Sensient Technologies - 10-Q quarterly report FY

On July 6, 2004, the EPA notified the Company’s Sensient Colors Inc. subsidiary that it may be a potentially responsible party (“PRP”) under the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”) for activities at the General Color Company Superfund Site in Camden, New Jersey. The EPA requested reimbursement of $10.9 million in clean-up costs, plus interest. Sensient Colors Inc. advised the EPA that this site had been expressly excluded from the Company’s 1988 stock purchase of H. Kohnstamm & Company, Inc. (now Sensient Colors Inc.). The selling shareholders had retained ownership of and liability for the site, and some became owners of General Color Company, which continued to operate there until the mid-1990s. The Company’s legal defense costs are being paid by an insurer with a reservation of coverage rights. Litigation to resolve coverage rights is pending. The Company continues to assess the existence and solvency of other PRPs, additional insurance coverage, the nature of the alleged contamination, and the extent to which the EPA’s activities satisfy the requirements for reimbursement under CERCLA, as well as the legal sufficiency of excluding this site from the 1988 transaction. In a letter to the EPA dated January 31, 2005, the Company outlined legal challenges to the recoverability of certain costs and urged the EPA to pursue General Color Company and related parties. The EPA subsequently informed the Company that it is unwilling to discuss these legal challenges without prior conditions and may refer this matter to the Department of Justice, which would evaluate the referral for potential civil litigation under applicable environmental laws.

As of March 31, 2006, the liabilities related to environmental remediation obligations could range from $1.4 million to $15.8 million. As of March 31, 2006, the Company has accrued $2.5 million for environmental matters, of which $2.1 million is related to the environmental reserves established in connection with the 2001 acquisition discussed above. This accrual represents management’s best estimate of these liabilities. Although costs could be significantly higher, it is the opinion of Company management that the probability that costs in excess of those accrued will have a material adverse impact on the Company’s consolidated financial statements is remote. There can be no assurance, however, that additional environmental matters will not arise in the future. The Company has not recorded any potential recoveries related to these matters, as receipts are not yet assured.

There are three significant commercial cases pending against the Company, which are disclosed below.

In June 2004, the Company and certain other flavor manufacturers were sued in Iowa state court by Kevin Remmes, who alleged that while working at American Popcorn Company of Sioux City, Iowa, he was exposed to butter flavoring vapors that caused injury to his lungs and respiratory system. The Company, among others, sold butter flavoring used in the manufacture of microwave popcorn to American Popcorn Company. The suit was removed to Federal District Court for the Northern District of Iowa, Western Division. The Company believes that plaintiff’s claims are without merit and is vigorously defending this case. A trial date has been set in March 2007. One of the Company’s insurers has acknowledged coverage and is paying defense costs since the deductible has been exceeded.

In August 2005, the Company and certain other flavoring manufacturers were sued in the City of St. Louis, Missouri, Circuit Court by Elizabeth Fults (as administrator for the Estate of Dixie Asbury), Nancy Lee Dudley and Jill Roth, all of whom allege that they suffered damage as a result of work-related exposure to butter flavoring vapors at the Gilster-Mary Lee microwave popcorn plant in McBride, Missouri. At present, it is unclear whether and to what extent the Company ever sold butter flavoring products to this facility. The Company intends to file a motion to dismiss and will vigorously defend its interests in this case. A trial date has been set in this matter for May 2007.

In late January 2006, the Company and certain other flavor manufacturers were sued in the Federal District Court for the Northern District of Iowa, Western Division, by Ronald Kuiper and his spouse, Conley Kuiper. Mr. Kuiper claims that while working at American Popcorn Company of Sioux City, Iowa, he was exposed to butter flavoring vapors that caused injury to his lungs and respiratory system. Ms. Kuiper’s claim is for loss of consortium. The allegations of this Complaint are virtually identical to those contained in the Remmes Complaint. Plaintiffs’ counsel

moved to consolidate the Kuiper case with the Remmes case for discovery purposes; the Court denied the motion on procedural grounds. The Company believes that plaintiffs’ claims are without merit and is vigorously defending this case. A trial date has not yet been set in this matter.

