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SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
  
 FORM 20-F  o
    
    Registration Statement Pursuant to Section 12(b) or (g) of the Securities Exchange Act of 1934 OR  þ
    
    Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934  
 For the Fiscal Year Ended:
    
    Commission File Number:March 31, 2005
    
    0-26448
  
 (DESWELL LOGO)
    
    DESWELL INDUSTRIES, INC.
  British Virgin Islands
(Jurisdiction of incorporation or organization) 17B, Edificio Comercial Rodrigues
599 Avenida da Praia Grande
Macao
(Address of principal executive offices)  
 Securities registered or to be registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: Common shares, no par value per share Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: Common
shares, no par value per share As of March 31, 2005, there were 14,778,730 common shares of the registrant outstanding.
Indicate by check mark whether the registrant: (i) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (ii) has been
subject to such filing requirements for the past 90 days. Yes þ No o Indicate by check mark which financial statement item the registrant has elected to follow: Item 17 o Item 18 þ




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TABLE OF CONTENTS PageFINANCIAL STATEMENTS AND CURRENCY PRESENTATION
    
    
    2PART I
    
    
    3ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS
    
    
    3ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
    
    
    3ITEM 3. KEY INFORMATION
    
    
    3ITEM 4. INFORMATION ON THE COMPANY
    
    
    10ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
    
    
    24ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
    
    
    33ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
    
    
    37ITEM 8. FINANCIAL INFORMATION
    
    
    40ITEM 9. THE OFFER AND LISTING
    
    
    41ITEM 10. ADDITIONAL INFORMATION
    
    
    42ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
    
    
    52ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
    
    
    52PART II
    
    
    52ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
    
    
    52ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS
    
    
    53ITEM 15. CONTROLS AND PROCEDURES
    
    
    53ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT
    
    
    53ITEM 16B. CODE OF ETHICS
    
    
    53ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES
    
    
    53ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR THE AUDIT COMMITTEE
    
    
    54ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATE PURCHASERS
    
    
    54PART III
    
    
    54ITEM 17. FINANCIAL STATEMENTS
    
    
    54ITEM 18. FINANCIAL STATEMENTS
    
    
    55ITEM 19. EXHIBITS
    
    
    72SIGNATURES
    
    
    74Exhibit 4.1Exhibit 4.3Exhibit 4.4Exhibit 4.5Exhibit 4.6Exhibit 4.7Exhibit 4.8Exhibit 4.9Exhibit 12.1Exhibit 12.2Exhibit 13.1Exhibit 14.1
  This Annual Report onForm 20-Fcontains forward-looking statements. These statements are
subject to certain risks and uncertainties that could cause actual results to differ materially
from those anticipated in the forward-looking statements. Factors that might cause such a
difference include, but are not limited to those discussed in the section entitled Risk Factors
under Item 3.  Key Information. Readers should not place undue reliance on forward-looking statements, which reflect
managements view only as of the date of this Report. The Company undertakes no obligation to
revise these forward-looking statements to reflect subsequent events or circumstances. Readers
should also carefully review the risk factors described in other documents the Company files from
time to time with the Securities and Exchange Commission. As used in this Report, we, our, us, Deswell or the Company refers to Deswell
Industries, Inc. and its subsidiaries unless the context otherwise indicates. All share and per share information in this Report, has been adjusted to reflect the Companys
three-for-two stock split effected in July 2002 and the Companys three-for-two stock split
effected in March 2005. 
 FINANCIAL STATEMENTS AND CURRENCY PRESENTATION The Company prepares its consolidated financial statements in accordance with generally
accepted accounting principles in the United States of America and publishes such statements in
United States dollars. See Report of Independent Registered Public Accounting Firm included
elsewhere herein. The Company publishes its financial statements in United States dollars as the
Company is incorporated in the British Virgin Islands, where the currency is the United States
dollar, and the functional currency of the Companys subsidiaries are Hong Kong dollar and Chinese
renminbi. All dollar amounts ($) set forth in this Report are in United States dollars, the
references to HK$ refer to Hong Kong dollars and RMB to Chinese renminbi. 2




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PART I 
 ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS Not applicable. 
 ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE Not applicable. 
 ITEM 3. KEY INFORMATION Selected Financial Data(1) The selected consolidated financial data set forth below should be read in conjunction with
our consolidated financial statements and notes thereto included elsewhere in this Report. The
selected income statement data for each of the three fiscal years in the period ended March 31,
2005, and the balance sheet data as of March 31, 2004 and 2005 are derived from our audited
consolidated financial statements included in this Report. The selected income statement data for
the years ended March 31, 2001 and 2002, and the balance sheet data as of March 31, 2001, 2002 and
2003 are derived from our audited consolidated financial statements, which are not included in this
Report. (In thousands, except per share and percentage data)Year ended March 31,2001
    
    
    2002
    
    
    2003
    
    
    2004
    
    
    2005Income Statement DataNet sales
    
    $
    80,847
    
    
    $
    83,320
    
    
    $
    90,905
    
    
    $
    97,195
    
    
    $
    125,590Cost of sales
    
    
    52,596
    
    
    
    54,448
    
    
    
    61,006
    
    
    
    66,105
    
    
    
    92,072Gross profit
    
    
    28,251
    
    
    
    28,872
    
    
    
    29,899
    
    
    
    31,090
    
    
    
    33,518Selling, general and administrative expenses
    
    
    15,414
    
    
    
    14,939
    
    
    
    15,354
    
    
    
    14,718
    
    
    
    15,759Operating income
    
    
    12,837
    
    
    
    13,933
    
    
    
    14,545
    
    
    
    16,372
    
    
    
    17,759Interest expense
    
    
    (6
    )
    
    
    (26
    )
    
    
    (6
    )
    
    
    (16
    )
    
    
    (12
    )Other income, net
    
    
    915
    
    
    
    877
    
    
    
    818
    
    
    
    910
    
    
    
    342Income before income taxes
    
    
    13,746
    
    
    
    14,784
    
    
    
    15,357
    
    
    
    17,266
    
    
    
    18,089Income taxes
    
    
    315
    
    
    
    535
    
    
    
    3,826
    
    
    
    589
    
    
    
    576Income before minority interests
    
    
    13,431
    
    
    
    14,249
    
    
    
    11,531
    
    
    
    16,677
    
    
    
    17,513Minority interests
    
    
    621
    
    
    
    925
    
    
    
    1,288
    
    
    
    1,957
    
    
    
    2,330Net income
    
    $
    12,810
    
    
    $
    13,324
    
    
    $
    10,243
    
    
    
    14,720
    
    
    
    15,183Basic earnings per share (2)(3)
    
    $
    1.06
    
    
    $
    1.06
    
    
    $
    0.79
    
    
    $
    1.08
    
    
    $
    1.04Average number of shares outstandingbasic (2)(3)
    
    
    12,096
    
    
    
    12,605
    
    
    
    13,008
    
    
    
    13,664
    
    
    
    14,656Diluted earnings per share (3)
    
    $
    1.05
    
    
    $
    1.05
    
    
    $
    0.77
    
    
    $
    1.04
    
    
    $
    1.02Average number of shares outstandingdiluted (2)(3)
    
    
    12,229
    
    
    
    12,699
    
    
    
    13,278
    
    
    
    14,160
    
    
    
    14,933Statistical Data:Gross margin
    
    
    34.9
    %
    
    
    34.7
    %
    
    
    32.9
    %
    
    
    32.0
    %
    
    
    26.7
    %Operating margin
    
    
    15.9
    %
    
    
    16.7
    %
    
    
    16.0
    %
    
    
    16.8
    %
    
    
    14.1
    %Dividends per share (3)
    
    $
    0.39
    
    
    $
    0.57
    
    
    $
    0.51
    
    
    $
    0.63
    
    
    $
    0.65
 At March 31,2001
    
    
    2002
    
    
    2003
    
    
    2004
    
    
    2005Balance Sheet DataWorking capital
    
    $
    47,356
    
    
    $
    54,922
    
    
    $
    58,223
    
    
    $
    52,876
    
    
    $
    57,576Total assets
    
    
    83,466
    
    
    
    94,744
    
    
    
    106,172
    
    
    
    113,534
    
    
    
    136,976Long-term debt, less current portion
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total debt
    
    
    
    
    
    
    482
    
    
    
    
    
    
    
    
    
    
    
    Shareholders equity
    
    
    63,877
    
    
    
    69,651
    
    
    
    81,846
    
    
    
    89,730
    
    
    
    104,767
 
 (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 splits effected in July 2002 and March 2005 (see Note 11 of Notes to Consolidated
Financial Statements). 3




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Risk Factors We may from time to time make written or oral forward-looking statements. Written
forward-looking statements may appear in this document and other documents filed with the
Securities and Exchange Commission, in press releases, in reports to shareholders, on our website,
and other documents. The Private Securities Reform Act of 1995 contains a safe harbor for
forward-looking statements on which we rely in making such disclosures. In connection with this
safe harbor we are hereby identifying important factors that could cause actual results to differ
materially from those contained in any forward-looking statements made by us or on our behalf. Any
such statement is qualified by reference to the following cautionary statements: We face numerous risks as a result of our operations in China. Our manufacturing facilities are located in China. As a result, our operations and assets are
subject to significant political, economic, legal and other uncertainties associated with doing
business in China, which are discussed in more detail below. The Chinese government could change its policies toward or even nationalize private
enterprise, which could result in the total loss of our investment in that country. Over the past several years, the Chinese government has pursued economic reform policies
including the encouragement of private economic activity and greater economic decentralization. The
Chinese government may not continue to pursue these policies or may significantly alter them to our
detriment from time to time without notice. Changes in policies by the Chinese government resulting
in changes in laws, regulations, or their interpretation, or the imposition of confiscatory
taxation, restrictions on currency conversion or imports and sources of supply could materially and
adversely affect us. The nationalization or other expropriation of private enterprises by the
Chinese government could result in the total loss of our investment in that country. There may be a lack of remedies and impartiality under the Chinese legal system that prevents
us from enforcing the agreements under which we operate our factories. We do not own the land on which our factories in China are located. We occupy our
manufacturing facilities under land use agreements or under tenancy agreements with the local
Chinese government. These agreements may be difficult to enforce in China, which could force us to
accept terms that may not be as favorable as those provided in our agreements. Unlike the U.S.,
China has a civil law system based on written statutes in which judicial decisions have little
precedential value. The Chinese government has enacted some laws and regulations dealing with
matters such as corporate organization and governance, foreign investment, commerce, taxation and
trade. However, their experience in implementing, interpreting and enforcing these laws and
regulations is limited, and our ability to enforce commercial claims or to resolve commercial
disputes is unpredictable. These matters may be subject to the exercise of considerable discretion
by agencies of the Chinese government, and forces unrelated to the legal merits of a particular
matter or dispute may influence their determination. If our business licenses in China were not renewed, we would be required to move our
operations out of China, which would impair our profitability, competitiveness and market position
and jeopardize our ability to continue operations. Our activities in China require business licenses. This requires a review and approval of our
activities by various national and local agencies of Chinese government. The Chinese government may
not continue to approve our activities or grant or renew our licenses. Our inability to obtain
needed approvals or licenses could prevent us from continuing to conduct operations in China. If
for any reason we were required to move our manufacturing operations outside of China, our
profitability would be substantially impaired, our competitiveness and market position would be
materially jeopardized and we may not be able to continue operations. A fire, severe weather, flood, or other act of God could cause significant damage to our
properties in China and disrupt our business operations. Firefighting and disaster relief or assistance in China are primitive by Western standards. At
March 31, 2005, we maintained fire, casualty and theft insurance aggregating approximately
$44,371,000 covering certain of 4




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our stock in trade, goods and merchandise, furniture and equipment and factory buildings in
China. The proceeds of this insurance may not be sufficient to cover material damage to, or the
loss of, any of our factories due to fire, severe weather, flood, or other act of God or cause. We
do not maintain any business interruption insurance. Possible changes and uncertainties in economic policies in the Special Economic Zones of China
in which we operate could harm our operations by eliminating benefits we currently enjoy. As part of its economic reform, China has designated certain areas, including Shenzhen where
we have certain manufacturing facilities, as Special Economic Zones. Foreign enterprises in these
areas benefit from greater economic autonomy and more favorable tax treatment than enterprises in
other parts of China. Changes in the policies or laws governing Special Economic Zones could
eliminate these benefits. Moreover, economic reforms and growth in China have been more successful
in certain provinces than others, and the continuation or increase of these disparities could
affect the political or social stability of China. Changes to Chinese tax laws and heightened efforts by the Chinese tax authorities to increase
revenues could subject us to greater taxes. Under applicable Chinese law, we can obtain and have obtained tax breaks by reinvesting
profits of certain of our subsidiaries in China. For information on our income taxes, rates and
concessions with respect to our Chinese operations, see Note 8 of Notes to Financial Statements.
However, the Chinese tax system is subject to substantial uncertainties with respect to its
interpretation and enforcement. Moreover, the Chinese government has attempted to augment its
revenues through heightened tax collection efforts. Continued efforts by the Chinese government to
increase tax revenues could result in decisions or interpretations of the tax laws by the Chinese
tax authorities that would increase our future tax liabilities or deny us expected concessions or
refunds. We could suffer losses from corrupt or fraudulent business practices. Conducting business in
China is inherently risky. Corruption, extortion, bribery, pay-offs, theft, and other fraudulent practices are common in
China. We could suffer losses from these practices if we are not successful in implementing and
maintaining preventative measures. Controversies affecting Chinas trade with the United States could harm our operations or
depress our stock price. While China has been granted permanent most favored nation trade status in the United States,
controversies between the United States and China may arise that threaten the status quo involving
trade between the United States and China. These controversies could adversely affect our business
by, among other things, causing our products in the United States to become more expensive, which
could result in a reduction in the demand for our products by customers in the United States.
Political or trade friction between the United States and China, whether or not actually affecting
our business, could also adversely affect the prevailing market price of our common shares. Changes in currency rates involving the Hong Kong dollar or Chinese renminbi could increase
our expenses or cause economic or political problems affecting our business. Tariffs imposed as a
result of Chinas refusal to adjust its currency would make our products exported to the United
State more expensive. Our sales are mainly in United States dollars and Hong Kong dollars and our expenses are
mainly in United States dollars, Hong Kong dollars and Chinese renminbi. The Chinese government may
not continue to maintain the present currency exchange mechanism, which fixes the Hong Kong dollar
at approximately 7.80 to each United States dollar and has cause the Chinese renminbi to trade
between 8.276 and 8.280 to the United States dollar for the last several years. Over the years, and
especially in the last several months, there have been reports that the Chinese Government is under
economic and political pressure from countries with which it trades to permit its currency to
appreciate against the United States dollar. For example, lawmakers in the United States have
threatened to impose high tariffs on Chinese imports if China does not adjust its currency. If the
currency exchange mechanism between the Hong Kong dollar and the U.S. dollar is changed, our
results of operations and financial condition could be materially adversely affected. Any material
increase in the value of the Hong Kong dollar or Chinese renminbi relative to the U.S. dollar would
increase our expenses when translated to US dollars and could make our products 5




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more expensive in global markets, such as the United States and the European Union. Tariffs imposed
as a result of Chinas refusal to adjust its currency would make our products exported to the
United State more expensive and could place us at a severe competitive disadvantage. Our financial results could be adversely impacted by tax audits by the Hong Kong Inland
Revenue Department on profits derived from activities of certain of our subsidiaries. The Hong Kong Inland Revenue Department, or IRD, which is tax authority of the Hong Kong
Government, is currently engaged in aggressive and frequent field audits and close and critical
scrutiny of commercial transactions. For example, during 2003 through July 2003, the Company
engaged in discussions with the IRD regarding whether Deswell should be assessed taxes on profits
derived from activities of certain of its subsidiaries during the six fiscal years ended March 31,
2002, which the Company believed were conducted outside of Hong Kong and were not subject to a
profits tax under the Hong Kong Inland Revenue Ordinance. While, based on consultations with Hong
Kong tax experts, Deswell believes that its tax position for these years was sound and supportable,
management nevertheless concluded that it would be in the Companys best interest to reach an
immediate resolution of the tax issue with the IRD in order to avoid the expenditure of substantial
time, effort and expense involved in proceedings that could extend years and to limit the
assessment of taxes, interest and/or penalties that would be incurred if the Company did not
prevail or sought to settle the dispute later. Accordingly, in June 2003 the Company made a
proposal to settle the entire tax dispute and in July 2003, the IRD accepted the proposal. As a
result, a provision of $3,532,000 was charged to the Companys consolidated income statements for
year ended March 31, 2003 and this adversely impacted the Companys net income reported for the
fourth quarter of, and the year ended, March 31, 2003. The Company believes, based on consultations
with Hong Kong tax experts, that it has restructured the operations of its subsidiaries in order to
strengthen further its tax position if audited by the IRD in the future for fiscal years after
March 31, 2002. However, litigating with the IRD is inherently uncertain, lengthy, time consuming
and expensive and there is no guarantee that the Company would prevail. Even if the Company
believed it would prevail, Deswell might choose to settle future assessments for amounts in excess
of the tax provisions it made for the years involved in order to eliminate the expense or
uncertainty of challenging such assessments. In either event, Deswells financial results could be
adversely impacted. Any future outbreak of severe acute respiratory syndrome or other diseases may have a negative
impact on our business and operating results. In the first calendar quarter of 2003, several economies in Asia, including Hong Kong, where
our logistic support office and some of our customers are located, and southern China, where our
factories are located, were affected by the outbreak of severe acute respiratory syndrome, or SARS.
If there is a recurrence of an outbreak of SARS, it may adversely affect our business and operating
results. For example, a future SARS outbreak could result in quarantines or closure to our office
in Hong Kong or factories in China if our employees are infected with SARS and ongoing concerns
regarding SARS, particularly its effect on travel, could negatively impact our customers and
suppliers based in Hong Kong or China and our business and operating results. In addition, there has recently been an outbreak of avian influenza in humans in Asian
countries, including Vietnam, South Korea and Japan, which has proven fatal in some instances. As
the human death toll continues to grow, many are concerned that the virus will mutate and trigger a
human pandemic. If such an outbreak were to spread to southern China, it may adversely affect our
business operating results. Political and economic instability of Hong Kong and Macao could harm our operations. Our administration and accounting office are located in Macao, formerly a Portuguese Colony
and some of our customers and suppliers are located in Hong Kong, formerly a British Crown Colony.
Sovereignty over Macao and Hong Kong was transferred to China effective on December 20, 1999 and
July 1, 1997, respectively. Since their transfers, Macao and Hong Kong have become Special
Administrative Regions of China, enjoying a high degree of autonomy except for foreign and defense
affairs. Moreover, Chinas political system and policies are not practiced in Macao or Hong Kong.
Under the principle of one country, two systems, Macao and Hong Kong maintain legal systems that
are different from that of China. Macaos legal system is based on the Basic Law of the Macao
Special Administrative Region and, similarly, Hong Kongs legal system is based on the Basic Law of
the Hong Kong Special Administrative Region. It is generally acknowledged as an open question
whether Hong Kongs future prosperity in its role as a hub and gateway to China after Chinas
accession to the World Trade Organization 6




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(introducing market liberalization in China) will be diminished. The continued stability of
political, economic or commercial conditions in Macao and Hong Kong remain uncertain, and any
instability could have an adverse impact on our business. A recent labor shortage in southern China could adversely affect our gross margins or
decrease revenue. The Company carries out all of its manufacturing operations in Southern China, where it has
been able to take advantage of the lower overhead costs and inexpensive labor rates as compared to
Hong Kong. Historically, there has been an abundance of labor in southern China, but, according to
a recent Chinese government survey, factories in southern China are facing a labor shortage as
migrant workers seek better wages and working conditions elsewhere. If this trend continues, the
Companys operations could be adversely affected by, for example, preventing the Company from
manufacturing at peak capacity or forcing the Company to increase wages to attract necessary
workers. This could result in lower revenues or increased manufacturing costs, which would
adversely affect gross margins. We are dependent on a few major customers and have no long-term contracts with them. Our sales
would substantially decrease and we would suffer decreases in net income or losses if we lose any
of our major customers, if they substantially reduce their orders or if they are unable to pay us. Historically, a substantial percentage of our sales have been to a small number of customers.
Our four largest customers during the year ended March 31, 2005 were Digidesign Inc., Epson
Precision (H.K.) Limited, Line 6 Manufacturing and VTech Telecommunications Limited. Each of these
customers individually accounted for 10% or more of our total net sales during the year ended March
31, 2005 and accounted for an aggregate of 47.2%, 57.6% and 64.6%, respectively, of our total net
sales during the years ended March 31, 2003, 2004 and 2005, respectively. Our sales are based on
purchase orders and we have no long-term contracts with any of our customers and the percentage of
sales to any of our customers may fluctuate from time to time. The loss of any one of our largest
customers or a substantial reduction in orders from any of them would adversely impact our sales
and decrease our net income or cause us to incur losses unless and until we were able to replace
the customer or order with one or more of comparable size. In addition, a substantial portion of
our sales is made on credit and our results of operations would be adversely affected if a major
customer were unable to pay for our products or services. We have no long-term contracts to obtain plastic resins and our profit margins and net income could
suffer from an increase in resin prices. The primary materials used by us in the manufacture of our plastic injection molded products
are various plastic resins. The following table shows our cost of plastic resins as a percentage of
our cost of plastic products sold and as a percentage of our total costs of goods sold for the
years ended March 31, 2003, 2004 and 2005: Year ended March 31,2003
    
    
    2004
    
    
    2005Resins cost as a % of plastic products sold
    
    
    53
    %
    
    
    52
    %
    
    
    58
    %Resins cost as a % of total cost of goods sold
    
    
    25
    %
    
    
    25
    %
    
    
    24
    %
 We have no long-term contracts with our resin suppliers. Accordingly, our financial performance is
dependent to a significant extent on resin markets and the ability to pass through price increases
to our customers. The capacity, supply and demand for plastic resins and the petrochemical
intermediates from which they are produced are subject to cyclical price fluctuations, including
those arising from supply shortages. Consequently, resin prices may fluctuate as a result of
changes in natural gas and crude oil prices and the capacity, supply and demand for resin and
petrochemical intermediates from which they are produced. We have found that increases in resin
prices are difficult to pass on to our customers. In the past increases in resin prices have
increased our costs of goods sold and adversely affected our profit margins. A significant increase
in resin prices in the future could likewise adversely affect our profit margins and results of
operations. 7




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We are facing increasing competition, which has had an adverse effect on our gross profit margins. Over the last few years we have been forced to lower our prices as a result of increasing
competition in our market segments. This has resulted in lower gross profit margins, which have
declined by:  
    
    16.6% from 32.0% during the year ended March 31, 2004, to 26.7% during the year ended
March 31, 2005,
    
    2.7%, from 32.9% during the year ended March 31, 2003, to 32.0% during the year ended
March 31, 2004, and
    
    5.2%, from 34.7% during the year ended March 31, 2002, to 32.9% during the year ended
March 31, 2003, If we are forced to continue to lower our prices and are unable to offset this decrease by
increasing our sales volumes, our net sales and gross margins will decline. If we cannot stem the
decline in our gross margins, our financial position may be harmed and our stock price may
decrease. Our customers are dependent on shipping companies for delivery of our products and interruptions to
shipping could materially and adversely affect our business and operating results. Generally, we sell our products F.O.B. Hong Kong or F.O.B. China and our customers are
responsible for the transportation of products from Hong Kong or China to their final destinations.
Our customers rely on a variety of carriers for product transportation through various world ports.
A work stoppage, strike or shutdown of one or more major ports or airports could result in shipping
delays materially and adversely affecting our customers, which in turn could have a material
adverse effect on our business and operating results. Similarly, an increase in freight surcharges
due to rising fuel costs or general price increases could materially and adversely affect our
business and operating results. Because our operations are international, we are subject to significant worldwide political,
economic, legal and other uncertainties. We are incorporated in the British Virgin Islands and have subsidiaries incorporated in the
British Virgin Islands, Hong Kong, Macao, Samoa, Malaysia and China. Our administrative and
accounting office is located in Macao. We manufacture all of our products in China. As of March 31,
2005, approximately 97% of the net book value of our total identifiable fixed assets was located in
China. We sell our products to customers principally in China, the United States, Europe and Hong
Kong. Our international operations may be subject to significant political and economic risks and
legal uncertainties, including:  
    
    changes in economic and political conditions and in governmental policies,
    
    changes in international and domestic customs regulations,
    
    wars, civil unrest, acts of terrorism and other conflicts,
    
    changes in tariffs, trade restrictions, trade agreements and taxation,
    
    difficulties in managing or overseeing foreign operations, and
    
    limitations on the repatriation of funds because of foreign exchange controls. The occurrence or consequences of any of these factors may restrict our ability to operate in
the affected region and decrease the profitability of our operations in that region. Our loss of certain members of our senior management could cause disruptions in our business and
harm our customer relationships thereby adversely affecting sales. We depend to a large extent on the abilities and continued participation of  
    
    Richard Lau, our Chairman of the Board and Chief Executive Officer;
    
    C. P. Li, our Executive Director, General Manager in charge of manufacturing and
administrative operations for plastic products, and Chief Financial Officer;
    
    C. W. Leung, Executive Director of Engineering in charge of the mold division
and engineering for our plastic manufacturing operations;
    
    S. K. Lee, our Director of Administration and Marketing and General Manager in
charge of administrative and marketing operations for electronic and metallic
products; and 8




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
    
    M. C. Tam, our Director of Engineering and Manufacturing, in charge of
manufacturing and operations for electronic and metallic products. Messrs. Lau, Li and Leung founded our company and have played integral roles in the management,
growth and development of our company in general and our plastic injection molding business in
particular. They have developed and maintain relationships with several of our key customers in our
plastic injection molding business. Mr. S. K. Lee and Mr. M. C. Tam founded our electronic products
manufacturing business and have developed and continue to manage it since we acquired control of
the business from them. We have no employment contracts with any of these executives and their loss
would require us to find executives suitable to replace them, which could be difficult and
disruptive to our business. Customers with whom they have relationships may cease to deal with us
or choose to use a competitor for a greater portion of their business, resulting in our loss of
sales. The concentration of share ownership in our senior management allows them to control or
substantially influence the outcome of matters requiring shareholder approval. Our senior management as a group, each of whom are also members and constitute a majority of
our board of directors, directly or indirectly through an affiliated company beneficially own
approximately 31.0% our shares at June 28, 2005. As a result, acting together they may be able to
control, and they can substantially influence, the outcome of all matters requiring approval by our
shareholders, including the election of directors and approval of significant corporate
transactions. This ability may have the effect of delaying or preventing a change in control of
Deswell, or causing a change in control of Deswell that may not be favored by our other
shareholders. If we do not receive an unqualified opinion on the adequacy of our internal control over financial
reporting, as required by Section 404 of the Sarbanes-Oxley Act of 2002 (currently required for our
fiscal year ending March 31, 2007 and thereafter), investors could lose confidence in the
reliability of our financial statements, which could result in a decrease in the value of our
shares. As directed by Section 404 of the Sarbanes-Oxley Act of 2002, the SEC adopted rules requiring
public companies to include a report of management on the companys internal control structure and
procedures over financial reporting in their annual reports on Form 20-F that contains an
assessment by management of the effectiveness of the companys internal control structure and
procedures over financial reporting. In addition, the public accounting firm auditing the companys
financial statements must attest to and report on managements assessment of the effectiveness of
the companys internal control structure and procedures over financial reporting. While we intend
to conduct a rigorous review of our internal control structure and procedures over financial
reporting in order to assure compliance with Section 404 requirements by the deadline applicable to
us (currently March 31, 2007 and fiscal years thereafter), if our independent auditors interpret
Section 404 requirements and the related rules and regulations differently from us or if our
independent auditors are not satisfied with our internal control structure and procedures over
financial reporting or with the level at which it is documented, operated or reviewed, they may
decline to attest to managements assessment or issue a qualified report. This could result in an
adverse reaction in the financial markets due to a loss of confidence in the reliability of our
financial statements, which could cause the market price of our shares to decline. Legislative actions and potential new accounting pronouncements are likely to impact our future
financial position and results of operations and in the case of FASBs new pronouncement regarding
the expensing of stock options will adversely impact our financial results. There have been regulatory changes, including the Sarbanes-Oxley Act of 2002, new SEC
regulations and Nasdaq Stock Market rules and there may be potential new accounting pronouncements
or regulatory rulings, which will have an impact on our future financial position and results of
operations. These regulatory changes and other legislative initiatives have increased general and
administrative costs. The Financial Accounting Standards Boards recent change to mandate the
expensing of stock options will require us to record charges to earnings for stock option grants to
employees and directors and will adversely affect our financial results after we implement the new
pronouncement, which we expect will be in the quarter ending June 30, 2006 unless the compliance
date to implement this accounting change is again postponed by the SEC. 9




