CONSOLIDATED BALANCE SHEETS
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Basis of Financial Statements
Deswell Industries, Inc. was incorporated in the British Virgin Islands on December 2, 1993.
The principal activities of the Company comprise the manufacture and sale of injection-molded plastic parts and components, electronic products assembling and metallic parts manufacturing. The manufacturing activities are subcontracted to subsidiaries operating in Mainland China. The selling and administrative activities were originally performed in the Hong Kong Special Administrative Region ("Hong Kong") of the People's Republic of China ("China"). From August 2003, these activities were moved to the Macao Special Administrative Region (“Macao”) of China.
As the Company is a holding company, the amount of any dividends to be declared by the Company will be dependent upon the amount which can be distributed from its subsidiaries. Dividends from subsidiaries are declared based on profits as reported in their statutory accounts. Such profits differ from the amounts reported under U.S. GAAP. At March 31, 2009, the retained earnings available for distribution as reflected in the statutory books of the subsidiaries were $50,467.
On January 20, 2003, the Company acquired a further 20% of the outstanding stock of Integrated International Limited (“Integrated”), a subsidiary of the Company, from the minority shareholders. After the acquisition, the Company increased its ownership in Integrated to 71% of the outstanding stock. The purchase consideration for the 20% of the outstanding stock of Integrated is 251,880 common shares of the Company. The value of the purchase consideration is based on the market price of the stocks issued which is lower than the fair value of net assets acquired by $115. The excess has been allocated as a pro rata reduction of the amounts that would have been assigned to certain acquired assets.
On April 20, 2005, the Company acquired a further 5% of the outstanding stock from one of the minority shareholders of Integrated. After the acquisition, the Company increased its ownership in Integrated to 76% of the outstanding stock. The purchase consideration for the 5% of the outstanding stock of Integrated is 120,000 common shares of the Company. The value of the purchase consideration is based on the market price of the stocks issued which is higher than the fair value of net assets acquired by $232. The excess purchase price has been recorded on the balance sheet as goodwill.
On August 17, 2007, the Company acquired the remaining 24% of the outstanding stock from minority shareholders of Integrated. After the acquisition, the Company increased its ownership in Integrated to 100% of the outstanding stock. The aggregate purchase consideration for the 24% of the outstanding stock of Integrated is 632,080 common shares of the Company and a cash payment of $414. The value of the purchase consideration is based on the market price of the stocks issued and the cash payment, which is lower than the fair value of net assets acquired by $1,314. The excess has been allocated a pro-rata reduction of the amounts that would have been assigned to certain acquired assets.
2. Summary of Significant Accounting Policies
Principles of consolidation
Property, plant and equipment
Valuation of long-lived assets
Allowance for doubtful account
Shipping and handling cost
The Company adopted the provisions of Financial Accounting Standard Board (“FASB”) Interpretation No.48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No.109 (“FIN 48”), which clarifies the accounting for uncertainty in income taxes recognized by prescribing a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides accounting guidance on de-recognition, classification, interest and penalties, disclosure and transition.
Foreign currency translation
All transactions in currencies other than functional currencies during the year are translated at the exchange rates prevailing on the transaction dates. Monetary items existing at the balance sheet date denominated in currencies other than the functional currencies are translated at period end rates. Gains and losses resulting from the translation of foreign currency transactions and balances are included in income.
Post-retirement and post-employment benefits
For the years ended March 31, 2007, 2008 and 2009, the Company records stock-based compensation expenses amounted to $820, $310 and $62 in the statement of income respectively. There is no tax benefit recognized in relation to the stock-based compensation expenses incurred for the three years.
The Company applied judgment in estimating key assumptions in determining the fair value of the stock options on the date of grant. The Company used historical data to estimate the expected life of options, stock volatility and expected dividend yield. The risk-free interest rate of the option was based on the 10 years U.S. Treasury yield at time of grant.
Basic net income per share and diluted net income per share calculated in accordance with SFAS No. 128, "Earnings Per Share", are reconciled as follows (shares in thousands):
For the years ended March 31, 2007, 2008 and 2009, potential common shares of 644,000, 644,000 and 726,000 shares related to stock options are excluded from the computation of diluted net income per share as their exercise prices were higher than the average market price.
