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, 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)
 
     
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  x
 
Accelerated filer  ¨
   
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, 2013): $805,019,401
 
Indicate the number of shares outstanding of each of the Registrant’s classes of common stock as of the latest practicable date:  13,199,043 shares of Common Stock, $1.00 Par Value, as of January 31, 2014.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Portions of the Registrant’s definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held on May 7, 2014 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 and offers chemical management services (“CMS”) for various heavy industrial and manufacturing applications in a global portfolio throughout its four regions: the North America region, the Europe, Middle East and Africa (“EMEA”) region, the Asia/Pacific region and the South America region. The principal products and services in Quaker’s global portfolio 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) chemical milling maskants for the aerospace industry and temporary and permanent coatings for metal and concrete products; (viii) construction products, such as flexible sealants and protective coatings, for various applications; (ix) specialty greases; (x) die casting lubricants; (xi) technology for the removal of hydrogen sulfide in various industrial applications; 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:
 
 
 
 
2013 
 
 
2012 
 
 
2011 
 
 
 
Rolling Lubricants
 
20.7 
%
 
20.7 
%
 
22.0 
%
 
 
Machining and grinding compounds
 
17.7 
%
 
17.6 
%
 
18.8 
%
 
 
Hydraulic fluids
 
12.9 
%
 
13.5 
%
 
12.9 
%
 
 
Corrosion preventives
 
12.5 
%
 
12.4 
%
 
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 relies less on the use of advertising, and more 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 its 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 $41.6 million, $39.3 million and $50.9 million for 2013, 2012 and 2011, 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 2013, the Company acquired a chemical milling maskants distribution network for net consideration of approximately $0.7 million and a business that primarily related to tin plating for net consideration of approximately $1.8 million.  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.
 
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, render technical services and laboratory assistance to the customer and, to a lesser extent, on price.
 

 
1

 
 
Major Customers and Markets
 
In 2013, Quaker’s five largest customers (each composed of multiple subsidiaries or divisions with semi-autonomous purchasing authority) accounted for approximately 18% of our consolidated net sales, with the largest customer (Arcelor-Mittal Group) accounting for approximately 9% of our 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 2013, three raw material groups (mineral oils and derivatives, animal fats and derivatives, and vegetable oils and derivatives) each accounted for at least 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 its 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 2013, 2012 and 2011 were $21.6 million, $20.0 million and $18.8 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 $0.6 million, $1.0 million and $1.0 million in 2013, 2012 and 2011, respectively. In 2014, the Company expects to incur approximately $1.4 million for capital expenditures directed primarily to regulatory compliance.
 
Number of Employees
 
On December 31, 2013, Quaker’s consolidated companies had 1,783 full-time employees of whom 563 were employed by the parent company and its U.S. subsidiaries and 1,220 were employed by its non-U.S. subsidiaries. Associated companies of Quaker (in which it owns less than 50% and has significant influence) employed 74 people on December 31, 2013.
 

 
2

 
 
Company Segmentation
 
The Company’s reportable operating segments evidence the structure of the Company’s internal organization, the method by which the Company’s resources are allocated and the manner by which the Company assesses its performance.  During 2013, certain internal shifts in the Company’s management and changes to the structure of internally reported information occurred.  The Company currently believes its structure, its resource allocation and its performance assessment are now more closely aligned with its four geographical regions: North America, EMEA, Asia/Pacific and South America.  Therefore, the Company changed its reportable operating segments from those categorized by product nature to those organized by geography and recast all prior period information to reflect the four regions as the Company’s new reportable operating segments.  See Note 3 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 and the E.U. Euro, the Brazilian Real, the Chinese Renminbi and the Indian Rupee, 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 3 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 the Company’s locations, 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 2013, 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 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
 

 
3

 

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 a loss of market share for us.  In addition, several competitors could potentially consolidate their businesses to gain scale to better position their product offerings, which could have a negative impact to our profitability and market share.  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 2013, three raw material groups (mineral oils and derivatives, animal fats and derivatives, and vegetable oils and derivatives) each accounted for at least 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 its 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.
 
In the past, Quaker experienced significant volatility in its raw material costs, particularly crude oil derivatives. In addition, refining capacity can be constrained by various factors, which can further contribute to volatile raw material costs and negatively impact margins. Animal fat and vegetable oil prices also can be impacted by increased biodiesel consumption.  Although the Company has been successful in the past 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 past pricing actions, customers may become more likely to consider competitors’ products, some of which may be available at a lower cost. A 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 for 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 2013, our five largest customers (each composed of multiple subsidiaries or divisions with semi-autonomous purchasing authority) together accounted for approximately 18% of our consolidated net sales, with the largest customer (Arcelor-Mittal Group) accounting for approximately 9% of our 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 $300.0 million unsecured credit facility (the “Credit Facility”) with a group of lenders, which can be increased to $400.0 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 2018, 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 certain limitations on 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, 2013, the Company had no outstanding borrowings under the Credit Facility.
 
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 or any potential future matter of a similar nature could materially and adversely affect the Company’s liquidity, financial position and results of operations. Incorporated herein by reference is the information concerning pending asbestos-related litigation against an inactive subsidiary and amounts accrued associated with certain environmental non-capital remediation costs in Note 22 of Notes to Consolidated Financial Statements which appears in Item 8 of this Report.
 

 
5

 

Compliance with a complex global regulatory environment could have an impact on the Company’s public perception and/or a material adverse effect on the Company’s liquidity, financial position and results of operations.
 
Changes in the Company’s regulatory environment, particularly, but not limited to, the United States, Brazil, China and the European Union, could lead to heightened regulatory scrutiny, could adversely impact our ability to continue selling certain products in our domestic or foreign markets and could increase the cost of doing business.  For instance, the European Union’s Registration, Authorization and Restriction of Chemicals (“REACH” and analogous non-E.U. laws and regulations), or other similar laws and regulations, could result in fines, ongoing monitoring and other future business activity restrictions, which could have a material adverse effect on the Company’s liquidity, financial position and results of operations.  In addition, non-compliance with the U.S. Foreign Corrupt Practices Act (“FCPA”), the UK Bribery Act and other similar laws and regulations, could result in a negative impact to the Company’s reputation, potential fines or ongoing monitoring, which could also have an adverse effect on the Company.
 
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.
 
Potential product, service or other related liability claims could have a material adverse effect on the Company’s liquidity, financial position and results of operations.
 
The development, manufacture and sale of specialty chemical products and other related services involve inherent exposure to potential product liability claims, service level claims, product recalls and related adverse publicity.   Any of these potential product or service risks could also result in substantial and unexpected expenditures and affect customer confidence in our products and services, which could have a material adverse effect on the Company’s liquidity, financial position and results of operations. Although the Company maintains product and other general liability insurance, there can be no assurance that this type or the level of coverage would be adequate to cover these potential risks.  In addition, the Company may not be able to continue to maintain its existing insurance or obtain comparable insurance at a reasonable cost, if at all, in the event a significant product or service claim arises.
 
We may be unable to adequately protect our proprietary rights, which may limit the Company’s ability to compete in its markets.
 
   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.   Despite our efforts to protect such proprietary information through patent and trademark filings and through the use of appropriate trade secret protections and the inability of certain products to be effectively replicated by others, it is possible that competitors and other unauthorized third parties may obtain, copy, use or disclose our technologies, products, and processes.  In addition, the laws and/or judicial systems of foreign countries in which we design, manufacture, market and sell our products may afford little or no effective protection of our proprietary technology.   These potential risks to our proprietary information could subject the Company to increased competition and negative impacts to our liquidity, financial position and results of operations.
 
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.
 

 
6

 

An inability to appropriately capitalize on Company growth, including 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 its business.  In addition, the Company continues to grow organically through increased end market growth and incremental market share.   The success of the Company’s growth depends on its ability to successfully integrate such opportunities, including, but not limited to, the following:
 
 
successfully execute the integration or consolidation of the acquired or additional business into existing processes and operations,
 
develop or modify financial reporting, information systems and other related financial tools to ensure overall financial integrity and adequacy of internal control procedures,
 
identify and take advantage of potential cost reduction opportunities, while maintaining legacy business and other related attributes, and
 
further penetrate existing markets with the product capabilities acquired in new acquisitions.
 
The Company may fail to derive significant benefits or may not create the appropriate infrastructure to support such additional business, which could have a material adverse effect 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 and the E.U. Euro, the Brazilian Real, the Chinese Renminbi and the Indian Rupee, 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 3 of Notes to Consolidated Financial Statements included in Item 8 of this Report.
 
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 past 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 jurisdictions 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 the 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 effect on the Company’s
 

 
7

 

liquidity, financial position and results of operations.  See Note 22 of Notes to Consolidated Financial Statements, included in Item 8 of this Report, which is incorporated herein by this reference, for further discussion.
 
