Earnings Call Transcript - BSY Q2 2023

Sandra-Ann Morency, Investor Communications Manager

Good morning and thank you for joining Bentley Systems' Q2 2023 Operating Results. I'm Sandra-Ann Morency, Bentley's Investor Communications Manager. 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 August 08, 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, which I'll moderate in Eric's absence. And with that, let me introduce the CEO of Bentley Systems, Greg Bentley.

Greg Bentley, CEO

Good morning, and as always, thanks to each of you for your interest. I will start today by sharing my observations of some notable directions within our strong '23 Q2 operating results and then as usual, I will briefly remark upon some corporate developments. In preview, our growth in the quarter was more broad and balanced, which I consider to be better, ranging from E365 accretion across our largest enterprise accounts, through broadening and compounding penetration within our large SMB opportunities. Among infrastructure sectors, resources, by way of mining, has slowed down and lost its lead for now to strongly growing public works/utilities. Despite the countervailing dip in global CapEx for new mines, our platform acquisition is growing considerably faster than Bentley Systems otherwise, following only our other platform acquisition, Power Line Systems. And as to our key metric year-over-year ARR growth, this all nets out, while broader and better, to a narrower full year 2023 range, considering that in China, which is where all relative security is concentrated, virtually any second-half new business outcome will continue to erode our ARR there. In '23 Q2, we were busier than ever before, beating or surpassing our own expectations on all corporate outlook metrics. Of course, we all primarily focus on constant currency business performance ARR growth year-over-year, which we sustain within the robust level of 13%, our high watermark. However, going behind this headline, I consider that our ARR growth has directionally improved. One aspect in the math is that programmatic acquisitions happen now to be contributing only minimally. But while acknowledging this year's favorable end market conditions, I think that strong rational execution by Nicholas' teams is ever broader and better. Although such balance and consistency increasingly characterize virtually every aspect of our business, an example is the breadth of new business momentum ranging from our largest to smallest accounts. Recall that we use this term new business to factor in license sales as well as ARR growth, though for quotas and achievement, we multiply recurring revenue by an appropriately higher weighting factor. By virtue of our main growth initiatives since going public in 2020, this quarter, the bulk of our new business was divided almost equally between our E365 program and our virtuosity-led growth in SMB. E365 ARR growth is a combination of one-time uplifts from accounts upgrading to the program where our consumption charges per application per day are meant to cover our costs of the enterprise success team, digital workflow experts that we dedicate to each 365 account and what is now most prevalent, accretion in these accounts consumption and application mix. Within '23 Q2, our ARR proportion from E365 increased very largely from this accretion in existing E365 accounts for home-going digital through E365 blueprint is a more urgent priority than ever. Constrained by skill shortages, these accounts need to improve the quality and throughput of their engineers' work as they face substantial and growing backlogs. In fact, this quarter's ACEC survey of all U.S. engineering firms shows that the median backlog is now a full year as demand for infrastructure engineering continues to outstrip capacity. The same survey shows that while these firms are not so sure about the macro U.S. economy 12 months from now, each firm tends to be ever more confident in their own resilience a year from now. As to a greater degree than ever, they expect their backlog then to be even greater. These firms year-ahead market outlook by infrastructure sector tends to correspond with our own '23 Q2 tone of business, led in growth sentiment now by public works/utilities then resources followed by industrial, and lastly, commercial/facilities. This quarter, ACEC also surveyed the extent of the labor shortage brought about by this unprecedented workload. Across all firms, there is one unfilled infrastructure engineering position for each 10 full-time positions. This is a motivator for our E365 accounts to prioritize blueprints for new digital workflows that entail upselling users to more specialized applications, better fit for purpose for their particular project work at any given time. This leads to greater spending per day, holding constant pricing for each product that we annually measure as application mix accretion. I can directionally confirm that our steadily expanding E365 program is continuing to broaden and accelerate our application mix accretion driving directionally better ARR growth. Our overall net revenue retention rate in turn reflects this progress in going digital within our existing accounts, led by E365 consumption and upsell even or particularly as our accounts deal with workforce constraints. I'm pleased to report that NRR was sustained for the quarter at our 110% high watermark. Getting from these 10 percentage points of NRR accretion in existing accounts to this year's 13% ARR growth is attributable to sustaining at our 3% high watermark, ARR growth from subscriptions in new logos, of course, mostly in SMB. Because the SMB share of the overall infrastructure engineering market substantially exceeds the SMB share of our own ARR, I believe that our investments and improvements in SMB are bearing fruit to make our ARR growth sustainably broader and better. In particular, our Virtuosity subscriptions for individual practitioners have grown exponentially in new and cumulative ARR, including in '23 Q2, and again, including a record number of quarterly new logos for Virtuosity, which is now approaching another digit. Now obviously, this magnitude of continued ARR compounding depends upon the renewal rates for these subscriptions. And I have previously mentioned that we would quantify this at such time as we would have statistically sufficient experience. Within smaller businesses and for individual practitioners, we cannot expect retention rates comparable to those of subscriptions used widely and diversely across an enterprise account. This is particularly the case for specialized Virtuoso subscriptions which may be entered into for a particular infrastructure project with a finite duration. So I am pleased to now be able to report that after much hard work, our Virtuosity