Bentley Systems, Incorporated (NASDAQ:BSY) Q4 2022 Earnings Call Transcript

Bentley Systems, Incorporated (NASDAQ:BSY) Q4 2022 Earnings Call Transcript February 28, 2023

Eric Boyer: Good morning and thank you for joining Bentley Systems Q4 2022 Operating Results and 2023 Outlook Webcast. I’m Eric Boyer, Bentley’s Investor Relations Officer. On the webcast today, we have Bentley Systems’ Chief Executive Officer, Greg Bentley; Chief Operating Officer, Nicholas Cumins; Chief Investment Officer, David Hollister; Chief Financial Officer, Werner Andre; and Chief Technology Officer, Keith Bentley. This webcast includes forward-looking statements made as of February 28, 2023, regarding the future results of operations and financial position, business strategy and plans and objectives for future operations of Bentley Systems Incorporated. All such statements made in or contained during this webcast other than statements of historical fact are forward-looking statements.

This webcast will be available for replay on Bentley Systems’ Investor Relations website at investors.bentley.com. After our presentation, we will conclude with Q&A. And with that, let me introduce the CEO of Bentley Systems, Greg Bentley.

Greg Bentley: Thank you, Eric, and I hope all of you have had a chance or soon will have to meet our new and very experienced Investor Relations Officer. And thanks to each of you, as always, for your interest and attention. Today, I and COO, Nicholas Cumins; and CFO, Werner Andre, will review our resilient 2022 Q4 and full year operating results. As the infrastructure engineering software company aligned global priorities and momentum from our three incremental growth initiatives, E365, Virtuosity for SMB and iTwin investments, reinforced our confidence for, again, a strong operational and financial outlook for 2023. Today, we will also hear as I always enjoy from founder, Keith Bentley, who will be transitioning his Chief Technology Officer role at the end of this quarter and retiring later this year, and the investment community will hear for the last time from former CFO and current Chief Investment Officer, David Hollister, who will be retiring at the end of this quarter.

As always, I will start with what’s new in our tone of business. Our key operating results headline is year-over-year constant currency ARR growth consistent with our original and sustained financial outlook of 12.5% in business performance, which excludes ARR acquired with Power Line Systems. For the quarter and for the year, this reflects robust and sustained momentum everywhere else in the world, making up for having lost Russia and for compounded headwinds in China. There, in addition to geopolitical concerns, which are not abating as evidenced by more recent developments to ring the fourth quarter’s major annual selling season, the pandemic first caused a shutdown of our offices and then widespread sickness after the reopening. And as well, the government’s intended infrastructure spending seemed to have been delayed.

For the year 2022, for instance, as reflected in our anticipation last quarter, we would have exceeded our range of ARR growth outlook, if not for the regression caused by Russia and then knock on counter globalism in China. We are cautiously bearing in mind those risks in China in our outlook for 2023. With respective to the relative tone, the color of business by infrastructure sector, the only change in Q4 was that the commercial facilities sector finally flatlined. We had been anticipating this earlier in 2022, and we do expect this to continue for 2023, though only affecting a single-digit percentage of our ARR. And we have regularly reported on the Dodge ENR quarterly survey of civil engineering firms, self-reported backlogs. I believe Q4’s reported downward assessment as a percentage of their ideal backlog has more to do with the reporting firm’s assessment of what’s ideal for them as the same firms reported net increases in backlog from Q3.

Moreover, the ACEC quarterly survey representing a much larger sample across all engineering firms actually quantifies the substantial current backlog as fully 12 months. And especially in this survey, there continued expectation of a further increase in backlog over the coming year. The related sentiment survey also shows continued improvement over last quarter. For our accounts in the face of workforce constraints and growing backlogs, going digital is the priority for increasing their infrastructure engineering capacity. And our consumption-based E365 commercial program, embedding our enterprise success expert teams to implement each E365 accounts prioritized blueprints for new digital workflows every quarter, is the first of our own primary incremental growth initiatives as E365 accounts achieve demonstrably faster ARR growth than our other enterprise accounts.

In 2022 Q4, as expected with our seasonal bulge in renewals, we upgraded accounts to E365 at about twice the ARR rate as in each earlier quarter of 2022. E365 increasingly becoming our mainstay commercial program has contributed to our application mix accretion that measures the annual change at constant pricing and average user spending per consumption hour. This reflects their pace of upgrading to more specialized and thus more expensive applications and has been expanding steadily from approximately 2.5 to 4.5 percentage points of ARR growth over the last two years. And of course, that’s in addition to growth from pricing escalation, volume and cloud services adoption. Our second incremental growth initiative has been our Virtuosity go-to-market strategy for SMB accounts and prospects.

