Rogue Missives -- February 28, 1997 -- Iomega Tax Benefits on the Way?

Rogue Missives

ROGUE ARCHIVES

Friday, February 28, 1997

Iomega Tax Benefits on the Way?
by Louis Corrigan (RgeSeymour)
There's no doubt that Americans usually feel uneasy about large U.S. corporations relocating their manufacturing facilities overseas. Globalization often seems to mean something very simple: U.S. workers losing out to cheaper labor somewhere in the developing world.
Of course, some people do live and breathe a kind of Darwinian view of capitalism that makes such displacements easy to justify. In this view, any "more efficient" use of capital resources will lead to inevitable benefits, and eventually, even for those workers who are displaced. For one thing, lowering production costs will ultimately keep prices in check, benefiting all consumers. Still, when it comes to mass lay-offs, most of us just feel a kind of creeping there-but-for-the-grace-of-god anxiety that makes the new world order feel as though it's built on quicksand.
As individual investors, in particular, we find ourselves in a particularly uncomfortable position. After all, shareholders are the chief beneficiaries of these reduced labor costs since the savings usually lead to fatter corporate profits. Indeed, there are some instances where it's easy for individual investors to understand how reducing manufacturing costs is absolutely critical to a company's long-term strategy. But as owners of these companies, investors face the basic question: how do we balance our personal financial interests against our sense of social justice?
Aside from simply abstaining from investing, there doesn't seem to be any great way for us to assuage our consciences on the matter, nor any easy way to deny or reverse our complicity with the sometimes ruthless truths of capitalism. Because there are no simple solutions, the labor market will continue to undergo globalization.
Still, if we're going to have the proverbial blood on our hands, it's worth our while as investors to understand the full benefits we stand to enjoy from these shifts of jobs overseas to low-wage countries. The benefits, in fact, go far beyond lower wage costs. One of the most important advantage of shifting production jobs to developing countries may be the sizable tax savings available to U.S. corporations doing business overseas. That's because companies don't have to pay U.S. taxes on income generated from international operations if the money isn't distributed to the U.S. Further, developing countries hungering for the benefits of technology transfer often make it worth a company's while financially to re-invest that income in the local operations.
Dale Velk, a frequent contributor to the Fool message boards, recently composed an astute series of posts to the IOMEGA <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IOM)") else Response.Write("(NYSE: IOM)") end if %> board which highlighted this little-appreciated fact. Indeed, though his posts were entitled "Pure Speculation," they offered some compelling evidence to suggest that Iomega's fiscal year 1997 earnings could be significantly above analyst projections simply because of reductions in the company's tax rate.
What applies to Iomega may apply to other companies that have moved or are planning to move plants to Malaysia, Singapore, or other countries where governments eagerly hand out tax-holidays in their effort to attract high-tech companies. DELL COMPUTER <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DELL)") else Response.Write("(Nasdaq: DELL)") end if %> and 3COM <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: COMS)") else Response.Write("(Nasdaq: COMS)") end if %> are two companies likely to benefit.
The Iomega story begins on July 18th, when the company announced its intent to purchase a 376,000 feet production facility in Penang, Malaysia from the disk-drive maker QUANTUM CORPORATION <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: QNTM)") else Response.Write("(Nasdaq: QNTM)") end if %>. Because Iomega decided to employ most of the existing workers at the plant, production of the company's removable Zip drives ramped up rather quickly, beginning the last week of August.
By the third quarter analyst conference call in mid-October, Iomega CEO Kim Edwards was already saying that the success of the Penang ramp was leading the company to reevaluate its worldwide production plans. By December, it became clear that the company would no longer need SEAGATE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:SEG)") else Response.Write("(NYSE:SEG)") end if %> as a manufacturer of Jaz drive cartridges.
On December 30th, Iomega announced definitive plans to close down most of its production operations in Roy, Utah, the company's headquarters. The Penang facility had achieved quality standards that met or exceeded that seen at the company's other manufacturing locations, so it would now perform the bulk of Iomega's production work. Starting in March, about 500 to 700 Iomega workers in Roy will be let go. They'll receive four weeks severance pay plus an extra week for every year they've worked for Iomega.
