Year Ended March 31, 2009 Compared to Year Ended March 31, 2008


Net Sales
The Company's net sales for the year ended March 31, 2009 were $131,738,000, a decrease of $12,068,000 or 8.4% as compared to the for year ended March 31, 2008. Sales to N&J Company Limited (“N&J”) and Digidesign Inc. (“Digidesign”), the Company’s two largest customers during the year ended March 31, 2009, represented approximately 41.3% of net sales for the year. The decrease was related to a decrease in sales revenue at our electronic and metallic segment of $26,637,000 offsetting the increase in sales at our plastic segment of $14,569,000. This represented a decrease of 31.3% and an increase of 24.8% respectively, as compared with the respective net sales from these segments in fiscal 2008.

The revenue increase at the plastic segment was mainly due to the increase in orders from existing and new customers of $23,321,000 offsetting the decrease in orders from other existing customers of $8,751,000. The increase was principally due to a $20,671,000 increase in plastic component sales of electronic entertainment products. The increase in orders in our plastic segment was largely from N&J, one of our major customers during both fiscal 2008 and 2009, which accounted for 28.6% of our total net sales during the year ended March 31, 2009, up from 11.8% of our total net sales during the year ended March 31, 2008.

The revenue decrease in the electronic and metallic segment was mainly due to the decrease in orders of electronics and metallic products from existing customers of $35,175,000 and $2,075,000, respectively, offsetting the increase in orders from existing and new customers for professional audio instrument products of $10,651,000. The increase in total orders for professional audio instrument products largely came from existing customers other than Digidesign. The overall decrease in orders of electronics and metallic products from existing customers was due to the combined factors of a decline in demand as a result of the global economic recession, persistent pressure of losing orders to competitors which provide lower-priced products, and a change in product mix from low-end to high-end products. We believe that these factors resulted in the reduction in orders from Digidesign, down to 12.7% of our total net sales the year ended March 31, 2009, from 17.0% of our total net sales during 2008, and the decline in orders from each of Line 6 Manufacturing (“Line 6”) and Inter-Tel Incorporated (“Inter-Tel”) to below 10% of our total net sales during the year ended March 31, 2009. Line 6 and Inter-Tel accounted for 14.3% and 10.2%, respectively, of our total net sales during the year ended March 31, 2008. These declines in net sales to Digidesign, Line 6 and Inter-Tel during the year ended March 31, 2009 illustrates our dependence on a few major customers and that substantial decreases in sales from any of our larger customers adversely impacts our sales and financial performance.

Gross Profit
Our gross profit for the year ended March 31, 2009 was $20,168,000, representing a gross profit margin of 15.3%. This compared with the overall gross profit and gross profit margin of $26,433,000 or 18.4%, respectively, for the year ended March 31, 2008.

Gross profit in the plastic segment decreased by $2,118,000 to $12,952,000, or 17.6% of net sales, for the year ended March 31, 2009, as compared to $15,070,000, or 25.6% of net sales, for the year ended March 31, 2008. The decrease in gross margin for the plastic segment was mainly due to the shift of product mix to lower margin products, as compared with the prior year. The decrease in gross margin was also driven by higher material costs as a result of a 10% rise in resin price and an approximate 9.05% appreciation of RMB, plus an increase in labor costs caused by a 17% rise in labor rates in spite of headcount reductions, when compared to fiscal 2008.

Gross profit in the electronic and metallic segment decreased by $4,147,000 to $7,216,000, or 12.4% of net sales, for the year ended March 31, 2009 compared to $11,363,000, or 13.4% of net sales, for the year ended March 31, 2008. The decrease in gross margin was primarily attributable to relatively higher labor cost caused by a 28.4% increase in labor rates despite headcount reductions throughout the year together with a general decline in sales demand in the year ended March 31, 2009, as compared with last year.

Selling, general and administrative expenses
SG&A expenses for the year ended March 31, 2009 were $19,291,000, amounting to 14.6% of total net sales, as compared to $19,601,000 or 13.6% of total net sales for the year ended March 31, 2009. There was a decrease in selling, general and administrative expenses of $310,000 or 1.6% over the corresponding period.