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Our boards ability to amend our charter without shareholder approval could have anti-takeover
effects that could prevent a change in control. As permitted by the law of the British Virgin Islands, our Memorandum and Articles of
Association, which are the terms used in the British Virgin Islands for a corporations charter and
bylaws, may be amended by our board of directors without shareholder approval provided that a
majority of our independent directors do not vote against the amendment. This includes amendments
to increase or reduce our authorized capital stock or to create from time to time and issue one or
more classes of preference shares (which are analogous to preferred stock of corporations organized
in the United States). Our boards ability to amend our charter documents without shareholder
approval, including its ability to create and issue preference shares, could have the effect of
delaying, deterring or preventing a change in control of Deswell, including a tender offer to
purchase our common shares at a premium over the then current market price. Our exemptions from certain of the reporting requirements under the Exchange Act limits the
protections and information afforded to investors. We are a foreign private issuer within the meaning of rules promulgated under the Securities
Exchange Act of 1934. As a foreign private issuer, we are exempt from certain provisions applicable
to United States public companies including:  
    
    the rules under the Exchange Act requiring the filing with the Commission of
quarterly reports on Form 10-Q or current reports on Form 8-K;
    
    the sections of the Exchange Act regulating the solicitation of proxies,
consents or authorizations in respect to a security registered under the Exchange
Act;
    
    and the sections of the Exchange Act requiring insiders to file public reports
of their stock ownership and trading activities and establishing insider liability
for profits realized from any short-swing trading transaction (i.e., a purchase
and sale, or sale and purchase, of the issuers equity securities within less than
six months). In addition, because the Company is a foreign private issuer, certain of the corporate
governance standards of The Nasdaq Stock Market that are applied to domestic companies having
securities included on The Nasdaq Stock Market may not be applied to us or their effectiveness may
be delayed beyond the effective date applicable to domestic companies. Because of these exemptions, investors are not afforded the same protections or information
generally available to investors in public companies organized in the United States or with
securities included on The Nasdaq Stock Market. 
 ITEM 4. INFORMATION ON THE COMPANY History and Development of Deswell The Company was incorporated in December 1993 as a limited liability International Business
Company under the laws of the British Virgin Islands. The Companys registered agent in the British
Virgin Islands is HWR Services Limited, P.O. Box 71, Craigmuir Chambers, Road Town, Tortola,
British Virgin Islands. The Companys principal administrative office is located in 17B, Edificio
Comercial Rodrigues, 599 Avenida da Praia Grande, Macao, and its telephone number is (853) 322096
and its facsimile number is (853) 323265. Deswell developed from the initial incorporation of Jetcrown Industrial Limited (JIL), a
Hong Kong limited liability company, in February 1987. Richard Lau, C. P. Li and C. W. Leung
founded JIL to manufacture injection-molded plastic parts for OEMs and contract manufacturers. JIL
is the ultimate predecessor of the Company as restructured in March 1994. In January 1990,
Jetcrown Industrial (Shenzhen) Limited, a limited liability China foreign operation (Jetcrown
Shenzhen), was organized to conduct the Companys manufacturing operations in China and JILs
manufacturing operations were relocated to China in 1990. Marcon Enterprises Limited, a British
Virgin Islands International Business Company (Marcon), was organized in July 1991 to hold the
beneficial ownership of Jetcrown Shenzhen and to supervise the latters manufacturing operations.
Marcon has been dormant since April 2003 and was sold to a third party in October 2003. Richtex
Services Limited (Richtex), a Hong Kong 10




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limited liability company, was organized in November 1991 to serve as Marcons local agent and
to discharge Marcons duties to supervise the manufacturing operations of Jetcrown Shenzhen.
Richtex was deregistered from the Companies Registry in March 2004. JIL has been dormant since
January 2004. In October 1992, the Company purchased a controlling interest of the outstanding stock of
Kwanasia Electronics Company Limited, a Hong Kong limited liability company (Kwanasia) and an
independent contract manufacturer of electronic products, components and subassemblies, from two
former shareholders. In December 1994, the Company increased its interest in Kwanasia to 51% of
the outstanding Kwanasia shares by purchasing the requisite stock from Mr. S. K. Lee and Mr. M. C.
Tam, Kwanasias then remaining two shareholders. The total price paid by the Company in 1994 for
its majority interest in Kwanasias shares was approximately $517,000, which was paid in cash. Kwanasia originally conducted the Companys contract electronic manufacturing operations
through a joint venture enterprise (organized as a limited liability China company) called Shenzhen
Kwanam Electronics, Co., Ltd. (Shenzhen Kwanam). Shenzhen Kwanam was initially established as a
70%-30% joint venture company pursuant to a Joint Venture Agreement between Kwanasia and Commercial
Trading Corporation (CTC), an independent Chinese party. However, the parties to the Joint
Venture Agreement subsequently elected to modify such arrangement. Such modification took various
forms but in each case essentially provided that Kwanasia and its successor (through the
subsidiaries which held the joint venture interest) would have in substance a 100% economic
interest in the joint venture enterprise, subject to a RMB60,000 (approximately $7,200 at May 30,
1996) annual payment by it to CTC. In May 1996, Kwanasia and CTC agreed that Kwanasia would
purchase CTCs 30% interest in Shenzhen Kwanam (the Buy-out Agreement) for RMB180,000
(approximately $22,000 at May 30, 1996, the day the purchase price was paid). This transaction was
completed during the year ended March 31, 1998 and resulted in Shenzhen Kwanam becoming a wholly
owned subsidiary. Following reorganization in electronic operations and its move into a new
manufacturing plant in Dongguan, China, the manufacturing operations of Shenzhen Kwanam were
switched to another wholly owned subsidiary, Dongguan Kwan Hong Electronics Co. Ltd. (Kwan Hong)
commencing April 1, 1999. Kwan Hong was initially established as an 85%-15% joint venture company
pursuant to a Joint Venture Agreement dated January 31, 1997 between Kwanasia and Dongguan Cheung
On Lang Wang Electronics Development Company (Lang Wang), an independent Chinese party. Pursuant
to a subsequent supplemental agreement signed on February 27, 1997 between Kwanasia and Lang Wang,
both parties agreed that Kwanasia would have in substance a 100% economic interest in the joint
venture enterprise with Lang Wang guaranteed an annual rental income for the buy out. In March
2004, Kwanasias 85% interest in Kwan Hong was transferred to Integrated International Limited (see
discussion of Integrated below) and in May 2004, Lang Wangs 15% interest in Kwan Hong was also
transferred to Hong Xin Electronics Company Limited (Hong Xin), a new independent Chinese party.
The registrations of Integrated and Hong Xin with the Chinese Government were approved in April and
July 2004, respectively. In a supplemental agreement signed on July 1, 2004, both parties agreed
that Intergrateds wholly-owned subsidiary would have in substance a 100% economic interest in the
joint venture enterprise with Hong Xin guaranteed an annual rental income for the buy out. The Companys incorporation in the British Virgin Islands in December 1993 was part of a
restructuring in which Deswell Industries, Inc. was organized to become the ultimate parent holding
company of the companies engaged in actual business operations and to spin off to Messrs. Lau, Li
and Leung other companies that hold real estate in Hong Kong. This restructuring, which was
completed in March 1994, involved the following steps. First, on December 13, 1993, the Company
(i) allotted a total of 2,539 common shares to provide the initial capital of the Company and (ii)
acquired the entire issued share capital of Leesha Holdings Limited, the former ultimate parent
company, in exchange for which it issued a total of 3,387,304 common shares. These shares were
issued in equal portions to Messrs. Lau, Li and Leung, the former shareholders of Leesha Holdings
Limited. Second, on March 22, 1994, the Company acquired the entire issued share capitals of JIL,
Marcon (including its interest in Jetcrown Shenzhen) and Richtex from Leesha Enterprises Limited, a
wholly owned subsidiary of Leesha Holdings Limited and a second-tier holding company, in exchange
for which the Company issued an aggregate of 7,618 common shares in equal proportions to Messrs.
Lau, Li and Leung. Third, also on March 22, 1994, the Company acquired Leesha Enterprises
Limiteds 50.00005% interest in Kwanasia in exchange for the issue of 2,539 common shares in the
Company in equal proportions to Messrs. Lau, Li and Leung and the assignment of a debt due to JIL
of approximately $465,000 relating to the original purchase of Kwanasia. Finally, on March 22,
1994, the Company made a distribution in specie of the entire share capital of Leesha Holdings
Limited to Messrs. Lau, Li and Leung. 11




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The immediate effect of this restructuring was that the Company wholly owned JIL, Marcon
(which wholly owned Jetcrown Shenzhen) and Richtex and also owned 51% of the outstanding capital
stock of Kwanasia (which, in turn had a 100% economic interest in Shenzhen Kwanam). Messrs. Lee
and Tam owned the balance of Kwanasia. In 1995, this restructuring was fine-tuned further, with the
Company forming two new corporations, Union International Limited (which changed its name to
Integrated International Limited on May 1, 1996) (Integrated) and Oriental Enterprises Limited
(which changed its name to Bright Oriental Enterprises Limited on May 1, 1996) (Oriental
Enterprises), both corporations organized under the laws of Samoa. Integrated issued its shares
proportionately to Deswell and Messrs. Lee and Tam in exchange for all outstanding capital stock of
Kwanasia respectively held by them, with the result that through February 1998, Integrated was
51%-owned by Deswell and 49%-owned by Messrs. Lee and Tam. In March 1998, Messrs. Lee and Tam together sold 5% shareholding interest in Integrated to
Micropower Enterprises, Ltd. In January 2003, the Company increased its interest in Integrated to
71% by purchasing an additional 20% from Messrs. Lee and Tam in exchange for the issuance to
Messrs. Lee and Tam of an aggregate of 251,880 common shares of Deswell. In April 2005, the Company
increased its interest in Integrated to 76% by purchasing the 5% interest owned by Micropower
Enterprises Ltd. in exchange for the issuance to Micropower Enterprises Ltd. of 120,000 common
shares of Deswell. Integrated in turn owns all of the outstanding capital stock of Kwanasia.
Messrs. Lee and Tam still own, in equal shares, 24% of the capital stock of Integrated and continue
to serve as the executives in charge of administrative and manufacturing operations, respectively,
for the Companys contract manufacturing operations for electronic products and subassemblies. See
Item 6 Directors, Senior Management and Employees. As part of the Companys restructuring, Oriental Enterprises was organized as a wholly-owned
subsidiary of Integrated and it was assigned Kwanasias joint venture interest in Shenzhen Kwanam
and assumed Kwanasias rights and responsibilities under the Shenzhen Kwanam joint venture. With
the completion during the year ended March 31, 1998 of the purchase of CTCs 30% joint venture
interest in Shenzhen Kwanam pursuant to the Buy-out Agreement, Shenzhen Kwanam became a wholly
owned subsidiary of Oriental Enterprises. Shenzhen Kwanam was closed on January 1, 2004 upon the
expiration of its 10-year business license. Oriental Enterprises has been dormant since April 2002
and was sold to a third party in October 2003. In October 1996, Integrated acquired a 64.9% interest in Kwanta Precision Metal Products Co.,
Ltd. (Kwanta), a corporation organized under the laws of Hong Kong, for $64,000, which was paid
in cash. In April and July 1999, Integrated acquired the remaining 35.1% interest in Kwanta for
$6,000, which was paid in cash. Kwanta manufactures metallic molds and accessory parts for use in
audio equipment, copying machines and fax machines. Kwanta supplies metallic molds for the
Companys plastic and electronic operations and manufactures metal parts for OEMs and contract
manufacturers, including the Company. Since September 2002, the Companys metallic manufacturing
operation was shifted to Kwan Hong and Kwanta has been dormant since then. In January 1999, the Company organized Star Peace Limited, a British Virgin Islands
International Business Company, in order to hold securities the Company acquires for investment. In January 2000, the Company organized Blue Collar Holdings Limited (Blue Collar), a British
Virgin Islands International Business Company to hold the beneficial ownership of Jetcrown
Industrial (Dongguan) Limited (Jetcrown Dongguan). Jetcrown Dongguan, a limited liability China
Foreign Enterprise registered in January 2000, was organized to conduct the Companys plastic
injection molding manufacturing operations in Dongguan, China. Jetcrown Dongguan commenced
production in July 2000. In April 2000, Integrated organized Digiwave Limited (originally named Wisetop Technology
Limited), a limited liability Hong Kong Company, to carry on original design manufacturing, or ODM,
in connection with our electronic manufacturing business. Digiwave was deregistered from the
Companies Registry in March 2004. In June 2000, the Company organized Jetcrown Industrial Sdn. Bhd. (JISB), a limited
liability Malaysian Company, to establish a representative office in Dongguan, China to handle our
overseas plastic injection product sales. On May 22, 2001, the Companys representative office
successfully obtained a registration certificate to allow it to do business from the Chinese
Government and it commenced business in August 2001. The representative office was deregistered
with the Chinese Government in January 2004 and JISB has been dormant since December 2003. 12




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In August 2001, the Company organized Jetcrown & Kwanasia (OEM) Specialist Limited (J&K
OEM), a limited liability Hong Kong Company, to conduct marketing for Deswells plastic and
electronic businesses. The capital stock of J&K OEM was owned 51% by Deswell, 39% by Dickson Lam,
Deswells former Director of Marketing for plastic and electronic products, and 10% by two other
individuals, who were employees of J&K OEM. In March 2003, the Company reorganized J&K OEMs
operations by organizing Triumph Wise Technology Limited (Triumph Wise), a British Virgin Islands
International Business Company, and in August 2003 also incorporated a new Macao company, namely,
J&K (OEM) Specialist (Macao Commercial Offshore) Limited (J&KMCO), that is wholly-owned by
Triumph Wise. The capital stock of Triumph Wise is owned 51% by Deswell, 39% by Dickson Lam and 10%
by two other individuals, who are now employees of J&KMCO. In August 2003, J&KMCO obtained
business license approval to carry out offshore marketing service activities in Macao. J&K OEMs
operations were transferred to J&KMCO in September 2003 and J&K OEM has been dormant since then. In
March 2005, the Hong Kong Companies Registry approved the application to deregister J&K OEM from
the Companies Registry. J&KMCO has been dormant since January 2005 following the retirement of
Dickson Lam and in June 2005, the Macao Company Registry approved the application of Deswell and
the minority shareholders of Triumph Wise to deregister J&KMCO from the Company Registry. In March 2003, Deswell also organized Rainbow Hill Limited, a 100% owned British Virgin
Islands International Business Company, in order to establish another new 100% owned Macao
incorporated company, namely Jetcrown Industrial (Macao Commercial Offshore) Limited (JIMCO). In
August 2003, JIMCO was incorporated and obtained business license approval to carry out offshore
trading activities in Macao. In October 2003, Deswell organized Ideatop Holdings Limited (Ideatop), a British Virgin
Islands International Business Company to hold the beneficial ownership of Jetcrown Shenzhen. The
registration of Ideatop with the Chinese Government was approved in December 2003. In September
2004, Ideatop reinvested retained earnings of $1,800,000 from Jetcrown Shenzhen to Jetcrown
Donnguan, a sister subsidiary. At the same time, Ideatop also invested an additional cash capital
of $1,800,000 in Jetcrown Dongguan, making its total investment holdings in Jetcrown Dongguan to
approximately 26.1%. As a result, Blue Collars holdings in Jetcrown Donnguan were reduced from
100% to approximately 73.9%. In October 2003, the Company also organized Joint Harvest Industries Limited, a British Virgin
Islands International Business Company and 100% owned by Integrated, in order to establish another
new 100% owned Macao incorporated company, namely Kwanasia Electronics (Macao Commercial Offshore)
Limited (KEMCO). In April 2004, KEMCO was incorporated and obtained business license approval to
carry out offshore trading activities in Macao. Kwanasia has been dormant since June 2004 when
KEMCO commenced operations. In December 2003, the Company also organized Spring Fountain Investments Limited, a British
Virgin Islands International Business Company and 100% owned by Integrated for investment holding
purpose. Organizational Structure The following chart illustrates the organizational structure of the Company and its active
subsidiaries at March 31, 2005. 13




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(FLOW CHART) 14




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Capital Expenditures Principal capital expenditures and divestitures made by Deswell during the three years in the
period ended March 31, 2005 include the following: 2003
    
    
    2004
    
    
    2005Purchase of property, plant and equipment
    
    $
    9,731,000
    
    
    $
    19,862,000
    
    
    $
    17,003,000Proceeds from the sale of property, plant and equipment
    
    
    127,000
    
    
    
    430,000
    
    
    
    36,000
 Principal capital expenditures made and currently in progress relate to improvements we are
constructing and have constructed on the land we purchased in Dongguan, China to build a new
factory. The construction of our new Dongguan factory and dormitories is planned to occur in three
to four phases. The pace of construction depends on our financial situation and future operating
results. Through March 31, 2005, Deswell spent an aggregate of approximately $7.5 million on the first
phase of construction of its new plastic injection molding plant. The facility comprises
approximately 440,000 square feet of factory space, an 85,000 square foot amenity center and 95,000 square feet of dormitory space.
Construction began in October 2001 and was completed in March 2003 with interior build-out
finished in June 2003. After installation of machinery and final touch up, Phase I of the new
factory became operational at the end of November 2003. During the same period, approximately
$14.6 million were used to expand the Companys injection molding and tool-making capacity through
the purchase of additional injection molding and tooling machinery and $6.4 million were used to
acquire and install furniture and fixtures for operations. Following completion of space built through Phase I, we spent an aggregate of approximately
$6.5 million for the second phase of construction, which comprises an additional two factory
building units covering approximately 220,000 square feet and three additional dormitory units of
216,000 square feet. Phase III of construction, with a planned investment of $10 million, will
consist of an approximate 133,000 square foot office building, an additional 377,000 square feet of
factory space and one additional dormitory unit of 120,000 square feet. Phase IV of construction,
which will consist of an additional two dormitory units and two other buildings, is planned for the
long-term, with construction to begin following completion of Phase III, as resources become
available. In July 2003, Deswells electronic & metallic subsidiary completed the $4.1 million
acquisition of 240,000 square feet of land and 400,000 square feet of factory buildings and
accommodations in Cheung On, Dongguan. These premises were previously leased from a local
government unit for the Companys electronics and metallic operations. All of the foregoing capital expenditures were financed principally from internally generated
funds and our current plan is to continue to use internally generated funds principally to finance
future capital expenditures. However, we may choose to obtain debt or equity financing if we
believe it appropriate to accelerate the phases of construction of our new factory. Business Overview Introduction to Deswell The Company is an independent manufacturer of injection-molded plastic parts and components,
electronic products and subassemblies and metallic molds and accessory parts for original equipment
manufacturers, or OEMs and contract manufacturers. The Company conducts all of its manufacturing
activities at separate plastics, electronics and metallic operation factories located in the
Peoples Republic of China. The Company produces a wide variety of plastic parts and components that are used in the
manufacture of consumer and industrial products, using different plastic injection technologies,
such as film injection, integrated injection and insert injection. The products include  
    
    cases and key tops for personal organizers;
    
    cases for flashlights, telephones, paging machines, projectors and alarm clocks;
    
    grips and rods for fishing tackle;
    
    toner cartridges and cases for photocopy machines;
    
    parts for electrical products such as air-conditioning and ventilators;
    
    parts for audio equipment;
    
    double injection caps and baby products;
    
    laser key caps; and
    
    automobile components. 15




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Electronic products manufactured by the Company include  
    
    complex printed circuit board assemblies using surface mount (SMT), ball grip
assembly (BGA) and pin-through-hole (PTH) interconnection technologies and
    
    finished products which include  Ø
    
    telecommunication products such as special purpose telephones used as a
private automated branch exchange (IPBX), a network terminal and an
internet platform etc.,Ø

    
    IP switches, routers, and  Ø

    
    sophisticated professional audio equipment such as power amplifiers,
digital mixers, digital signal processors, etc. Metal products manufactured by the Company include metallic molds and accessory parts used in
audio equipment, telephones, copying machines, pay telephones, multimedia stations, automatic
teller machines, etc. As part of its manufacturing operations, the Company consults with its customers in the design
of plastic parts and the design and production of the molds used to manufacture plastic parts,
which are made by Deswell at its customers expense, and provides advice and assistance in the
design and manufacturing of printed circuit boards. The Company believes that its ability to
manufacture high-end plastic and metal parts of the quality required by OEMs and contract
manufacturers which furnish products and services internationally, Deswells expertise in designing
and manufacturing molds for its customers and the Companys low production costs distinguish
Deswell from most other manufacturers of plastic products and provide it with a competitive
advantage. However, as a result of increased competition, Deswell has been forced to reduce the
sales prices of its products during the years ended March 31, 2003, 2004 and 2005, which has
resulted in lower gross profit margins during these years. Industry Overview Management believes that the injection molding and metal molds and parts manufacturing
industries have each benefited in recent years from a trend among major users of injection molded
and metal products to outsource an increasing portion of the parts requirements and to select a
small number of suppliers or a sole supplier to provide those products. The Company is not aware of
any empirical data defining the manufacturing industry in China, however, management believes that
injection molding and metal manufacturing firms which are much smaller than the Company make up the
largest segment of the industry in China. The Companys experience indicates that such smaller
firms are often unable to react quickly and responsively to the diverse demands of many customers
and are not capable of furnishing the level of quality that high-end plastic and metal products
require. Management believes that this inability on the part of these smaller manufacturers has
created opportunities for the Company to increase sales by catering to the outsourcing requirements
of OEMs and contract manufacturers that manufacture such high-end products. Similarly, as a result of the recognition by OEMs in the electronics industry of the rising
costs of operating a manufacturing site and the need to add more sophisticated and expensive
manufacturing processes and equipment, OEMs have turned increasingly to outside contract
manufacturers. By doing so, OEMs are able to focus on research, product conception, design and
development, marketing and distribution, and to rely on the production expertise of contract
manufacturers. Other benefits to OEMs of using contract manufacturing include: access to
manufacturers in regions with low labor and overhead costs, reduced time to market, reduced capital
investment, improved inventory management, improved purchasing power and improved product quality.
In addition, the use of contract manufacturers has helped OEMs manage production in view of
increasingly shorter product life cycles. 16




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Operations Plastic Injection Molding Plastic injection molding manufacturing accounted for 54.9%, 54.6% and 47.5% of the Companys
total sales during the years ended March 31, 2003, 2004 and 2005, respectively. At March 31, 2005,
the Company conducted its plastic manufacturing operations in approximately 311,000 and 693,000
square feet of factory space in its factories located in Shekou, Shenzhen, China and Dongguan,
Guangzhou, China, respectively. The Companys plastic injection molding process consists of three phases: (1) mold design and
production; (2) plastic injection; and (3) finishing. Mold design and production.The plastic injection-molding process begins when a customer
provides the Company with specifications for a product or part, which specifications are often
created in consultation with the Companys technical staff. Next the Company designs and produces
the mold, using great care in the design process and in the selection of materials to produce the
mold in an effort to create a high quality appearance of the completed product by reducing or
eliminating potential flaws such as the sinkage of materials and irregularities in the knit line of
joints. The mold-making process ranges from 25 to 75 days, depending on the size and complexity of the
mold. Mold making requires specialized machines and is capital intensive. At March 31, 2005, the
Company used 29 EDMs (electrical discharge machines), 30 CNC (computer numerical control) milling
machines and 85 NC (numerical control) milling machines in the mold-making process. Deswell is continually adding equipment to expand its mold making and injection molding
capabilities. During February to April 2002, the Company purchased 12 additional injection-molding
machines with clamping force of 365 to 550 tons for approximately $1.5 million. These new
injection-molding machines were installed in July 2002. In December 2002, the Company purchased
five additional sets of injection-molding machines with clamping force of 368 to 650 tons for
approximately $1 million. These new injection-molding machines, two of which have gas injection
functionality, were installed in March 2003. In March 2003, the Company purchased four sets of
precision double injection molding machines and one additional injection-molding machine with
clamping force of 650 tons for an aggregate of approximately $1 million. These new
injection-molding machines were installed in March and July 2003. During the year ended March 31, 2004, the Company purchased and installed approximately $3.6
million worth of small- to medium-size machines and equipment, including 102 sets of Chen Hsong
hydraulic injection machines with a clamping force of 55 tons to 218 tons; five sets of
double-injection machines with a clamping force of 200 tons; nine sets of Fanuc electric
precision-injection machines with a clamping force of 75 tons to 140 tons; four sets of Sumitomo
high-speed precision-injection machines with a clamping force of 75 tons to 100 tons; two sets of
high-precision large Makino electric discharge machines; and two sets of high-precision Mitsubishi
wire-cut machines. During the year ended March 31, 2005, the Company continued to expand its production
capabilities, purchasing and installing approximately $2.9 million of machines and equipment,
including four sets of EDMs; five sets of CNC milling machines; seven sets of NC milling machines;
sixteen sets of Chen Hsong hydraulic injection machines with clamping force of 128 tons to 268
tons; and six sets of injection molding machines with clamping force of 85 to 200 tons, replacing
10 sets of old injection machines and one set of EDMs. Molds produced by the Company generally weigh from 220 to 12,000 pounds and generally cost
between $3,000 and $500,000. The customer generally bears the cost of producing the molds and, as is customary in the
industry, the customers own them. However, the Company maintains and stores the molds at its
factory for use in production and it is the Companys policy not to make molds for customers unless
the customer undertakes to store its molds at the Companys factory and uses the Company to
manufacture the related parts. In this way, the Company seeks to use its mold-making expertise to
create dependence on the Company for the customers parts requirements. 17