Individual investors in the Fool's Iomega folder generally expressed regrets mixed with enthusiasm. The idea of Iomega's Roy employees working long hours and weekend shifts to crank out Zip drives had long warmed the hearts of the company's investors. A number of posters wished these employees well or regretted that such bad news had to come during the holiday season.
Still, labor is inexpensive in Malaysia. Iomega officials said that Malaysian workers typically make about 20% of U.S. wages, and those Roy workers were earning about $7 to $14 an hour, the company said. Few investors grumbled at the implications.
After all, Iomega has long stated it goal to bring Zip drive prices down to the consumer sweet spot of $99 for an external drive. Even with other cost savings expected from a chip-buying arrangement with INTEL <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: INTC)") else Response.Write("(Nasdaq: INTC)") end if %>, both the company and its shareholders would benefit from other efforts to drop drive prices as soon as possible. In this razor/blade business, getting millions of drives out onto the market offers the best way to grow margins through increased disk sales.
Lower labor costs were only part of the story, though. Wayne Stewart, Iomega's chief operating officer, said in December that the move to Penang would put Iomega's manufacturing operations closer to its suppliers. This would further reduce shipping and handling costs.
Edwards reiterated the broader advantages of the move in the late January analyst conference call. Not only are labor costs lower in Penang, so too is the overall overhead structure. Plus, shortening the delivery time from vendors has the added benefit of improving the company's use of capital. "So we'd certainly expect to have a benefit going forward," he said.
At the end of the call, Joe Besecker, an analyst with Pennsylvania-based Emerald Research, asked for some guidance regarding the company's tax rate for fiscal year '97. Recently, the company has been stuck paying a very high 38.6% tax rate. Leonard Purkis, Iomega's chief financial officer (CFO), suggested that the company was making a new effort to take advantage of tax benefits in managing the business.
"To the extent that we get tax rulings and holidays that are available to us in Europe, Malaysia, and the Far East," Purkis said, "we have worked with the business to include a tax-efficient structure in that decision-making process. So taxes are now an integral part of our business strategy. The tax structure and negotiations on holidays, if they're successful, should lower the overall tax rate of Iomega in 1997."
Edwards added that it was too soon to offer a figure on the tax rate. "[W]e still have a lot of this under negotiation." How these negotiations turn out could have "a very big swing on our actual results." He said the company should have a better handle on the matter by the second quarter, but that at the moment, any number would be "pure speculation."
What isn't speculation is that Malaysia is anxious to attract foreign high-tech investment. Prime Minister Mahathir Mohamad recently travelled to Silicon Valley to stir up interest in an ambitious new 25-year plan to turn a 9-by-30 mile stretch of largely rural Malaysia into a "multimedia supercorridor" (MSC). A new city to be named Cyberjava would serve as a center for education and research & development. American companies such as SUN MICROSYSTEMS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SUNW)") else Response.Write("(Nasdaq: SUNW)") end if %>, ORACLE <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ORCL)") else Response.Write("(Nasdaq: ORCL)") end if %>, HEWLETT-PACKARD <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HWP)") else Response.Write("(NYSE: HWP)") end if %>, MICROSOFT <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MSFT)") else Response.Write("(Nasdaq: MSFT)") end if %>, and NETSCAPE <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: NSCP)") else Response.Write("(Nasdaq: NSCP)") end if %> are among those companies that might participate in the project. Numerous telecom companies also have been battling to wire the peninsula with the necessary infrastructure.
Bill Gates's visit with the Malaysian Prime Minister last summer also sparked talk in Singapore that the two contiguous countries might need to think about reuniting, despite some significant cultural differences between them.
What's happening is that developing countries first lure multinationals with cheap labor for manufacturing in hopes that over time, tax incentives will help induce those companies to develop more important R & D facilities in the area. Simultaneously, it's becoming clear that having a regional presence makes increasing sense for multinationals since these developing economies are growing into significant markets for finished goods rather than just sources of cheap manufacturing.
