Zuora Inc

NYSE:ZUO

Earnings Call Transcript 2025-Q1

[Operator]

Thank you for standing by. My name is Pam, and I will be your conference operator today. At this time, I would like to welcome everyone to the Zuora FY '25 Q1 Earnings Conference Call. [Operator Instructions]. I would now like to turn the conference over to Luana Wolk, Head of Investor Relations. You may begin.

[Luana Wolk, executive]

Good afternoon, and welcome to Zuora's First Quarter Fiscal 2025 Earnings Conference Call. On the call, we have Tien Tzuo, Zuora's Founder and Chief Executive Officer; and Todd McElhatton, Zuora's Chief Financial Officer. Robbie Traber, our President and Chief Revenue Officer, will be joining us for the Q&A session.

During today's call, we'll make statements that represent our expectations and beliefs concerning future events that may be considered forward looking under federal securities laws. These statements reflect our views only as of today and should not be relied upon as representative of our views as of any subsequent date. We disclaim any obligation to update any forward-looking statements or outlook. These statements are subject to several risks and uncertainties that could cause actual results to differ materially from expectations. So for further discussion of the material risks and other important factors that could affect our financial results, please refer to our filings with the SEC.

And finally, unless otherwise noted, all numbers except revenue mentioned today are non-GAAP. You can find a reconciliation from GAAP to non-GAAP results for both the current and the prior year period in today's press release. Our press release and a replay of today's call can be found on Zuora's Investor Relations website at investor.zuora.com.

Now I'll turn the call over to you, Tien.

[Tien Tzuo, executive]

Thank you, Joanna, and thank you, everyone, for joining Zuora's First Quarter Fiscal 2025 Earnings Call. When I look back on the puts and takes of the past quarter, I would say I feel good about the progress we continue to make against the macro environment facing the technology industry. We continue to deliver on our guidance. We continue to benefit from a solid enterprise customer base with strong expansion opportunities. And of course, we remain focused on our strategy to deliver profitable, durable growth.

Let's start with the numbers. In Q1, subscription revenue was $99 million, up 10% year-over-year at the high end of our range. we exceeded guidance for non-GAAP operating income at $18.6 million, equating to a 17% operating margin, which is a quarterly record. Our adjusted free cash flow was at an all-time high of $31.4 million for this quarter, a significant increase from the $13 million we delivered in Q1 of last year. And finally, against the Rule of 40 framework, which combines growth and profitability, we are on track to exit this fiscal year at $30 [ million ] up from the $26 million level that we hit at the end of last year.

One highlight of Q1, I would say, is our installed base expansion our stable of large enterprise customers continue to anchor the durability of our business. Our customer satisfaction levels continue to rise as measured by Net Promoter Score. Customers continue to love our new innovations, and this is driving strong expansion opportunities. In fact, in Q1, we saw a year-over-year increase in cross-sells with customers either adding another Zuora products or adopting our technology in new business units. Some examples, our customers are adopting additional products like Zephr, the economist, a leading news magazine with over 1 million subscribers as a Zuora Billing customer that added Zephr in Q1. Their digital subscriber base continues to grow, and they'll be using Zephr to enhance their dynamic paywall experience.

Our customers are adopting us in new business units, one of the world's largest automakers expanded with Zuora to power another business units, this time for its software suite that manages connected services and telematics for commercial fleets. Our Zuora Revenue to Zuora Billing cross-sells are working. Last quarter, we talked about Toast as a great example, well, this quarter, we saw another Zuora revenue customer, a global leader in customer experience and contact center solutions with over $1.2 billion in annual revenue. They added Zuora Billing with advanced consumption to help them analyze millions of customer usage data point to monetize their AI-powered support offerings.

We are supporting our customers to expand into new countries or regions. In Q1 global manufacturing brand, Luxottica. They produce eyewear for brands like Oakley, Gucci and Prada and they expanded with us to support their eyewear subscription service in new countries. So our installed base business was a highlight in Q1. In Q1, though, our new logo business continues to be affected by the macro headwinds as we again saw companies to delay large multimillion dollar projects at the end of the quarter. Now as we mentioned on previous calls, we remain committed to our strategy of doing smaller, faster lands with great companies and brands. A good example in Q1 would be Mitsubishi Electric, one of the world's largest manufacturing companies with over $36 billion of revenue.