renewal rates are at about 80%. We believe that with our digital experience automation to make self-serviced renewals even easier, we can improve this somewhat. And by the way, given that the absolute ARR numbers are still relatively small, we won't report this renewal rate regularly. But even beyond ARR, our license sales new business is generated mostly in SMB accounts. For '23 Q2, about one third of these SMB license sales are to almost 300 new logos. Recalling that we continue to offer perpetual licenses principally because our main competitor does not, I believe that a significant proportion of these SMB new logos, including the many more for Virtuosity subscriptions must be competitive takeaways. Finally, SMB's broadening and better in contribution to our new business extends globally. In China, with geopolitical factors overhanging our prospects with our historical mainstay down enterprises, the majority of our reasonably improved net new business in '23 Q2 was thanks to perpetual license sales in SMB. Among the axes of directionally broader and better growth, I would like to turn now to infrastructure sectors, where, as Nicholas will provide our usual color, we saw in '23 Q2 the normalization that is the convergence towards the mean of resources and mining, in particular, its major impetus for us, down from its extraordinary global pace setting. You may have seen reports that this phenomenon is another reflection of an overlay cycle of reduction in demand in China. I don't think there's much doubt anywhere that the economic and environmental factors driving the current mining super cycle are still long-lived, but the momentum won't be consistently sustained at the maximum. Most recently, the mining majors are confronting pricing fluctuations and are thus acting more cautiously in their procurements and the mining juniors are considerably fettered by tighter equity markets, higher interest rates and inflation. These factors mainly impact CapEx for new mines and major extensions rather than the OpEx for throughput of existing mines, which accounts for most of the volume and growth for Seequent. But Seequent subsurface modeling is also used as a precursor to new mine development. So on the margin, these factors are impinging upon what have been sequenced consistently very high growth rates. Since acquisition over two years ago, while growing organically more than twice as fast as Bentley Systems otherwise, Seequent has, in fact, doubled in scale, including incorporating along with many subsequent programmatic acquisitions, our previously acquired geotechnical engineering software. During the past year, we have prioritized Seequent integration generally into our corporate systems, processes and commercial models, including into our E365 account and blueprints, by virtue of a lot of attention, this is going well. One purpose has been to extend the benefits of and opportunities for subsurface digital twins in the civil infrastructure market, which will also serve to bring Seequent an environmental modeling counterbalance to their historical concentration in mining. The predictable result of these maturing and integration factors has been a direction toward convergence between Seequent's growth rate and the increasing fundamental norm for Bentley Systems otherwise, which reflects largely the successful growth initiatives I've been discussing. A footnote is that the inflation factor since the beginning of 2022 would make it mathematically harder for Seequent's rate of growth to remain at an integer multiple. The result, as in '23 Q2, is a broader, better, balance and consistency across our company and market sectors. And that takes me to our midyear updated outlook for the full year 2023. Our established 2023 outlook ARR growth range, of course, constant currency business performance has been 11.5% to 13%, which we are now reasonably prepared given the consistently robust first half to narrow to 12% to 13%. Most of our initial caution about ARR growth for this year had to do with China. And visibility there remains relatively limited. While China now represents only about 3.3% of our overall ARR, and despite a welcome turnaround in SMB-driven new business there in Q2, over the course of 2023 to date, the Chinese proportion has fallen by about 0.4% of total ARR. This has correspondingly reduced what would otherwise have been our overall ARR growth rate had China merely kept pace with the rest of the world. This ARR growth drag is likely to continue or to increase as traditionally in China, each year's fourth quarter accounts for most of the year's new business. This year, we share with the rest of the world and for instance, with the mining market, obscured visibility into China's direction. But in our case, it's amplified by our own intentional go-to-market pivot in China, which, as I described last quarter, will tend to relatively reduce our ARR even if and as it hopefully becomes successful. After only one quarter so far, it's too soon to report on the net impact. But by the end of the year, presumably this will have become apparent. And in comparison to previous years, which have generally included more ARR acquired with programmatic acquisitions than in our current outlook for this full year, again, I consider our sustained ARR growth to be behind the numbers directionally broader and better. As I have discussed, this is true across commercial models and account sizes and across infrastructure sectors. Nicholas will reinforce this from the standpoint of regions and products as well. First, by way of corporate developments and related to these subjects, we announced during the quarter the recruitment of Alan Lee, formerly Chief Operating Officer of SAP China, and a wise veteran of creative alliances there as our only general manager anywhere in the world with responsibility for on-the-ground leadership of our new and unique for us go-to-market strategy in China by way of joint ventures and channels. Alan is now aboard in China and is enthusiastically at the helm. And we'll have more to say about this at the Year on Infrastructure 2023 conference. The conference will be in Singapore in October of this year, and to make up for the time zone difficulties of travel or even live streaming for most of you, I have asked Eric to compile concise video excerpts of the proceedings relevant to investors. The independent juries are presently judging our accounts 300-plus going digital award nominations, and the finalist who will present in person in Singapore will be announced next week. Their case studies will help us all to assess the pace and distribution of infrastructure digital twin advancements in the world, which I can't wait to see and report upon it. And now over to Nicholas for fuller operating perspectives on '23 Q2.

