Change in NWC & CapEx Assumptions

Good post, but one correction; a range of tech companies esp. in the software space capitalize R&D (e.g. 50%); not everything is expensed...

I’ll acknowledge I don’t know the software space generally and in my limited experience R&D is capitalized. So if I’m wrong about it being standard then I’m wrong.

I surrender. And thank you bringing this up. It is what makes the forums great. Pushing back on people. What was clear in my though process was not clear in my answer.

Notice I never said anything about S&M, R&D, or G&A. I was more attempting to convey that even in an industry like cloud software where there is "zero marginal cost (more like 10 - 25%)" and most expenses are recognized before the line there is still CapEx (more details below). However, the CapEx matches your industry. Why I started with industrials as my main example. I am a software guy and had just finished watching Zoom's analyst day when they were discussing future growth so it was top of mind. To assume that CapEx is immaterial for any company as a general rule of thumb is a mistake.

Also I agree with the point that when looking at the value of a company R&D should often be capitalized. Investments in current periods that will yield greater returns in future periods and should be amortized over its useful life. Damodaran has a great discussion on this. However, because it is hard to match those two up GAAP calls for expensing most of your R&D spend. 

In terms of capitalizing software, it is governed by two principles: ASC 985

For external delivery, until a technology has reached technological feasibility, all cost incurred up to that point will need to be expensed when incurred

And ASC 350

If a company is developing software internally solely to meet the company’s internal needs, then costs can begin to be capitalized once the product has passed its preliminary project stage and into the application development stage

Because of the barrier is so much higher in developing for external use (sold to customers) we often see more of these expenses expensed in R&D at a point-in-time than internal-use software which is typically more generously capitalized. It is a bit of a toss-up but most of the leading public tech companies recognize their expenses this way: MSFT, CRM, WDAY, ORCL etc. Further often what see capitalized in external facing costs are the implementation costs that can be easily analyzed on the time period for which they are to be amortized.

For reference the MD&A from one cloud company relating to their capitalized delivery costs.

We capitalize certain implementation costs incurred in a cloud computing arrangement during the application development stage. Costs incurred in the preliminary stages of development are analogous to research and development activities and are expensed as incurred. The preliminary stage includes activities such as formulation and evaluation of alternatives, determination of existence of needed technology, and final selection of alternatives. Once the application development stage is reached, internal and external costs are capitalized until the hosted software is ready for its intended use. Capitalized implementation costs are recorded as deferred costs, and are included in prepaid expenses and other current assets and other assets, noncurrent in the condensed consolidated balance sheets. Maintenance, minor upgrades, and training costs are expensed as incurred. Capitalized implementation costs are amortized over the term of the hosting arrangement on a straight-line basis, and are recorded under operating expenses in the same line item in the condensed consolidated statements of operations as the expense for fees for the associated hosting arrangement. The capitalized implementation costs were not material during the three months ended April 30, 2020.

However, for sake of discussion as these are not what we would all consider "traditional capital expenditures" and GAAP doesn't always match with Damodaran we will ignore capitalized software for the sake of the below analysis.

Turning back to Zoom what my post should have read to be more clear was:

Remember that CapEx is very dependent on industry and how much in fixed permanent assets you need to grow. While Zoom expenses most of their delivery costs, they will have a lot of future CapEx (as compared to their peers) not only tied to building out infrastructure, but opening more offices so that they can step up the pace on hiring very high quality talent diversified around the world like you need for a company that is trying to hit their targeted scale.

Turning to Zoom's MD&A

Future capital requirements will depend on many factors, including our revenue growth rate, subscription renewal activity, billing frequency, the timing and extent of spending to support further sales and marketing and research and development efforts, as well as expenses associated with our international expansion, and the timing and extent of additional capital expenditures to invest in existing and new office spaces

Looking ahead, we expect to increase capital expenditures for additional data center infrastructure

To conclude most types of businesses require some form of fixed investment. It may not be as material as an industrial or healthcare firm, but they do need to be examined. Just because I have don't have to build factories or Hospitals doesn't mean the investments into the computers, office space renovations, furniture, displays, kitchens, servers etc. needed to support my growth are free and depreciated over time.

At the end of the day, it still remains a tool to help true up EBIT or Net Income to cash flows.

Hopefully that clears my writing up a bit. Thanks for pushing back and calling me out.