Yet as these changes take place, areas such as Singapore, that have a more educated and thus higher-payed workforce, find they must compete with less developed countries such as Malaysia in order to maintain their relative trade position. The result is that even with increased economic activity in the developing world, tax incentives are probably here to stay for the foreseeable future.
The benefits to corporate America can be enormous. In Malaysia, for example, the corporate tax rate is 30%. Some manufacturing companies, however, need pay no taxes on 70% of their income for up to five years.
High-tech companies can get even better deals. Companies given "pioneer status" can be wholly exempted from taxes for five years. Malaysia can be even more generous to companies engaged in "strategic projects," or those "with heavy capital investment and high technology... which have significant impact on the Malaysian economy," according to guidelines provided by the Malaysian Industrial Development Authority. Such firms can receive complete tax exemption for ten years.
Exactly how such potential "tax holidays" could play out for Iomega is yet unknown. Neither Purkis nor Iomega Treasurer Robert Simmons were available this week to discuss the company's progress in negotiating potential tax breaks in Malaysia or elsewhere. But it at least seems possible that the company's $28 million payment for the Penang facility could come from income generated by the company's Malaysian operations. If this income was not distributed to the U.S. and yet was treated preferentially in terms of Malaysian taxes, the company could perhaps pay for the facility in untaxed income, saving Iomega millions of dollars.
That's "pure speculation," but it's also only one of some potentially long-term advantages of the relocation to Penang. Velk's posts on the subject bring to light some instructive comparisons.
For example, the disk drive maker WESTERN DIGITAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WDC)") else Response.Write("(NYSE: WDC)") end if %> has recently operated under an effective tax rate of just 10% in 1996 and 15% in the previous two years. The company's most recent 10K, filed September 18, 1996, spelled out the matter.
"Certain income of selected subsidiaries is taxed at substantially lower income tax rates as compared with local statutory rates. The lower rates reduced income taxes and increased net earnings by $30.1 million ($0.62 per share, fully diluted), $33.2 million ($0.65 per share, fully diluted) and $27.4 million ($0.60 per share, fully diluted) in 1996, 1995 and 1994, respectively. These lower rates are in effect through 2004."
At the end of last June, Western Digital has accumulated $261.6 million in earnings from international operations which it had not "distributed" to the American parent company and thus did not have to submit to U.S. tax charges. "The net undistributed earnings are intended to finance local operating requirements," according to the 10K.
Velk also pointed to Seagate, which expects to have an effective tax rate of 28% for FY97. The company's most recent 10K, filed August 23, 1996, indicated that Seagate distributed 64% of its income from foreign subsidiaries back to the U.S. parent. This means the company avoided paying U.S. taxes on about a third of its income from abroad. Again, the tax-savings add up for investors.
"A substantial portion of the Company’s Far East manufacturing operations in Singapore, Thailand, Malaysia and China operate free of tax under various tax holidays which expire in whole or in part during fiscal years 1997 through 2000. The net impact of these tax holidays was to increase net income by approximately $50,398,000 ($0.43 per share, fully diluted) in 1996 and approximately $59,788,000 ($0.48 per share, fully diluted) in 1995."
On January 24th, The Wall Street Journal reported that both PACKARD BELL-NEC and Dell Computer had been awarded the prized "strategic-project status" by the Malaysian authorities, giving them a ten-year tax exemption. Packard Bell-NEC plans to build a new factory in Penang, which could produce up to a million PCs annually by the turn of the century.
Dell, on the other hand, seems to have sweetened the deal it already had. In 1995, the company won a five-year tax holiday when it completed a $20 million, 238,000 square foot PC manufacturing facility in Penang. The Journal reported that the company has been working for the past year and a half to improve the deal.
Dell's year old 10K, filed March 28, 1996, shows that the company's effective tax rate for FY96 was just 29%, in part due to tax savings from international operations. The company's income before taxes was $176 million for FY96 and $126 million for FY95. "The Company has not recorded a deferred income tax liability of approximately $70 million for additional U.S. federal income taxes that would result from the distribution of earnings of its foreign subsidiaries, if they were repatriated. The Company currently intends to reinvest indefinitely the undistributed earnings of its foreign subsidiaries."