Nicholas Cumins, COO

Thank you, Greg. We had a strong quarter and a strong first half of 2023. Demand remains very positive, and we continue to build a pipeline with market dynamics and government investments playing in our favor. Project delivery firms are dealing with an extremely tight labor market, an aging workforce and increasing costs due to higher interest rates and inflation. All factors that lead them to seek new ways to improve productivity and efficiency. Bentley Systems is well positioned to help. Additionally, government programs around the world continue to invest in the resilience and sustainability of critical infrastructure. We expect this to be a long-term trend that benefits our markets. Looking at related performance across infrastructure sectors, Q2 reflected some reordering from previous quarters. Leading the way, growth in public works and utilities remains very strong, the sector being the biggest beneficiary of infrastructure investments around the world. Industrial improved, while resources normalized from record levels, with commercial and facilities remaining flat. Next, looking across regions. Growth remained very solid in North America. The trends follow the direction of the previous quarter with strength in public works and utilities, indications of IIJA funding flowing through more broadly and project confirmations having more work than they can handle with their project backlogs extending further out. We achieved steady growth in Europe driven by EU funding of transportation, water and green initiatives and purposeful targeting of the ecosystems of large infrastructure projects, which drives our software adoption across both owners and operators and their product firms, large and small. We're also getting good traction and achieving notable wins with water utilities in the U.K. In Asia Pacific, India remained a major growth driver even after many quarters of accelerated growth as it continues to benefit from strong tailwinds, in particular, large investments from the government into local infrastructure and global project delivery firms continuing to tap into the substantial population of engineers in India to supplement their workforces for projects abroad. The SMB segment is also performing well, and Virtuosity revenue in India year-to-date has already surpassed the 2022 total. In China, ARR continued to show signs of stabilization in Q2. We continue to do well there in the SMB segment, which is encouraging. However, as Greg mentioned, we believe it is prudent to be cautious for the balance of the year. Growth in Australia is benefiting from large investments in public works. The Australian government's five-year pipeline for major infrastructure projects is valued at more than $150 billion, and it is mostly focused on transportation, our sweet spot in Australia. One example is Brisbane's cross-cable project, a publicly funded megaproject with digital twins at its core. The project comprises a 10.2 kilometer section of rail that includes 5.9 kilometers of tunnel under the Brisbane River, four new underground stations and re-built for eight above-ground stations. Significantly, it was a key component of Brisbane's successful bid to host the '23 Summer Olympics. Digital twins enable them to plan for the whole life of the project with a full digital representation from construction through operations and maintenance. With virtual versions of stations, team members and stakeholders can bring the project to life, walking across, traveling down escalators and even riding the network. In addition, they're working to develop technically accurate and immersive environments that will assist with infrastructure acceptance, assurance, testing and commissioning. The team can even attach information to stations and overlay real-time data feeds such as air quality to geospatial locations for ongoing measuring and analysis. While Cross River Rail is the largest project in Queensland history, there are 400 to 500 major projects slated over the next 10 years. As with other regions, these projects not only provide opportunities for owners/operators but also with entire ecosystems. Moving on to products. Notable strong product performance in the quarter included STAT, our general structural analysis software, SAKS for offshore structural analysis, and Power Line Systems. Open Road and Open Bridge also performed well, standalone and as part of a broader open civil offering for SMB. One topic that has been top of mind recently, and which I'm sure you have questions about is AI. Let me take a couple of minutes to explain our position. AI is not new to Bentley. Our primary focus to date has been on computer vision for asset condition monitoring and inspection use cases. A great example of that is our bridge monitoring solution, which became generally available in Q2. The solution leverages AI to automatically identify potential issues in bridges such as cracks and spalling and to prompt interventions. You're going to see more and more of the types of solutions in operations and maintenance, starting with bridges and dams and then for other critical infrastructure. But AI has a lot of potential for design assistance. We already have generative design capabilities for the concept phase, primarily parameter-based in civil site engineering, and our users see low-hanging fruit in the form of generative components which facilitates the programmatic reuse of modular digital components. One thing I will say is that for AI you need data; all engineering services firms realize how valuable AI is. The issue is that their data is typically locked into different formats and systems. Digital twins are the key to unlock that data, surface it and make it available for AI. The good news is that adoption of digital twins has significantly increased over the past few years, thanks largely to our twin platform. iTwin is strongly positioned to enable the endless ways that AI may be applied. And remember, most of the data that we're talking about is already a project-wise part of Bentley Infrastructure Cloud. We believe we are just starting to tap into the potential for our iTwin platform and products for AI, and we look forward to providing more details at the Year Infrastructure 2023 Conference. And with that, I will now hand over to Werner to go over our financial results.