Terrorist attacks, other acts of violence or war, 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, if at all, 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.  In addition, a 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 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 the North American segment’s Conshohocken, Pennsylvania office. The Company’s other principal facilities in the North American segment are located in Detroit, Michigan; Middletown, Ohio; Santa Fe Springs, California; Batavia, New York; Dayton, Ohio;  and Monterrey, N.L., Mexico.  The Company’s EMEA segment has principal facilities in Uithoorn, The Netherlands; Santa Perpetua de Mogoda, Spain; Tradate, Italy; and Gorgonzola, Italy. The Company’s Asia/Pacific segment operates out of its principal facilities located in Qingpu, China and Kolkata, India, while its South American segment operates out of its principal facility in Rio de Janeiro, Brazil.  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, 2013, were mortgage free. Quaker also leases sales, laboratory, manufacturing, and warehouse facilities in other locations.
 
Quaker’s principal facilities (excluding Conshohocken) consist of various manufacturing, administrative, warehouse, and laboratory buildings. Substantially all of the buildings (including Conshohocken) are of fire-resistant construction and are equipped with sprinkler systems. All facilities are primarily of masonry and/or steel construction and are adequate and suitable for Quaker’s present operations. The Company has a program to identify needed capital improvements that are implemented as management considers necessary or desirable. Most locations have various numbers of raw material storage tanks ranging from 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 22 of Notes to Consolidated Financial Statements, included in Item 8 of this Report, which is incorporated herein by this reference. The Company is a party to other litigation which management currently believes will not have a material adverse effect on the Company’s results of operations, cash flow or financial condition.
 
Item 4.  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, Mr. Steeples and Mr. Hostetter) 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 respective periods indicated.  Each of the executive officers, with the exception of Mr. Hostetter, is elected annually to a one-year term. Mr. Hostetter 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 the Past Five
Years and Period Served as an Officer
     
  Michael F. Barry, 55
  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 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, 54
  Vice President, Chief Financial Officer
  and Treasurer
  
Ms. Loebl, has served as Vice President, Chief Financial Officer and Treasurer since she joined the Company in June 2012.  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.
     
  D. Jeffry Benoliel, 55
  Vice President and Global Leader –
  Metalworking, Can and Corporate Secretary
  
Mr. Benoliel, who has been employed by the Company since 1995, has served as Vice President and Global Leader – Metalworking, Can and Corporate Secretary since July 1, 2013.  He served as Vice President – Global Metalworking and Fluid Power and Corporate Secretary from June 2011 through June 2013, and until March 2012 also held the position of General Counsel.  He served as Vice President – Global Strategy, General Counsel and Corporate Secretary from October 2008 until mid-June 2011 and Vice President, Secretary and General Counsel from 2001 through September 2008.
 
     
  Joseph A. Berquist, 42
  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.
     
  Ronald S. Ettinger, 61
  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 through November 2011.
     

 
9

 


Name, Age, and Present
Position with the Company
  
Business Experience During the Past Five
Years and Period Served as an Officer
     
  Shane W. Hostetter, 32
  Corporate Controller
 
Mr. Hostetter, who has been employed by the Company since July 2011, has served in his current position since May 2013.  He served as Assistant Global Controller from July 2011 through May 2013.  Prior to joining the Company, Mr. Hostetter led the financial reporting department for Pulse Electronics Corporation (formerly Technitrol, Inc.) from May 2008 to June 2011.
 
     
  Dieter Laininger, 51
  Vice President and Managing
  Director – South America and
  Global Leader – Primary Metals
 
Mr. Laininger, who has been employed by the Company since 1991, has served as Vice President and Managing Director – South America, since January 2013, in addition to his position as Vice President and Global Leader – Primary Metals, to which he was appointed in June 2011.  He served as Industry Business Manager for Steel and Metalworking – EMEA from March 2001 through July 2011.
 
     
  Joseph F. Matrange, 72
  Vice President and Global Leader  – Coatings
 
Mr. Matrange, who has been employed by the Company since 2000, has served as Vice President and Global Leader – 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, 53
  Vice President and Global Leader – Grease,
  Fluid Power and Mining
  
Mr. Nieman, who has been employed by the Company since 1992, was appointed to his current position, effective August 2013.  He served as Vice President and Managing Director – Asia/Pacific from February 2005 through July 2013.
     
   Wilbert Platzer, 52
  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.
     
   Adrian Steeples, 53
  Vice President and Managing
    Director – Asia/Pacific
 
Mr. Steeples, who has been employed by the Company since 2010, has served as Vice President and Managing Director – Asia/Pacific since July 1, 2013.  He served as Industry Business Director – Metalworking from March 2011 through June 2013, and Manager, European and Global Special Projects, from May 2010 through February 2011.  Prior to joining the Company, he worked for the BP Group serving as BP/Castrol European and Asian Pacific Sales Director in Industrial Lubricants and Services from January 2009 through December 2009.
     

 
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 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
 
 
2013
 
2012
 
Declared
 
Paid
 
 
High
 
Low
 
High
 
Low
 
2013
 
2012
 
2013
 
2012
 
First quarter
$ 63.50   $ 54.24   $ 48.15   $ 35.82   $ 0.245   $ 0.24   $ 0.245   $ 0.24  
Second quarter
  67.27     53.54     46.59     37.86     0.25     0.245     0.245     0.24  
Third quarter
  73.41     61.67     50.55     40.21     0.25     0.245     0.25     0.245  
Fourth quarter
  81.52     70.02     54.00     45.07     0.25     0.245     0.25     0.245  
 
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 payment of future 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, 2014, there were 948 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, 2014, 13,197,638 shares of Quaker common stock were issued and outstanding. Based on the information available to the Company on January 17, 2014, as of that date the holders of 808,653 shares of Quaker common stock would have been entitled to cast ten votes for each share, or approximately 39% of the total votes that would have been entitled to be cast as of that record date and the holders of 12,388,985 shares of Quaker common stock would have been entitled to cast one vote for each share, or approximately 61% 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, 2014 could be more than 20,475,515.
 
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.
 

 
11

 

The following graph compares the cumulative total return (assuming reinvestment of dividends) from December 31, 2008 to December 31, 2013  for (i) Quaker’s common stock, (ii) the S&P SmallCap 600 Index (the “SmallCap Index”), and (iii) the S&P 600 Materials Group Index (the “Materials Group Index”).  The graph assumes the investment of $100 on December 31, 2008 in each of Quaker’s common stock, the stocks comprising the SmallCap Index and the stocks comprising the Materials Group Index.
 
 
 
 
12/31/2008
   
12/31/2009
   
12/31/2010
   
12/31/2011
   
12/31/2012
   
12/31/2013
 
Quaker
  $ 100.00     $ 133.66     $ 279.02     $ 266.75     $ 377.28     $ 548.20  
SmallCap Index
    100.00       125.57       158.60       160.22       186.37       263.37  
Materials Group Index
    100.00       148.18       175.26       160.77       201.45       273.56  

 
12

 

Item 6.  Selected Financial Data.
 
The following table sets forth selected financial data for the Company and its consolidated subsidiaries (in thousands, except dividends and per share data):
 
 
 
Year Ended December 31,
 
 
 
2013 (1)
   
2012 (2)
   
2011 (3)
   
2010 (4)
   
2009 (5)
 
Summary of Operations:
 
 
   
 
   
 
   
 
   
 
 
Net sales
  $ 729,395     $ 708,226     $ 683,231     $ 544,063     $ 451,490  
Income before taxes and equity in net income of associated companies
    72,826       62,948       59,377       46,213       23,692  
Net income attributable to Quaker Chemical Corporation
    56,339       47,405       45,892       32,120       16,058  
Per share:
                                       
Net income attributable to Quaker Chemical Corporation
                                       
Common Shareholders - basic
  $ 4.28     $ 3.64     $ 3.71     $ 2.85     $ 1.46  
Net income attributable to Quaker Chemical Corporation
                                       
Common Shareholders - diluted
  $ 4.27     $ 3.63     $ 3.66     $ 2.80     $ 1.45  
Dividends declared
    0.995       0.975       0.955       0.935       0.92  
Dividends paid
    0.99       0.97       0.95       0.93       0.92  
Financial Position
                                       
Working capital
  $ 197,991     $ 170,018     $ 152,900     $ 114,291     $ 98,994  
Total assets
    584,146       536,634       511,152       452,868       398,183  
Long-term debt
    17,321       30,000       46,701       73,855       63,685  
Total equity
    345,031       289,676       261,357       190,537       159,186  
 
Notes to the above table (in thousands):
 
  (1 )
The results of operations for 2013 include equity income from a captive insurance company of $5,451 after tax; an increase to other income of $2,540 related to a mineral oil excise tax refund; and an increase to other income of $497 related to a change in an acquisition-related earnout liability; partially offset by an after-tax charge of $357 related to a currency devaluation at the Company’s 50% owned affiliate in Venezuela; $1,419 of charges related to cost streamlining initiatives in the Company’s EMEA and South American segments; and a $796 net charge related to a non-income tax contingency.
  (2 )
The results of operations for 2012 include equity income from a captive insurance company of $1,812 after tax; and an increase to other income of $1,737 related to a change in an acquisition-related earnout liability; partially offset by a charge of $1,254 related to the bankruptcy of certain customers in the U.S.; and a charge of $609 related to CFO transition costs.
  (3 )
The results of operations for 2011 include equity income from a captive insurance company of $2,323 after tax;  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; and an increase to other income of $595 related to a change in an acquisition-related earnout liability.
  (4 )
The results of operations for 2010 include equity income from a captive insurance company of $313 after tax;  offset by a final charge of $1,317 related to the retirement of the Company’s former Chief Executive Officer in 2008; a net charge of $4,132 related to a non-income tax contingency; a $322 after-tax charge related to a currency devaluation at the Company’s 50% owned affiliate in Venezuela; and a $564 after-tax charge related to an out-of-period adjustment at the Company’s 40% owned affiliate in Mexico.
  (5 )
The results of operations for 2009 include other income of $1,193 from the disposition of land in Europe; offset by a charge for restructuring and related activities of $2,289; a charge of $2,443 related to the retirement of the Company’s former Chief Executive Officer in 2008; and an equity loss from a captive insurance company of $162 after tax.


