##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION    FORM 20-F [  ]
    
    Registration Statement Pursuant to Section 12(b) or (g) of the Securities Exchange Act of 1934
 OR [X]
    
    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, 2004
    
    0-26448
   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: NONE As of March 31, 2004, there were 9,149,085 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 [X]  No [  ] Indicate by check mark which financial statement item the registrant has
elected to follow: Item 17 [  ]
Item 18 [X]




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TABLE OF CONTENTS Financial Statements and Currency Presentation
    
    
    2PART IItem 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
    
    
    22Item 6.
    
    Directors, Senior Management and Employees
    
    
    31Item 7.
    
    Major Shareholders and Related Party Transactions
    
    
    34Item 8.
    
    Financial Information
    
    
    37Item 9.
    
    The Offer and Listing
    
    
    38Item 10.
    
    Additional Information
    
    
    39Item 11.
    
    Quantitative and Qualitative Disclosure about Market Risk
    
    
    51Item 12.
    
    Description of Securities Other than Equity Securities
    
    
    51PART IIItem 13.
    
    Defaults, Dividend Arrearages and Delinquencies
    
    
    52Item 14.
    
    Material Modifications to the Rights of Security Holders and Use of Proceeds
    
    
    52Item 15
    
    Controls and Procedures
    
    
    52Item 16A
    
    Audit Committee Financial Expert
    
    
    52Item 16B
    
    Code of Ethics
    
    
    52Item 16C
    
    Principal Accountant Fees and Services
    
    
    52Item 16D
    
    Exemptions for the Listing Standards for Audit Committee
    
    
    53Item 16E
    
    Purchases of Equity Securities by the Issuer and Affiliated Purchasers
    
    
    53PART IIIItem 17.
    
    Financial Statements
    
    
    53Item 18
    
    Financial Statements
    
    
    54Item 19
    
    Exhibits
    
    
    55SIGNATURES
    
    
    
    
    57Exhibit 4.1Exhibit 4.3Exhibit 4.11Exhibit 4.12Exhibit 4.13Exhibit 11.1Exhibit 12.1Exhibit 12.2Exhibit 13.1Exhibit 14.1Exhibit 14.2
 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 publicly 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. 
 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 Independent
Auditors Report 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, 2004, and the balance
sheet data as of March 31, 2003 and 2004 are derived from our audited
consolidated financial statements included in this Report. The selected income
statement data for the years ended March 31, 2000 and 2001, and the balance
sheet data as of March 31, 2000, 2001 and 2002 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 31,2000
    
    2001
    
    2002
    
    2003
    
    2004Income Statement DataNet sales
    
    $
    60,958
    
    
    $
    80,847
    
    
    $
    83,320
    
    
    $
    90,905
    
    
    $
    97,195Cost of sales
    
    
    38,262
    
    
    
    52,596
    
    
    
    54,448
    
    
    
    61,006
    
    
    
    66,105Gross profit
    
    
    22,696
    
    
    
    28,251
    
    
    
    28,872
    
    
    
    29,899
    
    
    
    31,090Selling, general and administrative expenses
    
    
    11,970
    
    
    
    15,414
    
    
    
    14,939
    
    
    
    15,354
    
    
    
    14,718Operating income
    
    
    10,726
    
    
    
    12,837
    
    
    
    13,933
    
    
    
    14,545
    
    
    
    16,372Interest expense
    
    
    (3
    )
    
    
    (6
    )
    
    
    (26
    )
    
    
    (6
    )
    
    
    (16
    )Other income, net
    
    
    898
    
    
    
    915
    
    
    
    877
    
    
    
    818
    
    
    
    910Income before income taxes
    
    
    11,621
    
    
    
    13,746
    
    
    
    14,784
    
    
    
    15,357
    
    
    
    17,266Income taxes
    
    
    890
    
    
    
    315
    
    
    
    535
    
    
    
    3,826
    
    
    
    589Income before minority interests
    
    
    10,731
    
    
    
    13,431
    
    
    
    14,249
    
    
    
    11,531
    
    
    
    16,677Minority interests
    
    
    433
    
    
    
    621
    
    
    
    925
    
    
    
    1,288
    
    
    
    1,957Net income
    
    $
    10,298
    
    
    $
    12,810
    
    
    $
    13,324
    
    
    $
    10,243
    
    
    
    14,720Basic earnings per share (2)(3)
    
    $
    1.27
    
    
    $
    1.59
    
    
    $
    1.59
    
    
    $
    1.18
    
    
    $
    1.62Average number of shares outstandingbasic (2)(3)
    
    
    8,118
    
    
    
    8,064
    
    
    
    8,403
    
    
    
    8,672
    
    
    
    9,109Diluted earnings per share (3)
    
    $
    1.26
    
    
    $
    1.57
    
    
    $
    1.57
    
    
    $
    1.16
    
    
    $
    1.56Average number of shares outstandingdiluted (2)(3)
    
    
    8,174
    
    
    
    8,153
    
    
    
    8,466
    
    
    
    8,852
    
    
    
    9,440Statistical Data:Gross margin
    
    
    37.2
    %
    
    
    34.9
    %
    
    
    34.7
    %
    
    
    32.9
    %
    
    
    32.0
    %Operating margin
    
    
    17.6
    %
    
    
    15.9
    %
    
    
    16.7
    %
    
    
    16.0
    %
    
    
    16.8
    %Dividends per share (3)
    
    $
    0.59
    
    
    $
    0.59
    
    
    $
    0.86
    
    
    $
    0.77
    
    
    $
    0.94
 At March 31,2000
    
    2001
    
    2002
    
    2003
    
    2004Balance Sheet DataWorking capital
    
    $
    44,727
    
    
    $
    47,356
    
    
    $
    54,922
    
    
    $
    58,223
    
    
    $
    52,876Total assets
    
    
    71,841
    
    
    
    83,466
    
    
    
    94,744
    
    
    
    106,172
    
    
    
    113,534Long-term debt, less current portion
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total debt
    
    
    
    
    
    
    
    
    
    
    482
    
    
    
    
    
    
    
    Shareholders equity
    
    
    53,031
    
    
    
    63,877
    
    
    
    69,651
    
    
    
    81,846
    
    
    
    89,730
   (1)
    
    Our consolidated financial statements are prepared in accordance with
generally accepted accounting principles in the United States of America
and are stated in U.S. dollars. See Financial Statements and Currency
Presentation.(2)
    
    Basic EPS excludes dilution from potential common shares and is computed
by dividing income available to common shareholders by the
weighted-average number of common shares outstanding for the period.
Diluted EPS reflects the potential dilution from potential common shares.(3)
    
    Share and per share amounts presented above have been adjusted to reflect
the three-for-two stock split effected in July 2002 (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 and Hong Kong. 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 tenancy agreements under which we
operate our factories. We operate our factories under tenancy agreements with the local Chinese
government. These tenancy 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 tenancy 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. 4




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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, 2004, we maintained fire, casualty and theft
insurance aggregating approximately $39,576,000 covering certain of 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 have been afforded a number of tax
concessions by the Chinese taxing authorities and have avoided paying taxes on
a substantial portion of our operations in China by reinvesting all or part of
the profits attributable to our Chinese plastic manufacturing subsidiary for at
least five years. However, the Chinese tax system is subject to substantial
uncertainties with respect to its interpretation and enforcement. Currently,
under the Chinese tax system we can obtain tax breaks by reinvesting profits of
certain of our subsidiaries in China. We reinvested a portion of our profits of
$4,000,000, from our Chinese plastic manufacturing subsidiary for the year
ended December 31, 2001 and, we are subject to taxes of 7.5% on these
operations for the remaining profits for tax year ended December 31, 2001. For
the tax years commencing January 1, 2002, 2003 and 2004, the Company is subject
to taxes of 10%, 10% and 15% respectively, on these operations and has made a
provision for taxes for the 2002, 2003 and 2004 tax years on its financial
statements at and for the years ended March 31, 2003 and 2004, respectively.
Following the Chinese governments program of privatizing many state owned
enterprises, 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. 5




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Changes in currency rates involving the Hong Kong dollar or Chinese yuan
could increase our expenses or cause economic or political problems affecting
our business. Our sales are predominately denominated in Hong Kong dollars. 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. 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 yuan relative to the U.S. dollar would
increase our expenses when translated to US dollars. A devaluation of the Hong
Kong dollar or yuan relative to the U.S. dollar would be likely to reduce our
expenses when translated to US dollars. However, any benefits we receive from
devaluation could be offset if the devaluation results in inflation or
political unrest. 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 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 accounting and logistic support office is
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 closures to some of our offices 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. Political and economic instability of Hong Kong and Macao could harm our
operations. In August 2003, we set up a new administration and accounting office in
Macao, formerly a Portuguese Colony and in December 2003 closed our office in
Hong Kong, formerly a British Crown Colony. Some of our customers and
suppliers remain in Hong Kong. Sovereignty over Hong Kong and Macao were
transferred to China effective on July 1, 1997 and December 20, 1999,
respectively. Since their transfers, Hong Kong and Macao 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 Hong Kong and Macao. Under 6




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the principle of one country, two systems, Hong Kong and Macao maintain
legal systems that are different from that of China. Hong Kongs legal system
is based on the Basic Law of the Hong Kong Special Administrative Region and,
similarly, Macaos legal system is based on the Basic Law of the Macao 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 recent accession to the World Trade Organization (introducing a market
liberalization in China) will be diminished. The continued stability of
political, economic or commercial conditions in Hong Kong and Macao remain
uncertain, and any instability could have an adverse impact on our business. 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,
2004 were Digidesign Inc., VTech Telecommunications Limited, Epson Precision
(H.K.) Limited and, Inter-Tel Incorporated. Each of these customers
individually accounted for 10% or more of our total net sales during the year
ended March 31, 2004 and accounted for an aggregate of 49.1%, 60.4% and 61.1%,
respectively, of our total net sales during the years ended March 31, 2002,
2003 and 2004, 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, 2002, 2003 and 2004: Year ended March 31,2002
    
    2003
    
    2004Resins cost as a % of plastic products sold
    
    
    52
    %
    
    
    53
    %
    
    
    52
    %Resins cost as a % of total cost of goods sold
    
    
    25
    %
    
    
    25
    %
    
    
    25
    %
 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. 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:  
    
    2.7%, from 32.9% during the year ended March 31, 2003, to 32.0%
during the year ended March 31, 2004,
    
    5.2%, from 34.7% during the year ended March 31, 2002, to 32.9%
during the year ended March 31, 2003, and
    
    0.6%, from 34.9% during the year ended March 31, 2001 to 34.7%
during the year ended March 31, 2002. 7




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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, 2004, approximately
61% 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 our day-to-day 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 our day-to-day administrative
and marketing operations for electronic products;
    
    M. C. Tam, our Director of Engineering and
Manufacturing, in charge of manufacturing and operations for
electronic products; and
    
    Dickson Lam, our Director of Marketing for plastic and
electronic 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 8




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continue to manage it since we acquired control of the business from them. Mr.
Dickson Lam has developed and maintains several key relationships with our key
customers in our electronic and plastic injection products manufacturing
business. 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 37.4% our shares at June
30, 2004. 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. 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. Our boards
ability to amend our charter documents 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. 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. 9




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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, a Hong Kong limited liability company (Jetcrown), in February 1987.
Richard Lau, C. P. Li and C. W. Leung founded Jetcrown to manufacture
injection-molded plastic parts for OEMs and contract manufacturers. Jetcrown 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 Jetcrown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 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 Company Registry in March 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. 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, 10




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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 Jetcrown,
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 Jetcrown 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. The immediate effect of this
restructuring was that the Company wholly owned Jetcrown, 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 for tax purposes, 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 Western 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 another minority shareholder. 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. 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 fine-tuning for tax purposes, 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, 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. 11




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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 Company 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. 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 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 2003, the Company 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, the Company organized Ideatop Holdings Limited
(Ideatop), a British Virgin Islands International Business Company to hold
the beneficial ownership of Jetcrown Industrial (Shenzhen) Limited. The
registration with the Chinese Government was approved in December 2003. 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. 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. For a chart showing the Companys organizational structure at March 31,
2004 (which excludes companies that were dormant at, or sold prior to, that
date), see Organizational Structure, below. Capital Expenditures Principal capital expenditures and divestitures made by Deswell during the
three years in the period ended March 31, 2004 include the following: 2002
    
    2003
    
    2004Purchase of property, plant and equipment
    
    $
    4,397,000
    
    
    $
    9,731,000
    
    
    $
    19,862,000Proceeds from the sale of property, plant and equipment
    
    
    276,000
    
    
    
    127,000
    
    
    
    430,000
 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. 12




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Through March 31, 2004, Deswell spent an aggregate of approximately $12
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 $12 million was used to
expand the Companys injection molding and tool-making capacity through the
purchase of additional injection molding and tooling machinery. Following completion of space built through Phase I, we estimate spending
an aggregate of approximately $6 million for the second phase of construction,
which will comprise an additional two factory building units covering
approximately 220,000 square feet and three additional dormitory units of
approximately 195,000 square feet. Phase III of construction, with a planned
investment of $10 million, will consist of an approximate 110,000 square foot
office building, an additional 370,000 square feet of factory space and one
additional dormitory unit of 95,000 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. 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. 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 13