Werner Andre, CFO

Thank you, Nicholas. We are pleased that we started the first half of the year strong. Total revenues for the second quarter were $297 million, up 11% year-over-year or 10% on a constant currency basis. Year-to-date, total revenues grew 12% or 14% in constant currency. ProjectWise subscription revenues grew 12% year-over-year or 11% in constant currency, and represented 87% of our total revenues. As a reminder, Q2 is typically our lowest revenue quarter, and we discussed last quarter that we saw a shift in revenue seasonality from the continued expansion of our consumption-based E365 program, which yields a more ratable revenue recognition when compared to the accounting treatment of our traditional software subscriptions. That shift benefited Q1 and was a drag on Q2. Therefore, the more meaningful comparison to the prior years is our first half in which subscription revenues grew 13%, or 15% in constant currency. The onboarding of Power Line Systems at the end of January 2022 accounts for about one percentage point of this year-to-date improvement. Our E365 and SMB initiatives continue to be solid contributors to our subscription revenue growth. Perpetual license revenues remained essentially flat, reflecting our preference for recurring subscription revenues. While license sales continue to play an important role for us, especially within SMB, what they serve as is a competitive differentiator helping to attract new logos, particularly in China due to local preferences as we go to market increasingly indirectly. Our professional services revenues benefited from the acquisition of a company we purchased within our cohesive digital integrator group in Q4 of 2022. Moving on to our recurring revenue performance. Our last 12 months recurring revenues increased by 12% year-over-year or by 16% on a constant currency basis. On a constant currency basis, the acquisition of Power Line Systems contributed about two percentage points to this improvement. Our constant currency account retention rate remained 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 Q2 with ARR of $1.106 billion at quarter end spot rates. Our constant currency ARR growth rate was 13% year-over-year and 3.1% on a sequential quarterly basis. In this quarter, compared to our usual norm, we had no programmatic acquisitions. Our strong and sustained ARR growth performance was supported by broad market growth led by our resources and public works and utilities sectors. Year-over-year, resources led the way. Well, quarter-over-quarter, the pace was set by public works and utilities. Our growth was further supported by our balanced business performance across our regions other than China and by our E365 and SMB growth initiatives. Our GAAP operating income was $53 million for the second quarter and $119 million year-to-date. 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 with stock-based compensation expense. Our primary profitability and margin performance measure starting this year. Adjusted operating income with stock-based compensation expense was $73 million for Q2, up $9 million or 14% year-on-year with a margin of 24.7%, up 70 basis points. Year-to-date, our adjusted operating income with stock-based compensation expense was $164 million, up $21 million or 15%, with a margin of 26.8%, up 60 basis points. Our Q2 and year-to-date margins are fully in line with our expectations. Q2 is typically a lower-margin quarter for us compared to Q1 due to OpEx seasonality. We concentrate our annual raises for colleagues to occur as of April 01 each year, and since approximately 80% of our cost structure is headcount and related support costs, annual raises have a significant impact on our operating expenses in Q2, Q3 and Q4 relative to Q1. Margin progression for the year should improve in part due to lower relative impact of stock-based compensation compared to the second half of last year. We expect that our annual stock-based compensation expense will be decreasing as a percentage of revenues towards a range of 6% from approximately 7% in 2022. There will continue to be some stock-based compensation expense volatility between quarters, including for the timing of our ongoing annual rounds of broad-based equity grants which are predominantly granted in the first and fourth calendar quarter. With respect to liquidity, our Q2 operating cash flow of $81 million increased by $14 million year-over-year and had a trailing 12-month conversion from adjusted EBITDA of 92%. 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. 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. During the first half of the year, along with providing sufficiently for our growth initiatives, we paid $29 million in dividends, we spent about $51 million on share repurchases to offset dilution from stock-based compensation, and we repaid $147 million of bank debt. As of the end of Q2, our net senior debt leverage was 0.8 times, and including our 2026 and 2027 convertible notes, full year STAT, our net debt leverage was four times. This is down from the end of 2022, which was 1.3 times and 4.7 times, respectively. Approximately 85% of our debt is now protected from rising interest rates through either very low fixed coupon interest in our convertible notes or our $200 million interest rate swap expiring in 2013. With regards to our 2023 financial outlook, given our strong first half of the year and expectations for the second half, we have narrowed our constant currency business performance ARR growth range to 12% to 13% from 11.5% to 13.5% while maintaining our financial outlook for the other metrics. This ARR growth range balances our broad-based business momentum with offsets from lower expectations from programmatic acquisitions, a cautious approach towards our commercial and facility infrastructure sector, and China, as Greg has explained. Given the relative volatility of license and services, we are not narrowing our revenue outlook. With regards to foreign exchange rates, the U.S. dollar has weakened relative to the exchange rates assumed in our 2023 annual financial outlook. The impact during the first half of 2023 was not significant with approximately $4 million of incremental revenues from currency. And the end of July exchange rates would prevail throughout the remainder of the year, and our second half GAAP revenues will be positively impacted by approximately $8 million. And with that, I think we are ready for Q&A. Over to Sandra Ann, who is going to moderate in Eric's absence. Thank you.

Sandra-Ann Morency, Investor Communications Manager

Our first question will come from Matthew Broome from Mizuho Group. Matthew?

Matthew Broome, Analyst

All right. Thanks very much. Good morning, everyone. So I guess just to get started, how are your customers really thinking about the longer-term demand environment? Is the increase in government spending giving them the confidence to commit to larger investments in software? Or is there any sort of broader uncertainty we see across other areas of design sort of increasingly creeping into that thinking?

Greg Bentley, CEO

I would say that nothing from other areas is creeping into the thinking of those in infrastructure engineering, and the confidence you can see in the surveys that things are getting better and they expect to continue to get better. And that's broken down by subsector as well. One of the things I noted this time in the surveys, and by the surveys are those of the ACAC is the U.S. group, but I don't think it's different in our perception across the world. But in the U.S., expectations are thought to be better in the water sector now. And indeed, some IIJA funding, recall the other half of the IIJA funding beyond transportation is only starting to flow, but water is where it's starting. So yes, I think there's not any bleed from other macro concerns into infrastructure engineering that's perceptible. Now when you talk about confidence of our accounts generally, I think in the mining sector, as we mentioned, there is some bleeding and it's perhaps by way of volatility and prices having to do with demand fluctuations from China in particular, and that is notable in renewals in mining somewhat. They still need to use a lot more technology and consumption is increasing well but not to the same extent of a couple of quarters back. And we think that's a cycle sort of overlaid on the general super cycle there. But other than mining, now infrastructure engineering is quite comfortable.

