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Sirona Dental Systems, Inc. (NASDAQ:SIRO)

F1Q09 (Qtr End 12/31/08) Earnings Call

February 05, 2009, 9:00 am ET

Executives

John Sweeney - VP, IR

Jost Fischer - Chairman, President and CEO

Simone Blank - EVP and CFO

Analysts

Natalie - William Blair & Company

Jon Wood - Bank of America/Merrill Lynch

Jeff Johnson - Robert Baird

Operator

Good day ladies and gentlemen and welcome to the Sirona Dental Systems First Quarter 2009 Earnings Conference Call. My name is [Shakuana] and I will be your coordinator for today. At this time all participants are in a listen-only mode. (Operator Instructions).

I would now like to turn the call over to your host for today, Mr. John Sweeney, Vice-President of Investor Relations. Please proceed.

John Sweeney

Thank you and good morning everyone. Before I turn the call over to Jost Fischer, Chairman, President, and CEO of Sirona Dental Systems, I need to inform you that information in this conference call contains forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995.

Forward-looking statements are information of a non-historical nature and are subject to risks and uncertainties that are beyond the company’s ability to control. The matters discussed in this conference call are subject to various factors which could cause actual events and results to differ materially from such statements. Such factors include uncertainties as to product sales volumes of the company's products, the possibility of changing economic, market, and competitive conditions, dependence of product dependence on key personnel, technological developments, intense competition, market uncertainties, dependence on distributors’ ability to manage growth, dependence on key suppliers, and other risks and uncertainties including those detailed in the company's filings with the Securities and Exchange Commission.

The company undertakes no obligation and does not intend to update these forward-looking statements to reflect events or circumstances occurring after this conference call. You are cautioned not to place undue reliance on these forward-looking statements which speaks only as of the date of this conference call.

Please note that in today’s conference call you’ll be presented with additional financial information including non-GAAP financial measures under Section 101 of Reg G of the 1934 Exchange Act. In addition, during today's conference call, management will comment on guidance for fiscal 2009. Please note that all statements made in connection with the guidance are based on current expectations, and actual results could differ materially from such forward-looking statements.

Now, I will turn the call over to Jost Fischer, Chairman, President, and CEO of Sirona Dental Systems.

Jost Fischer

Thanks John. It is my pleasure to welcome all of you to our first quarter 2009 conference call. Joining me today are Simone Blank, Executive Vice President and CFO and Jeffrey Slovin, Executive Vice President and COO of US Operation.

Our first quarter results are in line with our expectations against the backdrop of a challenging economic environment we continue to execute and we are taking the necessary steps to succeed, while we see some dentists postponing equipment purchases. We also see that they continue to evaluate and invest in innovative high-tech products that improve their competitive position and increase their practice income.

Our CEREC AC launch is off to a great start and represents another example of our industry leading research and development efforts benefit the company. In addition our expense management initiatives are underway and we will start seeing the benefit as we move forward. The highlight of the dental calendar will be the buy annual IDS dental show in Cologne at the end of March. This is the largest show in the dental world and the key launch platform for the industry and for us.

Before I discuss these topics I will turn the call to Simona for a review of our results.

Simone Blank

Thank you, Jost. First quarter revenues were $179.7 million down 10.2% compared to prior year or down 4.4% constant currency. As we expected, our first quarter revenues were impacted by the global recession.

Now I would like to highlight the quarter's regional development. US revenues declined 6%, last year’s quarter benefited substantially from the MC-XL upgrade program. If we exclude the impact of the trading program from the prior year quarter, our US revenues in total would have shown a year-over-year increase. Also US sales of our of digital panoramic and 3D Galileos systems were particularly strong in the quarter. International revenues declined 12%, down 4% on a constant currency basis. European revenues were down versus the prior year was mixed results among the countries. The German, UK and Spanish markets declined where as our sales in France, Austria, and certain other countries showed growth.

Our non-US, non-European revenues were up materially with continued strong performance in Japan.

Moving on to a review of our business segments performance. Imaging segment revenues declined 5% flat constant currency, benefiting from positive development in the US as well as solid performance in many of our non European market such as Japan, and Australia. This was offset by a weak performance in Germany, which was down materially. Imaging segment gross profit margin was 60% in line with the prior year period.