 
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 performed very well in terms of net sales, earnings and cash flow in 2013.  The Company’s performance was driven by an increase of 3% in net sales from 2012, which was primarily the result of increased product volumes.   In addition, the Company’s gross profit increased 9% from 2012, with gross margin improving to 35.8% from 33.7% in 2012, which reflects the return of product margins to more acceptable levels.  The Company achieved the improvements in sales and margin through market share gains and acquisitions, despite a market that was generally down due to several challenges in the global economic environment.  Due to selling and other costs related to the Company’s improved performance and costs added with its recent acquisitions, along with higher labor related costs on general year-over-year merit increases, there was an 8% increase in selling, general and administrative expenses (“SG&A”) from 2012.  In addition, the Company’s performance in 2013 and 2012 included certain uncommon costs in SG&A, other income and other expense, which are further discussed in the Company’s non-GAAP section and operations section below.
 
The net result was earnings per diluted share of $4.27 in 2013 compared to earnings per diluted share of $3.63 for 2012, with non-GAAP earnings per diluted share increasing approximately 10% to $3.84 in 2013 compared to $3.49 in 2012 and adjusted EBITDA increasing 11% to $89.6 million for 2013 from $80.9 million for 2012.   See the Non-GAAP Measures section in this Item, below.
 
Net cash flows provided by operating activities were $73.8 million in 2013, increasing by $10.9 million, or 17%, from 2012 on higher net income and improved working capital management.  In addition, the Company’s balance sheet remains very strong with no borrowings on its credit facility and its cash position exceeding its debt at December 31, 2013, which will provide opportunities for the Company to pursue strategic growth opportunities, including acquisitions, in the future.  In addition, the Company enhanced its financial flexibility during 2013 by revising its credit facility, expanding the amount available for borrowing under this facility from $175.0 million to $300.0 million.
 
As the Company looks to 2014, it expects to see modest market growth in all regions of the world.  In addition, the Company expects market share gains from its strategic initiatives and its recent acquisitions, which will build upon anticipated end market growth.  However, the Company continues to operate in a highly competitive market with challenging economic conditions over various parts of the world.  Also, the Company could experience increases in raw material costs from their current levels in the near term.  On balance, the Company remains confident in its future and expects 2014 to be another good year for Quaker as we strive to increase revenue and earnings for the fifth consecutive year.
 
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 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 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
 

 
14

 

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 $7.1 million and $6.4 million at December 31, 2013 and December 31, 2012, respectively. Further, the Company recorded provisions for doubtful accounts of $1.1 million, $2.1 million and $0.9 million in 2013, 2012 and 2011, respectively. An increase of 10% to the recorded provisions would have decreased the Company’s pre-tax earnings by approximately $0.1 million, $0.2 million and $0.1 million in 2013, 2012 and 2011, 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 22 of Notes to Consolidated Financial Statements which appears in Item 8 of this Report.
 
3. Realizability of equity investments—Quaker holds equity investments in various foreign companies, whereby it has the ability to influence, but not control, the operations of the entity and its future results. Quaker 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, 2013 was $19.4 million, which included four investments of $12.1 million, or a 32.8% interest, in Primex, Ltd. (Barbados), $5.3 million, or a 50% interest, in Nippon Quaker Chemical, Ltd. (Japan), $1.6 million, or a 50% interest, in Kelko Quaker Chemical, S.A. (Venezuela) and $0.4 million, or a 50% interest, in Kelko Quaker Chemical, S.A. (Panama), respectively.  See Note 12 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 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.  The guidance also requires that an entity net its liability for unrecognized tax benefits against deferred tax assets related to net operating losses or other tax credit carryforwards that would apply if the uncertain tax position were settled for the presumed amount at the balance sheet date.  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. The amount of such undistributed earnings at December 31, 2013 was approximately $188.0 million.  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.
 

 
15

 

5. Goodwill and other intangible assets — During 2013, certain internal shifts in the Company’s management and changes to the structure of internally reported information occurred.  The Company currently believes its structure, its resource allocation and its performance assessment are now more closely aligned with its four geographical regions: North America, EMEA, Asia/Pacific and South America.  Therefore, the Company changed its reportable operating segments from those categorized by product nature to those organized by geography.  See Note 3 of Notes to Consolidated Financial Statements in Item 8 of this Report for further information.  Similarly, the Company reassessed and changed its reporting units for goodwill testing purposes during the third quarter of 2013 to adhere to its geographical orientation.
 
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, but the actual cash flows could differ from management’s estimates due to changes in business conditions, operating performance, and economic conditions. 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 estimated future cash flows. In addition, the Company revised its calculation for its step one impairment model during 2013, which now includes an estimate of future growth and cash flows in perpetuity, among other, less significant, changes.
 
  Based on its revised reporting units, the Company completed its annual impairment assessment as of the end of the third quarter of 2013, and no impairment charge was warranted. Furthermore, the estimated fair value of each of the Company’s reporting units substantially exceeded its carrying value, with none of the Company’s reporting units at risk for failing step one of the goodwill impairment test.  The Company’s consolidated goodwill and indefinite-lived intangible assets at December 31, 2013 and December 31, 2012 were $59.3 million and $60.3 million, respectively. The Company currently uses a WACC of 12% and, at September 30, 2013, this assumption would have had to increase by more than 73.2 percentage points before any of the Company’s reporting units would fail step one of the impairment analysis. Further, at September 30, 2013, the Company’s estimate of future NOPAT would have had to decrease by more than 70.3% before any of the Company’s reporting units would be considered potentially impaired.
 
6. 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, 2013:
 

 
1/2 Percentage Point Increase
 
1/2 Percentage Point Decrease
 
 
Foreign
 
Domestic
 
Total
 
Foreign
 
Domestic
 
Total
 
 
(Dollars in millions)
 
Discount rate
$ (0.6 ) $ (0.1 ) $ (0.7 ) $ 0.7   $ 0.1   $ 0.8  
Expected rate of return on plan assets
  (0.3 )   (0.2 )   (0.5 )   0.3     0.2     0.5  

Liquidity and Capital Resources
 
Quaker’s cash and cash equivalents increased to $68.5 million at December 31, 2013 from $32.5 million at December 31, 2012.  The $36.0 million increase was primarily the result of a strong amount of cash provided by operating activities of $73.8 million, net of cash used in investing activities of $12.4 million, cash used in financing activities of $26.2 million and an increase due to foreign exchange rate translation of $0.8 million. At December 31, 2013, the Company held approximately $48.6 million of its total cash and cash equivalents among its foreign subsidiaries, which is subject to possible limitations on repatriation to the United States.
 
Net cash flows provided by operating activities were $73.8 million in 2013, compared with $62.9 million provided by operating activities in 2012.  The $10.9 million increase in net operating cash flow was led by the Company’s higher net income and improved working capital management.  Affecting the working capital comparison from 2012 to 2013 were higher cash inflows in 2013 related to accounts payable and accrued liabilities due to increased business activity and timing of such expenses and lower cash outflows in 2013 for payments on estimated taxes, which were partially offset by significant cash outflows in 2013 from accounts receivable due to the timing of sales in the final months of the year compared to lower sales in the comparable months of 2012.  In addition, the Company’s first dividend distribution from its captive insurance equity affiliate of $2.0 million, the mineral oil excise tax refund, discussed below and lower pension plan contributions during 2013, partially offset by fees related to the Company’s 2013 revision to its credit facility discussed below, also affected the net operating cash flow comparisons.
 

 
16

 

 Net cash flows used in investing activities decreased from $16.7 million in 2012 to $12.4 million in 2013. The $4.3 million decrease of cash used in investing activities was primarily caused by lower payments for acquisitions and lower investments in property, plant and equipment.  In 2013, the Company acquired a business that primarily related to tin plating and a chemical milling maskant distribution network for its North American segment for net consideration of approximately $2.5 million.  Whereas, the Company acquired NP Coil Dexter Industries, S.r.l. for approximately $2.7 million for its EMEA segment and, also, paid hold-backs of consideration that were assumed in the past acquisitions of Tecniquimia Mexicana, S.A. de C.V. and G.W. Smith and Sons, Inc. for approximately $3.0 million during 2012. As it relates to the Company’s lower investments in property, plant and equipment, the primary changes were higher payments for the Company’s technology infrastructure during 2012, which were partially offset by an increased investment in its Asia/Pacific facilities during 2013.
 
