Quaker Chemical Corporation

Notes to Condensed Consolidated Financial Statements—(Continued)

(Dollars in thousands, except per share amounts)

(Unaudited)

The Company recognized approximately $601$262 of share–basedshare-based compensation expense and $210$92 of related tax benefits in our unaudited condensed consolidated statement of operations for the ninethree months ended September 30, 2006.March 31, 2007. The compensation expense was comprised of $156$95 related to stock options, $327$126 related to nonvested stock awards, $24$10 related to the Company’s Employee Stock Purchase Plan, and $94$31 related to the Company’s Director Stock Ownership Plan.

Approximately $73$41 of the amount of compensation cost recognized in the first quarter of 2006 for stock option awards reflects amortization relating to the remaining unvested portion of stock option awards granted prior to January 1, 2006. The estimated fair value of the options granted during prior years was calculated using a Black-Scholes model. The Black-Scholes model incorporates assumptions to value stock-based awards. The Company will continue to use the Black-Scholes option pricing model to value share-based awards. The estimated fair value of the Company’s share-based awards is amortized on a straight–line basis over the awards’ vesting period.period of the awards. The risk-free rate of interest for periods within the contractual life of the option is based on U.S. Government Securities Treasury Constant Maturities over the contractual term of the equity instrument. Expected volatility is based on the historical volatility of the Company’s stock. The Company uses historical data on exercise timing to determine the expected life assumption. The assumptions used for stock option grants made in the first quarter of 2005 include the following: dividend yield of 3.4%, expected volatility of 22.6%, risk-free interest rate of 3.9%, an expected life of 5 years, and a forefeitureforfeiture rate of 8% over the remaining life of these options.

Based on our historical experience, we have assumed a forfeiture rate of 13% on the nonvested stock. Under the true-up provisions of SFAS 123R, we will record additional expense if the actual forfeiture rate is lower than we estimated, and we will record a recovery of prior expense if the actual forfeiture is higher than we estimated.

The adoption of SFAS 123R had an impact of $66 and $156$41 due to the accrual of compensation expense on the unvested stock options for the three and nine months ended September 30,March 31, 2006.

No compensation expense related to stock option grants had been recorded in the unaudited condensed consolidated statement of operations for the three and nine months ended September 30, 2005, as all of the options granted had an exercise price equal to the market value of the underlying stock on the date of grant. Accordingly, results for prior periods have not been restated.

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 arebecome 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 for options issued in 1999 or later and ten years for options issued in prior years. Beginning in 1999, the LTIP program provided for common stock awards, the value of which was generally determined based on Company performance over a two to five-year period. Common stock awards issued in 2006 and 2007 under the LTIP program are subject only to time vesting over a two 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.

Stock option activity under all plans during the nine months ended September 30, 2006 is as follows:

The total intrinsic value of options exercised during 20062007 was approximately $884.$514. Intrinsic value is calculated as the difference between the current market price of the underlying security and the strike price of a related option. As of September 30, 2006,March 31, 2007, the total intrinsic value of options outstanding was approximately $731,$3,152, and the total intrinsic value of exercisable options was approximately $731.$2,731.

Quaker Chemical Corporation

Notes to Condensed Consolidated Financial Statements—(Continued)

(Dollars in thousands, except per share amounts)

(Unaudited)

A summary of the Company’s outstanding stock options at September 30, 2006March 31, 2007 is as follows:

As of September 30, 2006, unrecognized compensation expense related to nonvested stock options awarded prior to the adoption of SFAS 123R was $18 to be recognized over the remainder of 2006. As of September 30, 2006,March 31, 2007, unrecognized compensation expense related to options granted during 2006 was $481.$342, and for options granted during 2007 was $697.

During the secondfirst quarter of 2006,2007, the Company granted 120,600166,065 stock options under the Company’s LTIP plan that are subject only to time vesting over a 3-yearthree-year period. The options were valued using the Black-Scholes model with the following assumptions: dividend yield of 4.1%4.4%, expected volatility of 27.1%27.0%, risk free interest rate of 5.0%4.7%, an expected term of 6 years, and a forfeiture rate of 3% over the remaining life of the options. Approximately $83$20 of expense was recorded on these options during 2006.2007. The fair value of these awards is amortized on a straight-line basis over the awards vesting period.period of the awards.

Under the Company’s LTIP plan, 29,65049,550 shares of nonvested stock were granted duringoutstanding at December 31, 2006. In the first quarter of 2006 at a weighted average grant date fair value of $19.99 per share. In the second quarter of 2006, an additional 19,9002007, 38,240 shares of nonvested stock were granted at a weighted average grant date fair value of $17.01 per share.$23.13. None of these awards were vested or were forfeited and were all outstanding as of September 30, 2006.March 31, 2007. 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 September 30, 2006,March 31, 2007, unrecognized compensation expense related to these awards was $731,$1,203, to be recognized over a weighted average remaining period of 1.92.6 years.