Treatment Center revenues declined 12% or down 4% on a constant currency basis. Strong performance in non-US, non-European markets was offset by weakness in Europe and some European dentist postponed purchases of treatment center.

Segment gross profit margin was 37.7%, down 5% from prior year. The margin decline was due to product and regional mix. Revenues in our CAD/CAM segment declined 13% or down 9% constant currency. If you back out the impact of last years trading program in the US, CAD/CAM segment revenues would have shown growth. We experienced revenue declines in Europe, with Germany down significantly.

Non-US, non-European markets had strong growth in the quarter. CAD/CAM segment gross profit margin improved 350 basis points to 70%, up from 66.5% in the first quarter of 2008. The absence of trading units improved margin performance of our MCXL milling unit and the favorable exchange rate drove the CAD/CAM margin expansion.

Instrument revenues declined 14% or down 6% constant currency with the weakest performance in Germany. Otherwise Pockets posted growth in the quarter. Instrument segment's profit margin was 45.6% down slightly compared to the prior year.

Cost of sales was $92.7 million for the quarter, a decrease of $13 million or 12.3%. Gross profit margin was 48.4% up from 47.2% in the prior year. Cost of sales included deal-related amortization and depreciation expense of $16.2 million versus $20.6 million for the same period last year. Excluding deal-related amortization and depreciation expense, gross profit margin in the first quarter was 57.5% in line with prior year.

Moving onto operating expenses. SG&A expense was $57.4 million, an increase of $1.5 million. As a percentage of sales, SG&A expense was 32% up from 27.9%. SG&A expense increased due to our continued expansion in selected countries. In addition we had some cost-related to the launch of our CEREC AC unit.

Looking forward, we expect SG&A as a percentage of sales to be similar to the full fiscal 2008. R&D was $11.1 million down to $2.6 million as compared to last year. The decrease in R&D was mainly due to the timing of our new product introduction. In 2009, R&D is expected to be at historical levels of 6% to 7% of revenues.

Operating income plus amortization expense $39.4 million down 20.5%. Foreign currency loss amounted to $3.6 million in the quarter comprised of $2.3 million non-cash unrealized loss on the revaluation of the Patterson exclusivity payment, and $1.4 million loss on the revaluation of short-term intra-group loans.

The non-cash loss on derivative instruments amounted to $5 million. This loss included over $8.1 million unrealized non-cash loss on interest rate derivative resulting from currently very low LIBOR and EURIBOR rates. This loss was partially offset by a non-cash gain on foreign currency derivatives in the amount of $3.1 million.

Net interest expense was $6.1 million compared to $6.7 million. The income tax provision for the first quarter of fiscal 2009 was $2 million compared to $7.2 million for the prior year period. Please note that the 2009 fiscal year effective tax rate is expected to be 28% compared to 24% effective tax rate in 2008. The 2009 rate is forecasted to be higher than 2008 mainly due to the estimated of profits across the different countries.

The company’s net income was $5.6 million compared to net income of $17 million in the prior year. On a GAAP basis, first quarter, 2009 EPS was $0.10 compared to $0.31 in the prior year. First quarter 2009 GAAP EPS included a $0.22 expense for deal-related amortization and depreciation, a loss of $0.03 related to the revaluation of the Patterson exclusivity fee, a loss of $0.02 related to the revaluation of intra-group loans and a $0.01 gain on the sale of investments. In the prior year quarter GAAP EPS included $0.27 of deal-related amortization and depreciation. A $0.05 gain from the revaluation of the Patterson exclusivity fee and the $0.03 gain related to the revaluation of short-term intra-group loans.

Excluding these items in both periods, first quarter diluted earnings per share was $0.36 as compared to $0.51 per share in the first quarter of 2008. Please note that the first quarter 2009 EPS of $0.36 includes an $8.1 million unrealized non-cash loss or $0.11 per share on the mark-to-market revaluation of interest rate derivate.

Moving onto cash flow, operating cash flow during the quarter was negative $1.6 million and investing cash flow was $0.4 million. During the quarter we purchased 25,000 shares other than new share repurchase equipments. At December 31, 2008 the company had cash and cash equivalents of $143.7 million and total debt of $548.5 million resulting in net debt of $404.8 million. This compares to net debt of $403.8 million at September 30, 2008.

