ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

OTHER EXPENSE (INCOME), NET
Other expense, net for the three months ended September 30, 2008 was $1.4 million compared to other income, net of $1.1 million in the prior year quarter. This change was driven by unfavorable foreign currency transaction results of $2.5 million and lower other income of $1.1 million, partially offset by higher interest income of $1.1 million.
INCOME TAXES
The effective income tax rate for the three months ended September 30, 2008 and 2007 was 19.0 percent and 37.7 percent, respectively. The prior year's rate was unfavorably impacted by a $6.6 million non-cash income tax charge related to a German tax law change which impacted the rate by 11.4 percent. The current year rate reflects a benefit from the release of a valuation allowance in Europe that was driven by further expansion of our Pan-European business strategy. On October 3, 2008, the Emergency Economic Stabilization Act of 2008 was enacted, which extended the Research Credit for Increasing Research Activities in the United States of America. Our subsequent filings will reflect the impact of this legislation, which will have a slightly favorable impact on our effective tax rate.
BUSINESS SEGMENT REVIEW
Our operations are organized into two reportable operating segments consisting of Metalworking Solutions & Services Group (MSSG) and Advanced Materials Solutions Group (AMSG), and Corporate. The presentation of segment information reflects the manner in which we organize segments for making operating decisions and assessing performance. Corporate represents certain corporate shared service costs, employee benefit costs, employment costs, such as performance-based bonuses and stock-based compensation expense, and eliminations of operating results between segments.

METALWORKING SOLUTIONS & SERVICES GROUP

                                             Three months ended
                                                September 30
                     (in thousands)          2008          2007

                     External sales       $ 431,286     $ 407,697
                     Intersegment sales      50,690        43,131
                     Operating income        43,311        55,352

For the three months ended September 30, 2008, MSSG external sales increased $23.6 million, or 5.8 percent, from the prior year quarter. This increase was the result of 6 percent from favorable foreign currency effects, 2 percent from more workdays, less 2 percent from divestitures. On a global basis, industrial activity was mixed. Activity in certain industry and market sectors, such as aerospace, defense and energy, remained positive while others, such as automotive and other durable goods, were somewhat weaker. MSSG achieved organic sales growth of 22 percent in Asia Pacific, 7 percent in Latin America, 6 percent in India and 2 percent in Europe. This growth offset a reduction in North American organic sales of 8 percent primarily attributed to a decline in distribution sales that resulted from our distributors' increased reliance on our higher fill rates as well as the overall economic environment. For the three months ended September 30, 2008, MSSG operating income decreased $12.0 million, or 21.8 percent, from the prior year quarter. Operating margin on total sales of 9.0 percent for the current quarter decreased 330 basis points compared to 12.3 percent in the prior year quarter. The primary drivers of the decline in operating margin were restructuring and related charges of $7.2 million, temporary disruption effects related to restructuring initiatives and higher raw material costs offset somewhat by benefits from price increases and favorable foreign currency effects.

ADVANCED MATERIALS SOLUTIONS GROUP

                                             Three months ended
                                                September 30
                     (in thousands)          2008          2007

                     External sales       $ 237,979     $ 207,379
                     Intersegment sales       6,953        10,853
                     Operating income        29,990        29,980

For the three months ended September 30, 2008, AMSG external sales increased $30.6 million, or 14.8 percent, from the prior year quarter. This was the result of 10 percent organic growth, 3 percent from favorable foreign currency effects and 2 percent from more workdays. Organic sales increased on stronger mining and construction sales and higher energy-related sales, offset somewhat by lower sales of engineered products and surface finishing machines and services.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

For the three months ended September 30, 2008, AMSG operating income was flat compared to the prior year quarter. Operating margin on total sales of 12.2 percent for the current quarter decreased 150 basis points compared to 13.7 percent in the prior year quarter. This decline is primarily due to restructuring and related charges of $1.4 million, unfavorable business mix and lower performance related to the engineered products and surface finishing machines and services businesses. Improved price realization more than offset the impact of higher raw material costs for the current quarter.
CORPORATE

