RESULTS OF OPERATIONS
SALES
Sales for the three months ended December 31, 2008 were $568.7 million, a decrease of $78.7 million, or 12.2 percent, from $647.4 million in the prior year quarter. The decrease in sales was due to 10 percent organic decline and 5 percent from unfavorable foreign currency effects partially offset by the net favorable impact of acquisitions and divestitures of 2 percent and more workdays of 1 percent. On a global basis, industrial production declined in contrast to the prior year quarter. Demand in most industry and market sectors weakened considerably in the latter half of the current year quarter.
Sales for the six months ended December 31, 2008 were $1,238.0 million, a decrease of $24.5 million, or 1.9 percent, from $1,262.5 million in the same period a year ago. The decrease in sales was primarily due to 3 percent organic decline partially offset by more workdays of 1 percent. Organic sales declined in all major metalworking markets except for Latin America and Asia Pacific. Organic sales increased in our advanced materials business primarily due to stronger sales of energy and related products as well as higher sales of mining and construction products partially offset by lower sales of engineered products.
GROSS PROFIT
Gross profit for the three months ended December 31, 2008 decreased $57.6 million, or 26.1 percent, to $163.3 million from $220.9 million in the prior year quarter. This decrease was primarily due to lower organic sales volume, reduced absorption of manufacturing costs due to lower production levels, unfavorable impact of foreign currency effects of $7.2 million, temporary disruption effects from restructuring programs, unfavorable business unit mix as well as restructuring and related charges of $3.9 million. Improved price realization more than offset the impact of higher raw material costs and the net favorable impact of acquisitions and divestitures was $7.4 million for the current quarter.
Gross profit margin for the three months ended December 31, 2008 was 28.7 percent, down 540 basis points from 34.1 percent in the prior year quarter. The change from the prior year quarter was primarily due to reduced absorption of manufacturing costs due to lower production levels, temporary disruption costs from restructuring programs as well as the unfavorable impact of restructuring and related charges of 70 basis points and less favorable business unit mix partially offset by the net favorable impact of improved price realization.
Gross profit for the six months ended December 31, 2008 decreased $50.9 million, or 11.8 percent, to $382.1 million from $433.0 million in the prior year quarter. The decrease was primarily due to lower organic sales volume, reduced absorption of manufacturing costs due to lower production levels, temporary disruption effects from restructuring programs and less favorable business unit mix as well as restructuring and related charges of $4.6 million. Improved price realization more than offset the impact of higher raw material costs, whereas the net favorable impact of acquisitions and divestitures was $6.7 million and foreign currency effects were favorable by $4.1 million for the current period. Gross profit margin for the six months ended December 31, 2008 was 30.9 percent, down 340 basis points from 34.3 percent in the prior year period. The change from the prior year period was primarily due to reduced absorption of manufacturing costs due to lower production levels, temporary disruption costs from restructuring programs and the unfavorable impact of restructuring and related charges of 30 basis points as well as less favorable business unit mix partially offset by the net favorable impact of price realization.
OPERATING EXPENSE
Operating expense for the three months ended December 31, 2008 was $130.3 million, a decrease of $17.6 million, or 11.9 percent, compared to $147.9 million in the prior year quarter. The decrease is attributable to an $11.8 million decrease in employment expenses driven by lower provisions for employee incentive compensation programs, favorable impact of foreign currency effects of $6.4 million and the impact of other cost reductions of $3.2 million offset somewhat by the net unfavorable impact of acquisitions and divestitures of $3.8 million.
Operating expense for the six months ended December 31, 2008 was $284.0 million, a decrease of $9.0 million, or 3.0 percent, compared to $293.0 million in the prior year period. The decrease is attributable to a $10.6 million decrease in employment expenses driven by lower provisions for employee incentive compensation programs as well as the impact of other cost reductions of $2.7 million offset somewhat by the net unfavorable impact of acquisitions and divestitures of $3.2 million and unfavorable foreign currency effects of $1.2 million.