The Company is involved in various other claims and litigation arising in the normal course of business. In the judgment of management, which relies in part on information from Company counsel, the ultimate resolution of these actions will not materially affect the consolidated financial statements of the Company except as described above.

OVERVIEW

Revenue for the quarter ended March 31, 2006, increased 4.8% to $262.9 million from $250.9 million for the comparable quarter in 2005. Revenue for the Flavors & Fragrances segment increased 7.7% for the quarter ended March 31, 2006, over the comparable period last year. Revenue for the Color segment decreased 1.0% for the quarter ended March 31, 2006, over the comparable period last year. Revenue for Asia Pacific decreased 5.1% for the quarter. Additional information on group results can be found in the Segment Information section.

The gross profit margin increased 40 basis points to 30.2% for the first quarter of 2006 from 29.8% for the comparable period in 2005. Improved pricing and product mix increased gross profit margin by approximately 240 basis points. These increases were partially offset by higher raw material and energy costs.

Selling and administrative expenses as a percent of revenue were 18.5% for the three months ended March 31, 2006, versus 19.9% for the 2005 comparable period. The first quarter of 2005 included a $4.5 million expense related to an arbitration order in the matter of Kraft Foods North America, Inc. v. Sensient Colors Inc. This reduction was partially offset by an increase in accruals for performance-based incentives and stock-based compensation. The Company adopted SFAS No. 123(R) in the first quarter of 2006 which resulted in additional expense of approximately $0.5 million.

Operating income for the quarter ended March 31, 2006, was $30.8 million compared to $24.9 million for the comparable period in 2005. The improvement was due to the revenue, margin and expense changes discussed above.

Unfavorable foreign exchange rates decreased revenue and operating income by approximately 1.9% and 0.6%, respectively, for the three months ended March 31, 2006, over the comparable period in the prior year.

Interest expense was $8.7 million for the quarters ended March 31, 2006 and 2005. A reduction in interest expense due to lower average debt balances was offset by higher average rates.

The effective income tax rate was 29.2% and 20.6% for the three months ended March 31, 2006 and 2005, respectively. The effective tax rate for the three months ended March 31, 2006, was reduced by the settlement of prior years’ tax liabilities. The effective tax rate for the three months ended March 31, 2005, was reduced by the revaluation of deferred tax liabilities in connection with a rate reduction in a foreign country and finalization of prior year income tax returns. The effective tax rate is expected to be approximately 31% for the remainder of 2006, prior to the recording of any discrete items, which will be reported separately in the quarter in which they occur.

SEGMENT INFORMATION

Flavors & Fragrances –

Revenue for the Flavors & Fragrances segment increased 7.7% to $170.5 million for the quarter ended March 31, 2006, compared to $158.4 million for the same period last year. The increase in revenue is primarily due to higher sales of dehydrated flavors ($7.5 million), traditional flavors in North America ($3.8 million) and fragrances ($2.0 million). These items were partially offset by the impact of unfavorable exchange rates ($2.7 million).

Operating income in the quarter ended March 31, 2006, increased 11.5% to $22.9 million from $20.5 million last year. The increase in operating income is primarily due to higher profit in dehydrated flavors ($1.6 million), traditional flavors in North America ($0.5 million) and the impact of exchange rates ($0.3 million). Higher profit in dehydrated flavors was primarily due to improved pricing partially offset by higher raw material and energy costs. The increase in profit for traditional flavors in North America primarily related to higher sales and favorable product mix. Operating income as a percent of revenue was 13.4%, an increase of 40 basis points from the comparable quarter last year.