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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, 2002,
2003 and 2004, 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. Operations Plastic Injection Molding Plastic injection molding manufacturing accounted for 57.0%, 54.9% and
54.6% of the Companys total sales during the years ended March 31, 2002, 2003
and 2004, respectively. At March 31, 2004, the Company conducted its plastic
manufacturing operations in approximately 401,000 and 520,000 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 14




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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, 2004, the Company used 26 EDMs (electrical
discharge machines), 25 CNC (computer numerical control) milling machines and
78 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 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. 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. During the year ended March 31, 2004, 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. 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, 2004, the Company had 356 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, 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 15




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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, 2004 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, 2002, 2003 and 2004, manufacturing of electronic products
accounted for approximately 40.4%, 42.0% and 41.2%, respectively, of the
Companys total sales. During the same periods, manufacturing of finished
products accounted for 96%, 97% 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 the other components onto the PCBs.
Completed PCBs are checked by in-circuit-testers before delivery. 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 method of assembling printed circuit boards in which components
are fixed 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, the components are then placed onto the
solder paste and heated to the point of melting the paste (a process called
reflow) to establish a strong solder joint. The SMT process allows for more
miniaturization, cost savings and shorter 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 in the miniaturization process. Manufacturing operations include PCB assembly and testing and, in those
cases where finished products are to be provided, assembly into final product
housing. While the Company has automated various aspects of the many
processes, the assembly of components into electronic products remains a
labor-intensive process generally requiring a high degree of precision and
dexterity in the assembly stage and multiple quality control checks prior to
shipment. The Company utilizes specially designed equipment and techniques to
maintain its ability to assemble efficiently a wide variety of electronic
products and assemblies. Metal Parts Manufacturing In an aggregate of approximately 117,000 square feet of factory space at
March 31, 2004 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 2.6%, 3.1%
and 4.2% of Deswells total sales during the years ended March 31, 2002, 2003
and 2004, respectively. 16




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##### Table of Contents



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 assembly stage, the Company randomly
checks finished products. 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, 2002, 2003 and 2004. In 1995, the Company earned ISO 9002 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 9002 is the
ISO level appropriate for manufacturers like the Company. The Companys receipt
of ISO 9002 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. 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 is working toward having its plastic injection manufacturing
plant obtain QS-9000 qualifications. QS-9000 is an internationally recognized
set of quality system requirements for the automotive industry, in which
industry leaders such as Chrysler, Ford and General Motors set out their
fundamental quality system expectations for internal and external suppliers of
production and service parts and materials. The Company is on course to
achieve QS-9000 certification by mid-2005. 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, 2002,
2003 and 2004 averaged approximately 52%, 53% and 52%, respectively, of the
Companys cost of plastic products sold and 25%, 25% and 25%, 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 14,720,000 pounds of plastic resins during
the year ended March 31, 2004 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. 17




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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,
2002, 2003 and 2004. 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. 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, 2002, 2003 and 2004. Net sales as a
percentage of total sales to customers by geographic area consisted of the
following for the years ended March 31, 2002, 2003 and 2004: Geographic areas
    
    2002
    
    2003
    
    2004China
    
    
    56.3
    %
    
    
    58.9
    %
    
    
    51.6
    %United States
    
    
    23.2
    
    
    
    28.5
    
    
    
    38.4Europe
    
    
    4.9
    
    
    
    8.2
    
    
    
    5.9Hong Kong
    
    
    14.0
    
    
    
    3.1
    
    
    
    2.3Others
    
    
    1.6
    
    
    
    1.3
    
    
    
    1.8Total
    
    
    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, 18




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##### Table of Contents



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, 2004 the products
purchased and the percentage of total Company net sales accounted for by such
customers during the years ended March 31, 2002, 2003 and 2004. Year ended March 31,Customer
    
    Product
    
    2002
    
    2003
    
    2004Digidesign, Inc.
    
    Professional audio equipments
    
    
    *
    
    
    
    13.5
    %
    
    
    17.8
    %VTech Telecommunications Limited
    
    Telephones and organizers
    
    
    15.3
    %
    
    
    11.6
    %
    
    
    17.6
    %Epson Precision (H.K.) Limited
    
    Plastic components
    
    
    17.5
    %
    
    
    22.3
    %
    
    
    15.4
    %Inter-Tel Incorporated
    
    Telephones
    
    
    11.6
    %
    
    
    13.0
    %
    
    
    10.3
    %
   *
    
    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. 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. 19




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##### Table of Contents



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. Organizational Structure The chart below illustrates the organizational structure of the Company
and its active subsidiaries at March 31, 2004. (FLOW CHART) 20




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Property, Plants and Equipment Macao The Company leases Unit 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 administrative and accounting
office for the Company and for its marketing office respectively. The monthly
rent is approximately $2,000. Hong Kong The Company disposed the previously owned Unit 516-517, Hong Leong
Industrial Complex, No. 4 Wang Kwong Road, Kowloon Bay, Kowloon, Hong Kong to
an unaffiliated party in December 2003. The premises were previously used for
accounting and logistic support of its plastic injection molding operations in
China. 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. The Company leases from an unaffiliated party Unit 605, Hong Leong
Industrial Complex, No. 4 Wang Kwong Road, Kowloon Bay, Kowloon, Hong Kong for
use as a support office for its electronic and metal operations. The lease
expires in July 2004. 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, 2004 the Company leased approximately 288,000 square feet of
manufacturing space at Block A, 1/F-2/F, Block B, 1/F-3/F, Block D, 1/F-5/F,
Block F, 1/F-5/F, and Block H, G/F and 2/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 April 2004 to
December 2007. The aggregate monthly rent is approximately $63,100. 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. As at March 31, 2004, there were 440,000 square feet of factory
space, 85,000 square feet of amenity space and 95,000 square feet of dormitory
built and operational. At March 31, 2004, the Company also leased
approximately 58,100 square feet of manufacturing space and 22,400 square feet
of ancillary dormitory space at Huangguan Industrial Estate, Houjie Town,
Dongguan, Shenzhen, China, which are used for its plastic injection molding
operations. The premises are leased from a third party expiring in July 2004.
The aggregate monthly rental is approximately $8,100. The Company leases space at various locations near its plastics
manufacturing factories in Shekou and Dongguan that it uses as dormitories for
factory workers. Management estimates that the space leased for dormitories
approximated 76,900 square feet and 27,100 square feet at March 31, 2004 in
Shekou and Dongguan, respectively. The facilities are leased for period of one
year, expiring from May 2004 to December 2004. The aggregate monthly rental is
approximately $15,900. 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 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 21




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##### Table of Contents



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, 2004, 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
$7,800. In addition, the Company leases approximately 28,200 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 2004 to December 2005. The aggregate monthly rental is
approximately $5,100. 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. The Company believes that its existing offices and manufacturing space,
together with 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. 
 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. Jetcrown (a wholly owned
subsidiary) carries 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. Integrated acquired a 64.9% interest in Kwanta in October 1996 and
the Company has included the results of Kwanta in its consolidated financial
statements since the date of acquisition. In April and July 1999, Integrated
acquired the remaining 35.1% interest in Kwanta. 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. 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. 22




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##### Table of Contents



The Companys earnings have benefited from favorable overall effective
income tax rates of 3.6%, 24.9% and 3.4 % for the years ended March 31, 2002,
2003 and 2004, 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, 2002, see the
discussion under Year ended March 31, 2003 Compared to Year Ended March 31,
2002, 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. Deswell reinvested
a portion of our profits of $4,000,000, from its Chinese plastic manufacturing
subsidiary for the year ended December 31, 2001 and was subject to taxes of
7.5% on these operations for the remaining profits for tax year ended December
31, 2001. For the tax years commencing January 1, 2002, 2003 and 2004, the
Company is subject to taxes of 10%, 10% and 15% respectively, on these
operations and has made provision for taxes for the 2002, 2003 and 2004 tax
years on its financial statements at and for the years ended March 31, 2003 and
2004. Certain of the Companys income accrue in tax-free jurisdictions and are
not subject to any income taxes. See Note 8 of Notes to consolidated financial
statements for a further description of income taxes. 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 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 &
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, 2004. Year ended March 31, 2002
    
    Year ended March 31, 2003
    
    Year ended March 31, 2004Plastic
    
    
    
    
    
    
    
    
    
    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
    
    
    55.2
    
    
    
    78.8
    
    
    
    65.3
    
    
    
    57.0
    
    
    
    79.4
    
    
    
    67.1
    
    
    
    60.4
    
    
    
    77.2
    
    
    
    68.0Gross profit
    
    
    44.8
    
    
    
    21.2
    
    
    
    34.7
    
    
    
    43.0
    
    
    
    20.6
    
    
    
    32.9
    
    
    
    39.6
    
    
    
    22.8
    
    
    
    32.0Selling, general and
administrative expenses
    
    
    18.8
    
    
    
    16.8
    
    
    
    18.0
    
    
    
    19.1
    
    
    
    14.1
    
    
    
    16.9
    
    
    
    18.5
    
    
    
    11.1
    
    
    
    15.2Operating income
    
    
    26.0
    
    
    
    4.4
    
    
    
    16.7
    
    
    
    23.9
    
    
    
    6.5
    
    
    
    16.0
    
    
    
    21.1
    
    
    
    11.7
    
    
    
    16.8Interest expense
    
    
    
    
    
    
    (0.1
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other income, net
    
    
    1.4
    
    
    
    0.7
    
    
    
    1.1
    
    
    
    1.6
    
    
    
    
    
    
    
    0.9
    
    
    
    1.0
    
    
    
    0.9
    
    
    
    0.9Income before income taxes
and minority interst
    
    
    27.4
    
    
    
    5.0
    
    
    
    17.7
    
    
    
    25.5
    
    
    
    6.5
    
    
    
    16.9
    
    
    
    22.1
    
    
    
    12.6
    
    
    
    17.8Income taxes
    
    
    0.9
    
    
    
    0.3
    
    
    
    0.6
    
    
    
    4.1
    
    
    
    4.3
    
    
    
    4.2
    
    
    
    0.5
    
    
    
    0.8
    
    
    
    0.6Income before
minority interests
    
    
    26.5
    
    
    
    4.7
    
    
    
    17.1
    
    
    
    21.4
    
    
    
    2.2
    
    
    
    12.7
    
    
    
    21.6
    
    
    
    11.8
    
    
    
    17.2Minority interests
    
    
    0.2
    
    
    
    2.3
    
    
    
    1.1
    
    
    
    0.8
    
    
    
    2.1
    
    
    
    1.4
    
    
    
    0.9
    
    
    
    3.4
    
    
    
    2.0Net income
    
    
    26.3
    %
    
    
    2.4
    %
    
    
    16.0
    %
    
    
    20.6
    %
    
    
    0.1
    %
    
    
    11.3
    %
    
    
    20.7
    %
    
    
    8.4
    %
    
    
    15.1
    %
 23




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##### Table of Contents



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 Inc., Vtech Telecommunications Ltd.
(VTech), Epson Precision (H.K.) Ltd. (Epson), and Inter-Tel Incorporated
(Inter-Tel), the Companys four largest customers during the year ended March
31, 2004, represented approximately 61.1% of net sales for the year. See Item
4. Information on the Company  Major Customers. 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 & 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. 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 & 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 & 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 24




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##### Table of Contents



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 & 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 & 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 & 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 &
metallic segment, the dollar amount of 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. 25




