Brady Corp (BRC) 2006 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth quarter 2006 Brady Corporation earnings conference call. My name is [Sherelle] and I will be your facilitator for today.

[OPERATOR INSTRUCTIONS].

I would now like to turn the presentation over to Barbara Bolens, Director of Investor Relations. Please proceed.

Thank you and good morning, everybody. We're happy you can join us. During the call this morning you will hear from Frank Jaehnert, CEO, David Mathieson, CFO, who will be presenting Brady's quarterly financial review, and then joining us will be Matt Williamson, Vice President of Brady Americas, Peter Sephton, Vice President of Brady's European Region, and Allan Klotsche, Vice President of Asia Pacific, who will all provide a portion of the regional reports. As usual after the brief presentations by the team, we will open up the call to questions.

We encourage you to follow along with the slides located on the Internet as we will be referring to the individual slides as we proceed through the presentation. These slides can be found on our website at www.investor.bradycorp.com. You will have a few minutes to get to those while we go through our Safe Harbor statement and other usual information. Please note that in this call we may make comments about forward-looking information. Words such as expect, believe and anticipate are a few of the words identifying a forward-looking statement. It is important to note that forward-looking information is subject to various risk factors and uncertainties which could significantly impact expected results. Risk factors were noted in our news release this morning and in Brady's 10-Q filed with the SEC in May of 2006.

Second, please note that this teleconference is copyrighted by Brady Corporation and there may be no rebroadcasting of this without expressed written consent of Brady. Note also that Brady will be taping the call and rebroadcasting it on the Internet, and your participation in the question-and-answer session will constitute your consent to being recorded.

Thank you, and now here is Frank Jaehnert.

Good morning. Today we announced a record fourth quarter and a record fiscal year. Our fourth quarter sales increased 37% to $288 million. We are pleased that our organic growth was also very strong again this quarter at over 8%. Net income increased 40% over fiscal 2005 to $22.5 million. During the quarter we completed three acquisitions including Tradex, Carroll and Daewon. This brings our acquisitions completed in the year to 11 which is extraordinary.

We also made significant investments in new product development and geographic expansion. Also during the quarter we completed a secondary stock offering to continue to fund our organic and acquisition growth. We are very pleased with the result of this offering.

For the full fiscal year, we surpassed new milestones of over $1 billion in sales and over $100 million in net income, making fiscal 2006 a very successful year for Brady. I will now turn the call over to David Mathieson for a more detailed review of the financials and of our guidance for fiscal 2007. After the regional reports, I will be back to summarize our key initiatives for the year.

David?

Thanks, Frank. I will begin at slide 4. We had record sales in the quarter, a total growth of 37% with just over 8% organic, 27% from acquisitions and 2% from currency. Gross margins were down 200 basis points from the prior year, SG&A was also down 320 basis points from the prior year. Operating income of $36.9 million up 53% and at 12.8% of sales is up 130 basis points. Fourth quarter net income of $22.5 million is up 40% and at 7.8% of sales is up 20 basis points from the prior year. Diluted earnings per share was $0.43 and is up 34%. The impact of the equity offering in June was $0.01 dilutive for the quarter.

In slide 5, organic growth for the quarter was just over 8% with Americas’ organic growth at 5%, Europe at 8%, and Asia Pacific had another strong quarter with 21% organic growth. The quarter saw growth from acquisitions made in the last 12 months at 27% and currency for the fourth quarter added 2% to the top line.

On slide 6, in the Americas we saw solid organic growth throughout the year ending with 5% for quarter four. Acquisitions are at 19% with our acquisitions focused on three main areas in Americas. Diversification and people identification through the acquisitions of STOPware, J.A.M., and GE IDenticard, and medical conducting with the acquisition of TruMed, and in direct marketing with the acquisition of Personnel Concepts. Currency added 1% in the quarter.

On slide 7, Europe had the strongest organic growth in the last quarter at 8% and you can see that organic growth strengthened during the year. Acquisitions added 21%, currency added 2% in quarter four.