Use of estimates
Fair value of financial instruments
Recent changes in accounting standards
In December 2007, FASB issued SFAS No. 160 “Non-controlling Interest in Consolidated Financial Statements”(“SFAS160”). SFAS 160 amends Accounting Research Bulletin No.51, Consolidated Financial Statements, to establish accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 defines “a non-controlling interest, sometimes called a minority interest, is the portion of equity in a subsidiary not attributable, directly or indirectly, to a parent”. The objective of SFAS 160 is to improve the relevance, comparability, and transparency of the financial information that a reporting entity provides in its consolidated financial statements. SFAS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008 and is required to be adopted by the Company in the first quarter of fiscal year 2010. The Company is evaluating the impact, if any, of the adoption of SFAS 160. It is not expected to have material impact on the Company’s financial position, results of operations and cash flows.
In March 2008, the FASB issued SFAS No. 161 “Disclosures about Derivative Instruments and Hedging Activities amendment of FASB Statement No. 133” (“SFAS 161”). This statement changes the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures stating how and why an entity uses derivative instruments; how derivatives and related hedged items are accounted for under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”) and its related interpretations; and how derivative instruments and related hedge items affect an entity’s financial position, financial performance and cash flows. SFAS 161 is effective in fiscal years beginning after November 15. 2008 and is required to be adopted by the Company in the first quarter of fiscal year 2010. The Company does not expect the adoption of SFAS 161 will have a material impact on the Company’s disclosures.
In April 2009, the FASB issued FSP 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly” (“FSP 157-4”). FSP 157-4 provides additional guidance for estimating fair value in accordance with SFAS 157 when the volume and level of activity for the asset or liability have significantly decreased. FSP 157-4 also includes guidance on identifying circumstances that indicate a transaction is not orderly. FSP 157-4 is effective for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. FSP 157-4 does not require disclosures for earlier periods presented for comparative purposes at initial adoption. In periods after initial adoption, FSP 157-4 requires comparative disclosures only for periods ending after initial adoption. The adoption of the provisions of FSP 157-4 is not anticipated to materially impact on the Company’s results of operations or the fair values of its assets and liabilities.
In May 2009, the FASB issued SFAS No. 165 “Subsequent Events” (“SFAS 165”), which provides guidance to establish general standards of accounting for and disclosures of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. SFAS 165 also requires entities to disclose the date through which subsequent events were evaluated as well as the rationale for why that date was selected. This disclosure should alert all users of financial statements that an entity has not evaluated subsequent events after that date in the set of financial statements being presented. SFAS 165 is effective for interim and annual periods ending after June 15, 2009 and is required to be adopted by the Company in the first quarter of fiscal year 2010. Since SFAS 165 at most requires additional disclosures, the Company does not expect the adoption to have a material impact on the Company’s financial position, results of operations and cash flows.
In June 2009, the FASB issued SFAS No. 166 “Accounting for Transfers of Financial Assets” (“SFAS 166). This statement is intended to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial reports about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement in transferred financial assets. This Statement must be applied as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, and is required to be adopted by the Company in the first quarter of fiscal year 2011. Earlier application is prohibited. This Statement must be applied to transfers occurring on or after the effective date. The Company does not expect the adoption of SFAS 166 to have a material impact on the Company’s financial position, results of operations and cash flows.
In June 2009, the FASB issued SFAS No. 167 “Amendments to FASB Interpretation No. 46(R)” (“SFAS 167”). SFAS 167 seeks to improve financial reporting by enterprises involved with variable interest entities. SFAS No. 167 is applicable for annual periods after November 15, 2009 and interim periods therein and thereafter. The Company does not expect the adoption of SFAS 167 to have a material impact on the Company’s financial position, results of operations and cash flows.
