Dassault Systemes Q4 2006 Earnings Call Transcript

Feb.14.07 | About: Dassault Systemes (DASTY)
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Dassault Systemes SA (OTCPK:DASTY)

Q4 2006 Earnings Call

February 14, 2007 9:00 am ET

Executives

Michele Katz - U.S. Investor Relations Executive

Bernard Charles - President and CEO

Thibault de Tersant - Senior EVP and CFO

Analysts

Jay Vleeschhouwer - Merrill Lynch

Rajeev Bahl - Deutsche Bank

John Segrich - JP Morgan

Presentation

Operator

Thank you for standing by, and welcome to the Dassault Systemes conference calls. At this time all participants are in a listen only mode. There will be a presentation followed by a question-and-answer session (Operator Instructions). I must advise you that this conference is being recorded today, Wednesday, 14 February 2007. I would now like to turn the conference over to your first speaker today, Michele Katz. Please go ahead.

Michele Katz

Thank you for joining us for a review and discussion of our financial performance and business progress for the fourth quarter and year ended December 31, 2006. On the conference call are Bernard Charles, President and Chief Executive Officer and Thibault de Tersant, Senior EVP and CFO.

In addition to presenting our results under US GAAP, we believe it is helpful to provide you with supplemental non-GAAP financial information. In particular, we will discuss our revenue, operating income, operating margin and EPS on a non-GAAP basis before deferred revenue write-downs, amortization of acquired intangibles, stock-based compensation expense and one-time tax restructuring effects, as applicable. For reconciliations of the differences between these figures and our US GAAP figures, please see the tables included in our earnings press release, which has been posted on our website at www.3ds.com.

You will also find information explaining the impact of currency fluctuations. Some of the comments we will make on this call, either as part of the prepared remarks or in response to questions, will contain forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements. Information about the principal factors that could cause actual results to differ materially from these forward-looking statements can be found in today's earnings press release and in Item 3 of our Form 20-F. On our website you can find our business and financial presentation, which was given earlier today in Paris. I would now like to turn the call over to Bernard Charles.

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Bernard Charles

Thank you, Michele. 2006 was a remarkable year for Dassault Systemes. First, we delivered strong financial results. Looking at the year, we met all our objectives. By segment, we had a solid PLM performance and a very good year for SolidWorks.

Second, we successfully integrated two major acquisitions within a twelve-month period; ABAQUS, which we closed in October of 2005 and MatrixOne, which we completed in early May of 2006. At the time, concerns were raised that MatrixOne was a very different type of acquisition. Certainly, MatrixOne had substantial financial difficulties, and I am pleased to say that we have navigated a significant turnaround.

But, on the fundamentals, MatrixOne's acquisition was about technology and team and a terrific core product, just as ABAQUS and all of our acquisitions have been. For those of you who follow our strategic step chart, ABAQUS is a core component of our realistic simulation strategy and MatrixOne is about managing complex business processes which is very important to companies across a wide array of industries.

Now, as we move into 2007, we are one company, clearly unified and working together. Third, based upon our performance in 2006, we extended our leadership of the PLM market and have reached an important milestone with a market share of 25%. Fourth, we are redesigning our PLM distribution channels.

In mid-January, we announced jointly with IBM, an expansion of our strategic partnership, what I would call the fourth evolution of our partnership which has endured over 26 years. We are building on the strength of this relationship, making it more robust with each of us focusing on our core strengths. I hope our actions and progress during 2006 have put to rest some worries related to the risks of integrating MatrixOne and coming to agreement with IBM.

I'd like to turn the call to Thibault at this point for a detailed review of our financial performance and objectives and then I will return to review the year.

Thibault de Tersant

Thank you, Bernard. My remarks today will focus in three key areas; a review of the year; a discussion of our PLM sales channels and changes underway to enhance future growth opportunities, and our objectives for 2007 and the first quarter. As my remarks will be based upon our non-GAAP financial information, let me begin with a brief review of our GAAP and non-GAAP figures.

For the fourth quarter and year, non-GAAP revenue excludes deferred revenue write-downs; operating income, operating margin and earnings per share exclude deferred revenue write-downs and are before amortization expenses for acquired intangibles and stock-based compensation expenses. And in addition to these items, our earnings are presented excluding the positive impact of one-time tax restructuring effects.

