaries filed with the Customs’ Authority of Milan (“Customs Office” or “Office”) requests to obtain a refund of the above-mentioned amount.  The parties appealed rulings to various levels of tax courts up through the Supreme Court of Italy.  In March 2012, the Supreme Court rejected the appeal of the Customs Office, ruling in favor of the subsidiaries and granting a refund for the amounts requested.  After filing an enforcement action, the Company collected approximately $2,057, along with approximately $483 of interest, in the second quarter of 2013.  This amount was recorded as other income on the Company’s Condensed Consolidated Statement of Income in the second quarter of 2013.
 
During the second quarter of 2012, the Company recorded charges of $1,156 to its allowance for doubtful accounts and selling, general and administrative expenses (“SG&A”) due to the bankruptcies of two U.S. customers.  In addition, during the second quarter of 2012, the Company incurred a total charge of approximately $609 related to CFO transition costs, which were also recorded in SG&A.
 
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 the principal, revenue is recognized on a gross reporting basis at the selling price negotiated with customers. Where the Company acts as an agent, such revenue is recorded using net reporting as service 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 $19,338 and $20,944 for the six months ended June 30, 2013 and June 30, 2012, respectively.
 
Note 2 – Out of Period Adjustment
 
As previously disclosed in the Company’s 2012 Annual Report on Form 10-K, the Company had reassessed its ability to significantly influence the operating and financial policies of its captive insurance equity affiliate, 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, changed its method of accounting from the cost to equity method.   During the first quarter of 2013, the Company identified errors in Primex’s estimated 2012 financial statements, which primarily related to a reinsurance contract held by Primex.  The identified errors resulted in a cumulative $1,038 understatement of the Company’s equity in net income from associated companies for the year ended December 31, 2012.  The Company corrected the errors related to Primex in the first quarter of 2013, which had the net effect of increasing equity in net income from associated companies by $1,038 for the three months ended March 31, 2013 and the six
 
 
7

Quaker Chemical Corporation
Notes to Condensed Consolidated Financial Statements - Continued
(Dollars in thousands, except per share amounts)
(Unaudited)

 
months ended June 30, 2013.  The Company does not believe this adjustment is material to the consolidated financial statements for the year ended December 31, 2012 or to the Company’s projected results for the current year and, therefore, has not restated any prior period amounts.  As the Company’s assessment was based on projected full year 2013 results, the Company will update its assessment at year-end based upon actual 2013 results.
 
Note 3 – Income Taxes and Uncertain Income Tax Positions
 
The Company's effective tax rate for the first six months of 2013 of 28.3% was higher than the first six months of 2012 effective tax rate of 26.1%.  Both effective tax rates reflect decreases in reserves for uncertain tax positions due to the expiration of applicable statutes of limitations for certain tax years of approximately $0.10 and $0.12 per diluted share for the six months ended June 30, 2013 and June 30, 2012, respectively.  Also contributing to the increase in the effective tax rate is that the tax rate in China was 15% in the first six months of 2012 compared to 25% in the first six months of 2013.  While the Company’s recertification of its Chinese subsidiary’s high tech status is pending, the Company will record tax expense at the current statutory rate of 25%.
 
As of June 30, 2013, the Company’s cumulative liability for gross unrecognized tax benefits was $11,822.  At December 31, 2012, the Company’s cumulative liability for gross unrecognized tax benefits was $12,410.
 
The Company continues to recognize interest and penalties associated with uncertain tax positions as a component of taxes on income before equity in net income of associated companies in its Condensed Consolidated Statement of Income. The Company recognized $144 and $(333) for interest and $148 and $241 for penalties on its Condensed Consolidated Statement of Income for the three and six months ended June 30, 2013, respectively, and recognized $164 and $(51) for interest and $99 and $194 for penalties on its Condensed Consolidated Statement of Income for the three and six months ended June 30, 2012, respectively. As of June 30, 2013, the Company had accrued $1,931 for cumulative interest and $1,848 for cumulative penalties compared to $2,288 for cumulative interest and $1,630 for cumulative penalties at December 31, 2012.
 
