Sirona Dental Systems Q4 2007 Earnings Call Transcript

Dec. 7.07 | About: Sirona Dental (SIRO)

Sirona Dental Systems (NASDAQ:SIRO)

Q4 2007 Earnings Call

December 7, 20079:00 am ET

Executives

John Sweeney - IR

Jost Fischer - Chairman, President and CEO

Simone Blank - Executive Vice President and Chief FinancialOfficer

Jeffrey Slovin - Executive Vice President and COO of U.S.Operations

Analysts

Steven Postal - Lehman Brothers

John Kreger - William Blair

Analyst for John Wood - Banc of AmericaSecurities

Ross Taylor - CL King

Tycho Peterson – JP Morgan

Jeff Johnson - Robert W. Baird

John Putnam - DawsonJames Securities

Mike [Schubb] - Civic Healthcare

Operator

Welcome to the Sirona Dental Systems 2007 fourth quarter conferencecall. (Operator Instructions) I wouldnow like to turn the presentation over to your host for today’s call, Mr. JohnSweeney. You may proceed, sir.

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 thatthe information in this conference call contains forward-looking statements asdefined in the Private Securities Litigation Reform Act of 1995.

Forward-looking statements are information of anon-historical nature and are subject to risks and uncertainties that arebeyond the company’s ability to control. The matters discussed in this conference call are subject to variousfactors which could cause actual events and results to differ materially fromsuch statements.

Such factors include: uncertainties as to future salesvolumes of the company’s products; the possibility of changing economic, marketand competitive conditions; dependence on products, dependence on keypersonnel; technological developments; intense competition; marketuncertainties; dependence on distributors; ability to manage growth; dependenceon key suppliers; and other risks and uncertainties, including those detailedin the company’s filings with the Securities and Exchange Commission.

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

Please note that in today’s conference call you will bepresented with additional financial information, including non-GAAP financialmeasures under Section 101 of Regulation G of the 1934 Exchange Act.

In addition, during today’s conference call, management willcomment on guidance for fiscal year 2008. Please note that all statements made in connection with the guidance arebased on current expectations and actual results could differ materially fromsuch forward-looking statements.

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

Jost Fischer

Thank you, John. Itis my pleasure to welcome all of you to our fiscal 2007 fourth quarter conferencecall. Joining me today are Simone Blank,Executive Vice President and Chief Financial Officer and Jeffrey Slovin,Executive Vice President and COO of U.S. Operations.

Let me start by saying that we are pleased with our resultsfor the fourth quarter and I am happy to report that our business momentumaccelerated as we finished out the year with solid performance across all ofour business segments.

For 2007, revenues reached $659.9 million, up 14.6% comparedto 2006, including the Schick business for the full prior year. Operating income plus amortization reached $132.9million, or up 5.8% compared to 2006, again including the Schick business forthe full prior year. I am pleased tonote that both revenues and operating income exceeded our revised guidancerange.

Turning now to the fourth quarter, revenues reached $177.9million, an increase of $42.4 million or 31.3%. In the fourth quarter, our gross profit margin increased due to abeneficial mix effect resulting from stronger growth in our higher marginCAD/CAM and Imaging segments. Thispositive development was offset in part by the MC XL trade-in program and thefact that we are still in the early stage of our MC XL product life cycle.

We were able to leverage our revenue growth into operatingmargin expansion in the quarter, as sales and gross profit increased by over30% while operating expenses increased by 15%.

As we mentioned in our last conference call, we continue ourinvestment in research and development and the build out of our local sales andservice infrastructure in selected markets.

Now let me give you some details on our fourth quarterregional development. We haddouble-digit revenue growth in the United Statesand Europe. OurGerman and other European markets benefited from strong CAD/CAM, Imaging, andInstruments performance. In the U.S.markets, revenues increased 32%, driven by our CAD/CAM and Imaging segments. In thefourth quarter, we started shipping the first units of our MC XL trade-inprogram. Our U.S. Imaging business benefited from robust sales of Panoramicunits and sales of our Galileos 3D Imaging System.

Our non-U.S, non-European markets showed the high increase, withparticularly strong growth in the Asia Pacific region and Russia. These markets are an important part of theSirona story and in the fourth quarter accounted for more than one quarter oftotal company sales.