As Mitsubishi Electric continues to expand beyond hardware and complementary digital services for offering like its air conditioning and factory automation systems, what they needed with a monetization suite that we will build to support recurring revenue. Overall, however, the lack of large transformational deals, coupled with the seasonality of the software business meant a lighter overall new logo quarter.

That being said, we are getting more and more efficient in how we generate pipeline. We're switching to more digital and inbound techniques, and we're already seeing positive leading indicators that show improved response rates and lead generation efficiency. And so we believe that our opportunity remains strong as the year progresses. The most exciting news of the quarter, however, is our acquisition of Togai. And so I'd like to spend a few minutes talking through why this announcement is so important.

Now we've seen an increase in demand for usage-based pricing, especially in the SaaS market. Our advanced consumption solution is one of our fastest-growing products in terms of pipeline. As of Q1, we have over 50 customers that have selected our advanced consumption offering and usage-based models continue to accelerate even further with the explosion that we're all seeing of Gen AI-based technologies. But in supporting our customers around consumption strategies, we've also uncovered a huge need that engineering organizations have around capturing and metering their usage information. And this is where Togai comes in.

Togai provides a leading metering and rating solution that enables developers to directly convert raw data and to usage metrics through a 3-step no-code configuration builder with flexibility to monetize products in many, many different ways. This is really, really exciting. But the last thing I'll say about Togai is that this isn't just about usage-based models. There's a broader strategy going on, one that I will call total monetization. So what do I mean by that? Well, you probably know Zuora as the company that predicted and led the shift to description economy, and this shift has happened. Today, you and I, we are buying less and less stuff and it sure seems like every week, the CEO of another Fortune 500 company is declaring a target of shifting some meaningful percentage of their business to recurring revenue models.

But now at the subscription economy, this new world is a new normal. People are asking, what's next? Well, we believe what's next is a concept that we call total monetization. This is no longer just about stand-alone subscription businesses with monthly fees. It's also about onetime transactions like product sales or paid review or professional services revenues or the usage and consumption model that Togai helped us power. Total monetization is about mixing multiple business models in a way that maximizes the value of your innovations in your target market. And so we see this with companies Like the New York Times which transforms and unbundled how it offers products like games or cooking or news or sports alongside its traditional offering, and they've been able to see their annual digital subscription revenues with this strategy go beyond $1 billion a year.

So if you look at the innovations and acquisitions that we have made over the last 7 years, revenue recognition, payment orchestration, consolidated billing, Zephr, consumption billing and now usage, metering and rating with the acquisition of Togai, we are no longer just a billing company. We are building what I'll call a total monetization software stack for powering any business model. And what's unique about this platform is that it's totally modularized. So you can start with billing or metering or revenue or payments. And so when you look at our customer base, you see us owning the entire billing layer in some companies and for other companies where the entire payments layer or the entire revenue layer. Ultimately, our strategy is to be able to land with a new logo where our customers' pain point is greatest and then expand with them over time across the entire order to revenue process. In fact, this is our own total monetization strategy.

And so in summary, we believe that our bigger opportunity is to power a company's total modernization strategy and not just simply be a billing provider. We believe the innovations and acquisitions that we've made over the last few years put us in the best position to deliver all the technologies needed to capture this emerging opportunity. And Togai is another key step in that journey, especially around the usage-based models that are exploding due to Gen AI and IoT. We believe our modular approach is critical to enabling the broader land-and-expand strategy within our growing product portfolio that you've heard us talking about in recent quarters.

And finally, we are committed to driving sustainable, profitable growth as we lead in this new era. Finally, we hope you join us as subscribe live on June 26 in the Bay Area to learn more from our customers as we help them monetize every part of their business.

With that, let me turn over the call to Todd to review our financials. Todd?

