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Executives

Tom Lawrence - Dye, Van Mol & Lawrence

Norman E. Johnson - Chief Executive Officer and President

Bruce A. Klein - Chief Financial Officer

Analysts

Richard Eastman - Robert W. Baird & Co.

Matt McGarry - Central Asset Management

David Lebowitz – Burnham Securities

Andrew Deangelis - KeyBanc Capital Markets

John Wasshausen – Wasshausen & Co.

Gregory M. Macosko - Lord, Abbet & Co.

CLARCOR Inc. (CLC) Q2 2008 Earnings Call June 18, 2008 11:00 AM ET

Operator

Welcome to the CLARCOR, Inc. second quarter 2008 earnings conference call. (Operator Instructions) It is now my pleasure to turn the conference over to Tom Lawrence of Dye, Van Mol & Lawrence.

Tom Lawrence

We appreciate your interest in joining us on CLARCOR’s conference call to discuss results of the second quarter and first half of 2008. 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 Bonnie Cash 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, June 18, 2008. 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 may be done only with the consent of CLARCOR.

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

Norman E. Johnson

With me are Bruce Klein, our Chief Financial Officer and Kim Moore, our Corporate Controller.

Let me begin by saying the diversification moves we made to increase our presence in process liquid markets, and more specifically, oil and gas, as well as expanding geographically, drove our results this quarter.

I am sure you have already seen our sales are up 14%, operating profits increased 19%; revenues were 18% more than the second quarter of last year, and our operating margin improved from 13.4% to 14% of sales. We are very pleased with these results, which were primarily driven by our Peco acquisition, as well as increased sales to aerospace, dust collector, and railroad markets.

There is no doubt we are in challenging times, as evidenced by oil and gas prices and inflationary pressures on raw material costs. In spite of these challenges we were able to improve margins. We are fortunate 80% of our sales are recurring revenue. Our products are needed in any economic environment. We serve the growing, some might say booming, oil, gas, and aerospace markets and we can raise prices to offset material increases. I believe our company is better positioned than most for increased sales and profits in this and any other economic environment.

There is no doubt the high price of oil is having an impact on truck tonnage and us. For our domestic engine business both sales and operating profits were flat compared to last year, but margins were maintained. This shows our ability to offset costs with productivity and raise prices where needed, as well as the ability to increase overall profits with the diversification moves we have made.

In a lot of ways this was an unusual quarter. The quarter began with our Peco plant in Texas being damaged by a severe hail storm. In the middle of the month we had two factories in Greensboro, North Carolina, hit by tornadoes, and the quarter ended with a tornado in Kearney, Nebraska, which did some minor damage to our Baldwin facility and knocked out power for a couple of days, causing us to miss several days of shipping.

We had no injuries and no significant damage in any of these facilities. Our people did an outstanding job in getting the plants running in a short time period, but we did incur $750,000 of costs related to insurance deductibles plus the loss of productivity and other costs incurred from the storms.

In spite of all these challenges, we were able to deliver another record quarter. Based on some comments I have seen regarding our earnings release, I think the point we intended to make regarding costs increases and inflation was misinterpreted. There is no doubt costs are rising for us, and every other company in our industry. What we said is we can offset these cost increases with improved productivity and price increases. We improved margins this quarter and we will get an additional bang in future quarters as our HVAC business contributes to profitability.

Bruce will now review our outlook for inflation more thoroughly and then go over the financials for CLARCOR and then I will cover what we see for the future.

Bruce A. Klein

What I would like to do first is address raw material costs and then discuss the certain financial issues afterwards.

Certain raw material costs have clearly increased. Our primary raw materials are steel and filter media. Steel prices clearly differed by grade and type, have increased overall by approximately 50% from the second quarter of last year with most of the increase coming in the first six months of this fiscal year. Based upon current pricing, we expect steel prices to remain at this level for the rest of 2008. In other words, we do not expect further dramatic increases, but neither do we think that steel prices will fall.

