Earnings Call Transcript - BSY Q4 2022

Eric Boyer, Investor Relations Officer

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, CEO

Thank you, Eric, and I hope all of you have had a chance or soon will 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 a strong operational and financial outlook for 2023. Today, we will also hear 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. 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 respect 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 is 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 uptick 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 milestone of over 40,000 unique accounts globally, and new logos added almost 3 percentage points of ARR growth. 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. Even in China, SMB new business grew year-over-year in 2022 Q4. In fact, new business overall was healthy in Hong Kong and Taiwan. 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 our second Chinese joint venture 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 will work to increasingly shift the mix towards all indigenously developed Chinese products built on our platform, paying us royalties rather than net product revenues—eventually leading to hoped-for investment returns as well. Moreover, the JV will cater to the preferences of this Chinese enterprise market—those preferences for perpetual licenses rather than subscriptions and instead of 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. Major portions of our ARR in China will tend to regress from gross to net, 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 cannot occur again, the possibility of China somewhat following suit could be a significant 2023 factor. For both years, let me emphasize that Russia and China are 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, COO

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. 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 the operating council. Of course, I would 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 the 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 can point to mega projects in transportation, especially in rail. At the Year in Infrastructure and Going Digital Awards 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? These practitioners and organizations, who may be using MicroStation for the first time, represent an installed base that we can in future upsell to higher value, more powerful engineering applications—what Greg calls application mix accretion. Beyond that, we can 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 rate 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 quiet quitting. This is due in no small part, we believe, to our intentional approach to work flexibility and colleague 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, allowing our colleagues across the world to contribute to Bentley Systems' success in a meaningful way. With those operational perspectives, back to you, Greg, for corporate governance.

Greg Bentley, CEO

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 cohort 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. This includes capturing operating depreciation and amortization, becoming 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 the 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 merits 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 retirement wave, which I described, our equity incentives have enabled us to prioritize intentionally rebuilding appreciable equity holdings by our next generation of leaders. Subject to cash versus stock elections by 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. 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. 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. Moving to our 2023 outlook, our outlook reflects our continued margin improvement commitment of approximately 100 basis points and our continued focus to maximize our long-term ARR growth.

Keith Bentley, CTO

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 as they say, time waits for no man. 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 full of potential than it did when we began with the advent of the personal computer nearly 40 years ago. I will also remain a director and investor in Bentley Systems. I hope to leave anyone who might 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. I trust him deeply and have 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. As you may know, in the infrastructure software market, we find ourselves at a real inflection point around infrastructure digital twins, a concept that Bentley nearly single-handedly invented. In my biased but informed humble opinion, there's currently nothing remotely competitive to our iTwin technology stack. Our priority is 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, which has increased from 20% in 2020 to more than 40% last year. That's because infrastructure digital twins empower engineering firms and operators to accomplish extraordinary things and make game-changing improvements to their workflows and business processes, even transforming their business models. 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 how they describe it in their own words. We want the benefits of using this technology to be experienced by all infrastructure projects and by all infrastructure professionals, no matter the size of their project, the size of their organization, or whatever phase of the infrastructure lifecycle 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? Infrastructure digital twins certainly make information more accessible and can become the building blocks for a very valuable industrial and professional metaverse. They make possible new capabilities and processes well beyond the state of the art today and probably beyond our current ability to conceive of their ultimate value. We are more excited than ever about the prospects for infrastructure digital twins and of course, Bentley iTwin. That means that iTwin should be pervasive. It already powers the Bentley Infrastructure Cloud and enables us to mobilize data across the infrastructure value chain across every stage of the infrastructure lifecycle. Our priorities for this year are to bring the power of cloud-native iTwin to our engineering, modeling, and simulation applications 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, we 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. I have to say it's one of my most enjoyable projects. 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 who have made it so rewarding. We began long ago in an era called Computer Aided Design, but I now describe our scope as software-aided infrastructure. I think the possibilities are near endless. Our world needs to improve the efficiency, longevity, and resilience of our global infrastructure as a matter of urgent priority, but that can only happen with innovative new technology and new processes for all phases of its lifecycle. It’s not a matter of if, but how. 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 Hollister, CIO

