XNYS:KWR Quaker Chemical Corp Quarterly Report 10-Q Filing - 6/28/2012

Effective Date 6/28/2012

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



 
FORM 10-Q

 



 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2012

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

For the transition period from              to             

Commission file number 001-12019
 
 


QUAKER CHEMICAL CORPORATION
(Exact name of Registrant as specified in its charter)
 



 
     
Pennsylvania
 
23-0993790
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
     
One Quaker Park, 901 E. Hector Street,
Conshohocken, Pennsylvania
 
19428 – 2380
(Address of principal executive offices)
 
(Zip Code)

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

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



 
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   x     No   ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).Yes   x     No   ¨

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


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



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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
     
Number of Shares of Common Stock
Outstanding on June 30, 2012
 
 
13,010,639
 


 
 
 

 

 
         
 
  
 
  
Page
PART I.
  
FINANCIAL INFORMATION
  
 
Item 1.
  
Financial Statements (unaudited)
  
 
 
  
  
3
 
  
  
4
     
5
 
  
  
6
 
  
  
7
Item 2.
  
  
23
Item 3.
  
  
28
Item 4.
  
  
29
PART II.
  
  
30
Item 1.
   
30
Item 2.
   
30
Item 6.
  
  
31
Signatures
  
31


FINANCIAL INFORMATION

Item 1.                                Financial Statements (Unaudited).

Quaker Chemical Corporation
 
Condensed Consolidated Balance Sheet
 


   
Unaudited
   
(Dollars in thousands,
   
except par value
   
and share amounts)
   
June 30, 2012
   
December 31, 2011*
 
 
ASSETS
               
Current assets
               
        Cash and cash equivalents
 
$
25,252
   
$
16,909
 
        Accounts receivable, net
   
156,424
     
150,676
 
        Inventories
               
                Raw materials and supplies
   
43,565
     
41,771
 
                Work-in-process and finished goods
   
34,113
     
32,987
 
        Prepaid expenses and other current assets
   
18,009
     
17,206
 
                Total current assets
   
277,363
     
259,549
 
Property, plant and equipment, at cost
   
214,027
     
214,695
 
        Less accumulated depreciation
   
(131,372)
     
(131,779)
 
                Net property, plant and equipment
   
82,655
     
82,916
 
Goodwill
   
57,033
     
58,152
 
Other intangible assets, net
   
30,397
     
31,783
 
Investments in associated companies
   
7,891
     
7,942
 
Deferred income taxes
   
27,644
     
29,823
 
Other assets
   
36,370
     
35,356
 
                Total assets
 
$
519,353
   
$
505,521
 
                 
LIABILITIES AND EQUITY
               
Current liabilities
               
        Short-term borrowings and current portion of long-term debt
 
$
563
   
$
636
 
        Accounts and other payables
   
74,679
     
68,125
 
        Accrued compensation
   
10,610
     
16,987
 
        Other current liabilities
   
22,334
     
20,901
 
               Total current liabilities
   
108,186
     
106,649
 
Long-term debt
   
45,004
     
46,701
 
Deferred income taxes
   
6,622
     
7,094
 
Other non-current liabilities
   
86,116
     
89,351
 
               Total liabilities
   
245,928
     
249,795
 
Equity
               
         Common stock $1 par value; authorized 30,000,000 shares; issued and outstanding
               
            2012 – 13,010,639 shares; 2011 – 12,911,508 shares
   
13,011
     
12,912
 
         Capital in excess of par value
   
92,199
     
89,725
 
         Retained earnings
   
192,116
     
175,932
 
         Accumulated other comprehensive loss
   
(32,091)
     
(29,820)
 
               Total Quaker shareholders’ equity
   
265,235
     
248,749
 
Noncontrolling interest
   
8,190
     
6,977
 
Total equity
   
273,425
     
255,726
 
         Total liabilities and equity
 
$
519,353
   
$
505,521
 

*
Condensed from audited financial statements

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


 
Condensed Consolidated Statement of Income

 
 
Unaudited
 
 
 
(Dollars in thousands, except per share amounts)
 
 
 
Three Months Ended June 30,
   
Six Months Ended June 30,
 
 
 
2012
   
2011
   
2012
   
2011
 
Net sales
  $ 176,797     $ 167,792     $ 354,435     $ 327,657  
Cost of goods sold
    116,161       114,026       234,004       221,157  
Gross profit
    60,636       53,766       120,431       106,500  
Selling, general and administrative expenses
    43,653       38,825       86,746       77,459  
Operating income
    16,983       14,941       33,685       29,041  
Other (expense) income, net
    (134 )     791       207       1,330  
Interest expense
    (1,151 )     (1,200 )     (2,325 )     (2,418 )
Interest income
    137       271       260       543  
Income before taxes and equity in net income of associated companies
    15,835       14,803       31,827       28,496  
Taxes on income before equity in net income of associated companies
    4,874       4,499       8,319       7,321  
Income before equity in net income of associated companies
    10,961       10,304       23,508       21,175  
Equity in net income of associated companies
    209       251       355       610  
Net income
    11,170       10,555       23,863       21,785  
Less: Net income attributable to noncontrolling interest
    630       714       1,377       1,344  
Net income attributable to Quaker Chemical Corporation
  $ 10,540     $ 9,841     $ 22,486     $ 20,441  
Per share data:
                               
Net income attributable to Quaker Chemical Corporation Common
                               
Shareholders – basic
  $ 0.81     $ 0.80     $ 1.74     $ 1.72  
Net income attributable to Quaker Chemical Corporation Common
                               