During the three months ended June 30, 2013, the Company recognized a decrease in its cumulative liability for gross unrecognized tax benefits of approximately $8 due to the expiration of the applicable statutes of limitations for certain tax years. During the three months ended June 30, 2012, there were no expirations of statutes of limitations for uncertain tax positions.
 
During the six months ended June 30, 2013, the Company recognized a $1,695 decrease in its cumulative liability for gross unrecognized tax benefits due to the expiration of the applicable statutes of limitations for certain tax years.  During the six months ended June 30, 2012, the Company recognized a $1,072 decrease in its cumulative liability for gross unrecognized tax benefits due to the expiration of the applicable statutes of limitations for certain tax years.
 
The Company estimates that during the year ending December 31, 2013 it will reduce its cumulative liability for gross unrecognized tax benefits by approximately $2,400 to $2,500 due to the expiration of the statute of limitations with regard to certain tax positions. This estimated reduction in the cumulative liability for unrecognized tax benefits does not consider any increase in liability for unrecognized tax benefits with regard to existing tax positions or any increase in cumulative liability for unrecognized tax benefits with regard to new tax positions for the year ending December 31, 2013.
 
The Company and its subsidiaries are subject to U.S. Federal income tax, as well as the income tax of various state and foreign tax jurisdictions. Tax years that remain subject to examination by major tax jurisdictions include the Netherlands and the United Kingdom from 2007, Brazil and Spain from 2008, the United States from 2009, China and Italy from 2010, and various domestic state tax jurisdictions from 1993.
 
In the first quarter of 2013, the Internal Revenue Service (“IRS”) initiated a limited scope audit of the Company’s 2010 Federal Income Tax Return.  By letter dated March 25, 2013, the IRS notified the Company that it had completed the review of the Company’s 2010 Federal Income Tax Return without any changes to the reported tax.
 
During the second quarter of 2012, the Italian tax authorities initiated a transfer pricing audit of the Company’s Italian subsidiary.  On July 7, 2012, the Company received a preliminary tax report related to this transfer pricing audit, which proposed several adjustments to the taxable income of the subsidiary.  During the fourth quarter of 2012, the Company’s Italian subsidiary received an assessment for the tax year 2007, which the Company appealed during the first quarter of 2013.  On June 24, 2013, a hearing was held before the Provincial Tax Court of Varese, Italy.  The Company and outside counsel believe the Company should prevail on the merits of its case.  The Company does not believe it has any exposures warranting an uncertain tax position reserve as of June 30, 2013.
 
At the end of March 2013, the Chinese tax authorities announced they would be reviewing the original applications of all companies that were certified as high tech enterprises in Shanghai.  If the tax authorities find issues with the application, they could disallow the benefits of high tech enterprise status retroactively.  The Company currently understands that a retroactive disallowance of the high tech enterprise status would affect only 2012.  Currently, no appointment with the tax auditor has been scheduled.  The Company does not believe that its status as a high tech enterprise will be revoked and as a result no uncertain tax position has been recorded.
 
 
8

Quaker Chemical Corporation
Notes to Condensed Consolidated Financial Statements - Continued
(Dollars in thousands, except per share amounts)
(Unaudited)

 
Note 4 – Fair Value Measurements
 
The Company values its company-owned life insurance policies, various deferred compensation assets and liabilities, acquisition-related consideration and an obligation related to a non-competition agreement at fair value.  The Company’s assets and liabilities subject to fair value measurement are as follows (in thousands):

         
Fair Value Measurements at June 30, 2013
 
   
Fair Value
   
Using Fair Value Hierarchy
 
   
as of
                   
Assets
 
June 30, 2013
   
Level 1
   
Level 2
   
Level 3
 
Company-owned life insurance
  $ 1,743     $     $ 1,743     $  
Company-owned life insurance - Deferred compensation assets
    387             387        
Other deferred compensation assets
                               
Large capitalization registered investment companies
    64       64              
Mid capitalization registered investment companies
    6       6              
Small capitalization registered investment companies
    11       11              
International developed and emerging markets registered investment
                               
                companies
    34       34              
Fixed income registered investment companies
    8       8              
                                 