Net cash flows used by financing activities were $26.2 million in 2013, compared with $30.6 million used by financing activities during 2012. In both years, the Company was able to leverage strong operating cash flow to fund its investing and financing activities, while also making payments on its revolving credit line.  However, there were lower repayments of debt in 2013 compared to 2012, as the Company had repaid all outstanding borrowings on its credit line as of the third quarter of 2013.  In addition, higher dividend payments and changes in stock option exercise activity in 2013 also affected the financing cash flow comparisons.
 
The Company completed its annual goodwill impairment assessment as of the end of the third quarter of 2013 and the estimated fair value of each of the Company’s reporting units substantially exceeded their carrying value, so no impairment charge was warranted.
 
As discussed in the Current Report on Form 8-K filed on June 17, 2013, the Company entered into a revised syndicated multicurrency credit facility on June 14, 2013, which amended and replaced the Company’s previous credit facility with Bank of America, N.A. and certain other major financial institutions.  The revised facility increased the maximum principal amount available for revolving credit borrowings under this facility from $175.0 million to $300.0 million, which can be increased to $400.0 million at the Company’s option if the lenders agree and the Company satisfies certain conditions.  This facility matures in June 2018.  In addition, the revised facility amended certain financial, acquisition and other covenants, but the consolidated leverage ratio calculation, on which access to credit under the former facility largely depended, remains relatively consistent and cannot exceed 3.50 to 1.  At December 31, 2013 and December 31, 2012, the consolidated leverage ratio was below 1.0 to 1 and the Company was also in compliance with all of the current and former facilities’ other covenants, respectively.  At December 31, 2013, the Company had no outstanding borrowings under this revised facility.  At December 31, 2012, the Company had approximately $12.2 million outstanding under its former facility.
 
During 2002 and 2003, the Company’s Netherlands and Italian subsidiaries paid excise taxes on mineral oil sales in Italy in the total amount of approximately $2.0 million.  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 ultimately collected the $2.0 million, along with approximately $0.5 million of interest, in the second quarter of 2013.  This amount was recorded as other income on the Company’s 2013 Consolidated Statement of Income.
 
At December 31, 2013, the Company’s gross liability for uncertain tax positions, including interest and penalties, was $16.8 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 $11.4 million as a result of offsetting benefits in other tax jurisdictions.
 
The Company believes it is capable of supporting its operating requirements, including pension plan contributions, payments of dividends to shareholders, possible acquisitions and other business opportunities, capital expenditures and possible resolution of contingencies, through internally generated funds supplemented with debt or equity, as needed.
 

 
17

 

The following table summarizes the Company’s contractual obligations at December 31, 2013, 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 2014 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, 2013. The contingent acquisition consideration is included based on management’s estimate of the earnout liability at December 31, 2013:


 
 
Payments due by period
 
 
 
 
   
 
   
 
   
 
   
 
   
 
   
2019 and
 
Contractual Obligations (Amounts in millions)
 
Total
   
2014
   
2015
   
2016
   
2017
   
2018
   
Beyond
 
Short-term debt
  $ 0.945     $ 0.945     $     $     $     $     $  
Long-term debt
    26.550       1.173       1.175       1.174       1.173       6.148       15.707  
Capital lease obligations
    0.361       0.141       0.096       0.065       0.059              
Non-cancelable operating leases
    14.468       4.991       4.154       3.507       1.811       0.005        
Purchase obligations
    6.836       5.489       1.347                          
Pension and other postretirement plan
                                                       
contributions
    6.779       6.779                                
Contingent acquisition consideration
    4.697       4.697                                
Other long-term liabilities (See Note 17 of Notes
                                                       
to Consolidated Financial Statements)
    6.144                                     6.144  
Total contractual cash obligations
  $ 66.780     $ 24.215     $ 6.772     $ 4.746     $ 3.043     $ 6.153     $ 21.851  

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.
 
Non-GAAP Measures
 
Included in this Form 10-K filing are non-GAAP financial measures of non-GAAP earnings per diluted share and non-GAAP adjusted EBITDA.  The Company believes these non-GAAP financial measures provide meaningful supplemental information as they enhance a reader’s understanding of the financial performance of the Company, are more indicative of the future performance of the Company and facilitate a better comparison among fiscal periods, as the non-GAAP financial measures exclude items that are not considered core to the Company’s operations.  Non-GAAP results are presented for supplemental informational purposes only, and should not be considered a substitute for the financial information presented in accordance with GAAP.
 

 
18

 

The following is a reconciliation between the non-GAAP (unaudited) financial measure of non-GAAP earnings per diluted share to its most directly comparable GAAP financial measure:
 
 
 
For the years ended December 31,
 
 
 
2013
   
2012
   
2011
 
 
 
 
   
 
   
 
 
GAAP earnings per diluted share attributable to Quaker Chemical Corporation
 
 
   
 
   
 
 
Common Shareholders
  $ 4.27     $ 3.63     $ 3.66  
Equity income in a captive insurance company per diluted share
    (0.41 )     (0.14 )     (0.19 )
Mineral oil excise tax refund per diluted share
    (0.14 )            
Change in acquisition-related earnout liability
                       
per diluted share
    (0.03 )     (0.09 )     (0.03 )
Revaluation of a previously held ownership interest in an equity affiliate per
                       
diluted share
                (0.22 )
Cost streamlining initiatives per diluted share
    0.08              
Devaluation of the Venezuelan Bolivar Fuerte per diluted share
    0.03              
Non-income tax contingency charge per diluted share
    0.04              
Customer bankruptcy costs per diluted share
          0.06        
CFO transition costs per diluted share
          0.03        
 
                       
Non-GAAP earnings per diluted share
  $ 3.84     $ 3.49     $ 3.22  

The following is a reconciliation of the non-GAAP (unaudited) financial measure of adjusted EBITDA to its most directly comparable GAAP financial measure:
 
 
 
For the years ended December 31,
 
 
 
2013
   
2012
   
2011
 
 
 
 
   
 
   
 
 
Net income attributable to Quaker Chemical Corporation
  $ 56,339     $ 47,405     $ 45,892  
Depreciation and amortization
    15,784       15,358       13,793  
Interest expense
    2,922       4,283       4,666  
Taxes on income before equity in net income of associated companies
    20,489       15,575       14,256  
Equity income in a captive insurance company
    (5,451 )     (1,812 )     (2,323 )
Mineral oil excise tax refund
    (2,540 )            
Change in acquisition-related earnout liability
    (497 )     (1,737 )     (595 )
Revaluation of a previously held ownership interest in an equity affiliate
                (2,718 )
Cost streamlining initiatives
    1,419              
Devaluation of the Venezuelan Bolivar Fuerte
    357              
Non-income tax contingency charge
    796              
Customer bankruptcy costs
          1,254        
CFO transition costs
          609        
 
                       
Adjusted EBITDA
  $ 89,618     $ 80,935     $ 72,971  

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 $1.0 million 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 $1.0 million for the three months ended March 31, 2013 and the year ended December 31, 2013.  The Company does not believe this adjustment is material to its consolidated financial statements for the year ended December 31, 2012 or to the Company’s results for the year ended December 31, 2013 and, therefore, has not restated any prior period amounts.  See Note 2 of Notes to Consolidated Financial Statements in Item 8 of this Report.
 

 
19

 

Consolidated Operations Review – Comparison of 2013 with 2012
 
Net sales for 2013 of $729.4 million increased approximately 3% from $708.2 million in 2012.  The increase in the Company’s net sales from the prior year was primarily due to a 3% increase in product volumes, including acquisitions, generally across all regions, partially offset by a decrease of $3.1 million, or less than 1%, due to foreign exchange rate translation.  The effects on net sales related to price and product mix were generally consistent in 2013 compared to 2012.
 
Gross profit increased by approximately $22.4 million, or approximately 9%, from 2012, which was primarily the result of an improvement in gross margin to 35.8% in 2013 from 33.7% in 2012.  The increase in gross margin reflects the return of the Company’s product margins to more acceptable levels.
 
SG&A increased approximately $14.3 million from 2012, which was primarily driven by higher labor related costs on general year-over-year merit increases, increased selling and other related costs on improved Company performance and costs added with our recent acquisitions.  In addition, non-operating SG&A expenses increased due to certain uncommon costs.  For instance, 2013 SG&A includes a non-income tax contingency charge of approximately $0.8 million, or $0.04 per diluted share, and, also, costs related to streamlining certain operations in the Company’s EMEA and South American segments of approximately $1.2 million, or $0.07 per diluted share. Whereas, in 2012, there were costs associated with the bankruptcies of certain U.S customers of $1.3 million, or $0.06 per diluted share, the prior year costs associated with the Company’s CFO transition of $0.6 million, or $0.03 per diluted share, and lower translation due to changes in foreign exchange rates.
 