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

RESTRUCTURING CHARGES
As previously announced, the Company continued to implement certain restructuring plans to reduce costs and improve efficiency in our operations. The actions taken in 2009 related to facility rationalizations and employment reductions. For the three and six months ended December 31, 2008, we recorded restructuring charges of $6.2 million and $14.6 million, respectively. For the three months ended December 31, 2008, restructuring charges for MSSG and AMSG were $4.5 million and $1.7 million, respectively. For the six months ended December 31, 2008, restructuring charges for MSSG, AMSG and Corporate were $11.2 million, $2.9 million and $0.5 million, respectively. See Note 5 to our condensed consolidated financial statements set forth in Part 1 Item 1 of this Form 10-Q.
The actions being taken pursuant to our restructuring plans are expected to be completed over the next six to nine months. The restructuring and related charges recorded through December 31, 2008 were $27.5 million. Including these charges, the company expects to recognize approximately $90 million of pre-tax charges related to its restructuring plans. Approximately 95 percent of these charges are expected to be cash expenditures. Annual ongoing benefits from these actions, once fully implemented, are expected to be approximately $100 million.
AMORTIZATION OF INTANGIBLES
Amortization expense was $3.3 million for the three months ended December 31, 2008, a decrease of $0.3 million from $3.6 million in the prior year quarter. Amortization expense was $6.7 million for the six months ended December 31, 2008, an increase of $0.1 million from $6.6 million in the prior year period.
INTEREST EXPENSE
Interest expense for the three months ended December 31, 2008 of $8.0 million decreased $0.5 million, or 5.9 percent, from $8.5 million in the prior year quarter. The impact of an increase in average domestic borrowings of $195.0 million was more than offset by the impact of a 220 basis point decrease in average interest rates on domestic borrowings. The increase in these borrowings was driven by first quarter share repurchases for $127.5 million and a cash outlay of $65.0 million in the second quarter for a business acquisition. Interest expense for the six months ended December 31, 2008 of $15.1 million decreased $1.2 million, or 7.3 percent, from $16.3 million in the prior year period. The impact of an increase in average domestic borrowings of $153.0 million due to the factors discussed above was more than offset by the impact of a 220 basis point decrease in average interest rates on domestic borrowings.
OTHER INCOME, NET
Other income, net for the three months ended December 31, 2008 and 2007 was $4.8 million and $1.0 million, respectively. The change was primarily driven by favorable foreign currency transaction results of $2.4 million. Other income, net for the six months ended December 31, 2008 and 2007 was $3.4 million and $2.1 million, respectively. The change was primarily driven by an increase in interest income of $1.2 million.
INCOME TAXES
The effective income tax rate for the three months ended December 31, 2008 and 2007 was 23.2 percent and 17.3 percent, respectively. The increase in the rate from the prior year was primarily the result of the impacts of restructuring and related charges in the current year and a benefit in the prior year associated with a dividend reinvestment plan in China. The impact of these items was partially offset by a benefit in the current quarter from the completion of a routine income tax examination for certain prior fiscal years.
The effective income tax rate for the six months ended December 31, 2008 and 2007 was 20.3 percent and 27.1 percent, respectively. The decrease in the rate from the prior year was driven by a non-cash income tax charge related to a German tax reform bill that adversely impacted the prior year, the release of a valuation allowance in Europe in the first quarter of the current year, and a benefit in the current year from the completion of a routine income tax examination for certain prior fiscal years. The impact of these items was partially offset by the impact of restructuring and related charges in the current year.

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

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, including performance-based bonuses and stock-based compensation expense, and eliminations of operating results between segments.

METALWORKING SOLUTIONS & SERVICES GROUP

                                   Three Months Ended           Six Months Ended
                                      December 31,                December 31,
           (in thousands)          2008          2007          2008          2007

           External sales       $ 344,630     $ 434,733     $ 775,916     $ 842,430
           Intersegment sales      36,353        39,186        87,043        82,317
           Operating income         7,827        61,986        51,138       117,338

For the three months ended December 31, 2008, MSSG external sales decreased $90.1 million, or 20.7 percent, from the prior year quarter. This decrease was the result of an organic sales decline of 15 percent, unfavorable foreign currency effects of 5 percent and 1 percent from the impact of divestitures. On a global basis, industrial production declined in contrast to the prior year quarter. Demand in most industry and market sectors weakened considerably in the latter half of the current year quarter. On a regional basis, Europe, India and North America reported organic sales declines of 17 percent, 17 percent and 16 percent, respectively, for the current year quarter. Asia Pacific and Latin America also experienced organic sales declines of 9 percent and 2 percent, respectively.
For the three months ended December 31, 2008, MSSG operating income decreased $54.2 million, or 87.4 percent, from the prior year quarter. Operating margin on total sales was 2.1 percent for the current quarter as compared to 13.1 percent in the prior year quarter. The primary drivers of the decline in operating margin were reduced absorption of manufacturing costs due to lower production levels and temporary disruption effects related to restructuring initiatives as well as restructuring and related charges of $7.3 million. The impact of recent price increases essentially offset the effect of higher raw material costs. For the six months ended December 31, 2008, MSSG external sales decreased $66.5 million, or 7.9 percent, from the prior year period. This decrease was the result of an organic sales decline of 8 percent and 1 percent from the impact of divestitures partially offset by the favorable impact of more workdays of 1 percent. On a regional basis, North America, Europe and India reported organic sales declines of 12 percent, 8 percent and 6 percent, respectively for the current period. Asia Pacific and Latin America experienced organic sales growth of 6 percent and 3 percent, respectively, for the same period.
For the six months ended December 31, 2008, MSSG operating income decreased $66.2 million, or 56.4 percent, from the prior year period. Operating margin on total sales was 5.9 percent for the current period as compared to 12.7 percent in the prior year period. The primary drivers of the decline in operating margin were reduced absorption of manufacturing costs due to lower production levels and temporary disruption effects related to restructuring initiatives as well as restructuring and related charges of $14.5 million. The impact of recent price increases nearly offset the effect of higher raw material costs.

