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Sirona Dental Systems, Inc. (NASDAQ:SIRO)

Q2 2012 Earnings Conference Call

May 4, 2012 8:30 am ET

Executives

Jost Fischer - Chairman & CEO

Simone Blank - CFO and EVP

Jeffrey Slovin - President and Director

Joshua Zable - VP, IR

Analysts

Ross Taylor - C.L. King & Associates, Inc

Robert Jones - Goldman Sachs Group, Inc

Brandon Couillard - Jefferies & Company

Elliot Feldman - Barclays Capital

Jonathan Block - SunTrust Robinson Humphrey

Scott Green - Bank of America Merrill Lynch

Steve Beuchaw - Morgan Stanley & Co. LLC

Jeffrey Johnson - Robert W. Baird & Co

Tycho Peterson - JP Morgan Chase & Co

John Kreger - William Blair & Company, LLC

Jeffrey Warshauer - Sidoti & Company, LLC

Operator

Good day ladies and gentlemen and welcome to the Sirona Dental Systems’ Second Quarter Fiscal Year 2012 Earnings Conference Call. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

I’d now like to turn the presentation over to your host for today’s call Mr. Joshua Zable, Vice President of Investor Relations. Please proceed, sir.

Joshua Zable

Thank you and good morning, everyone. Welcome to our second quarter 2012 conference call. I’d like to remind you that an earnings slide deck presentation relating to this call is available on our website at www.sirona.com.

Before we begin, please take a moment to read the forward-looking statements on slide two of our earnings slide presentation. During today’s conference call, we’ll make certain predictive statements that reflect our current views about our future performance and financial results. We make these statements on certain assumptions and expectations of future events that are subject to risks and uncertainties. Our most recent Form 10-K lists some of our most important risk factors that could cause actual results to differ from our predictions.

And with that, I’ll now turn the program over to Jost Fischer, Chairman and CEO of Sirona Dental Systems.

Jost Fischer

Thanks, Joshua. It is my pleasure to welcome all of you to our second quarter 2012 conference call. Joining me today are Jeffery Slovin, President and Simone Blank, Executive Vice President and Chief Financial Officer.

I’d like to introduce our new Vice President of Investor Relations, Joshua Zable. Joshua recently joined Sirona and he knows us well as he followed the Company when he was a medical device sales side analyst. We’re delighted to have him on our team and look forward to working with him.

I’m pleased to report solid results for the second quarter of fiscal 2012. Our double-digit revenue growth continued with sales up 11.1% on a constant currency basis. We continue to gain market share. Operating income plus amortization also grew double-digits, up 10.9%. Treatment Centers and the CAD/CAM segments were the strongest performers in the quarter, up 17.5% and 13.7% respectively, constant currency.

Under regional basis Sirona’s revenue growth was driven by international markets, up 13.7% constant currency and was particularly strong in the Asia Pacific region. This robust performance is directly attributable to the investments we made in our sales and service infrastructure and we’re pleased with the results they’re yielding.

It is important to note that many of the international markets that we’re investing in are growing materially above the Company’s average rate. Overall, our investments in key markets around the world will enable us to compete more effectively today and in the years to come.

Let me reiterate the two key pillars of our successful strategy. To expand our outstanding portfolio of high-tech dental products through continuous innovation. We have invested over $250 million in the past six years in the pursuit of creating new and enhanced products and solutions to continue our world-class global sales and service infrastructure. We’re active in over 135 countries around the globe. We continue to execute on our strategy giving Sirona a clear competitive advantage and enabling us to deliver consistently strong organic.

I will now turn the call over to Simone, who will review our second quarter financials.

Simone Blank

Thank you, Jost. In the second quarter our revenues increased $17.1 million to $231.9 million, up 8% or up 11.1% on a constant currency basis. Our double-digit revenue growth was mainly driven by continued strong performance in international markets, which increased 9.2% or up 13.7% constant currency. Sales were particularly robust in the Asia Pacific region. In the United States revenues increased 4.9% compared in the first quarter of this fiscal year.

Sirona’s operating income plus amortization increased 10.9% to $52.2 million. Moving on to a review of our business segment. Revenues in our CAD/CAM segments increased 11.1% to $85.6 million or up 13.7% on a constant currency basis. CAD/CAM revenues benefited from very strong growth in international market.

We continue to get excellent feedback from the marketplace on our CEREC 4.0 software. Dentists appreciate the ease of use, the ability to design multiple restorations and the increased processing speed. In the second quarter we also successfully launched the inlab 4.0 software for all our customers. Our CAD/CAM segment margin was 70%, down 160 basis points compared to the prior-year period, but on the levels of the full fiscal year 2011. The decrease in the quarter was mainly driven by current promotion.