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##### Table of Contents



Net income for the electronic & 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 & 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. Year ended March 31, 2003 Compared to Year Ended March 31, 2002 Net Sales.The Companys net sales for the year ended March 31, 2003 were
$90,905,000, an increase of $7,585,000 or 9.1% as compared to year ended March
31, 2002. Sales to Inter-Tel , Kyocera Mita Industrial Co. (H.K.) Ltd.
(Mita), VTech , Epson and Digidesign, Inc., the Companys five largest
customers during the year ended March 31, 2003, represented approximately 71.3%
of net sales for the year. The increase in sales during the year ended March 31, 2003 was mainly
related to the increase in sales of plastic segment of $2,403,000 and the
increase in sales of electronic and metallic segment of $5,182,000. This
represented an increase of 5.1% and 14.5%, respectively, as compared with
respective net sales from these segments in the prior year. The increase in
net sales in both segments was mainly due to an increase in orders from
existing customers, together with orders from new customers. 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, 2003, sales to China, the United States and Europe and
increased by $6,627,000, $6,574,000 and $3,382,000, respectively, and sales to
Hong Kong and other areas decreased by $8,852,000 and $145,000, respectively,
over levels for the year ended March 31, 2002. Gross Profit.The gross profit for the year ended March 31, 2003 was
$29,899,000, representing a gross profit margin of 32.9%. This compares with
the overall gross profit and gross profit margin of $28,872,000 or 34.7% for
the year ended March 31, 2002. The slight decrease in gross profit margin
primarily relates to the mix of products sold. Gross profit in the plastic segment increased by 0.9%, to $21,463,000 or
43.0% of net sales, for fiscal year ended March 31, 2003 compared to
$21,280,000 or 44.8% of net sales, for fiscal 2002. Gross profit in the electronic & metallic segment increased by 11.1%, to
$8,436,000 or 20.6% of net sales, for fiscal year ended March 31, 2003 compared
to $7,592,000 or 21.2% of net sales, for fiscal 2002. The increase was
primarily attributed to the increase in net sales, despite the slight decrease
in gross profit margin in both segments. Selling, general and administrative expenses.SG&A expenses for the year
ended March 31, 2003 were $15,354,000, amounting to 16.9% of total net sales,
as compared to $14,939,000 or 17.9% of total net sales for the year ended March
31, 2002. SG&A expenses in the plastic segment increased by $626,000 or 7.0%, to
$9,557,000 or 19.1% of net sales, for the year ended March 31, 2003 compared to
$8,931,000 or 18.8% of net sales, for fiscal 2002. SG&A expenses in the
electronic & metallic segment decreased by $211,000 or 3.5%, to $5,797,000 or
14.1% of net sales, for fiscal year ended March 31, 2003 compared to $6,008,000
or 16.8% of net sales, for fiscal 2002. The decrease in SG&A in electronic and
metal segment was mainly attributed to the decrease in selling expenses, which
were shifted to the plastic segment. Operating income.Operating income was $14,545,000 for the year ended
March 31, 2003, an increase of $612,000 or 4.4% as compared with the prior
year. On a segment basis, the operating income of plastic segment decreased
$443,000 to $11,906,000, or 23.9% of net sales, in fiscal 2003 compared to
$12,349,000, or 26.0% in net sales in fiscal 2002. This decrease in operating
income is attributable to the increase in SG&A expenses offsetting the increase
in gross profit described above. The operating income of electronic & metallic
segment increased $1,055,000 to $2,639,000, or 6.4% of net sales in fiscal
2003, compared to $1,584,000 or 4.4% of net sales in fiscal 2002. This
increase in operating income is attributable to the increase in gross profit
and the decrease in SG&A expenses described above. 26




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##### Table of Contents



Income Taxes. During 2003 through July 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 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. 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 has been charged to the
Companys consolidated income statements for 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 electronic & metallic segment. Income tax expense was $3,826,000 for the year ended March 31, 2003,
compared to $535,000 for the prior year. The increase was primarily the result
of the tax provision of $3,532,000, offset by a provision for a tax refund of
$322,000 resulting from the reinvestment of part of the retained earnings in
one of the Companys plastic manufacturing subsidiaries in China. Minority Interest.Minority interests represent a 29% minority interest in
Integrated International Limited, the holding company holding the capital stock
of Deswells electronics and metallic subsidiaries and a 49% minority interest
in Jetcrown & Kwanasia (OEM) Specialist Limited, 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 & metallic segment, the dollar amount of
minority interest increased to $1,288,000 for the year ended March 31, 2003,
from $925,000 for the year ended March 31, 2002, which reflects that both the
electronics and metallic subsidiaries and Deswells marketing subsidiary
generated more net income in the fiscal 2003 as compared to fiscal 2002. Net Income.Net income was $10,243,000 for the year ended March 31, 2003,
a decrease of $3,081,000 or 23.1%, as compared to the year ended March 31,
2002, and net income as a percentage of net sales decreased to 11.3% from
16.0%. The decrease in net income for fiscal 2003 was primarily the result of
the tax provision of $3.5 million made as a result of the settlement in July
2003 of the tax dispute with the IRD. Net Income for the plastic segment decreased 18.0% to $10,223,000 for
fiscal 2003 compared to $12,469,000 for fiscal 2002. The decrease in net
income of the plastic segment was mainly the result of the increase in income
taxes described above. Net Income for the electronic & metallic segment
decreased 97.7% to $20,000 for fiscal 2003 compared to $855,000 for fiscal
2002. The decrease in net income of the electronic & metallic segment was
mainly the result of the increase in income taxes and the increase in the
dollar amount of 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,
2004 (in thousands): Year ended March 31,2002
    
    2003
    
    2004Q1
    
    Q2
    
    Q3
    
    Q4
    
    Q1
    
    Q2
    
    Q3
    
    Q4
    
    Q1
    
    Q2
    
    Q3
    
    Q4Net sales
    
    $
    21,884
    
    
    $
    22,189
    
    
    $
    20,217
    
    
    $
    19,030
    
    
    $
    23,305
    
    
    $
    22,603
    
    
    $
    25,272
    
    
    $
    19,725
    
    
    $
    26,075
    
    
    $
    25,079
    
    
    $
    24,784
    
    
    $
    21,257Gross profit
    
    
    7,523
    
    
    
    7,564
    
    
    
    7,225
    
    
    
    6,560
    
    
    
    7,447
    
    
    
    7,733
    
    
    
    8,473
    
    
    
    6,246
    
    
    
    8,411
    
    
    
    7,980
    
    
    
    8,401
    
    
    
    6,298Operating income
    
    
    3,956
    
    
    
    3,806
    
    
    
    3,447
    
    
    
    2,724
    
    
    
    3,532
    
    
    
    3,665
    
    
    
    4,583
    
    
    
    2,765
    
    
    
    4,646
    
    
    
    4,511
    
    
    
    4,403
    
    
    
    2,812Net income
    
    
    3,369
    
    
    
    3,635
    
    
    
    3,430
    
    
    
    2,890
    
    
    
    3,691
    
    
    
    3,672
    
    
    
    3,787
    
    
    
    (907
    )
    
    
    4,354
    
    
    
    4,121
    
    
    
    3,535
    
    
    
    2,710
 27




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##### Table of Contents



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 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 Yuan
rates were unified, the value of the Yuan 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, 2002, 2003 and 2004. 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. The Company did not hedge its currency risk during the years ended March
31, 2002, 2003 or 2004 and at March 31, 2004, 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, 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. Accounts receivable and inventories increased by
$2,230,000 and $1,390,000, respectively, over levels at March 31, 2003,
primarily as a result of increases in sales and the general increase in
business activities. Accounts payable increased by $1,525,000 over levels at
March 31, 2003, primarily because of the increase materials purchases resulting
from the increase in net sales. For the year ended March 31, 2003, net cash
generated from operations totaled $19,842,000, including net income of
$10,243,000 and depreciation and amortization of $4,692,000. Accounts
receivable decreased by $161,000, and inventories increased by $1,559,000, over
levels at March 31, 2002, primarily as a result of better controls over
customers credit and the general increase in business activities. Accounts
payable increased by $2,060,000 over March 31, 2002, primarily because of the
increase materials purchases resulting from the increase in net sales. Net cash used in investing activities amounted to $14,078,000 and
$13,667,000 for the years ended March 31, 2004 and 2003, respectively. Capital
expenditures during these periods totaled $19,862,000 and $9,731,000,
respectively. Acquisition of marketable securities during these periods
totaled $1,056,000 and $4,061,000, 28




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##### Table of Contents



respectively. These were financed by cash generated from operations during
each year 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, 2004
and 2003 was $5,354,000 and $3,309,000, respectively. 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. Net cash used in
financing activities during the year ended March 31, 2003 was primarily to fund
the Companys dividend payments to its shareholders of $6,687,000, dividend
payments to minority shareholders of subsidiaries of $851,000 and repayment of
short-term bank borrowings of $482,000 netting off the proceeds of $4,217,000
from the exercise of stock options from directors and employees. Cash of
$495,000 was released as security for the short-term borrowing facilities
during the year ended March 31, 2003. 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 remained at 5.0% during
the year ended March 31, 2004. At March 31, 2004, the Company had cash and cash equivalents of
$30,193,000 and committed credit facilities of $10,118,000, of which none had
been used. The Company also had restricted cash of $390,000 and leasehold land
and buildings of $1,288,000, 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, purchase of plant and machinery and purchase of our
Dongguan electronic & metallic manufacturing plant of $2,449,000 as of March
31, 2004. The Company expects that internally generated funds will be
sufficient to satisfy its cash needs for at least the next 12 months. The
Company funded the payment of its tax settlement with the IRD discussed in
Operating Results  Year ended March 31, 2003 Compared to Year Ended March 31,
2002, above with cash on hand. A summary of our contractual obligations and commercial commitments as of March
31, 2004 is as follows: (In thousands)Year ending March 31,2010 andContractual obligation
    
    2005
    
    2006
    
    2007
    
    2008
    
    2009
    
    thereafterLong-term bank borrowing
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Capital (finance) lease obligations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Operating lease payments
    
    
    915
    
    
    
    600
    
    
    
    450
    
    
    
    272
    
    
    
    
    
    
    
    Capital expenditures
    
    
    2,449
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Purchase obligations
    
    
    9,969
    
    
    
    32
    
    
    
    11
    
    
    
    15
    
    
    
    1
    
    
    
    Other long-term liabilities
    
    
    
    
    
    
    
    
    

    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    13,333
    
    
    $
    632
    
    
    $
    461
    
    
    $
    287
    
    
    $
    1
    
    
    $
    
 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. 29




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##### Table of Contents



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 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 May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity
(SFAS 150). SFAS 150 established standards for how an issuer classifies and
measures certain financial instruments with characteristics of both liabilities
and equity. This statement is effective for financial instruments entered into
or modified after May 31, 2003 and otherwise is effective at the beginning of
the first interim period beginning after June 15, 2003. The Companys adoption
of this interpretation is not expected to have an effect on its consolidated
financial statements. In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133
on Derivative Instruments and Hedging Activities that amends and clarifies
accounting for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities under Statement 133.
With certain exceptions, SFAS No. 149 is effective for contracts entered into
or modified after June 30, 2003, and for hedging relationships designed after
June 30, 2003. Management does not expect the adoption of this standard to have
a material impact on the Companys financial position or results of operations. In November 2002, the FASB issued FASB Interpretation No. 45, Guarantors
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others (FIN 45). FIN 45 requires a guarantor to
recognize, at the inception of a qualified guarantee, a liability for fair
value of the obligation undertaken in issuing the guarantee. FIN 45 is
effective on a prospective basis for qualified guarantees issued or modified
after December 31, 2002. Management does not expect the adoption of this
Interpretation to have a material impact on the Companys financial position or
results of operations. In January 2003, the FASB issued FASB Interpretation No. 46,
Consolidation of Variable Interest Entities (FIN 46). FIN 46 explains how to
identify variable interest entities and how an enterprise assesses its interest
in a variable interest entity to decide whether to consolidate that entity.
This Interpretation requires existing 30




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unconsolidated variable interest entities to be consolidated by their primary
beneficiaries if the entities do not effectively disperse risks among parties
involved. FIN 46 is effective immediately for variable interest entities
created after January 31, 2003, and to variable interest entities in which an
enterprise obtains an interest after that date. Management does not expect the
adoption of this Interpretation to have a material impact on the Companys
financial position or results of operation. In December 2003, the FASB issued Interpretation No. 46R, a revision to
Interpretation No. 46, Consolidation of Variable Interest Entities, which
addresses how a business enterprise should evaluate whether it has a
controlling financial interest in an entity through means other than voting
rights and accordingly should consolidate the entity. Interpretation No. 46R
clarifies some of the provisions of Interpretation No. 46 and exempts certain
entities from its requirements. Interpretation No. 46R is effective at the end
of the first interim period ending March 15, 2004. Management does note expect
the adoption of this statement to have a material impact on the Companys
financial position or results of operations. 
 ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES Directors and Senior Management The directors and executive officers of the Company at June 30, 2004 are
as follows: Name
    
    Age
    
    Position(s) with CompanyLau Pui Hon (Richard Lau)
    
    
    59
    
    
    Chief Executive Officer and Chairman of the
Board of DirectorsLi Chin Pang (C. P. Li)
    
    
    58
    
    
    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)
    
    
    49
    
    
    Executive Director of Engineering for Plastic
Operations and Member of the Board of DirectorsLee Shu Kwan (S. K. Lee)
    
    
    58
    
    
    Director of Administration and Marketing for
Electronic OperationsTam Man Chi (M. C. Tam)
    
    
    54
    
    
    Director of Engineering and Manufacturing for
Electronic OperationsDickson Lam
    
    
    62
    
    
    Director of Marketing for Plastic and
Electronics OperationsEliza Y. P. Pang
    
    
    42
    
    
    Financial ControllerHung-Hum Leung
    
    
    58
    
    
    Member of Board of Directors and Audit CommitteeAllen Yau-Nam Cham
    
    
    57
    
    
    Member of Board of Directors and Audit Committee
 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. 31




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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. Dickson Lam. Mr. Lam has served as the Companys Director of Marketing
since April 1990 and assumed the title of Director of Marketing for Plastic and
Electronic Operations in August 2001. 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
Association of Chartered Certified 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. 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 (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. 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, 2004 to all
directors and officers as a group for services in all capacities was
approximately $2,605,000. This excludes amounts paid by the Company to
shareholders as dividends during the year ended March 31, 2004. 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, respectively, and are reimbursed for all reasonable expenses incurred
in connection with services as a director. 32




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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 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 and Allen Yau-Nam Cham. Although the Company does not currently have a compensation or
remuneration committee or a nominating committee, Deswell plans to create them
in time to comply with the rules of the Nasdaq Stock Market that are applicable
to foreign private issuers by July 31, 2005. Employees At March 31, 2004, the Company employed 4,900 persons on a full-time
basis, of which 16 were located in Macao and Hong Kong and 4,884 in China. Of
the Companys employees 3,500, 955 and 445 were engaged in plastic injection
molding manufacturing, contract electronic manufacturing and metal molds and
parts manufacturing, respectively, at March 31, 2004. 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 675,000 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 366,000
shares in the number of shares that can be optioned and sold under the Option
Plan bringing to a total of 1,041,000 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 750,000 common shares to employees, officers, directors and
consultants of the Company. On January 7, 2002 shareholders approved the 2001
plan. 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 600,000 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, 2004, options to purchase an aggregate of 2,391,000 Common
Shares had been granted under the option plans, options to purchase an
aggregate of 1,149,500 Common Shares were outstanding and no options to
purchase Common Shares were available for future grant under the option plans. 33




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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 30, 2004, 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
    
    
    2,738,117
    
    
    
    29.0
    %C. P. Li
    
    
    2,728,365
    
    
    
    28.9
    %C. W. Leung
    
    
    2,559,500
    
    
    
    27.2
    %Leesha Holdings Ltd.
    
