Bentley Systems, Incorporated (NASDAQ:BSY) Q1 2023 Earnings Call Transcript May 13, 2023
Eric Boyer: Good morning and thank you for joining Bentley Systems’ Q1 2023 Operating Results. 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; and Chief Financial Officer, Werner Andre. This webcast includes forward-looking statements made as of May 9th, 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 containing 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. Just a quick administrative matter before we begin. You can now find our 2022 annual report along with the CEO letter and our inaugural ESG report on our Investor Relations website. And with that, let me introduce the CEO of Bentley Systems, Greg Bentley.
Greg Bentley: Good morning and thanks to each of you for your interest and attention. With the retirement of our Chief Investment Officer, David Hollister, and the division of his responsibilities among the rest of us, our presentation sequence starting this quarter is meant to be simpler and more concise. I will offer observations about directions in our business, we’ll report on corporate developments, and provide updates on our capital allocation. Then Chief Operating Officer, Nicholas Cumins, will provide expanded operating perspectives, now including in my stead, tone of business by sector and commercial model as well as by region and by brand. CFO, Werner Andre, will conclude with our financial performance, as usual. Robust operating results for 2023 Q1 echo what I think has come to be expected of Bentley Systems end market resilience, predictably accretive business model, and the consistency of our execution and thankfully, absent last year’s unfavorable drama in Russia and China.
We met or surpassed expectations for our financial performance metrics, most significantly including operating margins measured now by adjusted operating income with stock-based compensation. Our operating cash flows were even higher than expected, but as Werner will explain, we expect consistency here on a trailing 12-month basis. As Nicholas will elaborate, all operating trends remain directionally strong. And as he will explain, even though this year has started appreciably better in China than in other recent years, that probably will serve to accelerate our intentional localization pivot there at some increasing cost to existing ARR. All considered, our across-the-board strength in 2023 Q1 duly increases our confidence in our annual financial outlook for 2023.
And as to what I consider our key metric, ARR growth, indeed, this expanded sequentially to a first quarter high of 13% year-over-year constant currency business performance, with net revenue retention over trailing 12 months remaining consistently high at 110%. This new business strength is consistent with external benchmarks as the Dodge survey of US civil engineering firms continues to show that their current backlogs have kept increasing continuously. Broadening to ACEC survey of US engineering firms generally, not limited to civil, such firms are confident about backlogs continuing to increase over the coming 12 months. And as to that 12-month horizon for their expectations about macro conditions at large versus their own environment, US engineering firms’ sentiment has generally improved over the last quarter, but again, more so for overall engineering and design services and especially for their own firms’ favorable prospects.
And this latest ACEC survey of US engineering firms’ current sentiment by industry here matched to BSY’s infrastructure sectors correlates with our own new business resilience with quite favorable sentiment for water or wastewater within our resources sector, broadly leading sentiment for industries within the public works/utilities sector, satisfactory sentiment for industrial and industries within the commercial facility sector, that is vertical infrastructure, generally lagging. For US ACEC firms, the most significant annual survey was just published by engineering news record earlier this month, ranking the US headquartered top 500 by design billings. They report their design billings to ENR in accordance with this breakdown. So, their aggregate design billings here can likewise be generally grouped within BSY’s infrastructure sectors in these proportions.
For resources, including at least water networks, the mainstay for us and for these top design firms overall, public works/utilities for industrial, and for the commercial facility sector, which leaves some reported design billings not applicable to infrastructure sectors. Of course, each year, the top 500 are a somewhat different set of firms, so the year-to-year growth in the total of their design billings does not per se correspond to an organic growth rate, but note the conspicuous inflection now underway in the top 500 firms design billings as along with somewhat greater inflation, design intensive infrastructure projects for resilience, adaptation, and energy security are being increasingly prioritized. ENR does not annually report the top design rankings for those largest headquartered outside the US until early summer.
So, the latest analytics for the global top design firms are still using the combined 2022 rankings when the consolidated top 637 firms reported aggregate design billings of $216 billion. I have been reasonably asked why when China represents only a few percent of BSY revenues? We are allocating so much attention and emphasis on our determinedly new China-specific go-to-market strategy, particularly as everywhere else in the world, we relatively uniformly apply our proven direct sales formula. The ENR top firm rankings show the answer in terms of magnitude. Just the top 29 firms in China performed 27% of the design buildings of all the world’s top firms. This proportion is not an abstract future projection, nor is it derived from murky economic statistics, rather, this reflects the here and now proportion that China already represents among our top accounts and prospects.