Thank you, Keith, for your vision, your leadership, and your kind words. 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. As you know, we formed iTwin Ventures to stimulate entrepreneurship in developing digital twin applications, including those leveraging our iTwin platform capabilities. In addition to our traditional venture portfolio investments, I will 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. Joint marketing and co-selling motions between Bentley and the cohort participants are already underway. It's our expectation that many of these iTwin Activate program participants will 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 a city scale. We also see the potential for Flow Labs' real-time datasets 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 great success in offering analysis and simulation applications, specifically for the 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. This is particularly relevant in the context of industrial mining and commercial building sectors. 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. 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 will find appealing and will 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 a presence in utilities, mining, oil and gas, and transportation. Vetasi also brings a highly skilled team of nearly 200 digital integrator consultants, including a cost-efficient base in Poland and Indonesia. We expect to realize G&A synergies, sales motion synergies, project delivery utilization synergies, and cross-sell opportunities as Vetasi integrates with Cohesive. While both the EasyPower and Vetasi acquisitions are of our programmatic scale and not material to warrant disclosure of their specific financial information, I consider we acquired each at what I believe to be very efficient valuations. They align perfectly with our historically successful programmatic acquisition strategy we've previously articulated. As I sign off, I would like to share that I am both humbled by the quality, character, and talent of my colleagues over the years, and I'm so very proud of what we've accomplished together. I will leave the body of work to speak for itself. While I personally may be moving away from driving value each day, I'm lifted by the even greater potential that I see for Bentley Systems, and I'm comforted that the depth of talent and quality of culture will continue to enable that potential. Like Keith, but maybe with a zero removed, I too will be a Bentley Systems shareholder for a very long time. You can bet that I'll be frequently checking in with one person or another when I see things that need fixing or opportunities to be exploited. Speaking of character and talent, I'd now like to hand over to our CFO, Werner Andre.

Werner Andre, CFO

Thank you, David. And thank you for your leadership, the profound impact you have had on Bentley and the mentoring and guidance you have given me over the years. We are pleased that we finished the year strong, and we feel good about our outlook for 2023. I'll start with our Q4 revenue performance. Total revenues were $287 million, up 7% year-over-year or 13% on a constant currency basis. On a constant currency basis, Americas grew 9%, EMEA, 16% and APAC 17%. For the quarter, subscription revenues grew 13% year-over-year or 18% in constant currency and represented 88% of our total revenues. The growth is supported by our balanced business performance across sectors and regions other than China, our E365 and SMB growth initiatives, and our platform acquisition of Power Line Systems in January 2022. Regarding our perpetual licenses and services revenues, recent trends continue, reflecting our focus on recurring subscription revenues. Now moving on to full year revenue, which were $1.1 billion, up 14% year-over-year or 20% in constant currency, which is at the high end of our constant currency outlook range. On a constant currency basis, Americas grew 22%, EMEA 15%, and APAC 21%. China was a nine-percentage-point headwind to APAC's constant currency revenue growth. Subscription revenues grew 18% or 24% in constant currency, which included 12 percentage points from our Seequent and Power Line Systems acquisition and 12 percentage points from our business performance. I'm covering next our recurring revenue performance. Our constant currency account retention rate was at 98%, and our constant currency recurring revenue net retention rate remained at 110%, led by continued accretion within our E365 consumption-based commercial model. We ended 2022 with ARR of $1.037 billion at year-end spot rates, for the first time above $1 billion, and our constant currency ARR growth rate was 15%. Power Line Systems onboarded 2.5% of this growth, and our business performance accounts for the remaining 12.5%, which is the midpoint of our financial outlook range. The strong and sustained momentum of our business performance is driven by our E365 and SMB growth initiatives and the continued growth velocity of our platform acquisitions of Seequent and Power Line Systems, compensating for lost ARR in Russia and headwinds in China. Our last 12 months recurring revenues at actual currencies increased by 17% year-over-year. Our GAAP operating income was $41 million for Q4, down $3 million and $209 million for the full year, up $114 million year-over-year. We have previously explained the impact on our GAAP operating results from acquisition costs, incremental amortization from purchased intangibles, increases in stock-based compensation, and the one-time accounting charge for deferred compensation of approximately $91 million in 2021. Moving on to adjusted EBITDA, our fourth quarter grew by approximately 5% over 2021 Q4 and our full year adjusted EBITDA of $366 million is an improvement of approximately 13%, with an adjusted EBITDA margin of 33.3%. We delivered on our 2022 adjusted EBITDA margin commitment of about 100 basis points margin improvement over our normalized adjusted EBITDA margin of 32.3% in 2021. In 2022, travel and events are now in line with what we believe to be a normalized post-pandemic run rate. In 2023, we will measure our operating margin performance and improvements the same way for our annual outlook as we will do for purposes of executive incentives, based on adjusted operating income, inclusive of stock-based compensation. This measure captures the true economic cost of shareholder dilution from stock-based compensation. It also includes operating depreciation and amortization, which will increase as our CapEx includes digital experience IT investments of approximately $10 million in 2023 and a comparable amount in 2024. With respect to liquidity, our Q4 operating cash flow of $36 million decreased 55%, and our full year operating cash flow of $274 million decreased by 5% year-over-year. We've previously discussed that our business model produces reliable and efficient cash flows over a trailing 12-month period, with some variability between quarters. We have no significant upfront multiyear collections, which limits variability on a trailing 12-month basis. Our continued expansion of our E365 program, where we collect the deposit for the estimated annual consumption at the onset of the annual contract period generates strong cash flows. However, our 2022 Q4 and full year cash flows were impacted by a shift in billing and therefore collections of certain E365 renewals and newly converted E365 contracts, all representing healthy new business. As of the end of December, our net debt senior leverage was 1.3 times, and when including our 2026 and 2027 convertible notes as debt, our net debt leverage was 4.7 times. Approximately 80% of the debt is protected from rising interest rates through either very low fixed coupon interest on our convertible notes or our $200 million interest rate swap expiring in 2030. Moving to our 2023 outlook, our outlook reflects our continued margin improvement commitment of approximately 100 basis points and our continued focus to maximize long-term ARR growth. While we continue to see unprecedented market demand for infrastructure engineering going digital, our outlook does factor in a cautious approach towards China due to continued uncertainties. Accordingly, we expect total revenue on an as-reported basis in the range of $1.205 billion to $1.235 billion, representing growth of 9.5% to 12.5%, or between 10.5% and 13.5% on a constant currency basis. We are projecting constant currency ARR growth between 11.5% and 13.5%. We expect an adjusted operating income with stock-based compensation margin of approximately 26%, reflective of our 100 basis point annual margin improvement commitment. Any FX impact on our margins is significantly mitigated by our fairly effective natural hedge. We expect our effective tax rate to be approximately 20%. As I mentioned before, we expect cash flows from operations to convert from our adjusted EBITDA at the rate of approximately 80%, and we expect capital expenditures of approximately $30 million, which includes approximately $10 million of incremental IT investments into our ERP system. To help you with your models, I also include here on the slide additional expectations on interest expense and cash interest cash taxes, stock-based compensation, operating depreciation and amortization, outstanding shares, and dividends. And with that, I think we are ready for Q&A. Over to Eric to moderate. Thank you.