Nicholas Cumins, COO

The only thing I will add is in our conversation with engineering firms, in particular, the discussion is more about capacity and supply than demand. They're very positive about the demand. But that's the point, they see their backlogs that are getting bigger and longer and expanding further out. The question is how exactly can they execute on that backlog, how do they cope with that demand when they're not able to hire fast enough? And obviously, our conversation then goes into how can we help them make more with what they have, with the capacity they have, how can we increase the productivity of their engineers.

Matthew Broome, Analyst

Right, absolutely. Makes sense. And then we did notice some recent price increases on the Virtuosity website, fairly consistent with what we saw in the prior year. I guess, how are you thinking about pricing currently? And how much pushback are you seeing from customers to increase this?

Nicholas Cumins, COO

Yes. As you said, it's aligned with the previous year. So we can defend those price increases because of the value that we're bringing with our software, and that's why we're making sure that there is no disconnect between the price and the value that we are delivering with our capabilities. And that is for both our accounts in SMB and in enterprise.

Operator, Operator

Our next question will come from Joe Verwing from Robert W Baird.

Joe Verwing, Analyst

Maybe just on the ARR outlook being narrowed to 12% to 13%. Can you bridge what changed and maybe quantify the growth factor for M&A in China? And then also what got better or went up to offset those two items?

Greg Bentley, CEO

Yes. And the offset for the programmatic acquisitions are nil for the quarter and our outlook is consistent with that for the remainder of the year. So that's a major component of the math. As far as China, what's interesting is even though we're more or less satisfying with our volume with our business in China in the second quarter, it has shifted to SMB and to perpetual license sales already. We have in mind further things that will shift it yet further in our new go-to-market strategy. But what we're measuring here is ARR growth and ARR growth where ARR from China is already for the first half, down by 0.4% from what would have been if China were merely at the average. And I think we're extrapolating that and may even increase that rate of impact on ARR growth during the remainder of the year, even though we're still hopeful for a good turnaround in China. So those are the major bottlenecks. What's broader and better is everything else and especially the balance in general, large accounts and small accounts globally and among sectors relying less particularly on resources and more on the broader for us, public works and utilities. Nicholas, anything to add?

Nicholas Cumins, COO

You've answered it quite well. The narrowing is really because of the uncertainty in China and the fact that we haven't done as much programmatic acquisitions that we've done in the past, yes. Everything else is indeed balancing itself.

Joe Verwing, Analyst

Okay. That's helpful. And then I wanted to go back to your comment on Open Road and Open Bridge doing well within SMB. I think one thing that's been happening is as state DOTs are looking to qualify and build out a larger supply chain, as engineering firms just see infrastructure as one of the better end markets to be associated with now and going forward, you're seeing growth in these supply chains. Is the strength in those product areas in SMB kind of related to new customer opportunities surfacing for you? And then how do you see that playing out as these other infrastructure subsectors kind of spring to life with some of the IIJA money getting more broadly deployed?

Nicholas Cumins, COO

Let me answer this. So Open Roads and Open Bridge, we have more and more transportation authorities, including DOTs in the U.S., that are standardizing on it. And then when that happens, the entire ecosystem starts to use the software as well. So what's happening and what we're seeing is in the U.S., but not just in the U.S., we see a lot of new accounts that are subscribing to Virtuosity for Open Roads or Open Bridge individually or together as part of our open civil suite in order to serve those transportation authorities. And I think we're getting better and better at understanding those dynamics and working across channels in order to leverage those dynamics, to win the entire ecosystem, not just the owners/operators, but all the product firms working with them, whether they're large or small. Whether they're large, we will go after them with our enterprise sales accounts. Whether they're small, we go after them with our SMB teams or even our channel partners accounts. And yes, you could argue this is a good playbook that could be applied to other industries. In fact, it's a similar playbook we are following with the water infrastructure in India, where we're winning not only large projects with the owners/operators, but also with their ecosystem. And in fact, open flows, which is used by hydraulics, hydrology engineers is in the top three products that we're selling through Virtuosity in India because of those large ecosystems.

Sandra-Ann Morency, Investor Communications Manager

So next question will come from Matt Hedberg from RBC.

Matt Hedberg, Analyst

Good morning. Thanks for the time. On the industry surveys that you guys noted on the call, why do you think that engineering firms are feeling better about their position in the economy? Do you think it's just a function of capacity from a headcount project perspective they see in their pipelines? But just any more color on what sounds like good results from that survey?

Greg Bentley, CEO

Well, when the backlog is a year and they're confident about winning new business, and if they could do it, the period of time you're confident about goes out for longer than what you might think is true in the economy in general. And I guess it's the stability and duration of the funding of the public works and utilities programs that makes that dichotomy prevail, persist.

Matt Hedberg, Analyst

Got it. So it sounds like just like it feels to me like it's a really good leading indicator on maybe sentiment from those buyers, which could be good for the next 12 months, 18 months to that effect.

Greg Bentley, CEO

Well, we know they're not going to be able to add capacity because the demographic is such that their workforce is retiring, and there are not sufficient replacements in engineering schools now, and there can't be very quickly.

Sandra-Ann Morency, Investor Communications Manager

Our next question will come from Devin Au from KeyBanc.

Devin Au, Analyst

So yes, my one question is on the renewal rate in Virtuosity. Nice to hear that it's at 80%. And you also mentioned that you continue to develop the self-serve and also the automation motion there; you could see that figure improving. So I'm just kind of curious where you see this figure improving in the long term? And how should we think about kind of the pace of improvement?