Revenue growth was also driven by our strategy to increaseour local sales and service infrastructure in selected markets. While this resulted in increased SG&Aexpense in recent quarters, these investments are starting to show results.

Moving on to our segment performance, Dental CAD/CAM systemrevenue increased 68% to $57.3 million. While this was impressive growth, it was against a weak quarter in2006. We continue to see a strongresponse to the MC XL milling machine from our dealers, current users and themarketplace.

Let me remind you of the benefits of our new millingsystem. The MC XL Mill does a quality,precisely fitted restoration in as fast as four minutes, approximately twice asfast as the compact milling unit. The MCXL’s fine tolerances are appreciated especially by doctors, who demand the mostprecise restoration possible.

Both the MC XL and the compact milling unit are compatiblewith all CEREC 3 units, allowing a smooth transition to the new technology forexisting CEREC owners who wish to upgrade. We reached our targeted production levels for the MC XL milling machinein September.

CAD/CAM segment gross profit margin declined to 65.6% from69.3% in the fourth quarter of 2006. Theyear-over-year margin decline was due to a higher manufacturing cost, andstart-up expenses related to the new milling machine and the impact of lowergross profit margin from our trade-in program. Our fourth quarter margins did improve 1 percentage point compared tothird quarter 2007.

Imaging System revenues increased 27%, with growthattributable to the continued adoption of digital radiography and sales of ournew product Galileos. Since the launch,we were able to sell over 200 Galileos units, primarily to specialists. Galileos is designed to provide the dentistswith the best overall solution in Imaging.

The Galileos system is based on proven technology adoptedfor dental applications. It hasexcellent image quality; integrated, easy-to-use software, facilitating fastand accurate implant planning. Importantly, given the recent controversy over CT scan radiation dosage,we are proud that the Galileos system has a very low radiation dosagerequirement.

As we mentioned in our last earnings call, we have seen manynew product offerings entering the 3D digital marketplace. These new products have caused the dentalcommunity to take longer than expected to evaluate the available options. While the overall category is tracking slowerthan we originally envisioned, we do believe that we have a strong 3D imagingproduct and that Galileos is a highly competitive offering. Imaging Systemssegment gross profit margin was 59.7% in the fourth quarter, above the prioryear’s margin.

Fourth quarter treatment center revenues increased 12%, withsolid performance in our non-U.S. and non-European markets. Treatment center segment gross profit marginwas 40%, up compared to prior year.

Instrument revenues increased 12%, with strong performancein our non-U.S. market. Instrumentsegment gross profit margin was 44.2%, in line with prior year.

Our results demonstrate that Sirona is well positioned inthe marketplace in terms of our leading high-tech products, our quality salesand service infrastructure worldwide, and strong relationships with our dealers,including our largest partners Patterson and Henry Schein.

I will now turn the call over to Simone, who will give youmore details on our financial results.

Simone Blank

Thank you, Jost. Revenues for the fourth quarter were $177.9 million, an increase of $42.4million, up 31% or 24.3% constant currency compared to last year with DentalCAD/CAM systems up 68%, up 61% constant currency; imaging systems up 27%, up22% constant currency; Instruments up 12%, up 5% constant currency; and treatmentcenters up 12%, up 4% constant currency.

Revenues increased 32% in the United States. International revenues increased 31%, up 22% constant currency, withparticularly encouraging performance in South Korea, Japan,Russia, Italyand the UK.

Cost of sales was $95.2 million for the quarter, an increaseof $18.6 million or 24.3%. Cost of salesincluded amortization expense amounting to $20.2 million compared with $17.9million for the same period last year. Excluding amortization expense, gross profit margin increased 1percentage point to 57.8%.

Now I will review some of the components of our operatingexpenses in the fourth quarter. SG&Aexpense was $53.6 million, an increase of $6 million. As a percentage of sales, SG&A expensedeclined to 30.1% from 35.1% in the prior year quarter. The increase in SG&A was mainly driven bythe strengthening euro versus the U.S. dollar, as most of Sirona’s expenses areeuro denominated; and the expanded sales and service presence, particularly inthe U.S., Japan, Italy and China.