Eric Boyer, Investor Relations Officer

Great. We'll now move to the Q&A portion of our presentation. We ask that each analyst limit themselves to one question and one follow-up. First, we'll go to Joe Vruwink from Baird.

Joe Vruwink, Analyst

Hi. Great. Can you hear me?

Eric Boyer, Investor Relations Officer

Yes. Go ahead, Joe.

Joe Vruwink, Analyst

First off, congrats to Keith and David on what have really been great careers and nothing but the best for both of you. India maybe seems like a good analogy or anecdote. This is a market that is spending a lot on infrastructure post stimulus. And you seem to be specifically seeing strength in your associated products in India around transportation. I guess my question would be, can we extend this into the U.S.? Have you started to see an acceleration in new business aligned with the sectors farthest along in the IIJA deployment? If this is so, is your expectation for the upcoming year that new business growth likely broadens out across the portfolio as the scope of IIJA broadens out across different subsectors?

Greg Bentley, CEO

Joe, I think that described it pretty well. I don't think it could be of the scope of increase of India. Remember, India was affected by the pandemic but it's come back above pre-pandemic levels. We did see an increase from the IIJA. We began to see that during the third quarter. The fourth quarter in North America was not so much a further increase, but we are expecting that during 2023, just as you said, because the IIJA spending broadens out to include other areas of expanded budgets in infrastructure at large. But I'll ask Nicholas if he'd like to add more.

Nicholas Cumins, COO

Well, maybe a few words about India. First, it is the country where we see the most direct link between additional investment in infrastructure engineering software and the infrastructure plan. So it is the most advanced, and we can point to a number of projects where our software is being used and is directly funded by the National Infrastructure Pipeline, as it is called over there. India benefits from something else, a number of global accounts moving work to India, right, to solve for the capacity issue. The way they move work over there is not just to be cost-effective; it’s really to tap into additional capacity that they don't have. They move work over there, giving them full responsibility, including product management. With respect to the U.S., we have evidence that the usage pick-up we see in transportation is indeed related to IIJA, but we also know that it will take time for the funding to flow from federal to state-level infrastructure owners contractors. This is going to be a tailwind for multiple years.