ADVANCED MATERIALS SOLUTIONS GROUP

                                   Three Months Ended           Six Months Ended
                                      December 31,                December 31,
           (in thousands)          2008          2007          2008          2007

           External sales       $ 224,054     $ 212,690     $ 462,033     $ 420,069
           Intersegment sales       4,662         9,695        11,615        20,548
           Operating income        19,437        27,197        49,427        57,177

For the three months ended December 31, 2008, AMSG external sales increased $11.4 million, or 5.3 percent, from the prior year quarter. This increase was the result of 8 percent from the impact of acquisitions partially offset by 3 percent from unfavorable foreign currency effects. Organic sales were flat as increased mining and construction sales and higher energy-related sales were offset by lower sales of engineered products.

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

For the three months ended December 31, 2008, AMSG operating income decreased $7.8 million, or 28.5 percent, from the prior year quarter. Operating margin on total sales was 8.5 percent in the current quarter as compared to 12.2 percent in the prior year quarter. The decline was primarily due to restructuring and related charges of $2.8 million, unfavorable business mix and lower performance in the engineered products business. Improved price realization more than offset the impact of higher raw material costs.
For the six months ended December 31, 2008, AMSG external sales increased $42.0 million, or 10.0 percent, from the prior year period. This was the result of 5 percent organic growth, 4 percent from the favorable impact of acquisitions and 1 percent from more workdays. Organic sales increased due to stronger energy-related and mining and construction product sales, offset somewhat by lower sales of engineered products.
For the six months ended December 31, 2008, AMSG operating income decreased $7.8 million, or 13.6 percent, from the prior year period. Operating margin on total sales was 10.4 percent in the current period as compared to 13.0 percent in the prior year period. This decline was primarily due to restructuring and related charges of $4.2 million, unfavorable business mix and lower performance in the engineered products business. Improved price realization more than offset the impact of higher raw material costs for the current period.
CORPORATE

Three Months Ended Six Months Ended December 31, December 31, (in thousands) 2008 2007 2008 2007

Operating loss $ (3,770 ) $ (19,792 ) $ (23,796 ) $ (41,010 )

For the three months ended December 31, 2008, operating loss decreased $16.0 million, or 81.0 percent, compared to the prior year quarter, primarily due to lower provisions for employee incentive compensation programs. For the six months ended December 31, 2008, operating loss decreased $17.2 million, or 42.0 percent, compared to the prior year period, primarily due to lower provisions for employee incentive compensation programs and the impact of continued 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 December 31, 2008, we had cash and cash equivalents of $69.7 million. Also at December 31, 2008, we had remaining borrowing capacity of $324.9 million available under our multi-currency, revolving credit line which extends to March 2011. Our current senior credit ratings are at 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 six months ended December 31, 2008, cash flow provided by operating activities was $115.5 million, compared to $68.9 million for the prior year period. Cash flow provided by operating activities for the current year period consisted of net income and non-cash items totaling $108.2 million and changes in certain assets and liabilities netting to $7.3 million. Contributing to these changes were a decrease in accounts receivable of $113.2 million partially offset by a decrease in accounts payable and accrued liabilities of $78.8 million due in part to a $14.3 million payment of 2008 performance-based bonuses, and an increase in inventories of $24.2 million.
During the six months ended December 31, 2007, cash flow provided by operating activities was $68.9 million and consisted of net income and non-cash items totaling $144.9 million offset somewhat by changes in certain assets and liabilities netting to $76.0 million. Contributing to these changes were a decrease in accounts payable and accrued liabilities of $60.7 million partially driven by a $15.1 million payment of 2007 performance-based bonuses, an increase in inventories of $39.9 million due to higher raw material prices and initiatives to increase service levels, and a decrease in accounts receivable of $45.5 million.