Under the Company’s GAIP plan, 42,500 shares of nonvested stock were granted during the second quarter of 2005 at a weighted average grant date fair value of $20.12 per share. ThereAt December 31, 2006, 40,250 shares were no new grants under this plan during the first nine months of 2006. None of these awardsoutstanding. Through March 31, 2007, 12,750 shares vested 2,250and were issued, no shares were forfeited and 40,25027,500 shares were outstanding as of September 30, 2006.outstanding. As of September 30, 2006,March 31, 2007, unrecognized compensation expense related to these awards was $399,$252, to be recognized over a weighted average remaining period of 1.41.9 years.

Employee Stock Purchase Plan

In 2000, the Board adopted an Employee Stock Purchase Plan (“ESPP”) whereby employees may purchase Company stock through a payroll deduction plan. Purchases are made from the plan and credited to each participant’s account at the end of each month, the “Investment Date.” The purchase price of the stock is 85% of the fair market value on the Investment Date. The plan is compensatory and the 15% discount is expensed on the Investment Date. All employees, including officers, are eligible to participate in this plan. A participant may withdraw all uninvested payment balances credited to a participant’s account at any time by giving written notice to the Committee. 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, our boardBoard of directorsDirectors approved a stock ownership plan for each member of our board of directorsBoard to encourage the directorsDirectors 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 committee may elect to adjust the number of

Quaker Chemical Corporation

Notes to Condensed Consolidated Financial Statements—(Continued)

(Dollars in thousands, except per share amounts)

(Unaudited)

shares. As of September 30, 2006,March 31, 2007, the committeeCommittee 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 boardBoard of directors. As of May 1, 2006,Directors. Currently, each Director who ownedowns less than 7,500 shares of Company Common Stock wasis required to receive 75% of the annual retainer in Common Stock and 25% of the annual retainer in cash. EachEffective as of the 2007 Annual Meeting, each Director who ownedowns 7,500 or more shares of Company Common Stock receives 35%will receive 20% of the annual retainer in Common Stock and 65%80% of the annual retainer in cash with the option to receive Common Stock in lieu of the cash portion of the retainer. AsEffective as of May 1, 2006,the 2007 Annual Meeting, the annual retainer was $24.will be $28. 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 byon 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. For the three and nine months ending September 30,ended March 31, 2007 and 2006, the Company recorded approximately $32$31 and $94,$29, respectively. For the three and nine months ending September 30, 2005, the Company recorded approximately $29 and $86, respectively.

Quaker Chemical Corporation

Notes to Condensed Consolidated Financial Statements—(Continued)

(Dollars in thousands, except per share amounts)

(Unaudited)

Note 45 – Earnings Per Share

The following table summarizes earnings per share (EPS) calculations:

The following number of stock options are not included in the earnings per share since in each case the exercise price is greater than the market price: 787,520321,790 and 840,810666,920 for the three months ended September 30,March 31, 2007 and 2006, and 2005, and 787,520 and 840,560 for the nine months ended September 30, 2006 and 2005, respectively.

Note 56 – Business Segments

The Company’s reportable segments are as follows:

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

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

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

Segment data includes direct segment costs as well as general operating costs.

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 reported segments:

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 associates.affiliates.

Quaker Chemical Corporation

Notes to Condensed Consolidated Financial Statements—(Continued)

(Dollars in thousands, except per share amounts)

(Unaudited)

Note 67 – Comprehensive Income

The following table summarizes comprehensive income:

Quaker Chemical Corporation

Notes to Condensed Consolidated Financial Statements—(Continued)

(Dollars in thousands, except per share amounts)

(Unaudited)

Note 78 – Restructuring and Related Activities

In 2001, Quaker’s management approved restructuring plans to realign the organization primarily in Europe and reduce operating costs (2001 program). Included in the restructuring charges were provisions for severance of 53 employees. The charge comprised $2,807 related to employee separations, $2,450 related to facility rationalization charges, and $597 related to abandoned acquisitions. In January of 2005, the last severance payment under the 2001 program was made and the Company reversed $117 of unused restructuring accruals related to this program. In 2005, the Company completed the sale of its Villeneuve, France site for $1,907, which completed all actions contemplated by this program. The Company reversed $159 of unused restructuring accruals related to this program in the fourth quarter of 2005.

In 2003, Quaker’s management approved a restructuring plan (2003 program). Included in the 2003 restructuring charge were provisions for severance for 9 employees totaling $273. As of March 31, 2005, all severance payments were completed and the Company reversed $59 of unused restructuring accruals related to this program, which completed all actions contemplated by this program.

In the first quarter of 2005, Quaker’s management approved a restructuring plan (2005 1^st Quarter Program). Included in the first quarter 2005 restructuring charge were provisions for severance for 16 employees totaling $1,408. At December 31, 2005, all severance payments were completed. The Company reversed $96 of unused restructuring charges related to this program in the fourth quarter of 2005, which completed all actions contemplated by this program.

In the fourth quarter of 2005, Quaker’s management approved a restructuring plan (2005 4^th Quarter Program) with the goal of significantly reducing operating costs in the U.S. and Europe. The restructuring plan included involuntary terminations, a freeze of the Company’s U.S. pension plan, a voluntary early retirement window to certain employees, with enhanced pension and other postretirement benefits. Included in the restructuring charges were provisions for severance (voluntary and involuntary) of 55 employees. Restructuring and related charges of $9,344 were recognized in the fourth quarter of 2005. The charge comprised $4,024 related to severance for involuntary terminations, $1,017 related to one-time payments for voluntary early retirement, and $2,668 related to the U.S. pension plan freeze and $1,635 for the enhanced pension and other postretirement benefits related to voluntary early retirement participants. The Company expects to complete the initiatives contemplated under this program during 2006.