Now I would like to give you an update on our cost cutting initiatives which are progressing as such. As we outlined in our last call we have initiated two programs to reduce expenses. The first initiative focuses on the near term and it is expected to result in savings of $10 million in fiscal 200. The second is to improve the efficiency of our organization. This initiative is expected to result an annualized savings of $10 million which will be fully realized in fiscal 2010. We would incur an estimated $10 million charge mainly in the second half of fiscal 2009 to implement these programs. This chart will offset the savings from the near-term initiatives in fiscal 2009.

This morning we reaffirmed our fiscal 2009 guidance. The first quarter of 2009 was a challenging environment for selling equipment. Having said that, our business is tracking inline with our expectations. In fiscal 2009, we continue to expect both revenues on a constant currency basis and operating income excluding amortization to be flat as compared to fiscal 2008. We would like to remind our investors to evaluate our business on an annual basis as our quarterly progression can vary significantly.

This is particularly true given that 2009 is an [IDS] year and at the year's quarterly progression will also be shaped so our product launches including the CEREC AC.

That concludes my review of the first quarter and guidance update. I will now turn the call back to Jost.

Jost Fischer

Thank you, Simone. Sirona has a long history of innovation in the dental equipment industry. We have continuously invested in research and development and these efforts have resulted in a pipeline of innovative new products that have shape the industry.

Our investment in CAD/CAM, Imaging, Treatment centers, and instruments continue. Most notably, in January, we launched the CEREC AC, which strengthens our dominant leadership position in the CAD/CAM market. CEREC AC is based blue light LED technology that gives a number of distinct advantages compared to the prior unit and competing products. CEREC AC has the following features: a uniform field of illumination which results in measurably increased precision. A built-in-shape control function which enables the unit to quickly and automatically capture a 3D image. The ability to capture arches and quadrants quickly and precisely as fast as 40 sec/scan and AC expands the range of indication of CEREC will include single-visit temporary bridges.

Our AC significantly enhances our CEREC CONNECT platform. With CEREC CONNECT the dentist can easily upload CEREC AC’s precise little impressions through the Sirona inLab owners of their choice. This will benefit Sirona’s four thousand plus inLab owners going forward as they have direct access through a large installed base of over 24,000 CEREC users. Let me remind you that digital impressions are more accurate than physical impression and have significantly lower rework requirements. In addition to productivity savings patients do not have to uncomfortable impression trays. We are the AC with new pricing options.

In May, we will start selling standalone AC units. In addition, we will make the AC available on a pay per use basis. CEREC AC is an important advancement in our offering and it rounds out our product portfolio in the CAD/CAM market.

At the Yankee Dental Show in Boston last month, we received first hand feedback from the dental community. That is we are very impressed by the speed of acquisition and the crisp, clear, precise utility impressions. Our CEREC AC unit generated a lot of excitement at the show. Patterson, our North American CEREC partner was very pleased with the level of interest that the new product is generating.

As you know we are entering a busy show period for Sirona with the Chicago midwinter at the end of February and the bi-annual International Dental show in Cologne in March. We will be exhibiting all of our products at these shows including our CEREC AC and other new products.

We will be delighted to host investors and either of these shows. Please contact John Sweeney our Vice President of Investor Relations, if you would like to book or for more additional information. With our continuing investment in research and development best in class product offering, and excellent relationships with our dealer partners including Patterson and Henry Schein, we are well positioned to successfully compete in the current environment.

Looking forward, I am confident that we are taking the right steps for the benefit of our company and our shareholders.

Simone, Jeffrey and I will now address your questions. Operator please proceed?

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of John Kreger with William Blair & Company.

Natalie - William Blair & Company

Hi everyone this is Natalie in for John.

Jost Fischer

Hi Natalie.

Natalie - William Blair & Company

First I was just hoping given sales and operating income were down in Q1 I was hoping you could talk about some of the factors that (inaudible) is performing better later in the year?

Simone Blank

Natalie, we reiterated guidance today and said that we expect to be less revenue and constant currency and plus amortization. And we also said before that we expect we are on-track we are inline with other expectations. And that we were expecting a week of first half and positive growth in the second half also driven by the IDS patent and by new product launches including the AC.

Natalie - William Blair & Company

Got it. Okay and then also what do you think drove the better Galileos performance in the quarter, do you think that was driven in part by some of the tax incentive?