The SG&A expenses in the plastic segment increased by $1,142,000 to $11,965,000, or 16.3% of net sales, for the year ended March 31, 2009 compared to $10,823,000, or 18.4% of net sales, for the year ended March 31, 2008. The increase in the SG&A expenses was primarily related to the increase in salaries and bonuses of $516,000 as a result of 17.3% increase in pay rates, and $132,000 in social insurance, and $100,000 in value-added taxes and property taxes , as compared with the year ended March 31, 2008.

The SG&A expenses in the electronic and metallic segment decreased by $1,452,000 to $7,326,000 or 12.6% of net sales, for the year ended March 31, 2009 compared to $8,778,000 or 10.3% of net sales for the prior year. The decrease was primarily due to the continued cost control measures resulting in a decrease of $612,000 in salaries and bonuses, $410,000 in social insurance and staff welfare expenses, $80,000 in travelling expenses and $52,000 in rental expenses as compared with the corresponding period in the prior year. There was also a decrease of $73,000 in selling expense as well as $65,000 in depreciation expense when compared to the year ended March 31, 2008.

Other operating income
Other operating expense was $132,000 for the year ended March 31, 2009, representing a decrease of $1,970,000 as compared with last year.
On a segment basis, other operating income attributable to our plastic segment for the year ended March 31, 2009 was $348,000, a decrease of $1,996,000 as compared with the prior year. The decrease was principally the result of a lower revaluation of monetary assets by $1,370,000 due to a less volatile exchange rate of United States Dollar to the RMB. The decrease in other operating income was also attributable to an additional provision for doubtful debt of $258,000, asset impairment for $176,000 and loss on disposal of fixed assets of $134,000 during the year ended March 31, 2009.

Other operating expense attributable to our electronic and metallic segment for the year ended March 31, 2009 was $480,000, as compared to the other operating expense of $508,000 in fiscal 2008. The decrease was primarily the result of no impairment on the goodwill relating to the metallic division during fiscal 2009 as compared to $318,000 impairment loss recognized during fiscal 2008. During fiscal 2009, there was also a decrease in foreign exchange loss by $176,000, partially offsetting an increase of $437,000 in allowance for doubtful receivables, as compared to fiscal 2008.

Operating Income
Operating income was $745,000 for the year ended March 31, 2009, as compared with the operating income of $8,670,000 from the corresponding year in the prior year.

On a segment basis, operating income of the plastic division was $1,335,000, or 1.8% of net sales, in the year ended March 31, 2009, as compared to operating income of $6,593,000, or 11.2% of net sales, for the year ended March 31, 2008. Operating income in the plastic division decreased primarily from the decrease in gross margin as a result of higher material usage and cost, factory overhead, and the decrease in other operating income as described above.

The operating loss of the electronic & metallic segment was $589,000, or 1.0% of net sales, in the year ended March 31, 2009, compared to operating income of $2,077,000, or 2.4% of net sales, in fiscal 2008. Electronic & metallic operating income decreased due to the decrease in sales revenue and gross margin as well as a relative increase in SG&A expenses as a percentage of sales as described above.

Non-operating income
Non-operating income for the year ended March 31, 2009 decreased by $353,000 to $168,000, as compared with fiscal 2008. This is mainly attributable to the decrease in interest income of $38,000 and an unrealized gain on the revaluation of marketable securities of $25,000 in the electronic and metallic segment, as well as the decrease in interest income of $243,000 in the plastic division during fiscal 2009.

Income Taxes
Income taxes for the year ended March 31, 2009 were comprised of income tax expenses of $234,000 and a deferred tax asset of $516,000, as compared with the income tax expenses of $654,000 and a deferred tax asset of $550,000 for fiscal 2008.