[Todd McElhatton, executive]

Thank you, Tien, and thank you, everyone, for joining our call. In Q1, our subscription revenue and total revenue were at the high end of our range as we continue to make strides in our profitability. We exceeded the range for our non-GAAP operating income and expanded our adjusted free cash flow by $18.4 million compared to last year. During the quarter, we continued to experience similar buyer behavior as we've seen in the last several quarters with longer sales cycles and fewer transformational deals. ARR growth and DBRR for the quarter were impacted by customer churn, including those discussed during our last earnings call.

As a reminder, the customer churn was already factored into our guidance for Q1 and we expect our growth to accelerate in the second half of the year. Despite these headwinds, we're making good progress towards exiting the year at a Rule of 30 run rate including absorbing the expenses associated with our recent Tobi acquisition. We had record quarterly performance for non-GAAP operating margin and adjusted free cash flow.

Now I'll run through our financial results. Subscription revenue in Q1 was $99 million, growing 10% year-over-year. Professional services revenue came in at $10.8 million which was at the high end of our outlook, representing a decrease of 19% year-over-year. Professional services revenue was 10% of total revenue. We expect our professional services revenue mix to slightly decrease over time as we continue to expand our partnerships with SIs. Non-GAAP subscription gross margin in Q1 was 81%, and up nearly 100 basis points year-over-year. This improvement is driven by continued efficiency optimization with our hyperscalers. As a reminder, in Q3 and Q4 of fiscal '24, we benefited from onetime vendor credits.

Non-GAAP professional services gross margin in Q1 was negative 14% and a decline from negative 3% in Q1 of last year. Similar to last quarter, this was expected as a result of our continued investment in customers. For the remainder of the year, you can expect margins to improve with professional services margin being in the negative mid-single-digit range for the full year. Our Q1 non-GAAP blended gross margin was 72%, an increase of over 230 basis points year-over-year. Our Q1 non-GAAP operating income was $18.6 million, exceeding the high end of our guidance by $2.6 million, representing a non-GAAP operating margin of 17%.

During the quarter, we remained disciplined in our spending, expansion of our operating margin is a key objective toward our goal of exiting the year at a rule of 30 run rate. Our fully diluted share count at the end of the quarter was approximately 185.1 million shares using both the treasury stock and if converted methods.

Let's dive into some of our key metrics for the quarter. Dollar-based retention rate ended at 104%, down 2 percentage points quarter-over-quarter and down 4 percentage points year-over-year. The decrease in DBR was primarily driven by the churn we discussed in our last call and foreign exchange. Without the FX headwind, DBRR would have been 105%. In Q1, total RPO ended at $581 million, growing 15% year-over-year. Noncurrent RPO was up 23% year-over-year to $256 million. We had a number of multiyear renewals in the quarter as customers continue to grow on our platform. At the end of Q1, we had 451 customers with an annual contract value at or above $250,000. This is up 15 customers year-over-year, but down 10% sequentially. During the quarter, some of the customers in this cohort downsized below the threshold, reflecting the impact of the macro environment on their business. We remain focused on the enterprise space, and this cohort represents 84% of our ARR.

In Q1, we closed 2 deals with ACV of $500,000 or more, down from 4 in Q1 of last year. This includes 2 deals over $1 million, up from 1 last year. ARR grew 8% in Q1, reaching $404.4 million. Adjusted free cash flow was $31.4 million for the quarter, a significant incremental improvement of over $18 million compared to Q1 of last year. Like other SaaS companies, our Q1 typically benefit from Q4 a higher billing seasonality, and we expect more normalized trends for the rest of the year. As a reminder, adjusted free cash flow does not include acquisition-related costs and other matters.

Turning to the balance sheet. We ended the quarter with $547 million in cash and cash equivalents, a sequential increase of $33 million. Total CapEx for the quarter was $2.7 million. Before we discuss guidance, I'd like to provide some color on our recent tuck-in acquisition. As Tien noted, Togai will bolster our consumption capabilities, and we expect it will broaden our ability to land and expand. From a financial standpoint, Togai's revenue is negligible, and we expect to absorb their operating costs. We are assuming the current macro trends continue, and this is reflected in our guidance.