Shareholders – diluted
  $ 0.81     $ 0.79     $ 1.72     $ 1.69  
Dividends declared
  $ 0.245     $ 0.24     $ 0.485     $ 0.475  
 
                               

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


 
Condensed Consolidated Statement of Comprehensive Income


 
 
 
   
 
   
 
 
 
 
 
   
 
   
 
 
 
 
Unaudited
 
 
 
(Dollars in thousands, except per share amounts)
 
 
 
Three Months Ended June 30,
   
Six Months Ended June 30,
 
 
 
2012
   
2011
   
2012
   
2011
 
Net income
  $ 11,170     $ 10,555     $ 23,863     $ 21,785  
 
                               
Other comprehensive (loss) income, net of tax
                               
Currency translation adjustments
    (7,211 )     3,656       (3,576 )     7,477  
Defined benefit retirement plans
    499       325       969       649  
Current period change in fair value of derivatives
    103       78       199       174  
Unrealized (loss) gain on available-for-sale securities
    (5 )           3       6  
Other comprehensive (loss) income
    (6,614 )     4,059       (2,405 )     8,306  
 
                               
Comprehensive income
    4,556       14,614       21,458       30,091  
Less: comprehensive income attributable to noncontrolling interest
    (205 )     (783 )     (1,243 )     (1,421 )
Comprehensive income attributable to Quaker Chemical Corporation
  $ 4,351     $ 13,831     $ 20,215     $ 28,670  

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



 
Condensed Consolidated Statement of Cash Flows

   
Unaudited
 
   
(Dollars in thousands)
 
   
For the Six Months Ended
 
   
June 30,
 
   
2012
   
2011
 
Cash flows from operating activities
           
Net income
  $ 23,863     $ 21,785  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation
    5,969       5,405  
Amortization
    1,465       973  
Equity in undistributed earnings of associated companies, net of dividends
    (171 )     (32 )
Deferred compensation and other, net
    1,332       4,162  
Stock-based compensation
    2,078       1,854  
Gain on disposal of property, plant and equipment
    (13 )     (78 )
Insurance settlement realized
    (808 )     (864 )
Pension and other postretirement benefits
    (1,951 )     (4,168 )
(Decrease) increase in cash from changes in current assets and current liabilities, net of acquisitions:
               
Accounts receivable
    (7,031 )     (17,392 )
Inventories
    (3,871 )     (13,986 )
Prepaid expenses and other current assets
    (1,946 )     (4,029 )
Accounts payable and accrued liabilities
    3,025       6,537  
Net cash provided by operating activities
    21,941       167  
                 
Cash flows from investing activities
               
Investments in property, plant and equipment
    (6,423 )     (6,641 )
Proceeds from disposition of assets
    84       221  
Payments related to acquisitions, net of cash acquired
          (717 )
Insurance settlement received and interest earned
    35       42  
Change in restricted cash, net
    773       822  
Net cash used in investing activities
    (5,531 )     (6,273 )
                 
Cash flows from financing activities
               
Repayment of long-term debt
    (1,754 )     (40,402 )
Dividends paid
    (6,213 )     (5,413 )
Stock options exercised, other
    (925 )     146  
Excess tax benefit related to stock option exercises
    1,420       162  
Proceeds from sale of common stock, net of related expenses
          48,143  
Distributions to noncontrolling shareholders
    (30 )      
Net cash (used in) provided by financing activities
    (7,502 )     2,636  
Effect of exchange rate changes on cash
    (565 )     1,245  
Net increase (decrease) in cash and cash equivalents
    8,343       (2,225 )
Cash and cash equivalents at beginning of period
    16,909       25,766  
Cash and cash equivalents at end of period
  $ 25,252     $ 23,541  

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

 
6

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


Note 1 – Condensed Financial Information

The condensed consolidated financial statements included herein are unaudited and have been prepared in accordance with generally accepted accounting principles in the United States for interim financial reporting and the United States Securities and Exchange Commission regulations. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the financial statements reflect all adjustments (consisting only of normal recurring adjustments, except as discussed below) which are necessary for a fair statement of the financial position, results of operations and cash flows for the interim periods. The results for the three and six months ended June 30, 2012 are not necessarily indicative of the results to be expected for the full year. These financial statements should be read in conjunction with the Company’s Annual Report filed on Form 10-K for the year ended December 31, 2011.

During the first quarter of 2012, the Company adopted the Financial Accounting Standards Board’s (“FASB’s”) guidance regarding presentation of comprehensive income.  The guidance requires that comprehensive income be presented with the Condensed Consolidated Statement of Income or as a separate statement immediately following the Condensed Consolidated Statement of Income, and can no longer be presented as part of the Consolidated Statement of Changes in Equity.  The Company adopted the guidance using the two statement approach, and the adoption of this guidance did not have a material impact on the Company’s results or financial condition.
 
During the second quarter of 2012, the Company recorded charges of $1,156 to its allowance for doubtful accounts and selling, general and administrative expenses due to the bankruptcies of two U.S. customers.
 
As part of the Company’s chemical management services, certain third-party product sales to customers are managed by the Company. Where the Company acts as the principal, revenue is recognized on a gross reporting basis at the selling price negotiated with customers. Where the Company acts as an agent, such revenue is recorded using net reporting as service revenues, at the amount of the administrative fee earned by the Company for ordering the goods. Third-party products transferred under arrangements resulting in net reporting totaled $20,944 and $24,276 for the six months ended June 30, 2012 and June 30, 2011, respectively.

