In the year under review, Deswell once again faced many of the same pressures that have emerged regularly over the past few years. These included spiraling labor costs in China, the effects of an ever-strengthening renminbi against the US dollar, and the knock-on effects of high oil prices on the cost of plastic resin. Before dropping in the latter half of 2008, crude oil prices rose to record highs, significantly raising the cost of Deswell’s primary raw material, plastic resins. The highly competitive market environment meant that Deswell had to absorb many of these increases itself, creating a direct impact on the bottom line of the Plastics Division.

Plastic Injection Molding

Deswell’s core operation, plastic injection molding, increased the percentage of its contribution to the Company’s total sales in the year ended March 31, 2009. For the year, plastic injection molding accounted for 55.7% of total sales, up from 40.9% in 2008 and 43.5% in 2007. This rise was partly a reflection of the contribution from the Company’s electronics division, which was lower than in recent years. However, it was also a result of a stronger customer base, which has been boosted by the installation in 2007 of a new clean room enabling the manufacture of more complex and sophisticated plastic components.

Mold Design and Production Deswell’s mold design and production division uses major tooling software to design a wide range of differently-sized molds tailored to the needs of clients. The division then manufactures the molds on various mold-making machines, including advanced Makino tooling machines, numerical control (NC) and graphite computer numerical control (CNC) milling machines, vertical machining centers, and electrical discharge machines (EDMs). As at March 31, 2009, the Company operated 30 EDMs, 32 CNC milling machines and 83 NC milling machines. Its molds weigh between 110 and 17,600 pounds, and range in price from as little as $2,000 to more than $200,000. In the year under review, the Company averaged production of between 50 and 60 different molds each month. The Company’s small Export Mold Division deals exclusively in the manufacture of large-scale molds that are shipped directly to overseas customers.

Plastic Injection Deswell’s state-of-the-art Dongguan plant has been fully operational since 2007, and currently provides the Company with 1,070,000 square feet of manufacturing space and 133,000 square feet of office space. Equipped with advanced injection molding machinery and equipment, at the end of the year under review the facility housed approximately 430 injection molding machines ranging from 22 to 1,600 tons of clamping force, with most machines within the 55 to 380 ton range. Amongst these machines are 38 double-injection molding machines which can inject two different color plastics into a mold, and produce brand labels, key caps and buttons for telecommunications products. The Company is continually adding equipment to expand its injection molding capabilities. In the 2009 fiscal year, it invested $1.7 million in various injection machines, comparable to the $1.6 million it spent in 2008 and the $2.2 million in 2007.

Electronic Products and Assemblies
Deswell’s electronics and metallics division is located at a facility in Chang An, Dongguan, owned by the Company. The site contains factory buildings and dormitories covering 420,000 square feet, and an extra 244,000 square feet of land. For the year ended March 31, 2009, this division accounted for 43.4% of the Company’s total sales [56.7% in 2008, and 54.8% in 2007].

The slow economic conditions over the past year meant that Deswell’s electronics division had to work hard to maintain its market position and client base. Amongst other initiatives, it made extra efforts to consolidate and expand its relationships with high-end professional audio companies. This led to the introduction during the year of new state-of-the art digital audio products, including a sophisticated digital mixing console for use in live concert performances.

Deswell’s electronics division manufactures professional audio equipment, including digital audio workstations, digital and analogue mixing consoles, instrument amplifiers, signal processors, firewire/USB audio interfaces, keyboard controllers and synthesizers. It also produces a range of business communication equipment such as digital system keysets and IP phones, together with surveillance products such as CCTV matrix switchers/controllers.

Metal Parts Manufacturing
Deswell’s metal parts manufacturing operation is situated alongside its electronic products assembly facilities. This division manufactures metallic molds and metal accessory parts for use in audio equipment, telephones, copying machines, racks for routers, pay-phones and automatic teller machines. Sales for the 2009 fiscal year accounted for 0.9% of Deswell’s total sales (2008: 2.4% and 2007: 1.9%).

Distribution Business
The Company’s audio equipment distribution business marked its fourth anniversary in January 2009. This small division continued to improve its distribution networks, and has gradually become better known in this specialized field. With a focus on providing quality equipment and ultra-reliable services, the division is in a solid position for achieving modest future growth.

Quality Control
The Company’s comprehensive testing and checking system has continued to help it maintain world-class quality standards in the year under review. It operates a system of hourly checks on machines and molds, careful inspection of all incoming components, regular checking of work in progress, and stringent pre-shipping quality assurance inspections. Another policy that helps Deswell minimize its scrap rates is its regular upgrading or replacement of key equipment, which reduces defects caused by old or faulty machinery. As a result, for the three years ended March 31, 2009, aggregate returns from all segments of Deswell’s business operations have amounted to less than 3% of total net sales.

Deswell also holds various ISO accreditations that testify to its strict international quality management standards. These include:

• ISO14001: electronics and metallics manufacturing plant (2006)
• ISO14001: Dongguan plastic injection manufacturing plant (2004)
• ISO9001: plastic and electronic products manufacturing operations (1995)
• ISO9002: metal parts manufacturing operation (2000)
• ISO/TS 16949: Dongguan plastic injection molding manufacturing plant (2006).

Raw Materials, Component Parts and Suppliers
The Company used 22,100,000 pounds of plastic resin for the manufacture of its plastic products in the year ended March 31, 2009, a significant rise from the 14,200,000 pounds used in fiscal 2008. Deswell sources its plastic resins from regional suppliers on the basis of price competitiveness, and holds inventory sufficient for two to three months’ manufacture. Most of the plastic resins sourced by Deswell originate from the United States, Malaysia, Singapore, Taiwan, Japan and Hong Kong.

Plastic resin prices tend to fluctuate in response to natural gas and crude oil prices and related factors of supply and demand for resins and the petrochemical intermediates from which they are produced. Increases in resin prices are often difficult to pass on to customers, and in the year under review this had an adverse impact on the Company’s profit margins.

Other raw materials purchased by the Company include component parts and supplies for its electronics division, and small quantities of raw metal for manufacturing metallic molds and parts.

Customers and Marketing
The Company continues mainly to serve OEM and contract manufacturer customers, located in Asia (Hong Kong, Thailand and China), North America (the United States and Canada) and Europe (Germany, the United Kingdom, Holland and Norway).

In the year under review net sales to China recorded a significant increase, as shown in the table below recording net sales by geographic area (based on customer shipping destinations) as a percentage of total sales to customers over the past three years:

Geographic Areas		2007	2008	2009
	United States	42.4%	46.8%	32.0%
	China	39.2%	37.0%	52.8%
	Europe	11.2%	10.7%	12.4%
	Hong Kong	3.4%	1.7%	1.3%
	Others	3.8%	3.8%	1.5%
	Total	100%	100%	100%

Capital Expenditures
The principal capital expenditures and divestitures made by Deswell during the three years ended March 31, 2009 are as follows:

The main capital expenditure over the past year has been for the purchase of new plastic injection molding machinery to maintain the Company’s plastic injection molding plant in Dongguan at a high level of capability. Money has also continued to be spent on the ongoing fit-out of the Dongguan premises, along with office equipment and computers. The Company continues to maintain a strong cash position, and it is able to finance most of its capital expenditure from internally generated funds.

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