3COM may also benefit from tax holidays in the future. Last November, the company announced plans to build a $70 million manufacturing, testing, and training facility in Singapore. Construction began in December and the plant should be occupied by the third quarter of FY98.
The company's recent 10Q, filed January 13, 1997, indicates that for the first six months of FY97, 3COM's effective tax rate was 36.4%, or 35% excluding various merger costs that were not tax deductible. Given those numbers, 3COM's earnings could benefit from the new plant if the company can negotiate an attractive tax agreement with the Singapore authorities.
As for Iomega, Emerald's Besecker thinks that Velk may be onto something. Though he hadn't read Velk's post, an associate had told him about it. "I think [he's] close to being on the money." Besecker said that while he wasn't sure Iomega had the tax holiday information in hand yet, "we certainly have been led to believe that there's a better than 50% chance that they will have significant tax savings because of it."
Besecker's estimates include the assumption that Iomega's tax rate will drop to 36%. "I feel very comfortable at 36%. I feel as if we're being overly conservative.... We're pretty confident that they're going to have a much lower tax rate, but we're not exactly sure how to quantify that at this time."
Besecker wonders, though, whether the market will even react to the news once Iomega makes it public. "I've seen plenty of stocks that have been punished because of increased tax rates. But it doesn't always work the other way. They can say, 'Well, that's not really core business. That's just tax manipulation.' And with Iomega, you never know how people are going to react. I feel comfortable, though, that [the company is] going to show a lot more on the bottom line. That's why the move [to Penang] was so significant."
Velk's posts, though, offered more than just another potential reason for some recently glum Iomega investors to get excited. He ultimately helped illuminate an area that most investors and commentators tend to overlook.
America's public companies, particularly high-tech companies, continue to move operations overseas, but the reasons for the move go beyond simply chasing after cheap labor. Operational issues as well as tax issues play an important role as well. To the degree that these companies can negotiate favorable tax deals with local governments and recycle that income within the developing countries, individual investors may be in for some positive earnings surprises. In term, investors who learn to ask the right questions about such moves overseas may discover some unexpected bargains.

--Louis Corrigan (RgeSeymour)

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ROGUE ARCHIVES

Friday, February 28, 1997
Iomega Tax Benefits on the Way? by Louis Corrigan (RgeSeymour) There's no doubt that Americans usually feel uneasy about large U.S. corporations relocating their manufacturing facilities overseas. Globalization often seems to mean something very simple: U.S. workers losing out to cheaper labor somewhere in the developing world. Of course, some people do live and breathe a kind of Darwinian view of capitalism that makes such displacements easy to justify. In this view, any "more efficient" use of capital resources will lead to inevitable benefits, and eventually, even for those workers who are displaced. For one thing, lowering production costs will ultimately keep prices in check, benefiting all consumers. Still, when it comes to mass lay-offs, most of us just feel a kind of creeping there-but-for-the-grace-of-god anxiety that makes the new world order feel as though it's built on quicksand. As individual investors, in particular, we find ourselves in a particularly uncomfortable position. After all, shareholders are the chief beneficiaries of these reduced labor costs since the savings usually lead to fatter corporate profits. Indeed, there are some instances where it's easy for individual investors to understand how reducing manufacturing costs is absolutely critical to a company's long-term strategy. But as owners of these companies, investors face the basic question: how do we balance our personal financial interests against our sense of social justice? Aside from simply abstaining from investing, there doesn't seem to be any great way for us to assuage our consciences on the matter, nor any easy way to deny or reverse our complicity with the sometimes ruthless truths of capitalism. Because there are no simple solutions, the labor market will continue to undergo globalization. Still, if we're going to have the proverbial blood on our hands, it's worth our while as investors to understand the full benefits we stand to enjoy from these shifts of jobs overseas to low-wage countries. The benefits, in fact, go far beyond lower wage costs. One of the most important advantage of shifting production jobs to developing countries may be the sizable tax savings available to U.S. corporations doing business overseas. That's because companies don't have to pay U.S. taxes on income generated from international