Note 2 – Recently Issued Accounting Standards

The FASB updated its guidance in December 2011 regarding disclosures pertaining to the netting and offsetting of derivatives and financial instruments on an entity’s Consolidated Balance Sheet.  Disclosures required under the updated guidance include presenting gross amounts of assets and liabilities related to financial instruments that may have been historically offset on the Consolidated Balance Sheet.  The guidance is effective for annual and interim fiscal periods beginning on or after January 1, 2013.   The Company is currently evaluating the effect of this guidance.
 
Note 3 – Income Taxes and Uncertain Income Tax Positions

The Company's year-to-date 2012 effective tax rate of 26.1% was higher than the year-to-date 2011 effective tax rate of 25.7%.  Both year-to-date 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 $0.12 and $0.11 per diluted share for the six months ended June 30, 2012 and June 30, 2011, respectively.  The most significant other items affecting the comparison of the 2012 and 2011 year-to-date effective tax rates were a higher utilization of foreign tax credits in 2011, which were previously not benefited, and lower withholding taxes on dividends in 2012.
 
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.
 
 
 
7

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

 
 
As of June 30, 2012, the Company’s cumulative liability for gross unrecognized tax benefits was $12,426.  At December 31, 2011, the Company’s cumulative liability for gross unrecognized tax benefits was $12,719.
 
The Company continues to recognize interest and penalties associated with uncertain tax positions as a component of taxes on income before equity in net income of associated companies in its Condensed Consolidated Statement of Income. The Company recognized $164 and $(51) for interest and $99 and $194 for penalties on its Condensed Consolidated Statement of Income for the three and six months ended June 30, 2012, respectively, and recognized $184 and $59 for interest and $145 and $424 for penalties on its Condensed Consolidated Statement of Income for the three and six months ended June 30, 2011, respectively. As of June 30, 2012, the Company had accrued $2,175 for cumulative interest and $1,463 for cumulative penalties, and $2,268 for cumulative interest and $1,298 for cumulative penalties at December 31, 2011.
 
During the three months ended June 30, 2012, there were no expirations of statutes of limitations for uncertain tax positions.  During the three months ended June 30, 2011, the Company recognized a decrease in its cumulative liability for gross unrecognized tax benefits due to the liquidation of the Company’s subsidiary in Wuxi China for certain tax years of approximately $36.
 
During the six months ended June 30, 2012, the Company recognized a $1,072 decrease in its cumulative liability for gross unrecognized tax benefits due to the expiration of the applicable statutes of limitations for certain tax years.  During the six months ended June 30, 2011, the Company recognized a $958 decrease in its cumulative liability for gross unrecognized tax benefits due to the expiration of the applicable statutes of limitations for certain tax years.
 
The Company estimates that during the year ending December 31, 2012 it will reduce its cumulative liability for gross unrecognized tax benefits by approximately $1,700 to $1,800 due to the expiration of the statute of limitations with regard to certain tax positions. This estimated reduction in the cumulative liability for unrecognized tax benefits does not consider any increase in liability for unrecognized tax benefits with regard to existing tax positions or any increase in cumulative liability for unrecognized tax benefits with regard to new tax positions for the year ending December 31, 2012.
 
The Company and its subsidiaries are subject to U.S. Federal income tax, as well as the income tax of various state and foreign tax jurisdictions. Tax years that remain subject to examination by major tax jurisdictions include the Netherlands and the United Kingdom from 2006, Brazil and Spain from 2007, the United States from 2008, China from 2009, Italy from 2010, and various domestic state tax jurisdictions from 1993.
 
In the second quarter of 2012, the Internal Revenue Service initiated a limited scope audit of the Company’s 2009 federal income tax return.  The Company has responded to all information requests and has not received any further communications.  Also, during the second quarter of 2012, the Italian tax authorities initiated a transfer pricing audit of the Company’s Italian subsidiary.  On July 7, 2012, the Company received the preliminary tax report, which proposed several adjustments to the taxable income of the subsidiary.  In conjunction with outside counsel, the Company reviewed the report and believes it should prevail on the merits of the case.  As a result, the Company does not believe it has any exposures warranting an uncertain tax position reserve.
 

Note 4 – Fair Value Measurements
 
The FASB’s guidance regarding fair value measurements establishes a common definition for fair value to be applied to guidance requiring use of fair value, establishes a framework for measuring fair value, and expands disclosure about such fair value measurements.  The guidance does not require any new fair value measurements, but rather applies to all other accounting guidance that requires or permits fair value measurements.
 
The guidance utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The following is a brief description of those three levels:
 

 
Level 1: Observable inputs such as quoted prices (unadjusted) in active markets for identical assets or liabilities.
     
 
Level 2: Inputs other than quoted prices that 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 not active.
     
 
Level 3: Unobservable inputs that reflect the reporting entity's own assumptions.