From the beginning, it has generated exponential growth continuing to reach in 2022 Q4 a milestone of over $33 million in Virtuosity ARR. And for yet another consecutive quarter, Virtuosity’s new business included more than 600 further new logos, enabling us to surpass the further milestone of over 40,000 unique accounts globally and new logos added almost 3 percentage points of ARR growth. And among our existing accounts, net revenue retention in Q4 remained at its high of 110%. Concluding as to SMB, in Q4, SMB represented fully 47% of our overall new business. And even in China, SMB new business grew year-over-year in 2022 Q4. And in fact, new business overall was healthy in Hong Kong and Taiwan. So I believe our applications are competitively well positioned throughout Greater China.

But to reach our potential there, we must navigate the geopolitical issues that currently limit our prospects in the primarily state-owned Mainland enterprises. Thus, in December, we announced in China, our second Chinese joint venture, which doesn’t yet have an English name. It’s with HDEC, a large design institute that’s part of Power China. We’ve worked closely with HDEC for decades as a major account and particularly to support their development of China’s specialized applications based on our platform, both for their internal use and to market to their peers. The joint venture with HDEC whose business is primarily engineering for hydroelectric power generation will soon become our exclusive channel partner for all hydro power accounts in China, representing almost 20% of our business there.

We will transfer to the JV along with some Bentley China colleagues, our existing direct relationships and a capital contribution for our one third ownership. HDEC will contribute two thirds of the capital and its existing application business and products. The JV will initially resell our existing applications as well as HDEC’s, but over some years we’ll work to increasingly shift the mix towards all indigenously developed Chinese products built on our platform, paying us royalties rather than net product revenues and eventually leading to hope for investment returns as well. Moreover, the JV will cater to the preferences of this Chinese enterprise market. Those are preferences for perpetual licenses rather than subscriptions and rather than our cloud-based enterprise systems for on-premise systems like iLink the reworked derivative of project-wise now coming to market from our first JV.

So during 2023, major portions of our ARR in China will tend to regress from gross to net and then as subscriptions are cannibalized for perpetual licenses. But given the magnitude of the Chinese market, accounting for 30% of global infrastructure spending, we think that to manage through the geopolitical headwinds, these investments and risks are warranted for the sake of the long-term. Now it’s too early to knowledgeably quantify this drag on 2023. However, you will notice that our annual outlook for 2023 in terms of ARR growth looks like 2022’s annual outlook and actual outcome. Although the complete loss of Russia obviously can’t occur again, the possibility of China somewhat following suit could be a significant 2023 factor. But for both years, let me emphasize that Russia and China are the asterisk exceptions to our backdrop of unprecedented sustained growth and momentum for our business and for our colleagues everywhere else in the world for 2023, as Nicholas will now elaborate.

Nicholas Cumins: Thank you, Greg. I am pleased to report that we made a strong finish to 2022 and see momentum continuing into 2023 with healthy pipelines and a very brisk pace of business. Market conditions remain positive. Q4 was a very busy quarter with more evidence of IIJA investment and EU recovery funds flowing through more so than in prior quarters. And as Greg pointed out, accounts appear to be more concerned about their capacity to execute rather than the book of business. Talking about momentum, I would like to acknowledge the invaluable work of our new Chief Revenue Officer, Brock Ballard, who has been instrumental in the successful global rollout of our E365 program, and I’m delighted that he now brings his wealth of industry experience to operating council.

Of course, I will be remiss if I didn’t also pay tribute to his predecessor, Gus Bergsma, whose relentless focus on execution elevated the company’s sales performance to a new level of precision. Looking at the regions, I will draw your attention to Europe and India. Europe was a bright spot with improving market conditions and a strong pipeline. The main growth drivers were public works and contractors in industrial sector, as well as an acceleration of E365 conversions and consumption. In India, momentum continued in both enterprise and SMB with public works and industrial driving year-on-year growth. Transportation continues to be a strong point for us with firms flowing and lots of project awards. India is also a focus for urban and rural drinking water programs, and we made the single largest sale of our water product line in India in the last 10 years.