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During the year ended March 31, 2005, the Company made on average about 70 to 100 different
molds every month. Management believes that the Companys skills and expertise in mold-making,
coupled with having its facilities and operations in China, allow the Company to produce molds at
costs substantially less than molds of comparable quality made in Japan, Korea and Taiwan. Plastic Injection.During the mold-making process, suitable plastic resin for the particular
product is selected and purchased. See Raw Materials, Component Parts and Suppliers, below. The
completed mold is mounted onto injection machines, which are classified according to the clamping
force (the pressure per square inch required to hold a mold in place during the injection molding
process). At March 31, 2005, the Company had 368 injection molding machines, ranging from 50 to
1,600 tons of clamping force, with most machines in the range of from 80 to 100 tons. Each of the
Companys machines is capable of servicing a variety of applications and product configurations and
the Company has machines, which permit the Company to fabricate plastic parts as small as a button
and as large as a 3 ft. x 2 ft. case for a copy machine. Using separate shifts, injection molding is generally conducted 24 hours a day, five to seven
days per week, other than normal down time for maintenance and changing of product molds. Molding
of products requiring extra concerns for appearance, such as cases for calculators, personal
organizers and telephones are conducted in an isolated and dust free section of the factory. In a
continuous effort to assure quality, the Companys quality control personnel inspect the products produced from each machine generally at hourly intervals during
production. When defects are discovered, the Companys maintenance personnel inspect the mold and
the machine to determine which is responsible. If the mold is the cause of the defect, it will be
immediately removed from the machine and serviced or repaired by one of a team of technicians
employed to maintain molds. The mold will then be remounted on the machine and production will
continue. If the machine is the source of the defect, the Companys technicians and engineers
service the machine immediately. Through this continuous vigilance to molds and machines, the
Company has experienced what it believes to be a relatively low scrap rate and has been able to
maintain a high level of productivity of its injection molding machines. Finishing.After injection molding, products are finished. Finishing consists of smoothing
and polishing, imprinting letters, numbers and signs through silk screening process, pad printing
or epoxy ultra violet cutting, and treating the product with an anti-fog coating for a lasting and
attractive appearance. Most of these functions are conducted by hand. Electronic Products and Assemblies In an aggregate of approximately 216,000 square feet of factory space at March 31, 2005
located at facilities in Dongguan, China, the Company manufactures and assembles electronic
products and electronic assemblies for OEMs. Finished products include consumer and sophisticated
studio-quality audio equipment, IPBX and commercial telephone units, network education platforms,
IP switches, routers etc. Assemblies consist of PCBs with passive (e.g., resistors, capacitors,
transformers, switches and wire) and active (e.g., semiconductors and memory chips) components
mounted on them. During the years ended March 31, 2003, 2004 and 2005, manufacturing of electronic
products accounted for approximately 42.0%, 41.2% and 48.1%, respectively, of the Companys total
sales. During the same periods, manufacturing of finished products accounted for 97%, 99% and 99%,
respectively, of electronic product sales and assembling of printed circuit boards accounted for
the balance of such sales during those periods. In assembling printed circuit boards the Company purchases printed circuit boards, surface
mounted components and chips and uses PTH, BGA and SMT interconnection technologies to assemble
various components onto the PCBs. Before delivery, completed PCBs are checked by
in-circuit-testers and outgoing quality assurance inspections are performed. PTH is a method of assembling printed circuit boards in which component leads are inserted and
soldered into plated holes in the board. While this technology is several decades old and is labor
intensive, it still has a significant market, particularly for consumer product applications. BGA is a method of mounting an integrated circuit or other component to a PCB. Rather than
using pins that consume a large area of the PCB, the component is attached to the circuit board
with small balls of solder at each contact. This method allows for greater component density and is
used in more complex PCBs. SMT is the automatic process of printed circuit board assembly in which components are mounted
directly to the surface of the board, rather than being inserted into holes. With this process,
solder is accurately stenciled in paste form on pads located on the printed circuit board and the
components are then placed onto the solder paste and fused to the melting point of the paste to
establish a strong solder joint between components and the printed circuit board. The SMT process
allows miniaturization of PCBs, cost savings and shorten lead paths between components (which
results in faster signal speed and improved reliability). Additionally, it allows components to be
placed on both sides of the printed circuit board, a major factor for the purpose of
miniaturization. Manufacturing operations include PCB assembly, wiring and testing. The process is completed by
assembling the PCBs into a plastic or metal housing that comprises the finished product. Quality
assurance is then conducted in accordance with the customers requirements before the shipment. 18




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Metal Parts Manufacturing In an aggregate of approximately 117,000 square feet of factory space at March 31, 2005
located at facilities in Dongguan, China next to the Companys electronic products assembly
facilities, Deswells metal forming division manufactures metallic molds and accessory parts for
use in audio equipment, routers, payphones, multimedia stations and ATMs. The Companys metal
molds and metal parts (products) manufacturing accounted for approximately 3.1%, 4.2% and 4.4% of
Deswells total sales during the years ended March 31, 2003, 2004 and 2005, respectively. Quality Control The Company maintains strict quality control procedures for its products. At hourly
intervals, the Companys quality control personnel monitor machines and molds to assure that
plastic parts are free from defects. For electronic operations, the Companys quality control personnel check all incoming
components. Moreover, during the production stage, the Companys quality control personnel check
all work in process at several points in the production process. Finally, after the final assembly
and before shipment, the Company conducts quality assurance inspections in accordance with the
customers Acceptable Quality Level, or AQL, requirements.. Plastic, electronic and metal products manufactured and assembled at the Companys facilities
have a low level of product defects, and aggregate returns represented less than 3% of total net
sales during each of the years ended March 31, 2003, 2004 and 2005. In 1995, the Company earned ISO 9001 certifications for both its plastic and electronic
products manufacturing operations. In April 2000, the Company also received ISO 9002 for its metal
manufacturing operation. The ISO or International Organization for Standardization is a
Geneva-based organization dedicated to the development of worldwide standards for quality
management guidelines and quality assurance. ISO 9000, which is the first quality system standard
to gain worldwide recognition, requires a company to gather, analyze, document and monitor and to
make improvements where needed. ISO 9001 is the ISO level appropriate for manufacturers like the
Company. The Companys receipt of ISO 9001 certification demonstrates that the Companys
manufacturing operations meet the established world standards. In August 2003, the Companys plastic injection manufacturing plant in Shenzhen obtained ISO
14001 certification, which evidences that the Companys environmental management standards or EMS
meet established international standards. In August 2004, the Companys plastic injection
manufacturing plant in Dongguan also obtained ISO 14001 certification. ISO 14000 is a series of
international standards on environmental management, ISO 14001 is the most well known of these
standards and is often seen as the corner stone standard of the ISO 14000 series. The Companys
electronic and metallic manufacturing plant is in the process of seeking ISO 14001 certification. The Company was working toward having its plastic injection manufacturing plant obtain QS 9000
Certification but before completing that process elected to seek ISO/TS 16949 Certification. ISO/TS
16949 is an ISO Technical Specification. This specification aligns existing American (QS-9000),
German (VDA6.1), French (EAQF) and Italian (AVSQ) automotive quality systems standards within the
global automotive industry. Together with ISO 9001:2000, ISO/TS 16949 specifies the quality system
requirements for the design/development, production, installation and servicing of automotive
related products. ISO/TS 16949 has been accepted as an equivalent to QS-9000, VDA6.1, AVSQ, and
EAQF. ISO/TS 16949 does not replace QS-9000; but is optional and eliminates the need for multiple
certifications. The Company expects to achieve ISO/TS 16949 Certificate by the end of 2005. 19




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##### Table of Contents



Raw Materials, Component Parts and Suppliers Plastic Resins.The primary raw materials used by the Company in the manufacture of its
plastic parts are various plastic resins, primarily ABS (acrylonitrile-butadiene-styrene), which in
the years ended March 31, 2003, 2004 and 2005 averaged approximately 53%, 50% and 58%,
respectively, of the Companys cost of plastic products sold and 25%, 24% and 24%, respectively, of
the Companys total cost of goods sold. Because plastic resins are commodity products, the Company
selects its suppliers primarily based on price. The Company has no long-term supply agreements for
plastic resins. The Company currently obtains its plastic resins from suppliers in Hong Kong,
Japan and Taiwan and normally maintains a three to four month inventory supply. The Company used in excess of 13,573,000 pounds of plastic resins during the year ended March
31, 2005. Management believes that the Companys large volume purchases of plastic resin have
generally resulted in lower unit raw material costs and generally has enabled the Company to obtain
adequate shipments of raw materials. While the Company is not generally bound by fixed price
contracts with its customers, the Company has found that increases in resin prices can be difficult
to pass on to its customers and, as a consequence, a significant increase in resin prices could
have, and in the past has had, a material adverse effect on the Companys operations. The primary plastic resins used by the Company are produced from petrochemical intermediates
derived from products of the natural gas and crude oil refining processes. Natural gas and crude
oil markets have in the past experienced substantially cyclical price fluctuations as well as other
market disturbances including shortages of supply and crises in the oil producing regions of the
world. The capacity, supply and demand for plastic resins and the petrochemical intermediates from
which they are produced are also subject to cyclical and other market factors. Consequently,
plastic resin prices may fluctuate as a result of natural gas and crude oil prices and the
capacity, supply and demand for resin and petrochemical intermediates from which they are produced. Although the plastics industry has from time to time experienced shortages of plastic resins,
the Company has not experienced to date any such shortages. Management believes that there are
adequate sources available to meet the Companys raw material needs. Component Parts and Supplies.The Company purchases over 500 different component parts from
more than 100 suppliers and is not dependent upon any single supplier for any essential component.
The Company purchases from suppliers in Japan, Taiwan, Korea, Hong Kong and elsewhere. At various
times there have been shortages of parts in the electronics industry, and certain components,
including PCBs and semiconductors, have been subject to limited allocations. Although shortages of
parts and allocations have not had a material adverse effect on the Companys results of
operations, there can be no assurance that any future shortages or allocations would not have such
an effect. Raw Metal. The primary materials used by the Company in metal molds and parts manufacturing
are various metals, but purchases of raw metal were immaterial to the Companys total operations
during the years ended March 31, 2003, 2004 and 2005. Typically the Company buys metals from a
variety of suppliers in Hong Kong and China and has no long-term contracts with metal suppliers. Transportation Transportation of components and finished products to customers in Shenzhen and to and from
Hong Kong and Shenzhen and Dongguan is by truck. Generally, the Company sells its products F.O.B.
China or F.O.B. Hong Kong. To date, the Company has not been materially affected by any
transportation problems and has found that the transition of Hong Kong to Chinese control in July
1997 has not had an adverse impact on the Companys ability to transport goods to and from Hong
Kong and China. 20




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Customers and Marketing The Companys customers are OEMs and contract manufacturers. The Company sells its products
in Asia (Hong Kong, Japan and China), the United States and Europe (Germany, United Kingdom, France
and Italy). Net sales to customers by geographic area are determined by reference to shipping
destinations as directed by the Companys customers. For example, if the products are delivered to
the customer in Hong Kong, the sales are recorded as generated in Hong Kong; if the customer
directs the Company to ship its products to Europe, the sales are recorded as sold to Europe. See
Note 16 of Notes to Consolidated Financial Statements for the dollar amounts of export sales by
geographic area for each of the years ended March 31, 2003, 2004 and 2005. Net sales as a
percentage of total sales to customers by geographic area consisted of the following for the years
ended March 31, 2003, 2004 and 2005: Geographic areas
    
    2003
    
    
    2004
    
    
    2005China
    
    
    58.9
    %
    
    
    51.6
    %
    
    
    44.8
    %United States
    
    
    28.5
    
    
    
    38.4
    
    
    
    40.5Europe
    
    
    8.2
    
    
    
    5.9
    
    
    
    10.9Hong Kong
    
    
    3.1
    
    
    
    2.3
    
    
    
    0.8Others
    
    
    1.3
    
    
    
    1.8
    
    
    
    3.0Total
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
 The Company markets its products and services to existing customers through direct
contact with the Companys management and direct sales personnel. The Companys sales personnel
attend trade shows advertise in trade publications such as Modern Plastics Internationaland
Injection Molding. Collecting information from trade-show, as well as websites, Deswells marketing
staffs contacts existing and potential customers directly by telephone, mail, fax, e-mail via the
Internet and in person, stressing Deswells capability as a complete solution provider for plastic
injection mold design, tooling and molding as well as an electronics manufacturing services, or
EMS, provider of advanced technology manufacturing processes and flexible logistic services. Major Customers The table below sets forth each of the Companys customers which accounted for 10% or more of
net sales during the year ended March 31, 2005 the products purchased and the percentage of total
Company net sales accounted for by such customers during the years ended March 31, 2003, 2004 and
2005. Year ended March 31,Customer
    
    Product
    
    2003
    
    
    2004
    
    
    2005Digidesign, Inc.
    
    Professional audio equipments
    
    
    13.5
    %
    
    
    17.8
    %
    
    
    19.1
    %Epson Precision (H.K.) Limited
    
    Plastic components
    
    
    22.3
    %
    
    
    15.4
    %
    
    
    18.5
    %Line 6 Manufacturing
    
    Professional audio equipments
    
    
    0.0
    %
    
    
    *
    
    
    
    14.9
    %VTech Telecommunications Limited
    
    Telephones and organizers
    
    
    11.6
    %
    
    
    17.6
    %
    
    
    12.1
    %
 
 *

Less than 10%. The Companys success will depend to a significant extent on the success achieved by its
customers in developing and marketing their products, some of which may be new. Many of the
industry segments served by the Companys customers are subject to technological change, which can
result in short product life cycles. The Company could be materially adversely affected if
advances in technology or other factors reduce the marketability of essential products of its
customers or if new products being developed by its customers do not attain desired levels of
acceptance. If the Company was to lose any customers who account for a material portion of total
net sales, or if any of these customers were to decrease substantially their purchases from the
Company, the Companys revenues, earnings and financial position would be materially and adversely
affected. The Companys dependence on these customers is expected to continue in the foreseeable
future. 21




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##### Table of Contents



The Companys sales transactions with all of its customers are based on purchase orders
received by the Company from time to time. Except for these purchase orders, the Company has no
written agreements with its customers. Sales of plastic parts and metallic products are primarily
made on credit terms, with payment in Hong Kong dollars expected within 30 to 60 days of shipment.
Sales of electronic products are typically based on letters of credit and are payable in United
States dollars. To date the Company has not experienced any significant difficulty in collecting
accounts receivable on credit sales. Management communicates regularly with credit sale customers
and closely monitors the status of payment and in this way believes it has kept the default rate
low. Additionally, plastic parts deliveries are made in several installments over a lengthy period
of time, which permits the Company to withhold delivery in the event of any delinquency in payment
for past shipments. While the Company has not experienced any difficulty in being paid by its
major customers, there can be no assurance that the Companys favorable collection experience will
continue in every case or at all. The Company could be adversely affected if a major customer were
unable to pay for the Companys products or services. Competition Management believes that the plastic injection molding, contract electronic manufacturing and
metal molds and accessories industries are each highly fragmented, although it is not aware of any
empirical data defining the business segments in China. Plastic injection molding and metal molds
and accessories manufacturing are characterized by a large number of relatively small operators and
divisions of larger companies and contract electronic manufacturing by numerous independent
manufacturers whose capabilities are evaluated by customers against each other and against the
merits of in-house production. Competition in each industry is intense and many competitors in
each industry are larger and have greater financial and other resources than the Company. The Company believes that competition for plastic injection molding, contract electronic
manufacturing and metal molds and parts manufacturing businesses are based on price, quality,
service and the ability to deliver products in a timely and reliable basis. The Company believes
that it competes favorably in each of these areas in each business segment. Patents, Licenses and Trademarks The Company has no patents, trademarks, licenses, franchises, concessions or royalty
agreements that are material to its business. Seasonality For information concerning the seasonality of the Companys business, see Seasonality
included under Item 5 Operating and Financial Review and Prospects. Property, Plants and Equipment Macao The Company leases Units 17B and 17E, Edificio Comercial Rodrigues, 599 Avenida da Praia
Grande, Macao from an unaffiliated party for a term of two years to July 2005. The premises are
used as trading, administrative and accounting office for the Companys plastic injection business.
The monthly rent is approximately $2,000. The Company also leases Unit 6B, Edificio Comercial Rodrigues, 599 Avenida da Praia Grande,
Macao from an unaffiliated party for a term of two years to February 2006. The premise is used as
trading, administrative and accounting office for the Companys electronic & metallic business. The
monthly rent is approximately $820. Hong Kong The Company owns Unit 10-14, 19/F., Kwong Sang Hong Centre, 151-153 Hoi Bun Road, Kwun Tong,
Hong Kong. This property has been vacant since July 2002 and is leased to an unaffiliated party for
a term of three years to October 2006. 22




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##### Table of Contents



Southern China In October 2000, the Company acquired under sale and purchase agreement with third party an
aggregate of approximately 112,900 square feet of manufacturing space at Block G, Wing Village
Industrial Estate, Shekou, Shenzhen, China which was previously leased by the Company for the use
of its plastic injection molding operations. Deswell paid approximately $1,461,000 to acquire this
property. At March 31, 2005 the Company leased approximately 198,000 square feet of manufacturing space
at Block A, 1/F-2/F, Block B, 1/F-3/F, Block D, 1/F-5/F, and Block F, 1/F-5/F Wing Village
Industrial Estate, Shekou, Shenzhen, China which are used for its plastic injection molding
operations. These factory premises are leased from the local Chinese government and third parties
under separate leases expiring from December 2005 to December 2007. The aggregate monthly rent is
approximately $47,600. In January 2000, the Company acquired under sale and purchase agreement with the local
government party an aggregate of approximately 1.3 million square feet of land to construct its own
manufacturing plant and dormitory buildings in Houjie, Dongguan, China. As at March 31, 2005, there
were built and operational 693,000 square feet of factory space, 91,000 square feet of amenity
space and 452,000 square feet of dormitory space. The Company leases space at various locations near its plastics manufacturing factories in
Shekou and Dongguan that it uses as dormitories for factory staff and workers. Management
estimates that the space leased for dormitories approximated 71,200 square feet and 4,500 square
feet at March 31, 2005 in Shekou and Dongguan, respectively. The facilities are leased for periods
of one to two years, expiring from April 2005 to January 2006. The aggregate monthly rental is
approximately $12,500. The Company has acquired under purchase and sale agreements with third
parties an aggregate of approximately 24,600 square feet of additional space at various locations
near its plastics manufacturing operations in Shenzhen, which are also used as dormitories for
factory staff and workers. In July 2003, the Company completed the acquisition with a third party an aggregate of
approximately 244,000 square feet of land and approximately 420,000 square feet of buildings,
including six blocks of dormitory buildings, a canteen, a factory building, a car park and a guard
room, at Cheung On, Dongguan, China, which was previously named Kwan Hong Building. This property
was previously leased by the Company for the use in its contract electronic and metal manufacturing
operations. The land use period is for 50 years from February 1, 2003 to January 31, 2053. The
Company paid approximately $4,186,000 to acquire this property. At March 31, 2005, the Company leased approximately 69,400 square feet of manufacturing space
in Kwanta Building, Cheung On, Dongguan, China for its contract metal manufacturing operation.
These premises are leased from third party expiring in May 2007. The aggregate monthly rental is
approximately $8,600. In addition, the Company leases approximately 38,600 square feet of space at various locations
near its contract electronics and metal manufacturing factories in Dongguan, Shenzhen, which are
used as staff quarters. The facilities are leased from third parties for periods of one to two
years and expire from July 2005 to November 2006. The aggregate monthly rental is approximately
$7,000. Management believes that Deswell will be able to renew each of the leases described above as
it expires for periods comparable to the current term or find alternative space as needed. The Company believes that its existing offices and manufacturing space, together with the
additional manufacturing space in our Dongguan plant to be completed by end of this year and
manufacturing space in close proximity to its existing facilities, which management believes will
be available as needed for limited expansion, will be adequate for the operation of its business
for at least the next two years. 23




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##### Table of Contents



ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS Except for statements of historical facts, this section contains forward-looking statements
involving risks and uncertainties. You can identify these statements by forward looking words
including expect, anticipate, believe seek, estimate. Forward looking statements are not
guarantees of Deswells future performance or results and the Companys actual results could differ
materially from those anticipated in these forward-looking statements as a result of certain
factors, including those set forth under the section of this Report entitled Item 3. Key
Information  Risk Factors. This section should be read in conjunction with the Companys
Consolidated Financial Statements included under Item 18 of this Report. Operating Results The following discussion should be read in conjunction with the consolidated financial
statements and notes thereto included later in this Report. The Company prepares its financial
statements in accordance with U.S. GAAP. General The Companys revenues are derived from the manufacture and sale of injection-molded plastic
parts and components, electrical products and subassemblies and metallic molds and accessories.
JIMCO, Jetcrown Shenzhen and Jetcrown Dongguan (wholly owned subsidiaries) carry on the plastics
operations whereas Integrated carries out the electronics operations. The Company acquired a
controlling interest in Integrateds predecessor in October 1992 and has included the results of
the predecessor in its consolidated financial statements from the date of acquisition. Through
December 2002, the Company owned a 51% interest in Integrated. In January 2003, the Company
increased its interest in Integrated to 71% by purchasing an additional 20% from its minority
shareholders in exchange for the issuance to them of an aggregate of 251,880 common shares. In
April 2005, the Company increased its interest in Integrated to 76% by purchasing an additional 5%
from a minority shareholder in exchange for the issuance to it of 120,000 common shares. The Companys plastics operations are the mainstay of its business and have historically
accounted for the majority of its sales. 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. At the same time, the proximity of the Companys
factories in Southern China to Hong Kong permits the Company to manage easily its manufacturing
operations from Hong Kong, facilitates transportation of its products through Hong Kong and
provides the Companys plastic manufacturing operations with access to electricity from Hong Kong
and to nearby water, both of which resources are needed in abundance to manufacture plastic parts
and are often inadequate elsewhere in China. The Companys earnings have benefited from favorable overall effective income tax rates of
24.9%, 3.4% and 3.2% for the years ended March 31, 2003, 2004 and 2005, respectively. The Company
is subject to Hong Kong income tax on its income arising in, or derived from, Hong Kong. For
information relating to the Companys settlement of a tax dispute with the Hong Kong Inland Revenue
Department, or IRD, in 2003 regarding whether Deswell should be assessed additional taxes on
profits derived from activities of certain of its subsidiaries during the six fiscal years ended
March 31, 2003, see the discussion under Year ended March 31, 2004 Compared to Year Ended March
31, 2003, below. For information regarding Chinese governmental economic, fiscal, monetary or
political policies or factors have affected or could materially affect Deswells operations and
investments, please see Item 3. Key Information  Risk Factors  We Face Numerous Risks as a
Result of Our Operations in China And Hong Kong. Currently, under the Chinese tax system Deswell can obtain tax breaks by reinvesting profits
of certain of our subsidiaries in China. For information on our income taxes, rates and concessions
with respect to our Chinese operations, see Note 8 of Notes to Financial Statements. The Company
expects to continue to benefit from a low overall effective income tax rate in the future, barring
unforeseen changes in tax laws and regulations in the various jurisdictions in which it operates.
See Uncertain applications of Chinese tax laws could subject us to greater taxes in China
included under We face numerous risks as a result of our operations in China and Hong Kong in
Item 3. Key Information  Risk Factors. Deswells material operations are generally organized in three segments: plastic injection
molding, or the 24




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##### Table of Contents



plastic segment, electronic products assembling and metallic parts manufacturing.
Results from Companys metallic parts manufacturing operations have not been material to the Companys operations as a whole
and have therefore been combined as the electronic and metallic segment for the table presentation
and discussion below. The Companys reportable segments are strategic business units that offer
different products and services. The following table sets forth present selected consolidated
financial information stated as a percentages of net sales for each of the three years in the
period ended March 31, 2005. Year ended March 31, 2003
    
    
    Year ended March 31, 2004
    
    
    Year ended March 31, 2005Plastic
    
    
    
    
    
    
    
    
    
    
    Plastic
    
    
    
    
    
    
    
    
    
    
    PlasticInjection-
    
    
    Electronic
    
    
    
    
    
    
    Injection-
    
    
    Electronic
    
    
    
    
    
    
    Injection-
    
    
    ElectronicMolding
    
    
    & Metallic
    
    
    
    
    
    
    Molding
    
    
    & Metallic
    
    
    
    
    
    
    Molding
    
    
    & MetallicSegment
    
    
    Segment
    
    
    Total
    
    
    Segment
    
    
    Segment
    
    
    Total
    
    
    Segment
    
    
    Segment
    
    
    TotalNet sales
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of sales
    
    
    57.0
    
    
    
    79.4
    
    
    
    67.1
    
    
    
    60.4
    
    
    
    77.2
    
    
    
    68.0
    
    
    
    65.2
    
    
    
    80.6
    
    
    
    73.3Gross profit
    
    
    43.0
    
    
    
    20.6
    
    
    
    32.9
    
    
    
    39.6
    
    
    
    22.8
    
    
    
    32.0
    
    
    
    34.8
    
    
    
    19.4
    
    
    
    26.7Selling, general and
administrative expenses
    
    
    19.1
    
    
    
    14.1
    
    
    
    16.9
    
    
    
    18.5
    
    
    
    11.1
    
    
    
    15.2
    
    
    
    16.6
    
    
    
    8.9
    
    
    
    12.6Operating income
    
    
    23.9
    
    
    
    6.5
    
    
    
    16.0
    
    
    
    21.1
    
    
    
    11.7
    
    
    
    16.8
    
    
    
    18.2
    
    
    
    10.5
    
    
    
    14.1Interest expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other income, net
    
    
    1.6
    
    
    
    
    
    
    
    0.9
    
    
    
    1.0
    
    
    
    0.9
    
    
    
    0.9
    
    
    
    0.2
    
    
    
    0.3
    
    
    
    0.3Income before income taxes
and minority interest
    
    
    25.5
    
    
    
    6.5
    
    
    
    16.9
    
    
    
    22.1
    
    
    
    12.6
    
    
    
    17.8
    
    
    
    18.4
    
    
    
    10.8
    
    
    
    14.4Income taxes
    
    
    4.1
    
    
    
    4.3
    
    
    
    4.2
    
    
    
    0.5
    
    
    
    0.8
    
    
    
    0.6
    
    
    
    0.3
    
    
    
    0.6
    
    
    
    0.5Income before
minority interests
    
    
    21.4
    
    
    
    2.2
    
    
    
    12.7
    
    
    
    21.6
    
    
    
    11.8
    
    
    
    17.2
    
    
    
    18.1
    
    
    
    10.2
    
    
    
    13.9Minority interests
    
    
    0.8
    
    
    
    2.1
    
    
    
    1.4
    
    
    
    0.9
    
    
    
    3.4
    
    
    
    2.0
    
    
    
    0.7
    
    
    
    2.9
    
    
    