Cellulose-based filter media costs have increased by 10% to 15% in the last 12 months. Synthetic filer media based on hydrocarbons have increased approximately 15% to 30% over the last 12 months. Packaging materials have increased 10% to 20% and solvents and resins have increased, depending upon the type, from 10% to 50% over the last year.

The real question though, is how have commodity prices affected our cost of sales and how have we responded. Several of our companies, generally those that manufacture filtration vessels and also our packaging company, price to customers based on the current cost of raw materials and then purchase those materials immediately or there are price escalators tied to commodity prices built into customer contracts. So usually these operations are not adversely impacted by increasing raw material import costs.

Our other operations have successfully implemented price increases throughout this year and in some cases more than once. Although the increase has differed greatly by company and the timing of these increases vary as well, overall price increases have been in a 3% to 5% range this year. I expect that further price increases will be necessary later this year. Even if fuel prices stay where they are, increasing oil and natural gas prices will impact certain raw materials and certain operating costs, such as utilities.

What is important is that we pay very close attention to changing import costs at all of our operating companies and also with a dedicated group of corporates. Our goal is to maintain margins in our Engine/Mobile Filtration segment and continue to improve margins in Industrial/Environmental Filtration segment. I think that our second quarter and six month results show that we have done this successfully.

Further price increases will probably be necessary given commodity inflation. The cost reductions and improved manufacturing productivity will also play an important part.

Fluctuations in the U.S. dollar had only a minor impact on our dollar-denominated sales in operating profit in the second quarter. Our increase in geographic diversification and the fact that we sell and purchase in a variety of currencies tends to mitigate the impact on our earnings from currency fluctuations. In some currencies a weakening dollar boosts earnings while in other currencies it is the opposite. We usually have sufficient natural hedges to offset significant swings one way or the other.

The fastest sales growth rate in non-U.S. markets has now driven a percentage of our non-U.S. sales to our total sales of almost 30% for the first half of 2008 compared to 27% last year. Part of this increase is due to decline in our HVAC purchase sales, which is almost entirely a domestic business. More importantly, though, our Asian and European business overall is doing very well and is growing faster than our domestic business.

Also, Peco sells approximately 40% of its products outside the U.S. We expect that international sales as a percentage of our total sales to continue to increase, even as our domestic HVAC business recovers in the last half of this year and in 2009 as well.

As you will recall, we recorded approximately a $2.4 million to $2.5 million increase in interest expense in the first quarter of this year due to an interest rate swap valuation. In this quarter we reversed approximately $1.1 million of this amount as a reduction of interest expense. We expect that over the next six quarters we will reverse the remaining $1.3 million to $1.4 million. Unfortunately, the timing of the reverse by quarters is largely dependent on interest rates and we can’t forecast how much it will impact the particular quarter.

We expect our tax rate to be approximately 34% to 35% for the next two quarters. This may decline slightly if Congress passes an extension of the Research and Experimentation Tax Credit.

Cash flow continues to be strong with cash from operating activity, excluding increases in short-term investment growing by approximately $7 million in the first months of 2008 compared to the same period in 2007.

Capital spending was slightly less this quarter compared to capital spending in 2007. We expect capital spending for the last six months of 2008 to be about the same as it was in the first six months.

We did not repurchase any common stock this quarter. We will continue to look at share repurchases in the future based upon our stock price, interest rates, internal growth initiatives, and acquisitions.

We expect free cash flow over the next six months to be strong and our cash balances to build barring any acquisitions in the last half of 2008. We still have approximately $187 million remaining under our current share repurchase authorization.

Norman E. Johnson

We have repeatedly said we do not have a crystal ball to forecast the future, but if we did it would be cloudier than ever. We are well aware of the challenges but we also have opportunities. We believe our domestic non-railroad engine business will grow 0% to 5% for the year, excluding pricing. We expect stronger sales in the Ag/construction railroad markets while forecasting little growth in the heavy-duty truck market. Hopefully, we will be surprised by the upturn some are projecting for truck tonnage the second half of the year. A little good news, for the first two weeks of June, which is obviously a very short time period, our orders are slightly better than we projected. I hope it continues.

