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CLARCOR Inc. (NYSE:CLC)

F3Q09 Earnings Call

September 17, 2009; 11:00 am ET

Executives

Norman Johnson - Chief Executive Officer and President

Bruce Klein - Chief Financial Officer

Tom Lawrence - Dye Van Mol & Lawrence

Analysts

Kevin Maczka - BB&T Capital Markets

Rick Eastman - Robert W. Baird

Jeff Hammond - KeyBanc Capital Market

Adam Brook - Sidoti & Co.

Brian Drab - William Blair

David Lebowitz - Horizon Asset Management

Operator

Good morning ladies and gentlemen, and thank you for standing by. Welcome to the CLARCOR Inc third quarter earnings conference call. (Operator Instructions) It is now my pleasure to turn the conference over to Tom Lawrence of Dye Van Mol & Lawrence, please go ahead Mr. Lawrence.

Tom Lawrence

Thank you and good morning. We appreciate your interest in joining us on CLARCOR’s conference call to discuss results for the third quarter and first nine months of 2009. By now everyone should have received a copy of the press release that was distributed yesterday. If anyone does need a copy, it is available on CLARCOR’s website at www.clarcor.com, or you can call Shay Jones at 615-244-1818 and she will send you a copy immediately.

Before I turn the call over to Norm Johnson, CLARCOR’s Chairman and CEO, I remind you that all statements made in the press release and during this conference call, other than statements of historical fact, are forward-looking statements. These statements are made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995.

The company believes that its expectations are based on reasonable assumptions; however, these forward-looking statements involve known and unknown risks, uncertainties, and other important factors that could cause the company’s actual results, performance or achievements or industry results to differ materially from the company’s expectations of future results, performance or achievements expressed or implied by these forward-looking statements. In addition, the company’s past results of operations do not necessarily indicate its future results.

Finally, we wanted to let people know that the information statements made during the call are made as of the date of the call, September 17, 2009. Those listening to any replay should understand that the passage of time by itself will diminish the quality of the statements. Also, the contents of the call are the property of the company and the replay or transmission of the call maybe done only with the consent of CLARCOR.

It’s now my pleasure to turn the call over to Norm Johnson for his opening remarks.

Norman Johnson

Thanks Tom. Good morning and thank you for joining us today. With me are Bruce Klein, our CEO; [Dave Fallon] Vice President of Finance and Kim Orr, Vice President and Treasurer. Bruce is going to begin with a review of the quarter, and then I will discuss our outlook for the future.

Bruce Klein

Thanks Norm. As we expected, our third quarter this year was better than either of our first two quarters. It was still below last year’s results. In fact with lower earnings compared to last year, we were pleased with the quarter.

Gross margins not only improved to 32.1% which is better than either of the first two quarters this year, it was actually higher than the third quarter in 2008. Similarly, even as quarter sales have increased in the first quarter of this year to the third quarter, SG&A in dollars in the third quarter was the lowest of any quarter in 2009.

Most of our markets record lowest sales than last year, but it does appear that the bottom has been reached in our major markets based upon daily sales and order rates for August in the first two to three weeks of the first quarter. We expect the fourth quarter to record highest sales in operating profits than we’ve reported in the third quarters, though not significantly better.

Many of our major markets reported sales declines compared to the third quarter last year. In our Engine/Mobile market, the sales declines were roughly same for over-the-road trucking, agriculture, mining and construction markets, with a somewhat lower drop in sales of locomotive structures. Even though in 2009 we had experienced a first sales decline in these markets in many years, we expect to maintain our operating margins for 2009 in this segment above 20%.

Our Engine/Mobile Filtration companies are very efficient manufacturers and can be found quickly the changes in product demand. Also has been the case for many years, the aftermarket tends to be more stable in both good and bad economic periods, so even a mid-teen sales decline is still usually better than sales to OEM customers in recession. Our Engine/Mobile’s customer base is very diverse with many thousands of customers, both large and small.

We still primarily saw aftermarket structures in our industrial environmental segment as well. That segment does sell more of one-use of permanent filter product Engine/Mobile segment. For example, in general sales as well as used in offshore drilling, are normally one-time sales with a smaller aftermarket component. A drop in oil prices has led to a decline in oil drilling and resulted in a large drop of sales attached to this market in the third quarter.