 
8

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


The Company values its interest rate swaps, company-owned life insurance policies and various deferred compensation assets and liabilities, acquisition-related consideration and an obligation related to a non-competition agreement at fair value.  The Company’s assets and liabilities subject to fair value measurement are as follows:

         
Fair Value Measurements at June 30, 2012
 
   
Fair Value
   
Using Fair Value Hierarchy
 
   
as of
                   
Assets
 
June 30, 2012
   
Level 1
   
Level 2
   
Level 3
 
Company-owned life insurance
  $ 1,585     $     $ 1,585     $  
Company-owned life insurance - Deferred compensation assets
    441             441        
Other deferred compensation assets
                               
Large capitalization registered investment companies
    59       59              
Mid capitalization registered investment companies
    5       5              
Small capitalization registered investment companies
    8       8              
International developed and emerging markets registered investment
                               
                companies
    32       32              
Fixed income registered investment companies
    9       9              
                                 
Total
  $ 2,139     $ 113     $ 2,026     $  

         
Fair Value Measurements at June 30, 2012
 
   
Fair Value
   
Using Fair Value Hierarchy
 
   
as of
                   
Liabilities
 
June 30, 2012
   
Level 1
   
Level 2
   
Level 3
 
Deferred compensation liabilities
                       
Large capitalization registered investment companies
  $ 314     $ 314     $     $  
Mid capitalization registered investment companies
    83       83              
Small capitalization registered investment companies
    68       68              
International developed and emerging markets registered investment
                               
                  companies
    163       163              
Fixed income registered investment companies
    48       48              
Fixed general account
    169             169        
Interest rate derivatives
    112             112        
Acquisition-related consideration
    9,506                   9,506  
                                 
Total
  $ 10,463     $ 676     $ 281     $ 9,506  

         
Fair Value Measurements at December 31, 2011
 
   
Fair Value
   
Using Fair Value Hierarchy
 
   
as of
                   
Assets
 
December 31, 2011
   
Level 1
   
Level 2
   
Level 3
 
Company-owned life insurance
  $ 1,508     $     $ 1,508     $  
Company-owned life insurance - Deferred compensation assets
    487             487        
Other deferred compensation assets
                               
Large capitalization registered investment companies
    64       64              
Mid capitalization registered investment companies
    4       4              
Small capitalization registered investment companies
    7       7              
International developed and emerging markets registered investment
                               
                 companies
    32       32              
Fixed income registered investment companies
    8       8              
                                 
Total
  $ 2,110     $ 115     $ 1,995     $  
 
 
 
9

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

 

 
         
Fair Value Measurements at December 31, 2011
 
   
Fair Value
   
Using Fair Value Hierarchy
 
   
as of
                   
Liabilities
 
December 31, 2011
   
Level 1
   
Level 2
   
Level 3
 
Deferred compensation liabilities
                       
Large capitalization registered investment companies
  $ 318     $ 318     $     $  
Mid capitalization registered investment companies
    83       83              
Small capitalization registered investment companies
    68       68              
International developed and emerging markets registered investment
                               
                 companies
    168       168              
Fixed income registered investment companies
    50       50              
Fixed general account
    177             177        
Interest rate derivatives
    418             418        
Acquisition related consideration
    8,898                   8,898  
                                 
Total
  $ 10,180     $ 687     $ 595     $ 8,898  

The fair values of Company-owned life insurance (“COLI”) and COLI deferred compensation assets are based on quotes for like instruments with similar credit ratings and terms.  The fair values of other deferred compensation assets and liabilities are based on quoted prices in active markets.  The fair values of interest rate derivatives are based on quoted market prices from various banks for similar instruments.  The fair value of the earnout is based on unobservable inputs and is classified as Level 3.  Significant inputs and assumptions are management’s estimate of the probability of the earnout ultimately being met/paid and the discount rate used to present value the liability.  The fair value of the holdbacks and the obligation related to a non-competition agreement are also based on unobservable inputs and are classified as Level 3.  Significant inputs and assumptions for both the obligation related to the non-competition agreement and the holdbacks is management’s estimate of the discount rate used to present value the liabilities.  Significant changes in any Level 3 input or assumption in isolation would result in increases or decreases to the fair value measurements for the holdbacks, the earnout and the non-competition agreement.
 
Changes in the fair value of the Level 3 liabilities during the six months ended June 30, 2012 were as follows:

         
Non-competition
         
 
Earnout
 
Hold-back
 
Agreement
 
Hold-back
     
 
Summit
 
Tecniquimia
 
Obligation
 
GW Smith
 
Total
 
Balance at December 31, 2011
$ 5,444   $ 1,877   $ 675   $ 902   $ 8,898  
Interest accretion
  395     123     25     65     608  
Balance at June 30, 2012
$ 5,839   $ 2,000   $ 700   $ 967   $ 9,506  

Quantitative information about the Company’s Level 3 fair value measurements at June 30, 2012 were as follows:

   
Fair value at June 30, 2012
 
Valuation technique
 
Unobservable input
 
Input value
 
Summit earnout
 
 5,839
 
Discounted cash flow
 
Discount rate
 
14.5%
 
Tecniquimia hold-back
 
 2,000
 
Discounted cash flow
 
Discount rate
 
14.0%
 
Non-competition agreement obligation
 
 700
 
Discounted cash flow
 
Discount rate
 
14.0%
 
G.W. Smith hold-back
 
 967
 
Discounted cash flow
 
Discount rate
 
15.0%
 

The fair value of the Summit earnout is based on the weighted average probability of the outcome of different payout scenarios.  As of June 30, 2012, the probabilities applied to the payout scenarios ranged from 15% to 50%, depending on the Company’s estimate of the likelihood of each payout scenario.

Note 5 – Hedging Activities
 
The Company is exposed to the impact of changes in interest rates, foreign currency fluctuations, changes in commodity prices and credit risk.  The Company does not use derivative instruments to mitigate the risks associated with foreign currency fluctuations, changes in commodity prices or credit risk.  Quaker uses interest rate swaps to mitigate the impact of changes in interest rates.  The swaps convert a portion of the Company’s variable interest rate debt to fixed interest rate debt and are designated as cash flow hedges and reported on the balance sheet at fair value.  The effective portions of the hedges are reported in Other Comprehensive Income (“OCI”) until reclassified to earnings during the same period the hedged item affects earnings.  The Company has no derivatives designated as fair value hedges and only has derivatives designated as hedging instruments under the FASB’s guidance.  The notional amount of the Company’s interest rate swaps was $15,000 as of June 30, 2012 and December 31, 2011.
 