Minority Interest
There was no minority interest for the year ended March 31, 2009. In August 2007, the Company acquired the remaining 24% minority interest in Integrated International Limited, the holding company holding the capital stock of Deswell’s electronic and metallic subsidiaries, thereby increasing Deswell’s interest in that company from 76% to 100%. As a result, the dollar amount of minority interest decreased to zero for the year ended in March 31, 2009 from $228,000 for fiscal 2008.

Net Income
The Company reported net income of $1,195,000 for the year ended March 31, 2009, a decrease of $7,664,000, as compared to a net income of $8,859,000 for the year ended March 31, 2008. Net income for the year ended March 31, 2009 represented 0.9% of net sales, compared to 6.2% of net sales for the net income the prior year. The decrease in net income was mainly the result of the decrease in sales revenue, gross profit margin, and other operating income as described above.

Net income for the plastic segment for the year ended March 31, 2009 totaled $1,620,000, as compared to net income of $6,735,000 for the prior year. The decrease in net income of the plastic segment was primarily the result of lower gross profit margin and the decrease in other operating income as described above.

Net loss for the electronic and metallic segment for the year ended March 31, 2009 was $425,000, compared to net income of $2,124,000 for the prior year. The decrease in net income of the electronic and metallic segment was principally the result of the decrease in sales revenue, lower gross profit margin, and relatively higher SG&A expenses as a percentage of sales as described above.

Seasonality

The following table sets forth certain unaudited quarterly financial information for the twelve quarters in the three-year period ended March 31, 2009 (in thousands):

	2007
	Q1	Q2	Q3	Q4
Net sales	$31,689	$35,715	$39,002	$30,373
Gross profit	8,446	8,865	8,754	5,208
Operating income	3,866	3,973	4,016	1,837
Net income	3,403	3,597	3,605	1,562

	2008
	Q1	Q2	Q3	Q4
Net sales	$38,452	$38,414	$35,416	$31,524
Gross profit	6,762	6,698	7,923	5,050
Operating income	3,304	1,681	3,033	652
Net income	3,111	1,755	2,955	1,038

	2009
	Q1	Q2	Q3	Q4
Net sales	$35,039	$32,241	$37,101	$27,357
Gross profit	5,901	3,524	6,413	4,330
Operating income	1,310	(1,663)	878	220
Net income	1,293	(1,675)	987	590

The first calendar quarter (the fourth quarter of the fiscal year) is typically the Company’s slowest sales period because, as is customary in China, the Company’s manufacturing facilities in China are closed for two weeks for the Chinese New Year holidays. The Company does not experience any other significant seasonal fluctuations.

Impact of Inflation

The Company believes that inflation has not had a material effect on its business. Although the Company has found it difficult to increase the prices of its products in order to keep pace with inflation, particularly in its plastics operations, the Company believes that the location of its manufacturing operations in Southern China has resulted in a lower cost base which still provides it with a competitive advantage. Accordingly, the Company is reliant upon increasing its transaction volume in order to compensate for the effects of inflation.

Exchange Rates
The Company sells most of its products and pays for most components in either Hong Kong dollars or U.S. dollars. Labor cost and overhead expenses of the Company are paid primarily in Hong Kong dollars and RMB, respectively.

Since 1983, the exchange rate of the Hong Kong dollar to the U.S. dollar has been fixed by the Hong Kong government at approximately HK$7.80 to US$1.00 and accordingly Hong Kong Dollars has not, to date, represented a currency exchange risk to U.S. dollars. This could change in the future if those in Hong Kong arguing for a floating currency system prevail in the ongoing debate over whether to continue to peg the Hong Kong dollar to the U.S. dollar. There can be no assurance that the Chinese government will continue to maintain the present currency exchange mechanism in Hong Kong and if the currency exchange mechanism between the Hong Kong dollar and the U.S. dollar were changed, the Company’s results of operations and financial condition could be materially adversely affected.