In slide 8, Asia Pacific organic growth was 21%, and there is a number of things to note here. Acquisitions added 63% of growth to our sales in the quarter and we now have a significant position in the mobile handset die cut business with the acquisitions of Tradex and Daewon. The acquisitions of both Carroll and Accidental have expanded our MRO offering in Australia. Currency added 3%.

In slide 9, gross margins are down mainly as a result of the acquisitions. We have been successful in increasing our organic gross margins in Americas and in Europe, but this has been largely offset by downward pressure in Asia Pacific, due to cancellation of some programs and pricing pressure from customers.

In slide 10, our SG&A for quarter four was 73.7%, down 320 basis points from the prior year. The major driver of this improvement is due to the leveraging SG&A expenses over our organic growth, as well as some favorable comparisons with the timing of some expenses last year.

On slide 11, R&D spend at 3.4% of sales is slightly below last year as a percent of sales but is up 33% in dollar terms. We put a lot of emphasis on new product development this year and believe we've made a lot of progress in improving our processing.

Slide 12 shows our quarterly operating profit. Q4 was up 63% on the prior year with an improved profit rate. We had some lumpy expenses last year in the fourth quarter which has given us a favorable comparison.

Slide 13, net income is up 40% over the prior year. Our tax rate improved this year to 28% versus 29% last year. Net income as a percent of sales also improved by 20 basis points.

In slide 14, diluted earnings per share up 34% to $0.43. The equity offering, as I said, was $0.01 dilutive for the quarter and year.

On slide 15, this shows the quarterly cash flow from operations for the last three years, and you can see that with a very strong last quarter this year - and I would point out that our cash flow is very oriented to the last half of the year and this year is certainly no exception to that.

In slide 16, here is a summary of our cash flow for the year, and you can see we had a lot going on in fiscal 2006. We spent approximately $350 million in acquiring 11 companies funded by long-term debt of $200 million at an interest rate of 5.3%, an equity offering that raised 4.6 million shares at $36 a share, $166 million gross, $157 million net. We paid a nice dividend, an increase of 18% from the prior year, and earlier this year we repurchased shares - 800,000 at an average of $33 a share, and that's for the first time.

CapEx at $39 million is high for us. It includes $9 million for essential warehouse, $7 million for geographic expansion as well as $10 million for cost reduction projects, such as the Canadian facility consolidation, and we'll open that new facility in Toronto this week.

Slide 17, this shows EBITDA by quarter, and in Q4 our EBITDA increased by 51% over the prior year. Note this is a non-GAAP measure, and we have included a reconciliation to GAAP in the appendix.

Slide 18, here is our year-end balance sheet. We ended the year with a conservatively leveraged balance sheet, showing gross debt as a percent of total capital of 32%. I would point out that since closing the year we have purchased CIPI, which will reduce that cash balance.

In slide 19, here's the summary balance sheet by quarter over the last three years. Acquisitions and subsequent funding of those acquisitions have played a major part in shaping our balance sheet. We end the year, as I said, in very strong position with gross debt as a percent of total cap at 32%. We have also over the last three years added a large amount of inventory to our businesses.

This is due to a number of reasons. Organic growth and longer supply chain with [indiscernible] dollar in Tijuana impact inventory. Asian sourcing has also added inventory and by copying the EMed inventory model - where we have higher inventory levels by doing larger runs, less setups and gave higher service levels in our direct marketing businesses - also adds inventory. We believe we're near the end of that significant increase and should see more moderate increases in working capital going forward.

Accounts receivables has also come under pressure as we grow the business in Asia Pacific, where terms are generally longer.

Slide 20. We anticipate revenues in fiscal 2007 of $1.225 billion to $1.25 billion, and this guidance is up $75 million from previous guidance given in early June as we have acquired Carroll in Australia, Daewon in Korea and CIPI in the U.S. Earnings per share guidance of $2.18 to $2.27 remains unchanged from our post-equity guidance from June 5th, and this is consistent with net income of $120 to $125 million. We anticipate capital expenditures in fiscal 2007 of $45 million which includes $20 million for continued expansion, $5 million for the continued rollout of SEP, $10 million for cost reductions and $10 million for replacement capital. For D&A, we anticipate approximately $50 million.