Total
  $ 2,253     $ 123     $ 2,130     $  

         
Fair Value Measurements at June 30, 2013
 
   
Fair Value
   
Using Fair Value Hierarchy
 
   
as of
                   
Liabilities
 
June 30, 2013
   
Level 1
   
Level 2
   
Level 3
 
Deferred compensation liabilities
                       
Large capitalization registered investment companies
  $ 346     $ 346     $     $  
Mid capitalization registered investment companies
    94       94              
Small capitalization registered investment companies
    78       78              
International developed and emerging markets registered investment
                               
                  companies
    176       176              
Fixed income registered investment companies
    44       44              
Fixed general account
    163             163        
Acquisition-related consideration
    5,794                   5,794  
                                 
Total
  $ 6,695     $ 738     $ 163     $ 5,794  

         
Fair Value Measurements at December 31, 2012
 
   
Fair Value
   
Using Fair Value Hierarchy
 
   
as of
                   
Assets
 
December 31, 2012
   
Level 1
   
Level 2
   
Level 3
 
Company-owned life insurance
  $ 1,653     $     $ 1,653     $  
Company-owned life insurance - Deferred compensation assets
    437             437        
Other deferred compensation assets
                               
Large capitalization registered investment companies
    62       62              
Mid capitalization registered investment companies
    6       6              
Small capitalization registered investment companies
    9       9              
International developed and emerging markets registered investment
                               
                 companies
    37       37              
Fixed income registered investment companies
    8       8              
                                 
Total
  $ 2,212     $ 122     $ 2,090     $  
 
 
 
9

Quaker Chemical Corporation
Notes to Condensed Consolidated Financial Statements - Continued
(Dollars in thousands, except per share amounts)
(Unaudited)


         
Fair Value Measurements at December 31, 2012
 
   
Fair Value
   
Using Fair Value Hierarchy
 
   
as of
                   
Liabilities
 
December 31, 2012
   
Level 1
   
Level 2
   
Level 3
 
Deferred compensation liabilities
                       
Large capitalization registered investment companies
  $ 336     $ 336     $     $  
Mid capitalization registered investment companies
    88       88              
Small capitalization registered investment companies
    72       72              
International developed and emerging markets registered investment
                               
                 companies
    187       187              
Fixed income registered investment companies
    48       48              
Fixed general account
    173             173        
Acquisition-related consideration
    4,901                   4,901  
                                 
Total
  $ 5,805     $ 731     $ 173     $ 4,901  

The fair values of Company-owned life insurance (“COLI”) and COLI deferred compensation assets are based on quotes for like instruments with similar credit ratings and terms.  The fair values of other deferred compensation assets and liabilities are based on quoted prices in active markets.  The fair value of the Summit earnout is based on unobservable inputs and is classified as Level 3.  Significant inputs and assumptions are management’s estimate of the probability of the earnout ultimately being met/paid and the discount rate used to present value the liability.  The fair value of the obligation related to a non-competition agreement is also based on unobservable inputs and is classified as Level 3.  The significant inputs and assumptions for the obligation related to the non-competition agreement is management’s estimate of the discount rate used to present value the liability.  Significant changes in any Level 3 assumption in isolation would result in increases or decreases to the fair value measurements for the earnout and the obligation related to the non-competition agreement.
 
Changes in the fair value of the Level 3 liabilities during the six months ended June 30, 2013 were as follows:

     
Non-competition
     
 
Earnout
 
Agreement
     
 
Summit
 
Obligation
 
Total
 
Balance at December 31, 2012
$ 4,497   $ 404   $ 4,901  
Interest accretion
  326     17     343  
Change in fair value estimate
  675         675  
Payments
      (125 )   (125 )
Balance at June 30, 2013
$ 5,498   $ 296   $ 5,794  

During the first quarter of 2013, the Summit earnout liability became current and was reclassified from other non-current liabilities to other current liabilities on the Company’s Condensed Consolidated Balance Sheet.