Until July 21, 2005, exchange rate fluctuations between the RMB and the US dollar had not had a significant impact on the Company’s operating results. In 1994, China adopted a floating currency system whereby the official exchange rate is equal to the market rate. Between 1994 and July 2005, the market and official RMB rates were unified and the value of the RMB was essentially pegged to the US dollar and was relatively stable. During its fiscal years ended March 31, 2004 and 2005, the average exchange rate was 8.28 Yuan per US$1.00. On July 21, 2005, the People’s Bank of China adjusted the exchange rate of RMB to the U.S. dollar by linking the RMB to a basket of currencies and simultaneously setting the exchange rate of RMB to U.S. dollars, from 1:8.27, to a narrow band of around 1:8.11, resulting in an approximately 2% appreciation in the value of the RMB against the U.S. dollar. The four main currencies in the basket to which the RMB was linked were the US dollar, the Euro, the Japanese yen and the Korean won. In the months since July 2005, further appreciation against the US dollar continued to occur and by July 31, 2009, the RMB had risen to 6.8321 to the US dollar. As a consequence, and in addition to increases in plastic resin and labor costs, in each of the years ended March 31, 2007, 2008 and 2009, Deswell’s operating costs increased from levels existing prior to the exchange rate adjustment. Since the Company was not able to pass on to its customers most of these cost increases by price increases of its products, Deswell’s gross margins, operating income and net income were adversely affected.

If the trend of RMB appreciation to the US dollar continues or the Chinese government allows a further and significant RMB appreciation, Deswell’s operating costs would further increase and its financial results would be adversely affected by such increase. If Deswell determined to pass onto its customers through price increases the effect of increases in the Chinese RMB relative to the U.S. dollar, it would make the Company’s products more expensive in global markets, such as the United States and the European Union. This could result in the loss of customers, who may seek, and be able to obtain, products comparable to those Deswell offers in lower-cost regions of the world.

We did not hedge our currency risk during the years ended March 31, 2007, 2008 and 2009 and at March 31, 2009, we had no open forward currency contracts. We continually review our hedging strategy and there can be no assurance that hedging techniques we may implement will be successful or will not result in charges to our results of operations.

Liquidity and Capital Resources

For the year ended March 31, 2009, net cash generated from operations totaled $11,669,000, including net income of $1,195,000 and depreciation and amortization of $7,264,000. Accounts receivable increased by $918,000, over levels at March 31, 2008, primarily as a result of the increase in credit sales to our largest customer despite the increase in provision of doubtful accounts receivable of $275,000. Inventories decreased by $4,923,000 over levels at March 31, 2008, primarily resulting from the decrease in our inventory of electronic parts. Accounts payable decreased by $2,157,000 over levels at March 31, 2008, primarily because of the decrease in materials purchases. For the year ended March 31, 2008, net cash generated from operations totaled $16,418,000, including net income of $8,859,000 and depreciation and amortization of $6,940,000.

Net cash used in investing activities amounted to $7,057,000 and $7,369,000 for the year ended March 31, 2009 and 2008, respectively. Capital expenditures during these periods totaled $7,402,000 and $7,288,000, respectively. There were no acquisitions of marketable securities during either of these periods. Our capital expenditures were primarily related to the acquisition of property, plant and equipment for our two manufacturing plants in Dongguan, China.

Net cash used in financing activities for the years ended March 31, 2009 and 2008 were $3,789,000 and $8,537,000, respectively. Net cash we used in financing activities during the year ended March 31, 2009 was primarily to fund dividend payments to shareholders. Net cash we used in financing activities during the year ended March 31, 2008 was primarily to fund the dividend payments to shareholders of $9,523,000, net of the proceeds of $986,000 from the exercise of stock options from directors and employees.

As a consequence of the fixed exchange rate between the Hong Kong dollar and the U.S. dollar, interest rates on Hong Kong dollar borrowings are similar to U.S. interest rates. The Hong Kong Prime Rate was decreased from 5.25% to 5.0% during the year ended March 31, 2009.