Three months ended September 30 (in thousands) 2008 2007

Operating loss $ (20,026 ) $ (21,218 )

For the three months ended September 30, 2008, operating loss decreased $1.2 million, or 5.6 percent, compared to the prior year quarter, primarily due to the impact of cost containment efforts.
LIQUIDITY AND CAPITAL RESOURCES
Despite the recent unprecedented turmoil in the global financial markets, we continue to believe that cash flow from operations and the availability under our credit lines will be sufficient to meet our cash requirements for the foreseeable future. At September 30, 2008, we had cash and cash equivalents of $68.9 million. Also at September 30, 2008, we had additional borrowing capacity of $346.3 million available under our multi-currency, revolving credit line which extends to March 2011. Our current credit ratings are at solid investment grade levels. We believe that our current financial position, liquidity and credit ratings provide access to the capital markets. We continue to closely monitor our liquidity position and the condition of the capital markets as well as the counterparty risk of our credit providers.
There have been no material changes in our contractual obligations and commitments since June 30, 2008.
Cash Flow Provided by Operating Activities Cash flow from operations is our primary source of financing for capital expenditures and internal growth. During the three months ended September 30, 2008, cash flow provided by operating activities was $38.0 million, compared to $56.9 million for the prior year period. Cash flow provided by operating activities for the current year quarter consisted of net income and non-cash items totaling $62.5 million offset somewhat by changes in certain assets and liabilities netting to $24.5 million. Contributing to these changes were a decrease in accounts payable and accrued liabilities of $24.1 million, due in part to a $14.3 million payment of 2008 performance-based bonuses, and an increase in inventories of $26.9 million due to higher raw material costs, partially offset by a decrease in accounts receivable of $27.9 million. Cash flow provided by operating activities for the three months ended September 30, 2007 consisted of net income and non-cash items totaling $68.7 million offset somewhat by changes in certain assets and liabilities netting to $11.8 million. Contributing to these changes were a decrease in accounts receivable of $30.7 million, an increase in inventories of $29.4 million due to higher sales volume, initiatives to increase service levels and increased raw material inventory and a decrease in accounts payable and accrued liabilities of $18.9 million driven by a $15.1 million payment of 2007 performance-based bonuses.
Cash Flow Used for Investing Activities
Cash flow used for investing activities was $43.6 million for the three months ended September 30, 2008, an increase of $12.2 million, compared to $31.4 million in the prior year quarter. During the three months ended September 30, 2008, cash used for investing activities included $44.6 million used for purchases of property, plant and equipment, which consisted primarily of equipment upgrades.
During the three months ended September 30, 2007, cash used for investing activities included $42.7 million used for purchases of property, plant and equipment, which consisted primarily of equipment upgrades, partially offset by proceeds from the sale of an equity investment of $5.4 million, proceeds from divestitures of $3.0 million and $1.6 million of post-closing purchase price adjustments related to the acquisition of business assets. Cash Flow Provided by / Used for Financing Activities During the three months ended September 30, 2008, cash flow provided by financing activities was $4.1 million and included a $134.3 million net increase in borrowings and $3.4 million of dividend reinvestment and the effect of employee benefit and stock plans mostly offset by $127.3 million used for the repurchase of capital stock and $9.2 million of cash dividends paid to shareowners.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