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

Cash Flow Used for Investing Activities
Cash flow used for investing activities was $132.2 million for the six months ended December 31, 2008, an increase of $66.8 million, compared to $65.4 million in the prior year period. During the six months ended December 31, 2008, cash used for investing activities included $68.7 million used for purchases of property, plant and equipment, which consisted primarily of equipment upgrades, and $65.4 million used for the acquisition of business assets. For the six months ended December 31, 2007, cash flow used for investing activities was $65.4 million and included $79.6 million used for purchases of property, plant and equipment, which consisted primarily of equipment upgrades and geographical expansion, partially offset by proceeds from the sale of investments in affiliated companies of $5.9 million and proceeds from divestitures of $3.0 million.
Cash Flow Provided by Financing Activities Cash flow provided by financing activities was $25.9 million for the six months ended December 31, 2008, an increase of $22.0 million, compared to $3.9 million in the prior year period. During the six months ended December 31, 2008, cash flow provided by financing activities included a $163.7 million net increase in borrowings and $3.8 million of dividend reinvestment and the effect of employee benefit and stock plans partially offset by $127.5 million used for the repurchase of capital stock and $17.9 million of cash dividends paid to shareowners.
During the six months ended December 31, 2007, cash flow provided by financing activities was $3.9 million and included a $65.2 million net increase in borrowings and $11.9 million of dividend reinvestment and the effect of employee benefit and stock plans, mostly offset by $55.4 million for the repurchase of capital stock and $17.5 million of cash dividends paid to shareowners.
FINANCIAL CONDITION
At December 31, 2008, total assets were $2,625.4 million having decreased $158.9 million from $2,784.3 million at June 30, 2008. Total liabilities increased $60.6 million from $1,114.9 million at June 30, 2008 to $1,175.5 million at December 31, 2008.
Working capital was $590.9 million at December 31, 2008, a decrease of $39.8 million or 6.3 percent from $630.7 million at June 30, 2008. The decrease in working capital included a decrease in accounts receivable of $145.4 million, a decrease in accounts payable of $60.3 million and a decrease in accrued expenses of $31.2 driven partially by the payment of 2008 performance-based bonuses of $14.3 million. Foreign currency effects accounted for $42.4 million, $8.9 million and $9.8 million of the decreases in accounts receivable, accounts payable and accrued liabilities, respectively.
Property, plant and equipment, net decreased $13.8 million from $749.8 million at June 30, 2008 to $736.0 million at December 31, 2008, primarily due to the unfavorable impact of foreign currency effects of $38.9 million and depreciation expense of $42.2 million partially offset by the impact from a business acquisition of $14.5 million and capital additions of $53.1 million. At December 31, 2008, other assets were $885.2 million, an increase of $2.6 million from $882.6 million at June 30, 2008. The primary drivers for the increase were an increase in goodwill and other intangible assets of $32.0 million due to a business acquisition and an increase in the fair value of derivative contracts of $13.7 million partially offset by unfavorable foreign currency effects of $42.9 million and amortization of intangible assets of $6.7 million
Long-term debt and capital leases increased $166.5 million from $313.1 million at June 30, 2008 to $479.6 million at December 31, 2008 primarily due to borrowings for the repurchase of capital stock during the September quarter of $127.5 million and cash used for the acquisition of business assets for the six months ended December 31, 2008 of $65.4 million.
Shareowners' equity was $1,430.7 million at December 31, 2008, a decrease of $217.2 million from $1,647.9 million at June 30, 2008. The decrease was primarily attributed to a reduction from foreign currency translation adjustments of $141.0 million, the purchase of capital stock of $127.5 million and cash dividends paid to shareowners of $17.9 million partially offset by net income of $51.1 million.

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

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 December 31, 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.
Other Environmental Issues We also maintain reserves for other potential environmental issues. At December 31, 2008, the total of these accruals was $5.2 million and represents anticipated costs associated with the remediation of these issues. We recorded favorable foreign currency translation adjustments of $0.8 million during the six months ended December 31, 2008 related to these reserves.
GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill represents the excess of cost over the fair value of acquired companies. Goodwill and intangible assets with indefinite lives are tested at least annually for impairment. We perform our annual impairment tests during the June quarter in connection with our annual planning process. We also perform specific impairment tests on an interim basis if we deem that a triggering event indicating impairment of the goodwill for a reporting unit or an indefinite-lived intangible asset may have occurred. We evaluate the recoverability of goodwill for each of our reporting units by comparing the fair value of each reporting unit with its carrying value. The fair values of our reporting units are determined using a combination of a discounted cash flow analysis and market multiples based upon historical and projected financial information. We apply our best judgment when assessing the reasonableness of the financial projections used to determine the fair value of each reporting unit. We evaluate the recoverability of indefinite-lived intangible assets using a discounted cash flow analysis based on projected financial information. This evaluation is sensitive to changes in market interest rates and other external factors.
A possible indicator of impairment is the relationship of a company's market capitalization to its book value. As of December 31, 2008, our market capitalization exceeded our book value. The persistence or further acceleration of the recent downturn in global economic conditions and turbulence in financial markets could have a further negative impact on our market capitalization and/or financial performance. Going forward, this could increase the likelihood of future non-cash impairment charges related to our goodwill or indefinite-lived intangible assets.
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 . . .