Sensient Technologies - 10-Q quarterly report FY

OVERVIEW

Revenue for the second quarter of 2007 was $304.3 million, an increase of 7.8% from $282.2 million recorded in the prior year second quarter. For the six months ended June 30, 2007, revenue was $589.6 million, an increase of 8.2% from the comparable period in 2006. Revenue for the Flavors & Fragrances segment increased by 7.7% and 7.9% for the quarter and six months ended June 30, 2007, respectively, over the comparable periods last year. Revenue for the Color segment increased by 5.6% and 6.6% for the quarter and six months ended June 30, 2007, respectively, over the comparable periods last year. Revenue for Asia Pacific increased by 28.6% and 24.7% for the quarter and six months ended June 30, 2007, respectively, over the comparable periods last year. Additional information on group results can be found in the Segment Information section.

The gross profit margin increased 70 basis points to 31.0% for the three months ended June 30, 2007, from 30.3% for the same period in 2006. Higher selling prices and favorable product mix more than offset the impact of higher raw material costs. For the six months ended June 30, 2007 and 2006, the gross profit margin was 30.6% and 30.3%, respectively. Higher selling prices and lower energy costs more than offset the impact of higher raw material costs.

Selling and administrative expenses as a percent of revenue were 17.9% and 17.8% in the quarters ended June 30, 2007 and 2006, respectively. Selling and administrative expenses in the second quarter of 2006 were reduced by a gain of approximately $1.2 million on the sale of a non-core investment. For the six months ended June 30, 2007 and 2006, selling and administrative expenses as a percent of revenue were 18.1% and 18.2%, respectively. The reduction in the percent of revenue was primarily a result of revenues increasing at a higher rate than expenses, which more than offset the impact of the aforementioned $1.2 million gain on the sale of a non-core investment in 2006.

Operating income for the quarter ended June 30, 2007, was $40.0 million, an increase of 13.8% from $35.1 million for the second quarter of 2006. Operating income for the six months ended June 30, 2007, was $74.2 million compared to $65.9 million for the comparable period in 2006. The change in operating income for each period was due to the revenue, margin and expense changes discussed above.

Favorable foreign exchange rates increased revenue and operating profit by 3.3% and 3.4%, respectively, for the three months ended June 30, 2007, over the same quarter of 2006. For the six months ended June 30, 2007, foreign exchange rates increased revenue by 3.2% and operating income by 3.4% over the comparable period last year.

Interest expense for the quarter ended June 30, 2007, was $9.5 million, an increase of 5.5% over the prior year’s quarter. Interest expense for the six months ended June 30, 2007, was $18.7 million compared to $17.7 million in the prior year period. The increase in both periods was a result of higher average rates partially offset by a reduction in average debt balances.

The effective income tax rates were 30.4% and 29.4% for the quarter ended June 30, 2007 and 2006, respectively. The effective income tax rates were 30.5% and 29.3% for the six months ended June 30, 2007 and 2006, respectively. The effective tax rates for the three and six month periods in both years were reduced by changes in estimates associated with the finalization of prior year income tax returns and the resolution of prior years’ tax matters. For the three and six months ended June 30, 2006, these reductions were partially offset by a higher rate on the gain on the sale of a non-core investment. Management expects the effective tax rate for the remainder of 2007 to be 33%, excluding the income tax expense or benefit related to discrete items, which will be reported separately in the quarter in which they occur.

SEGMENT INFORMATION

Flavors & Fragrances –

Revenue for the Flavors & Fragrances segment in the second quarter of 2007 increased 7.7% to $202.9 million from $188.3 million for the same period last year. The increase in revenue was primarily due to higher volumes and prices in North America ($4.8 million) and higher volumes in the fragrances product line ($2.6 million) combined with the favorable impact of foreign exchange rates ($5.2 million).