Greg Bentley, CEO

Well, so I might say that the SMB subscriptions are new enough to us that we didn't have a clear view of where this would settle out. And even now, it's aspirational to grow above that. But we have really strong plans and budgets for our digital experience projects and perhaps Nicholas you'd like to comment on some of what that will accomplish.

Nicholas Cumins, COO

Yes, it has improved because we've increased the number of interactions during the subscription periods, and we've done this on a large scale. We have substantial data because we are working with a very large customer base now with Virtuosity. Additionally, we have begun automating the renewal process, although it is not fully automated yet. We expect to further enhance the renewal rate. However, as Greg mentioned, we do not anticipate that it will reach the high renewal rates we experience with enterprise accounts. The nature of the companies we work with is different; they are smaller organizations that tend to use the software for specific projects, unlike enterprise accounts that utilize our software across various projects and products. Therefore, while we believe the renewal rate for SMBs is quite strong, we still see room for improvement, but it likely won't match the levels we've seen in enterprise.

Sandra-Ann Morency, Investor Communications Manager

Our next question will come from Joshua Tilton from Wolfe.

Joshua Tilton, Analyst

Thanks for sneaking me here. We've definitely talked in the past about how important this whole pricing dynamic is to the story. You guys mentioned the accretion in the prepared remarks. Can you just maybe give us a sense or a flavor of what the ASP uplift is for these customers as they start to choose some of these higher-priced applications?

Greg Bentley, CEO

Right. So of course, this is we do have pricing escalation per se for the same product, and there was a question earlier about that. That tends to be in the inflation range of 2% to 5% depending on which year it is. But the application mix accretion holds the pricing constant then measures the pace by which engineers begin using more specialized products, and the potential uplift there is an order of magnitude actually. MicroStation, our most generic modeling product in E365, the price per day might be half of that of Open Roads or Open Bridge and then OpenFlows, OpenWind, Power, et cetera, could grow by a factor of five or even ten. But the more specialized modeling applications include the appropriate simulation engines and so forth, takes the place of needing a number of different products, but it's a broad range. And this is where I say the potential to go from what I referred last time one note that, on average, are the top design firms spend $1.41 per hour on our applications, and that can grow via magnitude as they need to have their engineers use more specialized applications to increase the throughput and quality as they go digital to compensate for not having the increased number of hours to do the same and more work in backlog. So there is quite an order of magnitude potential there over the long-term item.

Joshua Tilton, Analyst

And if I could sneak one more quick follow-up in.

Greg Bentley, CEO

If it's quick.

Joshua Tilton, Analyst

Super quick. Just I know you guys obviously have a really strong competitive positioning in transportation, but you're talking about some of these funding dollars starting to be allocated towards water projects. Like how do you feel about your competitive positioning in water compared to transportation? And how should we think about your ability to capture these dollars as more of that funding starts to get allocated?

Greg Bentley, CEO

In water, I believe we are also the leader, but it’s much closer. And of course, you know that our competitor Autodesk did an acquisition there of the other leader. In water, we're broader. We have a lot more to do with processing plants with plant design, process plants and so forth, not only the modeling of the networks. But it's a great market worldwide. There's a lot of digital twin potential in water operations and maintenance, improving energy, reducing non-revenue water to leakage and so forth. It's just something great for infrastructure engineers to work on and going digital.

Sandra-Ann Morency, Investor Communications Manager

Our next question will come from Andrew DeGasperi from Berenberg Capital Markets.

Andrew DeGasperi, Analyst

I guess first, just could you elaborate a little more in terms of the Seequent resource deceleration? I know you mentioned it was growing around two times the Bentley Group ARR growth. I'm just wondering like what should we expect at this point in terms of that growth, should would still exceed Bentley's Group revenue? And if so, how much would the swing be?

Greg Bentley, CEO

I previously stated that Seequent's growth was twice that of the overall company, and I wanted to clarify that this is no longer entirely true. Currently, Seequent is indeed growing at a faster rate than a few years back when the acquisition took place. To maintain its previous growth rate, it would have needed to grow at double the incremental rate. Throughout this period, Seequent has expanded significantly, taking on broader civil market opportunities, which helps integrate subsurface modeling for infrastructure projects. This diversification has shifted some focus away from mining, which experienced notable changes this quarter that impacted its growth compared to the overall company. Despite this, Seequent continues to grow significantly faster than the company as a whole. We anticipate this trend will persist, although growth is converging as the rest of the company expands. Only PLS is currently outpacing Seequent in growth. We are very pleased with Seequent and its management, noting many opportunities ahead, especially given that it has doubled in size over the past two years since the acquisition. However, we believe mining will face some fluctuations during this super cycle, and we are currently navigating one of those periods.

Sandra-Ann Morency, Investor Communications Manager

Our next question will come from Jay Vleeschhouwer from Griffin Securities.

Jay Vleeschhouwer, Analyst

Greg, Nicholas, Werner, I appreciate the comments you've been making about current momentum with regard to parts of the business getting directionally better. That was very interesting commentary. I'd like, however, to ask a longer-term question, specifically about the extensibility of or the preparation of your portfolio for the next half decade or more. And the reason I'm asking is at last November, Keith and Nicholas and Mike made some very interesting comments around your software development. You announced infrastructure cloud. You announced various flavors of iTwin. We've not really heard much about any of that since then. More recently, in June, it was a very interesting AEC conference in London. Bentley was there. There were some really interesting indications of what I would call customer ferment or interest in new technologies and processes related to AEC and BIM. So I know that's perhaps a too large a technology question for an earnings call, but maybe talk about where you think the company is positioning itself over the next half decade or more building upon the current momentum.