Though it will not occur in the near term, we expect the sales drop in oil drilling filters to reverse. We specialize in filters using offshore drilling for very harsh environment. It generally means deep wells, and unusually high pressures. In the recent oil finds of Brazil, in the Gulf of Mexico and certain areas off the coast of Africa and in the North Sea, it requires our type of oil drilling filters.

Sales of Aerospace filters which are sort of used on airplanes, had held up well this year until the third quarter where we saw sales decline of approximately 30% compared to last year. We expect the sales to continue to be lower than last year for the next several quarters, but gradually offsetting this will be the new certifications known as PMAs we are receiving from the FAA for our new further products. We have focused much more intensively over the last couple of years, the developing and obtaining as, and this is beginning to pay off for us.

Our portfolio of aerospace, such as PMAs is now the largest we have ever had. Thus Aviation fuel filters continue to grow, even with a drop in worldwide air travel. This is because we have won several voyages that air force throughout the world, for installations of new or standard aviation fuel systems. Once we install the systems, it’s usually the case that we continue to supply the aftermarket fuel filters to these airports as well.

Sales of natural gas filtration systems and such elements have remained steady for the first three quarters this year, despite a significant drop in natural gas prices. There are still many expansion projects in plan throughout the world for pipelines and transmission facilities. So we are beginning to see a drop in actual orders, even as request, the ports have remained robust.

This market tends to be more cyclical than most of our other markets, because it always can be very large, and it can affect the single quarter or year dramatically. That is why we have made a significant investment to grow the natural gas filter aftermarket, which is much more stable with higher margins in a natural gas filtrations aftermarket.

Our vessels include higher inventory availability, new marketing programs and particularly new product such as our new fiber step, which is lower cost replacement for traditional fiber glass, natural gas filters. So we expect fourth quarter sales to be slightly down in the natural gas market compared to the third quarter, based on our current backlog. We expect this to turnaround 2010 and this is particularly true for the aftermarket portion of the business.

In our press release we discussed the current status of our HVAC business, and particularly sales of the large retail store chain we first mentioned last quarter. This program is going very well. We have not heard yet that we’ll [reward] other regions by the chain. I should note that 3M of the company we replaced in the pilot program as a retail store chain. 3M, since they found us, they were no longer by residential HVAC project from us.

We had noted in the release that the current annual sales of 3M were $15 million to $18 million, and this was down from approximately $35 million a few years ago. We expect that if we had kept 3M as a customer, sales would have continued to decline in future years anyway. 3M had decided to move filters. We have a project from our U.S. manufacturing plants into one of their plants in Mexico.

We’re going next to our raw material prices. We are seeing increasing prices for certain grades of steel. So they are not significant to our input cost at this time. We are watching this closely, and as it becomes material, we expect to adjust our prices accordingly. For the third quarter of 2009, international sales in dollars terms composite approximately 30% of CLARCOR’s total sales, about the same as in the third quarter last year.

Briefly regarding financial issues, our cash flow continues to be very strong and we expect the same in the fourth quarter. Capital expenditures will pickup in the four quarter compared to the first three quarters of 2009, while we still expect free cash flow to be much higher this year than it was in 2008. Our capital investment this year has been focused on many a development, new product and spends on technical facilities.

Our tax rate in the fourth quarter should be a little over than it was in the third quarter. We did purchase shares of our common stock in the third quarter when the stock price dropped a little to $3 per share, and we will continue to review future share repurchases depending upon the share price and our cash flow. We also paid down some of our outstanding bank debt during the quarter, and we expect to do that in the fourth quarter as well.

Norman, Thank you.

Norman Johnson

Thanks Bruce. Before asking your questions, I want to briefly comment on our outlook for the markets we serve. The good news is, we do see some signs of a stake recovery and only have two months left in our fiscal 2009. It would be nice to have this year behind us. For us the downturn began in December of 2008. Sales fell off the cliff and it was our worst month from a percentage sales decline, in my time with the company. I will be the first to admit, we did not anticipate the recession would be as severe as it has been.