Imaging segment revenues increased 3.5% to $74.8 million, up 6% on a constant currency basis. Growth was mainly driven by the U.S. and the non-European international markets. This quarter we started to come up against the launch of the ORTHOPHOS 2D, 3D unit. As a reminder, last years Q2 imaging grew over 20%.

We continue to see robust interest in our ORTHOPHOS 2D and 3D product line. Imaging segment gross profit margin was 56.9%, down a 170 basis points compared to the prior-year period, but on a similar level we saw in the first quarter. The margin compression was mainly driven by strong payers of our ORTHOPHOS panoramic units.

Treatment Center segment revenues were $46.4 million, up 12.7% and up 17.5% constant currency. Growth in the quarter was driven by comfort and standard product lines. We continue to be excited about the markets strong reception of SINIUS, our mid to high-end ranged product. Treatment Center gross profit margins increased 60 basis points to 40.5%, slightly above the levels we saw in the first quarter. The quarterly development was driven by product mix.

Instruments revenues of $24.7 million were up 3.3% or up 7.7% on a constant currency basis. This growth was mainly driven by high volume projects in international markets. Instrument segment gross profit margin was 48.8% relatively good margin for instrument segment, up a 100 basis points over the first quarter, but down a 150 basis points compared to prior-year. The quarterly development was driven by product mix.

Moving on to review of the P&L. Gross profit margin was 53.8%, down 10 basis points compared to 53.9% in the prior-year. Gross profit margin benefited from lower amortization offset by margin compression due to product mix. Cost of sales included deal-related amortization and depreciation expense of $11 million versus $12.5 million in the prior-year.

SG&A expense was $72.7 million, up $2.1 million. This increase was due to the continued planned investments and expanding our sales and service infrastructure to capitalize on opportunities to gain share around the world and build out our presence in faster growing markets. SG&A in the second quarter of last year included the expenses related to the International Dental Show in Cologne.

R&D was $13.6 million slightly below prior year’s level. Between December 31, 2011, and March 31, 2012, we experienced a strengthening of the Euro relative to the Dollar from 129 to 133. Foreign currency loss amounted to $1.4 million in the second quarter. When you strip out the $1.7 million non-cash gain on the revaluation of the Patterson exclusivity payment and the $2.3 million gain on the revaluation of the short-term intra-group loans, we’re left with a loss due to the currency revaluation of short-term assets of $5.4 million. Partially offsetting that loss was a $2.9 million gain on currency-derivates, also due to the strengthening of the Euro versus the Dollar in the quarter. The net impact of these foreign currency fluctuations on adjusted EPS amounts to $0.02 to $0.03.

Net interest expense was $1 million compared to $0.9 million last year. The slight increase resulted from higher interest rates, largely offset by lower overall debt level. The income tax provision for the second quarter of fiscal 2012 was $9.3 million. The estimated effective tax rate for the quarter was 23%. Net income was $30.5 million, up from $29.3 million in the prior-year period.

Second quarter 2012 diluted GAAP EPS was $0.54, compared to $0.61 in the prior-year. On a non-GAAP basis, that is excluding deal-related amortization and depreciation and the currency revaluation of the Patterson exclusivity fee and short-term intra-group loans, non-GAAP earnings per share was $0.64 compared to $0.58 in the prior-year.

In the quarter, operating cash flow was $48.8 million, up 56% compared to $31.3 million in the prior-year. Capital expenditure was $10.3 million down compared to the $14.7 million in the prior-year period. Finance and cash flows were impacted by the repayment of the revolver and the share buyback program.

In August of 2011, we initiated our $100 million share repurchase authorization. To-date we have spend $36 million under our current plan. At March 31, 2012, the Company had cash and cash equivalents of $77.8 million and total debt of $77.6 million, resulting in net cash of $0.2 million. This compares to net debt of $22.5 million at September 30, 2011.

Now moving on to guidance. For the full-year 2012, we confirmed constant currency revenue growth at the upper-end of our 6% to 8% guidance range. This revenue growth is expected to be led by particularly solid performance in our non-U.S., non-European markets. We’ve been investing in these attractive markets over the past few years, and we expect them to continue to produce both near and longer term results as we expand our presence.

For the full-year, we anticipate segment gross profit margins to be on prior-year’s level. Reported gross profit margin is expected to be higher than the prior-year, due to the step-down in amortization expense.

SG&A as a percentage of sales is anticipated to be about 30% for fiscal 2012. R&D is anticipated to be about 6% of sales. We estimate our effective tax rate for fiscal 2012 to be 23%.Based on all of these factors, we reaffirm our guidance for operating income excluding amortization, estimated at around $50 million to be in the range of $227 million to $234 million.