For Q2, we currently expect subscription revenue of $101 million to $102 million, professional services revenue of $10.5 million to $11.5 million, total revenue of $111.5 million to $113.5 million, non-GAAP operating income of $17.5 million to $19.5 million and non-GAAP net income per share of $0.09 to $0.10 assuming a weighted shares outstanding of approximately $149.4 million. For the full fiscal year 2025, we are maintaining our top line outlook and raising our non-GAAP operating income range while absorbing the operating expense impact of Togai.

We currently expect subscription revenue of $410 million to $414 million, professional services revenue of $41 million to $45 million, total revenue of $451 million to $459 million, non-GAAP operating income of $80 million to $82 million and non-GAAP net income per share of $0.41 to $0.43, assuming a weighted average shares outstanding of approximately $151 million. For the fiscal year, we're maintaining our guidance for DBRR of 104% to 106% and ARR growth between 8% and 10%. However, we could slip slightly below the range in Q2 and Q3. You will continue to see us drive our bottom line leverage and maintain our goal of exiting fiscal 2025 at a Rule of 30 run rate. As a reminder, we define the Rule of 30 as a sum of year-over-year subscription revenue growth plus non-GAAP operating margin.

We maintained our guidance of free cash flow to be $80 million or greater for the full year. We continue to expect annual share dilution of approximately 4% for fiscal '25. For this purpose, dilution is calculated as a number of equity awards granted net of forfeitures during the fiscal year, divided by the total shares outstanding at the end of the fiscal year. We're committed to driving higher operating income and free cash flow. Acquisitions like Togai will allow us to attract new customers and accelerate growth for usage-based models across our customer base. We've shown consistent progress in our ability to drive improvements in profitability and adjusted free cash flow as a market leader in a mission-critical category.

With that, Tien, Robbie and I will take your questions, and I'll turn it over to the operator.

[Operator]

[Operator Instructions]. And your first question comes from the line of Joshua Reilly with Needham.

[Joshua Reilly, analyst]

In terms of the macro, can you help us understand what's the level of visibility you have right now into demand and has that changed over the last couple of quarters? And then along with that, as partners have sourced more deals, I think you were kind of alluding to this in the script, has there been any change in your overall visibility into deal flow through partners?

[Tien Tzuo, executive]

Yes, I'll jump in, and Robbie, feel free to add any color. Look, we still have good visibility in the pipe. We still feel good about the pipe. There's still demand certainly for shifting the subscription business models. What we really try to highlight though, especially when you look at new logos, as companies are cautious about the large deals. And so you could define large in many different ways, but if we'll just say these are 7-digit deals, you're seeing companies continue to hesitate to pull the trigger on signing up a new vendor at that 7-digit level. And so we're not seeing those deals necessarily go away, but we'll -- we're continuing to see companies cautious about those deals. And certainly, if you compare where the business has been historically from a multiyear perspective, that does continue to be a drag.

[Robert J. Traube, executive]

Yes. I think -- and then Tien to your point, they're a key part of our strategy and we have a great partner first focus. And the other thing is in the same way we closed [ Toast ] is a deal, for example, in the previous Q4, last quarter, we closed an equally sized opportunity again going from revenue, and it was co-sold with a partner. So we do see continued traction there.

[Tien Tzuo, executive]

Yes. Maybe just bridge the 2 comments there. Given that, what we have done recently is to bring partners more into our installed base. So you're seeing as we focus on driving short-term growth from expanding our installed base, the good news is we've got a solid enterprise customer base that has expansion opportunities, and we found some good success working with our partners in our installed base, where perhaps 2, 3 years ago, the focus there has been primarily around new logos.

[Joshua Reilly, analyst]

Got it. That's helpful. And then just on the sequential change in the customers above 250,000 being down 10% quarter-over-quarter. Can you just give us a sense or should we expect this to continue to decrease throughout the course of the year? And how are you thinking about the importance of this metric, I guess, relative to historical?

[Todd McElhatton, executive]

Josh, this is Todd. So thanks for asking the question. A couple of pieces of color here, I think, are really important to pick out. So I'm glad you asked about it. We did have a small group of customers that in this current -- in this current -- we had a current -- we had a group of customers in this cohort, small group that has had some challenges, and we've had to meet them where they are. And that was the primary reason that we saw a decrease in that. we might see a few more next quarter happening. But the one thing that we really needed to tease out of this metric that I don't think that you're seeing is if you look at the ACV growth of our cohort of customers over $250,000 year-over-year, that is growing by more than 10%. And that's really important because that's 1 of the things that we said. We want to land with the right customers. after we land with them that we have the ability to expand, and that's exactly what we're doing with focusing on the best customers that we can really maximize the revenue potential out of them over the lifetime.