I would like to begin with a review of our 2006 objectives and how we performed against these objectives. First, we targeted constant currency revenue growth of about 27% for 2006. And we reported total revenues of 1.18 billion euros, representing a 27% increase in constant currencies. Secondly, we targeted an operating margin of about 27%, and we reported an operating margin of 26.9% for 2006. Third, our objective was to grow earnings per share about 12% to 13%. We reported a 15% increase in 2006 earnings per share to 1.83 euros.

We were targeting double-digit core revenue growth and we achieved it. Revenue excluding MatrixOne and Abaqus was up 12% in constant currencies for 2006. Following the acquisition of MatrixOne we outlined a target maximum impact of 1.5 point dilution to our operating margin in 2006 which we met. With respect to Abaqus, we anticipated no further dilution to our operating margin and that was the case. We said we planned to strengthen our distribution channels and we are, with the transitions started in mid-2005 continuing through early 2008.

Now, let's look at some of the details behind our key figures. We had strong growth in revenue and software revenue for both the quarter and the year. Specifically, for the fourth quarter revenue increased 18% in constant currencies, with software up 17%. Similarly, for the year total revenue was up 27% in constant currencies with software revenue up 26%, also in constant currencies. EPS growth was 7% for the fourth quarter and 15% for the year. Looking at our annual trends, we have sustained a double-digit EPS growth rate over the last three years, with 11% in 2004, 17% in 2005 and 15% earnings per share growth this year.

Revenue growth reflected broad-based strength, with PLM up 28% for the year, including a 66% increase in ENOVIA with the MatrixOne acquisition. SolidWorks delivered a very strong year, with revenue higher by 22%. All these figures are in constant currencies.

Importantly, a key distinguishing feature of our financial model is the high level of recurring software revenue. With good growth of recurring software revenue and the licensing model for Abaqus, our percentage of recurring software revenue has grown to 54% of total software revenue from about 50% in 2005.

Turning to our performance by region, Europe increased 7% in the fourth quarter and 24% for the year. Overall, we were pleased with our performance in Europe during 2006. Fourth quarter growth simply reflects a tough comparable to last year. In Asia, revenue increased 19% in the quarter and 29% for the year, both figures in constant currencies. In the Americas revenue increased 39% in constant currencies in the quarter and 29% for the year. Some of you are probably wondering why we indicated some caution with respect to the Americas last quarter and then we report our highest growth here. Simply put, I would point out that the year-over-year growth in the Americas benefits from a greater impact from the inclusion of MatrixOne than our other regions and that the basis of comparison was low.

Total CATIA and SolidWorks units increased 4% in the fourth quarter to 23,280 new seats licensed. For the year, total CATIA and SolidWorks seats licensed increased 9% to 78,684. CATIA licenses decreased 2% in the quarter. For the year, CATIA units increased 2% to 35,343 units. CATIA Version 5 end-user revenue per seat was stable in constant currencies for both the quarter and the full year. In general 2006 had a number of key wins in the first half, whereas in 2005 similar types of wins occurred in the latter part of the year. And, as we mentioned earlier, CATIA's revenue results were very good, on recurring revenue growth, including the impact of rental licenses sold in the past 18 months and excellent maintenance renewals.

SolidWorks new seats licensed increased 10% in the fourth quarter to 12,141. For the year, SolidWorks units are up 16% to 43,341 compared to 37,280 for 2005. From a pricing perspective, SolidWorks average end-user revenue per seat increased 4% and 5% in constant currencies for the fourth quarter and year, respectively. We are seeing good growth in Europe and generally good results in the Americas and in Asia.

Turning to expenses, for both the quarter and full year 2006 expense growth closely tracked headcount growth. Specifically, for the fourth quarter operating expenses increased about 19% in comparison to the year-ago period, with average headcount growth up about 24%. Currency had a net beneficial impact of about 5 points. For the full year, operating expenses are closely tracking average headcount growth.

With respect to MatrixOne, we have achieved our anticipated synergies. Since May, when we completed the acquisition, we have managed a significant turnaround, from loss-making prior to acquisition to non-GAAP profitability in each of the last three quarters.

Before moving to our business outlook, I would like to spend a few minutes outlining the financial aspects of the changes we are making in our PLM sales channels. Under the new model, we are gradually assuming responsibility for the PLM indirect channel. Business partners will become VARs, and they will be in charge of customers' transactions and support. We will be providing enhanced marketing and sales support to them.