In terms of quarterly progression, the first quarter of fiscal 2012 represents the most difficult comparison for the year because of the high-level of orders from the International Dental Show last year.

As always, I suggest our investors evaluate our business on an annual basis, as our quarterly progression can vary significantly.

I’ll now turn the call back to Jost.

Jost Fischer

Thank you, Simone. Let me comment further on our investments in our global sales and service infrastructure.

Once again, our top-line growth was driven by international markets with a substantial contribution from those countries that we continue to invest in. Our philosophy is, be the first mover, provide innovative products through the market, leverage our infrastructure to support our customers, and drive short and long-term growth.

Our decisions to invest or paying off has now over 30% of our sales come from outside the U.S. and Europe. Equally important, we believe these new geographies will continue to grow in significance.

I’m also excited about the new products we continue to launch. We recently introduced our CEREC Guide, a break-through complete digital solution for integrated implant planning.

Let me give you some background. When a dentist chooses to use a drilling template for implant, he now has three options. CLASSICGUIDE, involving lab stone models, OPTIGUIDE, using digital impressions, or use our new revolutionary technology CEREC Guide. We created on our Chairside CAD/CAM system in-house. Although guide emplacements of implants is clearly superior to free-hand placement of implants in terms of safety and precision. Today, fewer than 10% of implants are placed with the aid of surgical guides. Some dentists are wary of high costs and long delivery times and thus deploy surgical guides only in so-called, “difficult” cases.

CEREC Guide removes these obstacles. It is a quick, simple, low cost and precise procedure tailored to a complete range of indications.

Let me comment on the dentist’s options. CLASSICGUIDE is the ideal solutions for complex cases involving lab-stone models. OPTIGUIDE is an industrially-produced surgical guide created on the basis of optical impressions acquired on Sirona’s 3D imaging systems.

CEREC Guides can be produced using either the classic Chairside CAD/CAM process or via the Sirona Connect portal. CEREC Guide enables a dentists to create a surgical guide, Chairside, allowing the dentist to get the guide faster and at a much lower cost. [Both these] feedback has been enthusiastic.

CEREC Guide enables better and safer dentistry, and once again clearly demonstrates continued leadership in CAD/CAM.

Before we take questions, I’d like to remind you that we’ll continue to execute on our successful strategy. Reported by our global sales and service infrastructure, best-in-class distribution partner’s, solid financial background and our employees who are unparalleled in the industry.

Sirona has never been in a better position to continue to compete and win in the years to come. Simone, Jeffrey, and I’ll now address your questions. Operator, please proceed.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Ross Taylor of C.L. King. Please proceed.

Ross Taylor - C.L. King & Associates, Inc

Hi. Just a couple of quick questions. I wonder if you could comment on performance in Europe and all during the quarter and I guess in particular maybe some of the larger markets like Germany.

Jost Fischer

Hey, good morning, Ross. This is Jost. Yeah, Germany continues to do well. We’re pleased with the performance there, and we were up in the quarter. We’ll face a tough comparison here in Q3 and as the prior-year quarter was very positively impacted by orders from the IDS.

The picture is different when you look at the other European countries. It’s kind of a mixed bag, Ross. The countries that have been in the headlines like Spain, Portugal, the U.K. and Ireland continue to be relatively weak, but these markets will not make a big difference to us one way or the other, U.K. slightly improving.

France and Italy remain relatively stable. And the Central European countries and the Scandinavian countries are doing fine. All in all, we remain cautious about the development in general.

Ross Taylor - C.L. King & Associates, Inc

Okay. And my second and last question, maybe I’m getting a little bit ahead of myself, but we’re halfway through fiscal year ’12, and just looking out at fiscal year ’13, do you think we might start to see in your financial results some margin leverage on some of the international infrastructure, sales and marketing infrastructure build that you’re doing or do you think your margins maybe stay flattish on the SG&A line?

Jost Fischer

Absolutely, Ross. Our business is doing extremely well in the markets outside the U.S. and Europe, and specifically led by Asia Pacific. This again was the growth engine for our business in the second quarter. We’ve good momentum in these markets, and we expect that growth to continue. So, clearly our investments are paying dividends.

Ross Taylor - C.L. King & Associates, Inc

Okay. That’s helpful. And actually maybe just one more question, I know you typically don’t like to talk about results or forecast on a quarterly basis, but given the very difficult comparison here in the June quarter, I mean, any color you could give as to whether we could even expect organic growth to be go up or down next quarter? And that’s my last question.