[Tien Tzuo, executive]

Philosophically, just to add to that, when you look at -- look, if there's a company that certainly need to downsell and we're looking at this $250,000 limit. Our goal has to be to hold opis a longer-term customer right? We've shown again and again that when we hold on to customers for long periods of time, we're able to grow the account. So we're going to be smart about these things. But exactly what Todd said. If you look at the whole group as a cohort, they are expanding.

[Todd McElhatton, executive]

And the other thing I'd add Josh, as you know, our gross retention rate remains very consistent. It just proves the stickiness and that is the mission-critical product that our customers are reliant on.

[Operator]

Your next question comes from the line of Adam Hotchkiss with Goldman Sachs.

[Adam Hotchkiss, analyst]

I guess to start, it would be great to get an update on the business churn. Some of the churn you mentioned last quarter. I know you mentioned 2 and also on the flip side of that, some multiyear renewals happening this quarter. So when reviewing some of your larger contracts and maybe some of your anticipated renewals for the rest of the year, what gives you confidence in the maintenance of DBRR and some of the other retention metrics versus where we are now?

[Tien Tzuo, executive]

Well, the number one thing is it's a sticky product. And when we can certainly see the volume that customers are putting through the system. We know how much they contracted for. We have a sense of, look, are these companies doing well? Are they growing? Are they declining? Usually for these subscription businesses, very few subscription businesses are actually shrinking. They're just not growing as fast as they might have been in previous years. And so that gives us a good strong set of visibility into how the base should be performing for, call it, the next 4 quarters.

[Todd McElhatton, executive]

Yes. But I would just kind of reemphasize here, Adam, is there was no real change. The expected churn that we talked about at the end of last year is what occurred. We had a few customers that need to do some rightsizing based upon the economics gross retention remains really consistent, and we are comfortable with the 104% to 106% range for the full year.

[Tien Tzuo, executive]

And look, that's one of the -- what I believe is the strength of our business, the stickiness and the quality of our installed base.

[Andrew DeGasperi, analyst]

Got it. No, that's really helpful. And then we've heard a lot from partners and businesses about the fairly rapid shift A lot of companies are making towards consumption billing. And I'd be curious if you could give us a sense from where we are there maybe versus a year ago. on demand and then what you've seen some of your larger billing competitors that maybe didn't play in the subscription space as a niche do, if at all, to address total monetization.

[Tien Tzuo, executive]

Well, what we're so excited about this total monetization phrase. It's just to remind folks that, hey, consumption is certainly on the upswing. But when you look from a long period of time, especially if you look at more mature industries like the telecom industry, you're going to always see a collection or a hybrid set of different ways of pricing, prepaid models, postpaid models, consumption arrears and advance, all sorts of things. And so look, we're excited really about the capabilities that we have. We talked about how our advanced consumption model has over 50 customers have signed up.

One of the big drivers that Robbie talked about, with a big call center application company that was a Zuora Revenue customer that signed up for Zuora Billing, that was also driven by the need to do consumption usage base. If you look at consumption made models and you look at the call center market, because of AI, it's one of the big areas where you're seeing consumption models explode and we're certainly a beneficiary of that.

And of course, the last thing was the Togai acquisition, right? When you look at these consumption models, we do a great job on that billing, the rating capabilities. The more and more we're seeing developers hey, how do we even grab the data from our systems put into place that can be metered, can be rated where the salespeople can see it. The customers can see it. And that turns out to be a big, big challenging space. Togai had a fantastic solution for it, and we're pretty excited about adding that company, that capability and that new collection of great folks into our organization.

[Operator]

Your next question comes from the line of Joseph Vafi with Canaccord.