If and when we can earn the same share of design billings in China as elsewhere, our overall scale of usage and revenues could grow at comparatively little incremental cost by almost 25%. To quantify BSY’s current penetration rate outside China, Consider that our ProjectWise enterprise collaboration system is particularly well established in these top firms to distribute their engineering workflows across their globally virtualized talent resources. Such work sharing has become increasingly essential for these firms throughout the pandemic and since then, in light of their staffing challenges, to meet the backlogs we were just looking at, we know from our consumption log analytics, the number of users of ProjectWise within these firms as we charge them each calendar quarter per unique user.
Based on the middle-of-the-road assumption that these top firms’ design billings are performed by full-time employees, FTEs, each estimated to generate an average of $200,000 of design billings annually. It turns out that about 14% of these FTEs in a calendar quarter are ProjectWise users. While I am sure this makes us, by far, the leader in enterprise collaboration for these top firms, the remaining opportunity for firms and projects to further standardize on ProjectWise is a compelling priority for our product, sales and success organizations. Collectively, these global ENR top design firms alone account for about one-fourth of BSY’s ARR. And of course, within this, we log each hour of each firm’s users BSY and application consumption. And most of these firms are E365 accounts that we charge per day of such use.
So how does our revenue compared to the design firms revenue for each such design hour as to which educated assumption is that these ex-China firms bill at about $150 on average. For each such power using BSY applications, the average expenditure by these top design firms is $1.41 or less than 1% of that hour’s rate of billing. And apportioning these firms’ ProjectWise expenditures over their BSY application usage hours adds on average about $0.39 in cost per such design hour. While there are other additional costs of going digital, among others, hardware, Microsoft, communications, internal support, I think there would be a general agreement that BSY’s application software and ProjectWise, if used, most largely determine the actual value of that design hour, yet presently account for only a few percent of the total cost to the design firm.
At this juncture, when such firms face record backlogs, but are constrained from adding hours by the limitations of skill shortages, I think this makes the case that there is a long upside runway ahead for us to provide and be paid commensurately for more valuable, more specialized applications, enabling a continuously increasing rate of application mix accretion. Now, by way of reporting corporate portfolio developments in the last two months, we announced during 2023 Q1, our investment in Worldsensing, up-and-coming global independent leader in integrated infrastructure IoT hardware connectivity solutions. In exchange for the thread connectivity hardware, which we acquired with sensemetrics in 2021, and a financial investment in Worldsensing’s Series D capital round, we have acquired a low double-digit equity stake.
But even more importantly, our sensemetrics software within iTwin IoT, will be closely though nonexclusively integrated with Worldsensing sensors and network connectivity hardware and our freemium trial license subscription will be included in all new Worldsensing installations. For this quarter’s observations about capital allocation, I will next show how I think about measuring and optimizing that leverage within our capital structure that’s dominated by convertible securities. I think this is significant because you can look at a Bloomberg screen that shows BSY as a highly leveraged outlier as a result of not distinguishing between convertibles and straight debt. Now, I recognize that accounting rules do treat convertible securities, 100% is debt.
But for leverage assessment, I believe it’s appropriate to look more through a finance lens as with the holders of the convertibles as they’re intrinsically and intentionally a dynamic mix between debt on the one hand and equity on the other. Obviously, our bank debt which was incurred early last year to finance our highly accretive platform acquisition of Power Line Systems and which net of cash, was down to $340 million at the end of 2023 Q1, anchors are debt leverage. But how should we think about our unquestionably attractive convertible debt with coupon rates of 1/8s and 3/8s percent covenant-free, which financed our highly accretive platform acquisition of Seequent in 2020. It consists of an issue maturing in 2026, which one can view on this Bloomberg page, including here a computed delta statistic, that’s for the embedded equity option.
The delta changes constantly based on the BSY stock price, volatility, interest rates, and the remaining time to maturity. And this snapshot reflected the market on a recent day. The other issue maturing in 2027 has a different delta statistic corresponding to its different parameters. In any prevailing market condition, these delta statistics — look here, I admit to being a recovering financial engineer. As the first company, I founded 35 years ago, was in the business of software for derivatives modeling. The delta can help us to conceptually apportion each convertible issue between debt and equity. The delta is the hedge ratio, the degree to which the value of the convertible issue moves in relation to the value of the underlying shares as the stock price changes.