Joe Vruwink, Analyst

Okay. That's great. To spend a bit of time on the resources side of the portfolio, I think you called out Leapfrog was one of the areas of strength. At one point, the E365 customers that were energy-exposed, EPC customers, that was a pretty big dilutive factor on net retention and ARR growth. In 2023, do you expect that pent-up CapEx comes back online, so you're able to regain a lot of that loss, if I can call it that ARR? What would be your more specific outlook on resources and the Seequent side of the business?

Greg Bentley, CEO

Yes, let me start with the EPCs, the big global firms who primarily do engineer, procure, construct for industrial CapEx. Of course, their business went down during the pandemic, and they have worked at diversifying into renewables and energy transition, which was a great choice for them to focus on. I don't think their growth rate is distinguishable from the leading tone of business in industrial and resources generally now. I'm not sure whether they are back to where they were during the pandemic, but we have stopped separating them because they look occupied at the moment, although their companies did shrink. As for mining and resources, Nicholas, could you comment on the pace of growth in mining and resources?

Nicholas Cumins, COO

Yes, mining is still in a super cycle. The early-stage drilling, which we see as an early indicator, is up and at its highest level since 2014. There is a lot of activity going on. I think there's a clear realization that a lot of mining is needed to support the world electrification. We see activities with large mining companies who are acquiring smaller mining companies. In fact, the first half of 2022 saw 50% more M&A activity than in the previous year. There is a lot of investment going into mining, and Seequent is well positioned to benefit from that.

Greg Bentley, CEO

Sorry, back to you, Nicholas.

Nicholas Cumins, COO

I just want to say that when it comes to EPCs, contractors, and industrial, those were actually among the two growth drivers we've seen in both Europe and India in Q4. So we've definitely seen strength there. Now Seequent will be used more for geothermal or even for offshore wind platforms, rather than oil and gas traditionally.

Joe Vruwink, Analyst

Thanks, guys.

Nicholas Cumins, COO

Thank you.

Eric Boyer, Investor Relations Officer

Next, we'll move to Matt Hedberg from RBC.

Matt Hedberg, Analyst

Great. Thanks for taking my questions, guys. Nicholas, the European strength really stood out to me. Can you double-click on maybe where you saw that strength? And how sustainable you think that is into 2023?

Nicholas Cumins, COO

Yes. I mentioned already in the prepared remarks that we saw growth drivers in public works and contractors in industrial sectors, so EPCs. We also see a net acceleration of conversions to the E365 program. But there's something else that I didn't mention in the prepared remarks, which is a very large infrastructure investment planned. The first one impacting us is the next-generation EU plan. Almost 20% of the funding for that plan is already being distributed across different countries. We can point to a number of projects funded by that plan where our software is being used, like multiple high-speed rail products in Italy.

Matt Hedberg, Analyst

Got it. And then Werner, for you on the guidance: is there any way to think about quantifying the inorganic contribution to ARR growth as well as maybe what you've included for China? I know you said things could deteriorate further, but just trying to get a sense of how derisked your guide is for China?

Greg Bentley, CEO

I jump in on China in particular. We began 2022 with China at about 5% of our ARR. This year, we start the year—it's under 4%. We had some net attrition, but everything else grew. The currency didn't do well during 2022, turning out to be a bigger headwind for us than the loss of Russia, and that's the reason to be apprehensive. If China were growing at a relatively favorable growth rate compared to the company as a whole prior to the pandemic, our outlook for 2023 would be at least 1% higher in ARR growth than it is.

Werner Andre, CFO

Regarding programmatic acquisitions, we include them in our business performance because it’s not worth breaking them out. They contribute an average of 1% to 1.5% to annual recurring revenue and top-line revenue as well. Although recently on ARR, it was a little bit higher, but approximately between 1% and 1.5%.

Matt Hedberg, Analyst

Great.

Greg Bentley, CEO

It was lower in 2022 because there were a few acquisitions, but we are resolved to get back to our pace of programmatic acquisitions over time. There's no particular reason it was lower in 2022. It was a matter of certain things.

Matt Hedberg, Analyst

Thanks, guys. Congrats on the results.

Eric Boyer, Investor Relations Officer

Next, we'll move to Kristen Owen from Oppenheimer.