From a financial model perspective, DS VARs will be receiving a larger share of revenue to invest in growing their resources. Now, from our perspective, these changes will have a limited impact on our P&L in 2007. We will see limited additional revenue in 2007 as our revenue share will increase from 60% to 65%, but the aggregate five-point increase will only materialize when the installed base has completed a multiyear transition. On the expense side, we estimate a temporary negative impact on the operating margin in 2007 and 2008 of about a half point in each year reflecting investments in marketing and sales and G&A primarily.

Turning to our business outlook, let me first share our objectives and then give you some color behind them. As a reminder our financial objectives are presented on a non-GAAP basis. In October we set an initial revenue growth objective for 2007 at about 11% to 12% in constant currencies. At this time, we are raising it to 12% to 13% in constant currencies on enhanced revenue prospects. At assumed currency exchange rates, this leads to a reported revenue range of about 1.29 billion to 1.3 billion euros.

Second, our 2007 EPS objective is about 2 euros to 2.05 euros, representing year-over-year growth of about 9% to 12%.

Third, we expect to maintain a stable operating margin of about 27% in comparison to 2006, thanks to profitability improvements that enable us to make PLM channel investments as well as compensate for unfavorable changes in currency exchange rates that we have seen to date.

Specifically, we will compensate a one-point margin dilution coming from two factors, the yen weakening for half a point and channel investments for another half point.

Our financial objectives are based upon a US dollar exchange rate of 1.30 per Euro and a Japanese yen assumption of 1.55 per Euro. This means that we are maintaining our prior US dollar exchange rate assumption, but are updating the Japanese yen exchange rate for further weakening relative to the euro.

With respect to the first quarter, which is typically our smallest quarter of the year, we have set a revenue objective of about 282 to 287 million euros. This represents a revenue growth rate of about 16 to 18% in constant currencies.

Our EPS objective is about 31 to 32 cents, representing a decrease of about 6 to 9%. We have been ramping up our marketing and sales resources since 2005, when we first began to manage a portion of the PLM channel for IBM. We continued to build up these resources during 2006, with additions late in the fourth quarter that will be reflected for a full period. As we are front-ending most of these investments, this will, of course, have an effect on year over year earnings comparisons in the first half of the year.

I would now like to turn the call back to Bernard.

Bernard Charles

Thank you, Thibault. Based upon our performance during 2006 DS has extended its leadership of the PLM market, with a total share estimated at 25%. We won two points of market share in 2006 and we have won 10 points of market share over the last five years.

DS is the leader of the overall CAD market, which represents about 50% of the total PLM market. Industry analysts estimate that the total CAD market grew about 6% in 2006. In total, DS sold 78,684 CAD licenses, base licenses in 2006.

CATIA is the leader of the PLM CAD market. During 2006 CATIA software revenue grew at almost twice the market in US dollars. SolidWorks is the leader of the 3D CAD market and grew over 22% in US dollars.

SolidWorks delivered an excellent performance in 2006, with strong growth in revenues, operating profits and new licenses. It also has built a very solid financial model with a significant level of recurring revenue, reflecting the high renewal rates for maintenance.

In a very competitive market, SolidWorks sells on value. Its ASP trends reflect a favorable product mix, with strong customer interest in its Office Professional and Office Premium design solutions. Just last week, SolidWorks World was held, bringing together the largest audience of 3D CAD event. Excitement was high at the conference and the preview of SolidWorks 2008 was extremely well received.

Working closely with its resellers, SolidWorks has built a dynamic channel. One year ago, we became number three in simulation following the acquisition of Abaqus, creating SIMULIA. This combination of product is now at the heart of our simulation offering.

With our progress in 2006, we are certainly gaining market share. SIMULIA had an excellent year, with four consecutive quarters of solid execution. SIMULIA grew twice as fast as the simulation market.

During 2006, we grew our relationships with existing accounts and diversified into new industries. Approximately, 66% of Abaqus' revenue is outside the automotive and aerospace verticals, spanning 11 industries. Our simulation solutions bring key competitive advantages with the broadest range of simulation applications for designers and engineers.

On the product development front, we are developing an open platform for realistic simulation and lifecycle management.