    
    2,302,500
    
    
    
    25.2
    %Royce & Associates, Inc.(6)
    
    
    941,650
    
    
    
    10.3
    %FMR Corp./ Edward C. Johnson 3d(7)
    
    
    877,150
    
    
    
    9.6
    %Micropower Enterprises Limited
    
    
    682,500
    
    
    
    7.5
    %Wellington Management Company, LLP(8)
    
    
    590,032
    
    
    
    6.4
    %M. C. Tam
    
    
    159,940
    
    
    
    1.7
    %S. K. Lee
    
    
    155,740
    
    
    
    1.7
    %Dickson Lam
    
    
    *
    
    
    
    *Eliza Y. P. Pang
    
    
    *
    
    
    
    *Hung-Hum Leung
    
    
    *
    
    
    
    *Allen Yau-Nam Cham
    
    
    *
    
    
    
    *
   *     Less than 1%.(1)     Based on 9,149,085 Common Shares outstanding on June 30, 2004. 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 2,302,500 Common Shares held of record by Leesha, 135,617
Common Shares held of record by Mr. Lau and options to purchase 300,000 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 $14.28 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 2,302,500 Common Shares held of record by Leesha, 125,865
Common Shares held of record by Mr. Li and options to purchase 300,000 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 $14.28 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 2,302,500 Common Shares held of record by Leesha, 2,000 Common
Shares held of record by Mr. Leung and options to purchase 255,000 Common
Shares granted to Mr. Leung under the Companys stock option plans. Mr.
Leungs 34




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##### Table of Contents



options are exercisable at a weighted average exercise price of $14.80 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 2,302,500 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. 1 to a Schedule 13G filed with the SEC on April 4,
2004.(7)     Based on Amendment No. 1 to a Schedule 13G filed with the SEC on February
17, 2004.(8)     Based on a Schedule 13G filed with the SEC on February 12, 2004. The following table reflects the percentage ownership of Deswells common
shares by its major shareholders during the past three years: Percentage Ownership (1) atJune 28, 2002
    
    Aug. 28, 2003
    
    June 30, 2004Richard Lau
    
    
    33.2
    %
    
    
    29.7
    %
    
    
    29.0
    %C. P. Li
    
    
    33.4
    %
    
    
    29.6
    %
    
    
    28.9
    %C. W. Leung
    
    
    33.0
    %
    
    
    28.5
    %
    
    
    27.2
    %Leesha Holdings Ltd.
    
    
    27.2
    %
    
    
    25.3
    %
    
    
    25.2
    %Royce & Associates, Inc.
    
    
    6.3
    %
    
    
    9.3
    %
    
    
    10.3
    %FMR Corp./ Edward C. Johnson 3d/
Abigail P. Johnson
    
    
    
    
    
    
    9.2
    %
    
    
    9.6
    %Micropower Enterprises Limited
    
    
    8.1
    %
    
    
    7.5
    %
    
    
    7.5
    %Wellington Management Company, LLP
    
    
    
    
    
    
    
    
    
    
    6.5
    %
   (1)     Based on 8,396,896, 8,470,246 and 9,149,085 common shares outstanding on
June 28, 2002, August 28, 2003 and June 30, 2004, 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 30, 2004, approximately 32 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 30, 2004, 24 holders of record with addresses in the United States held
approximately 6.3 million of our outstanding common shares. 35




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Related Party Transactions During the year ended March 31, 2002, sales to Nam Tai Electronic
(Shenzhen) Co. Limited (Namtai Shenzhen) amounted to less than 10% of the
Companys total sales. Namtai Shenzhen is an indirect wholly owned subsidiary
of Nam Tai Electronics, Inc. (Nam Tai), which, in September 2000, purchased
an aggregate of 750,000 Common Shares of the Company, equal to approximately 9%
of the Companys then outstanding Common Shares. During the year ended March
31, 2002, Nam Tai sold its shares of the Company in the open market. In the past, the Company rented staff quarters in China from Mr. S. K.
Lee and Mr. M. C. Tam, who are executive officers of the Company and minority
shareholders of Integrated International Limited, the parent holding company of
the Companys electronic and metallic subsidiaries. The charges for these
premises approximate the amount negotiable, in managements opinion, on an arms
length basis. Rentals charged by these parties to the Company are summarized
as follows: Year ended March 31,2002
    
    2003
    
    2004Rent charged by Mr. S. K. Lee and Mr. M. C. Tam
    
    $
    12,000
    
    
    Nil
    
    Nil
 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, 2002, 2003 and 2004, Integrated made distributions to
its shareholders, including Deswell, aggregating $nil, $1,609,000 and $426,000,
respectively, with Messrs. Lee and Tams share of these distributions
aggregating $nil, $708,000 and $102,000, 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 Director of Marketing for plastic and electronic products, and 10% by
two other individuals, who were employees of J&K OEM. During the years ended
March 31, 2002, 2003 and 2004, J&K OEM made distributions to its shareholders,
including Deswell, aggregating $nil, $129,000 and $935,000, respectively, with
Mr. Lams share of these distributions amounting to $nil, $50,000 and $365,000,
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 year ended
March 31, 2004, Triumph Wise did not make any distributions to its
shareholders. 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. 36




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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,  
    
    2003 aggregating $6,687,000, $1,578,000 of which was based on
results for the last quarter of the year ended March 31, 2002 and
$5,109,000 of which was based on results for the first three quarters
of the year ended March 31, 2003; and
    
    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. 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 be depended 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. 37




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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 split effected in July 2002): Year Ended
    
    High
    
    LowMarch 31, 2004
    
    $
    30.60
    
    
    $
    15.64March 31, 2003
    
    
    18.15
    
    
    

    11.00March 31, 2002
    
    
    14.75
    
    
    
    8.75March 31, 2001
    
    
    12.00
    
    
    
    8.17March 31, 2000
    
    
    12.33
    
    
    
    5.29
 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, 2003 and the average daily trading volume during each of the
quarters (adjusted for the Companys three-for-two stock split effected in July
2002) AverageDailyTradingQuarter ended
    
    High
    
    Low
    
    Volume(1)March 31, 2004
    
    $
    29.00
    
    
    $
    23.59
    
    
    
    12,330December 31, 2003
    
    
    30.60
    
    
    
    21.02
    
    
    
    14,103September 30, 2003
    
    
    25.75
    
    
    
    17.89
    
    
    
    12,014June 30, 2003
    
    
    21.52
    
    
    
    15.64
    
    
    
    9,023March 31, 2003
    
    
    18.15
    
    
    
    14.40
    
    
    
    6,905December 31, 2002
    
    
    14.75
    
    
    
    12.65
    
    
    
    9,882September 30, 2002
    
    
    15.00
    
    
    
    11.00
    
    
    
    9,686June 30, 2002
    
    
    15.77
    
    
    
    12.34
    
    
    
    8,498
   (1)
    
    Determined by dividing the sum of the reported daily volume for the
quarter by the number of trading days in the quarter. 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. AverageDailyTradingMonth ended
    
    High
    
    Low
    
    Volume(1)June 30, 2004
    
    $
    24.75
    
    
    $
    21.80
    
    
    
    2,902May 31, 2004
    
    
    25.00
    
    
    
    21.51
    
    
    
    3,499April 30, 2004
    
    
    27.22
    
    
    
    24.05
    
    
    
    6,497March 31, 2004
    
    
    27.73
    
    
    
    23.59
    
    
    
    12,237February 29, 2004
    
    
    27.90
    
    
    
    24.51
    
    
    
    13,418January 31, 2004
    
    
    29.00
    
    
    
    25.64
    
    
    
    11,404
   (1)
    
    Determined by dividing the sum of the reported daily volume for the
month by the number of trading days in the month. 38




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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. 39




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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 9,149,085 common
shares were outstanding on June 30, 2004. 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. 40




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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 8, 2004 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:(1) Overdraft facility of HK$5,000,000 (2) import
facility of HK$5,000,000. Interest on the overdraft facility is charged at 1 %
per annum below banks best lending rate. Consideration: HSBC time deposit for HK$5,000,000 (or other currency equivalent
with interest accrual) head under lien to bank together with security over
deposit & letter of set-off. Letter of awareness from Deswell Industries, Inc. Banking Facilities (Exhibit 4.2) Date:May 2, 2003 Parties:Standard and Kwanasia Electronics Co. Ltd. (Kwanasia) Nature of Contract:Standard to provide Kwanasia with working capital
facilities. Terms and Conditions:Working Capital Facilities (1) Current Account Overdraft
is HK$1,000,000 ; (2) Trade Finance Group All 9 Discrepant Credit Bills
Negotiated  with recourse) is HK$5,000,000; (3) Trade Finance Group 1 is
HK$5,000,000; (4) Trade Finance Group 2 is HK$4,000,000; (5) Trade Finance
Group 3 HK$4,000,000 (the trade finance groups all, 1, 2 and 3 are
complementary and combined amounts outstanding are not to exceed HK$5,000,000;
combined amounts outstanding of Trade Finance Groups 2 and 3 are not to exceed
HK$4,000,000) (6) Treasury Facilities to quote rates for foreign exchange spot
transactions and forward transactions;. Interest rate on all sums advanced
will be payable monthly in arrears at Prime or HIBOR, whichever is higher.
Default rate of 8% per annum over Prime or HIBOR, whichever is higher will
apply to amounts not paid when due or in excess of agreed facility amounts.
Export bills will be discounted and import bills will be financed at Banks
standard bills finance rate minus 0.25% per annum for Hong Kong Dollar Bills
and at Banks standard bills finance rate for foreign currency bills. All past
due bills shall bear interest at 4% per annum above the rates charged on
regular bills outstanding. Commission on Letters of Credit Opening is -1/4% on
the first $50,000, 1/12% on $50,001-$100,000 and 1/24% on the balance.
Commission in Lieu of Exchange is 1/8%. Commission on Import Acceptance is
1/8% per month. 41




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Consideration:An arrangement fee of HK$20,000. A handling fee in an amount
to be mutually agreed upon will be payable annually if the facilities are
continuing. Banking Facilities (Exhibit 4.3) 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. Revolving Short-term Renminbi Loan Facility (Exhibit 4.4) Date:November 28, 2002 Parties:UFJ Bank Limited, Shenzhen Branch (UFJ Shenzhen) and Dongguan Kwan
Hong Electronics Co. Ltd. (Kwan Hong) Nature of Contract:UFJ Shenzhen to provide Kwan Hong with short-term revolving
RMB loan facility. Terms and Conditions:Resolving short term Renminbi loan facility of
RMB7,000,000 as daily operating funds to Kwan Hong Consideration:The interest set forth in the agreement dated November 28,
2002. Revolving Short-term Renminbi Loan Facility (Exhibit 4.5) Date:May 6, 2003 Parties:Standard Chartered Bank, Shenzhen Branch (Standard Shenzhen) and
Kwan Hong Nature of Contract:Standard Shenzhen to provide Kwan Hong with short-term
revolving RMB loan facility to partial finance acquisition of existing factory. Terms and Conditions:Revolving short-term loan facility of RMB21,000,000.
Tenor is up to 1 year. The loan interest is payable monthly in arrears at the
interest rate permitted by the Peoples Bank of China (i.e. 10% below base
rate announced by PBOC, currently base rate is 5.04% for tenor up to 6 months
and 5.31% for tenor from 6 months up to one year). Consideration:The bank loan shall be secured by corporate guarantee for
HK$20,000,000 issued by Deswell Industries, Inc. Tenancy Agreement (Exhibit 4.6) Date:May 29, 2002 Parties:Shenzhen Shekou Yu Yi Shareholding Company Ltd. (Lessor) and Jetcrown
Industrial (Shenzhen) Limited. 42