    1.8Net income
    
    
    20.6
    %
    
    
    0.1
    %
    
    
    11.3
    %
    
    
    20.7
    %
    
    
    8.4
    %
    
    
    15.1
    %
    
    
    17.4
    %
    
    
    7.3
    %
    
    
    12.1
    %
 Year ended March 31, 2005 Compared to Year Ended March 31, 2004 Net Sales- The Companys net sales for the year ended March 31, 2005, were $125,590,000, an
increase of $28,395,000 or 29.2% as compared to year ended March 31, 2004. Sales to Digidesign
Inc. (Digidesign), Epson Precision (H.K.) Ltd. (Epson), Line 6 Manufacturing and VTech
Telecommunications Ltd. (VTech), the Companys four largest customers during the year ended March
31, 2005, represented approximately 64.6% of net sales for the year. See Item 4 Information on
the Company  Major Customers. The increase in sales was mainly related to the increase in sales of plastic segment of
$6,596,000 and the increase in sales of electronic and metallic segment of $21,799,000. This
represented an increase of 12.4% and 49.4%, respectively, as compared with the respective net sales
from these segments in the prior year. The revenue increase in the plastics segment was mainly a result of increase in orders from
its existing and new customers of $5,461,000 and $1,135,000, respectively, as compared to the
corresponding period last year. The increase in net sales in the electronic and metallic segment
was mainly due to an increase in orders from both existing and new customers of $21,041,000 and
$1,950,000, respectively, offsetting the net decrease in orders from old customers of $1,192,000
during the year ended March 31, 2005. The net increase resulted from a change in the customer mix
during the period as compared with last year. Gross Profit- The overall gross profit for the year ended March 31, 2005 was $33,518,000,
representing an overall gross profit margin of 26.7%. This compares with the overall gross profit
and gross profit margin of $31,090,000 or 32.0% for the year ended March 31, 2004. Gross profit in plastic segment decreased by $266,000, to $20,752,000 or 34.8% of net sales,
for the fiscal year ended March 31, 2005, compared to $21,018,000 or 39.6% of net sales for fiscal
2004. This was mainly attributed to an average 20% to 30% increase in resin cost and the increase
in net sales of relatively lower margin plastic injection assemblies over the fiscal year 2005, and
therefore offsetting the increase in net sales for the year. Gross profit in the electronic & metallic segment increased by $2,694,000, to $12,766,000 or
19.4% of net sales, for fiscal year ended March 31, 2005 compared to $10,072,000 or 22.8% of net
sales, for fiscal 2004. This was mainly attributed to the change in sales mix and the increased
demand for lower margin products over the 25




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##### Table of Contents



corresponding year. There was also an increase in
electronic material cost which could not be added to the selling price to customers. In addition, Deswells electronic division was more proactive in fiscal
2005 in offering volume pricing for large orders than it was in fiscal 2004. Selling, general and administrative expenses SG&A expenses for the year ended March 31, 2005
were $15,759,000, amounting to 12.5% of total net sales, as compared to $14,718,000 or 15.1% of
total net sales for the year ended March 31, 2004. The SG&A expenses in the plastic segment increased by $86,000 or 0.9%, to $9,890,000 or 16.6%
of net sales, for the year ended March 31, 2005 compared to $9,804,000 or 18.5% of net sales, for
fiscal 2004. The SG&A expenses in the electronic and metallic segment increased by $955,000 or 19.4%, to
$5,869,000 or 8.9% of net sales, for the year ended March 31, 2005, compared to $4,914,000 or 11.1%
of net sales for fiscal 2004. The increase was primarily related to the increase in salary
expenses of $542,000, other general administration expenses of $350,000 and selling expenses of
$218,000, offsetting a decrease in depreciation expenses of $159,000 during the year ended March
31, 2005. Operating income Operating income was $17,759,000 for the year ended March 31, 2005, an
increase of $1,387,000 or 8.5% as compared with the prior year. On a segment basis, the operating income of plastic segment decreased $352,000 to $10,862,000
or 18.2% of net sales, in fiscal 2005 compared to $11,214,000 or 21.1% of net sales in fiscal 2004.
The decrease in operating income was due to the decrease in gross profit together with the
increase in SG&A expenses. The operating income of electronic and metallic segment increased $1,739,000 to $6,897,000 or
10.5% of net sales, in fiscal 2005 compared to $5,158,000 or 11.7% of net sales in fiscal 2004.
The increase in operating income is attributable to the increase in net sales and gross profit,
despite the increase in SG&A expenses described above. Other income Other income was $342,000 for the year ended March 31, 2005, a decrease of
$568,000 or 62.4% as compared with the prior year. On a segment basis, other income attributable to
the plastic segment decreased $397,000 to $105,000 in fiscal 2005. This decrease in other income
was primarily attributable to the decrease in interest income of $103,000 and the decrease in net
realized gain on disposal of investment securities of $533,000, which offset the decrease in loss
on disposal of fixed assets of $269,000 during the year. Other income attributable to the electronic and metallic segment decreased $171,000, to
$237,000 in fiscal 2005. This decrease in other income was primarily attributable to the unrealized
loss on revaluation of marketable securities of $53,000, a decrease in rental income of $102,000, a
decrease in exchange gain of $92,000 and a decrease in compensation and rework charges of $209,000,
which offset a realized gain on disposal of other investments of $295,000 during the year. Income Taxes- Income tax expense was $576,000 for the year ended March 31, 2005, compared to
$589,000 for the prior year. On a segment basis, the income taxes of plastic segment decreased $51,000 to $202,000 for the
year ended March 31, 2005 whereas the income tax expenses for the electronic and metallic segment
increased $38,000 to $374,000 for the year ended March 31, 2005, respectively. The decrease in the
plastic segment was primarily due to the increase in net sales in a subsidiary that still benefited
from a tax exemption holiday period during the year ended March 31, 2005 whereas the increase in
the electronic and metallic segment was due to the increase in net sales during the fiscal year
2005 despite the tax exemption we receive since we relocated our trading operations to Macao in
June 2004. Minority InterestMinority interests represent a 29% minority interest in Integrated
International Limited, the holding company holding the capital stock of Deswells electronic and
metallic subsidiaries and a 49% minority interest in the subsidiary conducting marketing for
Deswells plastic and electronic businesses. In January 2003, the Company acquired an additional
20% interest in Integrated, increasing its ownership in that subsidiary from 51% to 71%. In
January 2005, the marketing subsidiary ceased operations and has been dormant since then. Despite
the 26




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##### Table of Contents



decrease in minority interest in Deswells electronic and metallic segment, the dollar amount
of minority interest increased to $2,330,000 for the year ended March 31, 2005, from $1,957,000 in the prior year,
which reflects that the electronics and metallic subsidiary generated more net income in the
quarter ended March 31, 2005, compared with corresponding quarter in fiscal 2004. Net Income- Net income was $15,183,000 for the year ended March 31, 2005, an increase of
$463,000 or 3.6%, as compared to the year ended March 31, 2004, and net income as a percentage of
net sales decreased to 12.1% from 15.1%. Net income for the plastic segment decreased by 5.7% to $10,374,000 for fiscal 2005 compared
to $10,996,000 for fiscal 2004. The decrease in net income of the plastic segment was mainly the
result of the decrease in operating income and other income offsetting the decrease in tax expenses
described above. Net income for the electronic and metallic segment increased $1,085,000 or 29.1% to $4,809,000
for fiscal 2005 compared to $3,724,000 for fiscal 2004. The increase in net income of the
electronic and metallic segment was mainly the result of the increase in operating income
offsetting the decrease in other income, the increase in income tax expenses and minority interest
as described above. Year ended March 31, 2004 Compared to Year Ended March 31, 2003 Net Sales- The Companys net sales for the year ended March 31, 2004, were $97,195,000, an
increase of $6,290,000 or 6.9% as compared to year ended March 31, 2003. Sales to Digidesign,
VTech, Epson and Inter-Tel Incorporated , the Companys four largest customers during the year
ended March 31, 2004, represented approximately 61.1% of net sales for the year. The increase in sales during the year ended March 31, 2004 was mainly related to the increase
in sales of plastic segment of $3,139,000 and the increase in sales of electronic and metallic
segment of $3,151,000. This represented an increase of 6.3% and 7.7%, respectively, as compared
with the respective net sales from these segments in the prior year. The increase in net sales in the plastic segment was mainly due to an increase in orders from
existing customers by $831,000, coupled with orders from new customers of $2,308,000 during the
year. The increase in net sales in the electronic and metallic segment was mainly due to an
increase in orders from new customers of $5,116,000 offsetting the net decrease in orders from
existing customers of $1,965,000 during the year. The net increase resulted from a change in
customer mix during the year. The increase in sales from new customers included $4,459,000 in
sales of professional audio equipment products. Net sales to customers by geographic area are determined by reference to shipping destinations
as directed by the Companys customers. During the year ended March 31, 2004, sales to North
America and other areas increased by $11,410,000 and $597,000, respectively, and sales to China,
Hong Kong and Europe decreased by $3,408,000, $652,000 and $1,657,000, respectively, over levels
for the year ended March 31, 2003. Gross Profit- The gross profit for the year ended March 31, 2004 was $31,090,000,
representing a gross profit margin of 32.0%. This compares with the overall gross profit and gross
profit margin of $29,899,000 or 32.9% for the year ended March 31, 2003. Gross profit in plastic segment decreased by $445,000, to $21,018,000 or 39.6% of net sales,
for fiscal year ended March 31, 2004 compared to $21,463,000 or 43% of net sales for fiscal 2003.
This was mainly attributed to an average of 20% increase in plastic resin costs, which we could not
pass on to our customers, and the increase in net sales of relatively lower margin plastic
injection assembly products over levels during fiscal year 2004, thereby offsetting increases in
net sales for the year as described above. Gross profit in the electronic and metallic segment increased by $1,636,000 to $10,072,000 or
22.8% of net sales, for fiscal year ended March 31, 2004 compared to $8,436,000 or 20.6% of net
sales, for fiscal 2003. This was mainly attributable to the result of focusing on higher margin
sales which could be seen in the change in customer mix as described above, the reduction of
factory rental expenses of $539,000 as a result of the purchase of the factory premises in July
2003, and the increase in orders from new customers over the year as described above. 27




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##### Table of Contents



Selling, general and administrative expenses SG&A expenses for the year ended March 31, 2004
were $14,718,000, amounting to 15.1% of total net sales, as compared to $15,354,000 or 16.9% of
total net sales for the year ended March 31, 2003. SG&A expenses in the plastic segment increased by $247,000 or 2.6%, to $9,804,000 or 18.5% of
net sales, for the year ended March 31, 2004 compared to $9,557,000 or 19.1% of net sales, for
fiscal 2003. SG&A expenses in the electronic and metallic segment decreased by $883,000 or 15.2%,
to $4,914,000 or 11.1% of net sales, for the year ended March 31, 2004 compared to $5,797,000 or
14.1% of net sales for fiscal 2003. The decrease was primarily related to the decrease in salary
expenses as a result of the write back of a $231,000 bonus provision and the reduction in a
provision for tax risk expenses of $315,000, coupled with the imposition of cost reduction controls
during the year in the electronic and metallic segment. Operating income Operating income was $16,372,000 for the year ended March 31, 2004, an
increase of $1,827,000 or 12.6% as compared with the prior year. On a segment basis, the
operating income of plastic segment decreased $692,000 to $11,214,000 or 21.1% of net sales, in
fiscal 2004 compared to $11,906,000 or 23.9% of net sales in fiscal 2003. The decrease in
operating income was attributable to the decrease in gross profit coupled with the increase in SG&A
expenses as described above. The operating income of electronic and metallic segment increased $2,519,000 to $5,158,000 or
11.7% of net sales, in fiscal 2004 compared to $2,639,000 or 6.4% of net sales in fiscal 2003.
The increase in operating income was attributable to the increase in gross profit and the decrease
in SG&A expenses as described above. Other income Other income was $910,000 for the year ended March 31, 2004, an increase of
$92,000 or 11.1% as compared with the prior year. On a segment basis, other income attributable to
the plastic segment decreased $279,000 to $502,000 in fiscal 2004. This decrease in other income
was primarily attributable to the decrease in interest income of $166,000 and the decrease in
exchange gain of $600,000, which offset the net realized gain on disposal of investment securities
of $533,000 during the year. Other income attributable to the electronic and metallic segment increased $371,000, to
$408,000 in fiscal 2004. This increase in other income was primarily attributable to the increase
in compensation and rework charge of $225,000, increase in scrap sales of $40,000, the write back
of a payable provision of $46,000 coupled with the decrease in exchange loss of $75,000. Income Taxes- During 2003, the Company engaged in discussions with the Hong Kong Inland
Revenue Department, or IRD, regarding whether Deswell should be assessed taxes on profits derived
from activities of certain of its subsidiaries during the six fiscal years ended March 31, 2002,
which the Company believed were conducted outside of Hong Kong and were not subject to a profits
tax under the Hong Kong Revenue Ordinance. While, based on consultations with Hong Kong tax
experts, Deswell believed that its tax position for these years was sound and supportable,
management nevertheless concluded that it would be in the Companys best interest to reach an
immediate resolution of the tax issue with the IRD in order to avoid the expenditure of substantial
time, effort and expense involved in proceedings that could extend years. The resolution also
limits the assessment of taxes, interest and/or penalties that would be incurred if the Company did
not prevail or sought to settle the dispute later. Accordingly, in June 2003 the Company made a
proposal to settle the entire tax dispute and in July 2003, the IRD accepted the proposal. As a
result, a provision of $3,532,000 was charged to the Companys consolidated income statements for
the three months and year ended March 31, 2003. Of the tax provision of $3,532,000, $2,085,000 was
related to the plastic segment and $1,447,000 was related to the electronics and metallic segment.
The tax payment was made in the year ended March 31, 2004. Income tax expense was $589,000 for the year ended March 31, 2004, compared to $3,826,000 for
the prior year. The decrease was primarily the result of the above resolution. Minority Interest  Minority interests represent a 29% minority interest in Integrated
International Limited, the holding company holding the capital stock of Deswells electronic and
metallic subsidiaries and a 49% minority interest in the subsidiary conducting marketing for
Deswells plastic and electronic businesses. In January 2003, the Company acquired an additional
20% interest in Integrated, increasing its ownership in that subsidiary from 51% to 71%. Despite
the decrease in minority interest in Deswells electronic and metallic segment, the dollar amount
of 28




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##### Table of Contents



minority interest increased to $1,957,000 for the year ended March 31, 2004, from $1,288,000 for
the year ended March 31, 2003, which reflects that both the electronics and metallic subsidiaries and
marketing subsidiary generated more net income in the fiscal 2004 as compared to fiscal 2003. Net Income- Net income was $14,720,000 for the year ended March 31, 2004, an increase of
$4,477,000 or 43.7%, as compared to the year ended March 31, 2003, and net income as a percentage
of net sales increased to 15.1% from 11.3%. The increase in net income for fiscal 2004 was
primarily the result of the tax provision of $3.5 million made in fiscal 2003 and settled in July
2003 of the tax dispute with the IRD. Net income for the plastic segment increased by 7.6% to $10,996,000 for fiscal 2004 compared
to $10,223,000 for fiscal 2003. The increase in net income of the plastic segment was mainly the
result of the decrease in income taxes $1,799,000, offsetting the decrease in operating profit and
the decrease in other income as described above. Net income for the electronic and metallic segment increased substantially to $3,724,000 for
fiscal 2004 compared to $20,000 for fiscal 2003. The increase in net income of the electronic and
metallic segment was mainly the result of the decrease in income taxes of $1,438,000, increase in
gross profit, decrease in SG&A expenses and the decrease in Deswells minority interest in
Integrated, 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, 2005 (in thousands): Year ended March 31,2003
    
    
    2004
    
    
    2005Q1
    
    
    Q2
    
    
    Q3
    
    
    Q4
    
    
    Q1
    
    
    Q2
    
    
    Q3
    
    
    Q4
    
    
    Q1
    
    
    Q2
    
    
    Q3
    
    
    Q4Net sales
    
    $
    23,305
    
    
    $
    22,603
    
    
    $
    25,272
    
    
    $
    19,725
    
    
    $
    26,075
    
    
    $
    25,079
    
    
    $
    24,784
    
    
    $
    21,257
    
    
    $
    28,788
    
    
    $
    31,924
    
    
    $
    36,185
    
    
    $
    28,693Gross profit
    
    
    7,447
    
    
    
    7,733
    
    
    
    8,473
    
    
    
    6,246
    
    
    
    8,411
    
    
    
    7,980
    
    
    
    8,401
    
    
    
    6,298
    
    
    
    8,318
    
    
    
    8,461
    
    
    
    9,402
    
    
    
    7,337Operating income
    
    
    3,532
    
    
    
    3,665
    
    
    
    4,583
    
    
    
    2,765
    
    
    
    4,646
    
    
    
    4,511
    
    
    
    4,403
    
    
    
    2,812
    
    
    
    4,812
    
    
    
    4,499
    
    
    
    4,837
    
    
    
    3,611Net income
    
    
    3,691
    
    
    
    3,672
    
    
    
    3,787
    
    
    
    (907
    )
    
    
    4,354
    
    
    
    4,121
    
    
    
    3,535
    
    
    
    2,710
    
    
    
    3,995
    
    
    
    3,628
    
    
    
    4,207
    
    
    
    3,353
 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. Exchange rate fluctuations have not had a significant impact on the
Companys operating results. Labor cost and overhead expenses of the Companys Hong Kong
operations and China factories are paid in Hong Kong dollars and renminbi, respectively. The
exchange rate of the Hong Kong dollar to the U.S. dollar has been fixed by the Hong Kong government
since 1983 at approximately HK$7.80 to $1.00 and accordingly has not represented a currency
exchange risk to the U.S. dollars. The Chinese government has announced its intention to maintain
this fixed exchange rate, but despite such assurances there has been uncertainty reported in this
regard. There can be no assurance that the Chinese government will continue to maintain the present
currency exchange mechanism and the Company could face increased currency risks if the current
exchange rate mechanism is changed. If the currency 29




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##### Table of Contents



exchange mechanism between the Hong Kong dollar and the U.S. dollar is changed, the Companys
results of operations and financial condition could be materially adversely affected. In 1994, China adopted a floating currency system whereby the official exchange rate is equal
to the market rate. Since the market and official renminbi rates were unified, the value of the
renminbi against the dollar has been essentially stable, with an average rate of 8.28 Yuan per
$1.00 during Deswells fiscal years ended March 31, 2003, 2004 and 2005. The Company believes,
because its Chinese operations presently are confined to manufacturing products for export or for
customers in China that are controlled by foreign investors and which pay the Company in Hong Kong
dollars, that the current economic climate in China should not have a direct adverse impact on the
Companys business. However, over the years, and especially in the last several months, there have
been reports that the Chinese Government is under economic and political pressure from countries
with which it trades to permit its currency to appreciate against the dollar. For example,
lawmakers in the United States have threatened to impose high tariffs on Chinese imports if China
does not adjust its currency. Any material increase in the value of the Hong Kong dollar or Chinese
renminbi relative to the U.S. dollar would increase our expenses when translated to US dollars and
could make our products more expensive in global markets, such as the United States and the
European Union. Tariffs imposed as a result of Chinas refusal to adjust its currency would make
our products exported to the United State more expensive and could place us at a severe competitive
disadvantage. The Company did not hedge its currency risk during the years ended March 31, 2003, 2004 or
2005 and at March 31, 2005, the Company had no open forward currency contracts. The Company
continues to review its hedging strategy and there can be no assurance that hedging techniques
implemented by the Company will be successful or will not result in charges to the Companys
results of operations. Liquidity and Capital Resources For the year ended March 31, 2005, net cash generated from operations totaled $16,425,000,
including net income of $15,183,000 and depreciation and amortization of $4,970,000. Accounts
receivable and inventories increased by $6,134,000 and $4,962,000, respectively, over levels at
March 31, 2004, primarily as a result of increases in sales and the general increase in business
activities. Accounts payable increased by $5,281,000 over levels at March 31, 2004, primarily
because of the increase materials purchases resulting from the increase in net sales. For the year
ended March 31, 2004, net cash generated from operations totaled $15,225,000, including net income
of $14,720,000 and depreciation and amortization of $4,402,000. Net cash used in investing activities amounted to $16,967,000 and $14,078,000 for the years
ended March 31, 2005 and 2004, respectively. Capital expenditures during these periods totaled
$17,003,000 and $19,862,000, respectively. Acquisition of marketable securities during these
periods were nil and $1,056,000, respectively. These were financed by cash generated from
operations and the proceeds from sale of marketable securities of $6,410,000 during the year ended
March 31, 2004. The capital expenditure primarily related to the construction of our new Dongguan
manufacturing plant and acquisition of plant and machinery for the Companys production facilities
in China. Net cash used in financing activities for the years ended March 31, 2005 and 2004 was
$1,578,000 and $5,354,000, respectively. Net cash used in financing activities during the year
ended March 31, 2005 was primarily to fund the Companys dividend payments to its shareholders of
$9,234,000, dividend payments to minority shareholders of subsidiaries of $756,000 netting off the
proceeds of $9,092,000 from the exercise of stock options from directors and employees and the
increase in restricted cash of $650,000. Net cash used in financing activities during the year
ended March 31, 2004 was primarily to fund the Companys dividend payments to its shareholders of
$8,569,000, dividend payments to minority shareholders of subsidiaries of $582,000 netting off the
proceeds of $1,733,000 from the exercise of stock options from directors and employees and the
release of restricted cash of $1,976,000. 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 increased from 5.0% to 5.25% during the year ended March 31, 2005. At March 31, 2005, the Company had cash and cash equivalents of $28,073,000 and committed
credit facilities of $8,078,000, of which none had been used. The Company also had restricted cash
of $1,040,000 and 30




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##### Table of Contents



leasehold land and buildings of $1,259,000, which were pledged as collateral for those credit
facilities. The Company expects that working capital requirements and capital additions will
continue to be funded through cash on hand and internally generated funds. The Companys working
capital requirements are expected to increase in line with the growth in the Companys business. The Company had capital commitments for construction of our Dongguan plastic injection-molding
manufacturing plant and purchase of plant and machinery of $4,018,000 as of March 31, 2005. The
Company expects that internally generated funds will be sufficient to satisfy its cash needs for at
least the next 12 months. However, we may choose to obtain debt or equity financing if we believe
it appropriate to accelerate the phases of construction of our new factory. A summary of our contractual obligations and commercial commitments as of March 31, 2005 is as
follows: (In thousands)Year ending March 31,2011 and2006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    2010
    
    
    thereafterContractual obligationLong-term bank borrowing
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Capital (finance) lease obligations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Operating lease payments
    
    
    835
    
    
    
    540
    
    
    
    283
    
    
    
    
    
    
    
    
    
    
    
    Capital expenditures
    
    
    3,940
    
    
    
    
    
    
    
    67
    
    
    
    11
    
    
    
    
    
    
    
    Purchase obligations
    
    
    8,695
    
    
    
    10
    
    
    
    11
    
    
    
    6
    
    
    
    
    
    
    
    Other long-term liabilities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    13,470
    
    
    $
    550
    
    
    $
    361
    
    
    $
    17
    
    
    $
    
    
    
    $
    
 Off Balance Sheet Arrangements We do not use off-balance sheet financing arrangements, such as securitization of receivables
or obtaining access to assets through special purpose entities. Critical Accounting Policies The Company prepares its consolidated financial statements in accordance with accounting
principles generally accepted in the United States of America. The preparation of these financial
statements requires the Company to make estimates and assumptions that affect the reported amounts
of assets and liabilities and the disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amount of revenues and expenses during the reporting
period. On an on-going basis, the Company evaluates its estimates and judgments, including those
related to inventories and the valuation of long-lived assets. The Company bases its estimates and
judgments on historical experience and on various other factors that the Company believes are
reasonable. Actual results may differ from these estimates under different assumptions or
conditions. The following critical accounting policies affect the more significant judgments and estimates
used in the preparation of the Companys consolidated financial statements. Inventories Inventories, consisting of raw materials, work-in-progress and finished goods,
are stated at the lower of cost or market with cost determined using the first-in, first-out
method. The Company makes certain obsolescence and other assumptions to adjust inventory based on
historical experience and current information. The Company writes down inventory for estimated
obsolete or unmarketable inventory equal to the difference between the costs of inventory and
estimated market value, based upon assumptions about future demand and market conditions. These
assumptions, although consistently applied, can have a significant impact on current and future
operating results and financial position. Valuation of long-lived assets- The Company periodically evaluates the carrying value of
long-lived assets to be held and used, including other intangible assets subject to amortization,
when events and circumstances warrant such a review. The carrying value of a long-lived asset is
considered impaired when the anticipated undiscounted cash flow from such asset is separately
identifiable and is less than its carrying value. In that event, a loss is recognized based on the
amount by which the carrying value exceeds the fair market value of the long-lived asset. Fair
market value is determined primarily using the anticipated cash flows discounted at a rate
commensurate with 31




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##### Table of Contents



the risk involved. Losses on long-lived assets to be disposed of are determined in a similar
manner, except that fair market values are reduced for the cost to dispose. Recent Changes in Accounting Standards In December 2004, the Financial Accounting Statements Board (FASB) issued SFAS No. 123
(revised 2004), Share-Based Payment, which is a revision of SFAS No. 123, Accounting for
Stock-Based Compensation, SFAS No. 123(R) supersedes APB Opinion No.25, Accounting for Stock
Issued to Employees and amends SFAS No.95, Statement of Cash Flows. Generally, the approach in
SFAS No.123(R) is similar to the approach described in SFAS No. 123. However, SFAS No.123 (R)
requires all share-based payments to employees, including grants of employee stock options, to be
recognized in the income statement based on their fair values. Pro forma disclosure is no longer
an alternative. SFAS No. 123 (R) was to be effective from the beginning of the first interim or
annual reporting period after June 15, 2005. In April 2005, the Securities and Exchange Commission
delayed the implementation of SFAS 123(R). As a result, SFAS 123(R) will be effective from the
beginning of the first annual reporting period after June 15,2005, which, for the Company, is the
fiscal year ending March 31, 2007. The Company is currently assessing the impact of this statement
on the Companys consolidated financial statements. In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, an amendment
of APB Opinion No. 29. SFAS No. 153 addresses the measurement of exchanges of nonmonetary assets
and redefines the scope of transactions that should be measured based on the fair value of the
assets exchanged. SFAS No. 153 is effective for nonmonetary asset exchanges occurring in fiscal
periods beginning after June 15, 2005, which would be our second quarter of fiscal 2006. The
adoption of SFAS No. 153 is not expected to have a material effect on our consolidated financial
position or results of operations. In November 2004, the FASB issued SFAS Statement No. 151, Inventory Costs, an amendment of
the Accounting Research Bulletin (ARB) No. 43, Chapter 4. Under FASB Statement No. 151, all
abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage)
should be recognized as current-period charges by requiring the allocation of fixed production
overheads to inventory based on the normal capacity of the production facilities. The adoption of
this pronouncement is not expected to have a material impact on the Companys consolidation
financial statements, results of operations, or cash flows. In October 2004, the FASB issued FASB Staff Position (FSP) No. 109-1, Application of FASB
Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production
Activities Provided by the American Job Creation Act of 2004, which provides a tax deduction of up
to nine percent (when fully phased in) of the lesser of (a) qualified production activities
income or taxable income (after the deduction for the utilization of any net operating loss carry
forwards). The adoption of this pronouncement is not expected to have a material impact on the
Companys consolidation financial statements, results of operations, or cash flows. In November 2003, the EITF issued EITF No. 03-6 Participating Securities and the Two-Class
Method under FASB Statement No. 128, which provides for a two-class method of calculating earnings
per share computations that relate to certain securities that would be considered to be
participating in conjunction with certain common stock rights. The adoption of this pronouncement
is not expected to have a material impact on the Companys consolidation financial statements,
results of operations, or cash flows. 32