Kristen Owen, Analyst

Great. Good morning. Thank you for taking the question. I wanted to follow up on some commentary around the EasyPower acquisition. We talked about the overlay of your portfolio with electrification and energy transition, but could you speak specifically to the grid digital twin ecosystem? Who becomes the steward of those digital assets? Are there areas of the portfolio that you feel are maybe missing similar to this EasyPower acquisition, maybe in load management or something like that? And then I have a follow-up?

Greg Bentley, CEO

Thank you, Kristen. We think there's a great opportunity in what we call the integrated grid, which puts together from a physical grid standpoint, the communications infrastructure—increasingly 5G—as well as towers and shared use with electrical transmission and distribution. EasyPower comes in on the modeling and analysis side. But regarding the grid, there's a portion, if you like, that belongs to the utility, and then we say behind the meter is the portion that belongs to the major power user. EasyPower has mainly focused to date on behind the meter. What goes on behind the meter is increasingly a mix of what we call distributed energy resources. Facilities starting to have solar, wind, and battery storage. For every industrial, commercial, or mining facility, engineering is never done. It constantly needs to be modeled and updated through a digital twin. EasyPower is highly approachable and accessible to make part of a digital twin. It’s an excellent acquisition for us.

Kristen Owen, Analyst

There we go. Apologies for that. My follow-up question is really a follow-up to the prior, which is you have EasyPower now that you've integrated this year. Should we think about you returning to the historical point of 1.5 points of programmatic acquisitions contributing to ARR growth this year? If you could speak to the valuation backdrop in your M&A pipeline, that would be helpful?

Greg Bentley, CEO

It went significantly below 1% during 2022, so I think it would be ambitious to get above 1%. We're disciplined about valuation, of course, but we'd be glad to get back to 1% if you ask me.

Kristen Owen, Analyst

Thank you so much.

Eric Boyer, Investor Relations Officer

Next question comes from Andrew DeGasperi from Berenberg.

Andrew DeGasperi, Analyst

Taking my questions; first, congratulations to Keith and David as well as Julien on the promotion. Maybe, Greg, could you elaborate a little bit on the digital twin impact getting embedded in terms of the software more broadly? Is there a timeline that you have in mind on whether that could happen? I have a follow-up; thanks.

Greg Bentley, CEO

We announced in November a Year in Infrastructure 2022, Bentley Infrastructure Cloud, which brings the iTwin Platform and the iTwin Schema to project-wise, Seequent, and Asset Life. That leaves two-thirds of our portfolio as the modeling and simulation applications focusing on the integration. Keith spoke to delivering the promise to integrate the iTwin Platform. Our users will create high models at the same time as their traditional deliverables. These capabilities are pipeline-related, and I think it’s a wonderful plan. By the end of the year, our modeling and simulation software will include iModel generation for all our users as they adopt their 2023 edition of our applications.

Andrew DeGasperi, Analyst

Thanks, Greg. That's helpful. Werner, on margin expansion, I wanted to touch base on that. If you could break out more in terms of what are the components that will get you to the 100 basis points? How much of it is core relative to stock-based compensation leverage? If Q4 looks like the core margin has slightly gone down, is that reversed in 2023? If you could elaborate a little more. Thanks.

Werner Andre, CFO

Coming to Q4, our year-to-date level on the margin base was high, and the goal was to come in at approximately 33% adjusted EBITDA margin at the end of the year. We knew that we would invest in the business and try to spend in areas that benefit the following year. Coming into Q4, we were balanced with that measure and the incremental investments into next year. In 2023, we scale as the orders deplete revenue as indicated, and we reduce our costs a little bit relative to the revenue growth and manage this through the alignment model.

Greg Bentley, CEO

I’m always confident we’ll meet our operating margin goal because our operating incentives—our operating management has this as a condition for their incentives. Their incentives depend on our ARR growth rate, but we condition on improving operating margins modestly every year.

Nicholas Cumins, COO

Yes. I confirm that we are committed to keeping improving our margin.

Andrew DeGasperi, Analyst

Thank you.

Eric Boyer, Investor Relations Officer

Great. The next question comes from Matthew Broome from Mizuho.

Matthew Broome, Analyst

Hi. Thanks for taking my question. I'll just add my congratulations to Keith and David and best wishes to both of you. How did demand trend during the quarter in terms of linearity? Given that we're now two months into the first quarter, is there anything you can say about how usage has been tracking year-to-date?