For the quarter ended June 30, 2007, operating income increased 15.0% to $31.2 million from $27.1 million last year. The increase was primarily attributable to higher profit in North America ($1.9 million), Europe ($1.2 million) and Latin America ($0.5 million), combined with the favorable impact of exchange rates ($0.4 million). The increase in North America was primarily due to improved pricing in dehydrated flavors and other flavors, higher volumes and favorable product mix partially offset by higher raw material costs. The increase in Europe was primarily due to lower costs. The increase in Latin America was primarily due to higher volumes and prices partially offset by increased raw material costs. Operating income as a percent of revenue was 15.4%, an increase of 100 basis points from the comparable quarter last year, primarily due to the reasons provided above.

For the six months ended June 30, 2007, revenue for the Flavors & Fragrances segment was $387.2 million, an increase of 7.9% from $358.8 million reported in the same period last year. The increase in revenue was primarily due to higher volumes and prices in North America ($9.9 million) and higher volumes in the fragrances product line ($4.3 million) combined with the favorable impact of foreign exchange rates ($9.6 million).

Operating income for the six months ended June 30, 2007, increased 14.7% to $57.4 million from $50.0 million last year. The increase in operating income was primarily due to improvements in North America ($4.2 million), Europe ($1.8 million) and Latin America ($0.9 million) combined with the favorable impact of foreign exchange rates ($0.6 million). The increase in North America was primarily due to improved pricing and higher volumes in dehydrated flavors and other flavors, and favorable product mix partially offset by higher raw material costs. The increase in Europe was primarily attributable to higher selling prices and lower costs. The increase in Latin America was primarily due to higher selling prices and favorable volumes. Operating income as a percent of revenue was 14.8%, an increase of 90 basis points from the comparable period last year, primarily due to the reasons provided above.

Color –

Revenue for the Color segment for the second quarter of 2007 was $95.6 million, an increase of 5.6% from $90.5 million reported in the prior year’s comparable period. The increase in revenue was primarily due to higher volumes of food and beverage colors ($3.0 million), higher volumes of cosmetic colors ($1.2 million) and the favorable effect of foreign exchange rates ($3.2 million), partially offset by lower sales of technical colors ($2.2 million). The decrease in sales of technical colors primarily related to lower demand for inkjet inks and colors for industrial applications.

Operating income for the quarter ended June 30, 2007, was $17.2 million versus $15.8 million in the comparable period last year. The increase was primarily due to higher profit from sales of food and beverage colors ($1.0 million) and cosmetic colors ($0.7 million), and the favorable effect of foreign exchange rates ($0.6 million), partially offset by lower profit from reduced sales of technical colors ($0.8 million). The improved profits from food and beverage colors and cosmetic colors primarily relate to higher volumes. Operating income as a percent of revenue increased 50 basis points from the prior year’s quarter to 18.0%.

For the six months ended June 30, 2007, revenue for the Color segment was $191.6 million compared to $179.7 million in 2006. The increase in revenue was primarily due to increased sales volume of food and beverage colors ($7.2 million), increased volumes of cosmetic colors ($3.2 million) and the favorable effect of foreign exchange rates ($6.1 million) partially offset by lower sales of technical colors ($4.6 million). The decline in technical colors was primarily due to lower demand for inkjet inks and colors for industrial applications.

Operating income for the six months ended June 30, 2007, increased 8.6% to $34.4 million from $31.7 million in the comparable period last year. The increase was primarily due to the impact of higher volumes of food and beverage colors ($1.7 million), the impact of increased volumes of cosmetic colors ($1.5 million) and the favorable effect of foreign exchange rates ($1.3 million). These items were partially reduced by the impact of lower volumes of technical colors ($1.5 million). Operating income as a percent of revenue was 18.0%, an increase of 40 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 40.4% as of June 30, 2007, from 43.1% as of December 31, 2006. The improvement resulted from an increase in equity and a decrease in total debt since December 31, 2006.

Net cash provided by operating activities was $48.8 million for the six months ended June 30, 2007, compared to $43.6 million for the comparable period last year. The increase in cash provided by operating activities was primarily due to higher net earnings.

Net cash used in investing activities was $13.7 million and $13.6 million for the six months ended June 30, 2007 and 2006, respectively. Capital expenditures were $15.6 million and $17.8 million for the six months ended June 30, 2007 and 2006, respectively.