Quantitative information about the Company’s Level 3 fair value measurements at June 30, 2013 were as follows:

   
Fair value at
June 30, 2013
 
Valuation technique
 
Unobservable input
 
Input value
 
Summit earnout
 
 5,498 
 
Discounted cash flow
 
Discount rate
 
14.5%
 
Non-competition agreement obligation
 
 296 
 
Discounted cash flow
 
Discount rate
 
14.0%
 

The fair value of the Summit earnout is based on the weighted average probability of the outcome of different payout scenarios.  As of June 30, 2013, the probabilities applied to the payout scenarios ranged from 10% to 70%, depending on the Company’s estimate of the likelihood of each payout scenario.  During the second quarter of 2013, the Company updated the fair value of the Summit earnout, which resulted in other expense and an increase to the liability of approximately $675.
 

 
10

Quaker Chemical Corporation
Notes to Condensed Consolidated Financial Statements - Continued
(Dollars in thousands, except per share amounts)
(Unaudited)


Note 5 – Hedging Activities
 
The Company utilized interest rate swaps to mitigate the impact of changes in interest rates by converting a portion of the Company’s variable interest rate debt to fixed interest rate debt.  These interest rate swaps had a combined notional amount of $15,000 during 2012 until their maturity, which occurred during the third quarter of 2012.  The Company had no derivatives designated as cash flow hedges as of December 31, 2012 and did not utilize any during the six months ended June 30, 2013.
 
Information about the Company’s interest rate derivatives is as follows:

Cash Flow Hedges
 
Interest Rate Swaps
 
                     
     
Three Months Ended
 
Six Months Ended
 
     
June 30,
 
June 30,
 
     
2013
 
2012
 
2013
 
2012
 
Amount of Gain Recognized in Accumulated OCI on Derivative
                   
(Effective Portion)
    $   $ 103   $   $ 199  
                             
Amount and Location of Gain Reclassified from Accumulated OCI into
                           
Income (Effective Portion)
Interest Expense
  $   $ (160 ) $   $ (318 )
                             
Amount and Location of Gain Recognized in Income on Derivative
                           
(Ineffective Portion and Amount Excluded from Effectiveness Testing)
Other Income
  $   $   $   $  

 
Note 6 – Stock-Based Compensation
 
The Company recognized the following share-based compensation expense in selling, general and administrative expenses in its Condensed Consolidated Statement of Income for the six months ended June 30, 2013 and the six months ended June 30, 2012:
 

   
For the Six Months Ended June 30,
 
   
2013
 
2012
 
Stock options
  $ 238   $ 263  
Nonvested stock awards and restricted stock units
    911     732  
Employee stock purchase plan
    26     23  
Non-elective and elective 401(k) matching contribution in stock
    936     1,030  
Director stock ownership plan
    41     30  
Total share-based compensation expense
  $ 2,152   $ 2,078  

As of June 30, 2013 and June 30, 2012, the Company recorded $452 and $1,420, respectively, of excess tax benefits in capital in excess of par value on its Condensed Consolidated Balance Sheets, related to stock option exercises. The Company’s estimated taxes payable was sufficient to fully recognize these benefits as cash inflows from financing activities in its Condensed Consolidated Statement of Cash Flows, which represented the Company’s estimate of cash savings through the six months ended June 30, 2013 and June 30, 2012, respectively.
 

 
11

Quaker Chemical Corporation
Notes to Condensed Consolidated Financial Statements - Continued
(Dollars in thousands, except per share amounts)
(Unaudited)


Stock option activity under all plans is as follows:

           
Weighted
           
Average
     
Weighted Average
Remaining
 
Number of
 
Exercise Price per
Contractual
 
Shares
 
Share
Term (years)
Options outstanding at December 31, 2012
107,455 
 
$
31.23 
   
Options granted
29,302 
   
58.26 
   
Options exercised
(23,415)
   
25.10 
   
Options forfeited
(3,601)
   
37.81 
   
Options expired
(768)
   
37.37 
   
Options outstanding at June 30, 2013
108,973 
 
$
39.55 
 
5.3 
Options exercisable at June 30, 2013
45,562 
 
$
28.50 
 
4.3 

As of June 30, 2013, the total intrinsic value of options outstanding was approximately $2,488, and the total intrinsic value of exercisable options was $1,544.  Intrinsic value is calculated as the difference between the current market price of the underlying security and the strike price of a related option.
 