Now we'll hand over to the business leaders who will handle the regional results. Matt?

Thank you, David. Good morning, everyone. Please refer to slide 21. The Americas performed well in the fourth quarter with continued strong revenue growth coming from our base business and recent acquisitions. Increased volume resulted in strong profit growth over the prior year fourth quarter. The region sales increased to $135 million, an increase of 25%.

Our base business was up 5% in the acquisitions of STOPware in August of 2005, TruMed in October of 2005, J.A.M. Plastics and Personnel Concepts, both in January of 2006, and IDenticard systems in February of 2006 added 19%. Foreign currency translation added about 1% to sales. Organic growth within our Brady brand was strong for the fourth quarter - up solidly over the prior year fourth quarter. This was driven primarily within the U.S. by double-digit growth in our Safety, Electrical and Electronics markets.

Our Electromark business, which was acquired in February of 2005, and is focused in the electric utility business, continues to outperform expectations with record sales and profitability.

Our organic growth in the Direct Marketing businesses is as expected. Regionally, Canada, Brazil and Mexico all contributed to the solid growth in the quarter while the U.S. grew more than 7% over the prior year fourth quarter. In order to continue to improve productivity, we moved into an expanded facility in Canada - allowing us to consolidate our operations there. Additionally, we began the process of consolidating Tradex Brazil into Brady Brazil in Manaus.

Segment profit rose 25% or $6.1 million to $30.3 million in the quarter. Segment profit as a percent of sales was consistent with the prior year at 22.4%. Excluding acquisitions for the quarter, our segment profitability actually improved over the prior year. While we continue to experience cost increases in utilities and materials, the impact of our increase in volume is offsetting our cost increases. However, as expected, our recent acquisitions have an initial rate of profit that is below the average of the group, and we expect that as we integrate and achieve synergies we will enjoy increasing levels of profit going forward.

Peter Sephton will now report on our European business results.

Thanks, Matt. We're now on slide 22.

Europe continued to perform well in the fourth quarter with revenue growth coming from both the base business as well as from acquisitions. The region's sales increased to $89 million, an increase of 31%. There was continued improvement in base growth with our overall organic business up 8%. The acquisitions of Signs & Labels in June 2005 and Texit in September of 2005, together with the recent addition of Tradex in May 2006 added 21%. Recent strength of the European currencies versus the dollar resulted in the positive currency impact in the quarter of 2%.

Sales across the region were encouraging. Organic sales increases in all countries apart from Belgium. France and Germany continued to show strong growth in both their Brady and Direct Marketing businesses. We're encouraged with our business in the U.K. which had [technical difficulties]. Belgium, organic sales were below prior year levels and continue to see migration of OEM business through [technical difficulties]. This is more than compensated by new business set up in Slovakia to penetrate the Eastern Central European areas. Geographic expansion continues with strong performance in newer geographies within the Nordic region, southern Europe and Turkey.

Looking at our business by brand, the Brady brand showed solid growth after decline in the third quarter. This has been driven by continued growth in newer geographies, underpinned by more focused market strategy in the more mature geographies. The Direct Marketing business continued the growth initiated in the third quarter. Both Germany and France continued their solid growth as a result of continuing to add new customers and product expansion.

Encouragingly, the U.K. base business improved in both its core Seton business and with positive synergies resulting in double-digit growth for the newly acquired Safety Shop brand. For the region as a whole, segment profit for the quarter was $21.9 million. This is an increase of 18% from quarter four of last year.

Segment profit was reduced by the Tradex acquisition in several ways. First, we have expected integration in acquisition-related costs. The expected seasonality of the sales versus the steady cost base, and finally the impact of the headquarter costs in Sweden. If you exclude acquisitions for the quarter, our segment profitability actually improved over the prior year. We are pleased with the productivity improvements in our organic business in a region that's still economically challenged.

