Financial reporting considerations for TMT companies during a rocky 2023

Economic headwinds and banking turmoil during the first half of 2023 caused an array of lingering problems in the technology, media, and telecom (TMT) industry, including a decrease in company valuations, a slowdown in access to the capital markets, and widespread layoffs.

“Many audit committees are asking their management teams to provide updates on areas where there could be concentration risk in the business, including customer and vendor relationships,” says Kevin Reagan, RSM’s TMT industry audit leader. “That’s something management teams should be thinking about.”

Reagan joined Sean Trepanier, RSM’s TMT audit policy leader, and Mike Lundberg, RSM’s industry audit policy leader, for a 10-minute discussion about the latest business issues and accounting implications facing TMT companies. Below is a transcript of the discussion, edited for clarity and length.

They covered the following topics, with the corresponding timestamp noted for your convenience:

• Why the first half of 2023 was rocky for TMT companies of all sizes (1:14)
• An opportunity that spawned from difficulties in the industry (3:32)
• Triggers for testing for goodwill impairment (4:44)
• Details about going concern and what boards of directors should be thinking about (7:26)

Mike Lundberg: Kevin, what business trends stand out to you most right now?

Kevin Reagan: Mike, 2023 has been a difficult year, and TMT companies have not been immune to the global macroeconomic headwinds that we've all experienced. While inflation is cooling, the Fed’s rapid rise in interest rates has had a very negative impact on company valuations, and the result has been an increase in market volatility and, effectively, a pause in initial public offering (IPO) market activity.

We haven't seen this type of pause in a number of years, and, in fact, only a few companies in the tech sector have been able to successfully capitalize on accessing the capital markets with either an IPO or de-SPAC (i.e., when a private company merges with a special purpose acquisition company).

Also, [the failure of] Silicon Valley Bank had a significant impact on many of our tech clients earlier in the year, and [although] the uncertainty in the banking sector has been largely resolved, this event, as well as the recent geopolitical tensions, have highlighted the need to continue to monitor concentration risk.

Many audit committees are asking their management teams to provide updates on areas where there could be concentration risk in the business, including customer and vendor relationships. That’s something management teams should be thinking about.

ML: Kevin, it's certainly been an interesting year. Given the current economic conditions, what threats or pitfalls are facing TMT organizations?

KR: Yeah, Mike, there are certainly a number of threats. But I have to say above all else, at this time, for the tech companies, maintaining sufficient cash and sources of liquidity is so critical due to the lower capital markets activity that we just discussed.

And many companies are struggling with obtaining financing, which is becoming much more challenging. So, in light of this, companies should revisit their cash burn. Really, the best way to prepare for an economic downturn is to reduce the business's cash burn rate and thus extend your cash runway.

ML: Thinking a little more positively, Kevin, what opportunities are out there that organizations are poised to take advantage of?

KR: Until recently middle market tech companies have been in a war for talent, but quite frankly they've been in a losing battle against the large public tech companies.

However, with the climbing interest rates and stubborn inflation that we've seen over the past six to nine months, many big tech companies have turned to layoffs as a means of managing their profitability and share price. This has created an opportunity for middle market companies to attract quality talent that is now available, and we're seeing that with many of our clients.

ML: Sean, thinking about the accounting and financial reporting implications of this, what comes to mind as some of the key priorities here?

Sean Trepanier: The first area that comes to mind is the impairment of goodwill and long-lived assets. Many of our TMT clients are acquisitive. They've made prior acquisitions, and as a result, they have goodwill and long-lived assets on their balance sheets.

And just as a reminder, companies are required to test for goodwill impairment annually, but also on an interim basis if there are certain triggers. A lot of these trends that Kevin just described are potential triggers. If we look into the accounting guidance, ASC 350 actually lists seven examples. And five of those examples are very closely related to the trends that Kevin just mentioned. I'll just run through them briefly.

The first triggering event would be just a general deterioration in general economic conditions or limits in accessing the capital markets, as Kevin was just discussing.

The second is more general industry or market considerations, such as deterioration in the environment which the company operates in or decline in market multiples.

The third is cost factors, so increases in raw materials or labor that could have a negative effect on earnings and cash flow.

And then you just have overall financial performance. A lot of companies right now are struggling to meet those forecasts. And so negative or declining cash flows or a decline in actual or planned revenue are also triggering events.

And then finally, if a company is publicly traded, a sustained decrease in share price is also another example of a triggering event. And as we just were discussing, many tech companies have seen that sustained decrease in share price.

So there are no bright lines here. This is just a list of examples. However, if multiple factors are in play, there's just a stronger indication that there's potential impairment.

ML: Sean, is this something that we can just wait and see if things get better before the end of the year? Or what happens if you meet a trigger, but then it gets better by the end of the year?

ST: No, unfortunately, under the guidance, you have to look at those triggers. If those triggers are there, and it's more likely than not that there's impairment, you would do that assessment on an interim basis. And so another important reminder too is that also not just waiting until year-end, but also the order in which you do the test.

You don't just jump right into goodwill. First, you look at property and equipment, finite-lived intangible assets, like customer relationships or developed technology, as well as right-of-use assets. And those fall under the guidance of ASC 360, and you look for impairment there first. If there's impairment, you record that, and then you move on to the goodwill impairment test, which should be done under ASC 350.

Just switching gears here a bit, the other relevant financial topic that goes along with these trends is going concern. And I just want to provide a few reminders here.

Going concern is not just an auditor consideration; it's also required by the standards to be assessed by management and in accordance with ASC 205. It's required for annual periods, as well as interim periods for public companies.

And just to review some of the terminology that's used in the standard: It refers to a look-forward period, which is defined as 12 months, so we're looking out for a year period.

And it also defines the assessment date. It's not the balance sheet or reporting date, but it's the date that the financials are issued or available to be issued. So we're looking a year out from the issuance of the financial statements.

What we're looking for is whether it's probable or more likely than not that the entity will not be able to meet its obligations. You also need to look at your current debt maturities and whether companies can meet that debt in the coming year, as well as potential noncompliance and forecasted noncompliance with debt covenants.

Finally, for many companies, because of the increase in interest rates, cash flow forecasts have been impacted by the higher interest rate costs because many of our companies haven’t hedged against interest rate risk.

Moving on to the going concern framework, it revolves around disclosure requirements. So you have three possible outcomes of this. If you do the assessment and there's no substantial doubt, then there's no disclosure in the financial statements.

Now, if substantial doubt does exist, but management has been able to mitigate it through certain plans that they can carry out, then you disclose those plans. And then, if doubt is not alleviated, you're required to have an explicit statement in the financial statements that indicates that substantial doubt exists.

And so, for boards and management, we just want to be proactive and thinking about these matters ahead of time, before the audit.