 
10

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

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

   
Fair Value
 
   
June 30,
 
December 31,
 
 
Balance Sheet Location
2012
 
2011
 
Derivatives designated as cash flow hedges:
         
Interest rate swaps
Other current liabilities
$ 112   $ 418  
    $ 112   $ 418  

Cash Flow Hedges
 
Interest Rate Swaps
 
                   
   
Three Months Ended
 
Six Months Ended
 
   
June 30,
 
June 30,
 
   
2012
 
2011
 
2012
 
2011
 
Amount of Gain Recognized in Accumulated OCI on Derivative
                 
(Effective Portion)
  $ 103   $ 78   $ 199   $ 174  
                           
Amount and Location of Gain Reclassified from Accumulated OCI into
                         
Income (Effective Portion)
Interest Expense
$ (160 ) $ (165 ) $ (318 ) $ (328 )
                           
Amount and Location of Gain Recognized in Income on Derivative
                         
(Ineffective Portion and Amount Excluded from Effectiveness Testing)
Other Income
$   $   $   $  

Note 6 – Stock-Based Compensation
 
The Company recognized share-based compensation expense in selling, general and administrative expenses in its Condensed Consolidated Statement of Income as follows:
 

   
For the Six Months Ended June 30,
 
   
2012
   
2011
 
Stock options
  $ 263     $ 228  
Nonvested stock awards and restricted stock units
    732       671  
Employee stock purchase plan
    23       23  
Non-elective and elective 401(k) matching contribution in stock
    1,030       902  
Director stock ownership plan
    30       30  
Total share-based compensation expense
  $ 2,078     $ 1,854  

Based on historical experience, the Company has assumed a forfeiture rate of 13% on the nonvested stock. 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.
 
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 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 not to exceed seven years from the date of grant.  Common stock awards 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.
 

 
11

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


As of June 30, 2012 and June 30, 2011, the Company recorded $1,420 and $162, respectively, of excess tax benefits in capital in excess of par value on its Condensed Consolidated Balance Sheets, related to stock option exercises. The Company’s estimated taxes payable was sufficient to fully recognize these benefits as cash inflows from financing activities in its Condensed Consolidated Statement of Cash Flows, which represented the Company’s estimate of cash savings through June 30, 2012 and June 30, 2011, respectively.
 
Stock option activity under all plans is as follows:

           
Weighted
           
Average
     
Weighted Average
Remaining
 
Number of
 
Exercise Price per
Contractual
 
Shares
 
Share
Term (years)
Balance at December 31, 2011
253,342
 
$
16.43
   
Options granted
40,157
   
38.57
   
Options exercised
(77,176)
   
9.62
   
Options forfeited
(8,470)
   
29.32
   
Balance at June 30, 2012
207,853
 
$
22.72
 
4.5
Exercisable at June 30, 2012
117,758
 
$
15.85
 
3.5

As of June 30, 2012, the total intrinsic value of options outstanding was approximately $4,761, and the total intrinsic value of exercisable options was $3,505.  Intrinsic value is calculated as the difference between the current market price of the underlying security and the strike price of a related option.
 
A summary of the Company’s outstanding stock options at June 30, 2012 is as follows: 

             
Weighted
 
Weighted
 
Number
 
Weighted
         
Number
 
Average
 
Average
 
Exercisable
 
Average
Range of
Outstanding
 
Contractual
 
Exercise
 
at
 
Exercise
Exercise Prices
at 6/30/2012
 
Life
 
Price
 
6/30/2012
 
Price
$
4.62
-
$
9.24
47,325
 
2.6
 
$
6.93
 
47,325
 
$
6.93
$
9.25
-
$
18.48
 
   
 
   
$
18.49
-
$
23.11
89,216
 
4.1
   
18.86
 
59,150
   
18.88
$
23.12
-
$
36.97
 
   
 
   
$
36.98
-
$
41.59
69,120
 
6.1
   
37.76
 
11,283
   
37.37
$
41.60
-
$
46.21
2,192
 
7.0
   
46.21
 
   
         
207,853
 
4.5
   
22.72
 
117,758
   
15.85

As of June 30, 2012, unrecognized compensation expense related to options granted during 2010 was $112, for options granted during 2011 was $263 and for options granted in 2012 was $568.
 
During the first quarter of 2012, the Company granted  37,965 stock options under the Company’s LTIP plan that are subject only to time vesting over a three-year period.  For the purposes of determining the fair value of stock option awards, the Company uses the Black-Scholes option pricing model and the assumptions set forth in the table below:

 
March, 31,
 
 
2012
 
Dividend Yield
3.09
%
Expected Volatility
69.90
%
Risk-free interest rate
0.61
%
Expected term (years)
4.0
 

Approximately $62 of expense was recorded on these options during the first six months of 2012.  The fair value of these awards is amortized on a straight-line basis over the vesting period of the awards.


 
12

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


In connection with a transition of key employees in the Company during the second quarter of 2012,  2,192 stock options were granted under the Company’s LTIP plan and will be subject only to time vesting over a three-year period. The following assumptions were made as set forth in the table below:

 
June 30,
 
 
2012
 
Dividend Yield
2.69
%
Expected Volatility
69.09
%
Risk-free interest rate
0.58
%
Expected term (years)
4.0
 

During the six months ended June 30, 2012, the Company did not record any expense on these options due to the timing of the issuance coinciding with the date of the financial statements.  The fair value of these awards will be amortized on a straight-line basis over the vesting period of the awards.