We have developed a contingency plan for a 15% sales decline and implemented at the beginning of the year, reducing costs as quickly as we could throughout the organization. These cost reductions and productivity improvements, contributed to our gross margin percentage increasing in the third quarter in spite of lower sales compared to last year, and lower end management selling expenses.

As I told you on previous calls, we’ve made the decision not to reduce our sales, customer service and new product development efforts. We still believe this is a good decision. We will spend more money on new product development in 2009 and in any year of our history. We are well positioned for the future with new products, our strengthened sales force and strong financial position.

We expect to generate $75 million of free cash flow this year, after dividends, capital expenditures, giving us the ability to finance future growth, make acquisitions and buyback stock. Over the years, we’ve had a fairly consistent track record of meeting or exceeding earnings expectation. While it was the course for the third quarter, we did lower our guidance for the remainder of the year, which I will explain later.

As you would expect, we have seen a dramatic difference in the sales of our recurring revenue business compared to first step related. While our sale, operating profits and earnings have improved sequentially every quarter of this year, we still do not see getting back to 2008 levels for at least the next several quarters. While lower, our Engine/Mobile business is held up fairly well. Sales are down 17%, but we have been able to maintain operating margins that nearly 20% to aggressive cost reduction action.

We do see some improvement in the transportation markets, and in the fourth quarter we are projecting a sales decline of 10% for the segment, which is where you’ll see sequential improvement over the first nine months and will be our best quarter compared to the prior year. We have also seen the operating margins in this segment improve sequentially from 15.6% in the first quarter, to 22.7% this quarter.

You may have seen the recent comment from Warren Buffett, “that if people around a Desert Island can only have one piece of information to engage in the economy, what would it be?” he said freight data. As the leading suppliers to the hovers of freight, where there’d be a truck, train, air freight, is the key driver of our business. We will be encouraged by the recent comments from FedEx and Best Buy regarding seeing an upturn.

So far this month our orders are tracking on increased numbers, I previously mentioned. From our experience, engine aftermarket sales lag the economy, and that our customers typically put yields back in service, which is in-part before doing maintenance; nevertheless, the signs have gone from being negative to slightly positive.

Our sales changes on the international side of the business are a mixed tag. Sales and local currency are down in Europe and China, but up in Australia and South Africa. Mexico is a star with a 30% year-to-date increase. While sales breakdown in China as a result of our business being much more set there and our other companies around the world, profits are up as the new management team has taken over the day-to-day responsibility for running the business, now that we own 100%.

In China we have a first step business with over 30 OEM. Our plants remain to grow that OEM business in Asia, as well as increase aftermarket sales and independent distributor in always service channel. We believe we are increasing market share in most places in the world and our sales will be starved in the fourth quarter than in previous quarters. We still need to strengthen the economy though if I were to really increase in our Engine/Mobile business over 2008 levels.

Our Industrial/Environmental business is more complicate to explain as we severed more end use markets. The good news is, CLC Air made money for the quarter, although not as much as we predicted and we’ll be profitable for the fourth quarter. As we communicated last quarter and Bruce discussed, we did receive the business from major retailer for the high-end residential HVAC filters. We are test marketing our Purolator brand filters and feedback we received from them, is a test is going very well. We fully expect to gain additional business from them and other customers.

As most of you know, we had private branded HVAC filters for 3M for a number of years. For the last several years, 3M has significantly reduced their business with us. As a result of obtaining this new retail business, which they formally had, they made the decision to immediately start buying from us.

While we expected this to eventually happen, the quickness of the decision did come as a surprise. We immediately announced the closing of the plant that produced filters for them. The cost of closing the plant and the reduced sales will have an impact on the fourth quarter and is one another reasons we lowered guidance. In spite of this and as I said earlier, we will make money in the fourth quarter.

We continue to believe we made the right decision to market our own branded products that it is the more profitable business and we are much more controlled by our own industry. We do expect to gain a couple of more regions from our current customer or business with new customers, which will more than offset the loss of the business from 3M.