R&D was $12.8 million, an increase of $2.8 million as aresult of the variations in the dollar/euro rate, as most of the expenses are euro-denominatedand continued investments in new product and product enhancements.

Operating income plus amortization expense was $36.9 million,comprised of operating income of $16.7 million, plus amortization expense of $20.2million. This compares to fourth quarter2006 operating income plus amortization expense of $19.5 million, which wascomprised of operating income of $1.6 million plus amortization expense of $17.9million.

The increase in operating income plus amortization was dueto an increased gross profit which was partially offset by higher SG&A andR&D expenses. The gain on foreigncurrency transactions in the quarter amounted to $7 million, compared to $0.4million in the prior year.

Fourth quarter 2007 results included a $4.9 million non-cashgain on the revaluation of the carrying value of the dollar-denominatedPatterson’s exclusivity fee and a $4 million non-cash gain on the revaluationof dollar-denominated short-term intra-group loans to the German entity.

The non-cash loss on derivative instruments amounted to $2.4million compared to a loss of $3.1 million in the prior year period. Netinterest expense was $7.2 million compared to $10.4 million. The decrease was driven by a more favorableinterest rate due to the November 2006 refinancing of our senior creditfacilities.

The income tax benefit for the fourth quarter of 2007 was $37.4million compared to a tax benefit for the fourth quarter ended 2006 of $10.1million. This fourth quarter 2007 taxbenefit was positively impacted by a one-time, non-cash revaluation of deferredtax liabilities resulting from a tax rate reduction in Germanyin the amount of $45.6 million. Thenormalized effective tax rate for the year amounted to 35%.

The company’s net income for the quarter was $51.8 millioncompared to a loss of $1.5 million in the prior year quarter. In addition to the non-cash tax benefit andthe non-cash foreign currency gains mentioned above, fourth quarter 2007 netincome included amortization expense primarily related to the step up to fairvalues of intangible and tangible assets related to the Schick acquisition andthe MDP transaction of $12.2 million net of taxes of $8 million, and stockoption expense of $2.2 million net of taxes of $1.6 million.

Operating cash flow during the quarter was $49.8 million,driven by the increased operating result and reduced working capital. Investing cash flow during the quarter was $15million, mainly resulting from investments in special tools for the ramp up ofnew product deliveries and a small acquisition.

At September 30th, 2007, the company had cash and cash equivalents of $99.8 millionand total debt of $563.2 million, resulting in net debt of $463.3 million. This compares to net debt of $452.8 millionat September 30, 2006. The increase in net debt was mainlyattributable to fluctuations in the dollar/euro exchange rate.

As stated in this morning’s press release, we areintroducing our fiscal 2008 guidance. Weexpect revenue for Sirona’s fiscal year ending September 30, 2008 to be in the range of $705 million to $725million. Operating income, excludingamortization, is anticipated to be in the range of $145 million to $155million.

Please note that our 2008 operating income estimatesincludes a $10 million benefit from the release of the Patterson exclusivitypayment, as well as depreciation expense of $18 million, and non-cash optionexpense of $16 million.

Our 2007 operating income including Schick results for thefull fiscal year included depreciation expense of $15 million and stock optionexpense of $14 million.

We continue to remind our investors to evaluate our businesson an annual basis, as our quarterly progression can vary significantly. In thinking about our 2008 quarterlyprogression, I would encourage you to take the following factors intoconsideration: the January 2007 German VAT increase, the biannual InternationalDental Show in March 2007, and the timing of our major 2007 product launches.

Looking ahead to 2008, we would expect interest expense tocontinue at a similar run rate to what we had in the fourth quarter of2007. We estimate that the effective taxrate for the full year 2008 will be 30%. The anticipated 5% reduction in our effective tax rate is due to a lowerGerman tax rate and tax planning initiatives.

That concludes our review of the fourth quarter and 2008guidance. I will now turn the call back to Jost.

Jost Fischer

Thank you, Simone. 2007 was another successful year for Sirona. During the year, we entered the third dimensionwith our 3D imaging system Galileos. Welaunched a significant upgrade to our CAD/CAM technology with a faster, moreprecise milling machine, and enhanced software. We showed solid revenue growth and profit improvements. We continued to integrate the Schickorganization, a global leader in imaging technology, into our operations andculture.