Greg Bentley, CEO

I may start on linearity. We had reduced collections during the quarter, which we didn't plan for. Our negotiations were taking us nearly to the end of the quarter because we were negotiating considerable increases in consumption and new deposit levels. The fourth quarter is not a quarter where we have learned to expect volume in E365 to grow much compared to sequential quarters due to holidays. It's more of the new business this year was of the nature I just described.

Nicholas Cumins, COO

I will add that the general trend is we are improving linearity. We have many of these E365 conversions that happened late in the quarter. As we convert accounts to E365, the consumption growth will contribute to better linearity. So the overall trend is improving.

Greg Bentley, CEO

Enterprise negotiations tend to drag to the end, while the SMB and Virtuosity sales are more reliant on steady flows.

Matthew Broome, Analyst

Okay. Thanks. How are you approaching hiring in the year ahead? To what extent are you still having success finding qualified civil engineers to build out your E365 program?

Greg Bentley, CEO

In terms of hiring, we see more applicants to our job openings than we've seen before, but we haven't seen an acceleration of the hiring process. We hope it will ease out during the year. We're hiring to sustain our growth.

Nicholas Cumins, COO

Yes, we’re definitely hiring. The key message is we must sustain our growth.

Greg Bentley, CEO

Most of the engineers we're hiring are software engineers, which is important for our success team.

Matthew Broome, Analyst

That makes sense. Sorry, I'll just squeeze in one last one. One of your competitors has been talking about seeing a lot of demand in smart water infrastructure. Just curious what you're seeing in that market, both in terms of fundamentals and competition?

Greg Bentley, CEO

Nicholas?

Nicholas Cumins, COO

OpenFlows, which is our brand for our applications for the water infrastructure, was a highlight in Q4. We saw notable growth globally. We signed our largest deal in India in the last 10 years, directly related to the major infrastructure plan in India, which includes provisions for upgrading the water infrastructure. More infrastructure owners in water infrastructure are looking into creating digital twins of their assets as a way to get efficiency and effectiveness in their processes.

Eric Boyer, Investor Relations Officer

Next question from Kash Rangan from Goldman Sachs.

Unidentified Analyst, Analyst

This is Matt on for Kash. Nice for taking my question. Greg, Bentley's performance down market has been very solid with Virtuosity, another quarter of 600 new logos. You made a comment in the last quarter about being surprised at the number of logos to go after in any given quarter. Could you characterize the opportunity for SMB heading into 2023? Any change to the competitive landscape?

Greg Bentley, CEO

I will ask Nicholas because we just had the sales group together. The Virtuosity leadership team plans for exponential growth in 2023. They don't see diminishing returns in competitive opportunities. Our investments in digital experience investment are self-service and automated renewals so that the same team can get more done.

Nicholas Cumins, COO

Virtuosity is going to be a big growth priority for 2023 and beyond. We see an important market to convert accounts to Bentley Software, from fundamental software like MicroStation to more sophisticated solutions like OpenFlows. There is also a sizable growth opportunity in the enterprise space with infrastructure owners and operators.

Eric Boyer, Investor Relations Officer

All right. The last question today will be from Jason Celino from KeyBanc.

Jason Celino, Analyst

Great. Sorry, there we go. Thanks for fitting me in. On the ARR guidance, a lot of moving parts, but for everyone's benefit, just to clarify that PLS is not included in the 11.5% to 13% guide. Is that correct?

Greg Bentley, CEO

No, PLS is included. What was never included for PLS was what we onboarded. Once onboard an acquisition, we move everything onto our paper, and after that, it’s impossible to parse it out.

Werner Andre, CFO

From Q1 to Q4 in 2022, sequentially on a constant currency basis, ARR grew 2% in Q1; 3.1% in Q2; 3.3% in Q3; and 3.3% in Q4. This reflects our business performance and does not include the onboarding of Power Line Systems.

Jason Celino, Analyst

Okay. Perfect. We can take that offline. Lastly, I'll ask about EBITDA one last time. Would this have also translated into 100 basis points of EBITDA margin expansion, or more than 100 basis points given the decrease in SBC?

Greg Bentley, CEO

For 2023, we estimate SBC around 6% plus or minus. It can jump around based on elections by executives of cash or stock in their compensation. That’s not visible how EBITDA might vary, so we predict adjustments will converge around adjusted operating income.

Jason Celino, Analyst

Perfect. I think that's it. Thanks, guys.

Eric Boyer, Investor Relations Officer

Great. Before concluding, we just wanted to announce that Bentley Systems will be ringing the opening bell at the NASDAQ on March 28. With that, we have now concluded today's presentation. Thank you for your interest and time in Bentley Systems.