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

           
     
Weighted
 
     
Average Grant
 
 
Number of
 
Date Fair Value
 
 
Shares
 
(per share)
 
Nonvested awards, December 31, 2011
169,863
 
$
20.66
 
Granted
42,754
 
$
39.43
 
Vested
(79,519)
 
$
12.33
 
Forfeited
(5,104)
 
$
28.32
 
Nonvested awards, June 30, 2012
127,994
 
$
31.79
 

The fair value of the nonvested stock is based on the trading price of the Company’s common stock on the date of grant. The Company adjusts the grant date fair value for expected forfeitures based on historical experience for similar awards.  As of June 30, 2012, unrecognized compensation expense related to these awards was $2,469 to be recognized over a weighted average remaining period of 2.08 years.
 
In 2012, the Company granted restricted stock units under the Company’s LTIP plan.  Activity of restricted stock units granted is shown below:
 

           
     
Weighted
 
     
Average Grant
 
 
Number of
 
Date Fair Value
 
 
units
 
(per unit)
 
Nonvested awards, December 31, 2011
 
$
 
Granted
2,100
 
$
38.13
 
Vested
 
$
 
Forfeited
 
$
 
Nonvested awards, June 30, 2012
2,100
 
$
38.13
 

The fair value of the nonvested restricted stock units is based on the trading price of the Company’s common stock on the date of grant. The Company adjusts the fair value for expected forfeitures based on historical experience for similar awards. As of June 30, 2012, unrecognized compensation expense related to these awards was $62 to be recognized over a weighted average remaining period of 2.75 years.


 
13

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


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

     
Weighted
 
     
Average Grant
 
 
Number of
 
Date Fair Value
 
 
Shares
 
(per share)
 
Nonvested awards, December 31, 2011
62,250
 
$
7.72
 
Granted
 
$
 
Vested
(59,850)
 
$
7.72
 
Forfeited
(2,400)
 
$
7.72
 
Nonvested awards, June 30, 2012
 
$
 

As of June 30, 2012, these shares were fully vested and all related compensation expense was recognized.
 
Employee Stock Purchase Plan
 
In 2000, the Board adopted an Employee Stock Purchase Plan (“ESPP”) whereby employees may purchase Company stock through a payroll deduction plan. Purchases are made from the plan and credited to each participant’s account at the end of each month, the “Investment Date.” The purchase price of the stock is 85% of the fair market value on the Investment Date. The plan is compensatory and the 15% discount is expensed on the Investment Date. All employees, including officers, are eligible to participate in this plan. A participant may withdraw all uninvested payment balances credited to a participant’s account at any time. An employee whose stock ownership of the Company exceeds five percent of the outstanding common stock is not eligible to participate in this plan.
 
2003 Director Stock Ownership Plan
 
In March 2003, the Company’s Board of Directors approved a stock ownership plan for each member of the Company’s Board to encourage the Directors to increase their investment in the Company. The Plan was effective on the date it was approved and remains in effect for a term of ten years or until it is earlier terminated by the Board. The maximum number of shares of Common Stock which may be issued under the Plan is 75,000, subject to certain conditions that the Compensation/Management Development Committee (the “Committee”) may elect to adjust the number of shares. As of June 30, 2012, the Committee has not made any elections to adjust the shares under this plan. Each Director is eligible to receive an annual retainer for services rendered as a member of the Board of Directors. Currently, each Director who owns less than 7,500 shares of Company Common Stock is required to receive 75% of the annual retainer in Common Stock and 25% of the annual retainer in cash. Each Director who owns 7,500 or more shares of Company Common Stock may elect to receive payment of a percentage (up to 100%) of the annual retainer in shares of common stock. Currently, the annual retainer is $40.  The number of shares issued in payment of the fees is calculated based on an amount equal to the average of the closing prices per share of Common Stock as reported on the composite tape of the New York Stock Exchange for the two trading days immediately preceding the retainer payment date. The retainer payment date is June 1.


 
14

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


Note 7 – 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.
 
The following table summarizes EPS calculations:

   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
2012
   
2011
   
2012
   
2011
 
Basic earnings per common share
                       
Net income attributable to Quaker Chemical Corporation
  $ 10,540     $ 9,841     $ 22,486     $ 20,441  
Less: income allocated to participating securities
    (101 )     (182 )     (289 )     (384 )
Net income available to common shareholders
  $ 10,439     $ 9,659     $ 22,197     $ 20,057  
Basic weighted average common shares outstanding
    12,850,917       12,043,858       12,790,799       11,668,657  
Basic earnings per common share
  $ 0.81     $ 0.80     $ 1.74     $ 1.72  
                                 
Diluted earnings per common share
                               
Net income attributable to Quaker Chemical Corporation
  $ 10,540     $ 9,841     $ 22,486     $ 20,441  
Less: income allocated to participating securities
    (100 )     (180 )     (288 )     (380 )
Net income available to common shareholders
  $ 10,440     $ 9,661     $ 22,198     $ 20,061  
Basic weighted average common shares outstanding
    12,850,917       12,043,858       12,790,799       11,668,657  
Effect of dilutive securities, employee stock options
    80,913       174,919       88,838       175,905  
Diluted weighted average common shares outstanding
    12,931,830       12,218,777       12,879,637       11,844,562  
Diluted earnings per common share
  $ 0.81     $ 0.79     $ 1.72     $ 1.69  

The following number of stock options are not included in diluted earnings per share since the effect would have been anti-dilutive: 9,917 and 8,209 for the three months ended June 30, 2012 and June 30, 2011, and 7,859 and 10,208 for the six months ended June 30, 2012 and June 30, 2011, respectively.