A summary of the Company’s outstanding stock options at June 30, 2013 is as follows: 

           
Weighted
 
Weighted
 
Number
 
Weighted
         
Number
Average
 
Average
 
Exercisable
 
Average
Range of
Outstanding
Contractual
 
Exercise
 
at
 
Exercise
Exercise Prices
at 6/30/2013
Life
 
Price
 
6/30/2013
 
Price
$
0.00
-
$
10.00
— 
— 
 
$
— 
 
— 
 
$
— 
$
10.01
-
$
20.00
22,490 
3.6 
   
18.82 
 
22,490 
   
18.82 
$
20.01
-
$
30.00
— 
— 
   
— 
 
— 
   
— 
$
30.01
-
$
40.00
54,989 
5.2 
   
37.79 
 
22,341 
   
37.66 
$
40.01
-
$
50.00
2,192 
6.0 
   
46.21 
 
731 
   
46.21 
$
50.01
-
$
60.00
29,302 
6.7 
   
58.26 
 
— 
   
— 
         
108,973 
5.3 
   
39.55 
 
45,562 
   
28.50 

As of June 30, 2013, unrecognized compensation expense related to options granted during 2011 was $98, for options granted during 2012 was $339 and for options granted in 2013 was $570.
 
During the first quarter of 2013, the Company granted stock options under the Company’s LTIP plan that are subject only to time vesting over a three-year period.  For the purposes of determining the fair value of stock option awards, the Company uses the Black-Scholes option pricing model and the assumptions set forth in the table below:

 
2013 
 
Number of options granted
 29,302 
 
Dividend yield
2.49 
%
Expected volatility
57.28 
%
Risk-free interest rate
0.63 
%
Expected term (years)
4.0 
 

Approximately $68 of expense was recorded on these options during the first six months of 2013.  The fair value of these awards is amortized on a straight-line basis over the vesting period of the awards.
 

 
12

Quaker Chemical Corporation
Notes to Condensed Consolidated Financial Statements - Continued
(Dollars in thousands, except per share amounts)
(Unaudited)


Activity of nonvested shares granted under the Company’s LTIP plan is shown below:
 

     
Weighted
 
     
Average Grant
 
 
Number of
 
Date Fair Value
 
 
Shares
 
(per share)
 
Nonvested awards, December 31, 2012
122,944 
 
$
31.98 
 
Granted
46,659 
 
$
61.00 
 
Vested
(47,481)
 
$
25.03 
 
Forfeited
(4,430)
 
$
40.85 
 
Nonvested awards, June 30, 2013
117,692 
 
$
45.95 
 

The fair value of the nonvested stock is based on the trading price of the Company’s common stock on the date of grant. The Company adjusts the grant date fair value for expected forfeitures based on historical experience for similar awards.  As of June 30, 2013, unrecognized compensation expense related to these awards was $3,471 to be recognized over a weighted average remaining period of 2.55 years.
 
Activity of nonvested restricted stock units granted under the Company’s LTIP plan is shown below:
 

     
Weighted
 
     
Average Grant
 
 
Number of
 
Date Fair Value
 
 
units
 
(per unit)
 
Nonvested awards, December 31, 2012
2,100 
 
$
38.13 
 
Granted
1,418 
 
$
58.26 
 
Nonvested awards, June 30, 2013
3,518 
 
$
46.24 
 

The fair value of the nonvested restricted stock units is based on the trading price of the Company’s common stock on the date of grant. The Company adjusts the grant date fair value for expected forfeitures based on historical experience for similar awards. As of June 30, 2013, unrecognized compensation expense related to these awards was $103 to be recognized over a weighted average remaining period of 2.37 years.
 
Employee Stock Purchase Plan
 
In 2000, the Board adopted an Employee Stock Purchase Plan (“ESPP”) whereby employees may purchase Company stock through a payroll deduction plan. Purchases are made from the plan and credited to each participant’s account at the end of each month, the “Investment Date.” The purchase price of the stock is 85% of the fair market value on the Investment Date. The plan is compensatory and the 15% discount is expensed on the Investment Date. All employees, including officers, are eligible to participate in this plan. A participant may withdraw all uninvested payment balances credited to a participant’s account at any time.  An employee whose stock ownership of the Company exceeds five percent of the outstanding common stock is not eligible to participate in this plan.
 