2007 was a year built upon the strength that hascharacterized Sirona since the very beginning; that is innovation. All the innovations of 2007 contributed tothe development of the dental equipment market. The demand for dental services has risen substantially in the pastseveral years with many markets experiencing growth rates well above average, atrend that we expect to continue. Keeping up with that demand will likely require dentists to increasetheir investment in high-tech dental equipment.

At the same time, consumers are demanding high qualityresults, precise restorations, excellent aesthetics and preservation of naturaltooth structure. This too motivatesdental professionals to invest in high-tech dental equipment from Sirona.

In the fourth quarter, we displayed strong top and bottom linegrowth. We continue to remind ourinvestors to evaluate our business on an annual basis, as our quarterlyprogression can vary significantly. Ourannual results better reflect our underlying performance.

In summary, we do believe we have a great business. We are well positioned in a growing industryand we continue to be excited about the growth opportunities that exists in ourglobal marketplace. Looking forward to 2008, we believe that Sirona will haveanother success year. We are confidentthat together with our world-class distribution partners, led by Patterson andHenry Schein, we will continue to grow our business.

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

Question-and-AnswerSession

Operator

Your first question comes from Steven Postal - LehmanBrothers.

Steven Postal -Lehman Brothers

How should we think about the CEREC trade-in program? When do you expect that to be completed? How should we think about the margin impactrelated to that program?

Jost Fischer

First of all, this trade-in program is a U.S.phenomenon only at this point in time and this is controlled by Patterson. Of course, we discussed amongst each otherhow this is executed and we expect that to continue for several quarters.

Jeffery Slovin

I think you would expect it to go through Patterson’s yearend, the trade-in program.

Jost Fischer

True.

Steven Postal -Lehman Brothers

There has been some suggestion as it relates to moderatingeconomic conditions in the U.S.that that has impacted capital spending plans by dentists. Can you maybe offer some perspectives on howyou think about that, both in the U.S.and throughout the world?

Jost Fischer

I think from our point of view the underlying factors aregreat. We have had a number of goodyears in the past and we see that trend continuing. When we look at worldwide, we see everywhere,at this point, a very healthy condition for our dental equipment and I mightremind you the U.S.is only about 30% of our total sales.

Alluding to the general conditions also in the U.S.we have seen some good growth in the general economy just recently. On the other hand, there are some factorsthat might cause a temporary confusion, as we said. Certainly in the Galileos world decision-makinghas not been done as fast. We do notattribute that to a general economic decision from the dentists’ side, we seerather it takes a little longer to make the decision. So we see generally the underlying factors aspositive.

Second, from our product offerings even if the economywouldn’t be in great shape, doctors will look at the offering that we have,digital imaging saves them a lot of money; it makes the situation easier forhim. CAD/CAM is a profit bringer forevery dentist that does restoration work. So we have seen in the past, notably in Germany,when we had a deteriorating economic situation, that our products were holdingup steady.

Jeffery Slovin

I’ll just add that I think again, Steven, we have to take alook at our product offering and the fact that it’s really aboutexecution. We have the right product forthe U.S.market. Quite frankly, we have to do abetter job executing on our strategies and tactics.

Steven Postal -Lehman Brothers

Back to the CEREC and CAD/CAM, it’s been a pretty visiblecompetitive launch in the U.S.. I am sure you don’t want to necessarily speakabout specifics but can you maybe elaborate on how you are going to approachthat market, the positioning of CEREC versus the competition after thiscompetitive launch?

Jost Fischer

First, Steven, this is not for us to decide what acompetitive launch would look like. Butfrom our point of view, we have not seen a working product out there in themarketplace. We have seen at shows thatthe people have demonstrated various parts of this product but we have not seena working product yet.

From our point of view, there are several factors to takeinto account. We believe that once therewas a launch -- if there was a launch -- that this will release some pent-updemand from doctors sitting on the sidelines just trying to evaluate. Do notforget it is $100,000 expense for each, they want to have visibility and take alook what’s out there. So that can beactually positive for CEREC, even if there was a good launch.