We're especially encouraged by the return to core growth in this and the previous quarter, continued aggressive integration of acquisitions coupled with the search for new acquisitions and our current organic growth strategies should see continued performance above GDP. We'll now continue with the Asian region reports so over to you, Al.

Thanks, Peter and good morning, everyone. We're now on slide 23.

Performance for the fourth quarter was solid as our business throughout the region benefited from continued strong demand for consumer electronics. For the fourth quarter sales for the region were $63.9 million, up 87% over last year. Base sales were up 21%, and acquisitions added another 63%. Currency had a 3% impact. Our mobile handset business grew significantly as we completed the acquisitions of Tradex Converting and Daewon. Both of these acquisitions significantly increased our regional coverage as well as manufacturing capabilities.

We also benefit from the strength of these two companies' management teams who have subsequently assumed key leadership positions for our combined business. The combination of Brady, Tradex and Daewon provides our mobile handset customers the most comprehensive solution for design, development and manufacturing of die cut parts anywhere in the world. We continue to expand in the region to support the growth of our business and shifting customer demands. Our Greenfield investment in India remains on schedule, and we expect to be producing labels and die cut parts by the end of the calendar year. We appear to be ahead of the curve in India as most of our customers are not scheduled to ramp up their high volume production until 2007.

Our other Greenfield in Donguan, China is also tracking to open by the end of the calendar year 2006. Demand in southern China for labels and die cut parts is very strong, and we expect this factory will be well utilized.

We recently opened our new manufacturing plant in Penang, Malaysia, which affords us more space to grow our core business in support of the region and also expand the contract manufacturing we're doing for other parts of the Brady Corporation.

In the hard disk drive market, Seagate's acquisition of Maxtor has had a short-term negative impact on our fourth quarter operating results, as several of the products that we had supplied to Maxtor were phased out following the acquisition by Seagate. Our acquisition of QDPT in Thailand with the support of Brandon International has really added some unique and differentiated products and capabilities, which have been very well received by our customers across the hard disk drive industry.

Our base business in Australia continues to perform very well and is well poised to handle the growth associated with our recent acquisition of Accidental Health and Safety in February and our most recent acquisition, Carroll Australasia in June. With many similarities between Carroll's business and Texit Denmark, a company we acquired in 2005, we look forward to leveraging many best practices.

This quarter we are embarking upon a journey to standardize our ERP systems and become linked with SAP which is running in most of the other Brady operations throughout the world. Our first go live in Asia occurred on September 4th without event and, most importantly, without disruption to our customers. We have built a very strong implementation team consisting of top performers in the region combined with seasoned SAP experts from around the world.

We have also engaged an external consultant to help us staff this project. We anticipate this project will take approximately two years to complete for the region.

Segment profit for the region was $12.2 million, up 38% over last year's segment profit of $8.8 million. As our business mix shifts towards our die cut business with the recent acquisitions of Tradex and Daewon, we also see a shift in our income statement with lower gross profit margins but also a lower cost of selling with our key account focus. As electronic manufacturers jockey for market share position at the end of this calendar year, we're seeing pricing pressures increase to levels that we have not seen before.

Pressures seem to be the greatest from those customers who have suffered a loss in market share. In some cases, our raw materials suppliers have recognized this and shown a willingness to share some of the cost burden. However, the consistency of this cost pressure necessitates our push for continued efficiencies in operations and the development of proprietary new solutions. We have worked diligently to ensure our readiness for the ramp up in production that we typically experience in the late summer and early fall.

Looking forward, we have a lot of work ahead of us to integrate the recent acquisitions in the region. We have assigned senior level Brady management to oversee these integrations and have also retained most of the management teams in both Tradex and Daewon. We believe these acquisitions help position our operations for continued ongoing success in the region and globally, as we have significantly improved capabilities to service our customers with quality products at competitive prices.

I will now turn the call back to David.

Thanks, Al.

I will now make a few comments on the full year. In slide 24, this shows in the last four years total Company growth by element. You can see that fiscal 2006 was our strongest year in the last four years both organically at 9% and for acquisitions at 16%.