The delta would range from zero at the maturity date if the stock price would be lower than the strike price such that the security then behaves as if all debt, to 1, if at maturity, the stock price would be higher than the strike price such that conversion to equity would be certain. Accordingly, at the delta of 0.43 for the first issue, we can ascribe 43% of its face value to be acting as if approximately 4.5 million shares of equity and the remainder to be acting approximately as is $400 million of debt. And at its delta of 0.39 doing the same for the 2027 issue results as if $350 million of debt. Now, we reckon our leverage ratio on the basis of our adjusted EBITDA as that’s what our bank syndicate does for pricing and covenants, and for the last 12 months through 2023 Q1, our adjusted EBITDA was $383 million, which implies a net bank debt leverage ratio of 0.9 times.
And for the delta adjusted debt portion of both convertible issues, additional leverage of 1.9 times. For a total current effective debt leverage ratio of 2.8 times adjusted EBITDA, tolerably approaching the range, which I think we would consider optimal. Now, I welcome feedback on this apparently novel delta-adjusted approach to monitoring leverage that includes convergence. But now over to Nicholas for his informed operational perspectives on 2023 Q1. Nicholas?
Nicholas Cumins: Thank you, Greg. We had a strong start to 2023 and we see momentum continuing into Q2 with healthy pipelines and many upgrade and expansion opportunities. The demand environment continues to be very positive and the pace of business is at risk. Incrementally, we see more evidence of funds from infrastructure investment programs flowing through to our accounts around the world, and this will continue to be a tailwind for the foreseeable future. Let me now provide some color commentary starting with infrastructure sectors. The trends in Q1 were consistent quarter-over-quarter. We saw very strong growth in resources, strong growth in public works and utilities, solid growth in the industrial sector, with commercial facilities somewhat flat.
We continue to hear from some accounts, concerns about interest rates and inflation. But in Q1, there were no surprises. Horizontal infrastructure remains very resilient. Turning to commercial models. Our E365 and Virtuosity growth initiatives continued their upward inflection. In Q1, we upgraded to E365 almost twice the number of accounts than we did in Q1 of 2022. Bear in mind, however, that the accounts remaining to be upgraded tend to be those with low ARR to start with. Over the last three years, we have grown E365 primarily with global enterprise accounts, and we increasingly view the regional mid-market as a significant opportunity for E365. We were excited to upgrade to E365 a number of regional mid-market accounts in Q1, and we are on pace to hit our target for the year.
As you know, E365 is a consumption-based commercial model and post-upgrade, our user success teams paid particular attention to the adoption of our software through success blueprints that are designed to achieve business outcomes through more efficient and effective use of digital delivery workflows. Q1 was a very strong quarter in terms of consumption growth by E365 accounts. In SMB, the tone of business was very positive, and we saw a continuation of our growth trajectory across the board. In fact, Virtuosity achieved its highest number of new logos in a single quarter. We see our SMB pipelines growing day in day out, and the good news is that a lot of Virtuosity business is closing within 30 days. Next, looking across regions. India was a bright spot.
The National Infrastructure Pipeline is funding large transportation and water projects. These projects are ecosystems of their own, and we have been very effective in driving adoption of our software by owner-operators and their value chain of project delivery firms, large and small. Global project delivery firms also continue to tap into India’s engineering talent to support projects around the world, and to help close their capacity gap. We also saw continued solid growth in Europe, with more evidence of EU funding flowing through, for example, in transportation and water projects in Italy. Growth was solid in the Americas too, with abundant project backlogs across multiple business lines, including projects from owner-operators extending to project delivery firms, primarily for design.
And we saw more IIJA funding flowing through to DoTs, which is very positive news for us. As we have mentioned on previous calls, infrastructure engineering in North America is characterized by a very tight labor market with an aging workforce, and project delivery firms simply cannot attract talent fast enough. Interest rates and inflation are also making infrastructure projects more expensive and, as a result, owners are very focused on managing costs. Both of these factors, productivity and efficiency, align very well with our value propositions. Middle East and North Africa showed some softness, but this was due to very specific account situations and one-time effects, and we do not believe these constitute a trend. In China, the impact of COVID is now in the rear-view mirror, and the Chinese government is very focused on bringing the economy back.