Jeffery Slovin

I would just also add that, why we ask has there really beena launch is because we don’t know a delivery date for the competing productwhich is always part of a launch.

The second thing, let’s remember that the U.S.market is a huge market opportunity for all of us. Our CEREC product is the market leader andthe only product out there with a 20 year successful track record.

Steven Postal -Lehman Brothers

I just have two quick financial questions and then I willhop back into queue. Can you talk aboutthe inventory turnover and DSOs? Howshould we think about your working capital now and the needs of the businessover the next year?

Simone Blank

Our working capital requirements haven’t really changed overthe last years. Our inventory turnsremain good. So, if you look at theannual turns that gives you a good indication of where we are. The same is true for DSO, as I have said inprevious calls, DSO is driven by the regional split of our sales because itvaries throughout the countries. But, onaverage I think the annual numbers reflects what we see also going forward.

Steven Postal -Lehman Brothers

Simone, you mentioned a number of issues. I think there were three specific issues asit relates to the quarterly progression. I know you guys don’t want to get into specific quarterly guidance. Could you maybe elaborate on some of those commentsand maybe allude to when specifically some of those costs and comparisons willbe in during the year?

Simone Blank

Certainly. The firstitem I talked about was the January 2007 German VAT increase. As you might recall, our fourth quarterfinancial year 2007 was positively impacted by this because the VAT increasewas effective in January. So the firstquarter was positively impacted by this.

And then the Biannual International Dental Show in March,which is our second quarter and then also third quarter is impacted by thatbecause people go to the show and see all the new products that arelaunched.

The timing of our major product launches, we launch theproducts maybe in January and March 2007. So, those were the quarters that were impacted before and after.

Operator

Your next question comes from John Kreger - WilliamBlair.

John Kreger - WilliamBlair

Simone, just following up on that last question, can youremind us of the added expenses you guys incurred around the IDS last spring?

Simone Blank

The expenses that you incur in connection with the show youincur in that quarter. That would havebeen our second quarter.

John Kreger - WilliamBlair

Right, but do you happen to have in front of you how much thatwas in incremental spend that you wouldn’t have this year since there won’t bean IDS show?

Simone Blank

No. This is a levelof detail we are not disclosing, John.

John Kreger - WilliamBlair

Another related question to that, the drivers that you justwent through are all things that occurred in 2007. As you look ahead to 2008, are there anyunusual cost drivers that we should be thinking about and preparing for?

Jost Fischer

John, first of all, I thank you for the question. As you see that after the launch of the twomajor products in March of 2007 we also have increased R&D spending in thefourth quarter and we continue to see spending in this area, as we certainlywill concentrate on new products and better products going forward.

Our R&D spend will be in the range of 6% to 7%, maybe alittle off from last year but we continue to invest into the future. We also see continued upgrades in our salesand service infrastructures throughout the world as this is part of ourstrategy and is showing in the results.

John Kreger - WilliamBlair

As we think about 2008, will the new product story continueto be dominated by Galileos and the CEREC enhancements, or are there otherlaunches you have planned?

Jost Fischer

Certainly the two major product launches will dominate ourstory within the next year. On the otherhand, please John, we do not announce any major product launches or upgrades inconference calls. But we remain activein R&D, as I said.

The one other thing, the two major product launches, butalso we have launched in September as we stated our [inaudible] Scan whichfinds a good response out of the box in the countries that we have launched itin.

John Kreger - WilliamBlair

You had very pronounced re-acceleration in CAD/CAM over thelast couple of quarters. Is thatsomething that you have experienced across your various geographies or shouldwe think of that as being more concentrated in certain regions such as the U.S.?

Jost Fischer

Absolutely, John. Thestory is not a U.S.story alone. We have seen some greatuptick around the world because dentists go into this area more and more. CAD/CAM is part of future dentistry, and thisis not a U.S.phenomenon. This is worldwide and it’sgoing to continue.

Operator

Your next question comes from John Wood - Banc of AmericaSecurities.

Analyst for John Wood- Banc of America Securities

Along the same lines, can you give us a sense of how bigCEREC is outside the U.S.?