2013 Director Stock Ownership Plan
 
In March 2013, the Company adopted the 2013 Director Stock Ownership Plan (the “Plan”), subject to the approval by the Company’s shareholders at the annual meeting, to encourage the Directors to increase their investment in the Company.  The Plan was approved at the Company’s May 2013 shareholders’ meeting.  The Plan authorizes the issuance of up to 75,000 shares of Quaker common stock in accordance with the terms of the Plan in payment of all or a portion of the annual cash retainer payable to each of the Company’s non-employee directors in 2013 and subsequent years during the term of the Plan.  Under the Plan, each director who, on May 1st of the applicable calendar year, owns less than 400% of the annual cash retainer for the applicable calendar year, divided by the average of the closing price of a share of Quaker Common Stock as reported by the composite tape of the New York Stock Exchange for the previous calendar year (the “Threshold Amount”), is required to receive 75% of the annual cash retainer in Quaker common stock and 25% of the retainer in cash, unless the director elects to receive a greater percentage of Quaker common stock (up to 100%) of the annual cash retainer for the applicable year.  Each director who owns more than the Threshold Amount may elect to receive common stock in payment of a percentage (up to 100%) of the annual cash retainer.  The annual retainer is $50 and the retainer payment date is June 1.  The Plan was adopted in order to replace the 2003 Director Stock Ownership Plan, which expired in May 2013.
 

 
13

Quaker Chemical Corporation
Notes to Condensed Consolidated Financial Statements - Continued
(Dollars in thousands, except per share amounts)
(Unaudited)


Note 7 – Earnings Per Share
 
The following table summarizes earnings per share calculations for the three and six months ended June 30, 2013 and June 30, 2012:

   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
2013
   
2012
   
2013
   
2012
 
Basic earnings per common share
                       
Net income attributable to Quaker Chemical Corporation
  $ 16,083     $ 11,108     $ 29,702     $ 23,473  
Less: income allocated to participating securities
    (139 )     (106 )     (249 )     (302 )
Net income available to common shareholders
  $ 15,944     $ 11,002     $ 29,453     $ 23,171  
Basic weighted average common shares outstanding
    13,037,822       12,850,917       13,019,991       12,790,799  
Basic earnings per common share
  $ 1.22     $ 0.86     $ 2.26     $ 1.81  
                                 
Diluted earnings per common share
                               
Net income attributable to Quaker Chemical Corporation
  $ 16,083     $ 11,108     $ 29,702     $ 23,473  
Less: income allocated to participating securities
    (138 )     (106 )     (248 )     (301 )
Net income available to common shareholders
  $ 15,945     $ 11,002     $ 29,454     $ 23,172  
Basic weighted average common shares outstanding
    13,037,822       12,850,917       13,019,991       12,790,799  
Effect of dilutive securities and employee stock options
    24,918       80,913       27,314       88,838  
Diluted weighted average common shares outstanding
    13,062,740       12,931,830       13,047,305       12,879,637  
Diluted earnings per common share
  $ 1.22     $ 0.85     $ 2.26     $ 1.80  

The following number of stock options are not included in diluted earnings per share since the effect would have been anti-dilutive: 6,170 and 9,917 for the three months ended June 30, 2013 and June 30, 2012, respectively, and 4,520 and 7,859 for the six months ended June 30, 2013 and June 30, 2012, respectively.
 