Note 8 – Business Segments
 
The Company organizes its segments by type of product sold.  The Company’s reportable segments are as follows:
 
 
Metalworking process chemicals—industrial process fluids for various heavy industrial and manufacturing applications.
     
 
Coatings—temporary and permanent coatings for metal and concrete products and chemical milling maskants.
     
 
Other chemical products—other various chemical products.

Segment data includes direct segment costs as well as general operating costs.  Any inter-segment transactions are immaterial for each period presented.


 
15

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


The table below presents information about the Company’s reported segments:

   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
2012
   
2011
   
2012
   
2011
 
Metalworking Process Chemicals
                       
Net sales
  $ 165,011     $ 156,772     $ 330,986     $ 307,505  
Operating income for reportable segments
    30,649       26,149       61,624       53,084  
Coatings
                               
Net sales
    10,950       10,487       21,473       18,969  
Operating income for reportable segments
    2,799       2,446       5,312       4,409  
Other Chemical Products
                               
Net sales
    836       533       1,976       1,183  
Operating income for reportable segments
    53       4       195       39  
Total
                               
Net sales
    176,797       167,792       354,435       327,657  
Operating income for reportable segments
    33,501       28,599       67,131       57,532  
Non-operating expenses
    (15,799 )     (13,171 )     (31,981 )     (27,518 )
Amortization
    (719 )     (487 )     (1,465 )     (973 )
Consolidated operating income
    16,983       14,941       33,685       29,041  
Interest expense
    (1,151 )     (1,200 )     (2,325 )     (2,418 )
Interest income
    137       271       260       543  
Other (expense) income, net
    (134 )     791       207       1,330  
Consolidated income before taxes and equity in net income of associated companies
  $ 15,835     $ 14,803     $ 31,827     $ 28,496  

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


 
16

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


Note 9 – Equity and Noncontrolling Interest
 
The following table presents the changes in equity and noncontrolling interest for the three and six months ended June 30, 2012 and June 30, 2011:
 

 
 
 
   
 
   
 
   
Accumulated
   
 
   
 
 
 
 
 
   
Capital in
   
 
   
Other
   
 
   
 
 
 
 
Common
   
Excess of
   
Retained
   
Comprehensive
   
Noncontrolling
   
 
 
 
 
Stock
   
Par Value
   
Earnings
   
Loss
   
Interest
   
Total
 
Balance at March 31, 2012
  $ 12,951     $ 90,836     $ 184,764     $ (25,902 )   $ 8,015     $ 270,664  
Net income
                10,540             630       11,170  
Currency translation adjustments
                      (6,786 )     (425 )     (7,211 )
Defined benefit retirement plans
                      499             499  
Current period changes in fair value of derivatives
                      103             103  
Unrealized gain on available-for-sale securities
                      (5 )           (5 )
Dividends ($0.245 per share)
                (3,188 )                 (3,188 )
Dvidends paid to noncontrolling shareholders
                            (30 )     (30 )
Share issuance and equity-based compensation plans
    60       1,195                         1,255  
Excess tax benefit from stock option exercises
          168                         168  
Balance at June 30, 2012
  $ 13,011     $ 92,199     $ 192,116     $ (32,091 )   $ 8,190     $ 273,425  
 
                                               
Balance at March 31, 2011
  $ 11,531     $ 39,132     $ 152,237     $ (9,497 )   $ 7,359     $ 200,762  
Net income
                9,841             714       10,555  
Currency translation adjustments
                      3,587       69       3,656  
Defined benefit retirement plans
                      325             325  
Current period changes in fair value of derivatives
                      78             78  
Dividends ($0.24 per share)
                (3,080 )                 (3,080 )
Stock offering, net of related expenses
    1,265       46,878                         48,143  
Share issuance and equity-based compensation plans
    27       1,155                         1,182  
Excess tax benefit from stock option exercises
          84                         84  
Balance at June 30, 2011
  $ 12,823     $ 87,249     $ 158,998     $ (5,507 )   $ 8,142     $ 261,705  


 
17

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



 
 
 
   
 
   
 
   
Accumulated
   
 
   
 
 
 
 
 
   
Capital in
   
 
   
Other
   
 
   
 
 
 
 
Common
   
Excess of
   
Retained
   
Comprehensive
   
Noncontrolling
   
 
 
 
 
Stock
   
Par Value
   
Earnings
   
Loss
   
Interest
   
Total
 
Balance at December 31, 2011
  $ 12,912     $ 89,725     $ 175,932     $ (29,820 )   $ 6,977     $ 255,726  
Net income
                22,486             1,377       23,863  
Currency translation adjustments
                      (3,442 )     (134 )     (3,576 )
Defined benefit retirement plans
                      969             969  
Current period changes in fair value of derivatives
                      199             199  
Unrealized gain on available-for-sale securities
                      3             3  
Dividends ($0.485 per share)
                (6,302 )                 (6,302 )
Dividends paid to noncontrolling interests
                            (30 )     (30 )
Share issuance and equity-based compensation plans
    99       1,054                         1,153  
Excess tax benefit from stock option exercises
          1,420                         1,420  
Balance at June 30, 2012
  $ 13,011     $ 92,199     $ 192,116     $ (32,091 )   $ 8,190     $ 273,425  
 