Accrued restructuring balances, included in other current liabilities and assigned to the Metalworking segment, are as follows:

Note 8—Business Acquisitions and Divestitures

In March 2005, the Company acquired the remaining 40% interest in its Brazilian joint venture for $6,700. In addition, annual $1,000 payments for four years will be paid subject to the former minority partners’ compliance with the terms of the purchase agreement. The firstsecond $1,000 payment was made in March 2006February 2007 and was recorded as goodwill assigned to the Metalworking Process Chemicals Segment.segment.

Quaker Chemical Corporation

Notes to Condensed Consolidated Financial Statements—(Continued)

(Dollars in thousands, except per share amounts)

(Unaudited)

Note 9 – Goodwill and Other Intangible Assets

The Company completed its annual impairment assessment as of the end of the third quarter 2006 and no impairment charge was warranted. The changes in carrying amount of goodwill for the ninethree months ended September 30, 2006March 31, 2007 are as follows:

Gross carrying amounts and accumulated amortization for definite-lived intangible assets as of September 30, 2006March 31, 2007 and December 31, 20052006 are as follows:

The Company recorded $1,058$339 and $1,014$351 of amortization expense in the first ninethree months of 20062007 and 2005,2006, respectively. Estimated annual aggregate amortization expense for the current year and subsequent five years is as follows:

The Company has one indefinite-lived intangible asset of $600 for trademarks recorded in connection with the Company’s 2002 acquisition of Epmar.

Quaker Chemical Corporation

Notes to Condensed Consolidated Financial Statements—(Continued)

(Dollars in thousands, except per share amounts)

(Unaudited)

Note 10 – Pension and Other Postretirement Benefits

The components of net periodic benefit cost for the three and nine months ended September 30, are as follows:

Employer Contributions:

The Company previously disclosed in its financial statements for the year ended December 31, 2005,2006, that it expected to make minimum cash contributions of $8,024$6,883 to its pension plans and $1,124$1,100 to its other postretirement benefit plan in 2006.2007. As of September 30, 2006, $5,902March 31, 2007, $1,865 and $756$275 of contributions have been made, respectively.

In accordance with local legislation, effective January 1, 2006, one of the Company’s European pension plans was partially curtailed to eliminate the supplemental early retirement payments for certain individuals. A curtailment gain of $942 was recognized in the first quarter of 2006.

Note 11 – Commitments and Contingencies

The Company is involved in environmental clean-up activities and litigation in connection with an existing plant location and former waste disposal sites operated by unaffiliated third parties. In April of 1992, the Company identified certain soil and groundwater contamination at AC Products, Inc. (“ACP”), a wholly owned subsidiary. Voluntarily in coordination with the Santa Ana California Regional Water Quality Board, ACP is remediating the contamination. The Company believes that the remaining potential-known liabilities associated with these matters range from approximately $1,300$1,600 to $1,500,$1,900, 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.

On or about December 18, 2004, the Orange County Water District (“OCWD”) filed a civil complaint in Superior Court, in Orange County, California against ACP and other parties potentially responsible for groundwater contamination containing tetrachloroethylene and other compounds, including perchloroethylene (“PCE”). OCWD is seeking to recover compensatory and other damages related to the investigation and remediation of the contamination in the groundwater. ACP seeks to defend this case vigorously on a number of bases including, most significantly, that it voluntarily investigated and remediated some or all of the PCE that appears to have originated at this facility. In cases such as these, parties often are allocated a percentage of responsibility for damages awarded or agreed upon. At this point in the case, it is not possible to provide an estimate of the percentage of liability, if any, that ACP ultimately may bear. Accordingly, it is not possible at this time to estimate the amount, if any, that ACP ultimately may be required to pay in settlement or to satisfy any adverse judgment as a result of the filing of this action or to assess whether the payment of such amount would be material to the Company.

Additionally, although there can be no assurance regarding the outcome of other environmental matters, the Company believes that it has made adequate accruals for costs associated with other environmental problems of which it is aware. Approximately $159 and $134 was accrued at September 30, 2006March 31, 2007 and December 31, 2005,2006, respectively, to provide for such anticipated future environmental assessments and remediation costs.