Other income for 2013 was approximately $3.5 million, which was primarily driven by a refund of $2.5 million, or $0.14 per diluted share, related to past excise taxes paid on certain mineral oil sales, income of $0.5 million, or $0.03 per diluted share, related to a change in an acquisition-related earnout liability and earnings from third-party license fees, partially offset by foreign exchange losses and $0.2 million, or $0.01 per diluted share, of costs associated with the streamlining initiatives mentioned above.  Other income for 2012 was approximately $3.4 million, which was primarily driven by income of $1.7 million, or $0.09 per diluted share, related to a change in the acquisition-related earnout liability noted above, earnings from third-party license fees and income from a change in a separate acquisition-related liability, partially offset by foreign exchange losses.
 
The decrease in interest expense from 2012 to 2013 was primarily due to lower average borrowings and lower interest rates.  The increase in interest income from 2012 to 2013 was primarily due to a higher level of the Company’s cash on hand.
 
The Company’s effective tax rates for 2013 and 2012 of 28.1% and 24.7%, respectively, reflect decreases in reserves for uncertain tax positions due to the expiration of applicable statutes of limitations for certain years of approximately $0.15 and $0.17 per diluted share, respectively.  In addition, the Company had certain one-time discrete items in the prior year that lowered its 2012 effective tax rate, which were partially offset by a change in the mix of income to lower tax jurisdictions in 2013.   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.
 
Equity in net income of associated companies increased due to higher earnings related to the Company’s equity interest in a captive insurance company in 2013 compared to 2012.  Earnings attributable to this equity interest increased from approximately $1.8 million, or $0.14 per diluted share, for 2012 to approximately $5.5 million, or $0.41 per diluted share, for 2013, which includes a non-cash out-of-period adjustment of approximately $1.0 million recorded in 2013.  See the Out-of-Period Adjustment section in this Item, above. Partially offsetting this increase in equity in net income of associated companies was a charge of approximately $0.4 million, or $0.03 per diluted share, related to the devaluation of the Venezuelan Bolivar Fuerte in 2013.
 
Changes in foreign exchange rates negatively impacted 2013 net income by approximately $0.7 million, or $0.05 per diluted share.
 
Consolidated Operations Review – 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 price and product 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 included charges of $1.3 million, or $0.06 per diluted share, for certain customer bankruptcies in the U.S. and $0.6 million, or $0.03 per diluted share, related to the Company’s CFO transition.
 
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.
 

 
20

 

Other income for 2012 of $3.4 million decreased from $5.1 million in 2011.  Other income increased in 2012 due to changes in the fair value of an acquisition-related earnout liability of $1.7 million, or $0.09 per diluted share and, also, a separate acquisition-related liability, compared to lower other income in 2011 included from a similar change in the acquisition-related earnout liability of $0.6 million, or $0.03 per diluted share. However, other income for 2011 also included $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, caused by 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 were generally consistent at 24.7% and 24.0%, respectively.  The 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 $0.17 and $0.16 per diluted share in 2012 and 2011, respectively.
 
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, which was $1.8 million, or $0.14 per diluted share, in 2012 compared to $2.3 million, or $0.19 per diluted share, in 2011.  This decrease from 2011 to 2012 in equity in net income of associated companies was partially offset by improved performance over the majority of the Company’s other equity affiliates during 2012, in particular in our Japanese affiliate.
 
Earnings per diluted share for 2012 of $3.63 reflected 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.
 
Reportable Operating Segment Review – Comparison of 2013 with 2012
 
The Company’s reportable operating segments evidence the structure of the Company’s internal organization, the method by which the Company’s resources are allocated and the manner by which the Company assesses its performance.  During 2013, certain internal shifts in the Company’s management and changes to the structure of internally reported information occurred.  The Company currently believes its structure, its resource allocation and its performance assessment are now more closely aligned with its four geographical regions: North America, EMEA, Asia/Pacific and South America.  Therefore, the Company changed its reportable operating segments from those categorized by product nature to those organized by geography.  All prior period information has been recast to reflect these four regions as the Company’s new reportable operating segments.  See Note 3 of Notes to Consolidated Financial Statements in Item 8 of this Report for further information.
 
The Company continues to offer its industrial process fluids, chemical specialties and technical expertise to a wide range of industries in a global product portfolio.  Overall, the Company experienced improved product margins in each of its four reportable operating segments in 2013 compared to 2012, as product margins have returned to more acceptable levels globally, within each regional segment.  The following is further analysis by reportable operating segment for each respective period.
 
North America
 
North America represented approximately 42% of the Company’s consolidated net sales in 2013, which decreased approximately $1.8 million, or approximately 1%, from 2012.  The decrease in net sales was primarily due to a 2% decrease in base product volumes, partially offset by an increase of 1% due to acquisitions.  The impact on net sales from price and product mix remained comparable to 2012.  This reportable segment’s operating earnings, excluding indirect expenses, increased approximately $2.7 million, or approximately 5%, from 2012, which reflects the increase in the reportable segment’s product margins, noted above.
 
EMEA
 
EMEA represented approximately 26% of the Company’s consolidated net sales in 2013, which increased approximately $13.0 million, or approximately 7%, from 2012.  The increase in net sales was primarily due to a 5% increase in base product volumes, a 3% increase from acquisitions and a 3% increase from foreign currency exchange rate translation, partially offset by a 3% decrease in price and product mix.  The foreign currency translation impact was primarily due to the E.U. Euro to U.S. Dollar exchange rate, which averaged 1.33 in 2013 compared to 1.29 in 2012.  This reportable segment’s operating earnings, excluding indirect expenses, increased approximately $5.0 million, or approximately 20%, from 2012, which reflects its increased net sales and the increase in the reportable segment’s product margins, noted above.
 
Asia/Pacific
 
Asia/Pacific represented approximately 23% of the Company’s consolidated net sales in 2013, which increased approximately $12.4 million, or approximately 8%, from 2012.  The increase in net sales was primarily due to a 7% increase in base product volumes and a 2% increase in price and product mix, partially offset by a 1% decrease in foreign currency exchange rate translation.  The foreign currency translation impact was primarily due to decreases in the Indian Rupee and Australian Dollar to U.S. Dollar exchange rates, which averaged 0.017 and 0.97 in 2013 compared to 0.019 and 1.04 in 2012, respectively.  These foreign exchange decreases were partially offset by an increase in the Chinese Renminbi to U.S. Dollar exchange rate, which averaged 0.161 in 2013 compared to 0.158 in 2012.  This reportable segment’s operating earnings, excluding indirect expenses, increased approximately $5.3 million, or
 

 
21

 

approximately 14%, from 2012, which reflects its increased net sales and the increase in the reportable segment’s product margins, noted above.
 
South America
 
South America represented approximately 9% of the Company’s consolidated net sales in 2013, which decreased approximately $2.5 million, or approximately 4%, from 2012.  The decrease in net sales was driven by an 11% decrease due to foreign currency exchange rate translation, partially offset by a 2% increase in base product volumes and a 5% increase in price and product mix.  The foreign currency translation impact was primarily due to decreases in the Brazilian Real and Argentinian Peso to U.S. Dollar exchange rates, which averaged 0.47 and 0.18 in 2013 compared to 0.51 and 0.22 in 2012, respectively. This reportable segment’s operating earnings, excluding indirect expenses, increased approximately $2.4 million, or approximately 36%, from 2012, which reflects the increase in the reportable segment’s product margins, noted above, and the favorable impact of cost streamlining initiatives implemented in 2013.
 
Reportable Operating Segment Review – Comparison of 2012 with 2011
 
Similar to the comparison between 2013 and 2012, the Company experienced improved product margins generally over each of its four reportable operating segments in 2012 compared to 2011.   This improvement was primarily caused by raw material costs stabilizing toward the end of 2012, which began the return of the Company’s product margins to more acceptable levels that continued into 2013.  The following is further analysis by reportable operating segment for each respective period.
 
North America
 
North America represented approximately 44% of the Company’s consolidated net sales in 2012, which increased approximately $41.6 million, or approximately 15%, from 2011.  The increase in net sales was primarily due to a 7% increase in price and product mix and an increase of 8% due to acquisitions.  The impact on net sales from base product volumes was comparable with 2011.  This reportable segment’s operating earnings, excluding indirect expenses, increased approximately $10.2 million, or approximately 21%, from 2011, which reflects its increased net sales and the increase in the reportable operating segment’s product margins, noted above.
 