Jost Fischer

Certainly. It’sgrowing and of course we do not disclose details on how much we have, but it isvery substantial and is more than 50%.

Analyst for John Wood- Banc of America Securities

That’s helpful. Canyou give us a view on operating cash flow in 2008 and qualitatively should weexpect excess cash to be used for deleveraging next year or should we expectacquisition activity to pick up/ Would you be interested in the consumablesplatform, for example, if the right opportunity arose?

Simone Blank

one of our priorities clearly with cash on the balance sheetis to pay down debt. We are alwaysevaluating our opportunities. On the acquisitions, if an interestingacquisition comes up, we will always be interested, as a general comment.

On the cash flow, our basic layout of our financials as you’veseen historically shows that we can actually generate a good operating cashflow which we also did this year and the years before. We expect this to continue going forward.

There is clearly no acquisition in our guidance, just toclarify.

Analyst for John Wood- Banc of America Securities

Have you included the impact of that deleveraging in yourforecast next year?

Simone Blank

No. As we have notyet made any decision on that, it’s not included in the forecast.

Operator

Your next question comes fromRoss Taylor - CL King.

Ross Taylor - CL King

Simone, in your prepared remarks I missed whether you saidyour revenue guidance included or excluded the $10 million in amortizationrelated to the Patterson payment.

Simone Blank

The $10 million release of exclusivity payment is notincluded in revenue. The currentassumption is that it will be shown in operating income, but is not in therevenue line.

Ross Taylor - CL King

Also related to your revenue guidance, what kind ofassumptions are you making about foreign currencies and what kind of impactthey might have on your results in fiscal 2008?

Simone Blank

When we did our guidance, we took into account the foreigncurrency situation at that point in time. That is reflected in there. Whatyou see, the 705 to 725, a7% to 10% growth rate and our assumption on constant currency is mid to highsingle-digit growth rate.

Operator

Your next question comes from Tycho Peterson – JPMorgan.

Tycho Peterson – JPMorgan

I’ll start with a question on the upgrade cycle. I know alot of this is in the hands of Patterson here in the U.S.,but can you give us a sense as to how they are prioritizing the upgrades versus new customers forCEREC?

To what extent do you think the opportunity is to upgradethe existing installed base here? Is it 10%, 15%, what percentage of thosecustomers out there over the next year do you think are upgradeable?

Jost Fischer

First of all, there is a genuine interest of our greatpartner Patterson to serve its best customers and its best customers own CERECand they want to upgrade. We have seen alot of interest and there was the four-week upgrade opportunity in July where Ithink 20% of the existing customer base signed up in just four weeks and thenthat was closed. So, therefore I thinkPatterson has an obligation to serve its best customers, so therefore this isgoing to happen, or this is happening right now.

On the other hand, we believe that a lot of customers thatnow own the compact milling unit will upgrade at a later stage if given theopportunity. So we believe finally thereis a lot of opportunity still left in the marketplace and of course, upgradeswill not only happen in North America but also international. So there is a significant opportunity also inthe installed base outside of North America to upgradeto MC XL.

Tycho Peterson – JPMorgan

What’s the timing of that, going international withupgrades?

Jost Fischer

Certainly, we have not announced any at this point in timebut we will in the near future.

Jeffrey Slovin

We will keep you updated on that on the next call. But wedon’t want to announce it on the call.

Tycho Peterson – JPMorgan

On Galileos, can you give us a sense as to whether you’veseen any improvement in the selling cycle and then importantly about pricing,whether pricing has stuck?

Whether you’ve seen any improvement in the selling cycle orwhether you anticipate any improvement over the coming year, and then also justwhat the pricing trends have been, have you been able to maintain your pricepoint on Galileos or are you having to respond to --

Jost Fischer

I think you will continue to see some delays in themarket. I think as we eloquently said inthe script that we have a very competitive product offering and we believe thatwe are getting significant market share on it.

I think that there are a numbers of new entrants and I thinkwe will see pricing pressure going forward. But, we have not seen that much right now but I think we will in thefuture.

Let me remind you that we believe we have the best imagequality with our Galileos, an integrated and easy-to-use software and thelowest dose available in the CT scan.