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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, 2002 to May 30, 2005. 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 RMB45,094 per month. Tenancy Agreement (Exhibit 4.7) Date: May 30, 2003 Parties: Shenzhen Shekou NanShui Enterprises Shareholding (Lessor) and
Jetcrown Industrial (Shenzhen) Ltd. (Lessee) Nature of Contract: Lease of property located at 2/F to 5/F, Block E, Wing
Village Industrial Estate, Shekou, Shenzhen. Terms and Conditions: The construction area of 2/F to 5/F is 4,094 square
meters. The rental period is four years, commencing June 1, 2003 to May 31,
2007. Rent for the total property is RMB61,410 per month. The Lessor is
responsible to pay for property tax, land use fees and the rental housing
management fee of the property. The Lessee is responsible for the water,
electricity, cleansing and management charges. A deposit of RMB87,000 is
required. Lessee is not allowed to sublet the property without the Lessors
written agreement. Lessee should inform Lessor of its desire to renew the
lease one month before expiration and Lessee should be given first priority to
renew under the same conditions offered by any third party. The delay charge
on Lessees payment of rent is 3% of the monthly rent multiplied by the number
of days the rent is overdue. Consideration: Rent of RMB61,410 per month. Tenancy Agreement (Exhibit 4.8) Date: April 9 and 11, 2001 (Extension is from May 1 2003 to April 30, 2004) Parties: Shenzhen Shekou East Empire Industrial Co. Ltd. (Lessor) and Jetcrown
Industrial (Shenzhen) Limited (Lessee). Nature of Contract: Lease of property located at 2/F-5/F, Block H, Wing
Village Industrial Estate, Shenzhen. Terms and Conditions: The construction area is 4,120 square meters. The
rental period is two years, commencing May 1, 2001 to April 30, 2003 and
extended further for one year from May 1, 2003 to April 30, 2004. The total
rent for the property is RMB63,860 per month. A deposit of RMB121,540 is
required. The Lessor is responsible to pay for the property tax, land use fees
and the rental housing management fees. The Lessee is responsible for the
water, electricity, cleansing and management charges. The Lessee may not
sublease the property without the written approval of the Lessor. Lessee
should inform Lessor in writing of its desire to renew the lease three months
before the expiration of the lease. Lessee should be given first priority to
rent the property under the same terms and conditions as offered by any third
party. The delay charge on Lessees payment of rent is 5% of the monthly rent
multiplied by the number of days the rent is overdue. Consideration: Rent of RMB63,860 per month. Tenancy Agreement (Exhibit 4.9) Date: December 31, 2002 43




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Parties: Shenzhen Shekou Tai Shen Enterprises Shareholding Co. Ltd. (Lessor)
and Jetcrown Industrial (Shenzhen) Limited (Lessee). Nature of Contract: Lease of property located at Block D (five floors total),
Wing Village Industrial Estate, Shekou, Shenzhen. Terms and Conditions: The construction area is 5,442 square meters. The
rental period is five years, commencing January 1, 2002 to December 31, 2007.
The total rent for the property is HK$108,840 per month. A deposit of
HK$300,000 is required. The Lessor is responsible to pay for the property tax,
land use fees and the rental housing management fees. The Lessee is
responsible for the water, electricity, cleansing and management charges. The
Lessee may not sublease the property without the written approval of the
Lessor. Lessee should inform Lessor in writing of its desire to renew the
lease three months before the expiration of the lease. Lessee should be given
first priority to rent the property under the same terms and conditions as
offered by any third party. The delay charge on Lessees payment of rent is 3%
of the monthly rent multiplied by the number of days the rent is overdue. Consideration: Rent of HK$108,840 per month. Tenancy Agreement (Exhibit 4.10) Date: January 2, 2003 Parties: Shekou District Yu Yee Shareholding Co. Ltd. (Lessor) and Jetcrown
Industrial (Shenzhen) Limited (Lessee). Nature of Contract: Lease of property located at 1/F to 5/F, Block F, Wing
Village Industrial Estate, Shekou, Shenzhen. Terms and Conditions: The construction area is 5,442 square meters. The
rental period is four years, commencing January 1, 2003 to December 31, 2007.
The total rent for the property is HK$108,840 per month. The Lessor is
responsible to pay for the property tax, land use fees and the rental housing
management fees. The Lessee is responsible for the water, electricity,
cleansing and management charges. The Lessee may not sublease the property
without the written approval of the Lessor. Lessee should inform Lessor in
writing of its desire to renew the lease three months before the expiration of
the lease. Lessee should be given first priority to rent the property under
the same terms and conditions as offered by any third party. The delay charge
on Lessees payment of rent is 3% of the monthly rent multiplied by the number
of days the rent is overdue. Consideration: Rent of HK$108,840 per month. Tenancy Agreement (Exhibit 4.11) Date: December 31, 2003 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,
402-405, 407, 409, 413-414, 416, 502-504, 506-507, 510, 513-516, 601, 603-607,
609-616, 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 3,268
square meters. The rental period is one year, commencing January 1, 2004 to
December 31, 2004. The total rent for the property is RMB49,027 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 RMB49,027 per month. 44




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Tenancy Agreement (Exhibit 4.12) Date: January 7, 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, Room
201-204, 206, 409 of Block 9, NanShui
Siu Village and Room 201 and 311 of Block C3 of New Wing Village, Shekou for
use as a dormitory. Terms and Conditions: The total construction area for all the rooms is 2,152
square meters. The rental period is one year, commencing January 1, 2004 to
December 31, 2004. The total rent for the property is RMB40,892 per month. A
deposit of RMB81,784 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 RMB40,892 per month. Tenancy Agreement (Exhibit 4.13) Date: January 1, 2004 Parties: Dongguan Houjie Town Chong Hing Trading Company (Lessor) and Jetcrown
Industrial (Dongguan) Limited (Lessee). Nature of Contract: Lease of a block of industrial building, a block of
dormitory, an electricity room at Huangguan Industrial Estate, Ma Tsui,
Dongguan. Terms and Conditions: The total construction area for the factory is 5,224
square meters, dormitory is 2,054 square meters and electricity room is 112
square meters (are in total is 7,390 square meters. The rental period is six
months , commencing January 1, 2004 to June 30, 2004. The total rent for the
property is RMB62,815 per month. A deposit of RMB200,000 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/1000 of the monthly
rental shall be levied on the rental. Consideration: Rent of RMB62,815 per month. Sale Contract on Land and Factory and Attestation Deed (Exhibit 4.14) Dates:February 28, 2003 and May 14, 2003, respectively Parties: Dongguan City Cheung On Town Siu Bin Estate Committee (Transferor) and
Dongguan Kwan Hong Electronics Co. Ltd. (Transferee). Nature of Contract: Sale of Land and factory and dormitory buildings located at
the area between Siu Bin Reservoir and Sai Cheong Road, the Second Industrial
Zone, Siu Bin Estate, Cheung On Town, Dongguan City for use as factory
premises. Terms and Conditions: The construction area is 22,410 square meters of land and
38,538 square meters of buildings. The period of right of land use is 50
years, from February 1, 2003 to 31 January 2053. The purchase consideration is
HK$650 per square meter for the building premises and HK$330 per square meter
for the land. The total consideration is HK$32,445,000. Consideration: Purchase consideration of HK$32,445,000 in total. 45




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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% 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; 46




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
    
    an estate whose income is subject to U.S. federal income tax
regardless of its source;
    
    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% (zero, in 2008) or 15%, 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 120-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%. A foreign corporation is a qualified foreign corporation with
respect to its stock that 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 U.S federal income tax law. Our
stock is traded on an established securities market in the United States; we
believe that we should not be considered a foreign personal holding company,
or a foreign investment company, but we have not made a specific
determination as to whether or not we are in fact a passive foreign investment
company. In December 2003, the United States Internal Revenue Service issued a
statement that for years after 2003, it intends to issue regulations providing
procedures for a foreign corporation to certify that it is a qualified foreign
corporation, including a certification that it is not a foreign personal
holding company, foreign investment company or a passive foreign investment
company. At June 30, 2004, no such guidance had been issued. However, if
such guidance is issued in the future, we may unable to certify that we are not
a passive foreign investment company. In this case, dividends received from us
will be taxed at regular federal income tax rates (up to 35%). 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:  
    
    the amount realized on such sale or other taxable disposition and 47




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
    
    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;  
    
    under the new tax law described above, 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% (zero, in 2008) or 15%,
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 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. We
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 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 specific 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,  
    
    the amount allocated to the taxable year in which you realize the
excess distribution or gain would be taxed as ordinary income, 48




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
    
    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% 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:  
    
    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 49




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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% 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%. 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 discussion above is for general information only. It does not cover
tax consequences that depend upon your particular tax circumstances. 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 and the U.S. federal estate and gift tax consequences of the
ownership and disposition of the common shares 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 and the stock split. 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. 50




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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, 2002, 2003 and 2004 the Company had no open forward exchange
contracts or option contracts. Cash on hand at March 31, 2004 of $30,583,000 held in the following
currencies: Equivalent U.S. Dollar HoldingsUnited States dollars
    
    $
    17,103,000Hong Kong dollars
    
    
    8,382,000Euro dollar
    
    
    5,000Chinese renminbi
    
    
    3,325,000Japanese yen
    
    
    1,746,000Macao dollars
    
    
    22,000
 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 $14,642,000 as at March 31, 2004 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, 2004 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. 51




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PART II 
 ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES 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, 2004, 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, 2004, 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, 2004, 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, 2004 was BDO
International (BDOI)and BDO McCabe Lo & Co. (BDOMLC). 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, 2003 and 2004. 52




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Year ended March 31,2003
    
    2004(US $ (in thousands)Audit Fees(1)
    
    
    97
    
    
    
    98Audit-related Fees(2)
    
    
    
    
    
    
    Tax Fees(3)
    
    
    
    
    
    
    All Other Fees(4)
    
    
    
    
    
    
    97
    
    
    
    98
   (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. Not Applicable until the report covering the year ending March 31, 2005. 
 ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATE
PURCHASERS. Not applicable. 
 PART III 
 ITEM 17. FINANCIAL STATEMENTS Not Applicable. 53




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ITEM 18. FINANCIAL STATEMENTS The following financial statements are filed as part of this Report: Page No.Report Of Independent Registered Public Accounting Firm
    
    
    F-1Report of Deloitte Touche Tohmatsu
    
    
    F-2Consolidated Balance Sheets as of March 31, 2003 and March 31, 2004
    
    
    F-3Consolidated Statements of Income for the years ended March 31, 2002,
March 31, 2003 and March 31, 2004
    
    
    F-4Consolidated Statements of Shareholders Equity for the years
ended March 31, 2002, March 31, 2003 and March 31, 2004
    
    
    F-5Consolidated Statements of Cash Flows for the years ended March 31, 2002,
March 31, 2003 and March 31, 2004
    
    
    F-6Notes to Consolidated Financial Statements
    
    
    F-7
 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. 54




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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, 2003 and
2004, and the related consolidated statements of income, shareholders equity
and cash flows for each of the two years in the period ended March 31, 2004.
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. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes 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, 2003 and 2004, and
the consolidated results of their operations and their cash flows for each of
the two years in the period ended March 31, 2004, in conformity with accounting
principles generally accepted in the United States of America. As discussed in note 2 to the consolidated financial statements, effective
April 1, 2002, the Company adopted Statement of Financial Accounting Standards
No. 142, Goodwill and Other Intangible Assets.   /s/ BDO McCabe Lo & CompanyBDO McCabe Lo & Company   Hong Kong, June 16, 2004 F-1




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{LETTERHEAD OF DELOITTE
TOUCHE TOHMATSU] 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 statements of income, shareholders
equity and cash flows of Deswell
Industries, Inc. and its subsidiaries for the year ended March 31, 2002, before the inclusion of the
disclosures required by Statement of Financial Accounting
Standards No. 142 Goodwill and Other Intangible Assets included in Note 2
and the revisions to related per share and number of shares information as a
result of the three-for-two stock split described in Note 11. 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 audit. We conducted our audit 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. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all
material respects, the results of operations and cash flows of Deswell Industries, Inc. and
its subsidiaries for the year ended  March 31, 2002 in
conformity with accounting principles generally accepted in the United States
of America. /s/ Deloitte Touche Tohmatsu June 28, 2002
Hong Kong F-2




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DESWELL INDUSTRIES, INC. 
 CONSOLIDATED BALANCE SHEETS
(U.S. dollars in thousands) March 31,2003
    
    2004ASSETSCurrent assets:Cash and cash equivalents
    
    $
    34,400
    
    
    $
    30,193Restricted cash (note 6)
    
    
    2,366
    
    
    
    390Marketable securities (note 3)
    
    
    4,821
    
    
    
    Accounts receivable
    
    
    16,727
    
    
    