Jost Fischer

I think certainly the section 179 did play a role, Natalie, but I have to say a lot of credit goes to territory managers and the Patterson reps who got behind selling this outstanding product and keep in mind we also launched the Compact which had a significant impact in the quarter.

Natalie - William Blair & Company

Okay, great. And then Simone, did the related amortization that you had in Q1, should that be above the level that we expect for the remaining quarters of '09?

Simone Blank

I didn’t fully get that question, Natalie.

Natalie - William Blair & Company

Yeah, the deal related amortization that you had in Q1, is that above the level we should expect going forward?

Simone Blank

Yeah. The amortization in the quarter is the level that we would expect going forward.

Natalie - William Blair & Company

Okay. Thank you.

Operator

Your next question comes from the line from Jon Wood with Bank of America/Merrill Lynch. Please proceed.

Jon Wood - Bank of America/Merrill Lynch

Thanks guys. Can you give us some color on the factors behind the considerable weakness you saw in Germany in the period?

Jost Fischer

Hi Jon. This is Jost. Yeah, market was weak in Germany, and it was down materially as we indicated in our last call, general economic environment certainly played a role and then the absence of any material tax incentives and during the quarter there was an announcement that an accelerated tax depreciation will be in place for 2009, which certainly did not encourage any doctor to buy during the 2008 side of it.

That certainly are the two major reasons, and the other reasons, of course, as the IDS approaches, some dentist are taking a harder look in postponing until the [show DC] what's happening.

On the other hand, anecdotally, we see some signs of optimism for this quarter, but obviously, we remain cautious for our second quarter in Germany.

Jon Wood - Bank of America/Merrill Lynch

Okay. That’s helpful.

Jost Fischer

Certainly, we will see an improvement in Q3 and Q4 for Germany for the just stated reasons.

Jon Wood - Bank of America/Merrill Lynch

Okay, thanks that’s helpful. Can you give us any incremental color on the trends you may have seen through December and perhaps into January?

Jost Fischer

Can you repeat the question?

Jon Wood - Bank of America/Merrill Lynch

Yes can you give us any incremental color on some of the trends you may have seen into December and into January, I know, you gave us some color on the month-to-month, last quarter?

Jost Fischer

Yes, I think what you can see is some slowing in patient traffic in the dental office, but generally it’s holding on. It’s not a fall off the cliff or anything like that. We also hear that there is some weakness in the higher end procedures like implant here, some softness overall but general dentistry is holding up okay. This is what we see.

Jon Wood - Bank of America/Merrill Lynch

Thanks. And is there any update to operating cash flow guidance for the year?

Simone Blank

Yes, operating cash flow we said while our general guidance is that we are flat, so we also expect that our cash flow, operating cash flow, free cash flow will be on the prior year’s level.

Jon Wood - Bank of America/Merrill Lynch

Great thanks.

Simone Blank

You’re welcome.

Operator

Your next question comes from the line of Jeff Johnson with Robert Baird. Please proceed.

Jeff Johnson - Robert Baird

Thank you Good morning guys.

Jost Fischer

Hi, good morning, Jeff

Jeff Johnson - Robert Baird

Sorry, I missed part of the early part of the call, but I just want to push on the first question there from Q&A. Your guidance for CAD operating income really at this point seems to imply 300 basis points to 350 basis points of operating margin expansion in the back three quarters of the year versus the 250 basis points contraction we saw this quarter.

I understand the revenue aspect will probably be a little bit of that with the AC launch and all that. How do you we get comfort there other than just you are reiterating guidance on where these margin improvements will come to such an extent over the next few quarters?

Jost Fischer

First of all as you know we are launching a number of new products and we just have launched a number of new products. And generally innovative products tend to come with higher margins than the products are on the market for a longer term. I think that is a reason for us to look positively into the near future. The other side is we have our expense control underway which will show results later in the year and therefore will benefit our bottom-line.

Jeff Johnson - Robert Baird

Okay great and then, I mean new product launches, obviously with MC-XL we went through some margin hiccups just initially and those were some field repairs and things so maybe that doesn’t come again with AC or hopefully it doesn’t come with AC. But should we think upgrades for AC being positive to the margin as well not just new system sales of AC but upgrades been margin accretive as well, Jost?