Jost Fischer

Also maybe one addition to that when we talk about pricing,we are the low cost producer due to our technology. So from that point of view, we are not afraidof that.

Tycho Peterson – JPMorgan

Jeff, you had just mentioned the dosage thing and it’ssomething that seems to be more important and something that’s coming up a lotmore, at least in our conversations. Is that more of a selling point than itwas in the past for you guys around the dosagelevels and how do we think about your marketing relative to dosage?

Jeffrey Slovin

At Sirona, we have always taken radiation as a very seriousissue starting with our sensors and the Schick sensor has one-tenth the radiationof film and we believe that absolutely is a significant issue for the patientand the doctor and the clear selling benefit of the Galileos system.

Tycho Peterson – JPMorgan

Finally just in terms of your international sales, youhighlighted some of the strongmarkets. You didn’t really talk aboutChina a lot, but can you give us a sense as to what percentage of your salesare coming out of that?

Jost Fischer

First of all, we don’t disclose that level of detail, butlet me give you a little flavor. Firstof all, we have a manufacturing plant there that is doing quite well. On the other hand, with the wealthaccumulating in China,we see a stronger demand for high-tech dental equipment from the Sirona pointof view and we have been preparing ourselves with building out theinfrastructure in the centers of Chinaand that is showing results.

Operator

Your next question comes from Jeff Johnson - Robert W.Baird.

Jeff Johnson - RobertW. Baird

On the Galileos number you put out there of 200 units, anyinformation or any color you could give us on U.S.versus OUS split of those sales?

Jost Fischer

Jeff first of all, we gave this information and this isunusual information, we don’t normally give volume out here and we want toleave it there. But we had some confusing information out there and we wantedto clarify where we stand. Of course, this reflects a global number.

Jeffrey Slovin

Jeff, the real issue is the competitive nature of it. We found out in the past when we discussedspecific regions we are more competitive and we are happy to make our market invarious parts of the world and keep it at that.

Jeff Johnson - RobertW. Baird

Impressive CAD/CAM number this quarter obviously. One thingI haven’t heard, what percentage – and I am sure you won’t give percentages --but may be how do we think about the in-lab upgrade cycle, how that isprogressing and may be on a scale of one to ten or percentage-wise, are we 50%,60% through that? Any color there would be helpful.

Jost Fischer

Jeff, no. Let meremind you on this one. I think as thisMC XL unit is a high volume unit, it is specifically attractive for labs toupgrade. Here we will eventually see alot higher percentages of upgrade than in the office side of it.

Jeff Johnson - RobertW. Baird

You said you would expect to see a higher percentage in theoffice not in the lab?

Jost Fischer

No, in the lab versus the office. The lab wants more volume,needs faster milling time and from that point of view, is the best reason toupgrade.

Jeff Johnson - RobertW. Baird

Any color on where we are in that cycle? Have the majorityof labs now upgraded in the U.S.or are we still very early in that?

Jost Fischer

No, we can’t give that and it varies.

Jeff Johnson - RobertW. Baird

With the Patterson exclusivity going into operating incomeor the amortization of that, is that going to go on a straight line basis of $10million a year?

Simone Blank

Yes.

Jeff Johnson - RobertW. Baird

Can you help me may be understand, may be I am missingsomething here, but if I would take that out and I think it’s a well-earnedbenefit by all means, but if I take it out it looks like your operating incomeguidance is about flat year-over-year on the low end and up may be 5% or so atthe high end. Why would operating incomeex that and again I think of it is an earned benefit, but why ex that wouldoperating income grow lower than revenue growth next year?

Simone Blank

If you look at operating income, you have to take intoaccount that there are also some other non-cash items in there and wehighlighted that, which is depreciation and also some option expense and theyare growing. If you back that out youcome to the real growth number of these items.

If you look at how that translates into adjusted EBITDA,which is a measure we have talked to before, then you are including the $10million, you add $179 million to $189 million and that is a double-digit growthnumber; if you exclude the $10 million you are at an 8% to 14% growth rate onthe adjusted EBITDA.

Operator

Your next question comes from John Putnam - Dawson JamesSecurities.