[Joseph Vafi, analyst]

Just one on Togai, I know you mentioned that current revenue there is kind of de minimis. Just wanted to drill down a little bit into how ready for prime time, the solution set is given that they really didn't have much revenue yet. Is it ready to sell and become part of your cross-sell efforts in the base now or is there some more R&D that needs to be done before you roll it out? And then I have a quick follow-up.

[Tien Tzuo, executive]

Yes. Look, this is -- when it comes to usage metering, I'll call it, usage capture, metering, rating. It's a fairly new space. You're really seeing 2 types of companies. You're really seeing young startups that are, call it, under 2 years old and you're seeing maybe companies come out of the telecom sector that are 20, 30 years old that they really have more dated old technology. We looked at them all. And I got to say, we were most excited about the technology that this group of folks have built.

If you dig into their background, they're successful entrepreneurs. They've built successful companies in the past. We think it's a great product. We think it is ready for prime time. Obviously, we're going to take, call it, weeks, not quarters to do some integration of the products together. But we've been already obviously showing this to our customer base and getting a lot of good positive response. .

[Joseph Vafi, analyst]

Okay. That's helpful. And then I know the large deal activity slowed down, but I think you did sign 2 in the quarter. Anything to note there on kind of why those customers are moving forward, I guess, a critical need or maybe changes in their operating environment that required or whatever you want to add on that?

[Tien Tzuo, executive]

I'll let Todd add some color, but I do want to stress that we are still seeing big deals. What we're seeing big deals is in our customer base. And that really speaks to the quality, durability and expansion potential that we have in our customer base and again, I really do believe that, that is the strength of the business. What we're seeing though is when a company is signing on a new vendor, they're going to be a little bit more cautious in that area.

[Todd McElhatton, executive]

Yes. I mean adding on to what Ken said, Joe, is both of these were installed base customers, and it really plays to the strength of the Zuora product. One of them we're able to monetize as they continue to grow and take advantage of that. And the other 1 takes advantage of our having a multiproduct portfolio. So they started with Zuora Revenue. Now we're moving them to Zuora Billing. And in fact, that billing is a takeaway from a large competitor.

[Operator]

Your next question comes from the line of Brent Thill with Jefferies.

[Luv Sodha, analyst]

This is Luv Sodha here for Brent Thill. Maybe the first one on ARR growth. So the sequential change in ARR was -- it declined pretty meaningfully this quarter. I guess, could you help us parse out, how much of the impact was from the churn versus macro? And what gives you confidence that this could rebound in the second half of the year?

[Todd McElhatton, executive]

Thanks for the questions. So I want to tease this out into 3 parts. One is our expansion. The second is our new logo and the third is our churn. And so on expansion, we felt we did really well there. We did pretty much as expected, and it really speaks to the quality of our customer installed base. On the new logos, we have a little bit of a slower start, but we always know that Q1 is our lightest quarter, and we're seeing nice acceleration in the pipeline, and that certainly is 1 of the things that gives us confidence for reaching the range for the full year. And finally, the churn is what we talked about onetime events. We talked about that last quarter, and that played out as expected.

So look, it's a challenging macro environment. But if I look at the quality of the specialty of our installed base, which I think is going to drive an awful lot of our bookings this year, I look at our product, the pipeline, what happens -- what's happening with Togai. We believe we've got the material that we need to exit the year at 8% to 10% ARR growth.

[Luv Sodha, analyst]

Got it. That's super helpful. And then I just wanted to ask a quick follow-up on the efficiency initiatives that you have put in place. Could you just talk to us about what stage of the innings are we in, in terms of driving those efficiency initiatives and is there more room in terms of pushing the inbound motion to deliver further profitability as the year goes on?

[Todd McElhatton, executive]

So thanks a lot Luv for that question also. I feel really good. We've done a lot of hard work on the cost structure. We have in place a very robust business. And frankly, we've got the capacity to deliver a lot more revenue without adding a whole lot of incremental costs. That gives me a lot of confidence on being able to meet our profit objectives. In fact, as you saw, not only absorbing all of the Toga costs, but I raised the midpoint of where our guidance is for profitability for the year. And we're never going to be done. We're constantly taking a look at the -- where we are in the business, where we can sit there and get incremental improvements, and we're working on that.