Slide 25. This chart shows our profitability metrics for the last four years. On gross margins -- our gross margin came down 150 basis points from fiscal '05 mainly due to acquisitions. Approximately two-thirds due to acquisitions and the other third due to a combination of business mix, placing and cost increases.

On SG&A, this has improved 170 basis points with the major impact being business mix towards more OEM electronics and organic growth. Acquisitions had a slightly negative impact while we worked to integrate and achieve synergies.

Overall, we are pleased with our 40 basis points operating margin improvement. We improved our organic operating margin nicely, but some of that was offset by new acquisitions.

In slide 26, this slide shows very strong results in the last three years with a CAGR of 71% growth in net income over that same period and 65% in diluted earnings per share.

And slide 27, before handing over to Frank, I will close with the guidance chart for fiscal 2007.

Over to Frank.

Thanks, David.

As we wrap up fiscal 2006 and look at our current year, fiscal 2007, our strategy of becoming the market leader in all our markets remains intact. In fiscal 2006, that strategy led us to successfully acquire 11 companies and drive the strong organic growth we have experienced. In fiscal 2007, we will continue to look at acquisitions but we will also focus on continued improvement in our new product development.

We view proprietary new products, material systems and software as key to continued organic growth in our traditional markets. We have instituted new processes and hired additional talent in R&D to assist us in these endeavors. We will continue to expand geographically as our customers move to new markets, and a number of those initiatives are already in place. Finally, we will continue to look to adjacencies to our products and strategies to match the needs of the market.

That is the end of our prepared comments, and we will now start the Q&A.

[OPERATOR INSTRUCTIONS]. Our first question comes from the line of Reik Read from Robert Baird & Co. Please proceed.

Good morning. Thanks for taking my question. Just with respect to Asia Pacific and the two issues you mentioned there, the cancellations and the price pressure, are the cancellations all related to Maxtor or is there something else there? How long do you think that that issue will persist? And then on the pricing front, can you give us a sense for what the magnitude of the pressure is and how much is being mitigated by your suppliers at this point?

Al?

Sure. Well, relative to the first question you asked if the cancellations were all focused around one customer with the acquisition, and yes, they are predominantly. And we'll probably see that effect through the first three quarters of this fiscal year.

Secondly, relative to the pricing pressures, it really depends on the customer specifically, but we're seeing anywhere in the neighborhood of -- instead of annual increases or decreases, they're looking at quarterly decreases and sometimes they’re in the neighborhood of 3 to 5% and sometimes when they face a lot of market pressure with a particular program they can be even more intense than that.

Our materials suppliers have really, I would say in the last quarter, they have started to recognize the significance of this and have begun to step up and help us by reducing costs and reengineering some of their solutions to be more competitive in the marketplace.

And, Al, with respect to the quarterly decreases, is that something you see persisting for at least the foreseeable future?

Probably. This isn't that new for us. I would say the pressures are a little bit more intense the last quarter, but we've seen this historically in the OEM electronics business. And I would say if there is good news associated with that, is that as product lifecycles become shorter and shorter, those pressures have a shorter life period as well.

Okay. Great. Thanks, and then just one more question.

Reik, if I may comment, you know, as Al said, we have seen this over the years. And we are clearly the number one player in our die cut for mobile phones. We’re also pretty strong in hard disk drives. And it is not that we are the only ones who are experiencing these kind of pressures. It is pressure which is universal, and what we have seen in the past and this is not only in die cut, it is across all of our businesses. The stronger companies are the ones who typically benefit in the long term from price pressures because it pushes weaker players out of the market. While short term like a recession, while short term this is not positive, midterm to long term, typically, the stronger players are the ones who benefit.

Okay. And then just from a cost reduction view point - because it seems to be happening in Asia, but I think you guys really made this a focus of the Company on a worldwide basis - can you give us a little bit of an overview in terms of what some of the margin improvement opportunities are within Brady on an internal basis, what some of the cost reduction opportunities might be with any of the new acquisitions, and then also give us a little bit of an overview in term of the Toronto facility as that opens up. Will that provide any near-term help in terms of margin improvement?