operations if the money isn't distributed to the U.S. Further, developing countries hungering for the benefits of technology transfer often make it worth a company's while financially to re-invest that income in the local operations. Dale Velk, a frequent contributor to the Fool message boards, recently composed an astute series of posts to the IOMEGA <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IOM)") else Response.Write("(NYSE: IOM)") end if %> board which highlighted this little-appreciated fact. Indeed, though his posts were entitled "Pure Speculation," they offered some compelling evidence to suggest that Iomega's fiscal year 1997 earnings could be significantly above analyst projections simply because of reductions in the company's tax rate. What applies to Iomega may apply to other companies that have moved or are planning to move plants to Malaysia, Singapore, or other countries where governments eagerly hand out tax-holidays in their effort to attract high-tech companies. DELL COMPUTER <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DELL)") else Response.Write("(Nasdaq: DELL)") end if %> and 3COM <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: COMS)") else Response.Write("(Nasdaq: COMS)") end if %> are two companies likely to benefit. The Iomega story begins on July 18th, when the company announced its intent to purchase a 376,000 feet production facility in Penang, Malaysia from the disk-drive maker QUANTUM CORPORATION <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: QNTM)") else Response.Write("(Nasdaq: QNTM)") end if %>. Because Iomega decided to employ most of the existing workers at the plant, production of the company's removable Zip drives ramped up rather quickly, beginning the last week of August. By the third quarter analyst conference call in mid-October, Iomega CEO Kim Edwards was already saying that the success of the Penang ramp was leading the company to reevaluate its worldwide production plans. By December, it became clear that the company would no longer need SEAGATE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:SEG)") else Response.Write("(NYSE:SEG)") end if %> as a manufacturer of Jaz drive cartridges. On December 30th, Iomega announced definitive plans to close down most of its production operations in Roy, Utah, the company's headquarters. The Penang facility had achieved quality standards that met or exceeded that seen at the company's other manufacturing locations, so it would now perform the bulk of Iomega's production work. Starting in March, about 500 to 700 Iomega workers in Roy will be let go. They'll receive four weeks severance pay plus an extra week for every year they've worked for Iomega. Individual investors in the Fool's Iomega folder generally expressed regrets mixed with enthusiasm. The idea of Iomega's Roy employees working long hours and weekend shifts to crank out Zip drives had long warmed the hearts of the company's investors. A number of posters wished these employees well or regretted that such bad news had to come during the holiday season. Still, labor is inexpensive in Malaysia. Iomega officials said that Malaysian workers typically make about 20% of U.S. wages, and those Roy workers were earning about $7 to $14 an hour, the company said. Few investors grumbled at the implications. After all, Iomega has long stated it goal to bring Zip drive prices down to the consumer sweet spot of $99 for an external drive. Even with other cost savings expected from a chip-buying arrangement with INTEL <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: INTC)") else Response.Write("(Nasdaq: INTC)") end if %>, both the company and its shareholders would benefit from other efforts to drop drive prices as soon as possible. In this razor/blade business, getting millions of drives out onto the market offers the best way to grow margins through increased disk sales. Lower labor costs were only part of the story, though. Wayne Stewart, Iomega's chief operating officer, said in December that the move to Penang would put Iomega's manufacturing operations closer to its suppliers. This would further reduce shipping and handling costs. Edwards reiterated the broader advantages of the move in the late January analyst conference call. Not only are labor costs lower in Penang, so too is the overall overhead structure. Plus, shortening the delivery time from vendors has the added benefit of improving the company's use of capital. "So we'd certainly expect to have a benefit going forward," he said. At the end of the call, Joe Besecker, an analyst with Pennsylvania-based Emerald Research, asked for some guidance regarding the company's tax rate for fiscal year '97. Recently, the company has been stuck paying a very high 38.6% tax rate. Leonard Purkis, Iomega's chief financial officer (CFO), suggested that the company was making a new effort to take advantage of tax benefits in managing the business. "To the extent that we get tax rulings and holidays that are available to us in Europe, Malaysia, and the Far East," Purkis said, "we have worked with the business to include a tax-efficient structure in that