Simone Blank

You know, Ross, the third quarter obviously is a tough comp as Jost already mentioned, driven by the orders that came through from the IDS last year. So that’s clearly something. Our second-half guidance, I mean the guidance for the full-year, and then, with that for the second-half in total cost for growth, and that is as much as we can tell you at this point.

Ross Taylor - C.L. King & Associates, Inc

Okay, good. Thank you very much.

Simone Blank

Thank you.

Jost Fischer

Thank you, Ross.

Operator

Your next question comes from the line of Robert Jones of Goldman Sachs. Please proceed.

Robert Jones - Goldman Sachs Group, Inc

Thanks for the questions. On the imaging segment, and specifically the gross profit margin there, does the compression from the ORTHOPHOS lines reverse at some point or as this continues to grow as a percentage of your imaging mix, should we be thinking about a slightly different gross profit margin profile for that segment?

Simone Blank

Yeah. In general, the gross profit margin in the imaging segment, as you said, is driven by mix. And we’ve seen that not only this quarter, also in the last two quarters that – because of the great success of our panoramic unit lines, the 2D and also the XG 2D, 3D, that margins are little bit below what we’ve seen in the past, the 60% level that we’ve seen in the past. It all depends on mix, but I’d say the strong growth that we had is very good for us. We’re gaining market share around the world. That’s very important.

Also, we’re pleased with every 2D unit that we’re selling because there is, on the one hand upgrade opportunity for these units to 3D, and it’s a great installed base, and our sales and service infrastructure clearly supported this growth. So we’re very pleased with the overall performance, and the development of the gross profit margin and specifically it will depend on the mix going forward.

Jost Fischer

I’ll add, Bob, every 2D unit that we place now will be an upgrade opportunity in the future to 2D and 3D.

Robert Jones - Goldman Sachs Group, Inc

Got it. And then if I could just ask one on CAD/CAM as well, nice acceleration there in the quarter. Any better sense you can give us of the drivers behind the growth in the quarter? And then more importantly, the sustainability of that growth in the back-half of this fiscal year?

Jost Fischer

We’re very pleased with the quarter, you’ve seen that. This quarter growth was mainly driven by our international markets as we continue to benefit from our investments and sales and service infrastructure.

Overall, nothing has changed. The business grew at 11% CAGR over the past five years and up 15% last year. We’ve some variability in the quarterly growth rates as you know, that’s long-term, we continue to believe this is a double-digit grower with a significant opportunity to penetrate, there is still lot of runway left for us and with the recent introduction of CEREC Guide, that will be another factor of helping the penetration of Sirona.

Robert Jones - Goldman Sachs Group, Inc

Thanks so much.

Simone Blank

Thank you.

Jost Fischer

Thanks, Bob.

Operator

Your next question comes from the line of Brandon Couillard of Jefferies. Please proceed.

Brandon Couillard - Jefferies & Company

Hi. Good morning. Thanks for taking the question. Jost or Simone, within the imaging segment, can you give us a sense of recent demand trends between both in for oral and extra-oral. And then what’s your sense of the pricing environment, have you seen any change in the competitive landscape there?

Jost Fischer

Okay. Brandon, this is Jost. Good morning. Imaging is growing. From our point of view we see particularly a strong demand for our panoramic 2D, 3D units out there. When you look at the Q2, financial year ’11 was up over 20%, so that was a tough comp. On the other hand, year-to-date we’re around 15% up constant currency. So we’re pretty pleased with what was going on. The XG 2D, 3D launch actually was annualizing this quarter. In January of last year we launched 2D, 3D which has been a very big success for us.

In general, our perspective on the category is double-digit growth, potentially its very big. We continue to take market share evidence by our growth rates and we expect that to continue. And from that point of view we’re pretty happy with where we are at this category.

Brandon Couillard - Jefferies & Company

Thanks for the news. Can you speak to any, I guess, monthly variability through the second quarter and to what degree have the trends that you experienced continued into the – early into the third quarter?

Jost Fischer

Yeah, I think usually, nothing unusual in this quarter. Usually last month is the strongest, nothing changed this month. And we do not see any change in the landscape, nothing unusual also looking forward as we said.

Simone Blank

We might want to add Q3 as a tough comp for us, as we've mentioned earlier. So, that clearly will influence the progression also in this quarter.

Brandon Couillard - Jefferies & Company

Thanks. And the last one, Simone, how should we think about capital redeployment opportunities here in the back-half, now with the revolver, I guess, they are taken care of, should we expect share repurchases potentially to pick-up later in the year or will you look to pay-down, I guess, the incremental debt loads on the balance sheet? Thanks.

Simone Blank

As you know we have the share buyback program in place. We've used it also this quarter again, but you know in general we do not pantograph our buybacks.