In June 2009, the FASB issued SFAS No. 168 “The FASB Accounting Standards Codification™ and the Hierarchy of Generally Accepted Accounting Principles” (“SFAS 168”). The FASB approved the FASB Accounting Standards Codification (the “Codification”) as the single source of authoritative nongovernmental U.S. GAAP to be launched on July 1, 2009. The Codification does not change current U.S. GAAP, but is intended to simplify user access to all authoritative U.S. GAAP by providing all the authoritative literature related to a particular topic in one place. All existing accounting standard documents will be superseded and all other accounting literature not included in the Codification will be considered nonauthoritative. The Codification is effective for interim and annual periods ending after September 15, 2009. The Codification is effective for the Company in the second quarter of fiscal year 2010. The Company does not expect the adoption of SFAS 168 to have a material impact on the Company’s financial position, results of operations and cash flows.
3. Marketable Securities
The Company acquired equity securities listed in Hong Kong.
Unrealized gain (loss) for the years ended March 31, 2007, 2008 and 2009 were ($57), $9 and ($16), respectively.
Net proceeds from sale of marketable securities for the year ended March 31, 2007, 2008 and 2009 were $nil, and realized gains from sale of marketable securities for the year ended March 31, 2007, 2008 and 2009 were $nil. For the purposes of determining realized gains and losses, the cost of securities sold was determined based on the average cost method.
The marketable securities were classified as Level 1 of the hierarchy established under SFAS 157 because the valuations were based on quoted prices for identical securities in active markets.
Inventories by major categories are summarized as follows:
5. Prepaid Expenses and Other Current Assets
Prepaid expenses and other current assets consist of the following:
6. Property, Plant and Equipment
Property, plant and equipment consists of the following:
(a) The land use rights of state-owned land and buildings erected thereon represent land and buildings located in China with lease terms of 50 years expiring in 2050.
(b) Long term leased land and buildings erected thereon represent land and buildings on collectively-owned land located in China on which an upfront lump-sum payment has been made for the right to use the land and building for a term of 50 years to 2053. Dongguan Chang An Xiaobian District Co-operation, the lessor, is the entity to whom the collectively-owned land has been granted. According to existing China laws and regulations, collectively-owned land is not freely transferable unless certain application and approval procedures are fulfilled by the Dongguan Chang An Xiaobian District Co-operation to change the legal form of the land from collectively-owned to state-owned. As of March 31, 2009, the Company is not aware of any steps being taken by the Dongguan Chang An Xiaobian District Co-operation for such application.
(c) Other buildings represent factory premises located in China purchased by the Company with lease term of 30 years expiring 2018. These factory premises are classified as “assets held for sale” under current assets at March 31, 2009 as the management plans to dispose them shortly.
The impairment in goodwill for the years ended March 31, 2007, 2008 and 2009 were nil, $317 and nil respectively. Details of the goodwill are as follows:
8. Other Accrued Liabilities
Other accrued liabilities consist of the following:
9. Income Taxes
The components of income before income taxes and minority interests are as follows:
The provision for current income taxes of the subsidiaries operating in Hong Kong has been calculated by applying the current rate of taxation of 16.5% (2007 and 2008: 17.5%) to the estimated taxable income arising in or derived from Hong Kong, if applicable.
From January 1, 2008, with the effect of the new Income Tax Law, the standard tax rate for all companies has been reduced from the rate of 33% to 25%. Moreover, there is no reduction in the tax rate for foreign investment enterprise which export 70% or more of the production value to their products (known as “Export-oriented Enterprise”).
Jetcrown Industrial (Shenzhen) Limited ("JISL") (a subsidiary of the Company) had fully enjoyed the above tax holiday and concessions by December 31, 1995. The applicable tax rate for the calendar year ended December 31, 2006 and 2007 was 15%. Under the new Income Tax Law, the tax rate applicable to JISL is 18%, 20%, 22%, 24% and 25% for the year ended December 31, 2008 and the years ending December 31, 2009, 2010, 2011 and 2012 respectively.
Dongguan Kwan Hong Electronics Company Limited (“DKHE”) (a subsidiary of the Company) had fully enjoyed the tax holiday and concessions by December 31, 2004. DKHE was approved as a “High-tech Enterprise” by the tax authority and enjoyed a national tax rate of 15%. For the calendar year ended December 31, 2006, DKHE was approved as an “Export-oriented Enterprises” by the local tax authority and enjoyed a lower tax rate of 10%. For the calendar year ended December 31, 2007, the tax rate for DKHE as “High-tech Enterprise” was 18%, in which 15% is for national tax and 3% is for the local tax. For the calendar year ended December 31, 2008, DKHE does not qualify as an “Export-oriented Enterprises” under the new Income Tax Law. The tax rate for the calendar year ended December 31, 2008 and year ending December 31, 2009 is 25%.