John Putnam - Dawson James Securities

I was interested in the competitive landscape in imaging andI think you’ve covered it pretty well. Do you see any changes, any new product, competitive products beinglaunched?

Jost Fischer

When we talk about the imaging world I think the majorplayers have remained the same and will remain the same going forward. I think you have a product offering comparedto Sirona where we are the market leader and we believe we have the bestoverall product offering and we do not see that changing going forward.

John Putnam - Dawson James Securities

Thanks very much.

Operator

Our next question comes from the line of Mike Schubb - CivicHealthcare.

Mike Schubb - CivicHealthcare

What kind of trends should we model in for the Imaging andthe CAD/CAM segment? It seems like yourguidance is suggesting a drop off in the trends we have seen in the second half of the year. Can you just talk about that?

Simone Blank

I would like to remind you on what we said about ‘06/‘07 and what we said about the quarterlyprogression in that year, that we have to look at it on an annual basis. I think you cannot extrapolate the trends yousee in an individual quarter.

As we said also for the guidance in `08 we are an annualplayer and our performance in the quarter can vary significantly.

Jost Fischer

On the other hand, it’s safe to assume that the highergrowth is in the CAD/CAM and imaging part of the business.

Mike Schubb - CivicHealthcare

But as far as ‘08 we should take what the `07 full yeargrowth rates are as a proxy and not necessarily the second half or the postlaunch growth rates?

Jost Fischer

Mike, I think we gave the guidance in the way we wanted toeducate the market. We don’t want to getinto more specifics at this point in time, but we will update you on the nextconference call.

Operator

Your next question comes from Steven Postal - LehmanBrothers.

Steven Postal -Lehman Brothers

On the imaging systems category, I have given Jeff a hardtime in the past few quarters about that. You talked a little bit about Galileos, but Jeff and Jost, if you canelaborate on some of the other products in the category? I think you alluded to traditional pans doingwell. What’s driving demand in thatcategory?

Jeffery Slovin

I think it’s the same things that have been driving it inthe past, it’s the adoption to digital radiography. Again, Steven, it’s difficult to say where weare on the penetration curve but we are somewhere at 30%, 35%. We haven’t seen anything change the fact thatI think if you talk to any of the distributors and you talk to dentists everybodybelieves that there is going to be a transition to digital from film. Whether that’sover the next three, five years we are not sure.

So, we continue to see the transition from film tosensors. Galileos is a strongcontributor. The Pan market has been animportant player in this. In the U.S.certainly Patterson has been an important driver for us, but keep in mind thatwe have a number of other distributors in the U.S.including Henry Schein.

Steven Postal -Lehman Brothers

How do you think about the laser market? How is the SIROLaser doing?

Jost Fischer

SIROLaser has met some more competition in the last quarterfrom competitive launches. We seefurther progression into this market for Sirona, plus the growth was more on theinternational side.

Jeffery Slovin

Steven, one of the things that we have seen that hasdeveloped which we expect from being a global player is our other world marketshave really stepped up in the digital arena and we are seeing stronger growth thereas well.

It would only make sense as they start to go from film todigital X-ray.

Steven Postal -Lehman Brothers

I guess there has been some discussion, I think it’s beengoing on for sometime, about this move to ceramics and composites and away fromusing mercury amalgam. I think itindirectly impacts your business. How doyou think about that trend impacting demand for your equipment?

Jost Fischer

First of all, the earlier it’s gone the better, is ourposition. Certainly, Sirona will benefitwith its offering from that trend and the stronger the trend is the better forus in that area.

Jeffery Slovin

It’s difficult to put a specific percent of growth on thatbut we certainly believe that the CEREC restoration will be the choice inrestoration over amalgam in the future.

Jost Fischer

Look at the retention rate of CEREC over more than a ten-yearperiod is greater than 95% of all restorations stay in the mouth versussomething around 50% for amalgam. On theother hand, we see the trend generally to better restorations already in thepast and with the discussion it can only accelerate.

Operator

There are no other questions at this time. I would like to turn the call back over tomanagement for closing remarks.

Jost Fischer

Thank you very much for participating in our fourth quarterearnings conference call. We will behappy to update you on our next conference call which will cover the firstquarter of 2008. Thank you very much andhave a nice day.

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