Color –

For the three months ended March 31, 2006, revenue for the Color segment was $89.2 million compared to $90.1 million in the prior year. The decrease primarily resulted from the impact of unfavorable foreign exchange rates ($2.1 million) and lower sales of technical colors ($1.2 million) partially offset by increased sales of cosmetic colors ($1.7 million) and food and beverage colors in Europe ($1.0 million). The decrease in sales of technical colors primarily related to lower demand for aftermarket inks and paper dyes.

Operating income for the quarter ended March 31, 2006, was $15.8 million, an increase of 7.3% from $14.8 million in the comparable period last year. The increase was primarily attributable to higher profit related to sales of food and beverage colors ($1.5 million) and cosmetic colors ($1.0 million) partially offset by lower profits from sales of technical colors ($1.1 million) and the impact of unfavorable exchange rates ($0.4 million). The improved profit in the food and beverage business relates to benefits from the 2005 restructuring program, favorable volume and favorable product mix. The improved profit in the cosmetic colors business was primarily attributable to higher volume. The lower profit in the technical colors business was primarily due to lower volume. Operating income as a percent of revenue was 17.8%, an increase of 140 basis points from the comparable quarter last year, primarily due to the reasons provided above.

FINANCIAL CONDITION

The Company’s ratio of debt to total capital improved to 46.4% as of March 31, 2006, from 47.1% as of December 31, 2005. The improvement resulted primarily from a $7.3 million reduction in debt levels since December 31, 2005.

Net cash provided by operating activities was $20.8 million for the quarter ended March 31, 2006, compared to $20.3 million for the quarter ended March 31, 2005. The increase in earnings was offset by an unfavorable comparison on the changes in working capital.

Net cash used in investing activities was $3.8 million for the three months ended March 31, 2006, compared to $6.3 million in the comparable period last year. Capital expenditures were $4.4 million and $6.5 million in the first quarters of 2006 and 2005, respectively.

Net cash used in financing activities was $21.3 million for the quarter ended March 31, 2006, compared to $11.5 million in the comparable period last year. During the first quarters of 2006 and 2005, net cash provided by operating activities was sufficient to fund capital expenditures, pay dividends, purchase treasury shares and reduce borrowings. Net repayments of debt were $9.8 million and $5.3 million for the three months ended March 31, 2006 and 2005, respectively. Dividends of $6.9 million and $7.1 million were paid during the quarters ended March 31, 2006 and 2005, respectively.

The Company purchased 200,949 shares of Company stock during the three months ended March 31, 2006, at a total cost of $3.6 million. The Company did not purchase any shares of Company stock during the three months ended March 31, 2005. In 2001, the Company approved a share repurchase program under which it is authorized to repurchase up to 5.0 million             shares of Company stock. As of March 31, 2006, 3.0 million shares were available under this authorization. The Company’s share repurchase program has no expiration date.

The Company believes that its financial position remains strong, enabling it to meet cash requirements for operations, capital expenditure programs and dividend payments to shareholders. The Company intends to fund working capital requirements, principal and interest payments, acquisitions (if any) and other liabilities with cash provided by operations, to the extent available, and short-term and long-term borrowings under new and existing credit facilities. The Company intends to finance current maturities of long-term debt of $209.4 million by using existing bank facilities and by utilizing new sources of financing with banks and other financial institutions. However, the Company cannot assure that new sources of financing will be available or that the terms of any such financing will be attractive to the Company.

CONTRACTUAL OBLIGATIONS

There have been no material changes in the Company’s contractual obligations during the quarter ended March 31, 2006. For additional information about contractual obligations, refer to page 23 of the Company’s 2005 Annual Report, portions of which were filed as Exhibit 13.1 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.

CRITICAL ACCOUNTING POLICIES

There have been no material changes in the Company’s critical accounting policies during the quarter ended March 31, 2006. For additional information about critical accounting policies, refer to pages 21 and 22 of the Company’s 2005 Annual Report, portions of which were filed as Exhibit 13.1 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.