Well, we're continually improving our organic operating margins, Reik. We've (indiscernible) improvements this year. We're doing the same next year. Our margins will probably remain at this year's level, though, as we integrate a couple hundred million dollars of acquisitions in fiscal 2007.

Reik, I will add to that a little bit. David Hawke here. We have a lot of programs going. But basically, those programs are built into our guidance. As you see our guidance, that's reflecting that we can drive cost reductions in our business. We have very aggressive programs in our existing businesses, and as you can well imagine in all of our acquired businesses.

Okay. And then just one more last question on the finance side of things. The investment in other income was down significantly. Can you guys just, given the cash and marketable securities balances don't seem to change all that much, can you give us some insight as to why that occurred?

It is other expenses, Reik. It is not actually investment income that’s down. If you look at that line it says investment and other income. It is other expenses.

Do you have another question?

Rob Damron, your line is open should you have any questions.

Good morning, yes, I wanted to talk a little bit more about your R&D expense. There is a plan, it looks like, to increase that going forward. Could you just give us a little bit more color on your new product development area, your ability to track engineers and maybe even give us a little insight into how much of your sales now are being driven by new products over the last several years?

We typically don't get into the details of what we've got coming out in products or specifically what we're driving. I guess I will suffice it to say we have boosted our spending in our materials area, our software area and our systems area as all of those areas are in fact important to our organic growth. We're not having any undue difficulty in finding talent or - let's say - we're not finding any difficulty different from other people, but it always does seem that if you need a particular skill it is not always easy to find. The beauty of it is we do have activities going on in a number of areas, so we can attract talent in Asia, for example, or the U.S. or Europe.

What I would - just as a summary comment, what we've got going in the Company right now is really a focus on innovation, and that innovation could be in the form of a product or the performance of a product for a customer. It could be in the form of driving the new production process that allows us to introduce some innovative products. We're really taking a broader view of innovation, and we're really looking particularly at the acquisitions in the die cut space as to sparking a lot more innovation in our production processes.

That's helpful. One other unrelated question on the acquisition environment. Can you tell us a little bit about what that currently looks like? Are there still lots of opportunities out there? Maybe you could talk about where you see the most opportunities and if the -- in the competitive environment for acquisitions, if that's increasing at this point?

David Hawke again. As I look at acquisitions, I would say we still see targets out there. People are -- it is an active market. We're really looking across the board. We're looking across our theaters and in all of our market areas.

Our acquisition activity is 100% grounded in the strategies of our businesses. So as they see a need for an interest, we mobilize our team to get on it. So we have an active program of looking at companies, putting them into discussions, et cetera, so we actively manage our pipeline. And I am not seeing any particular difficulty I would say at any one point in time since we so actively manage our pipeline. It might be a little thinner or thicker at different times, but in aggregate it is looking pretty good.

Okay. Thank you very much.

Your next question is from Andy [Yung] from Thomas Weisel Partners.

This is Andy Yung standing in for Ajit. I just have a couple questions. The first one is, with the recent acquisitions, was there a sales mix between your Electronic and OEM business and your MO supply business?

Well, right now the OEM electronics is above (indiscernibles) . I wouldn't say as much as 40%. It is certainly above one part of our business, and MRO makes up the rest. That is just a function of timing really. We will continue to make acquisitions in the MRO space.

Andy Yung Okay. Okay. And then also with higher growth rate in the electronic OEM business, should we expect SG&A and R&D as a percentage of sales to go down or should we expect another similar percentage right now?

Yes. That's a great question. We are trying to put up R&D as a percent of sales, but our top line keeps racing ahead of us. We're certainly spending more dollars, and in terms of gross margins and SG&A, what you will think is that OEM electronics business as it grows faster than MRO will tend to reduce gross margins and also reduce the SG&A.

But, we don't give guidance on gross margin percentages or SG&A percentages, because it is heavily dependent on acquisition activity, growth activities and so forth. So where we do give guidance is on that income as a percentage of sales, and it remains to get from 10% revenue where we were last year to about 12%.