To be conservative, since we just mapped and told, we will get any of this additional business, we’ve not included anything in the guidance we provided you. The net impact is a timing problem. We expect the future to be strong before retail HVAC’s there, but we will correct the cost for the panels for the year as we transition from private-label manufacturing to our own Purolator brand.

The two end-use markets, which will have the largest negative impact on us in 2009 are dust collectors and offshore oil and drilling. Sales in both of these businesses are down more than 50% and profits even more. We do expect both from recovery as we introduce new products and expand around the world. We again will return to double digit profit margin, also good markets and obviously the world needs cleaner air and more oil.

The business that it’s held up the most instead of last year is our plastic company which serves the aviation, fuel, pollution control and waste water markets. I think our acquisition has positioned us as the leading filtration company in the natural gas industry. The price of natural gas is at an all time low, and nearly $3 per million Btu and the amount stored is in the all the time high. Maybe you don’t see conditions sprinkling to later next year.

Given this scenario, we see global capital spending to be about flat with last year and our aftermarket business still able to grow as we increase market share with new products and distribution.

Productivity is still robust, but margins are under pressure. We are still remain very optimistic about the natural gas business and we’ll continue to be pipeline investments, maybe to transport gas from new discovers in Pennsylvania, Arkansas, Louisiana, Australia and offshore Brazil to name a few. Our business will grow in this segment with these new discoveries and as natural gas becomes even more widely used.

In the third quarter our Industrial/Environmental operating profit margin was 6.9%; sort of our long term goal of 10%, but it’s still higher than the 5.8% we made in the third quarter of 2007. While we’d obviously rather be at 10% we’d also use our clinical thermal, which has been impacted by the loss of 3M business and the downturn in the economy. I am extremely confident we will exceed our profit expectation for this segment as the economy improves.

JL Clark, our packaging company, has performed very well and we expect that performance to continue as we had new products and customers. The JL Clark team has been very creative in expanding into new markets with their new packaging solution.

We did low our guidance for the year based on the unexpected cost we’ve incurred, as a result of our transitioning from selling our own brand in the HVAC market. The weaker economy than we were expected, lower sales in our first freight businesses and higher healthcare cost. In spite of this, margins have improved sequentially. We have exciting new business opportunity, and our balance sheet is stronger than ever. We are well positioned to weather any downturn, and capitalize on the upturn.

We will now be pleased to answer any questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Kevin Maczka - BB&T Capital Markets

Kevin Maczka - BB&T Capital Markets

Norm first question, on the Engine/Mobile margin is almost 23%. Is there any reason to think as the business stabilizes and ultimately grows again with the economy next year, that those shouldn’t maintain at those levels if not go higher?

Norman Johnson

Well, I wouldn’t want to project that they’re going to go any higher than the 23.7, because certainly the 23.7 is higher than we earned in the first two quarters, but yes, we’ve been answering that question now for nearly 20 years, that we’ve been able to maintain those margins over 20%.

So we certainly expect that to continue as we go our international business. Some of those locations have a little bit lower operating margin than we do in the rest of the world, but as we said, north of 20% is still our long term goal and we’re happy they are higher in this economy.

Kevin Maczka - BB&T Capital Markets

Then on the Purolator rollout Norm, can you give us an idea of the size of the opportunity there? I know you said $35 million is where that 3M business was for you, a few years back. Is that the size of the opportunity or is it much larger than that?

Norman Johnson

Well, it depends on how you want to define the size of the opportunity. Certainly the retail HVAC market, if you look at it from the high-end into the filters versus the lower 12-way filters, it probably approaches $1 billion.

Now we were just being very conservative, but we expect and we certainly know we have some very strong competitors and don’t expect to be the leader in the high end market, but we think we have some significant opportunities with the Purolator brand.

Kevin Maczka - BB&T Capital Markets

That's $35 million; that was 3M outsourcing the entire production of that product to you or was that just a piece of their….?

Norman Johnson

That was a piece of it.

Kevin Maczka - BB&T Capital Markets

So 3M’s business in that space isn’t larger than the $35 million?

Norman Johnson

I’m not going to comment on 3M. You can call them, but we’re just talking about what we did.

Operator

Your next question comes from Rick Eastman - Robert W. Baird.

