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Sirona Dental Systems (NASDAQ:SIRO)

Q4 2007 Earnings Call

December 7, 2007 9:00 am ET

Executives

John Sweeney - IR

Jost Fischer - Chairman, President and CEO

Simone Blank - Executive Vice President and Chief Financial Officer

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 America Securities

Ross Taylor - CL King

Tycho Peterson – JP Morgan

Jeff Johnson - Robert W. Baird

John Putnam - Dawson James Securities

Mike [Schubb] - Civic Healthcare

Operator

Welcome to the Sirona Dental Systems 2007 fourth quarter conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, Mr. John Sweeney. 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 that the 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 future sales volumes of the company’s products; the possibility of changing economic, market and competitive conditions; dependence on products, 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 speak only as of the date of this conference call.

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

In addition, during today’s conference call, management will comment on guidance for fiscal year 2008. 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 would like to turn the call over to Jost Fischer, Chairman, President and CEO of Sirona Dental Systems.

Jost Fischer

Thank you, John. It is my pleasure to welcome all of you to our fiscal 2007 fourth quarter conference call. 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 results for the fourth quarter and I am happy to report that our business momentum accelerated as we finished out the year with solid performance across all of our business segments.

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

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

We were able to leverage our revenue growth into operating margin expansion in the quarter, as sales and gross profit increased by over 30% while operating expenses increased by 15%.

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

Now let me give you some details on our fourth quarter regional development. We had double-digit revenue growth in the United States and Europe. Our German and other European markets benefited from strong CAD/CAM, Imaging, and Instruments performance. In the U.S. markets, revenues increased 32%, driven by our CAD/CAM and Imaging segments. In the fourth quarter, we started shipping the first units of our MC XL trade-in program. Our U.S. Imaging business benefited from robust sales of Panoramic units and sales of our Galileos 3D Imaging System.

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

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

Moving on to our segment performance, Dental CAD/CAM system revenue increased 68% to $57.3 million. While this was impressive growth, it was against a weak quarter in 2006. We continue to see a strong response to the MC XL milling machine from our dealers, current users and the marketplace.

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

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

CAD/CAM segment gross profit margin declined to 65.6% from 69.3% in the fourth quarter of 2006. The year-over-year margin decline was due to a higher manufacturing cost, and start-up expenses related to the new milling machine and the impact of lower gross profit margin from our trade-in program. Our fourth quarter margins did improve 1 percentage point compared to third quarter 2007.

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

The Galileos system is based on proven technology adopted for dental applications. It has excellent image quality; integrated, easy-to-use software, facilitating fast and 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 dosage requirement.

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

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

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

Our results demonstrate that Sirona is well positioned in the marketplace in terms of our leading high-tech products, our quality sales and 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 you more details on our financial results.

Simone Blank

Thank you, Jost. Revenues for the fourth quarter were $177.9 million, an increase of $42.4 million, up 31% or 24.3% constant currency compared to last year with Dental CAD/CAM systems up 68%, up 61% constant currency; imaging systems up 27%, up 22% constant currency; Instruments up 12%, up 5% constant currency; and treatment centers up 12%, up 4% constant currency.

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

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

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

R&D was $12.8 million, an increase of $2.8 million as a result of the variations in the dollar/euro rate, as most of the expenses are euro-denominated and 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 $20.2 million. This compares to fourth quarter 2006 operating income plus amortization expense of $19.5 million, which was comprised of operating income of $1.6 million plus amortization expense of $17.9 million.

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

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

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

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

The company’s net income for the quarter was $51.8 million compared to a loss of $1.5 million in the prior year quarter. In addition to the non-cash tax benefit and the non-cash foreign currency gains mentioned above, fourth quarter 2007 net income included amortization expense primarily related to the step up to fair values of intangible and tangible assets related to the Schick acquisition and the MDP transaction of $12.2 million net of taxes of $8 million, and stock option 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 $15 million, mainly resulting from investments in special tools for the ramp up of new product deliveries and a small acquisition.

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

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

Please note that our 2008 operating income estimates includes a $10 million benefit from the release of the Patterson exclusivity payment, as well as depreciation expense of $18 million, and non-cash option expense of $16 million.

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

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

Looking ahead to 2008, we would expect interest expense to continue at a similar run rate to what we had in the fourth quarter of 2007. We estimate that the effective tax rate for the full year 2008 will be 30%. The anticipated 5% reduction in our effective tax rate is due to a lower German tax rate and tax planning initiatives.

That concludes our review of the fourth quarter and 2008 guidance. 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 dimension with our 3D imaging system Galileos. We launched a significant upgrade to our CAD/CAM technology with a faster, more precise milling machine, and enhanced software. We showed solid revenue growth and profit improvements. We continued to integrate the Schick organization, a global leader in imaging technology, into our operations and culture.