Net cash used in financing activities was $34.7 million and $31.9 million for the six months ended June 30, 2007 and 2006, respectively. Net repayments of debt were $27.7 million and $16.3 million for the first six months of 2007 and 2006, respectively. For purposes of the cash flow statement, net changes in debt exclude the impact of foreign exchange rates. Dividends of $15.0 million and $13.9 million were paid during the six months ended June 30, 2007 and 2006, respectively. For the first six months of 2007 and 2006, the net cash provided by operating activities was sufficient to fund capital expenditures, pay dividends and reduce borrowings.

The Company’s financial position remains strong. Its expected cash flows from operations and existing lines of credit can be used to meet future cash requirements for operations, capital expenditures and dividend payments to shareholders. The Company increased its quarterly cash dividend on its common stock from 16 cents per share to 18 cents per share effective for the quarterly dividend to shareholders of record on August 9, 2007.

In June 2007, the Company completed a new $300 million revolving credit facility with eight banks. The new facility replaces the Company’s $225 million facility, matures in 2012 and is unsecured. The facility will be used for general corporate purposes and to refinance approximately $90 million of notes that mature at the end of 2007.

CONTRACTUAL OBLIGATIONS

There have been no material changes in the Company’s contractual obligations during the quarter ended June 30, 2007. For additional information about contractual obligations, refer to pages 23 and 24 of the Company’s 2006 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, 2006.

OFF-BALANCE SHEET ARRANGEMENTS

The Company had no off-balance sheet arrangements as of June 30, 2007.

CRITICAL ACCOUNTING POLICIES

There have been no material changes in the Company’s critical accounting policies during the quarter ended June 30, 2007. For additional information about critical accounting policies, refer to page 22 of the Company’s 2006 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, 2006.

There have been no material changes in the Company’s exposure to market risk during the quarter ended June 30, 2007. For additional information about market risk, refer to pages 22 and 23 of the Company’s 2006 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, 2006.

Evaluation of 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 and Chief Financial Officer, of the effectiveness, as of the end of the period covered by this report, of the design and operation 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 and Chief Financial Officer have concluded that the disclosure controls and procedures were effective as of the end of the period covered by this report.

Change in Internal Control Over Financial Reporting: There has been no change in the Company’s internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) during the Company’s most recent quarter that has materially affected, or is 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 June 30, 2007, 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 and 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, including 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 and customer acceptance of price increases; currency exchange rate fluctuations; results of litigation, environmental investigations 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, 2006; 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 alleged 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 Lesaffre 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. The Company raised significant legal defenses in response to the June 2005 NOV. The Company 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. In December 2005, Lesaffre closed the Milwaukee plant. The Company informed the EPA of this development.

On December 18, 2006, the EPA issued an Administrative Complaint to assess a penalty for the alleged violations covered by the two NOVs. The EPA named Lesaffre as a respondent in that proceeding. The EPA did not name Sensient as a respondent in that proceeding. The EPA proposed a penalty covering both NOVs of $488,000.

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. On December 20, 2006, Lesaffre formally requested indemnification from Sensient for the portion of the civil penalty arising from the June 30, 2005 NOV. In January 2007, Sensient agreed to be responsible for and undertake the defense of the claim related to the June 30, 2005 NOV. Lesaffre agreed to be responsible for and undertake the defense of the claim related to the June 24, 2004 NOV.

In June 2007, Lesaffre entered into a comprehensive settlement agreement with the EPA under which Lesaffre agreed to pay an administrative penalty of $202,500 to resolve the liability under the Administrative Complaint in connection with both the June 24, 2004 and June 30, 2005 NOVs. As a part of the settlement, Sensient agreed to pay Lesaffre $125,000 for the portion of the penalty attributable to the June 30, 2005 NOV. Sensient made the payment to Lesaffre on July 9, 2007. Sensient’s payment fully resolved its liability to Lesaffre under the February 23, 2001 Asset Purchase Agreement as it relates to all matters arising under EPA’s Administrative Complaint.