Rick Eastman - Robert W. Baird

Norm or Bruce, could you just talk for a second or two about the Industrial/Environmental business? If you look at the business quarter-to-quarter, we made $2 million more in that business and a $5 million decline in sales in the quarter-to-quarter. can you just talk me through a little bit of where that incremental profit came from on that sales performance, was it all cost or mix or…?

Bruce Klein

Certainly we’re having the profit improvement, which the big one we’ve been talking about for a long time is in the CLC Air side of the business; that we’re finally making money in that business as one of the better ones. Also the mix on some of our more profitable aftermarket businesses, the sales have held up just as well. We’ve taken a lot of costs out as well, throughout that whole company.

Norman Johnson

Our aviation fuel business did really well and we all held the special sales in Germany as well, which helped the mix this quarter.

Rick Eastman - Robert W. Baird

In what area was that at?

Norman Johnson

That was within the facet organization.

Rick Eastman - Robert W. Baird

Then another question I have, we identified the plant closure as you talked about with 3M in Rockford. Could you just give us a sense of what kind of charge that you would need to put through for that business that went away in the fourth quarter? I mean is there a couple of million bucks or…?

Norman Johnson

No, it’s smaller that that. The charge we’re going to incur with respect to severance is a few hundred thousand dollars. So, that's a continuing leased expense that won’t end till probably the second quarter of next year.

Then probably the biggest number is simply we have to eliminate some of our fixed costs, because the business was absorbing some of our fixed costs, and that's going to take longer to eliminate entirely. I mean in total, I would guess the costs that we had to eliminate and that won’t happen over night is somewhere between $0.5 million and $1 million.

Rick Eastman - Robert W. Baird

So when I look at your guidance for the full year, it implies maybe a fourth quarter of $0.38 to $0.48. Later on in the press release you do talk about sales and operating profit being higher sequentially? Was that an attempt to maybe narrow the guidance for the fourth quarter to say $0.43 to $0.48?

Bruce Klein

Well, Rick it was an attempt to see how well you could add this…

Rick Eastman - Robert W. Baird

The last bit of that question would be, are there any charges in there that would maybe fall at the other expense line?

Norman Johnson

No. I think we tried to give the guidance. Obviously we tried to give a range, and mathematically, obviously you can say that if we’re going to beat the third quarter to where we are now, you can come up with a number. So we know if that’s going to be the number or not, but right now we feel comfortable at the range we’ve given you. Something else could obviously go wrong that we don’t know about it, or a few things can go right. I mean your math of 39 to 49 is correct the math of course, but we’ll see how it goes.

Operator

Your next question comes from Jeff Hammond - KeyBanc Capital Market.

Jeff Hammond - KeyBanc Capital Market

Just following up here on this retail opportunity, I guess two questions on it. Where would you need to take your direct to retail strategy from a revenue standpoint, to effectively replace what you’re loosing from this 3M business, at least on a profitability basis?

Then if you can maybe resize that $1 billion market to either this one retail customer you have or what your current capacity here is from a revenue standpoint, if you got as much business as you could handle?

Norman Johnson

As a result of ongoing discussions with 3M, I don’t remember commenting too much on the market size, but as I said before, that certainly being in control of our own destiny and the profit margins are higher, it would take less sales than we were getting from our former customer, selling directly into the retail market ourselves. In our expectations if we can meet our plans, then we will be stronger when this is all over, before going into it.

Jeff Hammond - KeyBanc Capital Market

When do you think you’d kind of reach a breakeven point?

Norman Johnson

That's hard to say, because as I said in my comments, and as we said in the second quarter press release, when we’re doing this trial, that certainly if they gave us a couple of more regions, we’d have the opportunity to reach it very quickly, but I would be disappointed that if on an annualized basis next year reach that number.

Jeff Hammond - KeyBanc Capital Market

Then what would you say your current capacity is for that type of business?

Norman Johnson

I’d say that this business is, that certainly we’ve been making air filters for Purolator and [Air Glider] are two legacy companies for 50 or 60 years, and a lot of the capabilities in this industry, we have ability to switch products from one line to another, so really capacity is not an issue. I mean we would be able to very quickly figure out how to meet all the demand that we could possibly be given.