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

At the same time, consumers are demanding high quality results, precise restorations, excellent aesthetics and preservation of natural tooth structure. This too motivates dental professionals to invest in high-tech dental equipment from Sirona.

In the fourth quarter, we displayed strong top and bottom line growth. We continue to remind our investors to evaluate our business on an annual basis, as our quarterly progression can vary significantly. Our annual results better reflect our underlying performance.

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

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

Question-and-Answer Session

Operator

Your first question comes from Steven Postal - Lehman Brothers.

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 impact related 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 other how 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 year end, the trade-in program.

Jost Fischer

True.

Steven Postal - Lehman Brothers

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

Jost Fischer

I think from our point of view the underlying factors are great. We have had a number of good years 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 might remind 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 factors that might cause a temporary confusion, as we said. Certainly in the Galileos world decision-making has not been done as fast. We do not attribute that to a general economic decision from the dentists’ side, we see rather it takes a little longer to make the decision. So we see generally the underlying factors as positive.

Second, from our product offerings even if the economy wouldn’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 for him. CAD/CAM is a profit bringer for every 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 holding up steady.

Jeffery Slovin

I’ll just add that I think again, Steven, we have to take a look at our product offering and the fact that it’s really about execution. We have the right product for the U.S. market. Quite frankly, we have to do a better job executing on our strategies and tactics.

Steven Postal - Lehman Brothers

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

Jost Fischer

First, Steven, this is not for us to decide what a competitive launch would look like. But from our point of view, we have not seen a working product out there in the marketplace. We have seen at shows that the people have demonstrated various parts of this product but we have not seen a working product yet.

From our point of view, there are several factors to take into account. We believe that once there was a launch -- if there was a launch -- that this will release some pent-up demand from doctors sitting on the sidelines just trying to evaluate. Do not forget it is $100,000 expense for each, they want to have visibility and take a look what’s out there. So that can be actually positive for CEREC, even if there was a good launch.

Jeffery Slovin

I would just also add that, why we ask has there really been a launch is because we don’t know a delivery date for the competing product which 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 and the 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 will hop back into queue. Can you talk about the inventory turnover and DSOs? How should we think about your working capital now and the needs of the business over the next year?

Simone Blank

Our working capital requirements haven’t really changed over the last years. Our inventory turns remain good. So, if you look at the annual turns that gives you a good indication of where we are. The same is true for DSO, as I have said in previous calls, DSO is driven by the regional split of our sales because it varies throughout the countries. But, on average 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 as it 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 comments and maybe allude to when specifically some of those costs and comparisons will be in during the year?

Simone Blank

Certainly. The first item I talked about was the January 2007 German VAT increase. As you might recall, our fourth quarter financial year 2007 was positively impacted by this because the VAT increase was effective in January. So the first quarter 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 that because people go to the show and see all the new products that are launched.

The timing of our major product launches, we launch the products 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 - William Blair.

John Kreger - William Blair

Simone, just following up on that last question, can you remind 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 you incur in that quarter. That would have been our second quarter.

John Kreger - William Blair

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

Simone Blank

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

John Kreger - William Blair

Another related question to that, the drivers that you just went through are all things that occurred in 2007. As you look ahead to 2008, are there any unusual 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 two major products in March of 2007 we also have increased R&D spending in the fourth quarter and we continue to see spending in this area, as we certainly will concentrate on new products and better products going forward.

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

John Kreger - William Blair

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

Jost Fischer

Certainly the two major product launches will dominate our story within the next year. On the other hand, please John, we do not announce any major product launches or upgrades in conference calls. But we remain active in R&D, as I said.

The one other thing, the two major product launches, but also we have launched in September as we stated our [inaudible] Scan which finds a good response out of the box in the countries that we have launched it in.

John Kreger - William Blair

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

Jost Fischer

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

Operator

Your next question comes from John Wood - Banc of America Securities.

Analyst for John Wood - Banc of America Securities

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

Jost Fischer

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

Analyst for John Wood - Banc of America Securities

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

Simone Blank

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

On the cash flow, our basic layout of our financials as you’ve seen historically shows that we can actually generate a good operating cash flow 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 to clarify.

Analyst for John Wood - Banc of America Securities

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

Simone Blank

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

Operator

Your next question comes from Ross Taylor - CL King.

Ross Taylor - CL King

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

Simone Blank

The $10 million release of exclusivity payment is not included in revenue. The current assumption is that it will be shown in operating income, but is not in the revenue line.

Ross Taylor - CL King

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

Simone Blank

When we did our guidance, we took into account the foreign currency situation at that point in time. That is reflected in there. What you see, the 705 to 725, a 7% to 10% growth rate and our assumption on constant currency is mid to high single-digit growth rate.

Operator

Your next question comes from Tycho Peterson – JP Morgan.

Tycho Peterson – JP Morgan

I’ll start with a question on the upgrade cycle. I know a lot 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 for CEREC?