In 2010.

2010. You please understand that we cannot give guidance across margin and SG&A because of the mix in OEM and MRO.

Right. Okay. And then one quick follow-up question about other expenses. It seems like for that department, there’s quite a bit of fluctuations. Can you give us a little bit color in terms of what kind of expenses and how we should expect that (indiscernible) ?

Other expenses?

Other expenses.

We had unusual item in other income. We made a gain on the option of 1.5 million that we used in Tradex. It has an unusual item again of 1.5 million if that helps.

Okay. Thanks.

[OPERATOR INSTRUCTIONS] The next question is from the line of Mark Roberts from Roberts and Company LLC. Please proceed.

Good morning.

Hi, Mark.

Good morning. Two questions. Could you elaborate a little more on the special labels in the disk drive business? Are you expecting that to start to reaccelerate as the merger of the two companies finishes up?

Do you want to take that, Al?

Sure. Well, there is a lot of changes that are going on in the drive industry besides the players we talk about. The actual format of the drives is starting to change, too; and there is a new concept coming online with perpendicular recording and that is actually working to our advantage despite the drives getting smaller.

They're a lot more complex in terms of maintaining cleanliness inside the drive. It is not purely in the labeling side of the business but also some of the functional die cuts where we see very nice growth opportunities - not quite as much as the terms of square yards and material we would be producing, but some of the pricing associated with the complexity of parts that will be required going forward.

Okay. And secondly, David, in looking at the model, and I know you don't want to comment on people's models, but I want to follow up on some of the other questions. It doesn't look like you're expecting a lot of cost-efficiencies in terms of gross margin to occur in 2007 to kind of be in line with the guidance. Is that because you have a lot of integration to do next year? And if that's true, can you give us a sense of what your targets would be for margin improvement, say, in future years from these acquisitions?

Well, go back to what Frank talked about in terms of our five-year guidance, we expect to get in fiscal 2005, our net income as a percent of sales was 10%. We expect to get to 12% in 2010. We are planning significant margin expansion this year. You can't see it in our guidance because we've got a lot of integration to do. We've acquired 4,000 people. We've doubled our head count in the last 15 months. That's an awful lot of integration to do. We’ve got our hands full in the next 11 months.

And on occasion, Mark, we are ramping up production in Donguan, China, in India near Bangalore. We just ramped up Slovakia. We are starting up in Turkey. Not (indiscernible) of sales. There is a lot of activity we are starting up shared service organizations in India, which just opened a call center a couple months ago in the Philippines.

These are all investments which drag down our operating income. But we certainly don't make those investments because we don't expect a return later on. So if you look at all of this in combination with doubling our head count, 11 acquisitions, this gives you a flavor of what's going on in this Company. At the same time growing at 8%, 9% organically. With all of this activity going on, I have to tell you we are very proud of what we have accomplished in fiscal '06 and we are also very optimistic looking forward in fiscal '07. We are on a roll in this Company, and I think the numbers speak for themselves.

Okay. Last question. In looking at your longer term model, do you have a target of what you think the competitive environment will allow you to achieve in terms of operating margin? Would it peak out at 16% or less than 16% or more?

I think if you look at 12% net income, that talks to 17, 18% operating margins roughly.

Okay. That's helpful. Thank you.

You're welcome.

Our final question comes from the line of Donald Bisson from Evergreen Funds.

My question has been asked. Thank you.

I would now like to turn the call over to Barbara Bolens for closing remarks.

We appreciate your participation today and would like to remind you the audio and slides from this call are also available on our website at www.investor.bradycorp.com. The replay of this taped call will be available via the phone beginning at noon Central today, September 13th. The phone number is 888-286-8010. The pass code is 18607480. The replay will be available until 11:59 p.m. on September 20th.

As always, if you have questions please feel free to contact us. Thanks for your interest, and have a great day. Operator, please disconnect the call.

Thank you for your attendance in today's conference. This concludes the presentation. You may now disconnect. Have a great day.