Turning to digital manufacturing, DELMIA attained key important wins during 2006 and demonstrated the significant benefits it brings to customer enabling global and flexible production systems. While public data on key competitors is limited, we believe DELMIA is number one. Importantly, our goal is to leverage these wins to achieve greater adoption of our digital manufacturing solutions.

ENOVIA finished 2006 with the most comprehensive collaborative offering into PLM market, which I will speak more about later in my remarks. I would like to highlight at this point that we are very pleased with how well our acquisition of MatrixOne had performed. It achieved the revenue growth about 20% in US dollars for the full year and through everyone's efforts, we continued dilution well inline with our initial targets.

Our business progress this year demonstrates that all of our growth drivers are important contributors to our performance. Briefly, let me highlight a few points.

First, we are expanding within our installed base. We are selling the complete V5 PLM offering, with Boeing as illustrated with its breakthrough virtual roll out one month ago, with Airbus selecting to standardize on CATIA and investing in ENOVIA VPLM and DELMIA and across a number of major customers including Toyota, Nokia, Bombardier, Northrop Grumman, Bath Irons Works to name a few. We are also seeing standardization across key product development departments, such as Ford adopting CATIA in all departments, and our CATIA V5 success in powertrain with Daimler Chrysler. As we are progressing in the supply chain with significant progress in Japan, with DaimlerChrysler recommending the use of DELMIA in supply chain, and wins with Keylex, Daehan, Kovovyroba Hoffmann.

Secondly, we are growing at new accounts and from many perspectives. For instance; DS, is diversifying into new industries such as semiconductors and apparel with MatrixOne. In addition to selling PLM to large accounts, we are selling PLM to channel accounts. SolidWorks is key to capturing 2D to 3D migration. Company is migrating from legacy to the installed base, continues to represent almost two-thirds of SolidWorks new customers. We are increasing our penetration in emerging markets with progress in China, Eastern Europe and India. And working together as one company, we are winning new accounts, thanks to each brand.

This brings me to my next topic. DS is widening the technological gap with competitors. We have been pursuing a consistent strategy since its inception, which is focused on innovation as a key differentiator. This year we made progress along several key areas, which I would like to highlight briefly.

We are developing a new ENOVIA brand offering unique coverage of functional and industry needs. We also unveiled our SOA strategy and open architecture for collaborative online PLM services. ENOVIA 3D Live was introduced; a revolutionary, easy-to use solution to search and navigate on-line and in 3D. Importantly this product brings the benefit of 3D to a new type of users. We announced our CATIA System strategy to simulate embedded system.

Looking at the calendar of 2006, we drove a dynamic product release schedule across our portfolio with ABAQUS Version 6.6 in April, SolidWorks 2007 in mid June and the introduction of V5 SOA on ENOVIA 3D Live on CATIA System later in that month. In September, we introduced PLM Version 5 release 17 and CATIA PLM Express in early October. And finally in December we introduced Virtools4, a live platform bringing the power of 3D to world communities.

PLM is becoming very visible. Everyday I am approached by companies across many industries. They see the benefits of PLM in other industries and they want to make PLM a key resource for their company. In December, PLM witnessed a truly defining moment for our industry. It was the virtual roll out of the Boeing 787 Dreamliner. Boeing's objective was to prove the design on production viability of the aircraft prior to building physically. This event, the first-ever of this type, was exceptional and symbolic of the virtual way the 787 is being built. It was the opportunity to simulate and validate, virtually, the entire manufacturing process. We are pleased to have played a leadership role in making this event possible.

We now have the most comprehensive and robust PLM portfolio on the market. In collaboration, our ENOVIA portfolio addresses a wide range of customer needs with three product lines offering unique competitive advantages

ENOVIA VPLM large customers can manage a virtual product model with high complexity. It offers product engineering for complex products.

With ENOVIA MatrixOne, we have a scalable and flexible data model for collaborative business processes and up to 150,000 users.

MatrixOne offers collaborative business processes for all industries. And ENOVIA SmarTeam offers a rapid return on investment, multi-CAD management and strong integration with CATIA. It offers design data management and engineering for the PLM mid-market.

Our three PDM product lines are already connected together and manage one single Bill of Materials. For this reason, we are winning at customers with a combination of our ENOVIA product lines. For example, Larsen & Toubro Limited, one of India's largest companies, selected ENOVIA MatrixOne for a unified enterprise PDM system. It is now adding ENOVIA VPLM in its shipbuilding business.