During the three months ended September 30, 2007, cash flow used for financing activities was $12.0 million and included $15.9 million for the repurchase of capital stock and $8.2 million of cash dividends paid to shareowners, partially offset by $7.1 million of dividend reinvestment and the effect of employee benefit and stock plans.
FINANCIAL CONDITION
At September 30, 2008, total assets were $2,678.2 million having decreased $106.1 million from $2,784.3 million at June 30, 2008. Total liabilities increased $77.1 million from $1,114.9 million at June 30, 2008 to $1,192.0 million at September 30, 2008.
Working capital was $626.9 million at September 30, 2008, a decrease of $3.8 million or 0.6 percent from $630.7 million at June 30, 2008. The decrease in working capital included a decrease in accounts receivable of $55.6 million, a decrease in accounts payable of $32.0 million and a decrease in accrued expenses of $22.5 driven by the payment of fiscal 2008 performance-based bonuses of $14.3 million. Foreign currency effects accounted for $26.9 million and $15.5 million of the decreases in accounts receivable and accrued liabilities, respectively.
Property, plant and equipment, net decreased $20.7 million from $749.8 million at June 30, 2008 to $729.1 million at September 30, 2008, primarily due to a reduction from foreign currency effects of $29.2 million and depreciation expense of $21.3 million partially offset by capital additions of $31.8 million related to machinery and equipment upgrades and geographic expansion. At September 30, 2008, other assets were $857.1 million, a decrease of $25.5 million from $882.6 million at June 30, 2008. The decrease in other assets was primarily attributed to a decrease in goodwill and intangible assets of $26.6 million caused mostly by unfavorable foreign currency effects of $23.6 million.
Long-term debt and capital leases increased $135.1 million from $313.1 million at June 30, 2008 to $448.2 million at September 30, 2008 primarily due to borrowings for the repurchase of capital stock during the current quarter of $127.3 million.
Shareowners' equity was $1,465.8 million at September 30, 2008, a decrease of $182.1 million from $1,647.9 million at June 30, 2008. The decrease was primarily attributed to the purchase of capital stock of $127.3 million and a reduction from foreign currency translation adjustments of $92.7 million partially offset by net income of $35.5 million.
ENVIRONMENTAL MATTERS
We are subject to various U.S. Federal, state and international environmental laws and regulatory requirements and are involved from time to time in investigations or proceedings of various potential environmental issues concerning activities at our facilities or former facilities or remediation efforts as a result of past activities (including past activities of companies we have acquired). From time to time, we receive notices from the U.S. Environmental Protection Agency or equivalent state or international environmental agencies that we are a potentially responsible party (PRP) under the Comprehensive Environmental Response, Compensation and Liability Act (commonly known as the "Superfund Act") and/or equivalent laws. These notices assert potential liability for cleanup costs at various sites, which include sites owned by us, sites we previously owned and treatment or disposal sites not owned by us.
Superfund Sites We are involved as a PRP at several Superfund sites, and have responded to notices for other Superfund sites as to which our records disclose no involvement or for which predecessors of certain of our acquired companies have acknowledged responsibility. We have established reserves that we believe to be adequate to cover our share of the potential costs of remediation at certain of the Superfund sites; at September 30, 2008 the total of these accruals was $0.2 million. For the remaining Superfund sites, proceedings in those matters have not yet progressed to a stage where it is possible to estimate the ultimate cost of remediation, the timing and extent of remedial action that may be required by governmental authorities or the amount of our liability alone or in relation to that of any other PRPs. Although the outcome of the pending Superfund claims cannot be predicted with certainty, management does not believe that the resolution of these claims will have a material adverse effect on our financial condition, results of operations or cash flows. Other Environmental Issues We also maintain reserves for other potential environmental issues. At September 30, 2008, the total of these accruals was $5.4 million, and represents anticipated costs associated with the remediation of these issues. We recorded favorable foreign currency translation adjustments of $0.6 million during the three months ended September 30, 2008 related to these reserves.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

DISCUSSION OF CRITICAL ACCOUNTING POLICIES
There have been no material changes to our critical accounting policies since June 30, 2008.
NEW ACCOUNTING STANDARDS
See Note 3 to our condensed consolidated financial statements set forth in Part 1 Item 1 of this Form 10-Q for a description of new accounting standards.