Southeast Asia continues to impress with the scale of its ambition and it can point to mega projects in transportation, in rail in particular. At the year in Infrastructure and Going Digital Awards, which were held in London in Q4, two rail projects from Southeast Asia were finalists, the Metro Manila Subway project and the eventual winner, the high-speed railway from Jakarta to Bandon. The project set a new benchmark for going digital. iTwin technology reduced the design review time by 10% and shortened the construction schedule by 6 months. Turning now to products. MicroStation grew fast in SMB. This is a positive indicator that there’s still an untapped segment of individual practitioners and smaller infrastructure organizations for whom MicroStation has a strong product market fit.

Why this is significant? Is that these practitioners and organizations who may be using MicroStation on a product for the first time represent an installed base that we can in future upsell to a higher value, more powerful engineering application, what Greg calls application makes accretion. And beyond that, help them get on the on ramp to infrastructure digital twins. Other brands with notable performance in Q4 included OpenRail, OpenBridge, OpenFlow, SACS and Infra. Finally, a few words about our colleague engagement. As you will see in the 10-K report, we had a remarkable 92 participation rates in our 2022 annual colleague engagement survey with 85% of colleagues responding that they’re proud to work for Bentley and 87 glad to recommend Bentley as a place to work.

It is gratifying to see favorable comparisons with tech industry benchmarks against the backdrop of tech layoffs and so-called quite quitting. This is due in no small part, we believe, to our intentional approach to work flexibility and colleagues’ well being, which facilitates a high level of engagement and productivity. What we call our infrastructure and employee workforce plan encourages our colleagues and their managers to make effective choices about the right balance of working from home or in the office and truly make the best of both worlds. Our policy of not requiring colleagues to come to the office at any specific frequency has been instrumental in attracting and retaining talent and allowing our colleagues across the world to contribute to Bentley Systems success in a meaningful way.

And with those operational perspectives, back to you, Greg, for corporate governments.

Greg Bentley: Thank you, Nicholas. And may I add my thanks to the whole of your operating teams for these best ever operating results that we’re reporting today and expecting for 2023. Following on from the Chief Revenue Officer transition that Nicholas just reviewed, the corporate developments we will cover now are also related to executive succession. Recall that the primary motivation for our IPO after 35 years was to help provide a prosperous retirement for our colleagues who had collectively earned one third of the company’s ownership while making possible our success. As an expected consequence, we will, this year, substantially complete the retirement succession for cumulatively nearly half of our officers. I described this wave of management promotions as generational.

This year’s retiree cohorts has an average tenure of 26 years. A commitment we have engrained over all that time is that our operating management is annually charged with realizing scale efficiencies sufficient to expand our operating margins by about 1 percentage point. In our financial outlook for the year 2023, we are now aligning our external margin metric with what we believe most appropriately measures this aspect of operating performance and improving on adjusted EBITDA for these purposes. Based on feedback to date, I think investors will also prefer our compass setting metric going forward, which is adjusted operating income, including stock-based compensation as encompassing real and substantial economic costs that are conspicuously overlooked in adjusted EBITDA, and this includes capturing operating depreciation and amortization, which becomes more significant for us in 2023 as our digital experience investments include some IT expenditures that require capitalization.

But most importantly, to us all as shareholders, stock-based compensation bears real cost of dilution. In our case, corresponding to the free cash flow we use to fund offsetting repurchases. As I described in our own history, we think stock-based compensation is crucial for a software company, but it’s economically fungible with cash compensation costs and merit the same informed scrutiny in trade-offs. As a private company, we issued stock options and incurred relatively minimal Black-Scholes accounting charges. Then as a public company, our comparable grants in full value restricted stock entailed accounting costs at a much higher magnitude. Following the ensuing retirement wave, which I described our equity incentives as having enabled, we have prioritized intentionally rebuilding appreciable equity holdings by our next generation of leaders.

But subject to cash versus stock elections by in four executives, including our CEO, I expect our SBC charges to level off in the 6% range of margin points. Giving full weight to these economic costs, we have progressed quite well in following our internal compass towards increased adjusted operating income with stock-based compensation. From pre-IPO years through the pandemic years, which were subject to normalizing adjustments for the temporary travel and event savings, and as reported today for 2022, leading to our confident 2023 outlook to achieve a compounded annual growth rate over the last five years of just under 16% in adjusted operating income with SBC. And most significantly, over this period spanning the pandemic impact, we have substantially accomplished our objective of an annual percentage point improvement in operating margins by this most appropriate and fully encompassing measure.