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ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES Directors and Senior Management The directors and executive officers of the Company at June 30, 2005 are as follows: Name
    
    Age
    
    Position(s) with CompanyLau Pui Hon (Richard Lau)
    
    
    60
    
    
    Chief Executive Officer and Chairman
of the Board of DirectorsLi Chin Pang (C. P. Li)
    
    
    59
    
    
    Executive Director and General
Manager of Manufacturing and
Administration for Plastic
Operations, Chief Financial Officer,
Secretary and Member of the Board of
DirectorsLeung Chi Wai (C. W. Leung)
    
    
    50
    
    
    Executive Director of Engineering for
Plastic Operations and Member of the
Board of DirectorsHung-Hum Leung
    
    
    59
    
    
    Member of Board of Directors and
Audit, Compensation and Nominating
CommitteesAllen Yau-Nam Cham
    
    
    58
    
    
    Member of Board of Directors and
Audit, Compensation and Nominating
CommitteesWing-Ki Hui
    
    
    59
    
    
    Member of Board of Directors and
Audit, Compensation and Nominating
CommitteesLee Shu Kwan (S. K. Lee)
    
    
    59
    
    
    Director of Administration and
Marketing for Electronic OperationsTam Man Chi (M. C. Tam)
    
    
    55
    
    
    Director of Engineering and
Manufacturing for Electronic
OperationsEliza Y. P. Pang
    
    
    43
    
    
    Financial Controller
 Richard Lau. Mr. Lau has served as Chief Executive Officer and Chairman of the Board
of Directors of the Company and its predecessors since their inception in 1987. C. P. Li. Mr. Li has served the Company as a Member of the Board of Directors and in
various executive capacities with the Company and its predecessors since their inception in 1987.
He became Secretary of the Company in February 1995 and Chief Financial Officer in May 1995. As
Executive Director and General Manager of Manufacturing and Administration for Plastic Operations,
Mr. Li is in charge of the day-to-day manufacturing and administrative operations for the Companys
plastic products. Mr. Li received his Bachelor of Science degree from Chun Yan Institute College,
Taiwan in 1967. C. W. Leung. Mr. Leung has served the Company as a Member of the Board of Directors
and in various executive capacities with the Company and its predecessors since their inception in
1987. As Executive Director of Engineering for Plastic Operations, Mr. Leung is in charge of the
mold division and engineering for the Companys plastic manufacturing operations. Hung-Hum Leung. Mr. Leung has been a director of the Company and member of the Audit
Committee since December 1999. Mr. Leung has over 25 years of experience in the manufacture of
electronic products. Mr. Leung was the founder of Sharp Brave Holdings Ltd., a Hong Kong public
company listed on the Hong Kong Stock Exchange, and from 1991 to 1995 served as the Chairman of
Sharp Brave Holdings Ltd. Since 1995, Mr. Leung has been an independent consultant to the
electronics industry. He received his Bachelor of Science degree in Physics from the National
Taiwan University in 1971. Allen Yau-Nam Cham. Mr. Cham has been a director of the Company and member
of the Audit Committee since August 2003. Mr. Cham has been the Managing Director and shareholder
of Kwong Fat Hong 33




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##### Table of Contents



(Securities) Limited since 1995. He has over 20 years of experience in the securities
industry. He is a Certified General Accountant in Canada. He obtained his Bachelor of Science
degree from St. Marys University, Halifax, Canada, Bachelor of Engineering (Electrical) degree
from Nova Scotia Technical College, Halifax, Canada and Master of Business Administration degree
from University of British Columbia, Canada. Wing-Ki Hui.Mr. Hui has been a director of the Company and member of the Audit
Committee since October 2004. Since 1995 he has been the Operation Director of Tomorrow
International Holdings Limited, a company listed on the Hong Kong Stock Exchange engaged in
manufacturing of consumer electronics and printed circuit boards. Prior to serving in this
capacity, Mr. Hui was Executive Director of Sharp Brave International Holdings Limited from 1991 to
1995 and Director of Sharp Brave Electronics Co., Ltd. from 1984 to 1995. Mr. Hui possesses over 20
years of experience in the electronic manufacturing industry, and is a graduate of South East
Electronic College in Hong Kong. S. K. Lee. Mr. Lee has served as Director of Administration and Marketing for
Electronic Operations since the Company acquired its majority interest in Kwanasia, Integrateds
predecessor, in 1992 and has served as the Chief Executive Officer of Kwanasia and Integrated since
Kwanasias inception in 1986. As Director of Administration and Marketing for Electronic
Operations, Mr. Lee is in charge of the Companys day-to-day administrative and marketing
operations for electronic products. Mr. Lee received his Bachelor of Science degree in Electronic
Engineering from National Taiwan University in 1967. M. C. Tam. Mr. Tam has served as Director of Engineering and Manufacturing for
Electronic Operations since the Company acquired its majority interest in Kwanasia, Integrateds
predecessor, in 1992 and has served in a similar capacity for Kwanasia and Integrated since
Kwanasias inception in 1986. As Director of Engineering and Manufacturing for Electronic
Operations, Mr. Tam is in charge of the Companys day-to-day contract manufacturing activities for
electronic products. Mr. Tam received his Bachelor of Science degree with a major in physics and
minor in electronics from the Chinese University of Hong Kong in 1973. Eliza Y. P. Pang. Ms. Pang has served as the Companys Financial Controller since
January 1995. She is a registered fellow member of The Hong Kong Institute of Certified Public
Accountants. Ms. Pang has worked at KPMG and Ernst & Young in Hong Kong. Ms. Pang received her
Professional Diploma in Accountancy and her MBA degree from The Hong Kong Polytechnic University in
1985 and 1996, respectively. No family relationship exists among any of the named directors, executive officers or key
employees. No arrangement or understanding exists between any director or officer and any other
persons pursuant to which any director or executive officer was elected as a director or executive
officer of the Company. Compensation of Directors and Senior Managers Executive Officers The aggregate amount of compensation (including non-cash benefits) paid by the Company and its
subsidiaries during the year ended March 31, 2005 to all directors and officers as a group for
services in all capacities was approximately $3,472,000. This includes amounts paid to Dickson Lam,
Deswells former Director of Marketing for Plastic and Electronics Operations who retired in
January 2005 and excludes amounts paid by the Company or its subsidiaries as dividends to
shareholders during the year ended March 31, 2005. Directors Effective August 1, 2003, directors who are not employees of the Company or any of its
subsidiaries are paid $2,000 per month for services as a director, and are reimbursed for all
reasonable expenses incurred in connection with services as a director and member of Board
committees. The Board has determined that Messrs. Hung-Hum Leung, Allen Yau-Nam Cham, Wing-Ki Hui
are independent within the meaning of Rule 4200 of the Nasdaq Marketplace Rules. 34




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Board Practices The directors of the Company are elected at its annual meeting of shareholders and serve until
their successors take office or until their death, resignation or removal. The executive officers
serve at the pleasure of the Board of Directors of the Company. The compensation of Deswells Chief Executive Officer and its other executive officers is
recommended to the Board for determination by a majority of the independent directors. Audit Committee The Audit Committee meets from time to time to review the financial statements and matters
relating to the audit and has full access to management and the Companys auditors in this regard.
The Audit Committee recommends the engagement or discharge of the Companys independent
accountants, consults on the adequacy of the Companys internal controls and accounting procedures
and reviews and approves financial statements and reports. Deswells audit committee consists of
Messrs. Hung-Hum Leung, Allen Yau-Nam Cham and Wing-Ki Hui. Mr. Allen Yau-Nam Cham currently acts
as the Chairman of the Audit Committee. Nominating Committee Deswell established a Nominating Committee on June 27, 2005, whose primary duties consist of
identifying and recommending to the Board of Directors individuals qualified to become Board
members. The Nominating Committee currently consists of three independent non-executive directors,
Messrs. Messrs. Hung-Hum Leung, Allen Yau-Nam Cham and Wing-Ki Hui. Mr. Hung-Hum Leung currently
acts as the Chairman of the Nominating Committee. Employees At March 31, 2005, the Company employed 5,014 persons on a full-time basis, of which 9 were
located in Macao and 5,005 located in and traveled to and from China. Of the Companys employees
3,396 and 1,818 were engaged in plastic injection molding manufacturing and contract electronic
manufacturing, metal molds and parts manufacturing, respectively, at March 31, 2005. The Company
has not experienced significant labor stoppages. Management believes that relations with the
Companys employees are satisfactory. Share Ownership Share Ownership of Directors and Senior Management For information concerning the beneficial ownership of the Companys common shares by
Directors and Senior Management and major shareholders, see Item 7 of this Report. Employee Stock Option Plans In 1995, the Company adopted its 1995 Stock Option Plan permitting the Company to grant
options to purchase up to 1,012,500 common shares to employees, officers, directors and consultants
of the Company. On September 29, 1997, the Companys Board of Directors and shareholders approved
an increase of 549,000 shares in the number of shares that can be optioned and sold under the
Option Plan bringing to a total of 1,561,500 shares the number of common shares that can be
optioned and sold under the 1995 Stock Option Plan. On August 15, 2001 the Board approved the adoption of the 2001 Stock Option Plan permitting
the Company to grant options to purchase up to an additional 1,125,000 common shares to employees,
officers, directors and consultants of the Company. On January 7, 2002 shareholders approved the
2001 plan. 35




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##### Table of Contents



On August 20, 2003, the Board approved the adoption of the 2003 Stock Option Plan permitting
the Company to grant options to purchase up to an additional 900,000 common shares to employees,
officers, directors, consultants and advisors of the Company. On September 30, 2003 shareholders
approved the 2003 plan. The Companys option plans are administered by the Board of Directors, which determines the
terms of options granted, including the exercise price, the number of shares subject to the option
and the options exercisability. The exercise price of all options granted under the option plans
must be at least equal to the fair market value of such shares on the date of grant. The maximum
term of options granted under the option plans is 10 years. At June 30, 2005, options to purchase an aggregate of 3,586,500 common shares had been granted
under the option plans, options to purchase an aggregate of 659,000 common shares were outstanding
and no options to purchase common shares were available for future grant under the option plans. 36




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##### Table of Contents



ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS Except as disclosed in the footnotes to the table below with respect to Leesha Holdings
Limited (Leesha),the Company is not directly owned or controlled by another corporation or by
any foreign government. The following table sets forth, as of June 28, 2005, the beneficial
ownership of the Companys Common Shares by each person known by the Company to beneficially own 5%
or more of the Common Shares of the Company and by each of the Directors and Senior Management of
the Company who beneficially own in excess of one percent of the Companys Common Shares. Number of sharesbeneficially owned (1)Name of beneficial owneror identity of group
    
    Amount
    
    
    PercentRichard Lau
    
    
    3,902,525
    
    
    
    25.9
    %C. P. Li
    
    
    3,858,083
    
    
    
    25.6
    %C. W. Leung
    
    
    3,622,617
    
    
    
    24.1
    %Leesha Holdings Ltd.
    
    
    3,453,750
    
    
    
    23.2
    %Royce & Associates, Inc. (6)
    
    
    1,384,099
    
    
    
    9.3
    %Wellington Management Company, LLP (7)
    
    
    1,244,628
    
    
    
    8.4
    %Micropower Enterprises Limited
    
    
    1,143,750
    
    
    
    7.7
    %FMR Corp./ Edward C. Johnson 3d (8)
    
    
    1,136,880
    
    
    
    7.6
    %M. C. Tam
    
    
    153,851
    
    
    
    1.0
    %S. K. Lee
    
    
    *
    
    
    
    *Eliza Y. P. Pang
    
    
    *
    
    
    
    *Hung-Hum Leung
    
    
    *
    
    
    
    *Allen Yau-Nam Cham
    
    
    *
    
    
    
    *Wing-Ki Hui
    
    
    *
    
    
    
    *
 
 *

Less than 1%. (1) Based on 14,908,730 Common Shares outstanding on June 28, 2005. However, in accordance with
Rule 13d-3(d)(1) under the Securities Exchange Act of 1934, Common Shares not outstanding but which
are the subject of currently exercisable options have been considered outstanding for the purpose
of computing the percentage of outstanding Common Shares owned by the listed person holding such
options, but are not considered outstanding for the purpose of computing the percentage of Common
Shares owned by any of the other listed persons. (2) Consists of 3,453,750 Common Shares held of record by Leesha, 313,775 Common Shares held of
record by Mr. Lau and options to purchase 135,000 Common Shares granted to Mr. Lau under the
Companys stock option plans. Mr. Laus options are exercisable at a weighted average exercise
price of $14.10 per share until September 30, 2013. As a director of Leesha, Mr. Lau shares the
voting and investment power of the Common Shares held by Leesha. (3) Consists of 3,453,750 Common Shares held of record by Leesha, 269,333 Common Shares held of
record by Mr. Li and options to purchase 135,000 Common Shares granted to Mr. Li under the
Companys stock option plans. Mr. Lis options are exercisable at a weighted average exercise
price of $14.10 per share until September 30, 2013. As a director of Leesha, Mr. Li shares the
voting and investment power of the Common Shares held by Leesha. (4) Consists of 3,453,750 Common Shares held of record by Leesha, 33,867 Common Shares held of
record by Mr. Leung and options to purchase 135,000 Common Shares granted to Mr. Leung under the
Companys stock option plans. Mr. Leungs 37




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##### Table of Contents



options are exercisable at a weighted average exercise price of $14.10 per share until September
30, 2013. As a director of Leesha, Mr. Leung shares the voting and investment power of the Common
Shares held by Leesha. (5) Leesha is an investment holding company organized as an International Business Company under
the laws of the British Virgin Islands. Messrs. Lau, Li and Leung, who are its directors, wholly
own Leesha in equal shares. Among other investments, Leesha owns the 3,453,750 Common Shares of
Deswell, which were transferred to Leesha by Messrs. Lau, Li and Leung after Deswells initial
public offering. (6) Based on Amendment No. 5 to a Schedule 13G filed with the SEC on January 25, 2005. (7) Based on Amendment No. 1 to Schedule 13G filed with the SEC on February 14, 2005. (8) Based on Amendment No. 2 to a Schedule 13G filed with the SEC on February 14, 2005. The following table reflects the percentage ownership of Deswells common shares by its
major shareholders during the past three years: Percentage Ownership (1) atAug. 28, 2003
    
    
    June 30, 2004
    
    
    June 28, 2005Richard Lau
    
    
    29.7
    %
    
    
    29.0
    %
    
    
    25.9
    %C. P. Li
    
    
    29.6
    %
    
    
    28.9
    %
    
    
    25.6
    %C. W. Leung
    
    
    28.5
    %
    
    
    27.2
    %
    
    
    24.1
    %Leesha Holdings Ltd.
    
    
    25.3
    %
    
    
    25.2
    %
    
    
    23.2
    %Royce & Associates, Inc.
    
    
    9.3
    %
    
    
    10.3
    %
    
    
    9.3
    %Wellington Management Company, LLP
    
    
    
    
    
    
    6.5
    %
    
    
    8.4
    %Micropower Enterprises Limited
    
    
    7.5
    %
    
    
    7.5
    %
    
    
    7.7
    %FMR Corp./ Edward C. Johnson 3d/
Abigail P. Johnson
    
    
    9.2
    %
    
    
    9.6
    %
    
    
    7.6
    %
 
 (1)
    
    Based on 12,705,369, 13,723,627 and 14,908,730 common shares outstanding on August 28, 2003,
June 30, 2004 and June 28, 2005, respectively. However, in accordance with Rule 13d-3(d)(1) under
the Securities Exchange Act of 1934, common shares not outstanding but which are the subject of
currently exercisable options have been considered outstanding for the purpose of computing the
percentage of outstanding common shares owned by the listed person holding such options, but are
not considered outstanding for the purpose of computing the percentage of common shares owned by
any of the other listed persons. All of the holders of the Companys common shares (including Deswells major
shareholders) have equal voting rights with respect to the common shares held. As of June 28, 2005,
approximately 35 holders of record, who, management believes, held for more than 3,000 beneficial
owners, held Deswells common shares. According to information supplied to the Company by its
transfer agent, at June 28, 2005, 23 holders of record with addresses in the United States held
approximately 9.5 million of our outstanding common shares. Related Party Transactions In January 2003, the Company issued to each of Messrs. Lee and Tam 125,940 of its Common
Shares, or an aggregate of 251,880 Common Shares, to acquire an additional 20% (10% from each of
Messrs. Lee and Tam) shareholding interest in Integrated raising the Companys interest in
Integrated to 71% of its outstanding shares. Messrs. Lee and Tam continue as minority shareholders
of Integrated each owning 12% (together 24%) of its outstanding shares and continue to serve as the
executives in charge of administrative and manufacturing operations for the Companys contract
manufacturing operations for electronic products and subassemblies. At the time of the closing of
this transaction on January 20, 2003, the market value of the 251,880 Deswell shares issued to
Messrs. Lee and Tam was $4,423,000, based on the closing price on that date of $17.56 per share as
reported on The Nasdaq Stock Market. During the years ended March 31, 2003, 2004 and 2005,
Integrated made distributions to its shareholders, including Deswell, aggregating $1,609,000,
$426,000 and $nil, respectively, with Messrs. Lee and Tams share of these distributions
aggregating $708,000, $102,000 and $nil, respectively. During the year ended March 31, 2002, the Company organized Jetcrown & Kwanasia (OEM)
Specialist Limited (J&K OEM), a limited liability Hong Kong Company, to conduct marketing for
Deswells plastic and electronics businesses. The capital stock of J&K OEM is owned 51% by
Deswell, 39% by Dickson Lam, Deswells 38




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former Director of Marketing for plastic and electronic products who retired in January 2005,
and 10% by two other individuals, who were employees of J&K OEM. During the years ended March 31,
2003, 2004 and 2005, J&K OEM made distributions to its shareholders, including Deswell, aggregating
$129,000, $935,000 and $289,000, respectively, with Mr. Lams share of these distributions
amounting to $50,000, $365,000 and $113,000, respectively. In March 2003, the Company reorganized
J&K OEMs operations by organizing Triumph Wise Technology Limited (Triumph Wise), a British
Virgin Islands International Business Company, and in August 2003 also incorporated another new
Macao company, namely, J&K (OEM) Specialist (Macao Commercial Offshore) Limited (J&KMCO), that is
wholly-owned by Triumph Wise. The capital stock of Triumph Wise is owned 51% by Deswell, 39% by
Dickson Lam and 10% by two other individuals, who are now employees of J&KMCO. In August 2003,
J&KMCO obtained business license approval to carry out offshore marketing service activities in
Macao. J&K OEMs operations were transferred to J&KMCO in September 2003 and, J&K OEM has been
dormant since then. During the years ended March 31, 2004 and 2005, Triumph Wise did not make any
distributions to its shareholders. During the years ended March 31, 2004 and 2005, J&KMCO made
distributions to its shareholders, including Deswell, aggregating $nil and $1,255,000,
respectively, with Mr. Lams share of these distributions amounting to $nil and $489,000,
respectively. Since the Company completed its initial public offering in the United States, it has been
Deswells policy that all transactions between Deswell and any interested director or executive
officer be approved by a majority of the disinterested directors and be on terms that are no more
favorable than would be available from an independent third party. 39




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##### Table of Contents



ITEM 8. FINANCIAL INFORMATION Financial Statements Our Consolidated Financial Statements are set forth under Item 18 Financial Statements. Legal Proceedings The Company is not involved in any material legal proceedings. Exports Sales Information regarding our export sales is provided in Item 4 Information on the Company 
Business Overview  Customers and Marketing. Dividend Policy Dividends paid under Hong Kong law are tax free to the recipient. While the Company had paid
dividends to its shareholders prior to its IPO, it discontinued payment of dividends after the IPO
until its new dividend policy was announced in July 1996. At that time, the Company announced that
it planned to pay cash dividends semi-annually in the form of an interim and final dividend based
on the Companys growth during the preceding year. The Company announced that dividends would be
25% to 35% of the net earnings of the preceding year limited, however, by the net cash flow
available for future development. The interim dividend would be based upon the Companys first six
months operating results and would be paid between November and December and the final dividend
would be based upon the Companys second six months of operations and would be declared and paid
between July and August. Under this dividend policy, the Company declared and paid dividends during
the year ended March 31, 2002 aggregating $7,229,000, $3,193,000 of which was based on results for
the second six months of the year ended March 31, 2001 and $4,036,000 of which was based on results
for the first nine months of the year ended March 31, 2002. Commencing with the fiscal year ended March 31, 2003, the Company announced it would pay cash
dividends on a quarterly basis based upon the Companys quarterly results. Under this dividend
policy, the Company declared and paid dividends during the year ended March 31,  
    
    2004 aggregating $8,569,000, $2,002,000 of which was based on results for the last
quarter of the year ended March 31, 2003 and $6,567,000 of which was based on results for
the first three quarters of the year ended March 31, 2004; and
    
    2005 aggregating $9,234,000, $2,196,000 of which was based on results for the last
quarter of the year ended March 31, 2004 and $7,038,000 of which was based on results for
the first three quarters of the year ended March 31, 2005 The Company currently plans to continue its quarterly dividend policy as announced, but such
plans and policy for future dividends consist of forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
Whether future dividends will be declared will depend upon the Companys future growth and
earnings, of which there can be no assurance, and the Companys cash flow needs for future
development, which growth, earning or cash flow needs may be adversely affected by one or more of
the factors discussed in Item 3. Key Information  Risk Factors. Accordingly, there can be no
assurance that future cash dividends on the Companys common shares will be declared, what the
amounts of such dividends will be or whether such dividends, once declared for a specific period
will continue for any future period or at all. 40




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##### Table of Contents



ITEM 9. THE OFFER AND LISTING The Companys common shares are traded exclusively on The Nasdaq National Market under the
symbol DSWL. The following table sets forth the high and low sale prices as reported by The Nasdaq National
Market for each of the last five years ended March 31 (adjusted for the Companys three-for-two
stock splits effected in July 2002 and March 2005): Year Ended
    
    High
    
    
    LowMarch 31, 2005
    
    $
    18.167
    
    
    $
    12.867March 31, 2004
    
    
    20.40
    
    
    
    10.43March 31, 2003
    
    
    27.23
    
    
    
    7.33March 31, 2002
    
    
    9.83
    
    
    
    5.83March 31, 2001
    
    
    8.00
    
    
    
    5.45
 The following table sets forth the high and low sale prices as reported by The Nasdaq National
Market during each of the quarters in the two-year period ended March 31, 2005 and the average
daily trading volume during each of the quarters (adjusted for the Companys three-for-two stock
split effected in February 2005). AverageDailyTradingQuarter ended
    
    High
    
    
    Low
    
    
    Volume(1)March 31, 2005
    
    $
    18.167
    
    
    $
    14.213
    
    
    
    22,529December 31, 2004
    
    
    17.327
    
    
    
    13.007
    
    
    
    26,420September 30, 2004
    
    
    16.313
    
    
    
    12.867
    
    
    
    13,692June 30, 2004
    
    
    18.147
    
    
    
    14.340
    
    
    
    6,469March 31, 2004
    
    
    19.33
    
    
    
    15.73
    
    
    
    18,495December 31, 2003
    
    
    20.40
    
    
    
    14.01
    
    
    
    21,155September 30, 2003
    
    
    17.17
    
    
    
    11.93
    
    
    
    18,201June 30, 2003
    
    
    14.35
    
    
    
    10.43
    
    
    
    13,535
 
 (1)
    
    Determined by dividing the sum of the reported daily volume for the quarter by the
number of trading days in the quarter (adjusted for the Companys three-for-two stock split
effected in March 2005). The following table sets forth the high and low sale prices as reported by The Nasdaq National
Market during each of the most recent six months and the average daily trading volume during each
of the months (adjusted for the Companys three-for-two stock split effected in March 2005). AverageDailyTradingMonth ended
    
    High
    
    
    Low
    
    
    Volume(1)June 30, 2005
    
    
    16.480
    
    
    
    14.380
    
    
    
    25,211May 31, 2005
    
    
    15.970
    
    
    
    14.700
    
    
    
    14,191April 30, 2005
    
    
    16.360
    
    
    
    13.670
    
    
    
    14,355March 31, 2005
    
    
    18.160
    
    
    
    14.740
    
    
    
    19,182February 29, 2005
    
    
    18.167
    
    
    
    15.167
    
    
    
    19,790January 31, 2005
    
    
    16.533
    
    
    
    14.213
    
    
    
    28,814
 
 (1)
    
    Determined by dividing the sum of the reported daily volume for the month by the
number of trading days in the month (adjusted for the Companys three-for-two stock split
effected in March 2005). 41




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ITEM 10. ADDITIONAL INFORMATION Share Capital Not applicable. Memorandum and Articles of Association Objects and Purposes Our objects and purposes are described in Clause 4 of our Memorandum of Association and are
generally to engage in any act or activity that is not prohibited under the laws of the British
Virgin Islands. Directors British Virgin Islands law and our Articles of Association provide that no agreement or
transaction between Deswell and one or more of its directors or any entity in which any director
has a financial interest or to whom any director is related (including as a director of that other
entity) is void or voidable for this reason only or by reason only that the director is present at
the meeting of directors, or at the meeting of the committee of directors, that approves the
agreement or transaction or that the vote or consent of the director is counted for the purpose if
the material facts of the interest of each director in the agreement or transaction and his or her
interest in or relationship to any other party to the agreement or transaction are disclosed in
good faith or are known by the other directors and a majority of the Companys directors (at least
one whom is an Independent Director) approve such transaction. Alternatively, the interest in the
transaction may be disclosed or known to or ratified by the shareholders.* In addition, a director
who has an interest in any particular business to be considered at a meeting of directors or
shareholders may be counted for the purposes of determining whether the meeting is duly
constituted. An Independent Director is defined in our Articles of Association as a director
other than an officer or employee of Deswell or any of its subsidiaries, a person related to an
officer or employee of Deswell or any of its subsidiaries, a person representing family or
concentrated (more than 10%) holdings of Deswells outstanding voting shares or any other
individual having a relationship which, in the opinion of the directors, would interfere with the
exercise of independent judgment in carrying out the responsibilities of a director. Our Articles of Association provide that the directors may by a resolution of directors, fix
the emoluments of directors with respect to services to be rendered in any capacity to the Company. British Virgin Islands law and our Articles of Association provide that the management of the
business and the control of Deswell shall be vested in the directors, who in addition to the powers
and authorities expressly conferred by the Articles of Association, may also exercise all such
powers, and do all such acts and things, as may be done by Deswell and are not by the Articles of
Association or British Virgin Islands law expressly directed or required to be exercised or done by
a meeting of shareholders. Our Articles of Association provide that the directors may by resolution
exercise all the powers of Deswell to borrow money and to mortgage or charge its undertakings and
property or any part thereof, to issue debentures, debenture stock and other securities whenever
money is borrowed or as security for any debt, liability or obligation of Deswell or of any third
party. British Virgin Islands law and our Memorandum of Association and Articles of Association do
not contain an age limit requirement for our directors. Under our Articles of Association, no
shares are required for directors qualification. 
 *
    
