After 22 years of continuous operation, for 14 of which it has been listed on the Nasdaq board, Deswell Industries, Inc. (‘Deswell’ or ‘the Company’) is today a globally known and well-respected OEM manufacturer of injection-molded plastic parts and components. More recently, it has been recognized for its high-quality manufacture of electronics products and subassemblies, along with metallic molds and accessory parts. It is also involved in distributing high-end audio equipment within China.

Deswell’s reputation as one of the leading companies in the field of plastic injection molding has been maintained by continuous investment and R&D over recent years. Its capabilities were boosted significantly with the construction of a brand new plastic injection molding factory in Dongguan, which came into full operation in 2007. The plant is in an ideal strategic location for access to stable supplies of raw materials, and at the same time enjoys some of the country’s best and most efficient logistics links and export facilities. A large proportion of the Company’s parts and components are produced here, using a range of advanced plastic molding production technologies such as film injection, integrated injection and insert injection. Deswell products are used in very many consumer goods and industrial equipment, and include:

• Plastic components for electronic entertainment products;
• cases for flashlights, telephones, paging machines, projectors and alarm clocks;
• toner cartridges and cases for photocopiers and printer machines;
• parts for electrical products such as air-conditioners and ventilators;
• parts for audio equipment;
• cases and key tops for personal organizers and remote controls;
• double injection caps and baby products;
• laser key caps; and
• automobile components.

The Company also has a factory in Chang An, Dongguan, dedicated to the manufacture of electronics products and subassemblies. Here it assembles complex printed circuit boards using surface mount (“SMT”), ball grip assembly (“BGA”) and pin-through-hole (“PTH”) interconnection technologies. Finished products manufactured or assembled at the Chang An facility include:

• business communication products such as digital phone systems or digital keysets and voice-over IP (VoIP) phones;
• high-end professional audio equipment such as digital audio workstations, digital and analogue mixing consoles, instrument amplifiers, signal processors, firewire/USB audio interfaces, keyboard controllers and synthesizers; and
• surveillance products such as CCTV matrix switcher/controllers.

The factory in Chang An also manufactures metal products, including metallic molds and accessory parts, which are used in audio equipment, telephones, copying machines, pay telephones, multimedia stations, and automatic teller machines.

Deswell employed around 3,622 employees across its various operations as at the end of the 2009 fiscal year. Its products were produced on both an OEM and contract basis, with customers spread across Asia, North America and Europe.

Over the fiscal year 2009, Deswell has continued to face three traditional areas of challenge: rising material prices, increasing labor costs, and ongoing appreciation of the RMB against the US dollar. Plastic is Deswell’s primary raw material, and prices of plastic typically reflect the cost of oil, from which it is made. However, the recent fall in the price of oil from record highs has yet to fully work its way through and bring down the cost of plastic. Consequently, in the year under review Deswell’s materials costs rose by an average of 10%. This rise was also driven by the gradual change in the Company’s customer mix, with a larger percentage of customers than in the past requiring higher quality materials in the products they ordered. The lower oil prices of recent months should be gradually reflected in lower plastic resin prices, helping stabilize this area of Deswell’s costs. In addition, once the Company’s customer mix has readjusted, the cost of materials as a percentage of sales should also become more stable on a year-to-year basis.

Overall, the cost of the labor for the Company has continued to rise as it did last year, both on a per head average and when calculated as a percentage of sales. Deswell’s policy of continuously upgrading its labor force by employing more highly skilled workers has meant that the average per head cost of labor has risen over the past year by around 20%. This rise has mainly been driven by the substantially increased cost of skilled labor for the Company’s electronics division, where the average labor cost per head is estimated to have risen by around 28%.

Over the year Deswell did, however, implement a significant reduction in its labor force in response to the downturn in the market. This means that the rise in per-head labor costs was offset to an extent by a smaller workforce. Consequently, the Company’s labor costs as a percentage of sales for 2009 rose slightly to 10.7%, against 9.8% in fiscal 2008. The more skilled workforce now in place should, however, lead to a rise in both productivity and quality, helping bring down this percentage figure over time.

In the year under review, the RMB continued its climb against the US dollar. It appreciated by 9% over the average exchange rate of the previous year, impacting directly on Deswell’s margin. The Company paid approximately 47% of its total costs and expenses for the fiscal year 2009 in RMB, and the higher RMB thus pushed up its total costs by approximately 4.2% as compared to the fiscal year 2008.

To keep the impact of these variables to a minimum, Deswell has worked hard at expanding its customer base and maintaining a healthy product mix. It has also put extra efforts into developing and promoting higher-margin products, which have been an important growth area since 2007 when the Company’s state-of-the-art Dongguan facility came into full operation. The move towards higher-margin production has, however, been temporarily slowed by recent economic uncertainty. Nevertheless, the year saw a satisfactory 24.8% increase in revenue from the Company’s plastics segment, largely as a result of increased sales to the video game industry.

Deswell’s electronics division experienced slow economic conditions generally over the past year. In addition, low-price competitors applied persistent pricing pressure, resulting in some cases in a loss of orders for the Company. As a result, revenue from Deswell’s electronics division fell by 31.3% for the year, after a trend of gradually increasing sales from 2003 to 2008.

Deswell remains committed to maintaining its policy of avoiding debt and redistributing profits to shareholders. Because the bulk of its operations are financed using funds derived from operating activities, the Company has little need for external financing. Its current cash reserves are stable and amount to $23.1 million [2008: $22.7 million]; as at March 31, 2009, it had no long- or short-term borrowings.

Inevitably, Deswell expects to be affected by the ongoing world economic crisis in the coming fiscal year. The Company will continue to take steps to maximize margins in both operations, with a focus on strengthening its core business, working on new projects, and expanding its customer base further. Though the road ahead may be difficult, the Company believes its position is significantly stronger than that of much of its competition in the region, and is optimistic that Deswell will emerge from the current economic downturn in an even stronger position than before.

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Copyright 2009 Deswell Industrial Ltd. All rights reserved.