Quaker Chemical Corporation

Notes to Condensed Consolidated Financial Statements—(Continued)

(Dollars in thousands except per share amounts)

(Unaudited)

An inactive subsidiary of the Company that was acquired in 1978 sold certain products containing asbestos, primarily on an installed basis, and is among the defendants in numerous lawsuits alleging injury due to exposure to asbestos. The subsidiary discontinued operations in 1991 and has no remaining assets other than its existing insurance policies andthe proceeds from an insurance settlementsettlements received in late 2005.2005 and early in the second quarter of 2007. To date, the overwhelming majority of these claims have been disposed of without payment and there have been no adverse judgments against the subsidiary. Based on a continued analysis of the existing and anticipated future claims against this subsidiary, it is currently projected that the subsidiary’s total liability over the next 50 years for these claims is approximately $10,100$12,700 (excluding costs of defense). Although the Company has also been named as a defendant in certain of these cases, no claims have been actively pursued against the Company, and the Company has not contributed to the defense or settlement of any of these cases pursued against the subsidiary. These cases have beenwere handled by the subsidiary’s primary and excess insurers who had agreed in 1997 to pay all defense costs and be responsible for all damages assessed against the subsidiary arising out of existing and future asbestos claims up to the aggregate limits of the policies. A significant portion of this primary insurance coverage was provided by an insurer that is now insolvent, and the other primary insurers have asserted that the aggregate limits of their policies have been exhausted. The subsidiary is challenginghas challenged the applicability of these limits to the claims being brought against the subsidiary. In response to this challenge, onetwo of these carriers entered into aseparate settlement and release agreements with the

Quaker Chemical Corporation

Notes to Condensed Consolidated Financial Statements—(Continued)

(Dollars in thousands, except per share amounts)

(Unaudited)

subsidiary in late 2005 and in the first quarter of 2007 for $15,000 and $20,000, respectively. The payments under the latest settlement and release agreement are structured to be received over a four-year period with annual installments of $5,000, the first of which was received early in the second quarter of 2007. The subsequent installments are contingent upon whether or not Federal asbestos legislation is adopted by the due date of each annual installment. If Federal asbestos legislation is so enacted, and such legislation eliminates the carrier’s obligation to make the installment payment and requires the carrier to contribute into a trust or similar vehicle as a result of the policies issued to the subsidiary, in late 2005 for $15,000.then the insurance carrier’s obligation to make the subsequent installments will be cancelled. The proceeds of the settlementboth settlements are restricted and can only be used to pay claims and costs of defense associated with the subsidiary’s asbestos litigation. Commencing in late 2005,With this latest settlement, the subsidiary is now paying out of these proceeds an allocated share of theall defense costs and settlements damages. The subsidiary has additional coverage underis still pursuing its excess policies.claim against the remaining primary insurer regarding the application of the policy limits. The Company also believes, however, that if the coverage issues under the primary policies with the other carriersremaining carrier are resolved adversely to the subsidiary and all settlement proceeds were used, the subsidiary may have limited additional coverage from a state guarantee fund established following the insolvency of one of the subsidiary’s insurance coverage will likely be exhausted. As a result,primary insurers. Nevertheless, liabilities in respect of claims may exceed the assets and coverage available to the subsidiary. See also Notes 16 and 17 of Notes to Consolidated Financial Statements filed with the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.2006.

If the subsidiary’s assets and insurance coverage were to be exhausted, claimants of the subsidiary may actively pursue claims against the Company because of the parent-subsidiary relationship. Although asbestos litigation is particularly difficult to predict, especially with respect to claims that are currently not being actively pursued against the Company, the Company does not believe that such claims would have merit or that the Company would be held to have liability for any unsatisfied obligations of the subsidiary as a result of such claims. After evaluating the nature of the claims filed against the subsidiary and the small number of such claims that have resulted in any payment, the potential availability of additional insurance coverage at the subsidiary level, the additional availability of the Company’s own insurance and the Company’s strong defenses to claims that it should be held responsible for the subsidiary’s obligations because of the parent-subsidiary relationship, the Company believes it is not probable that the Company will incur any material losses. All of the asbestos cases pursued against the Company challenging the parent-subsidiary relationship are in the early stages of litigation. The Company has been successful in the past having claims naming it dismissed during initial proceedings. Since the Company may be in this early stage of litigation for some time, it is not possible to estimate additional losses or range of loss, if any.

The Company is party to other litigation which management currently believes will not have a material adverse effect on the Company’s results of operations, cash flows or financial condition.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Executive Summary

Quaker Chemical Corporation is a worldwide developer, producer, and marketer of chemical specialty products and a provider of chemical management services (“CMS”) for various heavy industrial and manufacturing applications around the globe, with significant sales to the steel and automotive industries. The primary contributors toimproved first quarter 2007 results largely reflect the continued execution of the Company’s third quarter 2006 earnings result were a 10%strategy for growth and tactical actions taken over the past two years in revenues and improved performance from CMS.response to its challenging business environment.

The revenue growth in the thirdfirst quarter of 20062007 was primarily due to increased selling prices, as well as higher volume in China. CMS revenues were higher due to the U.S.renewal and China.renegotiation of several of the Company’s contracts. Higher selling prices, combined with improved CMS profitability, offset higher raw material and third-party finished product costs, resulting in significantly higher gross margin dollars but with only a slightly lowersmall improvement in gross margin as a percentage of sales as compared to the thirdfirst quarter of 2005.2006. Raw material costs primarily crude oil derivatives, continuedcontinue to increase during the quarterremain higher as compared to the prior year, mitigating pricing actions intended to improve gross margins as a percentage of sales. While oil prices have recently declined from a peak earlyyear. Factors impacting significantly higher selling, general and administrative costs in the thirdfirst quarter of 2007 include continued expansion into Asia/Pacific, higher commissions and incentive compensation on improved results, and unfavorable foreign exchange rate translation. Also negatively affecting the comparison with the prior year is a pension gain of $0.9 million recorded in the first quarter of 2006 due to date, the oil price reductions have not yet resulteda legislative change.