    18,957Inventories (note 4)
    
    
    14,784
    
    
    
    16,174Prepaid expenses and other current assets
    
    
    2,648
    
    
    
    2,952Income taxes receivable (note 8)
    
    
    323
    
    
    
    127Total current assets
    
    
    76,069
    
    
    
    68,793Property, plant and equipment-net (notes 5 and 6)
    
    
    29,623
    
    
    
    44,261Other investments
    
    
    2
    
    
    
    2Goodwill
    
    
    478
    
    
    
    478Total assets
    
    $
    106,172
    
    
    $
    113,534LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    9,643
    
    
    $
    11,168Accrued payroll and employee benefits
    
    
    1,312
    
    
    
    2,266Customer deposits
    
    
    494
    
    
    
    759Other accrued liabilities (note 7)
    
    
    2,451
    
    
    
    1,594Income taxes payable
    
    
    3,946
    
    
    
    130Total current liabilities
    
    
    17,846
    
    
    
    15,917Deferred income taxes (note 8)
    
    
    15
    
    
    
    15Commitments and contingencies (note 10)
    
    
    
    
    
    
    Minority interests
    
    
    6,465
    
    
    
    7,872Shareholders equity:Common shares nil par value-authorized 30,000,000 shares,
shares issued and outstanding March 31, 2003 - 9,030,835;
March 31, 2004 - 9,149,085 (note 11)
    
    
    28,247
    
    
    
    29,980Additional paid-in capital
    
    
    6,970
    
    
    
    6,970Retained earnings
    
    
    46,629
    
    
    
    52,780Total shareholders equity
    
    
    81,846
    
    
    
    89,730Total liabilities and shareholders equity
    
    $
    106,172
    
    
    $
    113,534
 See accompanying notes to consolidated financial statements. F-3




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DESWELL INDUSTRIES, INC. 
 CONSOLIDATED STATEMENTS OF INCOME
(U.S. dollars in thousands, except per share data) Year ended March 31,2002
    
    2003
    
    2004Net sales
    
    $
    83,320
    
    
    $
    90,905
    
    
    $
    97,195Cost of sales
    
    
    54,448
    
    
    
    61,006
    
    
    
    66,105Gross profit
    
    
    28,872
    
    
    
    29,899
    
    
    
    31,090Selling, general and administrative expenses
    
    
    14,939
    
    
    
    15,354
    
    
    
    14,718Operating income
    
    
    13,933
    
    
    
    14,545
    
    
    
    16,372Interest expense
    
    
    (26
    )
    
    
    (6
    )
    
    
    (16
    )Other income, net
    
    
    877
    
    
    
    818
    
    
    
    910Income before income taxes and minority interests
    
    
    14,784
    
    
    
    15,357
    
    
    
    17,266Income taxes (note 8)
    
    
    535
    
    
    
    3,826
    
    
    
    589Income before minority interests
    
    
    14,249
    
    
    
    11,531
    
    
    
    16,677Minority interests
    
    
    925
    
    
    
    1,288
    
    
    
    1,957Net income
    
    $
    13,324
    
    
    $
    10,243
    
    
    $
    14,720Net income per share (note 2)Basic:Net income per share
    
    $
    1.59
    
    
    $
    1.18
    
    
    $
    1.62Weighted average common shares outstanding
    
    
    8,403
    
    
    
    8,672
    
    
    
    9,109Diluted:Net income per share
    
    $
    1.57
    
    
    $
    1.16
    
    
    $
    1.56Weighted average common and potential common shares
    
    
    8,466
    
    
    
    8,852
    
    
    
    9,440
 See accompanying notes to consolidated financial statements. F-4




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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, 2001
    
    
    8,396,896
    
    
    
    19,929
    
    
    
    6,970
    
    
    
    36,978
    
    
    
    63,877Exercise of stock options
    
    
    24,750
    
    
    
    243
    
    
    
    
    
    
    
    
    
    
    
    243Repurchase and cancellation of common stock
    
    
    (51,150
    )
    
    
    (564
    )
    
    
    
    
    
    
    
    
    
    
    (564
    )Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    13,324
    
    
    
    13,324Dividends ($0.86 per share)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (7,229
    )
    
    
    (7,229
    )Balance at March 31, 2002
    
    
    8,370,496
    
    
    
    19,608
    
    
    
    6,970
    
    
    
    43,073
    
    
    
    69,651Exercise of stock options
    
    
    408,500
    
    
    
    4,217
    
    
    
    
    
    
    
    
    
    
    
    4,217Odd share redemption upon stock split
    
    
    (41
    )
    
    
    (1
    )
    
    
    
    
    
    
    
    
    
    
    (1
    )Issuance of common stock for acquisition
of additional 20% interest in a subsidiary
    
    
    251,880
    
    
    
    4,423
    
    
    
    
    
    
    
    
    
    
    
    4,423Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10,243
    
    
    
    10,243Dividends ($0.77 per share)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6,687
    )
    
    
    (6,687
    )Balance at March 31, 2003
    
    
    9,030,835
    
    
    
    28,247
    
    
    
    6,970
    
    
    
    46,629
    
    
    
    81,846Exercise of stock options
    
    
    118,250
    
    
    
    1,733
    
    
    
    
    
    
    
    
    
    
    
    1,733Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    14,720
    
    
    
    14,720Dividends ($0.94 per share)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8,569
    )
    
    
    (8,569
    )Balance at March 31, 2004
    
    
    9,149,085
    
    
    
    29,980
    
    
    
    6,970
    
    
    
    52,780
    
    
    
    89,730
 See accompanying notes to consolidated financial statements. F-5




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DESWELL INDUSTRIES, INC. 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
(U.S. dollars in thousands) Year ended March 31,2002
    
    2003
    
    2004Cash flows from operating activitiesNet income
    
    $
    13,324
    
    
    $
    10,243
    
    
    $
    14,720Adjustments to reconcile net income to net
cash provided by operating activities:Depreciation and amortization
    
    
    4,918
    
    
    
    4,692
    
    
    
    4,402Loss (gain) on sale of property, plant and equipment
    
    
    7
    
    
    
    6
    
    
    
    392Net realized (gain) and unrealized holding (gain) loss on marketable securities
    
    
    (119
    )
    
    
    355
    
    
    
    (533
    )Minority interests
    
    
    925
    
    
    
    1,288
    
    
    
    1,901Changes in operating assets and liabilities:Accounts receivable
    
    
    (1,111
    )
    
    
    161
    
    
    
    (2,230
    )Inventories
    
    
    (1,191
    )
    
    
    (1,559
    )
    
    
    (1,390
    )Prepaid expenses and other current assets
    
    
    (1,588
    )
    
    
    773
    
    
    
    (304
    )Income taxes receivable
    
    
    
    
    
    
    105
    
    
    
    196Accounts payable
    
    
    3,309
    
    
    
    2,060
    
    
    
    1,525Accrued payroll and employee benefits
    
    
    40
    
    
    
    (565
    )
    
    
    954Customer deposits
    
    
    844
    
    
    
    (2,200
    )
    
    
    265Other accrued liabilities
    
    
    (27
    )
    
    
    702
    
    
    
    (857
    )Income taxes payable
    
    
    (132
    )
    
    
    3,781
    
    
    
    (3,816
    )Net cash provided by operating activities
    
    
    19,199
    
    
    
    19,842
    
    
    
    15,225Cash flows from investing activitiesPurchase of property, plant and equipment
    
    
    (4,397
    )
    
    
    (9,731
    )
    
    
    (19,862
    )Proceeds from sale of property, plant and equipment
    
    
    276
    
    
    
    127
    
    
    
    430Acquisition of marketable securities
    
    
    (1,574
    )
    
    
    (4,061
    )
    
    
    (1,056
    )Proceeds from sale of marketable securities
    
    
    578
    
    
    
    
    
    
    
    6,410Acquisition of other investments
    
    
    
    
    
    
    (2
    )
    
    
    Net cash used in investing activities
    
    
    (5,117
    )
    
    
    (13,667
    )
    
    
    (14,078
    )Cash flows from financing activitiesDividends paid
    
    
    (7,229
    )
    
    
    (6,687
    )
    
    
    (8,569
    )Dividends paid to minority shareholders of a subsidiary
    
    
    
    
    
    
    (851
    )
    
    
    (582
    )Repurchase of common stock
    
    
    (564
    )
    
    
    
    
    
    
    Increase (decrease) in bank loans
    
    
    482
    
    
    
    (482
    )
    
    
    Exercise of stock options
    
    
    243
    
    
    
    4,217
    
    
    
    1,733Odd shares redemption
    
    
    
    
    
    
    (1
    )
    
    
    (Increase) decrease in restricted cash
    
    
    (873
    )
    
    
    495
    
    
    
    1,976Contribution from minority shareholders of subsidiaries
    
    
    63
    
    
    
    
    
    
    
    88Net cash used in financing activities
    
    
    (7,878
    )
    
    
    (3,309
    )
    
    
    (5,354
    )Net (decrease) increase in cash and cash equivalents
    
    
    6,204
    
    
    
    2,866
    
    
    
    (4,207
    )Cash and cash equivalents, beginning of year
    
    
    25,330
    
    
    
    31,534
    
    
    
    34,400Cash and cash equivalents, end of year
    
    $
    31,534
    
    
    $
    34,400
    
    
    $
    30,193Supplementary disclosures of cash flow information:Cash paid (refunded) during the year for:Interest
    
    $
    26
    
    
    $
    6
    
    
    $
    16Income taxes
    
    $
    669
    
    
    $
    (60
    )
    
    $
    4,210Supplementary 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. F-6




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DESWELL INDUSTRIES, INC. 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except 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 selling and administrative
activities were performed in the Hong Kong Special Administrative Region (Hong
Kong) of the Peoples Republic of China (China). From August 2003, these
activities have been moved to the Macau Special Administrative Region (Macau)
of China. The manufacturing activities are subcontracted to subsidiaries
operating in Mainland China. As the Company is a holding company, the amount of any dividends declared
by the Company will be dependent upon the amount which can be dividended up
from its subsidiaries. Dividends from subsidiaries will be declared based on
profits as reported in their statutory accounts. Such profits will differ from
the amounts reported under U.S. GAAP. At March 31, 2004, the retained earnings
available for distribution as reflected in the statutory books of the
subsidiaries were $43,122 of which $1,637 relates to a subsidiary in China,
certain of whose retained earnings are intended to be reinvested rather than
used to fund dividends in order to obtain favorable tax concessions (note 8). 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.  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. Had goodwill amortization been discontinued effective April 1, 2001, net income
for the financial year ended March 31, 2002 would have been increased by $35 to
$13,359. After adjusting for the impact of discontinued goodwill amortization,
net income per common share for the financial years ended March 31, 2002 would
remain the same, and diluted net income per share for the year ended March 31,
2002 would have been higher by $0.01. In accordance with SFAS No. 142, goodwill is evaluated to determine if
fair value of the asset has decreased below its carrying value. At March 31,
2004, the Company completed its 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. F-7




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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 lease term
    
    the shorter of 5 years or
 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, 2002, 2003 and 2004 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, 2002, 2003 and 2004, shipping and handling costs expensed to
selling expenses were $638, $653 and $989, 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 as an amount receivable at year end
when an application for reinvestment of profits has been filed and a refund is
expected unless there is an indication from the China tax authority that the
refund will be refused. 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. 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 $(306), $503 and $(52) for the years ended March 31, 2002, 2003 and
2004, 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, 2002, 2003 and 2004 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 PRC
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. F-8




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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: 2002
    
    2003
    
    2004Net income:As reported
    
    $
    13,324
    
    
    $
    10,243
    
    
    $
    14,720Pro forma
    
    
    11,775
    
    
    
    10,243
    
    
    
    11,525Stock-based employee compensation cost, net of tax
    
    $
    1,549
    
    
    $
    
    
    
    $
    3,195Basic net income per share:As reported
    
    $
    1.59
    
    
    $
    1.18
    
    
    $
    1.62Pro forma
    
    
    1.40
    
    
    
    1.18
    
    
    
    1.27Diluted net income per share:As reported
    
    $
    1.57
    
    
    $
    1.16
    
    
    $
    1.56Pro forma
    
    
    1.39
    
    
    
    1.16
    
    
    
    1.22
 The fair value of options granted in the years ended March 31, 2002 and
2004 was estimated to be approximately $1.93 and $5.33 per share respectively
using the Black-Scholes option pricing model with the following assumptions: 2002
    
    2003
    
    2004Risk-free interest rate - weighted average
    
    
    5.42
    %
    
    
    n/a
    
    
    
    3.93
    %Expected life of options - weighted average
    
    10 years
    
    
    n/a
    
    
    10 yearsExpected volatility
    
    
    32
    %
    
    
    n/a
    
    
    
    34.78
    %Expected dividend yield
    
    
    7.57
    %
    
    
    n/a
    
    
    
    4.60
    %
 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 31,2002
    
    2003
    
    2004Net income
    
    $
    13,324
    
    
    $
    10,243
    
    
    $
    14,720Basic net income per share
    
    $
    1.59
    
    
    $
    1.18
    
    
    $
    1.62Basic weighted average common shares outstanding
    
    
    8,403
    
    
    
    8,672
    
    
    
    9,109Effect of dilutive securities - Options
    
    
    63
    
    
    
    180
    
    
    
    331Diluted weighted average common and potential common
shares outstanding
    
    
    8,466
    
    
    
    8,852
    
    
    
    9,440Diluted net income per share
    
    $
    1.57
    
    
    $
    1.16
    
    
    $
    1.56
 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. F-9




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2.
    