Jeff Hammond - KeyBanc Capital Market

Then just, you mentioned a number of things that kind of impacted the lower guidance. Is there a way to kind of maybe put those in order of magnitude, or maybe talk about the one or two or three largest buckets of the revision?

Norman Johnson

Unfortunately, it’s a shame on us for this. We did anticipate the fourth quarter will come back stronger than we are now we projected, that would number one.

Number two, that we will have costs related to a transition into making the retail filters ourselves are certainly the two biggest ones. For example, as I said and as Bruce said as well, when you look at our dust collector business and our offshore oil drilling business, sales being down more than 50% and profits being down even more.

They’ve been historically very good profit margin businesses for us, and when we get the sales decline of that magnitude, which is really hitting us stronger in the fourth quarter, then we originally expected, that’s sort of a pretty big impact on the numbers.

The other big one, the third one is healthcare insurance that we started of at the year and we get a report actually every week on our healthcare claims. We were favorable less than last year, but that is really reversed throughout the year, and that’s our bigger cost and that’s the healthcare cost as a raw material. If you look at steel or any of the other things we buy, healthcare cost is the biggest cost increase we have.

Jeff Hammond - KeyBanc Capital Market

Then finally on share repurchase, I mean is it fair to say absent acquisitions, that’s kind of your primary use, and after the dividend primary use is share repo or is it more higher stock dips will come in and support it?

Norman Johnson

I’ll answer the question. I think we’ve answered historically. I remember one priority is to finance internal growth objectives which we’ve done this year more so than ever. Our second would be to make acquisitions. Third would be to maintain our dividend policy and certainly stock purchases, stock buybacks is something we look at all the time, but we don’t commit to doing it one way or another, but we certainly look at it.

Operator

Your next question comes from Adam Brook - Sidoti & Co.

Adam Brook - Sidoti & Co

Two quick questions here, as far as destocking all your customer, it seems like that's, at least for the most part runs closed. I mean, are you seeing any of that clear sales announced due to weak demand, but also destocking kind of magnify that. Has that kind of run its course or do you think that's going to continue for about…?

Norman Johnson

I’d say, there’s always a little bit, but yes, it has run its course.

Adam Brook - Sidoti & Co

I’m talking on the acquisition front; I mean going forward would there be a more of a focus kind of on liquid filtration. I mean I know this questions been asked before, anything within water, I know you’ve made that small acquisition, I guess it was bio process a year back?

Norman Johnson

Our acquisitions are opportunistic and we certainly have markets that we would like to expand into, but in the other hand, that compared to any other filtration company, I think we serve virtually every market, whether it would be Engine/Mobile, process liquid, environmental air. So if the right opportunity came in any of those segments by those end use markets, we would take a look at it.

Adam Brook - Sidoti & Co

At this point what percentage of your business is HVAC, I mean what does that make up I guess at this point?

Norman Johnson

About 15%.

Operator

Your next question comes from David Lebowitz - Horizon Asset Management.

David Lebowitz - Horizon Asset Management.

Briefly, the fourth quarter earnings that everybody is referring to, how much of the most recent guidance decline is because of accounting treatments versus operating results?

Norman Johnson

Nothing with respect to accounting that I know about, that I would know. I mean it’s all related to operating activity.

David Lebowitz - Horizon Asset Management.

It’s not going to be reversals that we setup to your accounts at the beginning of the year, and as always said we’ve exceeded the amount of money on the downside there or whatever else it might be?

Norman Johnson

I mean we always look at our reserves in each quarter and try to get them to be as large as we can. There’s nothing special coming up that we know of.

David Lebowitz - Horizon Asset Management.

Could we talk a little more about new product that reductions, the pace they are coming at with, as well as the results they are generating?

Norman Johnson

Yes, that certainly as we talked about, we’re increasing our spending money. I’ll give you a couple of examples that Bruce mentioned in his comments, that for the aerospace industry PMAs, which is the aftermarket parts, that without getting the specific numbers, we significantly increased the number that we do every year.

