American Reprographics Co (ARC) - first comment about ARC's Q2 2011 Results

First comment about ARC’s Q2 2011 results (I will likely have additional comments about ARC’s Q2 2011 results, after I’ve set-aside time to review the financials in more detail and to review the transcript of the earnings call.

But, for now, here’s a sentence that appeared in the Press Release about ARC’s Q2 2011 results:

ARC's net loss for the second quarter was $84.6 million or a loss of $1.87 per diluted share, primarily due to the recording of a goodwill impairment charge in the amount of $23.3 million and a deferred tax asset valuation allowance of $64.3 million.

Comment: Previously (if my memory serves me correctly, three times in the past we’ve seen ARC take charges for “goodwill impairment.” But, the charge ARC took in Q2 for “deferred tax asset valuation allowance” was a new one.

For those of you who are interested in learning more about the valuation allowance – the hit, if you will, to ARC’s income statement for Q2 2011, here’s some information – courtesy of a national CPA firm’s web-site – about that type of hit:

Deferred Tax Assets and the Need for a Valuation Allowance

Deferred tax assets are the deferred tax consequences attributable to deductible temporary differences and carryforwards. After the deferred tax asset has been measured using the applicable enacted tax rate and provisions of the enacted tax law, it is then necessary to assess the need for a valuation allowance. A valuation allowance is needed when, based on the weight of the available evidence, it is more likely than not (a likelihood of more than 50 percent) that some portion or all of a deferred tax asset will not be realized. Realization of a deferred tax asset is dependent on whether there will be sufficient future taxable income of the appropriate character (e.g., ordinary income, capital gain income) in the period during which deductible temporary differences reverse or within the carryback and carryforward periods available under the tax law. Assessing the need for, or the sufficiency of, a valuation allowance will require management to evaluate all available evidence, both negative and positive. When negative evidence (e.g., cumulative losses in recent years, history of operating loss or tax credit carryforwards expiring unused) exists, more positive evidence will be necessary. Objective negative evidence is difficult to overcome. At the heart of positive evidence necessary to overcome the negative evidence is future taxable income of sufficient amounts and character within the carryback and carryforward periods available under the tax law. The following sources of taxable income may be available under the tax law to realize a portion or all of a tax benefit for deductible temporary differences and carryforwards: • Future reversals of existing taxable temporary differences • Taxable income in prior carryback year(s) if carryback is permitted under the tax law • Tax planning strategies • Future taxable income exclusive of reversing temporary differences and carryforwards Management must usually prepare budgets or projections to document potential future taxable income. Auditors need to carefully evaluate the reasonableness and achievability, especially of the key assumptions, on which the forward-looking information depends. Whenever deferred tax assets are material, and especially if those assets are measured on operating loss and tax credit carryforwards, management's skills and auditors' professional skepticism need to be carefully applied and appropriately documented. In making "real-time" judgments about the valuation allowance, it should also be remembered that those judgments will be subject to second-guessing by those who have perfect hindsight. Further, the Securities and Exchange Commission expects certain disclosures in management's discussion and analysis of financial condition and results of operations about the "quality" of deferred tax assets. If significant objective negative evidence indicates uncertainty regarding realization of the deferred tax asset, the countervailing positive evidence relied upon by management in its decision not to establish a full allowance against the asset should be identified.