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 “Site”). The EPA requested reimbursement of $10.9 million in clean-up costs, plus interest. Sensient Colors Inc. advised the EPA that the Site had been expressly excluded from the Company’s 1988 stock purchase of H. Kohnstamm & Company, Inc. (now Sensient Colors). 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. 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 Sensient Colors Inc. that it was unwilling to discuss these legal challenges without prior conditions. In 2006, the EPA issued a news release stating that a private developer, Westfield Acres Urban Renewal Association II, LP, pursuant to an agreement with the EPA, began redevelopment efforts at the site (construction of affordable housing) by demolishing buildings thereon. Thereafter, the EPA removed allegedly contaminated soil from the locations where the buildings once stood. Documents received pursuant to a Freedom of Information Act request indicate that the EPA incurred additional alleged response costs of approximately $4 million.

On March 16, 2007, the United States filed a complaint in the U.S. District Court in New Jersey against Sensient Colors Inc. claiming “over $16 million” in response costs allegedly incurred and to be incurred by the EPA pursuant to CERCLA. On May 21, 2007, Sensient Colors Inc. filed a motion to dismiss the complaint. The motion was fully briefed in anticipation of a July 6, 2007 motion return date. The Company now awaits a response from the Court. Sensient Colors, Inc. intends to vigorously defend its interests in the litigation and is evaluating, among other things, the pursuit of additional PRPs, and additional challenges to the EPA’s right to recover its claimed response costs. The Company’s legal defense costs are being paid, in part, by an insurer with a reservation of coverage rights. Litigation to resolve coverage rights is pending.

The owner of Pleasant Gardens (the “Property”), an apartment complex adjacent to the General Color Superfund Site, filed a complaint in New Jersey state court in November 2003 against H. Kohnstamm & Co. (now Sensient Colors Inc.), the Company, General Color Company, and unknown defendants. Plaintiff seeks to hold defendants liable, in an unspecified amount, for damages related to the alleged contamination of the Property. Plaintiff voluntarily dismissed the Company without prejudice. Sensient Colors Inc. filed an answer denying liability and asserting affirmative defenses. Limited discovery has occurred. In November 2006, the Camden Redevelopment Agency (the “Agency”) filed condemnation litigation against plaintiff (and other purported interested parties) to take the Property. Sensient Colors Inc. is not a party to the condemnation litigation. In advance of its filing, the Agency notified plaintiff that its appraiser had assessed the fair market value of the Property at $7.7 million and that its environmental consultant had estimated the costs for environmental cleanup, purportedly to meet requirements of the New Jersey Department of Environmental Protection (“the DEP”), at $7.5 million. Sensient Colors Inc. and plaintiff have pursued a reduction in the scope and cost of the Agency’s proposed environmental cleanup in meetings with the DEP, the Agency and another party involved in the condemnation, the New Jersey Schools Construction Corporation (“the NJSCC”). On March 29, 2007, plaintiff filed an amended complaint naming the Agency, the NJSCC and the DEP as additional defendants in furtherance of this effort. On April 20, 2007, Sensient Colors Inc. filed its answer to the amended complaint, including cross claims against these newly added parties. The Company expects the DEP and the NJSCC to file answers to the complaint and cross claims in the near future. To the extent that there is a reduction in the condemnation value of the Property due to the Agency’s remediation of contamination for which Sensient Colors Inc. is allegedly responsible, such reduction may become a part of the damages claimed by plaintiff.

In late January 2006, the Company’s Sensient Flavors Inc. subsidiary and certain other flavor manufacturers, and a flavor industry trade association and its management company 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 the American Popcorn Company of Sioux City, Iowa, he was exposed to butter flavoring vapors that caused injury to his respiratory system. Ms. Kuiper’s claim is for loss of consortium. The allegations of this complaint are virtually identical to those contained in another complaint that was filed against Sensient Flavors Inc., involving another worker at the same facility. That lawsuit was ultimately settled and Sensient Flavors Inc. paid nothing to the plaintiff. The Company believes that plaintiffs’ claims are without merit and is vigorously defending this case. A motion for summary judgment has been filed and discovery is continuing. A trial ready date of November 5, 2007, has 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, 2006.

The information responsive to this item was provided in, and is incorporated by reference from, Item 4 of the Company’s quarterly report on Form 10-Q for the quarter ended March 31, 2007, filed on May 9, 2007.

See Exhibit Index following this report.