This is a very exciting time for us. With the benefits clear, and the best PLM portfolio in the marketplace, our goal is to drive more growth. We are strengthening our distribution channels and expanding our market coverage. Jointly with IBM, we recently announced a significant expansion of our 25 years partnership for sales and marketing. Under the terms of the agreement, we are both increasing our responsibilities.

Let me outline what we are doing and how we are organizing ourselves. IBM is now selling an expanded portfolio of our PLM solutions, to include the sales of ENOVIA MatrixOne and DELMIA to a specified list of large accounts. The new agreement has been designed to build upon and complement our existing direct sales and indirect channel resources for ENOVIA MatrixOne and DELMIA.

We are assuming the complete responsibility of the PLM indirect channel and expect to complete this transition by early 2008. This has been a progressive evolution, first begun in 2005 when we started managing the PLM channel in specified countries for IBM. We then began to manage selected countries directly starting in 2006 and we are now undertaking this transition in Korea, the US, Canada and the UK.

Our rationale for this evolution is straightforward: the PLM mid-market represents about 35% of the PLM market. We believe it is important to have a lean and efficient channel to benefit from mid-market growth opportunities and we believe partners require more support and a new business model to address these new opportunities.

In connection with these changes, we are reorganizing our marketing and sales organization, effective January 2007. Under this umbrella, we now have two organizations, one focused on the PLM indirect channel and the second focused on large accounts, working with IBM.

Looking back, over the last ten years since our IPO, we have delivered a strong track record with compounded revenue growth of 18% and earnings per share growth of 15%. We remain committed to continuing a high level of performance and believe that we are extremely well positioned to do so with leading brands addressing growing markets.

Looking at 2007, we see a year of good revenue and earnings growth and believe we have the roadmap in place and are tracking closely to our plans for doubling both revenue and earnings between 2005 and 2010.

With that, we would be happy to take your questions.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. (Operator Instructions) Your first question comes from Jay Vleeschhouwer from Merrill Lynch. Please ask your question.

Jay Vleeschhouwer - Merrill Lynch

Thanks. Good morning, Bernard. Good morning, Thibault.

Bernard Charles

Good morning, Jay. And I would not be disappointed if you were not the first to ask the question.

Jay Vleeschhouwer - Merrill Lynch

I would be the more disappointed. So, the first question concerns the structure of the company in effect that you used in your prepared remarks the term one company, which I believe was the theme of a recent global management meeting you hosted in last few weeks. And I guess, the question is, what is the practical effect of thinking about DS as one company? When we think about the structure today, you have multiple brands, each with a CEO, and it would seem to me that when we think about other technology companies that think of themselves as unified or as one company, they would have more of a functional orientation, R&D sales and the like, rather than the current vertical orientation of the company. I was wondering if you could address that. Similarly, given the magnitude of the changes you're undertaking in sales and distribution, would it make sense for you to have some kind of a corporate or global level executive for sales and channels, some COO in effect for all the changes that you are trying to make in this effect?

Bernard Charles

Thank you for the question, Jay. The practical way of looking at this message that we shared across the older management level is in fact very relatively easy to see in the way we are going to operate. First of all, I believe that these 7 brands in the group, I am not at the same level of maturity when it comes to the way the market itself is ready to adopt the different solutions. On the SolidWorks side, we see a race for market share and for volume. From the DELMIA side, the race is for [referencing] demonstrating that, yes, indeed it's possible to do digital manufacturing. And we have done that extremely well. For the ENOVIA piece now, it's about demonstrating that the real diversification across multiple industries is possible with PLM business processes and for collaborative innovation.

On the SIMULIA side, it is really about making the breakthrough with new approach to scientific simulation basically. And of course, with CATIA it's about confirming CAD to PLM CAD, which is very different. So, different matter (inaudible), so what it means from a customer standpoint and from a partnership standpoint. We want to add consistency in contracts. We want whether the contract is with partner or whether the contract is with the end customer. So, consistency is important. We want to ask, which was not the case due to a historical reason, we want consistency in the way the sales processes is under. That's a big value for speed of training the team from scaling up. Before the PLM sales was for older scope of PLM was through IBM.