EMEA
 
EMEA represented approximately 25% of the Company’s consolidated net sales in 2012, which decreased approximately $9.3 million, or approximately 5%, from 2011.  The decrease in net sales was primarily due to an 8% decrease in foreign currency exchange rate translation and a 1% decrease in base product volumes, partially offset by a 3% increase due to acquisitions and a 1% increase in price and product mix. The foreign currency translation impact was primarily due to the E.U. Euro to U.S. Dollar exchange rate, which averaged 1.29 in 2012 compared to 1.39 in 2011.  This reportable segment’s operating earnings, excluding indirect expenses, decreased approximately $2.7 million, or approximately 10%, from 2011, which reflects its decreased net sales, partially offset by the increase in the reportable operating segment’s product margins, noted above.
 
Asia/Pacific
 
Asia/Pacific represented approximately 22% of the Company’s consolidated net sales in 2012, which increased approximately $5.6 million, or approximately 4%, from 2011.  The increase in net sales was primarily due to a 3% increase in base product volumes and a 2% increase in price and product mix, partially offset by a 1% decrease in foreign currency exchange rate translation.  The foreign currency translation impact was primarily due to a decrease in the Indian Rupee to U.S. Dollar exchange rate, which averaged 0.019 in 2012 compared to 0.021 in 2011, partially offset by an increase in the Chinese Renminbi to U.S. Dollar exchange rate, which averaged 0.158 in 2012 compared to 0.155 in 2011.  This reportable segment’s operating earnings, excluding indirect expenses, increased approximately $4.9 million, or approximately 15%, from 2011, which reflects its increased net sales and the increase in the reportable operating segment’s product margins, noted above.
 
South America
 
South America represented approximately 9% of the Company’s consolidated net sales in 2012, which decreased approximately $12.9 million, or approximately 16%, from 2011.  The decrease in net sales was primarily driven by a 13% decrease in foreign currency exchange rate translation and a 2% decrease in base product volumes, while price and product mix remained consistent with 2011.  The foreign currency translation impact was primarily due to decreases in the Brazilian Real and Argentinian Peso to U.S. Dollar exchange rates, which averaged 0.51 and 0.22 in 2012 compared to 0.60 and 0.24 in 2011, respectively. This reportable segment’s operating earnings, excluding indirect expenses, decreased approximately $4.9 million, or approximately 42%, from 2011, which reflects the decrease in its net sales and a change in the mix of those sales to lower margin products during 2012.
 
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
 

 
22

 

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, 2013, 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 $0.4 million to $0.8 million, for which the Company has sufficient reserves. Notwithstanding the foregoing, the Company cannot be certain that liabilities in the form of remediation expenses and damages will not be incurred in excess of the amount reserved. See Note 22 of Notes to Consolidated Financial Statements which appears in Item 8 of this Report.
 
General
 
The Company generally does not use financial instruments that expose it to significant risk involving foreign currency transactions; however, the size of our 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 3 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 2013 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 throughout a given year. As of December 31, 2013, Quaker had no borrowings under its credit facility, but had weighted average borrowings of $25.1 million in 2012 and 2013 at a weighted average borrowing rate of approximately 1.66% (LIBOR plus a spread). If interest rates had changed by 10%, the Company’s interest expense would have correspondingly increased or decreased by less than $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 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 21 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 and the E.U. Euro, the Brazilian Real, the Chinese Renminbi and the Indian Rupee. As exchange rates vary, Quaker’s results can be materially affected.  If the E.U. Euro, the Brazilian Real, the Chinese Renminbi and the Indian Rupee had each changed by 10% against the U.S. Dollar, the Company’s 2013 revenues and pre-tax earnings would have correspondingly increased or decreased approximately $35.7 million and $5.5 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 prices for the contracted raw materials rise; 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 2013 pre-tax earnings would have correspondingly increased or decreased by approximately $7.3 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 have 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 $1.1 million, $2.1 million and $0.9 million in 2013, 2012 and 2011, respectively. A change of 10% to the recorded provisions would have increased or decreased the Company’s pre-tax earnings by approximately $0.1 million, $0.2 million and $0.1 million in 2013, 2012 and 2011, respectively.

 
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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, 2013 and December 31, 2012, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2013 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, 2013, based on criteria established in Internal Control - Integrated Framework (1992) 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.
 
/s/ PricewaterhouseCoopers LLP
Philadelphia, PA
February 28, 2014

 
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QUAKER CHEMICAL CORPORATION
 
CONSOLIDATED STATEMENT OF INCOME
(In thousands, except per share amounts)
 

 
 
Year Ended December 31,
 
 
 
2013
   
2012
   
2011
 
 
 
 
   
 
   
 
 
Net sales
  $ 729,395     $ 708,226     $ 683,231  
Costs and expenses
                       
Cost of goods sold
    468,320       469,515       460,581  
Selling, general and administrative expenses
    189,832       175,487       164,738  
 
    658,152       645,002       625,319  
Operating income
    71,243       63,224       57,912  
Other income, net
    3,519       3,415       5,050  
Interest expense
    (2,922 )     (4,283 )     (4,666 )
Interest income
    986       592       1,081  
Income before taxes and equity in net income of associated companies
    72,826       62,948       59,377  
Taxes on income before equity in net income of associated companies
    20,489       15,575       14,256  
Income before equity in net income of associated companies
    52,337       47,373       45,121  
Equity in net income of associated companies
    6,514       2,867       3,102  
Net income
    58,851       50,240       48,223  
Less: Net income attributable to noncontrolling interest
    2,512       2,835       2,331  
Net income attributable to Quaker Chemical Corporation
  $ 56,339     $ 47,405     $ 45,892  
Earnings per common share data:
                       
Net income attributable to Quaker Chemical Corporation Common Shareholders – basic
  $ 4.28     $ 3.64     $ 3.71  
Net income attributable to Quaker Chemical Corporation Common Shareholders – diluted
  $ 4.27     $ 3.63     $ 3.66  


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

 
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QUAKER CHEMICAL CORPORATION
 
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(In thousands)
 

 
 
Year Ended December 31,
 
 
 
2013
   
2012
   
2011
 
 
 
 
   
 
   
 
 
Net income
  $ 58,851     $ 50,240     $ 48,223  
 
                       
Other comprehensive income (loss), net of tax
                       
Currency translation adjustments
    (3,490 )     (1,510 )     (9,734 )
Defined benefit retirement plans
                       
Net gain (loss) arising during the period, other
    6,614       (14,582 )     (9,119 )
Amortization of actuarial loss
    2,748       1,852       1,230  
Amortization of prior service cost
    119       76       77  
Current period change in fair value of derivatives
          272       395  
Unrealized (loss) gain on available-for-sale securities
    (142 )     867       (138 )
Other comprehensive income (loss)
    5,849       (13,025 )     (17,289 )
 
                       
Comprehensive income
    64,700       37,215       30,934  
Less: comprehensive income attributable to noncontrolling interest
    (1,206 )     (2,698 )     (1,256 )
Comprehensive income attributable to Quaker Chemical Corporation
  $ 63,494     $ 34,517     $ 29,678  


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

 
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Table of Contents

QUAKER CHEMICAL CORPORATION
 
CONSOLIDATED BALANCE SHEET
(In thousands, except par value and share amounts)
 

 
 
December 31,
 
 
 
2013 
 
 
 
2012 
ASSETS
 
 
 
 
 
 
 
 
Current assets
 
 
 
 
 
 
 
 
        Cash and cash equivalents
 
$
68,492 
 
 
$
32,547 
 
        Accounts receivable, net
 
 
165,629 
 
 
 
154,197 
 
        Inventories, net
 
 
71,557 
 
 
 
72,471 
 
        Current deferred tax assets
 
 
7,826 
 
 
 
6,401 
 
        Prepaid expenses and other current assets
 
 
15,343 
 
 
 
12,194 
 
                Total current assets
 
 
328,847 
 
 
 
277,810 
 
Property, plant and equipment, net
 
 
85,488 
 
 
 
85,112 
 
Goodwill
 
 
58,151 
 
 
 
59,169 
 
Other intangible assets, net
 
 
31,272 
 
 
 
32,809 
 
Investments in associated companies
 
 
19,397 
 
 
 
16,603 
 
Non-current deferred tax assets
 
 
24,724 
 
 
 
30,673 
 
Other assets
 
 
36,267 
 
 
 
34,458 
 
                Total assets
 
$
584,146 
 
 
$
536,634 
 
 
 
 
 
 
 
 
 
 
LIABILITIES AND EQUITY
 
 
 
 
 
 
 
 
Current liabilities
 
 
 
 
 
 
 
 
        Short-term borrowings and current portion of long-term debt
 
$
1,395 
 
 
$
1,468 
 
        Accounts payable
 
 
72,281 
 
 
 
67,586 
 
        Dividends payable
 
 
3,299 
 
 
 
3,208 
 
        Accrued compensation
 
 
20,801 
 
 
 
16,842 
 
        Accrued pension and postretirement benefits
 
 
1,438 
 
 
 
2,188 
 
        Current deferred tax liabilities
 
 
1,057 
 
 
 
253 
 
        Other current liabilities
 
 
30,585 
 
 
 
16,247 
 
               Total current liabilities
 
 
130,856 
 
 
 
107,792 
 
Long-term debt
 
 
17,321 
 
 
 
30,000 
 
Non-current deferred tax liabilities
 
 
6,394 
 
 
 