The net result is a considerable improvement in any reduction in raw material prices. SG&A for the third quarter of 2006 increased $1.5 million as compared to the third quarter of 2005. Cost savings from restructuring efforts completed in 2005 were more than offset by increased spending in higher growth areas and higher variable compensation on increased earnings.

Earningsearnings per diluted share of $0.32$0.35 for the thirdfirst quarter of 2006 represent a considerable improvement over2007, compared to $0.26 in the $0.23 reported for the thirdfirst quarter of 2005. The Company’s restructuring efforts are positively impacting the bottom line as resources have been shifting to higher growth areas like China, CMS and coatings.2006. However, any improvementsfurther improvement in gross margin as a percentage of sales will depend in part upon a sustained period of stable or declining raw material costs. The Company remains focused on pursuing revenue opportunities, managing its raw material and other costs, and pursuing pricing initiatives.

Notwithstanding the improved quarterly performance, continued strength of the business environment in which the Company operates remains challenging.is subject to limited visibility. While demand in China is expected to continue to remain robust,strong, volume in other markets was limited by customer end marketend-market issues, including higher inventory levels in the U.S. steel industry and reduced vehicle sales experienced by some automotive customers, with indications that these conditions would continue intofor the foreseeable future. RawThe Company expects to experience higher raw material and third party product costs, continuedue to remain higher as compared to the prior year. In certain instances, the Company faces competitive or contractual constraints limiting pricing actions to recover these higher costs.raw material prices.

CMS Discussion

During 2003, the Company expanded its approach to its chemical management services (CMS) channel consistent with the Company’s strategic imperative to sell customer solutions - value - solutions—value—not just fluids. Prior to this change, the Company effectively acted as an agent whereby it purchased chemicals from other companies and resold the product to the customer at little or no margin and earned a set management fee for providing this service. Therefore, the profit earned on the management fee was relatively secure as the entire cost of the products was passed on to the customer. The approach taken in 2003 was dramatically different. The Company began entering into new contracts under which it receives a set management fee and the costs that relate to those management fees were and are largely dependent on how well the Company controls product costs and achieves product conversions from other third-party suppliers to its own products. This approach came with new risks and opportunities, as the profit earned from the management fee is subject to movements in product costs as well as the Company’s own performance. The Company believes this expanded approach is a way for Quaker to become an integral part of our customers’ operational efforts to improve manufacturing costs and to demonstrate value that the Company would not be able to demonstrate as purely a product provider.

Under this alternative pricing structure, the Company was awarded a series of multi-year CMS contracts, primarily at General Motors Powertrain, DaimlerChrysler and Ford manufacturing sites in 2003, 2004, 2005 and 2006.over the last several years. This business was an important step in building the Company’s share and leadership position in the automotive process fluids market and should positionhas positioned the Company well for penetration of CMS opportunities in other metalworking manufacturing sites. This newalternative approach had a dramatic impact on the Company’s revenue and margins. Under the traditional CMS approach, where the Company effectively acts as an agent, revenues and costs from these sales are reported on a net sales or “pass-through” basis. As discussed above, the alternative structure is different 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. As a result, the Company recognizes in the alternative structure in reported revenues 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. As some contracts have been renewed or renegotiated, some of the contracts reverted to a “pass through”“pass-through” basis, while others are renegotiated on a gross basis. Currently, the Company has a mix of contracts with both the traditional product pass throughpass-through structure and fixed priced contracts covering all services and products. The Company’s offerings will continue to include both approaches to CMS depending on customer requirements and business circumstances.

Liquidity and Capital Resources

Quaker’s cash and cash equivalents decreased to $15.8$10.8 million at September 30, 2006March 31, 2007 from $16.1 million at December 31, 2005.2006. The decrease resulted primarily from $3.4$5.0 million of cash provided byused in operating activities, $9.3$3.5 million of cash used in investing activities, offset in part by $5.0$3.2 million of cash provided by financing activities.

Net cash flows provided byused in operating activities were $3.4$5.0 million for the first ninethree months of 20062007, compared to $2.3$11.7 million of cash provided by operating activities for the first ninethree months of 2005. Higher2006. The Company’s higher net income and the effectcompletion of the gain on sale of partnership assetsall restructuring activities in the prior year2006 were the primary drivers of the increase in cash provided by operating activities over the prior year. These positives were offset in part by increased investments in working capital and significantlydecreased use of cash. In 2007, higher restructuring payments in the first nine months of 2006 as a result of the actions taken in the fourth quarter of 2005. Higher sales levels and raw material costs, as well as increased business from our CMS channel, continued to require investments in working capital in 2007 and 2006. The principal factors contributing to the startup of new CMS contractsfirst quarter $5.0 million cash used in operating activities include stronger sales later in the U.S. contributed toquarter, the increased usestart up of cash fromour new manufacturing facility in China and the Company’s working capital accounts.payment of the prior year’s incentive compensation.