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

Jost Fischer

First of all, there is a genuine interest of our great partner Patterson to serve its best customers and its best customers own CEREC and they want to upgrade. We have seen a lot of interest and there was the four-week upgrade opportunity in July where I think 20% of the existing customer base signed up in just four weeks and then that was closed. So, therefore I think Patterson has an obligation to serve its best customers, so therefore this is going to happen, or this is happening right now.

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

Tycho Peterson – JP Morgan

What’s the timing of that, going international with upgrades?

Jost Fischer

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

Jeffrey Slovin

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

Tycho Peterson – JP Morgan

On Galileos, can you give us a sense as to whether you’ve seen 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 or whether you anticipate any improvement over the coming year, and then also just what the pricing trends have been, have you been able to maintain your price point on Galileos or are you having to respond to --

Jost Fischer

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

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

Let me remind you that we believe we have the best image quality with our Galileos, an integrated and easy-to-use software and the lowest 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 afraid of that.

Tycho Peterson – JP Morgan

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

Jeffrey Slovin

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

Tycho Peterson – JP Morgan

Finally just in terms of your international sales, you highlighted some of the strong markets. You didn’t really talk about China a lot, but can you give us a sense as to what percentage of your sales are coming out of that?

Jost Fischer

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

Operator

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

Jeff Johnson - Robert W. Baird

On the Galileos number you put out there of 200 units, any information 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 is unusual information, we don’t normally give volume out here and we want to leave it there. But we had some confusing information out there and we wanted to 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 discussed specific regions we are more competitive and we are happy to make our market in various parts of the world and keep it at that.

Jeff Johnson - Robert W. Baird

Impressive CAD/CAM number this quarter obviously. One thing I 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 is progressing 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 me remind you on this one. I think as this MC XL unit is a high volume unit, it is specifically attractive for labs to upgrade. Here we will eventually see a lot higher percentages of upgrade than in the office side of it.

Jeff Johnson - Robert W. Baird

You said you would expect to see a higher percentage in the office 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 to upgrade.

Jeff Johnson - Robert W. Baird

Any color on where we are in that cycle? Have the majority of 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 - Robert W. Baird

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

Simone Blank

Yes.

Jeff Johnson - Robert W. Baird

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

Simone Blank

If you look at operating income, you have to take into account that there are also some other non-cash items in there and we highlighted that, which is depreciation and also some option expense and they are growing. If you back that out you come 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 $10 million, you add $179 million to $189 million and that is a double-digit growth number; if you exclude the $10 million you are at an 8% to 14% growth rate on the adjusted EBITDA.

Operator

Your next question comes from John Putnam - Dawson James Securities.

John Putnam - Dawson James Securities

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

Jost Fischer

When we talk about the imaging world I think the major players have remained the same and will remain the same going forward. I think you have a product offering compared to Sirona where we are the market leader and we believe we have the best overall 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 - Civic Healthcare.

Mike Schubb - Civic Healthcare

What kind of trends should we model in for the Imaging and the CAD/CAM segment? It seems like your guidance 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 quarterly progression in that year, that we have to look at it on an annual basis. I think you cannot extrapolate the trends you see in an individual quarter.

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

Jost Fischer

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

Mike Schubb - Civic Healthcare

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

Jost Fischer

Mike, I think we gave the guidance in the way we wanted to educate the market. We don’t want to get into more specifics at this point in time, but we will update you on the next conference call.

Operator

Your next question comes from Steven Postal - Lehman Brothers.

Steven Postal - Lehman Brothers

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

Jeffery Slovin

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

So, we continue to see the transition from film to sensors. Galileos is a strong contributor. The Pan market has been an important player in this. In the U.S. certainly Patterson has been an important driver for us, but keep in mind that we 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 quarter from competitive launches. We see further progression into this market for Sirona, plus the growth was more on the international side.

Jeffery Slovin

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

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

Steven Postal - Lehman Brothers

I guess there has been some discussion, I think it’s been going on for sometime, about this move to ceramics and composites and away from using mercury amalgam. I think it indirectly impacts your business. How do you think about that trend impacting demand for your equipment?

Jost Fischer

First of all, the earlier it’s gone the better, is our position. Certainly, Sirona will benefit with its offering from that trend and the stronger the trend is the better for us in that area.

Jeffery Slovin

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

Jost Fischer

Look at the retention rate of CEREC over more than a ten-year period is greater than 95% of all restorations stay in the mouth versus something around 50% for amalgam. On the other hand, we see the trend generally to better restorations already in the past 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 to management for closing remarks.

Jost Fischer

Thank you very much for participating in our fourth quarter earnings conference call. We will be happy to update you on our next conference call which will cover the first quarter of 2008. Thank you very much and have a nice day.

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Source: Sirona Dental Systems Q4 2007 Earnings Call Transcript
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