We certainly obtained margins in this segment with productivity improvements and price increases. Based on announced steel and other material costs increases we will have another price increase this summer at our engine business. Our HVAC business is in the process of implementing an increase right now. The oil and gas markets, as well as the aviation served by our Peco Facet and Purolator brands will drive our growth. We expect continued double-digit sales and earnings growth from these businesses.

Oil and gas is booming around the world and we are also seeing more waste water opportunities than ever. We just received our first waste water order in Romania and expect a lot more business in that country. We are combing the technology of BBT, the company we recently made an investment in, with our current system and efficiencies have improved by up to 30%, making it possible for us to meet tougher European waste-water standards. There are also significant water opportunities with current oil and gas customers, which we can now serve.

Our CLC HVAC business will contribute to earnings the second half of the year as the new machinery is installed and costs are further reduced by closing two factories. Let me give you just one example of the cost reductions we are expecting. While it may be on the high end, the cost of one high-volume filter will be reduced by nearly 30% with the new machinery we have installed. We are now at the point we can start playing offense. We have significant sales opportunities to go after.

We continue to introduce new products in all of our businesses with higher margins. We are reaching the goal of 10% operating profit in our Industrial/Environmental segment, even with the drain from our HVAC business. This quarter margins improved to 8.2% of sales versus 5.2% in the second quarter of 2007. As I’m sure you all remember 10% is our stated goal for this segment. The liquid side of the business is meeting objectives. The profit improvement on the air side will enable us to more than surpass the goal in the future, although we still might have some variations on a quarterly basis as things fall into place.

Our international sales have further increased, to 31% of our total. We do not see this slowing down. Our business in China continues to perform very well and we expect continued growth of 30% to 40% annually as we build sales from more of our operating companies. Businesses in the rest of the world should grow at least double-digit levels.

With all of this said, I do not want to be overly optimistic since we, and just about every other company, face some very significant challenges. We simply do not know how much this will impact our business. We do know goods still have to be shipped, buildings cooled, airplanes flown, and oil and gas wells drilled. We will still sell filters in any economic environment. The oil and gas business will continue its rapid growth. As a leading filter supplier to that industry we will grow with it.

Unfortunately, raw material prices are projected to continue to rise. Cost reduction alone will not enable us to maintain margins. We will raise prices, which is always risky. What this means is, we expect our business to grow in 2008 but we are being conservative in our projection. Our CLCR restructuring plans were well laid out, but not everything has gone perfectly. While we are still committed to the original savings, some admissions did take longer to work than we had originally planned, but we can now see light at the end of the tunnel. Output is exceeding our original estimate, which will result in lower cost.

We have turned the corner but lower sales from an economic downturn could stretch out the time table of the projected savings. The good news is the business will be profitable for the balance of this year and we expect good performance in 2009.

What it really boils down to is we have some wonderful opportunities and with our diversified portfolio of businesses and markets served around the world, we can still grow the company in a downturn.

With that said, we are projecting earnings of $1.90 to $2.00 per share for 2008. I see the headlines in many publications saying we narrowed our guidance, which is true. But the way I calculate, the average is still the same. In spite of our slower growth in our domestic engine business, future results will improve with increases earnings at both CLC Air and our process liquid companies.

I will finish the same way I started this overview. Our diversification program is working and will result in continued growth for CLARCOR. We will now be pleased to answer any questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Richard Eastman - Robert W. Baird.

Richard Eastman - Robert W. Baird & Co.

Can I just ask you, on the Engine/Mobile side of the business, I think the domestic/international split is around 75/25? But could you give us a sense of what the sales did in each of those two regions?

Bruce A. Klein

I can’t, I just don’t have it. I’ve got to calculate it. If you give me a moment, we’ll get back to you.

Richard Eastman - Robert W. Baird & Co.

Let me just ask you about the gross profit margin at 32%. What was the single biggest influence there? Was it Peco that drove that up? Again, with your raw material commentary and the mix here in the quarter I would have thought, that gross margin looks very good.