Greg Bentley, CEO

I know we're preparing, of course, for year-end infrastructure. So we're going to some power dry for that. But go ahead, please.

Nicholas Cumins, COO

We will need to provide a more detailed update soon. What we discussed at last year's conference is resonating very well with our clients. We are seeing significant interest in the Infrastructure Cloud and some of the iTwin products we mentioned, along with a noticeable increase in the capabilities powered by iTwins. The key shift in the industry is transitioning from being file-based to data-centric, and digital twins are essential for achieving this. They enable us to access data that is currently locked away in different formats and systems, which is becoming obsolete. The focus of the industry is on breaking free from those files, accessing data, and using that data to boost efficiency, enhance effectiveness, and potentially transform business models to provide new offerings to owners and operators as engineering firms. In discussions with these firms, they express the need to go digital to bridge the gap between demand and capacity and ask for assistance in managing their stale data. They want this data to be reusable across projects and possibly applicable for AI and machine learning, which I mentioned in the prepared remarks. I won't elaborate further today, but we will provide a comprehensive update soon.

Sandra-Ann Morency, Investor Communications Manager

Our next question will come from Kristen Owen from Oppenheimer.

Kristen Owen, Analyst

I was hoping you could break down some of the performance a little bit more in the public works and utilities space. How much uplift you're seeing from PLS? And since my follow-up is related, I'll ask it now. Just what permitting reform in the debt ceiling legislation can mean for your business coming into the back half of the year and in 2024?

Greg Bentley, CEO

I happen to think that electric transmission, especially is forthcoming super cycle, but it's still worth coming. PLS' growth leading the company at the moment is still in anticipation of that. It isn't yet actually due to major transmission projects having been permitted in the world. But I do think that the engineering firms are adding capacity for transmission engineering and contemplation of that. By the way, it's not possible to hire new transmission engineers. They're all busy. So one project that's underway is cross-training several structural engineers from other disciplines to be competent in transmission engineering and applying the tools to that. So I will mention as far as permitting, where we tend in the U.S. to be waiting for major legislation, but there was over the past month rulemaking by our Federal Electricity Regulatory Commission that did start to continue to improve, I'll say, the permitting environment. But it is being measured that there is a multiple of renewals capacity coming on stream or ready to come on stream that's in a queue waiting to be interconnected and depending on transmission capacity being extended and augmented and that's bound to happen and to be a strong driver for PLS. Now PLS is still a fraction only of the size of Seequent among our platform acquisitions, but it's on the launching pad, I think, still.

Sandra-Ann Morency, Investor Communications Manager

Our next question will come from Michael Funk from Bank of America.

Michael Funk, Analyst

So one for you, Greg, if I could. Can you help me conceptualize the potential benefit to NRR growth from application uplift, digital twins and IIJA? Do you expect them to be beneficial to that growth rate in '24 and '25?

Greg Bentley, CEO

Yes, I believe that while none of these factors may individually have a significant impact, together they could help us improve net revenue retention. It's important to note that net revenue retention also takes into account escalation and inflation, which we all hope will come to an end. However, the factors you've mentioned, such as digital twins, application mix enhancement, and the expansion of the IIJA in the U.S., will positively impact our existing accounts that contribute to our net revenue retention.

Michael Funk, Analyst

And then related to that, Greg, you previously spoke about several ready projects obviously getting off earlier and then kind of the majority kind of awaiting more work approval. How close are we that point in the process where that long tail begins to pick up spending that you start seeing benefits?

Greg Bentley, CEO

I recall mentioning in the third quarter reporting that we experienced a sudden increase in our ARR growth rate in the U.S., which has been maintained, but I’ve noted that it hasn’t been consistent. I’m starting to believe that the second half of the IIJA, expanding beyond transportation to include grid, broadband, and water, particularly with water funding already underway, will be a gradual process. Although water funding is happening now, broadband funding will take effect next year, and the same goes for the grid. From our perspective, this gradual rollout could actually be beneficial, as it may allow for a longer duration of support while addressing the existing capacity challenges in infrastructure engineering.

Sandra-Ann Morency, Investor Communications Manager

Our next question will come from Matt Martino from Goldman Sachs.

Matt Martino, Analyst

Question here for Greg. I just wanted to get a quick update on Europe and just kind of geographic distribution and kind of the performance that you guys saw there in each quarter.

Greg Bentley, CEO

Nicholas, if you wouldn't mind.

Nicholas Cumins, COO

Yes. There has been steady growth in Europe overall, driven mainly by transportation and industrial sectors. The trends are consistent with what we've observed in previous quarters, and there is a clear connection to the significant funding from the European Union that is being allocated to various countries and projects. Numerous initiatives in water and rail are utilizing our software, and we are aware that these projects are supported by EU funding. Steady is the word.

Greg Bentley, CEO

I might say that when I look at this as between Northern Europe and Southern Europe and Central Europe, it always seems to fluctuate enough from quarter to quarter that steady is the right way to put it over the course.

Sandra-Ann Morency, Investor Communications Manager

Our next question will come from Blair Abernethy from Rosenblatt Securities.