As you know, we established the filtration media research center, it’s actually in Cincinnati. We spent a lot of money on media development, one being a nanofibers that we have introduced into the marketplace in a couple of markets around stream.

On the Peco side of the business, the natural gas business, again Peco has mixed their own proprietary patented media, and they just come up with a new product that is pretty unique for the oil and gas business. I mean evolvement continues to develop new engine filters for all of our markets really. I only followed JL Clark’s packaging side of the business, and it was really new products that is enabling them to have this good strong years as they have.

David Lebowitz - Horizon Asset Management.

Looking forward to 2010, are there any things we should be highlighting in terms of where we’re going have the hardest comparisons year-over-year?

Norman Johnson

Actually, I just mention that about 2009 it was going to be launching throughout the years. We expect that the business to strengthen throughout the year, but on the other hand, last first quarter was pretty bad. We’re just going through the budgeting process right now. I can’t think of any quarter that would be a lot more difficult than another.

Bruce Klein

I think in quarter-to-quarter, we expect this quarter in 2010 to be better than the quarter 2009, but we’ll see. Norm’s still in terms of budgeting in terms of markets, popular aviation fueling that will be strong next year as it was this year, but this year it was pretty strong, but most of our remarks were fairly weak in 2009, and we hope that they’ll be improve.

David Lebowitz - Horizon Asset Management.

Lastly a follow-up to that; if we were to look at the leverage factor and say, if revenue was up 10%, how much should earning should be up year-over-year on a 10% increase in revenue?

Norman Johnson

Well, I’m going to stick my neck up, but I’d say at least 10%.

David Lebowitz - Verizon Asset Management

That’s not leverage when you go from 10% to 10%, Norm…?

Norman Johnson

It all depends David, and I don’t mean to give you a flip answer on that, but certainly we would expect operating leverage to increase as we do it, but just say it’s going to be 12% or 15% or some number like that; we can’t say right now.

Bruce Klein

As Norm said, we’re right now starting our budget season. Once we get the numbers, we would be able to answer that question much more clearly in January, when we talk about our expectations for 2010.

Norman Johnson

One of the challenge is obviously what happens on the cost side of the business. Early in the quarter we started seeing steel prices go up, you might have seen the article in yesterday’s Wallstreet Journal. Now steel prices are expected to go down. Healthcare costs this year they’ll be up 11% to 12%, hopefully next year it’ll be down less.

So part of the thing is for the sales increase, the whole pricing environment to our customers, and the whole mix of the cost base. So there’s a lot of things that go into the equation.

Operator

Your next question comes from Brian Drab - William Blair.

Brian Drab - William Blair

I might have missed this, but did you talk at all about what the near term EPS impact might be specifically from the 3M situation?

Norman Johnson

We didn’t give a number. Bruce made some comments regarding how much the cost would be which he can repeat, if cost was in the fourth quarter, but we didn’t comment specifically like X number or pennies per share. Certainly it has an impact in the fourth quarter.

Brian Drab - William Blair

Also the swaps that you’ve been talking about for a few quarters, is that old news now or did that have an impact on earnings this quarter, and what’s the status for that?

Norman Johnson

I’ve going to let Bruce comment, but I can assure you that when the swap expires, Bruce will be a happy camper.

Bruce Klein

It’s going to be over at the end of December. If you see in the press release and even walk through the 10-Q which we will file either as estimated tomorrow, interest expense was virtually nothing and well below in the third quarter.

It’s going to be the same in the fourth quarter, because although we’re paying interest on a nominal $100 million, we accrued all the expense mostly last year and earlier this year. So interest expense will be pretty much a wash for the fourth quarter and interest equity is going forward as well, because our actual borrowing cost is very low.

Brian Drab - William Blair

Then just one last question, you had great sequential margin improvements from the second quarter in every segment. What kind of margin level should we expect then going into the first quarter? Can you just give a little more color on maybe each of the segments, why we saw just based on the sequential volume growths not being overwhelming. Where did all that margin expansion come from?

Norman Johnson

I’ll start and Bruce can give us some more detail. As I said, we developed a contingency last November or December, what would happen if sales declined 15% and we implemented that right away. I mean I’ve got to give credit to our people in the operating company, that certainly now through the year we’ve reduced our M&S expenses, we did close some plans, we were able to come up with cost reductions.