We had a better start to the year, as revenue retention stabilized in the quarter, although we continue to be cautious for the remainder of the year due to the geopolitical and business environment. Last week, we officially formed East Wise, our joint venture with POWERCHINA HDEC. The focus is on engineering applications for the hydropower and water conservancy industries that leverage our platform but are developed and distributed domestically. As with our other joint venture TGGX and their product iLink, our net revenue proportion will decline for the accounts that transition to the new localized offerings. However, we expect that the depth of the market for autonomous Chinese solutions will eventually more than make up for this. In the meantime, especially because the joint ventures will cater to the preference of Chinese state-owned enterprises for perpetual licenses, the faster the JVs take off, the greater the erosion of our existing ARR in China.
With respect to products, the performance of OpenRoads, OpenBridge, MicroStation, and AssetWise was notable in Q1. Of particular interest, in transportation in North America, we saw strong growth in Bentley Open applications, especially OpenRoads and OpenBridge, as well as MicroStation, a reflection of our strength in the DoT ecosystems. DoTs are resource constrained, but the usage of our software accelerated with the engineering services firms that are part of their ecosystem. This was a result of the training and over-the-shoulder mentoring our User Success teams have been giving to engineering services firms to put them in a better position to deliver in the DoT market. The instances of DoTs requiring models in deliverables showed extensive growth in Q1, and we do not see that slowing down in Q2.
DoTs are looking to do more with less through going digital. Digital delivery tools and techniques can streamline processes across the infrastructure engineering lifecycle and enable seamless collaboration across DoT ecosystems. Digital delivery advances design intent to construction using digital twins for collaboration among project stakeholders. Digital twins created and updated throughout the digital delivery process can then be leveraged in asset operations and maintenance to take advantage of engineering data. In this context, we announced in Q1 a new collaboration with design and consulting firm WSB, aimed at leading civil infrastructure owners and contractors to adopt digital delivery and model-based digital workflows. WSB launched a new digital construction management solution and advisory service, based on Bentley’s SYNCHRO, leveraging the power of construction digital twins.
WSB joined the Bentley Digital Integrator Program, which provides programmatic go-to-market support and knowledge transfer to eligible project delivery firms that are creating and curating digital twins for their clients’ infrastructure assets. Before I hand over, I want to thank all Bentley colleagues for a great start to the year, and for your commitment to consistent execution. More infrastructure is in the works now than at any previous time in history and the infrastructure sector is relying on Bentley software to help it deliver a more sustainable and resilient future. And with those operational perspectives, I will now hand the call to Werner to go over our financials in more detail.
Werner Andre: Thank you, Nicholas. We are pleased that we started the year strong, which puts us in a good position to achieve our established full year outlook. I’m starting with a reminder of our full year 2023 revenue outlook as was provided during our year end 2022 operating results call with a range of $1,205 million to $1,235 million, representing GAAP revenue growth of 9.5% to 12.5% or 10.5% to 13.5% on a constant currency basis. Total revenues for the first quarter were $314 million, up 14% year-over-year while 17% on a constant currency basis. For the quarter, subscription revenues grew 15% year-over-year or 18% in constant currency and represented 88% of our total revenues. The onboarding of Power Line Systems at the end of January 2022 accounts for about two percentage points of this improvement, and the continued upgrades of our enterprise accounts to our consumption-based E365 program is moving us towards a more ratable allocation of GAAP revenues between calendar quarters, which benefited the first quarter on a year-over-year comparative basis.
Regarding our perpetual licenses, recent trends continue, which are reflective of our focus on recurring subscription revenues. Our professional services revenues benefited from the acquisition of Vetasi, which we acquired within our Cohesive Digital Integrator Group in 2022 Q4. With regards to foreign exchange rates, the U.S. dollar has weakened relative to the exchange rates assumed in our 2023 annual financial outlook. While the impact during 2023 Q1 was not significant, if end of April exchange rates would prevail for the remainder of the year, our full year GAAP revenues would be positively impacted by approximately $10 million relative to the revenues based on the exchange rates assumed in our full year 2023 outlook. Moving on to our recurring revenue performance.
Our last 12 months recurring revenues increased by 14% year-over-year while by 20% on a constant currency basis. On a constant currency basis, the onboarding of our platform acquisition, Seequent and Power Line Systems contributed about six percentage points to this improvement. Our constant currency account retention rate was at 98%, and our constant currency recurring revenues net retention rate remained at 110%, led by continued accretion within our E365 consumption-based commercial model. We ended Q1 with annualized recurring revenues of $1,071 million at quarter end spot rates. Our constant currency ARR growth rate was 13% year-over-year and 3.1% on a sequential quarterly basis. You can see in the dotted line, the ARR growth, which is attributable to the initial onboarding of our platform acquisitions.