    Summary of Significant Accounting Policies - continued Recent changes in accounting standards In May 2003, the FASB issued
SFAS No. 150, Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity (SFAS 150). SFAS 150
established standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity.
This statement is effective for financial instruments entered into or modified
after May 31, 2003 and otherwise is effective at the beginning of the first
interim period beginning after June 15, 2003. The Companys adoption of this
interpretation is not expected to have an effect on its consolidated financial
statements. In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133
on Derivative Instruments and Hedging Activities that amends and clarifies
accounting for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities under Statement 133.
With certain exceptions, SFAS No. 149 is effective for contracts entered into
or modified after June 30, 2003, and for hedging relationships designed after
June 30, 2003. Management does not expect the adoption of this standard to have
a material impact on the Companys financial position or results of operations. In November 2002, the FASB issued FASB Interpretation No. 45, Guarantors
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others (FIN 45). FIN 45 requires a guarantor to
recognize, at the inception of a qualified guarantee, a liability for fair
value of the obligation undertaken in issuing the guarantee. FIN 45 is
effective on a prospective basis for qualified guarantees issued or modified
after December 31, 2002. Management does not expect the adoption of this
Interpretation to have a material impact on the Companys financial position or
results of operations. In January 2003, the FASB issued FASB Interpretation No. 46,
Consolidation of Variable Interest Entities (FIN 46). FIN 46 explains how to
identify variable interest entities and how an enterprise assesses its interest
in a variable interest entity to decide whether to consolidate that entity.
This Interpretation requires existing unconsolidated variable interest entities
to be consolidated by their primary beneficiaries if the entities do not
effectively disperse risks among parties involved. FIN 46 is effective
immediately for variable interest entities created after January 31, 2003, and
to variable interest entities in which an enterprise obtains an interest after
that date. Management does not expect the adoption of this Interpretation to
have a material impact on the Companys financial position or results of
operation. In December 2003, the FASB issued Interpretation No. 46R, a revision to
Interpretation No. 46, Consolidation of Variable Interest Entities, which
addresses how a business enterprise should evaluate whether it has a
controlling financial interest in an entity through means other than voting
rights and accordingly should consolidate the entity. Interpretation No. 46R
clarifies some of the provisions of Interpretation No. 46 and exempts certain
entities from its requirements. Interpretation No. 46R is effective at the end
of the first interim period ending March 15, 2004. Management does note expect
the adoption of this statement to have a material impact on the Companys
financial position or results of operations.  3.
    
    Marketable Securities The Company acquired equity securities listed in Hong Kong. March 31,2003
    
    2004Cost
    
    $
    5,176
    
    
    $
    Market value
    
    $
    4,821
    
    
    $
    
 Unrealized gain (loss) for the years ended March 31, 2002, 2003 and 2004
were $34, $(355) and $nil, respectively. Net proceeds from sale of marketable securities for the year ended March
31, 2002, 2003 and 2004 were $578, $nil and $6,411, and realized gains from
sale of marketable securities for the year ended March 31, 2002, 2003 and 2004
were $85, $nil and $533, respectively. For the purposes of determining realized
gains and losses, the cost of securities sold was determined based on the
average cost method. F-10




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##### Table of Contents



4.
    
    Inventories Inventories by major categories are summarized as follows: March 31,2003
    
    2004Raw materials
    
    $
    7,432
    
    
    $
    7,832Work in progress
    
    
    4,454
    
    
    
    4,467Finished goods
    
    
    2,898
    
    
    
    3,875$
    14,784
    
    
    $
    16,174
  5.
    
    Property, Plant and Equipment Property, plant and equipment consists of the following: March 31,2003
    
    2004At cost:Land and buildings
    
    $
    4,957
    
    
    $
    18,178Plant and machinery
    
    
    22,160
    
    
    
    25,097Furniture, fixtures and equipment
    
    
    11,332
    
    
    
    13,515Motor vehicles
    
    
    2,577
    
    
    
    2,213Leasehold improvements
    
    
    3,942
    
    
    
    4,615Total
    
    
    44,968
    
    
    
    63,618Less: accumulated depreciation and amortization
    
    
    (26,943
    )
    
    
    (25,702
    )Construction in progress
    
    
    11,598
    
    
    
    6,345Net book value
    
    $
    29,623
    
    
    $
    44,261Cost of land and buildings consist of the following:Leasehold land and buildings (a)
    
    $
    2,122
    
    
    $
    1,482Land use right of state-owned land and buildings erected thereon (b)
    
    
    9
    
    
    
    9,684Long term leased land and buildings erected thereon (c)
    
    
    
    
    
    
    4,186Other buildings (d)
    
    
    2,826
    
    
    
    2,826$
    4,957
    
    
    $
    18,178
 (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 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, 2004,
the Company is not aware in respect of any steps 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, 2003 and 2004 these facilities
totalled $20,839, and $10,118, 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, 2003
and 2004, cash of $2,366 and $390, respectively, and leasehold land and
buildings of net book value $1,318 and $1,288, respectively, have been pledged
as collaterals for the above facilities. As of March 31, 2003 and 2004, the
Company has not borrowed against these lines. F-11




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##### Table of Contents



7.
    
    Other Accrued liabilities Other accrued liabilities consist of the following: March 31,2003
    
    2004Value added tax payable
    
    $
    695
    
    
    $
    306Accrued expenses
    
    
    235
    
    
    
    419Provision for tax risks
    
    
    801
    
    
    
    Commission expenses
    
    
    109
    
    
    
    57Others
    
    
    611
    
    
    
    812$
    2,451
    
    
    $
    1,594
  8.
    
    Income Taxes The components of income before income taxes and minority interests are as follows: Year ended March 31,2002
    
    2003
    
    2004Hong Kong
    
    $
    1,245
    
    
    $
    5
    
    
    $
    216China and others
    
    
    13,539
    
    
    
    15,352
    
    
    
    17,050$
    14,784
    
    
    $
    15,357
    
    
    $
    17,266
 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, 2001, 2002 and 2003. 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
and 2003. Jetcrown Industrial (Dongguan) Limited (a subsidiary of the Company) has
not commenced its first tax exemption year for the years ended March 31, 2002,
2003 and 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 on the proportion of 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, 2002, 2003 and 2004, the Company recorded
a benefit relating to its decision to reinvest earnings of its Chinese
subsidiary, Jetcrown Shenzhen, totaling $nil, $323 and $nil, respectively. F-12




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##### Table of Contents



8.
    
    Income Taxes- continued Had the all above tax holidays and concessions not been available, the
tax charge would have been higher by $272, $611 and $1,811 and the basic net
income per share would have been lower by $0.03, $0.07 and $0.18 for the years
ended March 31, 2002, 2003 and 2004 respectively, and diluted net income per
share for the years ended March 31, 2002, 2003 and 2004 would have been lower
by $0.03, $0.07 and $0.17, 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 31,2002
    
    2003
    
    2004Current tax- Hong Kong
    
    $
    251
    
    
    $
    3,674
    
    
    $
    132- China
    
    
    284
    
    
    
    152
    
    
    
    457Deferred tax
    
    
    
    
    
    
    
    
    
    
    $
    535
    
    
    $
    3,826
    
    
    $
    589
 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 31,2002
    
    2003
    
    2004Provision for income taxes at statutory tax rate in - Hong Kong
    
    
    2,365
    
    
    
    2,457
    
    
    
    - China
    
    
    
    
    
    
    
    
    
    
    4,661Effect of different tax rate in various jurisdictions
    
    
    (207
    )
    
    
    (238
    )
    
    
    (210
    )Tax holidays and concessions
    
    
    443
    
    
    
    (733
    )
    
    
    (1,811
    )Effect of income for which no income tax is payable
    
    
    (2,150
    )
    
    
    (1,047
    )
    
    
    (1,977
    )Increase (decrease) in valuation allowances
    
    
    46
    
    
    
    (310
    )
    
    
    Under (over) provision of income tax in previous year
    
    
    9
    
    
    
    78
    
    
    
    (22
    )Additional assessments for previous years (a)
    
    
    
    
    
    
    3,532
    
    
    
    Others
    
    
    29
    
    
    
    87
    
    
    
    (52
    )Effective tax
    
    
    535
    
    
    
    3,826
    
    
    
    589
 (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 31,2003
    
    2004Deferred tax asset:Net operating loss carryforwards
    
    $
    
    
    
    $
    Less: Valuation allowances
    
    
    
    
    
    
    Deferred tax liability:Property, plant and equipment
    
    
    (15
    )
    
    
    (15
    )Net deferred tax liability
    
    $
    (15
    )
    
    $
    (15
    )
  9.
    
    Related Party Transactions During the year ended March 31, 2002, the Company rented employee
accommodation in China from Mr. S.K. Lee and Mr. M.C. Tam, both are executive
officers of the Company and minority shareholders of Kwanasia, a subsidiary of
the Company. Rentals charged by them to the Company were $12 for the year
ended March 31, 2002. No such rental arrangement was made in the years ended
March 31, 2003 and March 31, 2004. F-13




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##### Table of Contents



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 $2,169, $1,917 and $1,507 for the
years ended March 31, 2002, 2003 and 2004, respectively. At March 31, 2004, the Company was obligated under operating leases
requiring minimum rentals as follows: Years ending March 31
2005
    
    $
    9152006
    
    
    6002007
    
    
    4502008
    
    
    272Total minimum lease payments
    
    $
    2,237
 At March 31, 2004, the Company had capital commitments for plant and
machinery totalling $758 which is expected to be disbursed during the year
ending March 31, 2005. The Company has contracted with some building contractors to construct the
Companys new factory plant in Dongguan, the PRC. The budgeted costs of the
whole project are estimated to be $20,242. At March 31, 2004, a total of
$18,552 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 41 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 $281, $260
and $272 for the years ended March 31, 2002, 2003 and 2004, respectively. In
December 1996, the Company established a defined contribution plan for certain
of the employees in Hong Kong. The plan provides for annual contributions by
the Company at the rate of 5% of eligible compensation of employees based on
length of service and requires contribution by employees at the rate of 5% of
eligible compensation. The plan ceased on November 30, 2000. 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 HK$20 for each
eligible employee) as calculated under the MPF legislation. The expense
related to the MPF in the years ended March 31, 2002, 2003 and 2004 amounted to
$66, $63 and $31, 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 675,000 shares of Common Stock. On September 29, 1998, the
Company approved an increase of 366,000 shares making a total of 1,041,000
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
750,000 shares of Common Stock. On September 30, 2003, the Company adopted
2003 Stock Option Plan to purchase an additional 600,000 shares of Common
Stock. At March 31, 2004, options to purchase an aggregate of 2,391,000 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: F-14




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##### Table of Contents



13.
    
    Stock Option Plan - Continued Year ended March 31,2002
    
    2003
    
    2004Number
    
    
    
    Number
    
    
    
    
    
    Numberof stock
    
    Weighted average
    
    of stock
    
    Weighted average
    
    of stock
    
    Weighted averageoptions
    
    exercise price
    
    options
    
    exercise price
    
    options
    
    exercise priceOutstanding at beginning of the year
    
    
    300,000
    
    
    $
    9.83
    
    
    
    1,076,250
    
    
    $
    10.95
    
    
    
    667,750
    
    
    $
    11.33Granted during the year
    
    
    801,000
    
    
    
    11.33
    
    
    
    
    
    
    
    
    
    
    
    600,000
    
    
    
    21.15Exercised during the year
    
    
    (24,750
    )
    
    
    9.83
    
    
    
    (408,500
    )
    
    
    10.32
    
    
    
    (118,250
    )
    
    
    14.65Outstanding and exercisable at the
end of the year
    
    
    1,076,250
    
    
    
    10.95
    
    
    
    667,750
    
    
    
    11.33
    
    
    
    1,149,500
    
    
    
    16.11Range of exercise price per share
    
    
    
    
    
    $9.83 to $11.33
    
    
    
    
    
    $
    11.33
    
    
    
    
    
    
    $11.33 to $21.15
 The weighted average remaining contractual life of the share options
outstanding at March 31, 2004 was 8.62 years. At March 31, 2003 and 2004,
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, 2002, 2003 and 2004 are as follows: Percentage of net salesYear ended March 31,2002
    
    2003
    
    2004Digidesign, Inc.
    