I think if you noticed, for example, we actually in absolute dollars, down about 10% in our go-to-market spend. So we feel like there's still more room to continue to optimize and get more efficient. And we've also got the capacity to deliver a lot more revenue with the current structure we have in place.

[Tien Tzuo, executive]

Yes. [indiscernible], just in case, I'll answer maybe the flip side of the question, which I think is might be what you're asking. I'll give you a stat. I mean, we're generating more pipeline with fewer people than we did 2 quarters ago because we're just getting much more efficient and smart about it.

[Operator]

We have time for 1 more question, and this comes from the line of Jacob Stephan of Lake Street.

[Jacob Stephan, analyst]

Tien, I wanted to get some clarity. I think you made a comment about switching to kind of a new sort of lead gen strategy. I just want to get any color that you have on that.

[Tien Tzuo, executive]

Yes. So I would say it's an evolution not an entire change, but if you talk to other companies in the industry, other SaaS companies, certainly, it feels like at a at a higher level, right, an industry level, outbound cold calling through business development reps is not paying off as well as it might have been 2, 3, 4 years ago. And if you look at our value prop we certainly are the leading advantage list of the subscription economy, but you're seeing people really come to us for different needs. You can see we have the need now to serve as a controller. We can service an AR team, we can service a developer.

And so we are switching more towards a classic inbound model, and we're finding that to be much more efficient and we're using more digital technologies versus human labor. And as you might suspect, AI tools are certainly a big, big part of that as well. So we're just learning to be much more efficient in the current environment and how to generate pipeline and we think it's paying dividends.

[Jacob Stephan, analyst]

Okay. Yes. Understood. That's helpful. And maybe just kind of -- I'll ask the free cash flow question here. You guys kept guidance at $80 million plus. You did 40% of that in Q1 here. You guided up on adjusted operating income. And you've also got a pretty sizable war chest on the balance sheet. So I mean, what are the capital allocation plans look like here in the future?

[Todd McElhatton, executive]

Yes. So thanks a lot for the question. So Q4, remember, we have a tremendous amount of billings as a lot of enterprise SaaS companies do. So that drives a lot of our collection activity that happens in the first quarter. So you always see a very strong Q1 that will normalize back to normal trends as we move through the year. So we're really comfortable about where the $80 million plus is. So we're going to keep that where it is. We're also absorbing the Togai.

Look, we would expect to see from a capital allocation perspective, similar probably, let's say, $3 million a quarter of CapEx as we go through the rest of the year. And then obviously, you're right, we've got a very nice balance sheet and we'll continue to use that where it makes sense for acquisitions, tuck-ins like with Togai that will help us accelerate our growth and accelerate our product road map.

[Tien Tzuo, executive]

I think that's exactly right. I think the growth in free cash flow in the war chest as you put it, are 2 big highlights to our story.

[Todd McElhatton, executive]

It's a great time to have a lot of cash.

[Jacob Stephan, analyst]

Yes. Yes, absolutely. Okay. That's helpful. Maybe just one more here. Todd, you kind of mentioned Q2 and Q3 ARR growth might fall slightly below kind of that 8% to 10% range. But just for a clarification that the 8% to 10% will be exiting the year. I guess what kind of gives you confidence in the ramp up in Q4.

[Todd McElhatton, executive]

Yes. So we expect to exit the year at the 8% to 10%. And as I said, what gives me confidence is extremely strong installed base, what we're seeing from the needs from our customers, how we're seeing the pipeline develop. And so when I look at pipeline development, product installed base customers, that gives us the confidence that we'll be able to exit the year at the 8% to 10% ARR growth.

[Tien Tzuo, executive]

Including having a new meaningful product in our portfolio that's servicing this consumption filling demand that certainly, we're all seeing in the marketplace.

[Operator]

That concludes our Q&A session. I will now turn the conference back over to Tien Tzuo for closing remarks.

[Tien Tzuo, executive]

Thank you. Well, thank you, everyone, for joining us today. I want to offer up a big thank you to all our CEOs, including the new CEO that have joined us from Togai. Our CEO's commitment really is what powers our future in this new era of total monetization. Thank you all very much.

[Operator]

Ladies and gentlemen, that concludes today's call. Thank you all for joining. You may now disconnect.