I think, probably the same that I’m happiest about, is that our gross margin actually not only sequentially, but our gross margin in the third quarter was higher than it was in the same quarter of ’08. Our operating expenses while was down, certainly a percentage of our operating expenses and sales, we just couldn’t take it down as much.

It was just a lot of blocking and tackling efforts. I mean we have cost reductions initiatives that go down to every one in our factory. We ask all of our employees, give us the ideas how to do things better in the yard, but those are some of the things you do.

You go back to your vendors to get cost reductions and of course that we talked one time about the improvements that’s going on in our CLC Air business. When we reached the target that we thought we would, when we started the project because volume is less, [Inaudible].

Bruce Klein

We could still in terms be higher in the fourth quarter than the third quarter. In term of margins, margin should be an adopted thing, maybe slightly higher, but roughly the same.

If there’s a potential shortfall in margin comparative quarter, it would be an Industrial/Environmental segments, because it’s kind of unclear that we have the HVAC project to go forward, we just don’t know yet, and weather or not some of the natural gas sales which we think to be down or maybe down would be well right now, but we’ll see, but in terms of margins overall, they should be about the same as they were in the third quarter. If they’re a little bit rough, it should be slightly higher.

Operator

(Operator Instructions) Your final question comes from Jeff Hammond - KeyBanc Capital Markets.

Jeff Hammond - KeyBanc Capital Markets

Just back on this retail opportunity, can you just speak to, are you closer to getting more business with your current retail customer or what are you seeing in terms of other retail opportunities.

Then also just on this transition cost, can you just explain a little bit better, what costs you’re incurring into the fourth quarter that you wouldn’t have anticipated around this retail opportunity?

Norman Johnson

Right now, we’re just focusing and doing a simple job for our current customer, and certainly we see potential with that customer, that we hope that they are kind enough to give us the business. As we’ve been talking about and Bruce can give you perhaps more details, but I mean, the problem with the first quarter is;

One, we are going to have some plant closure cost as we discussed. Two, we’re going to have less sales than we originally expected. As I said in my comments, that it doesn’t surprise us that our customer decided not to buy from us anymore, they gave some of those indication clear, but they did surprise us with the immediacy of it. So not having the inventory or the production volume to cover the fixed overhead cost, we can’t get rid of those quick enough and that’s going to be the two major cost problems in the fourth quarter.

Bruce Klein

Let me try and be a little more specific. The severance costs, we’ve already recorded that cost in the third quarter and that was a couple of thousand dollars. What’s going forward would be, we still have the other focus plant in Rockford, that doesn’t expire until April of next year. So we still have those costs related and patents and insurance taxes at that facility until then.

As Norm pointed out, we won’t get anymore sales to 3M and we don’t know whether it never would have been, but roughly say $3 million to $4 million and so there’s a margin that we won’t be getting related to $3 million to $4 million.

Now, the 3M sales we’re not comfortable, but the insurance will go head and that as Norm says, will take a while to eliminate as much as we can. Plus in the fourth quarter, we’re incurring some costs in moving equipment from Rockford to another one of our facilities and then in getting that equipments in place and in production, and that’s simply is costing us some money as well.

It’s very difficult to tell you what the impact is going to be, because we don’t know what the sales would have been if 3M had not be moved out of business from us, but hopefully that gives you a little bit of a insight.

Operator

It appears there are no further questions at this time. Mr. Johnson, I would like to turn the conference over to you for any additional or closing remarks.

Norman Johnson

Again thank you for joining us. Certainly this year has been a challenge, our people, and I want to thank them. They have worked very hard to reduce costs and position us to be an even stronger company in the future. I cannot be more excited about the long term growth prospects that we have. We’re certainly looking forward to get this year behind us and seeing you, I guess our next call is in January. We’ll talk about the fourth quarter and our expectations for 2010. Thanks.

Operator

This does conclude your conference call. At this time you may disconnect.

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Source: CLARCOR Inc. F3Q09 (Qtr End 08/29/09) Earnings Call Transcript

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