Two related final thoughts are about our leverage, consisting primarily of our convertible notes maturing in 2026 and 2027. First, if, as is our track record and our plan, we continue to extend this compounded annual growth rate. Then at current valuation multiples of adjusted OI with SBC, I think you would see that this debt will, in fact, convert. And second, to the extent valuation multiples become lower and the debt doesn’t convert, the compounding cash generation this portends after fully offsetting SBC dilution, should easily underwrite our choice of refinancing. Now back to our executive succession corporate developments. Keith Bentley, up next, will then introduce David Hollister to review our significant recent Bentley investments.

I can say with appreciation that we wouldn’t be here without David Hollister. I will certainly miss his influential thinking and steering. And I am sure that as a continued substantial investor, he will expect ample returns from the long-sighted investments he has overseen. David will then introduce Werner, his successor, our CFO, to wrap up. Setting aside any admitted bias, I think the infectious spunk and constructive values and work ethic of founder, Keith Bentley, have defined our company just as much as his technical groundbreaking and future proofing. Keith will cover our third primary growth initiative, the infrastructure, digital twin generational advancement powered by iTwin that will be his enduring legacy. Keith, you’re up.

Keith Bentley: Thank you, Greg. When we began Bentley Systems journey in 1984, I’m sure I wouldn’t have been able to predict where we’d be at this point as a publicly traded company with $1 billion in annual revenue. It’s been an incredibly rewarding and exciting journey for me as the years have just flown by. But of course, I’ve been at this for so long, and I’ve made so many multi-decade personal relationships with our wonderful user organizations. And I feel a real personal obligation to them. Likewise, I’m deeply committed to my colleagues here at Bentley, many of whom have dedicated their entire career to our company. So part of me wants to work forever. But last, as they say, time waits for no man. And inevitably, there must be a transition.

Best if it can happen while I can help make it as smooth and successful as possible. So while I’m stepping down as CTO and I intend to start gradually ramping down my schedule throughout the course of this year, the Bentley Systems journey will continue unabated. To me, the future looks even more exciting and more full of potential than it did when we began with the advent of the personal computer nearly 40 years ago. Of course, I will also remain a director and investor in Bentley Systems left anyone think there’s a danger that I may lose interest in our long-term success. I’ve been working with my successor as CTO, Julien Moutte, continuously over the past two years. And I’ve come to have a sincere trust in his in things and a real admiration for his drive to get things done.

Together, we’ll make the transition as smooth as possible, and we’re both committed to continuity, both in terms of our long-term directions and our immediate priorities. So we expect no drama. Now as you may know, in the infrastructure software market, we find ourselves at a very real inflection point around infrastructure digital twins, a concept that Bentley nearly single handedly invented. And my obviously biased, but informed humble opinion, there’s currently nothing remotely competitive to our iTwin technology stack. So it’s our priority to leverage our iTwin advantage as quickly and as jointly as we possibly can. Since we introduced iTwin in 2017, we’ve seen significant uptake by some of the world’s leading engineering firms on the world’s most significant projects.

A good indicator of that is the number of finalists in the Year in Infrastructure and going digital awards that credited iTwin for their project, that fraction has increased from 20% in 2020 to more than 40% last year. But that’s because infrastructure digital twins empower engineering firms, and over operators to accomplish extraordinary things and to make game-changing improvements to their workflows and their business process and even transform their business models. So if you haven’t already done so, I encourage you to review the recordings of the finalist presentation from last year’s Year in Infrastructure and see for yourselves, how they describe it in their words. We want the benefits of using this technology to be experienced by all infrastructure projects and in all by all infrastructure professionals no matter the size of their project, the size of their organization or whatever phase of the infrastructure life cycle they contribute.

With all the investment going on in infrastructure throughout the world, wouldn’t it be nice to think that together, we’re getting the maximum value for every dollar, every euro and every other currency being spent and that the projects are safer, greener and delivered on time. I know I do. Infrastructure digital twins certainly make information more accessible and I think can become the building blocks for a very valuable and €“ industrial and professional metaverse. They make possible new capabilities and process well beyond the state-of-the-art today and probably beyond our current ability to conceive of their ultimate value. We’re more excited than ever about the prospects for infrastructure digital twins and of course, Bentley iTwin.