Jost Fischer

We spent $36 million in the first seven months of existence.

Simone Blank

No, since existence, yeah.

Jost Fischer

Yeah.

Brandon Couillard - Jefferies & Company

Great. Thank you.

Jost Fischer

Thank you, Brandon.

Operator

Your next question comes from the line of Larry Marsh of Barclays. Please proceed.

Elliot Feldman - Barclays Capital

Hey guys, good morning. This is Elliot, filling in for Larry. Just a quick comment on the U.S. I know this time last year you had mentioned that, you would be a little bit disappointed if you didn’t see some acceleration of growth in the back-half of ’11. Now that we’re half-way through ’12, I just want to get sort of your qualitative sort of comments on what you could see from the U.S. we saw some slight acceleration here sequentially, but just trying to get a sense of what you’re seeing in the U.S. market and what you may expect for the back-half?

Jost Fischer

Sure. Revenues in the U.S. were up 4.9%, which is more than doubling the growth rate of the first quarter, and its up sequentially as we’ve said. We remain cautiously optimistic in the U.S., but this market has not yet returned to its full potential. We feel good about how we're positioned in the U.S. market, but as I said not back to its full potential as of today.

Elliot Feldman - Barclays Capital

Okay, that’s helpful, thanks. And just another question on capital deployment. Jost maybe for you on – may be with the M&A front and obviously R&D and internal investments is a hallmark of Sirona, but just trying to get a sense of anything interesting on the M&A front particularly in this environment for you guys?

Jost Fischer

Nothing to talk about at this point.

Elliot Feldman - Barclays Capital

Got you. Thank you.

Simone Blank

Well in general nothing has changed.

Jost Fischer

Yeah.

Elliot Feldman - Barclays Capital

Thanks, guys.

Jost Fischer

Thank you.

Operator

Your next question comes from the line of Jonathan Block of SunTrust. Please proceed.

Jonathan Block - SunTrust Robinson Humphrey

Thanks. Hey guys, good morning. I do want to follow-up a little bit on the last question just in the U.S. the growth has accelerated, but still somewhat modest growth considering the easy comps a year-ago, in a market that we hear a lot of data points has really picked-up from just patient volumes over the past three to six months. So, do you feel good about that accelerating in the back-half of the year and then Jost, when you talk to market share gains, are you confident those market share gains are applicable to here in the U.S. as well?

Jost Fischer

Okay. Jonathan, first of all we’ve heard some good news from consumable companies out there. And if their U.S. results are an indication that the market is accelerating, then that’s good for us too. We haven’t heard anything from our distributors yet, they will come out. But if patient traffic picks-up, dentists feel better about their business and they are more likely to invest into equipment, very clear. According to the market share side, yes we feel that’s applicable to the U.S. as well.

Jonathan Block - SunTrust Robinson Humphrey

Okay, great. And then, just next question, I want to focus a little bit on the upgrade opportunity. I think you called out some of the margin compression in imaging due to the pans and of course the pans or a large majority of the pans, I guess, are upgradable. Can you give us a feel for the type of margin that you would realize – the type of gross margin that you would realize if one of your customers went ahead and upgraded to the 3D component?

Simone Blank

No, I would say that’s in line with the gross profit margin we see for imaging then on the pan side, so nothing very different.

Jonathan Block - SunTrust Robinson Humphrey

So I am sorry, just to be clear on the upgrade there is a decent hardware component as well where you’ll get the incremental revenue whatever that is to go to 3D, but its not something Simone where its just largely software and that one be at a gross margin well north of where you’re today in imaging?

Simone Blank

No, it’s a combination of hardware and software and that’s why it will be similar to the gross profit margins we currently see.

Jost Fischer

In total.

Jonathan Block - SunTrust Robinson Humphrey

Got you. And then just lastly, real quick on the CAD/CAM side, obviously you’ve been selling Bluecam as a standalone for some time, and I just want to push you a little bit on the upper opportunity there. So, are you seeing some of those standalones convert where they’re adding the milling station or is it, we’re still a little bit early in the curve for that to occur? Thanks guys.

Jost Fischer

Yes, we see that, but as its little early in the curve absolutely. We see that, but its early in the curve.

Jonathan Block - SunTrust Robinson Humphrey

Thanks for your time.

Jost Fischer

Thank you.

Operator

Your next question comes from the line of Scott Green of Bank of America Merrill Lynch. Please proceed.

Scott Green - Bank of America Merrill Lynch

Hi. Thanks for the questions. First, I recall a few quarters ago, you had bought a developmental technology company for around $21 million. Is there something you could update us on that acquisition and any return on investment you’ve received on that?