Net cash flows used in investing activities were $9.3$3.5 million in the first ninethree months of 20062007, compared to $7.0$2.6 million in the same period of 2005.2006. The primary factors affecting the change inincreased use of cash flows werewas primarily due to higher capital expenditures in the current year for expansion primarily in Asia/Pacific and higher payments related to an equity acquisition in Brazil in 2005, offset in part by proceeds from the dispositionCompany’s continued expansion into China. In the first quarter of partnership real estate assets in the prior year. In March 2005,2007, the Company acquiredmade the second of four annual payments of $1.0 million related to the 2005 acquisition of the remaining 40% interest in its Brazilian joint venture for $6.7 million. In accordance with the purchase agreement, the Company made the first of four contingent annual payments of $1.0 million in the first quarter of 2006. In the first quarter of 2005, the Company received $3.0 million of proceeds in connection with the sale of real estate assets by the Company’s real estate joint venture. The Company also received $1.9 million of cash proceeds in 2005 from the sale of its Villeneuve, France site.

Net cash flows provided by financing activities were $5.0$3.2 million for the first ninethree months of 20062007, compared to $10.7$7.3 million of cash used inprovided by financing activities in the first ninethree months of 2005.2006. The increasedecrease was caused primarily by netgreater borrowings in 2006 compared to net repayments in 2005. The borrowings in 2006 werethe prior year used to fund the Company’s capital expansion and working capital needs as well as the restructuring actions taken in the fourth quarter of 2005. In September 2005,the first quarter of 2007, the Company repaid the $8.6 million remaining on its senior unsecured notes due in 2007 aheadexperienced a high level of their schedule maturities and in advance of entering into its current $100 million, five-year, unsecured syndicated multi currency revolving credit facility in October 2005. In addition, higher distributions paidstock option exercises compared to the minority shareholders of certain of the Company’s affiliates in 2005prior year, which contributed to the change in net cash flows.flows provided by financing activities.

In the first quarter of 2007, an inactive subsidiary of the Company reached a settlement agreement and release with one of its insurance carriers for $20.0 million. The prior year distributionsproceeds of the settlement are restricted and can only be used to minority shareholderspay claims and costs of defense associated with this subsidiary’s asbestos litigation. The payments are structured to be received over a four-year period with annual installments of $5.0 million, the first of which was drivenreceived early in large partthe second quarter of 2007. The subsequent installments are contingent upon whether or not Federal asbestos legislation is adopted by the due date of each annual installment. If Federal asbestos legislation is so enacted, and such legislation eliminates the carrier’s obligation to make the installment payment and requires the carrier to contribute into a distribution made priortrust or similar vehicle as a result of the policies issued to the Company’s acquisitionsubsidiary, then the insurance carrier’s obligation to make the subsequent installments will be cancelled. See also Note 11 of the remaining 40% interest in its Brazilian joint venture described above.Notes to Condensed Consolidated Financial Statements.

The Company had a net debt-to-totalnet-debt-to-total capital ratio of 38%43% at September 30, 2006March 31, 2007, compared to 35%40% at December 31, 2005. In addition, at September 30, 2006,2006. At March 31, 2007, the Company had approximately $76.4$83.5 million outstanding on its credit lines, compared to $63.8$79.2 million at December 31, 2005.2006. In connection with the adoption of FIN 48, the Company recorded a non-cash charge to shareholders’ equity of $5.5 million, which negatively impacted the Company’s net debt-to-total capital ratio by approximately 1 percentage point. At March 31, 2007 the Company’s gross FIN 48 liability, including accrued interest and penalties was $10.8 million. The Company cannot determine a reliable estimate of the timing of the cash flows by period related to its FIN 48 liability. However, should the FIN 48 liability be paid, the amount of the payment may be reduced by offsetting benefits in other tax jurisdictions by $3.6 million. The Company believes it is capable of supporting its operating requirements, including pension plan contributions, payment of dividends to shareholders, possible acquisitions and business opportunities, capital expenditures and possible resolution of contingencies, through internally generated funds supplemented with debt as needed.

Operations

Comparison of ThirdFirst Quarter 20062007 with ThirdFirst Quarter of 20052006

Net sales for the thirdfirst quarter of 2006 were $116.4$124.9 million up 10.1% from $105.8compared to $109.8 million for the thirdfirst quarter of 2005 due2006. The increase in net sales was primarily attributable to a combination of higher sellingsales prices and volume growth. Volume growth was mainly attributable to double digit sales growth in China and higher revenue related to the Company’s CMS channel. Foreign exchange rate translation also increased revenues by approximately 4% for the first quarter of 2007, compared to the same period in 2006. Selling price increases were realized across all regions and volume growthmarket segments, in part as an ongoing effort to offset higher raw material costs. CMS revenues were higher due to additional CMS accounts and the U.S.renewal and China.restructuring of several of the Company’s CMS contracts.

