1. Management's Statement In the opinion of Management, the accompanying unaudited financial statements contain all adjustments (all of which are normal and recurring in nature) necessary to present fairly the financial position of Deswell Industries, Inc. (the Company) at March 31, 1999 and March 31, 1998, the results of operations for the quarters and years ended March 31, 1999 and March 31, 1998, and the cash flows for the years ended March 31, 1999 and March 31, 1998. The notes to the Consolidated Financial Statements, which are contained in the Form 20-F Annual Report filed on July 14, 1998 under the Securities Exchange Act of 1934 should be read in conjunction with these Consolidated Financial Statements.

2. Inventories
 

	March 31,	March 31,
	1999	1998
Inventories by major categories :
Raw materials	$ 3,241	$ 3,515
Work in progress	1,595	1,819
Finished goods	1,066	1,081
	$ 5,902	$ 6,415

3. Earnings Per Share The basic earnings per share and diluted earnings per share are computed in accordance with the Statement of Financial Accounting Standards No.128 "Earnings Per Share" effective for financial statements after December 31, 1997. The basic and diluted earnings per share for prior periods are also restated in accordance with the Statement of Financial Accounting Standards No. 128.

The basic earnings per share is computed on the income from continuing operations and net income respectively, available to common stockholders, divided by the weighted average number of common shares outstanding throughout the relevant periods.

The diluted earnings per share is computed on the income from continuing operations and net income respectively, available to common stockholders, divided by the weighted average number of common shares outstanding and the number of additional common shares that outstanding if the dilutive potential common shares had been issued throughout the relevant periods.

The net income for the quarters and years ended March 31, 1999 and 1998 were from the Company's continuing operations.

Results of Operations

General

The Company's revenues are derived from the manufacture and sale of (i) injection-molded plastic parts and components, (ii) electronic products and subassemblies and (iii) metallic parts and components. The Company carries out all of its manufacturing operations in southern China, where it is able to take advantage of the lower overhead costs and inexpensive labor rates as compared to Hong Kong.

Quarter Ended March 31, 1999 Compared to Quarter Ended March 31, 1998

The Company's net sales for the quarter ended March 31, 1999 were $9,585,000, a decrease of $4,924,000 or 33.9% as compared to corresponding period in 1998. The decrease in sales was mainly related to decreased sales of injection-molded plastic, electronic and metallic products of $2,405,000, $2,230,000 and $289,000 respectively, or decreases of 28.1%, 47.3% and 23.3% respectively, as compared with the net sales in the corresponding period in the prior year.

The decrease in net sales in the respective divisions was mainly due to reduction in orders from its existing customers as a result of the gloomy economic environment faced by our customers in the Asian Market, especially the sub-contracted PCB assembly customers. The decrease in sales in the electronic division was mainly attributed to the substantial reduction in orders from sub-contracted PCB assembly customers and the reduction in selling prices in both OEM and sub-contracted sales as compared to prior year. The injection-molded plastic division affected by the reduction in orders from Mita Industrial (H.K.) Co. Ltd., Namtai Electronics (Shenzhen) Co. Ltd. and some existing customers.

The gross profit for the quarter ended March 31, 1999 was $3,338,000, representing a gross profit margin of 34.8%. This compares with the overall gross profit and gross profit margin of $5,904,000 or 40.7% for the quarter ended March 31, 1998.

There was decrease in the overall gross profit margin of 5.9%. This was mainly attributed to the reduction in selling price on both sub-contracted and OEM sales and the increase in raw material cost which we cannot pass on to our customers.

Selling, general and administrative expenses for the quarter ended March 31, 1999 were $2,312,000, amounting to 24.1% of total net sales, as compared to $2,531,000 or 17.4% of total net sales for the quarter ended March 31, 1998. The decrease in selling, general and administrative expenses of $219,000 over the corresponding period was largely due to the strict control in selling, general and administrative expenses this year.

As a result of the decrease in net sales, operating income was $1,026,000 for the quarter ended March 31, 1999, a decrease of $2,347,000 or 69.6% as compared with the corresponding quarter in the prior year.