Jost Fischer

As you know, we don’t like to discuss any new product development before we’re ready to launch. We’re about 90% finished for this process and from that point [it will] – lets keep it like that.

Scott Green - Bank of America Merrill Lynch

Okay, all right. And then could you just update us on your expectations for the August 27.5 show, how attendants and dentist interest is shaping up for that event?

Jost Fischer

Yeah, its very well shaping up. We’re pretty happy with the feedback we got from the market about this event and it clearly demonstrated it was the right thing to bring it up. Its going to be a great event and I encourage you to come and see yourself what the CEREC community is doing and how likely it is, its very positive development.

Scott Green - Bank of America Merrill Lynch

Okay. And one last one here, so just trying to put your constant currency revenue growth in context, I guess, the original guidance was 6% to 8% at that time you talked about caution you’re hearing among distributors for U.S. and Germany, guidance is still around that original level even though you suggested that caution had moderated. So, is there another reason its been a little weaker than you thought going into the year, or is it still just some uncertainty as to how U.S. and particularly Germany play out into the tough comp in the next quarter?

Simone Blank

No, you might recall that we've updated the guidance at the end of the first quarter and we said that we see it more at the upper-end of that guidance range. And Jost; commented at that time that he saw some of the caution easing in the U.S. and also in Germany. And he just commented on the U.S. and Germany in this call in the Q&A. So that’s unchanged, there’s nothing new, we’re pleased with our performance and the guidance as (indiscernible).

Jost Fischer

Everything is where we expected it to be.

Scott Green - Bank of America Merrill Lynch

Okay. So maybe that caution is a worth a point or so to your guidance, to the extent you’re in the upper-end of the range now, is that the way to think about it?

Simone Blank

No, as I said, Jost commented on his perspective on the caution at the end of last quarter already. Please, bear in mind that we’re heading to a tough comp in the third quarter because of the orders from the IDA as last year. That also needs to be taken into consideration when thinking about the quarterly progression this year.

Scott Green - Bank of America Merrill Lynch

Okay. Thank you.

Simone Blank

Thank you.

Jost Fischer

Thank you, Scott.

Operator

Your next question comes from the line of Steve Beuchaw of Morgan Stanley. Please proceed.

Steve Beuchaw - Morgan Stanley & Co. LLC

Hi. Good morning everyone and congratulations, Jost.

Jost Fischer

Good morning. Thank you.

Steve Beuchaw - Morgan Stanley & Co. LLC

The imaging number in the quarter was, the way we model it a bit below trend even considering the tough comp. I wonder if you could speak to whether there might have been any order push-ups in the quarter or any other non-organic dynamics?

Jost Fischer

No, nothing unusual from our point that we see out there in the market.

Steve Beuchaw - Morgan Stanley & Co. LLC

Okay. And then, I want to push a little bit more on the situation in Europe, just given the headlines we’re clearly in a situation where investors will be asking questions around the macro situation as they did last November. So can you speak to your view, the drivers that you have of relative confidence on the macro outlook in Europe right now. What are the data you look at and how are those trending differently than they did relative to November?

Jost Fischer

Okay, yeah. From my point of view the central European countries are doing well, specifically Germany we said that in November. I said that earlier this morning, there was no change from our point of view. The other Europeans as I said was kind of a mix bag when we looked at the southern part, the situation is a little bit more difficult. On the other hand France and Italy are doing okay. So no change there. We see the things the way you see them. And the Northern European, are like the Scandinavian down looked countries are fine as well.

Steve Beuchaw - Morgan Stanley & Co. LLC

Okay. And then just one housekeeping question, Simone. Do you have a sense for what at current rates the impact of currency might be on the top-line in the coming quarter?

Simone Blank

Yeah, it should be a headwind going forward into the next half year, but we can take you offline later through the (indiscernible).

Steve Beuchaw - Morgan Stanley & Co. LLC

Okay, great. Thanks everyone.

Simone Blank

Thank you.

Jost Fischer

Thank you, Steve.

Operator

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

Jeffrey Johnson - Robert W. Baird & Co

Thank you, good morning. Thanks for taking the call. Jost, I was wondering if I could start with some comments you made on the CAD/CAM side the five-year CAGR of the 11%. How do you think conceptually about that growth in the kind of upgrade years versus non-upgrade years and – sorry I’m in an airport if you hear the background noise there, but just upgrade versus non-upgrade years, there’s been some volatility, how do you think about in this cycle without an upgrade really driving over the next 12 months where that growth could go?