Jetcrown Industrial (Dongguan) Limited (“JIDL”) (a subsidiary of the Company) had revised its first and second tax exemption year from the calendar year ended December 31, 2004 and 2005 respectively, to the calendar years ended December 31, 2002 and 2003 respectively. The revision was upon a tax reassessment by the PRC Tax Bureau during the year ended March 31, 2007 regarding the commencement year of exemption and inter-company sales pricing issues. The tax rate applicable for JIDL for calendar years 2002 to 2006 was 24%. JIDL was entitled to a full tax exemption for each of the calendar years ended December 31, 2002 and 2003 and a 50% exemption for each of the calendar years ended December 31, 2004, 2005 and 2006. An aggregate amount of $450 additional income tax provision, which comprised approximately $154, $92, $166 and $38 for taxable calendar years 2004, 2005 and 2006 and the quarter ended March 31, 2007 respectively had been charged to the consolidation income statement for the year ended March 2007. The assessment and payment for income taxes for calendar years 2004 and 2005 were settled and concluded in September 2007 at the amount as provided. The assessment and payment for calendar year 2006 were settled at $101 in January 2008. However, there can be no assurance that the PRC Tax Bureau will not, in the future, further challenge (i) the reported revenue of JIDL for periods starting from the calendar year ended 31 December 2006; and (ii) revenues reported by JIDL for value-added tax filing purpose. There can also be no assurance that similar reassessments will not be extended to other PRC subsidiaries of the Company. The above reassessments, if conducted in the future, may cause an adverse impact to the net operating results of the Company.
For the calendar year ended December 31, 2007, JIDL was approved as an “Export-oriented Enterprises” by the local tax authority and enjoyed a lower tax rate of 12%. For the calendar year ended December 31, 2008 and the year ending December 31, 2009, the tax rate for JIDL is 25%, being the unified tax rate under the New Tax Law effective from January 1, 2008.
The Company has adopted the provisions of FIN 48 on April 1, 2007. The evaluation of a tax position in accordance with FIN 48 begins with a determination as to whether it is more-likely-than-not that a tax position will be sustained upon examination based on the technical merits of the position. A tax position that meets the more-likely-than-not recognition threshold is then measured at the largest amount of benefit that if greater than 50 percent likely of being realized upon ultimate settlement for recognition in the financial statements. There is no material impact on the adoption of FIN 48. The Company classifies interest and/or penalties related to unrecognized tax benefits as a component of income tax provisions; however, as of March 31, 2009, there is no interest and penalties related to uncertain tax positions, and the Company has no material unrecognized tax benefit which would favorably affect the effective income tax rate in future periods. The Company does not anticipate any significant increases or decreases to its liability for unrecognized tax benefit within the next twelve months.
The provision for income taxes consists of the following:
A reconciliation between the provision for income taxes computed by applying the statutory tax rate in China to income before income taxes and the actual provision for income taxes is as follows:
The components of deferred income tax are as follows:
No deferred tax asset has been recognized in respect of the unused tax losses of JISL. JISL had been dormant and no predictability of future profit streams.
10. Commitments and Contingencies
The Company leases premises under various operating leases, certain of which contain escalation clauses. Rental expenses under operating leases included in the statement of income were $531, $265 and $317 for the years ended March 31, 2007, 2008 and 2009, respectively.
At March 31, 2009, the Company was obligated under operating leases requiring minimum rentals as follows:
At March 31, 2009, the Company had capital commitments for purchase of plant and machinery totaling $130, which are expected to be disbursed during the year ending March 31, 2010. Also, the Company had capital commitments for system upgrade project at March 31, 2009 totaling $216, of which $82 are expected to be disbursed by March 31, 2010 and $134 by March 31, 2011, respectively.