Jost Fischer

Yes. To your first question, we certainly have prepared this launch and so far we can say this is the best launch Sirona has done ever. That having said means we took a little more time and the manufacturing of a milling unit which has carries about I would say 450 to 500 parts versus a camera which has round about 80 to 100 parts is from that challenge a little easier, because we are selling more technology than manufacturing ability in this one. We took a little bit more time to get out and I think that make us feel optimistic to have a great launch with this product.

To the second part of your question, will there be upgrade possibilities and what will be the margins here. Yes, we will plan and upgrade possibility but not before Q3. In our aspect it will be a good margin it will be an accretive margin to overall Sirona margin. That’s the IDS.

Jeff Johnson - Robert Baird

Okay. If I am hearing you right Jost then we think of ACB more of a benefit to new system sales at least in the fiscal second quarter and not till we get into fiscal Q3 do we see some of the upgrade benefits coming through?

Jost Fischer

Exactly.

Jeff Johnson - Robert Baird

Okay, great. And then last couple just small questions. You divested a distribution business in Spain during the quarter and I think that was contemplated in your guidance when you first gave it last quarter. Are there any other markets where you go direct you may be thinking about divestitures or do we need to think about that at all as we think about our model going forward?

Jost Fischer

No, there is nothing else in the pipeline from our point of view.

Jeff Johnson - Robert Baird

Okay, great. And the last two I guess. You surprised us a little bit on the good side coming out with AC when you did definitely earlier then I expected in, it seems to be pretty compelling technology, but just wondering are there other products not that I expect you to tell us what they are now but other new products coming as well when we get IDS in March or is the AC going to be the big one?

Jost Fischer

First of all within the last six months I think we have done some major product launches when you look at our (inaudible) the best treatment center out there. And our Galileos Compact which met a very positive response in the market. And then we came up with AC which in my mind it will change the phase of dentistry it will enable the combination between our in-lab owners and our CEREC in-office users and really provide the platform for digital dentistry in the near future, its not only a future, its here.

So, this is something which is great and we launched this product earlier in order to inform the market that we are able to come to the show in Chicago, mid-winter, as well as IDS and to meet informed dentist, to meet informed dealers and dealer reps, so that they are able to talk about this product, and that they are able to show that we have already an install-base of the new product in place. So, we have a better informed audience in order to faster move this product.

On top of that, Jeff, of course, we will have some surprises coming up at the mid-winter maybe to a smaller extent, the larger extent at the IDS, while we will bring some upgrades or some new products out there that hopefully than we will have very positive impact on top of the already known innovations.

Just remember, Sirona's hallmark is innovation in products. Sirona's first way of improving profitability is getting out new products with higher gross margins and we intend to prove that on top of what we already done as of today.

Jeff Johnson - Robert Baird

Great. Jost I may not understand the German dentist thought process as well as I hope I do anyway in the US. But if there is an accelerated depreciation schedule for calendar '09, is it fair to think German dentist are very similar to US dentist. They won’t really move because of that maybe until the last few months of the year and therefore pretty you guys it make more of fiscal first quarter '10, benefit as oppose to a late fiscal '09 benefit?

Jost Fischer

So to your remark our German dentists behaving similar to Americans, yes. When we come down through accelerated depreciation, I think we have a difference here to the American system. You will have a pro rata, accelerated depreciation in the month you buy. That means if you buy in December you get 1/12 if you buy in January you get the full-year, so there is no incentive for the dentists to wait as you have with the Section 179. So this is rather new. It was discussed in early December and put in place in mid-December, so certainly had an impact on our December sales if known by the dentist, but from today on from January on there is no incentive for him to wait. He will take advantage as he goes.

Jeff Johnson - Robert Baird

Okay, by today is a German dentist and get 11/12 of the accelerated depreciation.

Jost Fischer

Exactly

Jeff Johnson - Robert Baird

Okay, great, very helpful. Thanks guys

Jost Fischer

Okay, thank you.

Operator

(Operator Instructions). At this time I would like to turn the call over to Mr. Jost Fischer for closing remarks.

Jost Fischer

So, thank you very much for joining us today on our first quarter conference call and I am looking forward to updating you on our next quarterly call in May. Thank you very much and have a nice day.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect and have a great day.

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Source: Sirona Dental Systems, Inc. F1Q09 (Qtr End 12/31/08) Earnings Call Transcript.
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