Jost Fischer

Yeah – yeah. We see good end user demand out there, and we don’t see any situation of change with the upgrade or non-upgrade, its part of our business and it has been part of our business for that time. And we see variability in the quarterly growth you know that, Jeff. But generally double-digit growth, I think we invest R&D here. The CEREC Guide will help the penetration specifically for implant customers that have our 3D imaging will likely buy our CEREC or will have the opportunity to do that. So nothing unusual here.

Jeffrey Johnson - Robert W. Baird & Co

Okay, great. And then going back to Ross’s initial question on infrastructure spending and that, how do you think about cost versus profitability in that segment, at this point over the next 12 to 24 months, do you think cost rise in line with profitability or can profitability in those markets rise at a rate faster than you have to invest in them?

Jost Fischer

Yeah, leverage, yes. When we invest in markets, we typically rent offices, showrooms, hire sales and service a number of people. It takes some time to educate them and make them effective, I mean, that’s very normal. It usually takes about 18 months from the first day to leverage our structure, but of course we have been doing that for a while and we have been increasing the speed from that. So, we can continue to see leverage and that will show.

Jeffrey Johnson - Robert W. Baird & Co

All right, great. And Simone, just two housekeeping questions for you. Driver of operating cash flow in the quarter obviously is very strong and OI growth was good as well as the amortization, but where there anything else driving that or was there anything else? And then the second question just on the operating margin. If you were to break out IDS expenses and take our the probably slight benefit currently provided at the margin line this quarter, what would operating margin have been adjusting for those two factors?

Jost Fischer

Before you get in, Simone, I just want to point out to our excellent cash flow performance in the quarter. But Simone, please.

Simone Blank

Yeah, our cash flow performance was as you mentioned obviously on the one end driven by operating income, but on the other hand also by a favorable development of the working capital in the quarter, so that was favorable for us. Your other question was related to the IDS expenses. In last year second quarter that was about $3 million, so if you back that out obviously the increase in SG&A was higher on that pro forma basis. As you know, we continue to invest in sales and service infrastructure and that is an ongoing theme in the SG&A, yeah.

Jeffrey Johnson - Robert W. Baird & Co

Okay. And did FX add anything to the margin this quarter?

Simone Blank

In general, as you know we – our operating income line is relatively un-impacted because 40% to 50% of our sales are Euro denominated 70% of our expenses. So the operating income line is relatively un-impacted. On the revenue line we had about 3% headwinds reported to constant currency growth rate.

Jeffrey Johnson - Robert W. Baird & Co

All right, great. Thanks, guys.

Simone Blank

Thank you.

Jost Fischer

Thank you.

Operator

Your next question comes from the line of Tycho Peterson of JP Morgan. Please proceed.

Tycho Peterson - JP Morgan Chase & Co

Hey, thanks for taking the questions. Maybe just a couple of points of clarification. I appreciate the color you provided on ORTHOPHOS and in the margins, but I’m just wondering if you can give us a sense to what percentage of the customers that are taking the system now have 3D capabilities enabled? And how do we think – I know you had a question before about whether we’ll see an inflection point once those customers upgrade, I mean how are you thinking about those systems upgrading?

Jost Fischer

Yeah, Tycho, good morning. This is Jost. Yes, the majority of the 2D pans we sell are upgradable. And from that point of view, that reflect the opportunity going forward. But we haven’t seen much of upgrading at this point in time, but we expect that to come -- to kick-in over time.

Tycho Peterson - JPMorgan

Okay. And then, I guess as we think about your capital structure, I know you had a question before on M&A and one on buybacks, but your net debt neutral right now, I mean, what do you see as the optimal capital structure of the Company going forward?

Simone Blank

That’s always a frequently asked question. Historically, as you know, we’ve delivered our balance sheet successfully. Our number one priority is always investing our operations because as we’ve demonstrated that is clearly the best returns. As you know, Tycho, we’ve Asia purchase authorization in place for $100 million for three years. Up until now, we spent $36 million on that authorization. On acquisitions, we’re very disciplined, we look at everything, but we’re disciplined, and this – we’ll continue to look at that cover deployment going forward.

Tycho Peterson - JPMorgan

Okay. And then, on – in your comments Jost, you had talked a little bit about the CEREC Guide and OPTIGUIDE, can you just give us a sense to what percentage of dentist that are using CEREC today are using it to make a liners and surgical guides, where we kind of need option curve?

Jost Fischer

Yeah. The surgical guides they used are very small. We said, less than 10% of implant doctors are using surgical guides, but it’s a growing number, it’s a fast growing number that’s using our traditional and our OPTIGUIDE. But the CEREC Guide, of course we just launched, the feedback has been enthusiastic. We expect that to pick up largely in the near-future. On the other hand, that will drive penetration of CEREC into the implant world.