    British Virgin Islands law does not use the term
shareholder or stockholder but rather refers to
holders of shares of a company, like Deswell, organized under the International
Business Companies Act as members. In this Report, for the
convenience of our U.S. holders, we use the term shareholders
rather than members. 42




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Rights, Preferences and Restrictions of Authorized and Outstanding Shares and Changes to Rights
of Shareholders Deswell has one class and series of shares authorized or outstanding: common shares, no par
value per share. Our authorized capital consists of 30,000,000 common shares, no par value per
share, of which 14,919,730 common shares were outstanding on June 28, 2005. Holders of our common shares are entitled to one vote for each whole share on all matters to
be voted upon by shareholders, including the election of directors. Holders of our common shares
do not have cumulative voting rights in the election of directors. All of our common shares are
equal to each other with respect to liquidation and dividend rights. Holders of our common shares
are entitled to receive dividends if and when declared by our board of directors out of funds
legally available under British Virgin Islands law. In the event of our liquidation, all assets
available for distribution to the holders of our common shares are distributable among them
according to their respective holdings. Holders of our common shares have no preemptive rights to
purchase any additional, unissued common shares. Calling Annual General Meetings and Extraordinary General Meetings of Shareholders. British Virgin Islands law does not require an international business company, such as
Deswell, to have an annual meeting. Our Articles of Association do, however, require an annual
meeting of shareholders for the election of directors and for such other business as may come
before the meeting. Under British Virgin Islands law, unless otherwise provided by a companys Memorandum of
Association or Articles of Association, the directors may call meetings of shareholders at any
time. Our Memorandum and Articles of Association do not provide otherwise. Under British Virgin
Islands law, unless otherwise provided by a companys Memorandum of Association or Articles of
Association, directors are required to call meetings upon a written request from shareholders
holding more than 50% of outstanding voting shares. Our Articles of Association provide that
meetings of shareholders may be called only upon a written request from shareholders holding 10% or
more of the outstanding voting shares. British Virgin Islands law and our Articles of Association state that the directors may fix
the date that notice is given of a meeting of shareholders, whether extraordinary or annual, as the
record date for determining those shares that are entitled to vote at the meeting. British Virgin Islands law and our Articles of Association provide that notice of all meetings
of shareholders, stating the time, place and purposes thereof, shall be given not fewer than seven
days before the date of the proposed meeting to those persons whose names appear as shareholders in
our share register on the date of the notice and are entitled to vote at the meeting. Limitations on Share Ownership British Virgin Islands law and our Memorandum of Association and Articles of Association do
not impose any limitations on the right of anyone to own, hold or exercising voting rights to our
common shares. Potential Anti-Takeover Deterrence Neither our Articles of Association nor Memorandum of Association contain provisions that
would have an effect of delaying, deferring or preventing a change in control of Deswell and that
would operate only with respect to a merger, acquisition or corporate restructuring involving
Deswell or any of its subsidiaries. However, pursuant to our Memorandum and Articles of Association
and pursuant to the laws of the British Virgin Islands, our board of directors without shareholder
approval may amend our Memorandum and Articles of Association (provided that a majority of our
independent directors do not vote against the amendment). This includes amendments to increase or
reduce our authorized capital stock. Our ability to amend our Memorandum and Articles of
Association without shareholder approval could have the effect of delaying, deterring or preventing
a change in control of Deswell, including a tender offer to purchase our common shares at a premium
over the then current market price. 43




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Ownership Information Neither our Articles of Association nor Memorandum of Association provide that information
about our shareholders, even those owning significant percentages of our shares, must be disclosed. Differences from United States Law The laws of the British Virgin Islands governing the provisions of our Articles of Association
and Memorandum of Association discussed above are not significantly different than the laws
governing similar provisions in the charter documents of Delaware companies, other than with
respect to amending our Memorandum of Association without shareholder approval. Delaware law
requires shareholders to approve any amendments to a corporations Certificate of Incorporation. Material Contracts The following summarizes each material contract, other than contracts entered into in the
ordinary course of business, to which Deswell or any subsidiary of Deswell is a party for the two
years immediately preceding the filing of this report. The Reference to an Exhibit is to the
exhibits appearing in Item 19 of this report. Banking Facilities (Exhibit 4.1) Date:April 13, 2005 Parties:The Hongkong & Shanghai Banking Corporation Limited, Macao Branch (HSBC) and Jetcrown
Industrial (Macao Commercial Offshore Limited (JIMCO) Nature of Contract:HSBC provide JIMCO various general banking facilities. Terms and Conditions:Combined facilities of HK$10,000,000 within which (1) Overdraft facility of
sub-limit HK$5,000,000 (2) import facility of sub-limit HK$10,000,000. Interest on the overdraft
facility is charged at 1 % per annum below banks best lending rate. Consideration: HSBC time deposit for US$649,000 (or other currency equivalent HK$5,000,000 with
interest accrual) held under lien to bank together with security over deposit and letter of
set-off. Letter of awareness from Deswell Industries, Inc. Banking Facilities (Exhibit 4.2) Date:February 23, 2004 Parties:Fortis Bank Asia HK (Fortis) and Kwanasia Nature of Contract:Fortis to provide Kwanasia with various general banking facilities. Terms and Conditions:(1) Import facilities of limit HK$5,000,000; (2) Overdraft facilities of
HK$2,000,000 with sub-limit of the aforementioned trade limit of HK$5,000,000; (3) Standby letter
of credit issued on Kwanasias behalf of limit HK$1,000,000 under sub-limit of the overdraft limit
of HK$2,000,000; (4) Short-term loan facilities of HK$2,000,000 with sub-limit of the over draft
limit of HK$2,000,000. Consideration:The interest and commissions set forth in the agreement dated February 23, 2004.
An annual facilities fee of HK$5,000 per annum. 44




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Tenancy Agreement (Exhibit 4.3) Date:April 29, 2005 Parties:Shenzhen Shekou Yu Yi Shareholding Company Ltd. (Lessor) and Jetcrown Industrial
(Shenzhen) Limited. Nature of Contract:Rental of property located at 1/F and 2/F, of Block A, Wing Village Industrial
Estate, Shekou, Shenzhen. Terms and Conditions: The construction area of the property is 2,051 square meters. Three-year
term, commencing June 1, 2005 to May 30, 2007. Lessor is responsible for property tax, land use
fees and rental housing management fees. A deposit in the amount of RMB118,668 is required.
Lessee can only sublet with Lessors approval. Lessee should inform Lessor of desire to renew
lease one month before expiration. Consideration:Rent is RMB47,145 per month. Tenancy Agreement (Exhibit 4.4) Date: December 30, 2004 Parties: Shenzhen Shekou Real Property Company (Lessor) and Jetcrown Industrial (Shenzhen) Limited
(Lessee). Nature of Contract: Lease of Rooms 201-203, 205-208, 210-214, 305, 307-310, 402, 403, 405, 407,
409, 414, 502-504, 506-507, 510, 513-516, 601, 604-607, 609-614, 701-716, Block C1, New Wing
Village, Shekou for use as a dormitory. Terms and Conditions: The total construction area for all the rooms is 2,958 square meters. The
rental period is one year, commencing January 1, 2005 to December 31, 2005. The total rent for the
property is RMB44,374 per month. A deposit of RMB49,027 is required. The Lessee is responsible
for the water, electricity and garbage cleaning charges. If any delay of rental payment exceeds 5
days, a late charge penalty of 2% shall be levied on the rental. Consideration: Rent of RMB44,374 per month. Tenancy Agreement (Exhibit 4.5) Date: December 28, 2004 Parties: Shenzhen Shekou Real Property Company (Lessor) and Jetcrown Industrial (Shenzhen) Limited
(Lessee). Nature of Contract: Lease of 1/F-7/F, Block 13, Nanshui Siu Village and Room 201, 202,204, 206,
409 of Block 9, NanShui Siu Village, Shekou for use as a dormitory. Terms and Conditions: The total construction area for all the rooms is 2,020 square meters. The
rental period is one year, commencing January 1, 2005 to December 31, 2005. The total rent for the
property is RMB38,377 per month. A deposit of RMB76,754 is required. The Lessee is responsible
for the water, electricity and garbage cleaning charges. If any delay of rental payment, a late
charge penalty of 3% shall be levied on the rental. Consideration: Rent of RMB38,377 per month. Stock Purchase Agreement (Exhibit 4.6) Date: April 20, 2005 Parties: Deswell Industries, Inc. and Micropower Enterprises Ltd. Nature of Contract: Purchase of 5% of the outstanding shares of Integrated International Ltd. 45




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Terms and Conditions: Deswell issued 120,000 of its common shares to Micropower Enterprises Ltd in
exchange for the transfer to Deswell by Micropower Enterprises Ltd. of five percent of the
outstanding shares of Integrated International Ltd. Joint Venture Corporation Supplemental Agreement Four (Exhibit 4.7) Date: March 10, 2004 Parties: Dongguan Cheung On Lan Hong Electronics Development Company, Integrated International
Limited and Kwanasia Electronics Company Limited. Nature of Contract: Transfer of share ownership from Kwanasia Electronics Company Limited to
Integrated International Limited. Joint Venture Corporation Supplementary Agreement Five (Exhibit 4.8) Date: May 17, 2004 Parties: Dongguan Hong Xin Electronics Company Limited, Integrated International Limited and
Dongguan Cheung On Lan Hong Electronics Development Company. Nature of Contract: Transfer of share ownership from Dongguan Cheung On Lan Hong Electronics
Development Company to Dongguan Hong Xin Electronics Company Limited. Co-operation Agreement (Exhibit 4.9) Date: July 1, 2004 Parties Kwan Hong Electronics Company Limited and Dongguan Hong Xin Electronics Company Limited Nature of Contract: Supplemental Agreement providing that Integrateds wholly owned subsidiary
would in substance have a 100% economic interest in the joint venture enterprise with Hong Xin for
a guaranteed an annual rental income. 46




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Taxation United States Federal Income Tax Consequences General This section is a general summary of the material U.S. federal income tax consequences of the
ownership and disposition of our common shares as of the date of this Report. The summary applies
to you only if you hold our common shares as a capital asset for tax purposes (that is, for
investment purposes), and it does not purport to be a comprehensive description of all the tax
considerations that may be relevant to the ownership of our common shares. The summary is based on
current law. Changes in the law may alter your tax treatment of holding our common shares,
possibly on a retroactive basis. There can be no assurance that the U.S. Internal Revenue Service
(IRS) will not challenge the tax consequences described below, and we have not requested, nor
will we request, a ruling from the IRS or an opinion of counsel with respect to the U.S. federal
income tax consequences of acquiring, holding or disposing of our common shares. The discussion
below does not cover tax consequences that depend upon your particular tax circumstances and it
does not address any aspect of U.S. federal tax law other than U.S. federal income taxation.
Specifically, it does not cover any state, local or foreign law, or the possible application of
U.S. federal estate or gift tax. You are urged to consult your own tax advisors regarding the
application of the U.S. federal income tax laws to your particular situation as well as any state,
local, foreign and the U.S. federal estate and gift tax consequences of the ownership and
disposition of the common shares. In addition, this summary does not take into account any special
U.S. federal income tax rules that apply to a particular holder of our common shares, including,
without limitation, the following:  
    
    a dealer in securities or currencies;
    
    a trader in securities that elects to use a market-to-market method of accounting for
your securities holdings;
    
    a financial institution;
    
    a life insurance company;
    
    a tax-exempt organization;
    
    a person that holds our common shares in a hedging transaction or as part of a straddle
or a conversion transaction;
    
    a person whose functional currency for tax purposes is not the U.S. dollar;
    
    a person liable for alternative minimum tax;
    
    a person that owns, or is treated as owning, 10 percent or more of our common shares; or
    
    a person who receives our shares pursuant to the exercise of employee stock options or
otherwise as compensation. Tax Consequences to U.S. Holders For purposes of the discussion below, you are a U.S. Holder if you are a beneficial owner of
our common shares who or which is:  
    
    an individual U.S. citizen or resident alien of the United States (as specifically
defined for tax purposes);
    
    a corporation created or organized in or under the laws of the United States or any
State or political subdivision thereof;
    
    an estate whose income is subject to U.S. federal income tax regardless of its source; 47




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
    
    a trust (x) if a U.S. court can exercise primary supervision over the trusts
administration and one or more U.S. persons are authorized to control all substantial
decisions of the trust or (y) if it was in existence on August 20, 1996, was treated as a
U.S. person prior to that date and has a valid election in effect under applicable treasury
regulations to be treated as a U.S. person; or
    
    any other person or entity that would be subject to U.S. federal income tax on a net
income basis in respect of our common shares. If a partnership holds our common shares, the tax treatment of a partner will generally depend
upon the status of the partner and upon the activities of the partnership. If you are a partner of
a partnership holding our common shares, you should consult your tax advisor. Distributions Subject to the passive foreign investment company rules discussed below, for cash dividends,
the gross amount of any such distribution (other than in liquidation) that you receive with respect
to our common shares generally will be taxed to you as dividend income to the extent such
distribution does not exceed our current or accumulated earnings and profits (E&P), as calculated
for U.S. federal income tax purposes. Such income will be includable in your gross income as
ordinary income on the date of receipt. Under the tax law enacted in 2003 in the United States,
dividends received by individuals in their tax years beginning on January 1, 2003 from qualified
foreign corporations are taxed at the rate of 5 percent (zero, in 2008) or 15 percent, depending
upon the particular taxpayers U.S. federal income tax bracket; provided that the
recipient-shareholder has held his or her shares as a beneficial owner for more than 60 days during
the 121-day period beginning on the date which is 60 days before the shares ex-dividend date.
This law sunsets after December 31, 2008, at which time dividends will be taxed at the ordinary
income tax rates of up to 35 percent. A foreign corporation is a qualified foreign corporation
if the stock with respect to which it pays dividend is traded on an established securities market
in the United States, provided that the foreign corporation is not a foreign personal holding
company, a foreign investment company or a passive foreign investment company, as defined
under the United States federal income tax law. Tax laws enacted in the United States in 2004
repealed the rules relating to foreign personal holding company and foreign investment company
effective for tax years of foreign corporations that begin after December 31, 2004. Our stock is
traded on an established securities market in the United States; however, we have not made a
specific determination as to our passive foreign investment company status. In October 2004, the
IRS issued a statement that the U.S. Treasury Department and the IRS were developing detailed
procedures for foreign corporations to certify, as one of the prerequisites to the application of
the reduced tax rates on dividends paid, that they are qualified foreign corporations, including a
certification that they are not a passive foreign investment company. At June 30, 2005, no such
guidance was issued. However, when such guidance is issued in the future, we may be unable to
certify that we are not a passive foreign investment company, either because we will determine,
at that future time, that we are a passive foreign investment company or because the final
certification procedures will be materially burdensome to us and it will be impractical for us to
comply with them. If we are unable to comply with such future guidance and certify that we are not
a passive foreign investment company, dividends received from us will be taxed at regular federal
income tax rates (up to 35 percent). To the extent any distribution exceeds our E&P, the distribution will first be treated as a
tax-free return of capital to the extent of your adjusted tax basis in our common shares and will
be applied against and reduce such basis on a dollar-for-dollar basis (thereby increasing the
amount of gain and decreasing the amount of loss recognized on a subsequent disposition of such
shares). To the extent that such distribution exceeds your adjusted tax basis, the distribution
will be taxed as gain recognized on a sale or exchange of our common shares. See Sale or Other
Disposition of Our Common Shares, below. Because we are not a U.S. corporation, no
dividends-received deduction will be allowed to corporations with respect to dividends paid by us. Sale or Other Disposition of Our Common Shares Subject to the passive foreign investment company rules discussed below, generally, in
connection with the sale or other taxable disposition of our common shares:  
    
    you will recognize gain or loss equal to the difference (if any) between: 48




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o
    
    the amount realized on such sale or other taxable disposition ando
    
    your adjusted tax basis in such common shares (your adjusted tax basis
in the shares you hold generally will equal your U.S. dollar cost of such shares);  
    
    such gain or loss will be capital gain or loss and will be long-term capital gain or
loss if your holding period for our common shares is more than one year at the time of such
sale or other disposition;
    
    net long-term capital gains derived by individual U.S. Holders from sales or other
taxable dispositions of our shares after May 5, 2003 and before January 1, 2009, will
generally be taxed at the rate of 5 percent (zero, in 2008) or 15 percent, depending upon
the particular taxpayers U.S. federal income tax bracket;
    
    such gain or loss will generally be treated as having U.S. source for U.S. foreign tax
credit purposes; and
    
    your ability to deduct capital losses is subject to limitations. Passive Foreign Investment Company U.S. Holders generally would be subject to a special, adverse tax regime (that would differ in
certain material respects from that described above) if we are or were to be classified as a
passive foreign investment company (PFIC) for U.S. federal income tax purposes as to our U.S.
Holders. An actual determination of PFIC status is factual in nature, made on a
shareholder-by-shareholder basis, and generally cannot be made until the close of the applicable
tax year. The Company has not made a specific determination as to whether or not it is in fact a
PFIC as to any of its U.S. Holders. We are or will be a PFIC if either:  
    
    75 percent or more of our gross income in a taxable year is passive income (including
our pro-rata share of the gross income of any company in which we own, or are treated as
owning, 25 percent or more of the shares by value), which includes dividends, interests,
royalties, rents, annuities, and some types of gains; or
    
    the average percentage of the value of our assets in a taxable year (including our
pro-rata share of the assets of any company in which we own, or are treated as owning, 25
percent or more of the shares by value) that produce or are held for the production of
passive income is at least 50 percent. The application of the above tests could result in our classification as a PFIC even in a year
in which we have substantial gross revenues from product sales. If and when we determine that we
are a PFIC, we will endeavor to notify you. If you own common shares during any year in which we
are a PFIC, you must file IRS Form 8621. If we are or were classified as a PFIC during the time you hold our shares, unless you timely
make one of the available elections, a special tax regime would apply to both:  
    
    any excess distribution, which would be your share of distributions in any year that
are greater than 125 percent of the average annual distributions received by you in the
three preceding years before the current taxable year (or during your holding period for
the shares, if shorter), and
    
    any gain realized on the sale or other disposition of our common shares. Under this regime, any excess distribution and realized gain would be treated as ordinary
income and would be subject to tax generally in the following manner:  
    
    the excess distribution or gain would be allocated ratably to each day that you have
held our common shares, 49




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
    
    the amount allocated to the taxable year in which you realize the excess distribution or
gain would be taxed as ordinary income,
    
    the amount allocated to the taxable years prior to the first taxable year in which we
are a PFIC would be taxed as ordinary income for the taxable year in which you realize the
excess distribution or gain, and
    
    the amounts allocated to each of the prior taxable years for which we were a PFIC would
be taxed as ordinary income at the highest applicable tax rate in effect for that year,
and, in addition, an interest charge generally applicable to underpayments of tax would be
imposed on you for the tax deferred. Subject to certain limitations, if you own common shares in a PFIC that are treated as
marketable stock, you may make a mark-to-market election. If you make this election, for all
taxable years during which you held common shares and we were a PFIC, you would not be subject to
the PFIC rules described above. Instead, in general, you would include as ordinary income each
year the excess, if any, of the fair market value of your shares at the end of the taxable year
over the adjusted tax basis in your shares. You would also be allowed to take an ordinary loss in
respect of the excess, if any, of the adjusted basis of your shares over their fair market value at
the end of the taxable year, but only to the extent of the net amount of income previously included
as a result of the mark-to-market election. Your basis in the shares would be adjusted to reflect
any such income or loss amounts. Any gain realized upon disposition would be taxed as ordinary
income. If we are or become a PFIC, we believe our shares would be treated as marketable stock for
purposes of the mark-to-market election but we can give you no assurance that they in fact will be
so treated. In lieu of making a mark-to-market election, you may make a qualifying electing fund election.
In many situations, it would be desirable to make this election. However, even if your tax
advisor determines that this election is beneficial to you, if we are or were to become a PFIC, we
may not be able or willing to satisfy the record-keeping and other requirements that would enable
you to make a qualified electing fund election. You are urged to consult your own tax advisor concerning the potential application of the PFIC
rules to your ownership and disposition of our common shares. Tax Consequences to Non-U.S. Holders If you are not a U.S. Holder, you are a Non-U.S. Holder. Distributions You generally will not be subject to U.S. federal income tax, including withholding tax, on
distributions made on our common shares unless:  
    
    you conduct a trade or business in the United States and
    
    the distributions are effectively connected with the conduct of that trade or business
(and, if an applicable income tax treaty so requires as a condition for you to be subject
to U.S. federal income tax on a net income basis in respect of income from our common
shares, such distributions are attributable to a permanent establishment that you maintain
in the United States). If you meet the two tests above, you generally will be subject to tax in respect of such
dividends in the same manner as a U.S. Holder, as described above. In addition, any effectively
connected dividends received by a non-U.S. corporation may also, under certain circumstances, be subject to an additional branch
profits tax at a 30 percent rate or such lower rate as may be specified by an applicable income
tax treaty. Sale or Other Disposition of Our Common Shares Generally, you will not be subject to U.S. federal income tax, including withholding tax, in
respect of gain recognized on a sale or other taxable disposition of our common shares unless: 50




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
    
    your gain is effectively connected with a trade or business that you conduct in the
United States (and, if an applicable income tax treaty so requires as a condition for you
to be subject to U.S. federal income tax on a net income basis in respect of gain from the
sale or other disposition of our common shares, such gain is attributable to a permanent
establishment maintained by you in the United States), or
    
    you are an individual Non-U.S. Holder and are present in the United States for at least
183 days in the taxable year of the sale or other disposition, and certain other conditions
exist. You will be subject to tax in respect of any gain effectively connected with your conduct of a
trade or business in the United States generally in the same manner as a U.S. holder, as described
above. Effectively connected gains realized by a non-U.S. corporation may also, under certain
circumstances, be subject to an additional branch profits tax at a rate of 30 percent or such
lower rate as may be specified by an applicable income tax treaty. Backup Withholding and Information Reporting Payments (or other taxable distributions) in respect of our common shares that are made in the
United States or by a U.S. related financial intermediary will be subject to U.S. information
reporting rules. In addition, such payments may be subject to U.S. federal backup withholding at a
rate of 28 percent. You will not be subject to backup withholding provided that:  
    
    you are a corporation or other exempt recipient, or
    
    you provide your correct U.S. federal taxpayer identification number and certify that no
loss of exemption from backup withholding has occurred. If you are a Non-U.S. Holder, you generally are not subject to information reporting and
backup withholding, but you may be required to provide a certification of your non-U.S. status in
order to establish that you are exempt. Amounts withheld under the backup withholding rules may be credited against your U.S. federal
income tax liability, and you may obtain a refund of any excess amounts withheld under the backup
withholding rules by filing the appropriate claim for refund with the IRS. The discussions above are for general information only. You should consult your own tax
advisors regarding the application of the U.S. federal income tax laws to your particular situation
as well as any state, local, foreign tax and the U.S. federal estate and gift tax consequences of
the ownership and disposition of our common shares. British Virgin Islands Tax Consequences Under the International Business Companies Act of the British Virgin Islands as currently in
effect, a holder of common equity, such as our common shares, who is not a resident of the British
Virgin Islands is exempt from British Virgin Islands income tax on dividends paid with respect to
the common equity and all holders of common equity are not liable to the British Virgin Islands for
income tax on gains realized on sale or disposal of such shares: The British Virgin Islands does
not impose a withholding tax on dividends paid by a company incorporated under the International
Business Companies Act. There are no capital gains, gift or inheritance taxes levied by the British Virgin Islands on
companies incorporated under the International Business Companies Act. In addition, our common
shares are not subject to transfer taxes, stamp duties or similar charges. There is no income tax
treaty or convention currently in effect between the United States and the British Virgin Islands. 51




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ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Exchange Controls There are no exchange control restrictions on payments of dividends on the Companys common
shares or on the conduct of the Companys operations either in Hong Kong, where the Companys
principal executive offices are located, or the British Virgin Islands, where the Company is
incorporated. Other jurisdictions in which the Company conducts operations may have various
exchange controls. There are no material British Virgin Islands laws which impose foreign exchange
controls on the Company or that affect the payment of dividends, interest or other payments to
nonresident holders of the Companys common shares. British Virgin Islands law and the Companys
Memorandum and Articles of Association impose no limitations on the right of nonresident or foreign
owners to hold the Companys Securities or vote the Companys common shares. Chinas laws and regulations regulate dividend distribution and repatriation by the Companys
China subsidiaries. To date these controls have not had and are not expected to have a material
impact on the Companys financial results. To the extent that the Company may decide to pay cash
dividends in the future, such dividends will be declared from the retained earnings, i.e., surplus,
as determined by resolution of the directors of the Company. As the Company is a holding company,
the amount of its retained earnings will be limited by the amount of dividends that can be declared
by its subsidiaries. Dividends declared by subsidiaries will be based on the profits reported in
their statutory accounts prepared in accordance with generally accepted accounting principles in
the relevant countries, primarily Hong Kong and China, which differ from U.S. GAAP. See Note 1 of
Notes to Consolidated Financial Statements. Further, the Company intends that portions of the
profits earned by Jetcrown Shenzhen will be reinvested and therefore such profits will not be
available for the declaration of dividends. See Notes 1 and 8 of Notes to Consolidated Financial
Statements. Foreign Currency Risk At March 31, 2003, 2004 and 2005 the Company had no open forward exchange contracts or option
contracts. Cash on hand at March 31, 2005 of $29,113,000 was held in the following currencies: EquivalentU.S. DollarHoldingsUnited States dollars
    
    $
    16,439,000Hong Kong dollars
    
    
    9,044,000Euro
    
    
    40,000Chinese renminbi
    
    
    3,106,000Japanese yen
    
    
    459,000Macao dollars
    
    
    25,000
 See discussion of Exchange Rate Fluctuation in Item 5 Operating and Financial Review and Prospects. Interest Rate Risk Our interest expenses and income are sensitive to changes in interest rates, as all of our
cash reserves and borrowings are subject to interest rate changes. Cash on hand of $14,386,000 as
at March 31, 2005 was invested in short-term interest bearing investments. As such, interest
income will fluctuate with changes in short term interest rates. As of March 31, 2005 we had no
long-term debt or short-term bank loans outstanding on our credit facilities. 
 ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES Not applicable. 
 PART II 
 ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES 52




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Not Applicable. 
 ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS Not Applicable. 
 ITEM 15. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures As of the end of the Companys fiscal year ended March 31, 2005, we carried out an evaluation,
under the supervision and with the participation of our management, including our Chief Executive
Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures
(as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934 (the Exchange Act)) pursuant
to Rule 13a-15 of the Exchange Act. Based upon that evaluation, the Chief Executive Officer and
Chief Financial Officer concluded that as of the end of the Companys fiscal year ended March 31,
2005, the Companys disclosure controls and procedures are effective in timely alerting them to
material information relating to the Company (including its consolidated subsidiaries) required to
be included in the reports that the Company files or submits under the Exchange Act. Changes in Internal Controls There were no significant changes in the Companys internal controls or in other factors that
could significantly affect these controls during the year ended March 31, 2005, nor were there any
significant deficiencies or material weaknesses in the Companys internal controls requiring
corrective actions. 
 ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT Deswells Board of Directors has determined that at least one person serving on the Audit
Committee is an audit committee financial expert as defined under Item 16A(b) of Form 20-F. Mr.
Allen Yau-Nam Cham is an audit committee financial expert. 
 ITEM 16B. CODE OF ETHICS The Company has adopted a Code of Ethics for the Chief Executive Officer and Chief Financial
Officer, which applies to the Companys principal executive officer and to its principal financial
and accounting officers. A copy of the Code of Ethics is attached as Exhibit 11.1 to this Annual
Report on Form 20-F. 
 ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES Deswells principal accountants for the audit of its financial statements for each of the two
years in the period ended March 31, 2005 was BDO McCabe Lo & Company (BDO). The following table presents the aggregate fees for professional services and other services
rendered by the principal accountant to Deswell in the years ended March 31, 2004 and 2005. Year ended March 31,2004
    