Gross margin as a percentage of sales was 31.6%30.9% for the thirdfirst quarter of 2006, as2007, compared to 32.0%29.6% for the thirdfirst quarter of 2005.2006. Higher selling prices and a stronger performanceadditional contribution from the Company’s CMS channel helped restore margins to prior year thirdimprove margins. On a sequential basis, however, the first quarter levels despite continued significant escalations in raw material costs. The thirdgross margin percentage was below the fourth quarter 2006 gross margin percentage of 31.6% shows sequential improvement over32.3%, as higher CMS service revenues, which include revenues from third-party product sales to CMS accounts, have lower margin percentages than traditional product sales. This change in sales mix decreased gross margin as a percentage of sales by approximately 1.5 percentage points compared to the first two quartersfourth quarter of the year in which the Company reported gross margins of 29.6% and 30.4%, respectively.2006.

Selling, general and administrative expenses for the quarter increased $1.5$4.6 million but decreased as a percentagecompared to the first quarter of sales to 27% from 28.3% in2006. Foreign exchange rate translation accounted for approximately $1.0 million of the increase. Also negatively affecting the comparison with the prior year third quarter. Planned newis a pension gain of $0.9 million recorded in the first quarter of 2006 due to a legislative change. The remainder of the increase was due to continued planned spending in higher growth areas, was funded by savings from the Company’s restructuring programprimarily China, higher commissions as a result of higher sales, and increased incentive compensation as a result of higher earnings.

The increase in the fourth quarter of 2005. Higher variable compensation in the third quarter of 2006 as compared to the prior year third quarterother income was the result of increased earnings.

higher foreign exchange rate losses recorded in the prior year. The increasedincrease in net interest expense is attributable to higher average borrowings and higher interest rates.

The third quarter 2006 effective tax rate was 29.9% versus 32.5% during the third quarter of 2005. The decline in effective tax rate was primarily attributable to a refund of taxes previously paid in China related to the Company’s increased investment. Many external and internal factors can impact this rate and the Company will continue to refine this rate, if necessary, as the year progresses. Please refer to the comparison of the First Nine Months 2006 with the First Nine Months of 2005 section below32.9% for further disclosure.

The decrease in minority interest expense is due to lower financial performance from the Company’s minority affiliates.

Net income for the third quarter was $3.1 million compared to $2.2 million for the third quarter of 2005. Higher sales and a stronger performance from the Company’s CMS channel, contributing to higher gross margin, were primarily responsible for the increase in net income compared to the third quarter of 2005.

Segment Reviews — Comparison of the Third Quarter 2006 with Third Quarter of 2005

Metalworking Process Chemicals:

Metalworking Process Chemicals consists of industrial process fluids for various heavy industrial and manufacturing applications and represented approximately 92% of the Company’s net sales for the third quarter of 2006. Net sales were up $9.3 million, or 10%, compared to the third quarter of 2005. Foreign currency translation positively impacted net sales by approximately 2%, driven by the Euro and Brazilian real to U.S. dollar exchange rates. The average Euro to U.S. dollar rate was 1.28 in the third quarter of 2006 compared to 1.22 in the third quarter of 2005, and the Brazilian real to U.S. dollar rate was 0.46 in the third quarter of 2006 compared to 0.43 in the third quarter of 2005. Net sales was positively impacted by 7% growth in North America and 25% growth in Asia/Pacific, while sales in Europe and South America were flat, all on a constant currency basis. The growth in net sales was attributable to both higher sales prices and volume growth. The majority of the volume growth came from China, while price increases implemented across all regions helped to maintain margins despite higher raw material costs. The $1.8 million increase in this segment’s operating income compared to the third quarter of 2005 is largely reflective of the Company’s pricing actions, improved performance from the Company’s U.S. CMS channel and savings generated from the Company’s 2005 restructuring efforts.

Coatings:

The Company’s Coatings segment, which represented approximately 7% of the Company’s net sales for the third quarter of 2006, contains products that provide temporary and permanent coatings for metal and concrete products and chemical milling maskants. Net sales for this segment were up $1.5 million, or 21%, for the third quarter of 2006 compared to the third quarter of 2005. The increase in net sales was the result of increased demand for both coatings and chemical milling maskants to the aerospace industry. This segment’s operating income was up $0.2 million consistent with the noted volume increases.

Other Chemical Products:

Other Chemical Products, which represented approximately 1% of sales in the third quarter of 2006, consists of sulfur removal products for industrial gas streams sold by the Company’s Q2 Technologies joint venture. Net sales for this segment for the first nine months of 2006 decreased $0.1 million, or 30%, due to a variety of market conditions including reduced demand in the hydrocarbon market. This segment’s operating income was flat with the third quarter of 2005, experiencing a slight loss in both periods.

Comparison of the First Nine Months 2006 with First Nine Months 2005

Net sales for the first nine months of 2006 were $344.9 million, up 8.8% from $317.0 million for the first nine months of 2005. The increase in net sales was attributable to higher sales prices and volume growth. Volume growth was mainly attributable to market share growth and increased demand in the U.S. and China. Selling price increases continue to be broadly implemented across all regions and market segments to offset significantly higher raw material costs.

Gross margin as a percentage of sales was 30.5% for the first nine months of 2006, as compared to 30.8% for the first nine months of 2005. Higher selling prices and a stronger performance from the Company’s CMS channel helped maintain margins notwithstanding continued increases in raw material prices, particularly crude oil derivatives.