Tycho Peterson - JPMorgan

Okay. Last one, just I’m wondering if you can touch on the competitive dynamic in CAD/CAM on Chairside. It seems like E40 hasn’t had a lot of success, I mean there has been some rumbling that Glidewell is going to make more of a move in the market. Can you just talk on how you see additional competition in that market going forward?

Jost Fischer

Yeah, we don’t see changes in the marketplace as of today. This is not a factor for us, 13.7% growth for Sirona tells the story. We’ve heard about the Glidewell product, but we haven’t seen it in the marketplace. The comment that we’ve seen is Glidewell came out with a camera about 18 months ago or so. And this has not done any attraction. So, from that point of view, no change.

Tycho Peterson - JPMorgan

Okay. Do you know if they’ve a software to go with it, or is it just the camera at this point?

Jost Fischer

The camera – nothing is out there. So from the camera point of view, it’s also not gotten any attraction. So, leave it at that.

Tycho Peterson - JPMorgan

Okay, thank you very much.

Jost Fischer

Thank you.

Simone Blank

Thanks.

Operator

Your next question comes from the line of John Kreger of William Blair. Please proceed.

John Kreger - William Blair & Company, LLC

Hi. Thanks very much. Simone, a question, I noticed your provision for doubtful accounts is quite a bit larger this quarter than we’ve seen in recent years. Was there anything in particular driving that?

Simone Blank

No, I mean, we’re active in many international markets, and so the provisions reflect that also, nothing specific.

John Kreger - William Blair & Company, LLC

Okay.

Simone Blank

They’re very low in general.

John Kreger - William Blair & Company, LLC

So, should we assume that type of level going forward?

Simone Blank

It’s so small. I wouldn’t focus so much on this.

John Kreger - William Blair & Company, LLC

Okay. And then a follow-up question on CAD/CAM, if you look at the nice growth improvement you guys are seeing, could you give us a sense about how that breaks down between upgrades of existing users and new customers?

Jost Fischer

Yeah, it’s basically – almost everything is new user demand.

John Kreger - William Blair & Company, LLC

Great. And Jost, if you’re willing, if you look at your installed base in CEREC at this point, how would you say that breaks down across the full Chairside system versus scanner only versus the inlab?

Jost Fischer

Yeah, the vast majority is full Chairside systems. Although like the Connect is picking on. Its taking up.

John Kreger - William Blair & Company, LLC

Yeah, okay. And then lastly given the strong non-U.S., non-European results. Are there any – are there a few markets that are really key to driving that or are you seeing pretty broad growth across, I think, what you said about a 130 plus countries?

Jost Fischer

It is pretty broad, but the real dynamic is in the Asia Pacific.

John Kreger - William Blair & Company, LLC

Okay. Thank you.

Jost Fischer

Thank you.

Operator

Your next question comes from the line of Jeffrey Warshauer of Sidoti & Company. Please proceed.

Jeffrey Warshauer - Sidoti & Company, LLC

Hi. Good morning. I think lot of my questions were already addressed, but I just like to focus on Treatment Centers briefly, maybe to get a little more color. You know we saw a nice growth this quarter, maybe that was mostly result of a soft quarter last year. But maybe you could offer a little more color on to maybe the geographic growth across that segment and if maybe you’re taking share from your international competitors and really where you see the most opportunity with Treatment Centers? Thanks.

Jost Fischer

Sure. Treatment Centers growth was great as you know doubled. It’s usually not a double-digit grower, so this was driven mostly by our comfort and our standard lines. We continue to be pleased and excited about the markets positive reaction from our SINIUS. Our high to mid – the high range products out there, that has been getting good traction. Markets for that are usually the European markets, Australia, the Middle East and Japan. That’s where we also saw a good part of our growth.

Jeffrey Warshauer - Sidoti & Company, LLC

Do you think that, it’s just a function of growing demand in those markets or do you think you’re taking a share from competition?

Jost Fischer

Yeah, we are clearly taking share with this kind of growth. There is no doubt about that. On the other hand, some of these markets are growing like Middle East and so on because there is investment going on in healthcare. So there is a mix of growth of particular market and taking share.

Jeffrey Warshauer - Sidoti & Company, LLC

Great. That’s it. Thank you.

Jost Fischer

Thank you.

Simone Blank

Thank you.

Operator

At this time I’d like to turn the conference back over to Mr. Jost Fischer for closing remarks. Please proceed.

Jost Fischer

Ladies and gentlemen, thank you for joining us today for our second quarter fiscal 2012 conference call. I’m looking forward to updating you on our next quarterly conference call in August. You all have a good day.

Operator

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

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