decision-making process. So taxes are now an integral part of our business strategy. The tax structure and negotiations on holidays, if they're successful, should lower the overall tax rate of Iomega in 1997." Edwards added that it was too soon to offer a figure on the tax rate. "[W]e still have a lot of this under negotiation." How these negotiations turn out could have "a very big swing on our actual results." He said the company should have a better handle on the matter by the second quarter, but that at the moment, any number would be "pure speculation." What isn't speculation is that Malaysia is anxious to attract foreign high-tech investment. Prime Minister Mahathir Mohamad recently travelled to Silicon Valley to stir up interest in an ambitious new 25-year plan to turn a 9-by-30 mile stretch of largely rural Malaysia into a "multimedia supercorridor" (MSC). A new city to be named Cyberjava would serve as a center for education and research & development. American companies such as SUN MICROSYSTEMS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SUNW)") else Response.Write("(Nasdaq: SUNW)") end if %>, ORACLE <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ORCL)") else Response.Write("(Nasdaq: ORCL)") end if %>, HEWLETT-PACKARD <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HWP)") else Response.Write("(NYSE: HWP)") end if %>, MICROSOFT <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MSFT)") else Response.Write("(Nasdaq: MSFT)") end if %>, and NETSCAPE <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: NSCP)") else Response.Write("(Nasdaq: NSCP)") end if %> are among those companies that might participate in the project. Numerous telecom companies also have been battling to wire the peninsula with the necessary infrastructure. Bill Gates's visit with the Malaysian Prime Minister last summer also sparked talk in Singapore that the two contiguous countries might need to think about reuniting, despite some significant cultural differences between them. What's happening is that developing countries first lure multinationals with cheap labor for manufacturing in hopes that over time, tax incentives will help induce those companies to develop more important R & D facilities in the area. Simultaneously, it's becoming clear that having a regional presence makes increasing sense for multinationals since these developing economies are growing into significant markets for finished goods rather than just sources of cheap manufacturing. Yet as these changes take place, areas such as Singapore, that have a more educated and thus higher-payed workforce, find they must compete with less developed countries such as Malaysia in order to maintain their relative trade position. The result is that even with increased economic activity in the developing world, tax incentives are probably here to stay for the foreseeable future. The benefits to corporate America can be enormous. In Malaysia, for example, the corporate tax rate is 30%. Some manufacturing companies, however, need pay no taxes on 70% of their income for up to five years. High-tech companies can get even better deals. Companies given "pioneer status" can be wholly exempted from taxes for five years. Malaysia can be even more generous to companies engaged in "strategic projects," or those "with heavy capital investment and high technology... which have significant impact on the Malaysian economy," according to guidelines provided by the Malaysian Industrial Development Authority. Such firms can receive complete tax exemption for ten years. Exactly how such potential "tax holidays" could play out for Iomega is yet unknown. Neither Purkis nor Iomega Treasurer Robert Simmons were available this week to discuss the company's progress in negotiating potential tax breaks in Malaysia or elsewhere. But it at least seems possible that the company's $28 million payment for the Penang facility could come from income generated by the company's Malaysian operations. If this income was not distributed to the U.S. and yet was treated preferentially in terms of Malaysian taxes, the company could perhaps pay for the facility in untaxed income, saving Iomega millions of dollars. That's "pure speculation," but it's also only one of some potentially long-term advantages of the relocation to Penang. Velk's posts on the subject bring to light some instructive comparisons. For example, the disk drive maker WESTERN DIGITAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WDC)") else Response.Write("(NYSE: WDC)") end if %> has recently operated under an effective tax rate of just 10% in 1996 and 15% in the previous two years. The company's most recent 10K, filed September 18, 1996, spelled out the matter. "Certain income of selected subsidiaries is taxed at substantially lower income tax rates as compared with local statutory rates. The lower rates reduced income taxes and increased net earnings by $30.1 million ($0.62 per share, fully diluted), $33.2 million ($0.65 per share, fully diluted) and $27.4 million ($0.60 per share, fully diluted) in 1996, 1995 and 1994, respectively. These lower rates are in effect through 2004." At