6,383 
 
Non-current accrued pension and postretirement benefits
 
 
37,006 
 
 
 
49,916 
 
Other non-current liabilities
 
 
47,538 
 
 
 
52,867 
 
               Total liabilities
 
 
239,115 
 
 
 
246,958 
 
Equity
 
 
 
 
 
 
 
 
         Common stock $1 par value; authorized 30,000,000 shares; issued and outstanding
 
 
 
 
 
 
 
 
            2013 – 13,196,140 shares; 2012 – 13,094,901 shares
 
 
13,196 
 
 
 
13,095 
 
         Capital in excess of par value
 
 
99,038 
 
 
 
94,470 
 
         Retained earnings
 
 
258,620 
 
 
 
215,390 
 
         Accumulated other comprehensive loss
 
 
(34,700)
 
 
 
(41,855)
 
               Total Quaker shareholders’ equity
 
 
336,154 
 
 
 
281,100 
 
               Noncontrolling interest
 
 
8,877 
 
 
 
8,576 
 
               Total equity
 
 
345,031 
 
 
 
289,676 
 
                       Total liabilities and equity
 
$
584,146 
 
 
$
536,634 
 


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

 
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QUAKER CHEMICAL CORPORATION
 
CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
 

 
 
Year Ended December 31,
 
 
 
2013
   
2012
   
2011
 
Cash flows from operating activities
 
 
   
 
   
 
 
Net income
  $ 58,851     $ 50,240     $ 48,223  
Adjustments to reconcile net income to net cash provided by operating activities:
                       
Depreciation
    12,339       12,252       11,455  
Amortization
    3,445       3,106       2,338  
Equity in undistributed earnings of associated companies, net of dividends
    (4,162 )     (2,350 )     (2,365 )
Deferred income taxes
    (30 )     2,354       2,431  
Uncertain tax positions (non-deferred portion)
    (1,826 )     (1,407 )     3,673  
Acquisition-related fair value adjustments
    200       (1,909 )     (2,624 )
Deferred compensation and other, net
    (259 )     (156 )     566  
Stock-based compensation
    4,161       3,807       3,513  
Loss (gain) on disposal of property, plant and equipment
    200       (108 )     (86 )
Insurance settlements realized
    (988 )     (1,391 )     (1,840 )
Pension and other postretirement benefits
    862       (1,427 )     (4,239 )
(Decrease) increase in cash from changes in current assets and current liabilities, net of acquisitions:
                       
Accounts receivable
    (11,837 )     779       (31,558 )
Inventories
    406       3,228       (9,281 )
Prepaid expenses and other current assets
    (743 )     504       (2,505 )
Accounts payable and accrued liabilities
    11,301       (2,562 )     4,442  
Estimated taxes on income
    1,881       (2,067 )     (2,477 )
Net cash provided by operating activities
    73,801       62,893       19,666  
 
                       
Cash flows from investing activities
                       
Investments in property, plant and equipment
    (11,439 )     (12,735 )     (12,117 )
Payments related to acquisitions, net of cash acquired
    (2,478 )     (5,635 )     (25,477 )
Proceeds from disposition of assets
    513       245       393  
Interest earned on an insurance settlement
    52       69       80  
Change in restricted cash, net
    936       1,322       1,760  
Net cash used in investing activities
    (12,416 )     (16,734 )     (35,361 )
 
                       
Cash flows from financing activities
                       
Net decrease in short-term borrowings
          (315 )     (254 )
Repayment of long-term debt
    (12,791 )     (17,632 )     (27,364 )
Dividends paid
    (13,018 )     (12,616 )     (11,586 )
Stock options exercised, other
    (307 )     (924 )     1,105  
Excess tax benefit related to stock option exercises
    815       2,045       109  
Proceeds from sale of common stock, net of related expenses
                48,143  
Dividends paid to noncontrolling shareholders
    (905 )     (1,099 )     (1,000 )
Net cash (used in) provided by financing activities
    (26,206 )     (30,541 )     9,153  
              Effect of exchange rate changes on cash
    766       20       (2,315 )
       Net increase (decrease) in cash and cash equivalents
    35,945       15,638       (8,857 )
       Cash and cash equivalents at beginning of period
    32,547       16,909       25,766  
       Cash and cash equivalents at end of period
  $ 68,492     $ 32,547     $ 16,909  
 
                       
Supplemental cash flow disclosures:
                       
        Cash paid during the year for:
                       
    Income taxes
  $ 17,744     $ 13,190     $ 9,110  
    Interest
    1,776       2,809       3,298  
         Non-cash activities:
                       
    Accrued purchases of property, plant and equipment
  $ 1,287     $     $  


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

 
30

 
Table of Contents

QUAKER CHEMICAL CORPORATION
 
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
(In thousands, except per share amounts)
 

 
 
 
   
 
   
 
   
Accumulated
   
 
   
 
 
 
 
 
   
Capital in
   
 
   
other
   
Non-
   
 
 
 
 
Common
   
excess of
   
Retained
   
comprehensive
   
controlling
   
 
 
 
 
stock
   
par value
   
earnings
   
loss
   
interest
   
Total
 
Balance at December 31, 2010
  $ 11,492     $ 38,275     $ 146,802     $ (12,753 )   $ 6,721     $ 190,537  
Net income
                45,892             2,331       48,223  
Amounts reported in other comprehensive loss
                      (16,214 )     (1,075 )     (17,289 )
Dividends ($0.955 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
    12,912       89,725       180,710       (28,967 )     6,977       261,357  
Net income
                47,405             2,835       50,240  
Amounts reported in other comprehensive loss
                      (12,888 )     (137 )     (13,025 )
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  
Net income
                56,339             2,512       58,851  
Amounts reported in other comprehensive income
                      7,155       (1,306 )     5,849  
Dividends ($0.995 per share)
                (13,109 )                 (13,109 )
Dividends paid to noncontrolling interests
                            (905 )     (905 )
Shares issued upon exercise of stock options and other
    24       (668 )                       (644 )
Shares issued for employee stock purchase plan
    6       331                         337  
Equity based compensation plans
    71       4,090                         4,161  
Excess tax benefit from stock option exercises
          815                         815  
Balance at December 31, 2013
  $ 13,196     $ 99,038     $ 258,620     $ (34,700 )   $ 8,877     $ 345,031  


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

 
31

QUAKER CHEMICAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(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.
 
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 9 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 an 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. These costs are amortized over a period of three to five years once the assets are ready for their intended use.  In connection with the implementations and upgrades to the Company’s global transaction, consolidation and other related systems, approximately $1,198 and $2,395 of net costs were capitalized in property, plant and equipment on the Company’s December 31, 2013 and December 31, 2012 Consolidated Balance Sheets, respectively.
 
Goodwill and other intangible assets:    The Company records goodwill, definite-lived intangible assets and indefinite-lived intangible assets at fair value at the date of 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, consistent with the discussion of long-lived assets, above. See Note 11 of Notes to Consolidated Financial Statements.
 
Revenue recognition:    The Company recognizes revenue in accordance with the terms of the underlying agreements, when title and risk of loss have been transferred, 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 determinable, and when collectability is reasonably assured.  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 a principal, revenues are recognized on a gross reporting basis at the selling price negotiated with its customers. Where the Company acts as an agent, such revenue is recorded using net reporting as service
 
 
32

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

 
revenue at the amount of the administrative fee earned by the Company for ordering the goods. Third-party products transferred under arrangements resulting in net reporting totaled $41,553, $39,299 and $50,893 for 2013, 2012 and 2011, respectively.
 
Accounts receivable and allowance for doubtful accounts: Trade accounts receivable are recorded at the invoiced amount and generally do not bear interest. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses with its existing accounts receivable. Reserves for customers filing for bankruptcy protection are generally established at 75-100% of the amount owed at the 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 established for other customers based on historical experience. The Company performs a formal review of its allowance for doubtful accounts quarterly. Account balances are charged off against the allowance when the Company feels it is probable the receivable will not be recovered.  The Company does not have any off-balance-sheet credit exposure related to its customers. During 2013, the Company’s five largest customers accounted for approximately 18% of its consolidated net sales with the largest customer (Arcelor-Mittal Group) accounting for approximately 9% of the Company’s consolidated net sales.
 
During 2012, the Company recorded charges of $1,254 to its allowance for doubtful accounts and selling, general and administrative expenses (“SG&A”) due to the bankruptcies of two U.S. customers.  See Note 8 of Notes to Consolidated Financial Statements.
 
Research and development costs:    Research and development costs are expensed as incurred and are included in SG&A.  Research and development expenses were $21,578, $19,993 and $18,812 in 2013, 2012 and 2011, respectively.
 
Concentration of credit risk:    Financial instruments, which potentially subject the Company to a concentration of credit risk, principally consist of cash equivalents, short-term investments and trade receivables. The Company invests temporary and excess funds in money market securities and financial instruments having maturities typically within 90 days. The Company has not experienced losses from the aforementioned investments.
 