11. Employee Benefits
The Company contributes to a state pension scheme run by the Chinese government in respect of its employees in China. The expense related to this plan, which is calculated at the range of 8% to 11% of the average monthly salary, was $634, $817 and $697 for the years ended March 31, 2007, 2008 and 2009, respectively.
12. Stock Option Plan
On March 15, 1995, the Company adopted 1995 Stock Option Plan that permits the Company to grant options to officers, directors, employees and others to purchase up to 1,012,500 shares of Common Stock. On September 29, 1997, the Company approved an increase of 549,000 shares making a total of 1,561,500 shares of common stock available under the stock option plan. On January 7, 2002, the Company adopted 2001 Stock Option Plan to purchase an additional 1,125,000 shares of Common Stock. On September 30, 2003, the Company adopted 2003 Stock Option Plan to purchase an additional 900,000 shares of Common Stock. On September 19, 2005, the Company approved an increase of 500,000 shares making a total of 1,400,000 shares of common stock available under the 2003 Stock Option Plan. On August 17, 2007, the Company approved an increased of 400,000 shares making a total of 1,800,000 shares of common stock available under the 2003 Stock Option Plan.
At March 31, 2009, options to purchase an aggregate of 4,243,500 common shares had been granted under the stock option plans. Options granted under the stock option plans will be exercisable for a period of up to 10 years commencing on the date of grant, at a price equal to at least the fair market value of the Common Stock at the date of grant, and may contain such other terms as the Board of Directors or a committee appointed to administer the plan may determine. A summary of the option activity (with weighted average prices per share) is as follows:
The weighted average fair value of options granted for the year ended March 31, 2007, 2008 and 2009 was $1.64, $1.48 and $0.33 per share, respectively. The total intrinsic value of options exercised during the years ended March 31, 2007, 2008 and 2009 was $339, $433 and nil, respectively. At March 31, 2009, the aggregated intrinsic value of options outstanding and exercisable was $82.
There were nil, nil and 243,000 options canceled for the years ended March 31, 2007, 2008 and 2009. The weighted average remaining contractual life of the share options outstanding at March 31, 2009 was 6.75 years. At March 31, 2007, 2008 and 2009, there were nil, 190,000 and 243,000 options available for future grant under the plans respectively.
13. Operating Risk
Concentrations of Credit Risk and Major Customers - A substantial percentage of the Company's sales are made to a small number of customers and are typically sold either under letter of credit or on an open account basis. Details of customers accounting for 10% or more of total net sales for each of the three years ended March 31, 2007, 2008 and 2009 are as follows:
* Less than 10%
Sales to the above customers relate to both injection-molded plastic parts and electronic products.
Details of the amounts receivable from the five customers with the largest receivable balances at March 31, 2008 and 2009, respectively, are as follows:
There were bad debt expense of $5, $60 and $6 during the years ended March 31, 2007 and 2008 and 2009 respectively. There were provision for bad debts expenses of $270, $17 and $275 during the years ended March 31, 2007, 2008 and 2009 respectively.
Country risk - The Company has significant investments in China. The operating results of the Company may be adversely affected by changes in the political and social conditions in China, and by changes in Chinese government policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things. There can be no assurance, however, those changes in political and other conditions will not result in any adverse impact.
14. Fair Value of Financial Instruments
The carrying amounts of cash and cash equivalents, restricted cash, marketable securities, accounts receivable, accounts payable are reasonable estimates of their fair value. All the financial instruments are for trade purposes.
15. Segment Information
The Company has three reportable segments: plastic injection molding, electronic products assembling and metallic parts manufacturing. The Company's reportable segments are strategic business units that offer different products and services. They are managed separately because each business requires different technology and marketing strategies. Most of the businesses were acquired as a unit, and the management at the time of the acquisition was retained.
The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company accounts for intersegment sales and transfers as if the sales or transfers were to third parties, that is, at current market prices.
The location of the Company's identifiable assets is as follows:
16. Subsequent Event
On August 5, 2009, the Company signed a sale and purchase agreement with a third party for sale of a property with approximately 112,900 square feet manufacturing space at a selling price of $7,308. The Company expected the transaction will be completed in the third fiscal quarter ending December 31, 2009. The gain on disposal, net of transaction cost, will be recorded when the transaction is completed.
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