There have been no material changes in the Company’s market risk during the quarter ended March 31, 2006. For additional information about market risk, refer to pages 22 and 23 of the Company’s 2005 Annual Report, portions of which were filed as Exhibit 13.1 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.

Disclosure Controls and Procedures: The Company carried out an evaluation, under the supervision and with the participation of management, including the Company’s Chairman, President and Chief Executive Officer and its Vice President, Chief Financial Officer and Treasurer, of the effectiveness, as of the end of the period covered by this report, of the disclosure controls and procedures, as defined in Rule 13a-15(e) of the Exchange Act of 1934. Based upon that evaluation, the Company’s Chairman, President and Chief Executive Officer and its Vice President, Chief Financial Officer and Treasurer have concluded that the disclosure controls and procedures were effective as of the end of the period covered by this report.

Internal Control Over Financial Reporting: There have not been any changes in the Company’s internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) that occurred during the Company’s most recent quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

FORWARD-LOOKING STATEMENTS

This document contains forward-looking statements that reflect management’s current assumptions and estimates of future economic circumstances, industry conditions, Company performance and financial results. Forward-looking statements include statements in the future tense, statements referring to any period after March 31, 2006, and statements including the terms “expect,” “believe,” “anticipate” and other similar terms that express expectations as to future events or conditions. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for such forward-looking statements. Such forward-looking statements are not guarantees of future performance and involve known and unknown risks, uncertainties and other factors that could cause actual events to differ materially from those expressed in those statements. A variety of factors could cause the Company’s actual results and experience to differ materially from the anticipated results. These factors and assumptions include the pace and nature of new product introductions by the Company’s customers; the Company’s ability to successfully implement its growth strategies; the outcome of the Company’s various productivity-improvement and cost-reduction efforts; changes in costs of raw materials and energy; industry and economic factors related to the Company’s domestic and international business; competition from other suppliers of color and flavors and fragrances; growth or contraction in markets for products in which the Company competes; terminations and other changes in customer relationships; industry acceptance of price increases; currency exchange rate fluctuations; results of litigation or other proceedings; the matters discussed under Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2005; and the matters discussed above under Item 2 including the critical accounting policies described therein. The Company does not undertake to publicly update or revise its forward-looking statements even if experience or future changes make it clear that any projected results expressed or implied therein will not be realized.

On June 24, 2004, the United States Environmental Protection Agency (the “EPA”) issued a Notice of Violation/Finding of Violation (“NOV”) to Lesaffre Yeast Corporation (“Lesaffre”) for alleged violations of the Wisconsin air emission requirements. The NOV generally alleges that Lesaffre’s Milwaukee, Wisconsin facility violated air emissions limits for volatile organic compounds during certain periods from 1999 through 2003. Some of these violations allegedly occurred before Lesaffre purchased Red Star Yeast & Products (“Red Star Yeast”) from the Company.

On June 30, 2005, the EPA issued a second NOV to Lasaffre and Sensient which alleged that certain operational changes were made during Sensient’s ownership of the Milwaukee facility without complying with new-source review procedures and without the required air pollution control permit. While the Company’s evaluation is continuing, there appear to be significant legal defenses available to the Company in connection with the alleged violations.

The Company has met with the EPA in an attempt to resolve the NOVs. In September 2005, as follow-up to one of those meetings, the Company submitted information to refute the allegations of the June 30, 2005 NOV and requested that the NOV be withdrawn. The Company is awaiting the EPA’s response to that submission.

In connection with the sale of Red Star Yeast, the Company provided Lesaffre and certain of its affiliates with indemnification against environmental claims attributable to the operation, activities or ownership of Red Star Yeast prior to February 23, 2001, the closing date of the sale. See Note 9 to the Company’s consolidated condensed financial statements. The Company has not received a claim for indemnity from Lesaffre with respect to this matter. In December 2005, Lesaffre closed the Milwaukee plant. The Company informed the EPA of this development.