                                               
Balance at December 31, 2010
  $ 11,492     $ 38,275     $ 144,347     $ (13,736 )   $ 6,721     $ 187,099  
Net income
                20,441             1,344       21,785  
Currency translation adjustments
                      7,400       77       7,477  
Defined benefit retirement plans
                      649             649  
Current period changes in fair value of derivatives
                      174             174  
Unrealized loss on available-for-sale securities
                      6             6  
Dividends ($0.475 per share)
                (5,790 )                 (5,790 )
Stock offering, net of related expenses
    1,265       46,878                         48,143  
Share issuance and equity-based compensation plans
    66       1,934                         2,000  
Excess tax benefit from stock option exercises
          162                         162  
Balance at June 30, 2011
  $ 12,823     $ 87,249     $ 158,998     $ (5,507 )   $ 8,142     $ 261,705  

The items in Accumulated Other Comprehensive Loss are net of tax benefits of $247 and $168 for defined benefit retirement plans and $55 and $42 for current period changes in fair value for derivatives for the three months ended June 30, 2012 and June 30, 2011, respectively.  The items in Accumulated Other Comprehensive Loss are net of tax benefits of $527 and $335 for defined benefit retirement plans and $107 and $93 for current period changes in fair value for derivatives for the six months ended June 30, 2012 and June 30, 2011, respectively.
 
The Company sold 1,265,000 shares of its common stock during the second quarter of 2011.  The Company received proceeds of $48,143, net of related offering expenses, commissions and underwriting fees.  The Company used the proceeds to repay a portion of its revolving credit line during the second quarter of 2011.

 
18

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



Note 10 – Business Acquisitions
 
In October 2011, the Company acquired G.W. Smith & Sons, Inc. for approximately $14,518. G.W Smith manufactures and distributes high quality die casting lubricants, and also distributes metalworking fluids.  The Company allocated $6,260 of intangible assets, comprising trade names and formulations, to be amortized over 15 years; a trademark to be amortized over 5 years; a non-competition agreement to be amortized over 5 years; and customer lists to be amortized over 16 years.  In addition, the Company recorded $1,120 of goodwill, all of which will be tax deductible and was assigned to the metalworking process chemical segment.   Liabilities assumed include a hold-back of consideration to be paid to the former shareholder at one year from the acquisition date, absent the occurrence of unforeseen obligations.
 
In July 2011, the Company acquired the remaining 60% ownership interest in Tecniquimia Mexicana, S.A. de C.V., the Company’s Mexican equity affiliate, for approximately $10,500.  The acquisition strengthened the Company’s position in the growing Mexican market. The Company allocated $3,556 of intangible assets, comprising trade names and trademarks, to be amortized over 5 years; and customer lists, to be amortized over 20 years.  In addition, the Company recorded $6,773 of goodwill, none of which will be tax deductible, and was assigned to the metalworking process chemicals segment.  Liabilities assumed include a hold-back of consideration to be paid to the former shareholders at one year from the purchase date, absent the occurrence of unforeseen obligations.  Subsequent to June 30, 2012, the Company paid the $2,000 hold-back consideration to the former shareholders.
 
In December 2010, the Company completed the acquisition of Summit Lubricants, Inc., which manufactures and distributes specialty greases and lubricants, for approximately $29,116, which was subject to certain post closing adjustments.  During 2011, the Company paid an additional $717 to finalize the post closing adjustments and recorded non-cash adjustments to fixed assets and goodwill to finalize its valuation of the assets acquired and liabilities assumed at the acquisition date. The Company allocated $17,100 to intangible assets, comprising formulations, to be amortized over 15 years; customer lists, to be amortized over 20 years; a non-competition agreement, to be amortized over 5 years; and a trademark, which was assigned an indefinite life.  In addition, the Company recorded $3,423 of goodwill, all of which will be tax deductible, and was assigned to the metalworking process chemicals segment.  Liabilities assumed include an earnout to be paid to the former shareholders if certain earnings targets are met by the end of 2013.
 
The following table shows the allocation of the purchase price of the assets and liabilities acquired during 2011.  The pro forma results of operations have not been provided because the effects were not material:

 
 
Quaker
   
GW Smith
 
2011 Acquisitions
 
Tecniquimia
   
& Sons, Inc.
 
Current assets
  $ 8,946     $ 6,138  
Fixed assets
    4,308       2,869  
Intangibles
    3,556       6,260  
Goodwill
    6,773       1,120  
Other long-term assets
    1,355       1  
Total assets purchased
    24,938       16,388  
Current liabilities
    (2,224 )     (1,001 )
Long-term liabilities
    (6,869 )      
Present value of hold-back
    (1,754 )     (869 )
Total liabilities assumed
    (10,847 )     (1,870 )
Additional minimum pension liability
    987        
Total equity assumed
    987        
Fair value of previously held equity interest
    (4,578 )      
         Cash paid for acquisitions
  $ 10,500     $ 14,518  

Included in the 2011 acquisitions of Quaker Tecniquimia and G.W. Smith & Sons, Inc. was approximately $258 of cash acquired.
 
Subsequent to June 30, 2012, the Company acquired NP Coil Dexter Industries, S.r.l., a European manufacturer and supplier of metal surface treatment products.  The acquired business has annual net sales of approximately $11.0 million.  Certain pro forma and other disclosures have not been provided as of June 30, 2012, because the effects were not material.
 


 
19

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