Note 8 – Business Segments
 
The following table presents information about the Company’s reported segments for the three and six months ended June 30, 2013 and June 30, 2012:
 
   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
2013
   
2012
   
2013
   
2012
 
Metalworking Process Chemicals
                       
Net sales
  $ 172,241     $ 165,011     $ 337,177     $ 330,986  
Operating income for reportable segment
    34,121       30,649       66,148       61,624  
Coatings
                               
Net sales
    12,185       10,950       22,931       21,473  
Operating income for reportable segment
    3,616       2,799       6,122       5,312  
Other Chemical Products
                               
Net sales
    420       836       931       1,976  
Operating (loss) income for reportable segment
    (33 )     53       (54 )     195  
Total
                               
Net sales
    184,846       176,797       361,039       354,435  
Operating income for reportable segments
    37,704       33,501       72,216       67,131  
Non-operating expenses
    (17,027 )     (15,799 )     (33,249 )     (31,981 )
Amortization expense
    (884 )     (719 )     (1,763 )     (1,465 )
Consolidated operating income
    19,793       16,983       37,204       33,685  
Interest expense
    (762 )     (1,151 )     (1,506 )     (2,325 )
Interest income
    229       137       398       260  
Other income (expense), net
    2,301       (134 )     2,647       207  
Consolidated income before taxes and equity in net income of associated companies
  $ 21,561     $ 15,835     $ 38,743     $ 31,827  

Operating income is comprised of revenue less related costs and expenses. Non-operating items primarily consist of general corporate expenses identified as not being a cost of operation, interest expense, interest income, and license fees from non-consolidated affiliates.
 
 
14

Quaker Chemical Corporation
Notes to Condensed Consolidated Financial Statements - Continued
(Dollars in thousands, except per share amounts)
(Unaudited)

 
Note 9 – Equity and Noncontrolling Interest
 
The following table presents the changes in equity and noncontrolling interest for the three and six months ended June 30, 2013 and June 30, 2012:
 

                     
Accumulated
             
         
Capital in
         
Other
             
   
Common
   
Excess of
   
Retained
   
Comprehensive
   
Noncontrolling
       
   
Stock
   
Par Value
   
Earnings
   
Loss
   
Interest
   
Total
 
Balance at March 31, 2013
  $ 13,140     $ 95,775     $ 225,790     $ (41,747 )   $ 9,015     $ 301,973  
Net income
                16,083             592       16,675  
Amounts reported in other comprehensive income
                      (3,505 )     (831 )     (4,336 )
Dividends ($0.25 per share)
                (3,293 )                 (3,293 )
Share issuance and equity-based compensation plans
    28       1,227                         1,255  
Excess tax benefit from stock option exercises
          83                         83  
Balance at June 30, 2013
  $ 13,168     $ 97,085     $ 238,580     $ (45,252 )   $ 8,776     $ 312,357  
                                                 
Balance at March 31, 2012
  $ 12,951     $ 90,836     $ 189,961     $ (23,979 )   $ 8,015     $ 277,784  
Net income
                11,108             630       11,738  
Amounts reported in other comprehensive income
                      (6,557 )     (425 )     (6,982 )
Dividends ($0.245 per share)
                (3,188 )                 (3,188 )
Dividends paid to noncontrolling shareholders
                            (30 )     (30 )
Share issuance and equity-based compensation plans
    60       1,195                         1,255  
Excess tax benefit from stock option exercises
          168                         168  
Balance at June 30, 2012
  $ 13,011     $ 92,199     $ 197,881     $ (30,536 )   $ 8,190     $ 280,745  

                     
Accumulated
             
         
Capital in
         
Other
             
   
Common
   
Excess of
   
Retained
   
Comprehensive
   
Noncontrolling
       
   
Stock
   
Par Value
   
Earnings
   
Loss
   
Interest
   
Total
 
Balance at December 31, 2012
  $ 13,095     $ 94,470     $ 215,390     $ (41,855 )   $ 8,576     $ 289,676  
Net income
                29,702             1,164       30,866  
Amounts reported in other comprehensive income
                      (3,397 )     (964 )     (4,361 )
Dividends ($0.495 per share)
                (6,512 )                 (6,512 )
Share issuance and equity-based compensation plans
    73       2,163                         2,236  
Excess tax benefit from stock option exercises
          452                         452  
Balance at June 30, 2013
  $ 13,168     $ 97,085     $ 238,580     $ (45,252 )   $ 8,776     $ 312,357  
                                                 