As the PLS acquisition occurred at the end of January 2022, its ARR onboarding is no longer a factor in the year-over-year comparison. Our strong and sustained Q1 revenue and ARR growth performance was supported by consistently strong market growth trends, led by our resources and public works utilities infrastructure sectors, our balanced business performance across regions other than China and our E365 and Virtuosity growth initiatives. With regards to China, our first quarter was slightly better than in recent years, but we are still taking a cautious stance for 2023 due to the continued geopolitical uncertainties. And as Nicholas mentioned, our intentional pivot to license sales within that market, which will be a headwind to ARR growth as our joint ventures gained traction.
Our GAAP operating income was $66 million for the first quarter, up $9 million or 16% over 2022 Q1. We have previously explained the impact on our GAAP operating results from amortization of purchased intangibles, deferred compensation plan liability revaluations, and acquisition expenses. Moving on to adjusted operating income, inclusive of stock-based compensation expense, which as discussed in our 2022 Q4 earnings call is now our primary profitability and margin performance measure. While adjusted operating income with stock-based compensation normalizes for the GAAP charges I just mentioned, this measure intentionally includes stock-based compensation expense which we believe appropriately captures the economic cost to our business. Adjusted operating income with stock-based compensation expense was $90 million for the first quarter, up $12 million or 15% over 2022 Q1 with a margin of 28.8%, up 40 basis points year-over-year.
In 2023 and prospectively, we will now measure our long-term annual margin improvement commitment of 100 basis points expressed in terms of adjusted operating income with stock-based compensation with our margin target for 2023 of approximately 26%. In that regard, our Q1 margin of 28.8% was fully in line with our expectations for the first quarter, which is typically a higher margin quarter for us due to OpEx seasonality. And I do want to remind you of our seasonal pattern of expenses. We concentrate our annual raises for colleagues to occur as of April 1st of each year. And since approximately 80% of our cost structure is headcount and related to support cost, annual raises have a significant impact on our operating expenses in Q2, Q3, and Q4 relative to Q1.
This is further compounded by our larger promotional and event related costs, which are historically highest in the second half of the year. We expected our annual stock-based compensation expense will be decreasing as a percentage of revenues to a range of 6% from approximately 7% in 2022. There will continue to be some stock-based compensation expense volatility between quarters, corresponding to the timing of our ongoing annual round of broad-based equity grants, which are predominantly granted in the first and fourth calendar quarters. With respect to liquidity, our Q1 operating cash flow of $176 million increased by 73% year-over-year. As discussed during our 2022 Q4 operating results call that our 2022 Q4 cash flows from operations were atypically low due to a shift in timing of Q4 billings and therefore collections of certain E365 renewals and newly converted E365 contracts, all representing healthy new business.
These 2022 Q4 timing shortfalls were fully offset in early 2023, resulting in 2023 Q1 being a strong cash flow quarter. As previously discussed, our business model produces reliable and efficient cash flows over a trailing 12-month period, but with some variability between quarters due to timing. For 2023, and prospectively, we estimate that our conversion rate of adjusted EBITDA to cash flow from operations will be approximately 80% over a trailing 12-month period. Along with providing sufficiently for our growth initiatives and our 2023 increase to a modest dividend, in 2023 Q1, we spent about $21 million on de facto share repurchases associated mainly with deferred compensation plan distributions to offset dilution from stock-based compensation.
As of the end of Q1, our net senior debt leverage was 0.9 times and when including our 2026 and 2027 convertible notes as debt, our net debt leverage was 4.2 times. This is down from the end of 2022 which was 1.3 times and 4.7 times, respectively. As a reminder, now approximately 85% of our debt is protected from rising interest rates through either very low fixed coupon interest of our convertible notes or our $200 million interest rate swap expiring in 2030. With regards to our 2023 financial outlook, we started the year with strong operational execution and momentum in our end markets. This allows us to express great confidence in our 2023 outlook, which we believe is appropriately balanced between our business momentum and the cautious approach towards China and our commercial and facility sector due to geopolitical and macro uncertainties.
And with that, I think we are ready for Q&A. Over to Eric to moderate. Thank you.
A – Eric Boyer: We’ll now move to the Q&A portion of our call. We ask each analyst to please limit themselves to one question only so we can get to everybody today. Our first question will come from Kristen Owen from Oppenheimer.
Eric Boyer: Thanks Michael. That concludes our call today. We thank each of you for your interest and time in Bentley Systems and look forward to updating you on our progress in coming quarters.
Greg Bentley: Cheers.