Minority interests represent the 49% and 66.9% minority interest in the electronics and metallic subsidiaries respectively. The decrease in minority interest to deficiency of $33,000 for the quarter ended March 31, 1999 from $533,000 for the corresponding quarter in the prior year reflects the fact that the electronic business generated a loss in the current period as compared to a profit in prior year.

As a result of the above factors, net income was $1,059,000 for the quarter ended March 31, 1999, a decrease of $1,809,000 or 63.1%, as compared to the quarter ended March 31, 1998 and net income as a percentage of net sales decreased to 11.0% from 19.8%.

Year Ended March 31, 1999 Compared to Year Ended March 31, 1998

The Company's net sales for the year ended March 31, 1999 were $53,439,000, a decrease of $12,730,000 or 19.2% as compared to year ended March 31, 1998. The decrease in sales was mainly decreased sales of injection-molded plastic, electronic and metallic products of $2,450,000, $9,608,000 and $672,000 respectively, or decreases of 7.5%, 32.5% and 16.7% respectively as compared with the net sales in the prior year.

The decrease in sales in the electronic division was mainly attributed to the substantial reduction in orders from sub-contracted PCB assembly customers and the reduction in selling prices in both OEM and sub-contracted sales as compared to the prior year. As regards to the plastics division, the reduction in orders from Mita Industrial (HK) Co. Ltd. and some customers were off set by the increase in demand from some other customers.

The gross profit for the year ended March 31, 1999 was $21,260,000, representing a gross profit margin of 39.8%. This compares with the overall gross profit and gross profit margin of $29,923,000 or 45.2% for the year ended March 31, 1998.

The decrease in gross margin of 5.4% was mainly attributed to the reduction in selling prices on both OEM and sub-contracted sales and the substantial reduction in orders of relatively higher margin sub-contracted products of the electronic division this year.

Selling, general and administrative expenses for the year ended March 31, 1999 were $10,364,000, amounting to 19.4% of total net sales, as compared to $14,067,000 or 21.3% of total net sales for the year ended March 31, 1998. The decrease in selling, general and administrative expenses of $3,703,000 over prior year was largely due to the stricter control in these expenses and the internal takeover of quality control and research and development support work this year.

As a result of the decrease in net sales, operating income was $10,896,000 for the year ended March 31, 1999, a decrease of $4,960,000 or 31.3% as compared with the prior year.

Minority interests represent the 49% and 66.9% minority interest in the electronics and metallic subsidiaries respectively. The decrease in minority interest to $1,575,000 for the year ended March 31, 1999 from $3,289,000 for the year ended March 31, 1998 reflects the fact that the electronic business generated less profits in the current year as compared to the prior year. This offset the effect of less loss generated by the metallic subsidiary in the current year as compared to the prior year.

As a result of the above factors, net income was $9,699,000 for the year ended March 31, 1999, a decrease of $3,272,000 or 25.2%, as compared to the year ended March 31, 1998 and net income as a percentage of net sales decreased slightly to 18.1% from 19.6%.

Liquidity and Capital Resources

Traditionally, the Company has relied primarily upon internally generated funds and short-term borrowings (including trade finance facilities) to finance its operations and expansion, although capital expenditure has been partly financed by long-term debt, including capital leases.

As of March 31, 1999, the Company had a working capital surplus of $41,273,000. This compares with a working capital surplus of $35,968,000 at March 31, 1998. The increase in working capital was mainly attributed to net cash generated from its operating activities offset by the cash dividend distributed of $5,917,000 in June and December 1998.

The Company has generated sufficient funds from its operating activities to finance its operations and there is little need for external financing other than short-term borrowings which are used to finance accounts receivable and are generally paid with cash generated from operations. The Company has no outstanding short-term borrowings and no long-term debt as of March 31, 1999.

As of March 31, 1999, the Company had in place general banking facilities with three financial institutions aggregating approximately $11,499,000. Such facilities, which are subject to annual review, include overdrafts, letters of credit, import facilities, trust receipt financing, inward bills financing as well as fixed loans. As of March 31, 1999, the Company had ( i ) unused credit facilities of $11,499,000 ( ii ) cash and cash equivalents of $27,556,000 and ( iii ) restricted cash of $2,376,000, which has been pledged as collateral for those credit facilities.

The Company expects that working capital requirements and capital additions will be funded through a combination of internally generated funds and existing facilities.

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