Norman E. Johnson

There were two things. One is that we maintained our Engine/Mobile margin, but what drove it really was Peco. But also we have another company that is in the aerospace and aviation business, what we call Purolator and Facet. I know all these names get confusing but they are doing very well and improving margins, in addition.

As I said before, it’s really companies that are serving the oil and gas and aerospace businesses that drove the margins. There was some improvement in our CLC Air business.

Richard Eastman - Robert W. Baird & Co.

Could you just give us a sense of how much revenue that maybe was pushed into the third quarter here from the lost shipping days?

Norman E. Johnson

It’s a tough one. It was not significant, $2 million to $3 million perhaps.

Bruce A. Klein

To get back to you, in the first quarter international sales Engine/Mobile was probably under 25% and in the second quarter they were certainly over 26%.

Richard Eastman - Robert W. Baird & Co.

Bruce, what I was actually looking for was just the change in sales in the second quarter year-over-year domestic versus international. Was the domestic business down, Engine/Mobile sales?

Bruce A. Klein

Just slightly, yes.

Operator

Your next question comes from Matt McGarry - Central Asset Management.

Matt McGarry - Central Asset Management

I thought you did a really good job maintaining margins with Engine/Mobile. As you look at that business and your ability to adjust the cost structure, how confident are you, knowing that the economy is still a long part at this point, but how much dry powder do you have left to play with on the cost side to mitigate some potential continued pressure from the revenue side?

Norman E. Johnson

Well, cost reductions are a way of life for us. And one of the things that we always do is keep a backlog of future cost reduction projects that have not been implemented yet. And this could be the redesign of a product or the changing of raw material component or whatever.

And what we said is when you look at the combination of the price increases we will be implementing, and cost reduction, we’re confident that we can maintain the margins and if we get lucky maybe we can improve them a little bit. But there are significant cost reduction opportunities our people are working.

Matt McGarry - Central Asset Management

And on the restructuring of CLC Air, I think you had mentioned that the equipment issue has been resolved. Could you walk us through how that’s looking there, when you expect things delivered? I’m assuming that is on schedule.

Norman E. Johnson

As I said in my comments and as we said in previous calls that the equipment came in slower than we originally projected but it didn’t really change from what we said in the last conference call.

So to answer your question specifically, the equipment is now installed in some of the plants that we operate; it’s not in all of the plants. But the equipment is working and in some cases exceeding our projections. I gave you that one example where the cost on one filter is down 30%.

Hopefully by certainly 2009, all of the equipment will be installed. But even with the equipment that is there right now, we expect the business to be profitable for the remainder of 2008 and to continue that profitability in 2009. So, not to belabor it, but as I said, we see the end of the tunnel and are, at least as we speak right now, optimistic about the future.

Operator

Your next question comes from David Lebowitz - Burnham Securities.

David Lebowitz – Burnham Securities

First, anything new with total filtration that you can update us on?

Norman E. Johnson

What’s happening in total filtration, we continue to when we entered that business we were heavily dependent upon the automotive segment. That is still a very good piece of business for us but we have significantly increased our presence in non-automotive business with significant customers whether they be in the chemical or farm machinery business or beverage or whatever. And our sales force is continually going after that and we expect to continue to increase our business in the non-automotive sector.

David Lebowitz – Burnham Securities

We have a major initiative to improve profitability at our largest operation. Where do we stand in terms of the milestones that you had spoken to on conference calls in the past?

Norman E. Johnson

Let’s just be clear. You said our largest operation and you are saying the Industrial/Environmental.

David Lebowitz – Burnham Securities

Correct.

Norman E. Johnson

Technically, it’s our largest operation. The first thing about that is that business is really broken down into companies that serve liquid applications, Peco being one of them. Our Purolator, Facet brands being another. And then what we call CLC Air, the HVAC side of the business.

On the liquid side of the business you can see that increased our margins this quarter from 5.2% to 8.2%, which is really driven by the liquid piece of the business. We have significantly increased our margins in businesses which serve the oil and gas drilling business, waste water, chemical processing. So we are increasing margins in all our business in that segment.