the end of last June, Western Digital has accumulated $261.6 million in earnings from international operations which it had not "distributed" to the American parent company and thus did not have to submit to U.S. tax charges. "The net undistributed earnings are intended to finance local operating requirements," according to the 10K. Velk also pointed to Seagate, which expects to have an effective tax rate of 28% for FY97. The company's most recent 10K, filed August 23, 1996, indicated that Seagate distributed 64% of its income from foreign subsidiaries back to the U.S. parent. This means the company avoided paying U.S. taxes on about a third of its income from abroad. Again, the tax-savings add up for investors. "A substantial portion of the Company’s Far East manufacturing operations in Singapore, Thailand, Malaysia and China operate free of tax under various tax holidays which expire in whole or in part during fiscal years 1997 through 2000. The net impact of these tax holidays was to increase net income by approximately $50,398,000 ($0.43 per share, fully diluted) in 1996 and approximately $59,788,000 ($0.48 per share, fully diluted) in 1995." On January 24th, The Wall Street Journal reported that both PACKARD BELL-NEC and Dell Computer had been awarded the prized "strategic-project status" by the Malaysian authorities, giving them a ten-year tax exemption. Packard Bell-NEC plans to build a new factory in Penang, which could produce up to a million PCs annually by the turn of the century. Dell, on the other hand, seems to have sweetened the deal it already had. In 1995, the company won a five-year tax holiday when it completed a $20 million, 238,000 square foot PC manufacturing facility in Penang. The Journal reported that the company has been working for the past year and a half to improve the deal. Dell's year old 10K, filed March 28, 1996, shows that the company's effective tax rate for FY96 was just 29%, in part due to tax savings from international operations. The company's income before taxes was $176 million for FY96 and $126 million for FY95. "The Company has not recorded a deferred income tax liability of approximately $70 million for additional U.S. federal income taxes that would result from the distribution of earnings of its foreign subsidiaries, if they were repatriated. The Company currently intends to reinvest indefinitely the undistributed earnings of its foreign subsidiaries." 3COM may also benefit from tax holidays in the future. Last November, the company announced plans to build a $70 million manufacturing, testing, and training facility in Singapore. Construction began in December and the plant should be occupied by the third quarter of FY98. The company's recent 10Q, filed January 13, 1997, indicates that for the first six months of FY97, 3COM's effective tax rate was 36.4%, or 35% excluding various merger costs that were not tax deductible. Given those numbers, 3COM's earnings could benefit from the new plant if the company can negotiate an attractive tax agreement with the Singapore authorities. As for Iomega, Emerald's Besecker thinks that Velk may be onto something. Though he hadn't read Velk's post, an associate had told him about it. "I think [he's] close to being on the money." Besecker said that while he wasn't sure Iomega had the tax holiday information in hand yet, "we certainly have been led to believe that there's a better than 50% chance that they will have significant tax savings because of it." Besecker's estimates include the assumption that Iomega's tax rate will drop to 36%. "I feel very comfortable at 36%. I feel as if we're being overly conservative.... We're pretty confident that they're going to have a much lower tax rate, but we're not exactly sure how to quantify that at this time." Besecker wonders, though, whether the market will even react to the news once Iomega makes it public. "I've seen plenty of stocks that have been punished because of increased tax rates. But it doesn't always work the other way. They can say, 'Well, that's not really core business. That's just tax manipulation.' And with Iomega, you never know how people are going to react. I feel comfortable, though, that [the company is] going to show a lot more on the bottom line. That's why the move [to Penang] was so significant." Velk's posts, though, offered more than just another potential reason for some recently glum Iomega investors to get excited. He ultimately helped illuminate an area that most investors and commentators tend to overlook. America's public companies, particularly high-tech companies, continue to move operations overseas, but the reasons for the move go beyond simply chasing after cheap labor. Operational issues as well as tax issues play an important role as well. To the degree that these companies can negotiate favorable tax deals with local governments and recycle that income within the developing countries, individual investors may be in for some positive earnings surprises. In term, investors who learn to ask the right questions about such moves overseas may discover some unexpected bargains. --Louis Corrigan (RgeSeymour)