Balance at December 31, 2011
  $ 12,912     $ 89,725     $ 180,710     $ (28,967 )   $ 6,977     $ 261,357  
Net income
                23,473             1,377       24,850  
Amounts reported in other comprehensive income
                      (1,569 )     (134 )     (1,703 )
Dividends ($0.485 per share)
                (6,302 )                 (6,302 )
Dividends paid to noncontrolling interests
                            (30 )     (30 )
Share issuance and equity-based compensation plans
    99       1,054                         1,153  
Excess tax benefit from stock option exercises
          1,420                         1,420  
Balance at June 30, 2012
  $ 13,011     $ 92,199     $ 197,881     $ (30,536 )   $ 8,190     $ 280,745  


 
15

Quaker Chemical Corporation
Notes to Condensed Consolidated Financial Statements - Continued
(Dollars in thousands, except per share amounts)
(Unaudited)


The following tables show the reclassifications from and resulting balances of accumulated other comprehensive loss for the three and six months ended June 30, 2013 and June 30, 2012:
 

                     
Unrealized
       
   
Currency
   
Defined
   
Change in
   
gain (loss) in
       
   
translation
   
benefit
   
fair value of
   
available-for-
       
   
adjustments
   
pension plans
   
derivatives
   
sale securities
   
Total
 
Balance at March 31, 2013
  $ 1,706     $ (45,608 )   $     $ 2,155     $ (41,747 )
Other comprehensive (loss) income before reclassifications
    (3,352 )     (214 )           (289 )     (3,855 )
Amounts reclassified from accumulated other comprehensive loss
          1,065             (795 )     270  
Current period other comprehensive (loss) income
    (3,352 )     851             (1,084 )     (3,585 )
Related tax amounts
          (289 )           369       80  
Net current period other comprehensive (loss) income
    (3,352 )     562             (715 )     (3,505 )
                                         
Balance at June 30, 2013
  $ (1,646 )   $ (45,046 )   $     $ 1,440     $ (45,252 )
                                         
Balance at March 31, 2012
  $ 8,466     $ (34,203 )   $ (176 )   $ 1,934     $ (23,979 )
Other comprehensive (loss) income before reclassifications
    (7,284 )     668       (2 )     (248 )     (6,866 )
Amounts reclassified from accumulated other comprehensive loss
          747       160       (318 )     589  
Current period other comprehensive (loss) income
    (7,284 )     1,415       158       (566 )     (6,277 )
Related tax amounts
          (418 )     (55 )     193       (280 )
Net current period other comprehensive (loss) income
    (7,284 )     997       103       (373 )     (6,557 )
                                         
Balance at June 30, 2012
  $ 1,182     $ (33,206 )   $ (73 )   $ 1,561     $ (30,536 )

                     
Unrealized
       
   
Currency
   
Defined
   
Change in
   
gain (loss) in
       
   
translation
   
benefit
   
fair value of
   
available-for-
       
   
adjustments
   
pension plans
   
derivatives
   
sale securities
   
Total
 
Balance at December 31, 2012
  $ 3,336     $ (46,914 )   $     $ 1,723     $ (41,855 )
Other comprehensive (loss) income before reclassifications
    (4,982 )     549             859       (3,574 )
Amounts reclassified from accumulated other comprehensive loss
          2,120             (1,288 )     832  
Current period other comprehensive (loss) income
    (4,982 )     2,669             (429 )     (2,742 )
Related tax amounts
          (801 )           146       (655 )
Net current period other comprehensive (loss) income
    (4,982 )     1,868             (283 )     (3,397 )
                                         
Balance at June 30, 2013
  $ (1,646 )   $ (45,046 )   $     $ 1,440     $ (45,252 )
                                         
Balance at December 31, 2011
  $ 4,709     $ (34,260 )   $ (272 )   $ 856     $ (28,967 )
Other comprehensive (loss) income before reclassifications
    (3,527 )     106       (12 )     1,589       (1,844 )
Amounts reclassified from accumulated other comprehensive loss
          1,497       318       (521 )     1,294  
Current period other comprehensive (loss) income
    (3,527 )     1,603       306       1,068       (550 )
Related tax amounts
          (549 )     (107 )     (363 )     (1,019 )
Net current period other comprehensive (loss) income
    (3,527 )