Environmental liabilities and expenditures:    Accruals for environmental matters are recorded when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated. If there is a range of estimated liability and no amount in that range is considered more probable than another, then the Company records the lowest amount in the range in accordance with generally accepted accounting principles. Accrued liabilities are exclusive of claims against third parties and are not discounted. Environmental costs and remediation costs are capitalized if the costs extend the life, increase the capacity or improve safety or efficiency of the property from the date acquired or constructed, and/or mitigate or prevent contamination in the future.
 
Asset retirement obligations: The Company follows the FASB’s guidance regarding asset retirement obligations, which addresses the accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated retirement costs.  Also, the Company follows the FASB’s guidance for conditional asset retirement obligations (“CARO”), which relates to legal obligations to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the entity.  In accordance with this guidance, the Company records a liability when there is enough information regarding the timing of the CARO to perform a probability-weighted discounted cash flow analysis.  At December 31, 2013 and December 31, 2012, the Company had limited exposure to such obligations and had immaterial liabilities recorded for such on its Consolidated Balance Sheets.
 
Pension and other postretirement benefits: The Company maintains various noncontributory retirement plans, the largest of which is in the U.S., covering substantially all of its employees in the U.S. and certain other countries.  The plans of the Company’s subsidiaries in The Netherlands, the United Kingdom and Mexico are subject to the provisions of FASB’s guidance regarding employers’ accounting for defined benefit pension plans.  The plans of the remaining non-U.S. subsidiaries are, for the most part, either fully insured or integrated with the local governments’ plans and are not subject to the provisions of the guidance.  The guidance requires that employers recognize on a prospective basis the funded status of their defined benefit pension and other postretirement plans on their consolidated balance sheet and, also, recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost. The Company’s U.S. pension plan year ends on November 30 and the measurement date is December 31.  The measurement date for the Company’s other postretirement benefits plan is December 31.
 
The Company’s pension investment policy is designed to ensure that pension assets are invested in a manner consistent with meeting the future benefit obligations of the pension plans and maintaining compliance with various laws and regulations including  the Employee Retirement Income Security Act of 1974 (“ERISA”).  The Company establishes strategic asset allocation percentage targets and appropriate benchmarks for significant asset classes with the aim of achieving a prudent balance between return and risk.  The Company’s investment horizon is generally long term, and, accordingly, the target asset allocations encompass a long-term
 

 
33

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


perspective of capital markets, expected risk and return and perceived future economic conditions while also considering the profile of plan liabilities.  To the extent feasible, the short-term investment portfolio is managed to immunize the short-term obligations, the intermediate portfolio duration is immunized to reduce the risk of volatility in intermediate plan distributions, and the total return portfolio is expected to maximize the long-term real growth of plan assets.  The critical investment principles of diversification, assessment of risk and targeting the optimal expected returns for given levels of risk are applied.  The Company’s investment guidelines prohibit use of securities such as letter stock and other unregistered securities, commodities or commodity contracts, short sales, margin transactions, private placements (unless specifically addressed by addendum), or any derivatives, options or futures for the purpose of portfolio leveraging.
 
The target asset allocation is reviewed periodically and is determined based on a long-term projection of capital market outcomes, inflation rates, fixed income yields, returns, volatilities and correlation relationships.  The interaction between plan assets and benefit obligations is periodically studied to assist in establishing such strategic asset allocation targets.  Asset performance is monitored with an overall expectation that plan assets will meet or exceed benchmark performance over rolling five-year periods.  The Company’s pension committee, as authorized by the Company’s Board of Directors, has discretion to manage the assets within established asset allocation ranges approved by senior management of the Company.  As of December 31, 2013, the plan’s investments were in compliance with all approved ranges of asset allocations. See Note 16 of Notes to Consolidated Financial Statements.
 
Comprehensive income (loss):    The Company presents other comprehensive income (loss) in its Statement of Comprehensive Income. During 2013, the Company adopted the 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 Consolidated Statement of Comprehensive Income or in the Notes to the Consolidated Financial Statements.  The Company elected to present the information in the Notes to the 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 18 of Notes to Consolidated Financial Statements.
 
Income taxes and uncertain tax positions:    The provision for income taxes is determined using the asset and liability approach of accounting for income taxes. Under this approach, deferred taxes represent the future tax consequences expected to occur when the reported amounts of assets and liabilities are recovered or paid. The provision for income taxes represents income taxes paid or payable for the current year and the change in deferred taxes during the year. Deferred taxes result from differences between the financial and tax bases of the Company’s assets and liabilities and are adjusted for changes in tax rates and tax laws when changes are enacted. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized. The FASB’s guidance regarding accounting for uncertainty in income taxes prescribes the recognition threshold and measurement attributes for financial statement recognition and measurement of tax positions taken or expected to be taken on a tax return. The guidance further requires the determination of whether the benefits of tax positions will be more likely than not sustained upon audit based upon the technical merits of the tax position. For tax positions that are determined to be more likely than not sustained upon audit, a company recognizes the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement in the financial 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.  During 2013, the Company adopted guidance that requires an entity to net its liability for unrecognized tax benefits against deferred tax assets related to net operating losses or other tax credit carryforwards that would apply if the uncertain tax position were settled for the presumed amount at the balance sheet date, which had an immaterial impact on the Company’s current year results and financial condition.  See Note 6 of Notes to Consolidated Financial Statements.
 
Derivatives:    The Company is exposed to the impact of changes in interest rates, foreign currency fluctuations, changes in commodity prices and credit risk.  The Company is currently not using derivative instruments to mitigate the risks associated with foreign currency fluctuations, changes in commodity prices or credit risk, but has used derivative financial instruments primarily for purposes of hedging exposures to fluctuations in interest rates in the past. The Company recognized all derivatives on its balance sheet at fair value. For derivative instruments designated as cash flow hedges, the effective portion of any hedge would be reported in Accumulated Other Comprehensive Income (Loss) until it was cleared to earnings during the same period in which the hedged item affected earnings. The Company currently uses no derivative instruments designated as fair value hedges and has not entered into derivative contracts for trading or speculative purposes.  See Note 21 of Notes to Consolidated Financial Statements.
 

 
34

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


Fair value measurements: The Company utilizes the FASB’s guidance regarding fair value measurements, which establishes a common definition for fair value to be applied to guidance requiring use of fair value, establishes a framework for measuring fair value and expands disclosure about such fair value measurements.  Specifically, the guidance utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The following is a brief description of those three levels:
 

 
Level 1: Observable inputs such as quoted prices (unadjusted) in active markets for identical assets or liabilities.
 
 
 
 
Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly.  These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.
 
 
 
 
Level 3: Unobservable inputs that reflect the reporting entity's own assumptions.
 
Stock-based compensation: The Company applies the FASB’s guidance regarding share-based payments, which requires the recognition of the fair value of stock-based compensation as a component of expense.  The Company has a long-term incentive program (“LTIP”) for key employees which provides for the granting of options to purchase stock at prices not less than its market value on the date of the grant. Most options become exercisable between one and three years after the date of the grant for a period of time determined by the Company, but not to exceed seven years from the date of grant. Common stock awards and Restricted Stock Units (“RSU”) issued under the LTIP program are subject only to time vesting over a three to five-year period.  In addition, as part of the Company’s Global Annual Incentive Plan (“GAIP”), nonvested shares may be issued to key employees, which generally vest over a two to five-year period.  Based on historical experience, the Company has generally assumed a forfeiture rate of 13% on its nonvested stock awards. The Company will record additional expense if the actual forfeiture rate is lower than estimated, and will record a recovery of prior expense if the actual forfeiture is higher than estimated.  See Note 4 of Notes to Consolidated Financial Statements.
 
Earnings per share: The Company follows FASB’s guidance regarding the calculation of earnings per share (“EPS”) for nonvested stock awards with rights to non-forfeitable dividends.  The guidance requires nonvested stock awards with rights to non-forfeitable dividends to be included as part of the basic weighted average share calculation under the two-class method.   See Note 7 of Notes to Consolidated Financial Statements.
 
Segments: The Company’s reportable operating segments evidence the structure of the Company’s internal organization, the method by which the Company’s resources are allocated and the manner by which the Company assesses its performance.  During 2013, certain internal shifts in the Company’s management and changes to the structure of internally reported information occurred.  The Company currently believes its structure, its resource allocation and its performance assessment are now more closely aligned with its four geographical regions: the North America region, the Europe, Middle East and Africa (“EMEA”) region, the Asia/Pacific region and the South America region.  Therefore, the Company changed its reportable operating segments from those categorized by product nature to those organized by geography.  All prior period information has been recast to reflect these four regions as the Company’s new reportable operating segments.  See Note 3 of Notes to Consolidated Financial Statements.
 
Reclassifications:    Certain information has been reclassified to conform to the current year presentation.
 
Accounting estimates:    The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and disclosure of contingencies at the date of the financial statements and the reported amounts of net sales and expenses during the reporting period. Actual results could differ from such estimates.
 
Note 2 – 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,
 

 
35

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