So, contract consistency counts consistency in processes, unifying the IT infrastructure. So, they are very practical results. But we don't want and I don't want to lose the advantage of powerful brands, because at the end of the day this is what the end user loves, this is what they want to buy and buy again. And when we negotiate with large companies, soon we will be able to do a single contract, whether it's through IBM, as I explained, or if it's a smaller company through [SOA] system.

The second aspect of your question is on the magnitude of the challenges. If you look at carefully about the approach, we basically want to create global lean and efficient channels. We have three which is part of our total go-to-market, one with IBM, and clearly this one is strengthening and will continue to scale in the total PLM portfolio as I explained. One with the indirect PLM channel, because we think time is right, the timing is right, because PLM for mid companies now is affordable, easy enough to deploy and the technology and integration is there and of course we want to continue to scale at the dynamics of the SolidWorks channel, to ultimately make it a volume channel for Dassault Systemes. So, that in short is the approach and I think we have strong leaders for both the channels as well as the branch and it's [somehow old], but I believe works and we'll scale.

Jay Vleeschhouwer - Merrill Lynch

Okay. Thibault, you pointed out that you expect about 0.5 point margin effect from the investments you are making in the channel this year. That would work out about 6 million euros or 7 million euros according to your revenue forecast. That would almost seem an improbably low amount of incremental revenue, again given the number of resellers that you have. Could you perhaps describe how that will be invested in developing the channels?

Thibault de Tersant

Well what you have to bear in mind Jay, is that this evolution is not starting just now. We started the evolution if you remember, with an agreement with IBM to do the support of their business partner channels and we also did a few transitions in the course of 2006. So, the dilution we are speaking about hear is just the incremental investment that has to be made, and certainly not the full investment required to support a channel.

Jay Vleeschhouwer - Merrill Lynch

Okay. Two final questions, your CATIA unit growth for the year was 2% in terms of units. Would you expect to have positive comparisons each quarter for CATIA in 2007 year-over-year? And then finally Bernard, what do you think will be the most important new technology or product releases of '07? You talked about the '06 releases. In '07 do you think that completion of the master model project, any further CATIA development, anything you care to name for '07 as the critical releases, would help? Thank you.

Thibault de Tersant

Okay, first of all yes, we have this modest 2% increase in new CATIA licensees for the year. And that's true, it's in line with the [0.5%] we had indicated. But I don't think that's -- I'd like to say first of all that this is not probably the most important measure, although it's an important one. And I think it is highlighted by the fact that we have been growing the CATIA revenue, the software CATIA revenue in 2006 at about 10%, which is because of maintenance renewals that we are at a very good level and also because of our dynamics that goes on in renting licenses and those increases in licenses that we were able to do in the past year. And that in 2005 has been producing effects in 2006.

So, I agree, we need to keep good dynamic at growing number of licenses we sell, but we are now in a model with CATIA because of the investment of seats and because of the rental model and the recurring model we have, where we have now some disconnects between the revenue growth and the new licenses, units we report. And in fact, if we look at it, we have been growing the CATIA revenues at a little bit more than 10% in both 2006 and 2005. No, and the answer to your specific question, Jay, no, I am expecting, we will have a positive unit growth in each quarter of 2007 for the main reason that the first half of 2006 was pretty good and dynamic in new CATIA units and particularly the second quarter had seen very large orders and the timing of these large orders can vary, and it's very difficult to predict exactly for 2007.

Bernard Charles

Related to your last question about the most important technology breakthrough, there are many, many firms. There is a very, very large product portfolio introduction and technology introduction this year and in the next 18 months. Clearly, there is one that I just would mention right now. It's most probably related to the new collection of collaborative environment that's being built around what we call 3D Live. I talked about it and we have presented it to customers last year and really the traction there to provide a comprehensive portfolio is really great. This is probably the most important driver for product introduction, because it increases the diffusion on access and capabilities to leverage the digital IP, all our customers are creating around the world across all our brands and that's in short. One thing I want to add to Thibault's comments about the CATIA revenue is, we believe we have a lot of room to continue to take advantage and it was indirectly said by Thibault, that take advantage of the incredible product portfolio around the CATIA brand because the product portfolio is very large. We see customers coming to us and asking for composites, customers coming to us and asking for electrical. And those are under one brand name called CATIA, but you can sell them on existing seats. And it sometime represents more than any basic CAD seats in terms of revenues, and that's why the gap that Thibault explained between the unit growth and the revenue growth.