At March 31, 2009, the Company had cash and cash equivalents of $23,134,000. At that date, Deswell had no committed credit facilities and no restricted cash. Deswell expects that working capital requirements and capital additions will continue to be funded through cash on hand and internally generated funds. However, Deswell may choose to seek to obtain additional debt or equity financing if it believes it to be appropriate and available on reasonable terms. The Company’s working capital requirements are expected to increase in line with the growth in the Company’s business.

At March 31, 2009, the Company had capital commitments for purchase of plant and machinery totaling $130,000 which are expected to be disbursed during the year ending March 31, 2010. Also, the Company had capital commitments for a new enterprise resource planning software system upgrade project at March 31, 2009 totaling $216,000 of which $82,000 are expected to be disbursed by March 31, 2010 and $134,000 by March 31, 2011, respectively.

A summary of our contractual obligations and commercial commitments as of March 31, 2009 is as follows:

	Payments due by period (in thousands)
Contractual obligations	Total		Year ending March 31, 2010		Period from April, 2010 to March 31, 2012		Period from April, 2012 to March 31, 2014		Period after March 31, 2014
Long-term bank borrowing	$	-	$	-	$	-	$	-	$	-
Capital (finance) lease obligations	-		-		-		-		-
Operating lease payments	154		136		18		-		-
Capital expenditures	346		212		134		-		-
Purchase obligations	5,854		5,854		-		-		-
Other long-trem liabilities	-		-		-		-		-
Total	$	6,354	$	6,202	$	152	$	-	$	-

Five year financial summary
(in thousands except per share data)

Income Statement Data:	Year ended March 31,
	2005	2006	2007	2008	2009
Net sales	$125,590	$115,276	$136,779	$143,806	$131,738
Cost of sales	92,072	89,850	105,506	117,373	111,570
Gross profit	33,518	25,426	31,273	26,433	20,168
Selling, general and administrative expenses	15,759	15,052	18,957	19,601	19,291
Other income (expenses), net	(106)	(823)	1,376	1,838	(132)
Operating income (4)	17,653	9,551	13,692	8,670	745
Interest expense	(12)	(6)	-	-	-
Non-operating income(expenses), net	448	447	547	521	168
Income before income taxes	18,089	9,992	14,239	9,191	913
Income taxes	576	(27)	1,239	104	(282)
Income before minority interests	17,513	10,019	13,000	9,087	1,195
Minority interests	2,330	1,240	833	228	-
Net income	$15,183	$8,779	$12,167	$8,859	$1,195
Basic earnings per share(2)(3)	$1.04	$0.59	$0.81	$0.57	$0.08
Average number of shares outstanding —basic (2)(3)	14,656	14,908	14,956	15,517	15,791
Diluted earnings per share(3)	$1.02	$0.59	$0.81	$0.57	$0.08
Average number of shares outstanding —diluted (2)(3)	14,933	14,936	15,048	15,566	15,805
Statistical Data:
Gross margin	26.7%	22.1%	22.9%	18.4%	15.3%
Operating margin (4)	14.1%	8.3%	10.0%	6.0%	0.6%
Dividends per share  (3)	$0.65	$0.63	$0.65	$0.61	$0.24
Balance Sheet Data:	At March 31,
	2005	2006	2007	2008	2009
Working capital	$57,576	$55,114	$58,672	$54,751	$52,605
Total assets	136,976	130,670	141,210	140,407	137,482
Long-term debt,less current portion	-	-	-	-	-
Total debt	-	-	-	-	-
Shareholders’ equity	104,767	106,768	111,655	121,257	120,307

(1) Our consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States of America and are stated in U.S. dollars. See “Financial Statements and Currency Presentation.”
(2) Basic EPS excludes dilution from potential common shares and is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution from potential common shares.
(3) Share and per share amounts presented above have been adjusted to reflect the three-for-two stock split effected in March 2005.
(4) Other operating income (expenses) were reclassified in the consolidated statement of income for the year ended March 31, 2007 for a comparable presentation. Comparative figures for the years ended March 31, 2005 and 2006 were reclassified accordingly. The reclassification of operating income had no impact on the net income on the consolidated statements of income for the years ended March 31, 2005 and 2006.

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