But when we talk about the restructuring, and perhaps that the milestones that you’re talking about, and it goes back to the question that was just asked, how are we doing on the CLC HVAC business, and that’s where we have brought in the new machinery that I just mentioned. We expect the business to be profitable the remainder of this year.

As far as milestones go, we identified that we would save $14 million on an annualized basis in 2009. We are not backing away from that outlook, but as we’ve said, we did not get there as fast as we expected because some of the machinery took longer.

David Lebowitz – Burnham Securities

In terms of getting there, you will get the full achievement in 2009.

Norman E. Johnson

Going out the year we will be running on an annualized basis for that achievement. So if you’re asking me will we get a $14 million improvement in 2009, I don’t know yet. But some of it will depend upon does the machinery get there the first quarter or whatever, but on an annualized basis that’s what we’re projecting.

David Lebowitz – Burnham Securities

In Bruce’s presentation he indicated that the numbers were prior to any potential acquisition in the second half of the year. Is CLARCOR actually in negotiation at this time for an acquisition?

Norman E. Johnson

I think you know that if we were I couldn’t tell you anyway.

David Lebowitz – Burnham Securities

You could say you were talking to companies. You might not identify the part of the business or who they are, but you could say you are in fact having conversations.

Norman E. Johnson

I think what I will say instead is that we are always welcome to acquisition opportunities and right now who knows what might happen.

Operator

Your next question comes from Andrew Deangelis - KeyBanc.

Andrew Deangelis - KeyBanc Capital Markets

On the Engine/Mobile segment, you did point out the impact of the weather-related items you said before, but the underlying trend in the business during the quarter, did you see it, I’m talking about the domestic business now; decelerate meaningfully from trends earlier within the year?

Norman E. Johnson

I wouldn’t say discernibly, meaningfully. Actually, as I said in my comments, it actually improved a little bit towards the end of the quarter and the first couple weeks of June. But I don’t want everybody to run away and say it’s really booming again. But certainly there was nothing of a significant magnitude one way or another.

We had a problem at the end of the quarter with the tornadoes that probably had more of an impact than anything else.

Andrew Deangelis - KeyBanc Capital Markets

Following up on Peco, the notable improvement in the sequential rate of operating profits, where did that really come from outside of not having the inventory step up within the quarter?

Norman E. Johnson

The basic thing is that the business around the world is very strong. Backlogs are growing, sales are growing and as we speak, one of the things that we’re looking for in the future for Peco is Peco was really not that strong in the after market of their products. They certainly sold a lot of vessels and had some very patented products for replacement elements, but we’ve now put a couple of people to help them from our Baldwin operation to make them a true after-market company. So we’re expecting good things.

But if you look at the primary driver, it was Malaysia and that part of the world. Of course, the Mid East is a big market as well.

Andrew Deangelis - KeyBanc Capital Markets

Can you flush out the timing of that after-market opportunity? It seems more of a longer-range opportunity rather than something that we might see on the horizon.

Norman E. Johnson

I think it’s again, we’ve always said we’re a company of singles. Maybe a double once in a while. So it’s going to be an incremental growth. But one of the things, just to give you an example, in our Baldwin side of the business 97% of our orders are shipped within 24 hours. We had a business, what we call Facet that serves the aviation pool business and some other industrials. We got that business in 1999. Profits were zero and the fill rate was about 60%. That business is now in significant double-digit profitability and basically on-time shipments are 100%.

Peco, just a couple of weeks ago, the program is now in place that the inventory is available to ship next day. So are we going to have a $50 million increase the next quarter? No. But do we expect significant results over the next two-year time period? Yes.

Andrew Deangelis - KeyBanc Capital Markets

You entered the year talking about a $10 million operating profit improvement within the CLC Air business on a year-over-year basis. Where do we stand now, after the second quarter?

Norman E. Johnson

We will not meet the $10 million because of the delayed machinery that we talked about. It will certainly be somewhere between $5 million-$10 million.

Operator

Your next question comes from John Wasshausen - Wasshausen & Co.

John Wasshausen – Wasshausen & Co.