Blair Abernethy, Analyst

Just a question on India. Greg, can you give us a sense of whether things are going well there, perhaps even better than in China? Is this driven domestically, or is it helping to compensate for capacity issues in North America or Europe where civil engineering is facing constraints due to significant backlogs?

Greg Bentley, CEO

Well, it's much better than China. And we ask the same question because it's for both reasons, the domestic programs in India and of course their need for infrastructure is greater than any other country in the world. At the same time, they had this greater source of capacity with students and universities and so forth coming into the engineering professions. So we have studied it closely with a bulk of the faster growth in India these couple of years is domestic to do with the programs there. And I might say that it's our impression that the programs there have been very well received by the population in India, and we hope are likely, even though they're reaching in a year or two, their stated expiration, we like to think there will be successor programs, what would you add, Nicholas?

Nicholas Cumins, COO

You answered it. Again, perfectly, the share keeps getting higher actually. So the growth is really primarily coming from those local infrastructure projects, but not only, as you were asking, and as I also mentioned in the prepared remarks, India is also benefiting from global firms tapping into the local engineering talent to help for projects. When they do that, it's interesting. By the way, it's not just outsourcing some of the functions. They outsource entire, let's say, responsibility for technical delivery including project management, which is a change from the past.

Greg Bentley, CEO

And maybe we haven't had a question about demand in China. But China historically has had the higher spending on infrastructure. And I think the government there intends to resume that, but it's in fits and starts. Do you want to comment further on that, Nicholas?

Nicholas Cumins, COO

Yes. In China, the infrastructure plan was discussed multiple times last year. We saw it come into action in the fourth quarter. It mainly focused on projects that were already under construction. Now, it has transitioned to funding design projects in the first half of the year, particularly for new airports and the expansion of existing ones. Our software is being utilized in these efforts, so we are reaping some benefits despite the challenging overall business environment in China. This actually serves as a tailwind for us.

Greg Bentley, CEO

And I just want to emphasize that we feel pretty good about China. China this year has been reassuring so far compared to last year. But almost anything that happens isn't going to register in ARR except probably as a decrement to ARR because of the preference there for perpetual licenses and in SMB, especially. So we'll need to look more broadly at how we measure tone of business in China. But it's not a bleak picture there necessarily. And we think our structural changes in the go-to-market are timely and worthwhile, not particularly bearing fruit yet, although we see some instances of what we've been expecting and leading us to emphasize it's going to increase the pressure on ARR while the overall business can grow.

Sandra-Ann Morency, Investor Communications Manager

We will move on to Clarke Jeffries from Piper Sandler.

Clarke Jeffries, Analyst

I wanted to ask, when you reflect on the year so far, where do you specifically expect to invest most incrementally for the rest of the year? And then maybe beyond that for the next 12 months will be the highest investment priority in terms of OpEx investment.

Greg Bentley, CEO

Well, let me just say first that the year so far really has been reassuring that without very much a pace of programmatic acquisitions, without the extreme reliance on mining and Seequent with everything broadening out and especially the SMB and E365 doing better than ever, it feels to us broader and better behind the numbers as we've emphasized. The principal investments on our mind in OpEx, and it's also CapEx are for the digital experience. The SMB opportunity is so large, and we're getting such reinforcement I say way we think there's competitive takeaways going on there. It's as Nicholas described learning that where there is a major project, there's an ecosystem of Tier 1 and Tier 2 for us to fully penetrate and help as well. And digital experience is a lot of how you do that. And it's a lot of different projects. Maybe you might even want to mention some of them Nicholas during the remainder of the year in the 12 months, as you've asked about, Clark, we had a number of major new digital investments coming onstream and some of them have so far already this year, we've implemented ServiceNow and a couple of other broad digital experience things we're integrating rather than inventing.

Nicholas Cumins, COO

We have upgraded most of our marketing technology, including our marketing automation platform, account-based marketing platform, and website. We are also in the process of transitioning our commerce platform, which has primarily served small and medium-sized businesses through Virtuosity, to be utilized in the enterprise sector as well. Overall, we are nearly completing a complete overhaul of our front office systems to enhance scalability. Additionally, we are investing in both systems and personnel, particularly in the digital experience department, which is where our greatest hiring needs lie. Our goal is not only to implement these systems but also to operate them effectively, ensuring that both user and customer experiences are increasingly digital-focused. Interaction with our colleagues will only occur when users from both SMB and enterprise sectors specifically request it.

Greg Bentley, CEO

So we're engineers, and we love working on this, and it's just getting a sweet spot seems in SMB. So we definitely have to say. So by the way, this is the first quarter that I had looked myself, net licensing in SMB. And that's 300 new logos alone from the license sales, first-time names for us. So we really are seeing that license sales are an outright competitive differentiator for us perpetual licenses. And again, I consternate this notion that we measure ourselves by ARR growth. We're very comfortable about that. But when we expand our sights to SMB and for instance, to China with local preference for perpetual licenses, we need to appreciate that doing broader and better will be reflected beyond ARR growth.

Clarke Jeffries, Analyst

And then just one follow-up. Just curious about...

Sandra-Ann Morency, Investor Communications Manager

Sorry, Clark, the webinar will finish in one minute.

Greg Bentley, CEO

We're going to come back to you, Clark. The first time, conclude on time. Thank you all.

Sandra-Ann Morency, Investor Communications Manager

That concludes our call today, and we thank each of you for your interest and time in Bentley Systems, and we look forward to updating you on our progress in coming quarters. Have a great week, everyone.

Greg Bentley, CEO

Thank you.