    
    *
    
    
    
    13.5
    %
    
    
    17.8
    %VTech Telecommunications Limited
    
    
    15.3
    %
    
    
    11.6
    %
    
    
    17.6
    %Epson Precision (H.K.) Limited
    
    
    17.5
    %
    
    
    22.3
    %
    
    
    15.4
    %Inter-Tel Incorporated
    
    
    11.6
    %
    
    
    13.0
    %
    
    
    10.3
    %Kyocera Mita Industrial Co. (H.K.) Limited
    
    
    13.6
    %
    
    
    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, 2003 and 2004, respectively, are as follows: Percentage ofaccountsreceivableMarch 31,2003
    
    2004Largest receivable balances
    
    
    65.5
    %
    
    
    58.3
    %
 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 has been no
significant bad debt expense during each of the three years ended March 31,
2002, 2003 and 2004 and there was no provision for bad debts at the beginning
and end of the three years ended March 31, 2002, 2003 and 2004. 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. F-15




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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,
2002, 2003 and 2004 are as follows: Year ended March 31,2002
    
    2003Intersegment
    
    
    
    
    
    
    
    
    
    IntersegmentNet sales
    
    sales
    
    Profit (loss)
    
    Net sales
    
    sales
    
    Profit (loss)Segment:Injection molded
plastic parts
    
    $
    47,504
    
    
    $
    
    
    
    $
    13,010
    
    
    $
    50,975
    
    
    $
    1,068
    
    
    $
    12,687Electronic products
    
    
    33,672
    
    
    
    15
    
    
    
    2,067
    
    
    
    38,221
    
    
    
    8
    
    
    
    3,313Metallic parts
    
    
    4,987
    
    
    
    2,828
    
    
    
    (258
    )
    
    
    5,542
    
    
    
    2,757
    
    
    
    (643
    )Segment total
    
    $
    86,163
    
    
    $
    2,843
    
    
    $
    14,819
    
    
    $
    94,738
    
    
    $
    3,833
    
    
    $
    15,357Reconciliation to
consolidated totals:Sales eliminations
    
    
    (2,843
    )
    
    
    (2,843
    )
    
    
    
    
    
    
    (3,833
    )
    
    
    (3,833
    )
    
    
    Goodwill amortization
not allocated to
segment
    
    
    
    
    
    
    
    
    
    
    (35
    )
    
    
    
    
    
    
    
    
    
    
    Consolidated totals:Net sales
    
    $
    83,320
    
    
    $
    
    
    
    
    
    
    
    $
    90,905
    
    
    $
    Income before
income taxes
and minority
interests
    
    
    
    
    
    
    
    
    
    $
    14,784
    
    
    
    
    
    
    
    
    
    
    $
    15,357
   [Continued from above table, first column(s) repeated] Year ended March 31,2004IntersegmentNet sales
    
    sales
    
    Profit (loss)Segment:Injection molded
plastic parts
    
    $
    54,745
    
    
    $
    1,699
    
    
    $
    11,717Electronic products
    
    
    40,083
    
    
    
    3
    
    
    
    5,378Metallic parts
    
    
    6,185
    
    
    
    2,116
    
    
    
    171Segment total
    
    $
    101,013
    
    
    $
    3,818
    
    
    $
    17,266Reconciliation to
consolidated totals:Sales eliminations
    
    
    (3,818
    )
    
    
    (3,818
    )
    
    
    Goodwill amortization
not allocated to
segment
    
    
    
    
    
    
    
    
    
    
    Consolidated totals:Net sales
    
    $
    97,195
    
    
    $
    Income before
income taxes
and minority
interests
    
    
    
    
    
    
    
    
    
    $
    17,266
 Year ended March 31,2002
    
    2003
    
    2004Interest
    
    Interest
    
    Interest
    
    Interest
    
    Interest
    
    Interestincome
    
    expenses
    
    income
    
    expenses
    
    income
    
    expensesSegment:Injection molded
plastic parts
    
    $
    719
    
    
    $
    
    
    
    $
    396
    
    
    $
    
    
    
    $
    230

    
    
    $
    Electronic products
    
    
    70
    
    
    
    26
    
    
    
    26
    
    
    
    6
    
    
    
    17
    
    
    
    16Metallic parts
    
    
    14
    
    
    
    
    
    
    
    4
    
    
    
    
    
    
    
    0
    
    
    
    Consolidated total
    
    $
    803
    
    
    $
    26
    
    
    $
    426
    
    
    $
    6
    
    
    $
    247
    
    
    $
    16
 Year ended March 31,2002
    
    2003Depreciation
    
    
    
    
    
    
    
    
    
    DepreciationIdentifiable
    
    Capital
    
    and
    
    Identifiable
    
    Capital
    
    andassets
    
    expenditure
    
    amortization
    
    assets
    
    expenditure
    
    amortizationSegment:Injection molded plastic
parts
    
    $
    68,165
    
    
    $
    3,916
    
    
    $
    2,921
    
    
    $
    80,335
    
    
    $
    8,868
    
    
    $
    3,082Electronic products
    
    
    24,508
    
    
    
    335
    
    
    
    1,444
    
    
    
    26,400
    
    
    
    532
    
    
    
    1,190Metallic parts
    
    
    4,477
    
    
    
    146
    
    
    
    518
    
    
    
    4,563
    
    
    
    331
    
    
    
    420Segment totals
    
    $
    97,150
    
    
    $
    4,397
    
    
    $
    4,883
    
    
    $
    111,298
    
    
    $
    9,731
    
    
    $
    4,692Reconciliation to
consolidated totals:Elimination of receivables
from intersegments
    
    
    (2,884
    )
    
    
    
    
    
    
    
    
    
    
    (5,604
    )
    
    
    
    
    
    
    Goodwill not allocated to
segments
    
    
    478
    
    
    
    
    
    
    
    35
    
    
    
    478
    
    
    
    
    
    
    
    Consolidated totals
    
    $
    94,744
    
    
    $
    4,397
    
    
    $
    4,918
    
    
    $
    106,172
    
    
    $
    9,731
    
    
    $
    4,692
   [Continued from above table, first column(s) repeated] Year ended March 31,2004DepreciationIdentifiable
    
    Capital
    
    andassets
    
    expenditure
    
    amortizationSegment:Injection molded plastic
parts
    
    $
    83,391
    
    
    $
    14,285
    
    
    $
    2,992Electronic products
    
    
    29,182
    
    
    
    5,162
    
    
    
    949Metallic parts
    
    
    5,083
    
    
    
    414
    
    
    
    460Segment totals
    
    $
    117,656
    
    
    $
    19,861
    
    
    $
    4,401Reconciliation to
consolidated totals:Elimination of receivables
from intersegments
    
    
    (4,600
    )
    
    
    
    
    
    
    Goodwill not allocated to
segments
    
    
    478
    
    
    
    
    
    
    
    Consolidated totals
    
    $
    113,534
    
    
    $
    19,861
    
    
    $
    4,401
 F-16




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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 31,2002
    
    2003
    
    2004Net salesChina
    
    $
    46,876
    
    
    $
    53,503
    
    
    $
    50,095United States of America
    
    
    19,375
    
    
    
    25,949
    
    
    
    37,359Hong Kong
    
    
    11,690
    
    
    
    2,838
    
    
    
    2,186Europe
    
    
    4,053
    
    
    
    7,435
    
    
    5,778Others
    
    
    1,326
    
    
    
    1,180
    
    
    
    1,777Total net sales
    
    $
    83,320
    
    
    $
    90,905
    
    
    
    97,195
 The location of the Companys identifiable assets is as follows: March 31,2002
    
    2003
    
    2004Hong Kong and Macau
    
    $
    53,156
    
    
    $
    58,579
    
    
    $
    43,660China
    
    
    41,110
    
    
    
    47,115
    
    
    
    69,396Goodwill
    
    
    478
    
    
    
    478
    
    
    
    478Total identifiable assets
    
    $
    94,744
    
    
    $
    106,172
    
    
    $
    113,534
 F-17




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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 8, 2004 between The Hongkong & Shanghai Banking Corporation
Limited, Macao Branch (HSBC) and Jetcrown Industrial (Macao Commercial Offshore Limited
(JIMCO).4.2
    
    Facility letter dated May 2, 2003 between Standard Chartered Bank and Kwanasia Electronics
Company Limited (incorporated by reference to Exhibit 4.3 of registrants Form 20-F for the
year ended March 31, 2003, filed with the SEC on September 15, 2003).4.3
    
    Facility letter dated February 23, 2004 between Fortis Bank Asia HK and Kwanasia Electronics
Company Limited4.4
    
    Revolving Short-term Renminbi Loan Facility letter dated November 28, 2002 between UFJ Bank
Shenzhen Branch and Dongguan Kwan Hong Electronics Co., Limited (incorporated by reference
to Exhibit 4.6 of registrants Form 20-F for the year ended March 31, 2003, filed with the
SEC on September 15, 2003).4.5
    
    Revolving Short-term Renminbi Loan Facility letter dated May 6, 2003 between Standard
Chartered Bank Shenzhen Branch and Dongguan Kwan Hong Electronics Company Limited
(incorporated by reference to Exhibit 4.7 of registrants Form 20-F for the year ended March
31, 2003, filed with the SEC on September 15, 2003).4.6
    
    Tenancy Agreement dated May 29, 2002 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 (incorporated by reference to Exhibit 4.8 of registrants Form 20-F
for the year ended March 31, 2003, filed with the SEC on September 15, 2003).4.7
    
    Tenancy Agreement dated May 30, 2003 between Shekou NanShui Enterprises Shareholding Co.
Ltd. and Jetcrown Industrial (Shenzhen) Limited for the 2nd to 5th Floor, Block E, Wing
Village Industrial Estate, Shekou, Shenzhen (incorporated by reference to Exhibit 4.9 of
registrants Form 20-F for the year ended March 31, 2003, filed with the SEC on September
15, 2003).4.8
    
    Extension from May 1, 2003 to April 30, 2004 of and including Tenancy Agreement dated April
9 and 11, 2001 between Shekou East Empire Industrial Company Limited and Jetcrown Industrial
(Shenzhen) Limited for the 2nd Floor to 5th Floor, Block H, Wing Village Industrial Estate,
Shekou, Shenzhen (incorporated by reference to Exhibit 4.10 of registrants Form 20-F for
the year ended March 31, 2003, filed with the SEC on September 15, 2003).
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Exhibit No.
    
    Description4.9
    
    Tenancy Agreement dated December 31, 2002 between Shekou Tai Shen Enterprises Shareholding
Co. Ltd. and Jetcrown Industrial (Shenzhen) Limited for Block D (five floors total) Wing
Village Industrial Estate, Shekou, Shenzhen (incorporated by reference to Exhibit 4.11 of
registrants Form 20-F for the year ended March 31, 2003, filed with the SEC on September
15, 2003).4.10
    
    Tenancy Agreement dated January 2, 2003 between Shekou District Yu Yee Shareholding Co. Ltd.
and Jetcrown Industrial (Shenzhen) Limited for the 1st to 5th Floor, Block F, Wing Village
Industrial Estate, Shekou, Shenzhen (incorporated by reference to Exhibit 4.12 of
registrants Form 20-F for the year ended March 31, 2003, filed with the SEC on September
15, 2003).4.11
    
    Tenancy Agreement dated December 31, 2003 between Shenzhen Shekou Real Property Company
(Lessor) and Jetcrown Industrial (Shenzhen) Limited (Lessee) for Room 201-203, 205-208,
210-214, 305, 307-310, 402-405, 407, 409, 413-414, 416, 502-504, 506-507, 510, 513-516, 601,
603-607, 609-616, 701-716, Block C1, New Wing Village, Shekou.4.12
    
    Tenancy Agreement dated January 7, 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 201-204, 206, 409 of Block 9, NanShui Siu Village and Room 201 and 311 of
Block C3 of New Wing Village, Shekou4.13
    
    Tenancy Agreement dated January 1, 2004 between Dongguan Houjie Town Chong Hing Trading
Company (Lessor) and Jetcrown Industrial (Dongguan) Limited (Lessee) for Lease of a block of
industrial building, a block of dormitory, and electricity room at Huangguan Industrial
Estate, Ma Tsui, Dongguan.4.14
    
    Contract on Land and Factory dated February 28, 2003 between Dongguan City Cheung On Town
Siu Bin Estate Member Committee and Dongguan Kwan Hong Electronics Co. Ltd. for the land and
factory and dormitory buildings on the area between Siu Bin Reservoir and Sai Cheong Road,
the second Industrial Zone, Siu Bin Estate, Cheung On Town, Dongguan City and the
Attestation Deed dated May 14, 2003 (incorporated by reference to Exhibit 4.14 of
registrants Form 20-F for the year ended March 31, 2003, filed with the SEC on September
15, 2003).4.15
    
    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.)4.16
    
    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 20 of this report)11.1
    
    Code of Ethics12.1
    
    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-8.14.2
    
    Consent of Deloitte Touche Tohmatsu to incorporation of its report on the Companys
consolidated financial statements into Registrants Registration Statements on Form S-8.
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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 16, 2004
    
    By:
    
    /s/ Richard LauRichard LauChairman of the Board andChief Executive Office
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