On the Purolator aviation business, you talked about how strong it is and the good outlook and at the same time we’re seeing all the announcements of airlines reducing capacity and things like that. Where is the growth coming from and why do you expect it to continue?

Norman E. Johnson

Well, first of all, it comes from both Europe and around the world. In Asia, for example, we have customers, whether it be Hong Kong airport or the Shanghai airport or different parts of the world. So there is good global growth around the world.

Secondly, the customer service initiative I’ve talked about. Probably the other thing in that business is waste water. I talked about the orders.

As far as the aviation business, many of those, when do you change your filter? And you probably have a furnace filter in your home that you change every three months or six months or whatever. So a lot of the aviation business is done on time, not gallons or whatever that go through it. So we expect that business to hold up.

John Wasshausen – Wasshausen & Co.

You set some goals and some expectations about the air business, among other thing it will get to a 10% operating margin business. It seems like you are making that goal almost too easy for yourself. Because as I do the calculations, getting the $14 million savings on air gets you pretty close to 10% there. The historical industrial business is now in the mid-teens rate and Peco’s at least to double-digits. So it would certainly seem to be doing better than 10% there.

Norman E. Johnson

I’ve been in this job a long time and I’ve learned it’s a lot better to set goals that we’re confident we can meet and then increase. So our objective is let’s get to 10% and then we’ll let you know what the next goal is. I would not disagree with your comments.

Operator

Your last question comes from Gregory Macosko - Lord Abbet.

Gregory M. Macosko - Lord, Abbet & Co.

Just with regards to your comments on the price increases, etc. Just give us some color on that. What have you done so far and what are you expecting and is this intended to cover commodity costs or to maintain gross margins?

Norman E. Johnson

Our objective with a combination of cost reductions and price increases is to maintain gross margins. We have raised prices at various of our businesses, as Bruce mentioned, last year, some in the first quarter of this year. HVAC business we’re doing right now and we anticipate it furthermore in our Engine/Mobile business. As Bruce said, they’ve been in the range of 3% to 5%, depending upon which business it is.

Nobody likes to raise prices, nobody likes to give cost increases, but certainly in an economic environment like this, you read it every day in the paper, and we’re not the only company. I think you saw a couple of weeks ago where Dow Chemical and other chemical companies increased prices by 20%. We had to give a little seminar to some of our younger people in the company to remind them what inflation was since it’s been so long since we’ve seen it. But I don’t think anybody can deny that we’re operating in an inflationary environment.

Gregory M. Macosko - Lord, Abbet & Co.

And what you’re saying is that your smaller competitors or others are following you?

Norman E. Johnson

I don’t know if they’re following us or we’re following them but there’s no alternative. If you look at our Engine/Mobile business, maintaining the margins, we think that’s an accomplishment. And our other competitors, or any other industry, I don’t care if it’s the filter industry or other industry, when you get some of the cost increases that have been announced for steel and other raw materials, that there’s no choice.

Gregory M. Macosko - Lord, Abbet & Co.

And then your comments on the new product, you sounded somewhat aggressive on that score. You have new products in all the areas? Is it accelerating at this point?

Norman E. Johnson

We do have new products in all of our companies but you’ve followed our stock for probably just as long as anybody, we’ve increased our R&D spending virtually every year for a lot of years and of course, the growth of that is just to get new products. There are some really significant coming on the CLC Air side of the business, as well as our engine business and with Peco/Facet and dealing with the combination of those two companies; there are some other good ones. So, yeah, it’s a way of life. That and cost reduction parts.

Gregory M. Macosko - Lord, Abbet & Co.

And finally, on the $750,000 cost from the storms. Was that pretty much in the industrial area or was that also in your Mobile. I didn’t quite hear it all.

Norman E. Johnson

$250,000 of it was related to a tornado in Kearney. The other $500,000 was in the industrial.

Operator

There are no other questions.

Norman E. Johnson

Again, thank you for joining us today. We are excited about the future of the company. We do have many opportunities and we are expecting another record year. Thank you for joining us.

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