Jay Vleeschhouwer - Merrill Lynch

Thank you very much.

Operator

Your next question comes from Rajeev Bahl of Deutsche Bank. Please ask your question.

Rajeev Bahl - Deutsche Bank

Thanks, afternoon gents. It's a quick question really on the front-loading of costs that you were talking about, Thibault, I was wondering if you could put some detail around to what extent those costs are going to be front-loaded, looking at the margin cuts for Q1, it looks like 5 percentage points below where we were last year. How much of that is coming from Matrix? How much of that is the front-loading of these costs? And as a result, how much of that incremental cost increase can we see fall away, as we move through the course of the year?

Thibault de Tersant

To explain it, I think the first and foremost reason is a slightly different pattern of revenue generation compared to 2006, where we had a very good first and very good second quarter from the revenue standpoint. The channel investments we have, certainly started to increase them in this Q4 of 2006. And then we continue across the 2007 year with a peak in the first quarter. So this is also of course a contributor to this margin erosion in the first quarter. Not completely uncommon. We have years now where there is margin appreciation in the first half and less in the second half, and the opposite scenario in the following year, and we have been following that pattern now for four years.

Rajeev Bahl - Deutsche Bank

Okay. So if I was to think about the amounts of extra cost that you are loading on to the P&L in Q1 and then I guess Q2 we'll have a smaller load, what kind of number of millions, is this around the 5 million number that we are talking about, additional sales and marketing cost or is it bigger or smaller than that?

Thibault de Tersant

No, it's a bit smaller than that. And in addition, you must bear in mind that Q4 is always a strong quarter from an expense standpoint. So, we are not factoring a very large increase in expenses in first quarter. Because Q4 is always the quarter, where there are more variable pay expenses and commissioning, etcetera, and also marketing programs that we need to launch in Q4, if we want the following year sale to be showing up. So, the increase in expenses compared to Q4 is relatively modest, but these types reflect that there is this front-loading of [channel support].

Rajeev Bahl - Deutsche Bank

I see, because on the normal seasonal pattern you would expect cost to drop in Q1 relative to the prior Q4. So what you are saying essentially is that you are going to maintain the level of cost you've built up, but we should see the cost ratios, if you like, move back towards more normal levels by the end of the year.

Thibault de Tersant

That's right.

Rajeev Bahl - Deutsche Bank

Yeah, that's fine. Thank you.

Bernard Charles

That's why we can achieve what we said to achieve operating margin target at 27%, as we have said in our press announcement this morning.

Rajeev Bahl - Deutsche Bank

Yeah.

Operator

(Operator Instructions) Your next question comes from John Segrich of JP Morgan. Please ask your question.

John Segrich - JP Morgan

Hey, Thibault, just a quick question one the CATIA upfront revenue, it looks like in the last two quarters or so, you have seen a pretty sharp decline in the upfront revenue. And I know the compares are a little bit tough from last year but, still you have been generally growing pretty fast and now it's slowed down. Do you think any of that has to do with the change that you are making to the channel model? Do you see any hesitation in the channel maybe, and therefore, we should expect maybe the upfront business to start picking up again, as we move through 2007.

Thibault de Tersant

I think clearly that a couple of reasons we could highlight or maybe we'll see, and the number one is the timing of last deal. We were able to deliver our fourth quarter of 2006 without any large transactions, and I want to make the point that I see it's showing that we have an hefty base of revenue that we can deliver on even in absence of a mega deal whose timing is always very difficult to predict because evaluations for a very large deal can last for a long time and vary quite a lot. So, I think this was really the number one factor in this new license revenue and unit dynamic. Besides that, secondly, there was uncertainty with our partner IBM relative to the negotiation of the addition of new product line for them and the transition of the channel, which caused some disruption in [sales and purchases]. And last, even if it's not so visible in our figures, we have seen a little bit of weakening in some regions in United States since last December.

John Segrich - JP Morgan

Okay. Thanks.

Operator

We have no further questions at this time. Please go ahead.

Thibault de Tersant

Okay. Thank you very much all of you and thank you very much for many of you participating in our presentation this morning and of course, you know how to reach us and we will be always delighted to address any of your questions. With that, we will talk to you next quarter. Bye. Have a good day.

Operator

That does conclude our conference for today. Thank you for participating. You may all disconnect.

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