Selling, general and administrative expenses for the first nine months of 2006 increased $1.4 million compared to the first nine months of 2005. As was the case in the third quarter, cost savings from the Company’s restructuring efforts in 2005 enabled increased spending in higher growth areas, restoration of variable compensation and higher professional fees with only minor cost increases. In addition, due to a legislative change, effective January 1, 2006, the Company recorded a pension gain in the first quarter of 2006 of $0.9 million relating2007, compared to one of its European pension plans. As a percentage of sales, selling, general and administrative expenses were 25.7%36.2% for the first nine monthsquarter of 2006, as compared to 27.5% in the first nine months of 2005.

The decrease in other income is largely due to $4.2 million of pre-tax gain relating to the Company’s real estate joint venture recorded in 2005. The remainder of the decrease was the result of foreign exchange losses in the first nine months of 2006 compared to gains in the first nine months of 2005. The increase in net interest expense is attributable to higher average borrowings and higher interest rates.

The effective tax rate for the first nine months of 2006 was 35.4% versus 32.5% during the first nine months of 2005.2006. Many external and internal factors can impact this rate and the Company will continue to refine this rate, if necessary, as the year progresses. The most significant factors impactingdecrease in the effective tax rate includedwas primarily attributable to a refundshifting of taxes previously paidincome to lower rate tax jurisdictions, which was offset in China related topart by the Company’s increased investment being more than offset by a shifting mixfirst quarter 2007 adoption of income among taxing jurisdictions.FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). At the end of 2005,2006, the Company had net U.S.U.S deferred tax assets totaling $15.3$15.5 million, excluding deferred tax assets relating to additional minimum pension liabilities. The Company records valuation allowances when necessary to reduce its deferred tax assets to the amount that is more likely than not to be realized. The Company considers future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance. However, in the event the Company were to determine that it would not be able to realize all or part of its net deferred tax assets in the future, an adjustment to the deferred tax assetassets would be a non-cash charge to income in the period such determination was made, which could have a material adverse impact on the Company’s financial statements. The continued price pressure in the Company’s crude-oil based raw materials has been negatively impacting profitability in certain taxing jurisdictions. The Company continues to closely monitor this situation as it relates to its net deferred tax assets and the assessment of valuation allowances. The Company is continuing to evaluate alternatives that could positively impact U.S. taxable income.

The decreaseincome in minority interest expense for the year is due to the acquisition of the remaining 40% interest in the Company’s Brazilian affiliate in March of 2005 and lower financial performance from the Company’s minority affiliates.these jurisdictions.

Net income for the first nine monthsquarter of 20062007 was $8.7$3.5 million as compared to $7.1$2.5 million for the first nine monthsquarter of 2005, which included2006, primarily as a $4.2 million pre-tax gain from the Company’s real estate joint venture, partiallyresult of increased sales and gross margin offset in part by a $1.2 million pre-tax restructuring charge.higher selling, general and administrative expenses.

Segment Reviews - Reviews—Comparison of the First Nine Months 2006Quarter 2007 with First Nine Months 2005Quarter of 2006

Metalworking Process Chemicals:Chemicals

Metalworking Process Chemicals consists of industrial process fluids for various heavy industrial and manufacturing applications and represented approximately 92%93% of the Company’s net sales for the first nine monthsquarter of 2006.2007. Net sales were up $24.5$14.4 million, or 8%14%, compared towith the first nine monthsquarter of 2005.2006. Foreign currency translation positively impacted net sales by approximately 1%4%, driven by the euro to U.S. dollar and Brazilian real to U.S. dollar exchange rates. The average Brazilian realeuro to U.S. dollar exchange rate was 1.31 in the first quarter of 2007 compared to 1.20 in the first quarter of 2006, and the Brazilian real exchange rate was 0.47 in the first quarter of 2007 versus 0.46 in the first nine monthsquarter of 2006 compared to 0.40 in the first nine months of 2005.2006. Net sales were positively impacted by 8%40% growth in Asia/Pacific, 7% growth in North America, and 19%5% growth in Asia/Pacific, 4% growth inboth Europe and 2% growth South America, all on a constant currency basis. The growth in net sales was attributable to both higher sales prices, volume growth and volume growth.higher CMS sales due to the renegotiation of certain contracts. The majority of the volume growth came from increased demand in both North America and China, while price increases implemented across all regions helped to maintain margins despiteoffset higher raw material costs. The $7.5$3.7 million increase in this segment’s operating income compared to the first nine monthsquarter of 20052006 is largely reflective of the Company’s pricing actions and improved performance from the Company’s U.S. CMS channel and savings generated from the Company’s 2005 restructuring efforts.channel.

Coatings:Coatings

The Company’s Coatings segment, which represented approximately 7% of the Company’s net sales for the first nine monthsquarter of 2006,2007, contains products that provide temporary and permanent coatings for metal and concrete products and chemical milling maskants. Net sales for this segment were up $4.9$0.9 million, or 25%12%, for the first nine monthsquarter of 20062007 compared with the prior year period primarily due to the first nine months of 2005. The increase in net sales was the result of increased demand for bothhigher temporary and permanent coatings and chemical milling maskants to the aerospace industry.product sales. This segment’s operating income was up $1.2down $0.1 million consistent with the noted volume increases.due to higher contract manufacturing and selling costs.