    
    2005(US $ (in thousands))Audit Fees(1)
    
    
    98
    
    
    
    100Audit-related Fees(2)
    
    
    
    
    
    
    Tax Fees(3)
    
    
    
    
    
    
    All Other Fees(4)
    
    
    
    
    
    
    98
    
    
    
    100
 53




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##### Table of Contents



(1)
    
    Audit Fees consist of fees billed for the annual audit of our consolidated financial
statements and the statutory financial statements of our subsidiaries. They also include fees
billed for other audit services, which are those services that only the external auditor
reasonably can provide, and include the provision for consents relating to the review of
documents filed with the SEC.(2)
    
    There were no other audit-related fees billed by the principal accountant during the last two
fiscal years for assurance and related services that were reasonably related to the
performance of the audit not reported under Audit Fees above.(3)
    
    There were no tax fees billed by the principal accountant during the last two fiscal years.(4)
    
    There were no other fees billed by the principal accountant during the last two fiscal years
for products and services provided by BDO. Audit Committee Pre-approval Policies and Procedures The Audit Committees policy is to pre-approve all audit and permissible non-audit related
services provided by the independent auditors. These services may include audit services,
audit-related services, tax services and other services. Pre-approval is generally provided for up
to one year and any pre-approval is detailed as to the particular service or category of services.
The management will periodically report to the Audit Committee regarding the extent of services
provided and the fees for the services performed by the independent auditors in accordance with
this pre-approval policy. The Audit Committee may also pre-approve particular services on a
case-by-case basis. 
 ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR THE AUDIT COMMITTEE. As of the date of this Report, Deswell is not availing itself of an exemption from the
independence standards contained in paragraph (b)(1)(iv) of Rule 10A-3 under the Securities
Exchange Act of 1934 (except paragraph (b)(1)(iv)(B) of that Rule), the general exemption contained
in paragraph (c)(3) of that Rule or the last sentence of paragraph (a)(3) of that Rule. 
 ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATE PURCHASERS. Not applicable. 
 PART III 
 ITEM 17. FINANCIAL STATEMENTS Not Applicable. 54




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ITEM 18. FINANCIAL STATEMENTS The following financial statements are filed as part of this Report: PageReport of Independent Registered Public Accounting Firm
    
    
    56Consolidated Balance Sheets
    
    
    57Consolidated Statements of Income
    
    
    58Consolidated Statements of Shareholders Equity
    
    
    59Consolidated Statements of Cash Flows
    
    
    60Notes to Consolidated Financial Statements
    
    
    61
 All other schedules for which provisions are made in the applicable accounting regulations of
the Securities and Exchange Commission are not required under the related instructions or are
inapplicable, and therefore have been omitted. 55




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[Letterhead of BDO McCabe Lo & Company] 
 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Shareholders and the Board of Directors of
Deswell Industries, Inc. We have audited the accompanying consolidated balance sheets of Deswell Industries, Inc. and
subsidiaries (the Company) as of March 31, 2004 and 2005, and the related consolidated statements
of income, shareholders equity and cash flows for each of the three years in the period ended
March 31, 2005. These financial statements are the responsibility of the Companys management.
Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. The
Company is not required to have, nor were we engaged to perform, an audit of its internal control
over financial reporting. Our audits include consideration of internal control over financial
reporting as a basis for designing audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the Companys internal control
over financial reporting. Accordingly, we express no such opinion. Our audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates made by management,
as well as evaluating the overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Deswell Industries, Inc. and subsidiaries
as of March 31, 2004 and 2005, and the consolidated results of their operations and their cash
flows for each of the three years in the period ended March 31, 2005, in conformity with accounting
principles generally accepted in the United States of America. /s/
BDO McCabe Lo &
CompanyBDO McCabe Lo & Company Hong Kong, June 15, 2005 56




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DESWELL INDUSTRIES, INC. 
 CONSOLIDATED BALANCE SHEETS (U.S. dollars in thousands)
 March 31,2004
    
    
    2005ASSETSCurrent assets:Cash and cash equivalents
    
    $
    30,193
    
    
    $
    28,073Restricted cash (note 6)
    
    
    390
    
    
    
    1,040Marketable securities (note 3)
    
    
    
    
    
    
    244Accounts receivable, less allowances for doubtful amounts of nil and $28
at March 31, 2004 and 2005, respectively
    
    
    18,957
    
    
    
    25,091Inventories (note 4)
    
    
    16,174
    
    
    
    21,136Prepaid expenses and other current assets
    
    
    2,952
    
    
    
    4,761Income taxes receivable (note 8)
    
    
    127
    
    
    
    20Total current assets
    
    
    68,793
    
    
    
    80,365Property, plant and equipment-net (notes 5 and 6)
    
    
    44,261
    
    
    
    56,133Other investments
    
    
    2
    
    
    
    Goodwill
    
    
    478
    
    
    
    478Total assets
    
    $
    113,534
    
    
    $
    136,976LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    11,168
    
    
    $
    16,449Accrued payroll and employee benefits
    
    
    2,266
    
    
    
    2,020Customer deposits
    
    
    759
    
    
    
    868Other accrued liabilities (note 7)
    
    
    1,594
    
    
    
    3,127Income taxes payable
    
    
    130
    
    
    
    325Total current liabilities
    
    
    15,917
    
    
    
    22,789Deferred income taxes (note 8)
    
    
    15
    
    
    
    Commitments and contingencies (note 10)
    
    
    
    
    
    
    Minority interests
    
    
    7,872
    
    
    
    9,420Shareholders equity:Common shares nil par value-authorized 30,000,000 shares,
shares issued and outstanding March 31, 2004 - 13,723,627;
March 31, 2005 - 14,778,730 (note 11)
    
    
    29,980
    
    
    
    39,068Additional paid-in capital
    
    
    6,970
    
    
    
    6,970Retained earnings
    
    
    52,780
    
    
    
    58,729Total shareholders equity
    
    
    89,730
    
    
    
    104,767Total liabilities and shareholders equity
    
    $
    113,534
    
    
    $
    136,976
 See accompanying notes to consolidated financial statements. 57




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DESWELL INDUSTRIES, INC. 
 CONSOLIDATED STATEMENTS OF INCOME (U.S. dollars in thousands, except per share data)
 Year ended March 31,2003
    
    
    2004
    
    
    2005Net sales
    
    $
    90,905
    
    
    $
    97,195
    
    
    $
    125,590Cost of sales
    
    
    61,006
    
    
    
    66,105
    
    
    
    92,072Gross profit
    
    
    29,899
    
    
    
    31,090
    
    
    
    33,518Selling, general and administrative expenses
    
    
    15,354
    
    
    
    14,718
    
    
    
    15,759Operating income
    
    
    14,545
    
    
    
    16,372
    
    
    
    17,759Interest expense
    
    
    (6
    )
    
    
    (16
    )
    
    
    (12
    )Other income, net
    
    
    818
    
    
    
    910
    
    
    
    342Income before income taxes and minority interests
    
    
    15,357
    
    
    
    17,266
    
    
    
    18,089Income taxes (note 8)
    
    
    3,826
    
    
    
    589
    
    
    
    576Income before minority interests
    
    
    11,531
    
    
    
    16,677
    
    
    
    17,513Minority interests
    
    
    1,288
    
    
    
    1,957
    
    
    
    2,330Net income
    
    $
    10,243
    
    
    $
    14,720
    
    
    $
    15,183Net income per share (note 2)Basic:Net income per share
    
    $
    0.79
    
    
    $
    1.08
    
    
    $
    1.04Weighted average common shares outstanding
    
    
    13,008
    
    
    
    13,664
    
    
    
    14,656Diluted:Net income per share
    
    $
    0.77
    
    
    $
    1.04
    
    
    $
    1.02Weighted average common and potential common shares
    
    
    13,278
    
    
    
    14,160
    
    
    
    14,933
 See accompanying notes to consolidated financial statements. 58




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DESWELL INDUSTRIES, INC. 
 CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY (U.S. dollars in thousands, except share and per share data)
 Common stock
    
    
    AdditionalShares
    
    
    
    
    
    
    paid-in
    
    
    Retained
    
    
    Shareholdersoutstanding
    
    
    Amount
    
    
    capital
    
    
    earnings
    
    
    equityBalance at March 31, 2002
    
    
    12,555,744
    
    
    
    19,608
    
    
    
    6,970
    
    
    
    43,073
    
    
    
    69,651Exercise of stock options
    
    
    612,750
    
    
    
    4,217
    
    
    
    
    
    
    
    
    
    
    
    4,217Odd share redemption upon stock split
    
    
    (62
    )
    
    
    (1
    )
    
    
    
    
    
    
    
    
    
    
    (1
    )Issuance of common stock for acquisition
of additional 20% interest in a subsidiary
    
    
    377,820
    
    
    
    4,423
    
    
    
    
    
    
    
    
    
    
    
    4,423Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10,243
    
    
    
    10,243Dividends ($0.51 per share)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6,687
    )
    
    
    (6,687
    )Balance at March 31, 2003
    
    
    13,546,252
    
    
    
    28,247
    
    
    
    6,970
    
    
    
    46,629
    
    
    
    81,846Exercise of stock options
    
    
    177,375
    
    
    
    1,733
    
    
    
    
    
    
    
    
    
    
    
    1,733Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    14,720
    
    
    
    14,720Dividends ($0.63 per share)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8,569
    )
    
    
    (8,569
    )Balance at March 31, 2004
    
    
    13,723,627
    
    
    
    29,980
    
    
    
    6,970
    
    
    
    52,780
    
    
    
    89,730Exercise of stock options
    
    
    1,055,250
    
    
    
    9,092
    
    
    
    
    
    
    
    
    
    
    
    9,092Odd share redemption upon stock split
    
    
    (147
    )
    
    
    (4
    )
    
    
    
    
    
    
    
    
    
    
    (4
    )Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    15,183
    
    
    
    15,183Dividends ($0.65 per share)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (9,234
    )
    
    
    (9,234
    )Balance at March 31, 2005
    
    
    14,778,730
    
    
    
    39,068
    
    
    
    6,970
    
    
    
    58,729
    
    
    
    104,767
 See accompanying notes to consolidated financial statements. 59




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DESWELL INDUSTRIES, INC. 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 (U.S. dollars in thousands)
 Year ended March 31,2003
    
    
    2004
    
    
    2005Cash flows from operating activitiesNet income
    
    $
    10,243
    
    
    $
    14,720
    
    
    $
    15,183Adjustments to reconcile net income to net
cash provided by operating activities:Depreciation and amortization
    
    
    4,692
    
    
    
    4,402
    
    
    
    4,970Loss on sale of property, plant and equipment
    
    
    6
    
    
    
    392
    
    
    
    125Realized gain on disposal of other investments
    
    
    
    
    
    
    
    
    
    
    (295
    )Net realized (gain) and unrealized holding loss on marketable securities
    
    
    355
    
    
    
    (533
    )
    
    
    53Minority interests
    
    
    1,288
    
    
    
    1,901
    
    
    
    2,330Deferred tax
    
    
    
    
    
    
    
    
    
    
    (15
    )Changes in operating assets and liabilities:Accounts receivable
    
    
    161
    
    
    
    (2,230
    )
    
    
    (6,134
    )Inventories
    
    
    (1,559
    )
    
    
    (1,390
    )
    
    
    (4,962
    )Prepaid expenses and other current assets
    
    
    773
    
    
    
    (304
    )
    
    
    (1,809
    )Income taxes receivable
    
    
    105
    
    
    
    196
    
    
    
    107Accounts payable
    
    
    2,060
    
    
    
    1,525
    
    
    
    5,281Accrued payroll and employee benefits
    
    
    (565
    )
    
    
    954
    
    
    
    (246
    )Customer deposits
    
    
    (2,200
    )
    
    
    265
    
    
    
    109Other accrued liabilities
    
    
    702
    
    
    
    (857
    )
    
    
    1,533Income taxes payable
    
    
    3,781
    
    
    
    (3,816
    )
    
    
    195Net cash provided by operating activities
    
    
    19,842
    
    
    
    15,225
    
    
    
    16,425Cash flows from investing activitiesPurchase of property, plant and equipment
    
    
    (9,731
    )
    
    
    (19,862
    )
    
    
    (17,003
    )Proceeds from sale of property, plant and equipment
    
    
    127
    
    
    
    430
    
    
    
    36Acquisition of marketable securities
    
    
    (4,061
    )
    
    
    (1,056
    )
    
    
    Proceeds from sale of marketable securities
    
    
    
    
    
    
    6,410
    
    
    
    Acquisition of other investments
    
    
    (2
    )
    
    
    
    
    
    
    Net cash used in investing activities
    
    
    (13,667
    )
    
    
    (14,078
    )
    
    
    (16,967
    )Cash flows from financing activitiesDividends paid
    
    
    (6,687
    )
    
    
    (8,569
    )
    
    
    (9,234
    )Dividends paid to minority shareholders of a subsidiary
    
    
    (851
    )
    
    
    (582
    )
    
    
    (756
    )Decrease in bank loans
    
    
    (482
    )
    
    
    
    
    
    
    Exercise of stock options
    
    
    4,217
    
    
    
    1,733
    
    
    
    9,092Odd shares redemption
    
    
    (1
    )
    
    
    
    
    
    
    (4
    )(Increase) decrease in restricted cash
    
    
    495
    
    
    
    1,976
    
    
    
    (650
    )Contribution from (loan to) minority shareholders of subsidiaries
    
    
    
    
    
    
    88
    
    
    
    (26
    )Net cash used in financing activities
    
    
    (3,309
    )
    
    
    (5,354
    )
    
    
    (1,578
    )Net (decrease) increase in cash and cash equivalents
    
    
    2,866
    
    
    
    (4,207
    )
    
    
    (2,120
    )Cash and cash equivalents, beginning of year
    
    
    31,534
    
    
    
    34,400
    
    
    
    30,193Cash and cash equivalents, end of year
    
    $
    34,400
    
    
    $
    30,193
    
    
    $
    28,073Supplementary disclosures of cash flow information:Cash paid (refunded) during the year for:Interest
    
    $
    6
    
    
    $
    16
    
    
    $
    12Income taxes
    
    $
    (60
    )
    
    $
    4,210
    
    
    $
    289Supplementary disclosures of significant non-cash transactions:Issuance of common stock in connection with acquisition of
additional 20% shareholding in a subsidiary
    
    $
    4,423
    
    
    $
    
    
    
    $
    
 See accompanying notes to consolidated financial statements. 60




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DESWELL INDUSTRIES, INC. 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (U.S. dollars in thousands, except per share data)
 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 Macau Special Administrative Region (Macau) 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 dividended up 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, 2005, the retained earnings
available for distribution as reflected in the statutory books of the subsidiaries were $59,998. 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. 2. Summary of Significant Accounting Policies Principles of consolidation-The consolidated financial statements, prepared in accordance with
generally accepted accounting principles in the United States of America, include the assets,
liabilities, revenues, expenses and cash flows of all subsidiaries. Intercompany balances,
transactions and cash flows are eliminated on consolidation. Goodwill-The excess purchase price over the fair value of net assets acquired is recorded on
the balance sheet as goodwill. Prior to April 1, 2002, goodwill was amortized to expense on a
straight line basis over 20 years. On April 1, 2002, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 142 Goodwill and other Intangible Assets, which established new
standards for goodwill acquired in a business combination, eliminates the amortization of goodwill
and requires the carrying value of goodwill to be evaluated for impairment on an annual basis. In accordance with SFAS No. 142, goodwill is evaluated to determine if fair value of the asset
has decreased below its carrying value. The Company regularly conducted annual impairment
evaluation and determined that there was no impairment in goodwill. Cash and cash equivalents-Cash and cash equivalents include cash on hand, cash accounts,
interest bearing savings accounts and time certificates of deposit with a maturity of three months
or less when purchased. Marketable securities-All marketable securities are classified as trading securities and are
stated at fair market value. Market value is determined by the most recently traded price of the
security at the balance sheet date. Net realized and unrealized gains and losses on trading
securities are included in other income. The cost of investments sold is based on the average cost
method and interest earned is included in other income. Inventories-Inventories are stated at the lower of cost, determined by the first-in, first-out
method, or market. Work-in-progress and finished goods inventories consist of raw materials,
direct labour and overhead associated with the manufacturing process. Prepaid expenses and other current assets-Prepaid expenses and other current assets consist
principally of rental deposits, prepaid expenses and other miscellaneous receivables. 61




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2. Summary of Significant Accounting Policies  continued Property, plant and equipment-Property, plant and equipment is stated at cost including the
cost of improvements. Maintenance and repairs are charged to expense as incurred. Depreciation
and amortization are provided on the straight line method based on the estimated useful lives of
the assets as follows: Leasehold land and buildings
    
    40 - 50 yearsPlant and machinery
    
    4 - 10 yearsFurniture, fixtures and equipment
    
    4 - 5 yearsMotor vehicles
    
    3 - 4 yearsLeasehold improvements
    
    the shorter of 5 years or the lease term
 Valuation of long-lived assets-The Company periodically evaluates the carrying value of
long-lived assets to be held and used, including other intangible assets subject to amortization,
when events and circumstances warrant such a review. The carrying value of a long-lived asset is
considered impaired when the anticipated undiscounted cash flow from such asset is separately
identifiable and is less than its carrying value. In that event, a loss is recognized based on the
amount by which the carrying value exceeds the fair market value of the long-lived asset. Fair
market value is determined primarily using the anticipated cash flows discounted at a rate
commensurate with the risk involved. Losses on long-lived assets to be disposed of are determined
in a similar manner, except that fair market values are reduced for the cost to dispose. Revenue recognition-The Company recognizes revenue at the time the title is passed to
customers upon shipment and when collectibility is reasonably assured. Comprehensive income-The comprehensive income of the Company for the years ended March 31,
2003, 2004 and 2005 was represented by the net income of the respective years. Shipping and handling cost-Shipping and handling costs related to the delivery of finished
goods are included in selling expenses. During the year ended March 31, 2003, 2004 and 2005,
shipping and handling costs expensed to selling expenses were $653, $989 and $549, respectively. Income taxes-Income taxes are provided on an asset and liability approach for financial
accounting and reporting of income taxes. Any China tax paid by subsidiaries during the year is
recorded. Deferred income tax liabilities or assets are recorded to reflect the tax consequences in
future years of differences between the tax basis of assets and liabilities and the financial
reporting amounts at each year end. A valuation allowance is recognized if it is more likely than
not that some portion, or all, of a deferred tax asset will not be realized. Foreign currency translation-The consolidated financial statements of the Company are
presented in U.S. dollars as the Company is incorporated in the British Virgin Islands where the
currency is the U.S. dollar. The Companys subsidiaries conduct substantially all of their
business in Hong Kong dollars, the exchange rate of which has been fixed to the U.S. dollar at
approximately HK$7.80 to $1.00 since 1983, and U.S. dollars. There is, however, no assurance that
this rate will continue indefinitely. All transactions in currencies other than functional currencies during the year are translated
at the exchange rates prevailing on the transaction dates. Related accounts payable or receivable
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. Aggregate net foreign currency transaction gains (losses) included in income were $503, $(52)
and $(111) for the years ended March 31, 2003, 2004 and 2005, respectively. On consolidation, the financial statements of subsidiaries are translated from Hong Kong
dollars, being the functional currency of all of the Companys subsidiaries, into U.S. dollars in
accordance with SFAS No. 52, Foreign Currency Translation. Accordingly all assets and
liabilities are translated at the exchange rates prevailing at the balance sheet dates and all
income and expenditure items are translated at the average rates for each of the years. The
exchange rate between the Hong Kong dollar and the U.S. dollar used for the years ended March 31,
2003, 2004 and 2005 were HK$7.75 to US$1.00. Post-retirement and post-employmentbenefits-The Company and its subsidiaries contribute to a
state pension scheme in respect of its Chinese employees and a mandatory provident fund scheme in
respect of its Hong Kong employees. Neither the Company nor its subsidiaries provide any other
post-retirement or post-employment benefits. Stock-basedcompensation-SFAS No. 123 Accounting for Stock-Based Compensation allows
companies which have stock-based awards to employees to adopt a new fair value basis of accounting
for stock options and other equity instruments or to continue to apply the existing accounting
rules under Accounting Principles Board (APB) No. 25, Accounting for Stock Issued to Employees,
but with additional financial statement disclosure. 62




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2. Summary of Significant Accounting Policies  continued The Company accounts for its stock-based awards to employees using the intrinsic value method
in accordance with APB No. 25, SFAS No.123 requires the disclosure of pro forma net income and net
income per share as if the Company had adopted the fair value method, as follows: 2003
    
    
    2004
    
    
    2005Net income:As reported
    
    $
    10,243
    
    
    $
    14,720
    
    
    $
    15,183Pro forma
    
    
    10,243
    
    
    
    11,525
    
    
    
    15,183Stock-based employee compensation cost, net of tax
    
    $
    
    
    
    $
    3,195
    
    
    $
    Basic net income per share:As reported
    
    $
    0.79
    
    
    $
    1.08
    
    
    $
    1.04Pro forma
    
    
    0.79
    
    
    
    0.85
    
    
    
    1.04Diluted net income per share:As reported
    
    $
    0.77
    
    
    $
    1.04
    
    
    $
    1.02Pro forma
    
    
    0.77
    
    
    
    0.81
    
    
    
    1.02
 The fair value of options granted in the year ended March 31, 2004 was estimated to be
approximately $3.55 per share respectively using the Black-Scholes option pricing model with the
following assumptions: 2003
    
    
    2004
    
    
    2005Risk-free interest rate  weighted average
    
    
    n/a
    
    
    
    3.93
    %
    
    
    n/aExpected life of options  weighted average
    
    
    n/a
    
    
    10 years
    
    
    n/aExpected volatility
    
    
    n/a
    
    
    
    34.78
    %
    
    
    n/aExpected dividend yield
    
    
    n/a
    
    
    
    4.60
    %
    
    
    n/a
 Net income pershare-Basic net income per share is computed by dividing net income available
to common shareholders by the weighted average number of common shares outstanding during the
period. Diluted net income per share gives effect to all dilutive potential common shares
outstanding during the period. The weighted average number of common shares outstanding is
adjusted to include the number of additional common shares that would have been outstanding if the
dilutive potential common shares had been issued. In computing the dilutive effect of potential
common shares, the average stock price for the period is used in determining the number of treasury
shares assumed to be purchased with the proceeds from the exercise of options. 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): Year ended March 31,2003
    
    
    2004
    
    
    2005Net income
    
    $
    10,243
    
    
    $
    14,720
    
    
    $
    15,183Basic net income per share
    
    $
    0.79
    
    
    $
    1.08
    
    
    $
    1.04Basic weighted average common shares outstanding
    
    
    13,008
    
    
    
    13,664
    
    
    
    14,656Effect of dilutive securities  Options
    
    
    270
    
    
    
    496
    
    
    
    277Diluted weighted average common and potential common
shares outstanding
    
    
    13,278
    
    
    
    14,160
    
    
    
    14,933Diluted net income per share
    
    $
    0.77
    
    
    $
    1.04
    
    
    $
    1.02
 Use of estimates-The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates. 63




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2. Summary of Significant Accounting Policies  continued Recent changes in accounting standards In December 2004, the Financial Accounting
Statements Board (FASB) issued SFAS No. 123 (revised 2004), Share-Based Payment, which is a
revision of SFAS No. 123, Accounting for Stock-Based Compensation, SFAS No. 123(R) supersedes APB
Opinion No.25, Accounting for Stock Issued to Employees and amends SFAS No.95, Statement of Cash
Flows. Generally, the approach in SFAS No.123(R) is similar to the approach described in SFAS No.
123. However, SFAS No.123 (R) requires all share-based payments to employees, including grants of
employee stock options, to be recognized in the income statement based on their fair values. Pro
forma disclosure is no longer an alternative. SFAS No. 123 (R) was to be effective from the
beginning of the first interim or annual reporting period after June 15, 2005. In April 2005, the
Securities and Exchange Commission delayed the implementation of SFAS 123(R). As a result, SFAS
123(R) will be effective from the beginning of the first annual reporting period after June 15,
2005, which is the fiscal year ending March 31, 2007 for the Company. The Company is currently
assessing the impact of this statement on the Companys consolidated financial statements. In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, an
amendment of APB Opinion No. 29. SFAS No. 153 addresses the measurement of exchanges of nonmonetary
assets and redefines the scope of transactions that should be measured based on the fair value of
the assets exchanged. SFAS No. 153 is effective for nonmonetary asset exchanges occurring in fiscal
periods beginning after June 15, 2005, which would be our second quarter of fiscal 2006. The
adoption of SFAS No. 153 is not expected to have a material effect on our consolidated financial
position or results of operations. In November 2004, the FASB issued SFAS Statement No. 151, Inventory Costs, an amendment
of the Accounting Research Bulletin (ARB) No. 43, Chapter 4. Under FASB Statement No. 151, all
abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage)
should be recognized as current-period charges by requiring the allocation of fixed production
overheads to inventory based on the normal capacity of the production facilities. The adoption of
this pronouncement is not expected to have a material impact on the Companys consolidation
financial statements, results of operations, or cash flows. In October 2004, the FASB issued FASB Staff Position (FSP) No. 109-1, Application of FASB
Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production
Activities Provided by the American Job Creation Act of 2004, which provides a tax deduction of up
to nine percent (when fully phased in) of the lesser of (a) qualified production activities
income or taxable income (after the deduction for the utilization of any net operating loss carry
forwards). The adoption of this pronouncement is not expected to have a material impact on the
Companys consolidation financial statements, results of operations, or cash flows. In November 2003, the EITF issued EITF No. 03-6 Participating Securities and the Two-Class
Method under FASB Statement No. 128, which provides for a two-class method of calculating earnings
per share computations that relate to certain securities that would be considered to be
participating in conjunction with certain common stock rights. The adoption of this pronouncement
is not expected to have a material impact on the Companys consolidation financial statements,
results of operations, or cash flows. 3. Marketable Securities The Company acquired equity securities listed in Hong Kong. March 31,2004
    
    
    2005Cost
    
    $
    
    
    
    $
    297Market value
    
    $
    
    
    
    $
    244
 Unrealized loss for the years ended March 31, 2003, 2004 and 2005 were $355, $nil and $53,
respectively. Net proceeds from sale of marketable securities for the year ended March 31, 2003, 2004 and
2005 were $nil, $6,410 and $nil, and realized gains from sale of marketable securities for the year
ended March 31, 2003, 2004 and 2005 were $nil, $533 and $nil, respectively. For the purposes of
determining realized gains and losses, the cost of securities sold was determined based on the
average cost method. 64