But that means that iTwin should be pervasive. It already powers the Bentley Infrastructure Cloud, it already enables us to mobilize data across the infrastructure value chain across every stage of the infrastructure life cycle. But our priority for this year are to bring the power of cloud-native iTwin to our engineering, modeling and simulation application, but without requiring our users to fundamentally change their ways of working. They should be able to incrementally realize the benefits of infrastructure digital twins without having to start over. To accomplish that, will embed the iTwin engine inside our existing applications. It’s an exciting project and one where Julien and I have been actively involved and engaged with nearly every team here at Bentley.

And I have to say it’s one of my most enjoyable projects ever. So I’ve had a tremendous career and I’m very thankful to all the talented people here at Bentley now and over the years, we’ve made it so rewarded. We began long ago in an era called Computer Aided Design. But I now describe our scope as software-aided infrastructure. And I think the possibility for that are near endless. Our world needs to improve the efficiency, the longevity and the resilience of our global infrastructure as a matter of urgent priority, but that can only happen with innovative new technology, new processes for all phases of its life cycle period. It’s not a matter of if, but how. And on that note, I’d like to hand it over to my good friend and our long-time CFO, David Hollister, who will be speaking today on our operating results call for the last time.

David, what new investments have you been working on for our futures as retirees?

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Q&A Session

David Hollister: Thank you, Keith, for your vision, your leadership and your kind words. And indeed, I will talk about some new investments. Beyond our noted progress in developing formal joint ventures in China to forge an alternative means of doing business in that evolving landscape, I’d like to give updates on our iTwin Ventures activities and expand a bit more on two of our latest acquisitions, EasyPower and Vetasi. So as you know, we formed iTwin Ventures to stimulate entrepreneurialism in developing digital twin applications, including those leveraging our iTwin platform capabilities. In addition to our traditional venture portfolio investments, and I’ll highlight a new addition to that in a moment, we sponsor and support a development ecosystem, wherein iTwin Activate is our accelerator program, where we engage with early-stage companies and fund approved development projects in exchange for equity, typically safe notes.

We completed our first cohort of iTwin Activate focused on the grid and the success of this cohort has already led to certain products ripe for introduction. And joint marketing and co-selling motion between Bentley and the cohort participants are already underway. It’s our expectation that many of these iTwin Activate program participants graduate into venture investable businesses for iTwin Ventures and others to invest in. Since we last spoke, we continue to be enthusiastic and supportive of our investment portfolio and are pleased to announce our recent investment in Oakland, California-based Flow Labs. The Flow Labs platform leverages aggregated real-time traffic sensor and connected car data to generate a synthetic data set approximating all road usage.

This data supports a range of optimization and analytics use cases, starting with traffic signal optimization and extending to traffic flow monitoring and optimization at city scale. We also see the potential for Flow Labs real-time data sets to contribute to Bentley’s advanced traffic simulation solutions. Our EasyPower acquisition adds electrical design and analysis capabilities to our portfolio. We’ve historically found really good success in offering analysis and simulation applications, specifically for infrastructure context, which are fit for purpose and easy to apply, iterate and incorporate for optimized design and operation of infrastructure assets. Financially, these solutions tend to be mature, sticky and high-margin contributors for us, and we expect the same from EasyPower.

We estimate EasyPower can offer everything that 90% of infrastructure, electrical power engineers will ever need and it’s a solution that’s easy for them to learn and apply but can also complement other advanced electrical analysis solutions outside of our portfolio and not presently our focus. Within our comprehensive portfolio, EasyPower will initially complement our open buildings, open flows, open plant and raceway cable management design and modeling applications, in particular, in the context of industrial mining and commercial building sectors. EasyPower will also serve as a platform to introduce electrical analysis to other of our sectors in due course. We’re excited to welcome EasyPower’s CEO, Kevin Bates and his Portland, Oregon-based team to Bentley Systems.

Since our last operating results call, our Cohesive business has also completed its acquisition of Vetasi. You’ll recall our Cohesive digital integrator business was formed to provide digital strategy consulting, integration, deployment and system services support to help our clients achieve business outcomes and benefits from digital twins. Cohesive seeks to adopt improved commercial models that we believe engineering firms in particular, will find to be an appealing business model and will also adopt accordingly. Vetasi is a European-based, Maximo focused, digital integrator which very nicely fills geographic voids for us and complements our existing sector focus with presence in utilities, mining, oil and gas and transportation. Vetasi also brings a highly skilled team of nearly 200 digital integrator consultants, including in cost-efficient basis in Poland and Indonesia.