On July 6, 2004, the EPA notified the Company’s Sensient Colors Inc. subsidiary that it may be a potentially responsible party (“PRP”) under the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”) for activities at the General Color Company Superfund Site in Camden, New Jersey. The EPA requested reimbursement of $10.9 million in clean-up costs, plus interest. Sensient Colors Inc. advised the EPA that this site had been expressly excluded from the Company’s 1988 stock purchase of H. Kohnstamm & Company, Inc. (now Sensient Colors Inc.). The selling shareholders had retained ownership of and liability for the site, and some became owners of General Color Company, which continued to operate there until the mid-1990s. The Company’s legal defense costs are being paid by an insurer with a reservation of coverage rights. Litigation to resolve coverage rights is pending. The Company continues to assess the existence and solvency of other PRPs, additional insurance coverage, the nature of the alleged contamination, and the extent to which the EPA’s activities satisfy the requirements for reimbursement under CERCLA, as well as the legal sufficiency of excluding this site from the 1988 transaction. In a letter to the EPA dated January 31, 2005, the Company outlined legal challenges to the recoverability of certain costs and urged the EPA to pursue General Color Company and related parties. The EPA subsequently informed the Company that it is unwilling to discuss these legal challenges without prior conditions and may refer this matter to the Department of Justice, which would evaluate the referral for potential civil litigation under applicable environmental laws.

In June 2004, the Company and certain other flavor manufacturers were sued in Iowa state court by Kevin Remmes, who alleged that while working at American Popcorn Company of Sioux City, Iowa, he was exposed to butter flavoring vapors that caused injury to his lungs and respiratory system. The Company, among others, sold butter flavoring used in the manufacture of microwave popcorn to American Popcorn Company. The suit was removed to Federal District Court for the Northern District of Iowa, Western Division. The Company believes that plaintiff’s claims are without merit and is vigorously defending this case. A trial date has been set in March 2007. One of the Company’s insurers has acknowledged coverage and is paying defense costs since the deductible has been exceeded.

In August 2005, the Company and certain other flavoring manufacturers were sued in the City of St. Louis, Missouri, Circuit Court by Elizabeth Fults (as administrator for the Estate of Dixie Asbury), Nancy Lee Dudley and Jill Roth, all of whom allege that they suffered damage as a result of work-related exposure to butter flavoring vapors at the Gilster-Mary Lee microwave popcorn plant in McBride, Missouri. At present, it is unclear whether and to what extent the Company ever sold butter flavoring products to this facility. The Company intends to file a motion to dismiss and will vigorously defend its interests in this case. A trial date has been set in this matter for May 2007.

In late January 2006, the Company and certain other flavor manufacturers were sued in the Federal District Court for the Northern District of Iowa, Western Division, by Ronald Kuiper and his spouse, Conley Kuiper. Mr. Kuiper claims that while working at American Popcorn Company of Sioux City, Iowa, he was exposed to butter flavoring vapors that caused injury to his lungs and respiratory system. Ms. Kuiper’s claim is for loss of consortium. The allegations of this Complaint are virtually identical to those contained in the Remmes Complaint. Plaintiffs’ counsel moved to consolidate the Kuiper case with the Remmes case for discovery purposes; the Court denied the motion on procedural grounds. The Company believes that plaintiffs’ claims are without merit and is vigorously defending this case. A trial date has not yet been set in this matter.

The Company is involved in various other claims and litigation arising in the normal course of business. In the judgment of management, which relies in part on information from Company counsel, the ultimate resolution of these actions will not materially affect the consolidated financial statements of the Company except as described above.

See “Risk Factors” in Item 1A of the Company’s annual report on Form 10-K for the year ended December 31, 2005.

The following table provides the specified information about the repurchases of shares by the Company during the first quarter of 2006.

At the Company’s 2006 Annual Meeting of Shareholders, held on April 27, 2006, the following actions were taken:

See Exhibit Index following this report.