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4. Inventories Inventories by major categories are summarized as follows: March 31,2004
    
    
    2005Raw materials
    
    $
    7,832
    
    
    $
    8,329Work in progress
    
    
    4,467
    
    
    
    8,088Finished goods
    
    
    3,875
    
    
    
    4,719$
    16,174
    
    
    $
    21,136
 5. Property, Plant and Equipment Property, plant and equipment consists of the following: March 31,2004
    
    
    2005At cost:Land and buildings
    
    $
    18,178
    
    
    $
    24,638Plant and machinery
    
    
    25,097
    
    
    
    31,386Furniture, fixtures and equipment
    
    
    13,515
    
    
    
    17,701Motor vehicles
    
    
    2,213
    
    
    
    2,367Leasehold improvements
    
    
    4,615
    
    
    
    4,939Total
    
    
    63,618
    
    
    
    81,031Less: accumulated depreciation and amortization
    
    
    (25,702
    )
    
    
    (30,088
    )Construction in progress
    
    
    6,345
    
    
    
    5,190Net book value
    
    $
    44,261
    
    
    $
    56,133Cost of land and buildings consist of the following:Leasehold land and buildings (a)
    
    $
    1,482
    
    
    $
    1,482Land use right of state-owned land and buildings erected thereon (b)
    
    
    9,684
    
    
    
    16,144Long term leased land and buildings erected thereon (c)
    
    
    4,186
    
    
    
    4,186Other buildings (d)
    
    
    2,826
    
    
    
    2,826$
    18,178
    
    
    $
    24,638
 
 (a)
    
    Leasehold land and buildings are located in Hong Kong with lease terms of 50 years expiring
in 2047.(b)
    
    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.(c)
    
    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 Cheng 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 Cheng
An Xiaobian District Co-operation to change the legal form of the land from collectively-owned to
state-owned. As of March 31, 2005, the Company is not aware of any steps being taken by the
Dongguan Cheng An Xiaobian District Co-operation for such application.(d)
    
    Other buildings represent factory premises and dormitory units located in China purchased by
the Company with lease terms from 30 to 70 years expiring from 2018 to 2063. 6. Credit facilities and pledged assets The Company has credit lines with various banks representing trade acceptances, loans and
overdrafts. At March 31, 2004 and 2005 these facilities totalled $10,118, and $8,078,
respectively. The maturities of these facilities are generally up to 90 days. Interest rates are
generally based on the banks prime lending rates and the credit lines are normally subject to
annual review. There are no significant covenants or other financial restrictions relating to the
Companys facilities except that at March 31, 2004 and 2005, cash of $390 and $1,040, respectively,
and leasehold land and buildings of net book value $1,288 and $1,259, respectively, have been
pledged as collaterals for the above facilities. As of March 31, 2004 and 2005, the Company has
not borrowed against these lines. 65




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7. Other Accrued liabilities Other accrued liabilities consist of the following: March 31,2004
    
    
    2005Value added tax payable
    
    $
    306
    
    
    $
    972Accrued expenses
    
    
    419
    
    
    
    1,323Commission expenses
    
    
    57
    
    
    
    138Others
    
    
    812
    
    
    
    694$
    1,594
    
    
    $
    3,127
 8. Income Taxes The components of income before income taxes and minority interests are as follows: Year ended March 31,2003
    
    
    2004
    
    
    2005Hong Kong
    
    $
    5
    
    
    $
    216
    
    
    $
    80China and others
    
    
    15,352
    
    
    
    17,050
    
    
    
    18,009$
    15,357
    
    
    $
    17,266
    
    
    $

    18,089
 Hong Kong The Company is subject to Hong Kong taxation on its activities conducted in Hong Kong. Each
company in Hong Kong files a separate tax return and is subject to tax on its taxable income
arising in or derived from Hong Kong. China Enterprise income tax in China is generally charged at 33%, in which 30% is for national tax
and 3% is for local tax, of the assessable profit. For foreign investment enterprises established
in a Special Economic Zone or Coastal Open Economic Zone, where the subsidiaries of the Company are
located, and which are engaged in production-oriented activities, the national tax rate could be
reduced to 15% and 24% respectively. The Companys subsidiaries incorporated in China are subject
to China income taxes at the applicable tax rates on the taxable income as reported in their
Chinese statutory accounts in accordance with the relevant income tax laws applicable to foreign
enterprises. Pursuant to the same income tax laws, the subsidiaries are fully exempted from China
income tax for two years starting from the first profit-making year, followed by a 50% tax
exemption for the next three years. Jetcrown Industrial (Shenzhen) Limited (Jetcrown Shenzhen) (a subsidiary of the Company) had
fully enjoyed the above tax holiday and concessions by December 31, 1995. Afterwards, Jetcrown
Shenzhen has been approved as an Export-oriented Enterprise by the local tax authority and
enjoyed a lower tax rate of 10% for the calendar years ended December 31, 2002, 2003 and 2004. Dongguan Kwan Hong Electronics Company Limited (Dongguan Kwan Hong) (a subsidiary of the
Company) has been approved as a High-tech Enterprise by the local tax authority and enjoyed a
lower tax rate of 15%. Dongguan Kwan Hong has its first tax exemption year in the calendar year
ended December 31, 2000 and enjoyed the 50% tax exemption for the calendar years ended December
2002, 2003 and 2004. Jetcrown Industrial (Dongguan) Limited (a subsidiary of the Company) has commenced its first
tax exemption year for the calendar year ended December 31, 2004. Pursuant to a further concession in the income tax laws, the Company, as a foreign shareholder
in a foreign enterprise in China, is eligible for a refund of taxes paid by its Chinese
subsidiaries in proportion to the after-tax profits of these subsidiaries which are reinvested by
the Company in these subsidiaries or in other foreign enterprises in China provided that the
reinvestment period relating to such subsidiaries or other foreign enterprises is for at least five
years from the date the reinvested funds are contributed. If the reinvestment period is less than
five years, the income tax refunded will be repayable to the Chinese tax authorities. During the years ended March 31, 2003, 2004 and 2005, the Company recorded a benefit relating
to its decision to reinvest earnings of its Chinese subsidiary, Jetcrown Shenzhen, totaling $323,
$nil and $nil, respectively. 66




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8. Income Taxes- continued Had the all above tax holidays and concessions not been available, the tax charge would have
been higher by $611, $1,811 and $719 and the basic net income per share would have been lower by
$0.05, $0.13 and $0.05 for the years ended March 31, 2003, 2004 and 2005 respectively, and diluted
net income per share for the years ended March 31, 2003, 2004 and 2005 would have been lower by
$0.05, $0.13 and $0.05, respectively. Others Certain of the Companys income accrues in tax free jurisdictions and is not subject to any
income taxes. The provision for income taxes consists of the following: Year ended March 31,2003
    
    
    2004
    
    
    2005Current tax- Hong Kong
    
    $
    3,674
    
    
    $
    132
    
    
    $
    51- China
    
    
    152
    
    
    
    457
    
    
    
    540Deferred tax
    
    
    
    
    
    
    
    
    
    
    (15
    )$
    3,826
    
    
    $
    589
    
    
    $
    576
 A reconciliation between the provision for income taxes computed by applying the statutory tax
rate in Hong Kong or China to income before income taxes and the actual provision for income taxes
is as follows: Year ended March 31,2003
    
    
    2004
    
    
    2005Provision for income taxes at statutory tax rate in  Hong Kong
    
    $
    2,457
    
    
    $
    
    
    
    $
     China
    
    
    
    
    
    
    4,661
    
    
    
    4,884Effect of different tax rate in various jurisdictions
    
    
    (238
    )
    
    
    (210
    )
    
    
    (219
    )Tax holidays and concessions
    
    
    (733
    )
    
    
    (1,811
    )
    
    
    (666
    )Effect of income for which no income tax is payable
    
    
    (1,047
    )
    
    
    (1,977
    )
    
    
    (3,459
    )Increase (decrease) in valuation allowances
    
    
    (310
    )
    
    
    
    
    
    
    Under (over) provision of income tax in previous year
    
    
    78
    
    
    
    (22
    )
    
    
    34Additional assessments for previous years (a)
    
    
    3,532
    
    
    
    
    
    
    
    Others
    
    
    87
    
    
    
    (52
    )
    
    
    2Effective tax
    
    $
    3,826
    
    
    $
    589
    
    
    $
    576
 
 (a)
    
    The Company has made a settlement with Hong Kong Inland Revenue Department (IRD) regarding a
disagreement on whether taxes should be assessed on profits derived from activities of certain of
its subsidiaries during the six fiscal years ended March 31, 2002, which the Company believed were
conducted outside of Hong Kong and were not subject to profits tax under the Hong Kong Revenue
Ordinance. While, based on consultations with Hong Kong tax experts, management believes that its
tax position for these years was sound and supportable, management nevertheless concluded that it
would be in the Companys best interest to make a proposal for settlement with the IRD in order to
avoid the expenditure of substantial time, effort and expense involved in proceedings that could
extend years. An amount of $3,532 has been charged to the consolidated income statement for the
year ended March 31, 2003. The components of deferred income tax are as follows: March 31,2004
    
    
    2005Deferred tax asset:Net operating loss carryforwards
    
    $
    
    
    
    $
    Less: Valuation allowances
    
    
    
    
    
    
    
    
    
    
    Deferred tax liability:Property, plant and equipment
    
    
    (15
    )
    
    
    Net deferred tax liability
    
    $
    (15
    )
    
    $
    
 9. Subsequent Event 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. 67




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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 $1,917, $1,507 and $981 for the years ended March 31, 2003, 2004 and 2005, respectively. At March 31, 2005, the Company was obligated under operating leases requiring minimum rentals
as follows: Years ending March 312006
    
    $
    8352007
    
    
    5402008
    
    
    283Total minimum lease payments
    
    $
    1,658
 At March 31, 2005, the Company had capital commitments for plant and machinery totalling $952
which is expected to be disbursed during the year ending March 31, 2006. The Company has contracted with some building contractors to construct the Companys new
factory plant in Dongguan, China. The budgeted costs of the whole project are estimated to be
$30,307. At March 31, 2005, a total of $27,252 has been paid on the project and are recorded in
property, plant and equipment. 11. Shareholders Equity On July 8, 2002, the Company completed a three-for-two stock split. In conjunction with this
stock split, the authorized share capital has been increased from 20,000,000 to 30,000,000 common
shares. The par value of common stock has been changed to nil at the same time. No fractional
shares were issued and 62 shares were redeemed and cancelled upon the stock split. All financial
statements have been retroactively restated to account for the change. On March 15, 2005, the Company completed a three-for-two stock split. No fractional shares
were issued and 147 shares were redeemed and cancelled upon the stock split. All financial
statements have been retroactively restated to account for the change. 12. 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 16% of the
average monthly salary, was $260, $272 and $310 for the years ended March 31, 2003, 2004 and
2005, respectively. According to the Mandatory Provident Fund (MPF) legislation regulated by the
Mandatory Provident Fund Schemes Authority in Hong Kong, with effect from December 1, 2000, the
Company is required to participate in a MPF scheme operated by approved trustees in Hong Kong and
to make contributions for its eligible employees. The contributions borne by the Company are
calculated at 5% of the salaries and wages (monthly contribution is limited to 5% of $3 for each
eligible employee) as calculated under the MPF legislation. The expense related to the MPF in the
years ended March 31, 2003, 2004 and 2005 amounted to $63, $31 and $2, respectively. 13. 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, 1998, 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. At March 31, 2005, options to purchase an aggregate of
3,586,500 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: 68




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##### Table of Contents



13. Stock Option Plan  Continued Year ended March 31,2003
    
    
    2004
    
    
    2005Weighted
    
    
    
    
    
    
    Weighted
    
    
    
    
    
    
    WeightedNumber
    
    
    average
    
    
    Number
    
    
    average
    
    
    Number
    
    
    averageof stock
    
    
    exercise
    
    
    of stock
    
    
    exercise
    
    
    of stock
    
    
    exerciseoptions
    
    
    price
    
    
    options
    
    
    price
    
    
    options
    
    
    priceOutstanding at beginning of the year
    
    
    1,614,375
    
    
    $
    7.30
    
    
    
    1,001,625
    
    
    $
    7.55
    
    
    
    1,724,250
    
    
    $
    10.74Granted during the year
    
    
    
    
    
    
    
    
    
    
    900,000
    
    
    
    14.10
    
    
    
    
    
    
    
    Exercised during the year
    
    
    (612,750
    )
    
    
    6.88
    
    
    
    (177,375
    )
    
    
    9.77
    
    
    
    (1,055,250
    )
    
    
    8.61Outstanding and exercisable at the
end of the year
    
    
    1,001,625
    
    
    
    7.55
    
    
    
    1,724,250
    
    
    
    10.74
    
    
    
    669,000
    
    
    
    14.10Range of exercise price per share
    
    
    
    
    
    $
    7.55
    
    
    
    
    
    
    $7.55 to $14.10
    
    
    
    
    
    $
    14.10
 There were nil options forfeited or expired for the years ended March 31, 2003, 2004 and 2005.
The weighted average remaining contractual life of the share options outstanding at March 31, 2005
was 8.50 years. At March 31, 2003, 2004 and 2005, there were nil options available for future
grant under the plans respectively. 14. 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, 2003, 2004 and 2005 are as follows: Percentage of net salesYear ended March 31,2003
    
    
    2004
    
    
    2005Digidesign, Inc.
    
    
    13.5
    %
    
    
    17.8
    %
    
    
    19.1
    %Epson Precision (H.K.) Limited
    
    
    22.3
    %
    
    
    15.4
    %
    
    
    18.5
    %Line 6 Manufacturing
    
    
    n/a
    
    
    
    *
    
    
    
    14.9
    %VTech Telecommunications Limited
    
    
    11.6
    %
    
    
    17.6
    %
    
    
    12.1
    %Inter-Tel Incorporated
    
    
    13.0
    %
    
    
    10.3
    %
    
    
    *Kyocera Mita Industrial Co. (H.K.) Limited
    
    
    10.9
    %
    
    
    *
    
    
    
    *
 
 *
    
    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, 2004 and 2005, respectively, are as follows: Percentage ofaccountsreceivableMarch 31,2004
    
    
    2005Largest receivable balances
    
    
    58.3
    %
    
    
    53.7
    %
 The Company has not experienced any significant difficulty in collecting its accounts
receivable in the past and is not aware of any financial difficulties being experienced by its
major customers. There were bad debt expense of $nil, $nil and $28 during the years ended March
31, 2003 and 2004 and 2005 respectively. There was no provision for bad debts at the beginning and
end of the three years ended March 31, 2003, 2004 and 2005. 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 taxation, among other
things. There can be no assurance, however, those changes in political and other conditions will
not result in any adverse impact. 69




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##### Table of Contents



15. Fair Value of Financial Instruments The carrying amounts of cash and cash equivalents, restricted cash, marketable securities,
accounts receivable, accounts payable and are reasonable estimates of their fair value. All the
financial instruments are for trade purposes. 16. 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. Contributions of the major activities, profitability information and asset information of the
Companys reportable segments for the years ended March 31, 2003, 2004 and 2005 are as follows: Year ended March 31,2003
    
    
    2004
    
    
    2005Intersegment
    
    
    
    
    
    
    
    
    
    
    Intersegment
    
    
    
    
    
    
    
    
    
    
    IntersegmentNet sales
    
    
    sales
    
    
    Profit (loss)
    
    
    Net sales
    
    
    sales
    
    
    Profit (loss)
    
    
    Net sales
    
    
    sales
    
    


    Profit (loss)Segment:Injection molded
plastic parts
    
    $
    50,975
    
    
    $
    1,068
    
    
    $
    12,687
    
    
    $
    54,745
    
    
    $
    1,699
    
    
    $
    11,717
    
    
    $
    61,519
    
    
    $
    1,877
    
    
    $
    10,967Electronic products
    
    
    38,221
    
    
    
    8
    
    
    
    3,313
    
    
    
    40,083
    
    
    
    3
    
    
    
    5,378
    
    
    
    60,472
    
    
    
    
    
    
    
    6,660Metallic parts
    
    
    5,542
    
    
    
    2,757
    
    
    
    (643
    )
    
    
    6,185
    
    
    
    2,116
    
    
    
    171
    
    
    
    8,200
    
    
    
    2,724
    
    
    
    462Segment total
    
    $
    94,738
    
    
    $
    3,833
    
    
    $
    15,357
    
    
    $
    101,013
    
    
    $
    3,818
    
    
    $
    17,266
    
    
    $
    130,191
    
    
    $
    4,601
    
    
    $
    18,089Reconciliation to
consolidated totals:Sales eliminations
    
    
    (3,833
    )
    
    
    (3,833
    )
    
    
    
    
    
    
    (3,818
    )
    
    
    (3,818
    )
    
    
    
    
    
    
    (4,601
    )
    
    
    (4,601
    )
    
    
    Goodwill amortization
not allocated to
segment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Consolidated totals:Net sales
    
    $
    90,905
    
    
    $
    
    
    
    
    
    
    
    $
    97,195
    
    
    $
    
    
    
    
    
    
    
    $
    125,590
    
    
    $
    Income before
income taxes
and minority
interests
    
    
    
    
    
    
    
    
    
    $
    15,357
    
    
    
    
    
    
    
    
    
    
    $
    17,266
    
    
    
    
    
    
    
    
    
    
    $
    18,089
 Year ended March 31,2003
    
    
    2004
    
    
    2005Interest
    
    
    Interest
    
    
    Interest
    
    
    Interest
    
    
    Interest
    
    
    Interestincome
    
    
    expenses
    
    
    income
    
    
    expenses
    
    
    income
    
    
    expensesSegment:Injection molded
plastic parts
    
    $
    396
    
    
    $
    
    
    
    $
    230
    
    
    $
    
    
    
    $
    128
    
    
    $
    Electronic products
    
    
    26
    
    
    
    6
    
    
    
    17
    
    
    
    16
    
    
    
    13
    
    
    
    12Metallic parts
    
    
    4
    
    
    
    
    
    
    
    0
    
    
    
    
    
    
    
    0
    
    
    
    Consolidated total
    
    $
    426
    
    
    $
    6
    
    
    $
    247
    
    
    $
    16
    
    
    $
    141
    
    
    $
    12
 Year ended March 31,2003
    
    
    2004
    
    
    2005Depreciation
    
    
    
    
    
    
    
    
    
    
    Depreciation
    
    
    
    
    
    
    
    
    
    
    DepreciationIdentifiable
    
    
    Capital
    
    
    and
    
    
    Identifiable
    
    
    Capital
    
    
    and
    
    
    Identifiable
    
    
    Capital
    
    
    andassets
    
    
    expenditure
    
    
    amortization
    
    
    assets
    
    
    expenditure
    
    
    amortization
    
    
    assets
    
    
    expenditure
    
    
    amortizationSegment:Injection molded plastic
parts
    
    $
    80,335
    
    
    $
    8,868
    
    
    $
    3,082
    
    
    $
    83,391
    
    
    $
    14,285
    
    
    $
    2,992
    
    
    $
    94,707
    
    
    $
    15,232
    
    
    $
    3,550Electronic products
    
    
    26,400
    
    
    
    532
    
    
    
    1,190
    
    
    
    29,182
    
    
    
    5,162
    
    
    
    949
    
    
    
    36,072
    
    
    
    1,479
    
    
    
    968Metallic parts
    
    
    4,563
    
    
    
    331
    
    
    
    420
    
    
    
    5,083
    
    
    
    414
    
    
    
    460
    
    
    
    8,628
    
    
    
    292
    
    
    
    452Segment totals
    
    $
    111,298
    
    
    $
    9,731
    
    
    $
    4,692
    
    
    $
    117,656
    
    
    $
    19,861
    
    
    $
    4,401
    
    
    $
    139,407
    
    
    $
    17,003
    
    
    $
    4,970Reconciliation to
consolidated totals:Elimination of receivables
from intersegments
    
    
    (5,604
    )
    
    
    
    
    
    
    
    
    
    
    (4,600
    )
    
    
    
    
    
    
    
    
    
    
    (2,909
    )
    
    
    
    
    
    
    Goodwill not allocated to
segments
    
    
    478
    
    
    
    
    
    
    
    
    
    
    
    478
    
    
    
    
    
    
    
    
    
    
    
    478
    
    
    
    
    
    
    
    Consolidated totals
    
    $
    106,172
    
    
    $
    9,731
    
    
    $
    4,692
    
    
    $
    113,534
    
    
    $
    19,861
    
    
    $
    4,401
    
    
    $
    136,976
    
    
    $
    17,003
    
    
    $
    4,970
 70




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##### Table of Contents



16. Segment Information  Continued The Companys sales are coordinated through the Hong Kong or Macau subsidiaries and a
breakdown of sales by destination is as follows: Year ended March 31,2003
    
    
    2004
    
    
    2005Net salesChina
    
    $
    53,503
    
    
    $
    50,095
    
    
    $
    56,311United States of America
    
    
    25,949
    
    
    
    37,359
    
    
    
    50,837Hong Kong
    
    
    2,838
    
    
    
    2,186
    
    
    
    1,001Europe
    
    
    7,435
    
    
    
    5,778
    
    
    
    13,733Others
    
    
    1,180
    
    
    
    1,777
    
    
    
    3,708Total net sales
    
    $
    90,905
    
    
    $
    97,195
    
    
    $
    125,590
 The location of the Companys identifiable assets is as follows: March 31,2003
    
    
    2004
    
    
    2005Hong Kong and Macau
    
    $
    58,579
    
    
    $
    43,660
    
    
    $
    49,626China
    
    
    47,115
    
    
    
    69,396
    
    
    
    86,872Total identifiable assets
    
    $
    105,694
    
    
    $
    113,056
    
    
    $
    136,498Goodwill
    
    
    478
    
    
    
    478
    
    
    
    478Total assets
    
    $
    106,172
    
    
    $
    113,534
    
    
    $
    136,976
 71




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##### Table of Contents



ITEM 19. EXHIBITS The following documents are filed as exhibits herewith: Exhibit No.
    
    Description1.1
    
    Memorandum and Articles of Association (as amended through March 7, 1995) (incorporated by
reference to Exhibit 3.1 to Deswells Registration Statement on Form F-1 filed with the SEC
on June 19, 1995).1.2
    
    Amendment to Memorandum and Articles of Association filed with BVI Registry of Companies on
July 19, 1995 (incorporated by reference to Exhibit 1.2 to Deswells Annual Report on Form
20-F for the year ended March 31, 2001 filed with the SEC on July 10, 2001).1.3
    
    Notice of amendment of Memorandum and Articles of Association, with Certified Extract of a
Resolution Adopted by the Directors Pursuant to the Articles of Association of the Company
on the 8th day of July 2002 (incorporated by reference to Exhibit 1.3 to Deswells Form 8A/A
(Amendment No. 1) filed with the SEC on August 14, 2002).1.4
    
    Notice of amendment of Memorandum and Articles of Association (Amendment No. 2), with
Notice of Increase in Authorised Capital and Certified Extract of a Resolution Adopted by
the Directors Pursuant to the Articles of Association of the Company on the 8th day of July
2002 (incorporated by reference to Exhibit 1.4 to Deswells Form 8A/A (Amendment No. 2)
filed with the SEC on August 14, 2002)2.1
    
    Form of common share certificate (incorporated by reference to Exhibit 4.1 of Amendment No.
1 to Deswells Registration Statement on Form F-1 filed with the SEC on July 13, 1995).4.1
    
    Facility letter dated April 13, 2005 between The Hongkong & Shanghai Banking Corporation
Limited, Macao Branch (HSBC) and Jetcrown Industrial (Macao Commercial Offshore Limited
(JIMCO).4.2
    
    Facility letter dated February 23, 2004 between Fortis Bank Asia HK and Kwanasia Electronics
Company Limited (incorporated by reference to Exhibit 4.3 of registrants Form 20-F for the
year ended March 31, 2004, filed with the SEC on July 16, 2004).4.3
    
    Tenancy Agreement dated April 29, 2005 between Shekou Yu Yi Shareholding Co. Ltd. and
Jetcrown Industrial (Shenzhen) Limited for the 1st and 2nd Floor, Block A, Wing Village
Industrial Estate, Shekou, Shenzhen.4.4
    
    Tenancy Agreement dated December 30, 2004 between Shenzhen Shekou Real Property Company
(Lessor) and Jetcrown Industrial (Shenzhen) Limited (Lessee) for Room 201-203, 205-208,
210-214, 305, 307-310, 402, 403, 405, 407, 409, 414, 502-504, 506-507, 510, 513-516, 601,
604-607, 609-614, 701-716, Block C1, New Wing Village, Shekou.4.5
    
    Tenancy Agreement dated December 28, 2004 between Shenzhen Shekou Real Property Company
(Lessor) and Jetcrown Industrial (Shenzhen) Limited (Lessee) for 1/F-7/F, Block 13, Nanshui
Siu Village, Room 201, 202-204, 206, 409 of Block 9, NanShui Siu Village, Shekou4.6
    
    Stock Purchase Agreement between the Company and Microwpower Enterprises Ltd. dated April
20, 20054.7
    
    Joint Venture Corporation Supplemental Agreement Four, between Donnguan
Cheung On Lan Hong Electronics Development Company, Integrated International Limited and
Kwanasia Electronics Company Limited dated March 10, 20044.8
    
    Joint Venture Corporation Supplemental Agreement Five between Dongguan Hong Xin Electronics
Company Limited, Integrated International Limited and Dongguan Cheung On Lan Hong
Electronics Development Limited dated May 17, 20044.9
    
    Co-operation Agreement dated: July 1, 2004 between Kwan Hong Electronics Company Limited and
Dongguan Hong Xin Electronics Company Limited4.10
    
    2001 Stock Option Plan (incorporated by reference to Exhibit A to the Companys Proxy
Statement for its 2001 Annual Meeting of Stockholders filed with the SEC under cover of Form
6-K on December 12, 2001.)
 72




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##### Table of Contents



Exhibit No.
    
    Description4.11
    
    2003 Stock Option Plan (incorporated by reference to Exhibit A to the Companys Proxy
Statement for its 2003 Annual Meeting of Stockholders submitted to the SEC under cover of
Form 6-K on September 15, 2003.)8.1
    
    Diagram of the Companys operating subsidiaries and affiliates  (see page 14 of this report)11.1
    
    Code of Ethics (incorporated by reference to Exhibit 11.1 of registrants Form 20-F for the
year ended March 31, 2004, filed with the SEC on July 16, 2004)12.1
    
    Certification of Chief Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) under
the Securities Exchange Act of 193412.2
    
    Certification of Chief Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) under
the Securities Exchange Act of 193413.1
    
    Certification Pursuant To 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act Of 200214.1
    
    Consent of BDO International to incorporation of its report on the Companys consolidated
financial statements into Registrants Registration Statements on Form S-8.
 73




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SIGNATURES Pursuant to the requirements of Section 12 of the Securities Exchange Act of 1934, the
registrant certifies that it meets all of the requirements for filing on Form 20-F and has duly
caused this annual report to be signed on its behalf by the undersigned thereunto duly authorized. DESWELL INDUSTRIES, INC.Date: July 8, 2005
    
    By:
    
    /s/ Richard LauRichard LauChairman of the Board and
Chief Executive Office
 74