The major macro-economic factors affecting the Company’s performance in the year under review were, firstly, the ongoing appreciation of the RMB against the US dollar, and secondly, the increase in the minimum wage level imposed in 2010. RMB appreciation has always impacted on the Company’s margins, since a considerable percentage of its costs and expenses are settled in RMB. The steady upward rise in the value of the RMB, something quite out of Deswell’s control, has required the Company to be very disciplined in expenditure and cost control. As for the raising of the minimum wage in 2010, the only way in which such a rise can be counterbalanced is by reducing staff levels; in fact, Deswell’s staff numbers have dropped over the year but the wage rise combined with ongoing RMB appreciation has nevertheless increased the Company’s overall operational expenses and to an extent adversely affected operating results for the year ended March 31, 2011.

PLASTIC INJECTION MOLDING
Deswell’s core operation, plastic injection molding, accounted for 50.9% of its total sales for the year ended March 31, 2011, down from 57.6% in 2010 and 55.7% in 2009. This fall was largely due to particularly tight competition in the plastics market at the moment. The Company’s three main plastic injection molding operations are mold design and production, plastic injection, and finishing.

MOLD DESIGN AND PRODUCTION
The mold design and production process starts with Deswell’s technicians using tooling software to design molds suited to the needs of individual clients. Once a design is finalized, the actual mold is manufactured on one of Deswell’s many mold-making machines, which include Makino tooling machines, numerical control (NC) and graphite computer numerical control (CNC) milling machines, vertical machining centers, and electrical discharge machines (EDMs). As at March 31, 2011, the Company operated 26 EDMs, 28 CNC milling machines and 65 NC milling machines. The Company produced molds between 5 and 50 per month, ranging in weight between 110 and 17,600 pounds. Selling prices ranged from $2,000 to $200,000. A few large-scale molds produced by Deswell were shipped directly to the client overseas, through the Company’s Export Mold Division.

PLASTIC INJECTION
Deswell’s Dongguan facility has 1,070,000 square feet of manufacturing space and 133,000 square feet of office space, and is fully equipped with advanced injection molding machinery and accessory equipment. As at March 31, 2011, around 400 injection molding machines were installed there, ranging from 22 to 2,000 tons of clamping force. Most machines operate in the 55 to 380 ton range, and can be configured to manufacture a wide variety of different parts and products both large and small. Deswell has significantly upgraded the number and quality of its plastic injection molding machines in recent years, and as a result in the 2011 fiscal year it only needed to acquire one additional plastic injection machine in order to maintain optimum molding capabilities.

FINISHING
Finishing is largely carried out by hand, by a team of skilled operatives who carry out tasks such as smoothing and polishing plastic surfaces, imprinting letters, numbers and symbols by processes such as silk-screening, pad printing and epoxy ultra-violet cutting, and treating products with anti-fog coatings to achieve a durable and attractive finish.

ELECTRONIC PRODUCTS AND ASSEMBLIES
Deswell’s electronics and metallics division operates out of its self-owned factory in Chang An, Dongguan, with 420,000 square feet of factory buildings and dormitories and 244,000 square feet of bare land. For the year ended March 31, 2011, this division accounted for 49.1% of the Company’s total sales, as compared to 42.4% in 2010 and 43.4% in 2009.

Deswell’s electronics division manufactures professional audio equipment that is deployed in sports stadiums, concert halls, recording studios, and radio and television stations. These products include digital audio workstations, mixing consoles, instrument amplifiers, signal processors, and active speaker enclosures. Also manufactured are home entertainment products, such as AV receivers and active subwoofers, as well as a range of business communication equipment such as digital system keysets.

METAL PARTS MANUFACTURING
Deswell’s metal parts manufacturing operation is situated on the same site as its electronic products assembly facilities. This division manufactures precision sheet metal parts and assemblies, built in-house using CNC equipment and hard tooling, for products such as audio equipment, telecom equipment, vending machines and automatic teller machines. Sales by its metal tooling and metal parts operation continued to account for less than one per cent of Deswell’s total sales in the year under review.

QUALITY CONTROL
Deswell is well known for its world-class quality standards, achieved due to a stringent testing and checking regime. This includes hourly checks on machines and molds, inspections of all incoming components, regular checking of work in progress, and detailed pre-shipping quality assurance inspections. The Company also regularly upgrades and replaces key equipment.

The ISO accreditations held by Deswell include:

• ISO14001: electronics and metallics manufacturing plant
• ISO14001: Dongguan plastic injection manufacturing plant
• ISO9001: plastic and electronic products manufacturing operations
• ISO9002: metal parts manufacturing operation
• ISO/TS 16949: Dongguan plastic injection molding manufacturing plant

RAW MATERIALS, COMPONENT PARTS AND SUPPLIERS
The main raw material used by the Company for its plastic products is plastic resin, primarily ABS (acrylonitrile-butadiene-styrene). Over the past three fiscal years the Company has used between 10 and 22 million pounds of plastic resin per annum, which overall averages out at around 35% of the total costs of all plastic products sold. Deswell continues to source its plastic resins from regional suppliers on the basis of price competitiveness, and holds inventory sufficient for two to three months’ manufacture. Deswell’s plastic resins mainly originate from the United States, Malaysia, Singapore, Taiwan, Japan and Hong Kong.

Raw materials needed for the Company’s electronics division include component parts and supplies. These are purchased from a range of suppliers in China, Hong Kong, the United States and elsewhere. The Company is not dependent upon any single supplier for any essential component.

The Company purchases small quantities of raw metal for manufacturing metallic molds and parts, but their cost does not impact on the Company’s total operations.

CUSTOMERS AND MARKETING
Most of Deswell’s clients are OEMs and contract manufacturers, spread over a wide area. The Company has customers in Asia (Hong Kong, Thailand, Japan, Taiwan and China), North America (the United States and Canada) and Europe (Germany, the United Kingdom, Holland and Norway). The following table shows net sales by geographic area (based on customer shipping destinations) as a percentage of total sales for the past three years:

Geographic Areas		2009	2010	2011
	China	52.8%	52.5%	42.7%
	United States	32.0	44.3	41.7
	Europe	12.5	2.0	11.5
	Hong Kong	1.3	0.7	0.7
	Others	1.4	0.5	3.4
	Total	100%	100%	100%

In terms of business acquisition, the Company actively markets its products and services by regularly contacting both existing and potential customers directly, participating in trade shows, and advertising in trade publications. Through these channels, Deswell has positioned itself as a complete solutions provider for plastic injection mold design, tooling, molding and finishing, as well as a reputable EMS provider of advanced technology manufacturing processes and flexible logistics services.

CAPITAL EXPENDITURES
The principal capital expenditures and divestitures made by Deswell during the three years ended March 31, 2011 are as follows (in thousands):

Following investment of over seven million US dollars in new plastic injection molding machinery for the Company’s Dongguan plastic injection molding plant in the fiscal year 2009, capital expenditure in fiscal 2010 and 2011 has fallen significantly. In 2011, the total expenditure of around US$1.0 million was primarily used in fitting out and upgrading the Dongguan facility, and replacing computers and office equipment. The Company’s cash position remains strong, and it continues to finance most of its capital expenditure from internally generated funds.

Copyright 2011 Deswell Industries, Inc. All rights reserved.