INTRODUCTION

This Annual Report on Form 20-F contains forward-looking statements. These statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those anticipated in the forward-looking statements. Factors that might cause such a difference include, but are not limited to those discussed in the section entitled Risk Factors under Item 3. –— Key Information.

Readers should not place undue reliance on forward-looking statements, which reflect management’s view only as of the date of this Report. The Company undertakes no obligation to revise these forward-looking statements to reflect subsequent events or circumstances. Readers should also carefully review the risk factors described in other documents the Company files from time to time with the Securities and Exchange Commission.

Except where the context otherwise requires and for purposes of this Annual Report only:

	•		“we,” “us,” “our company,” “our,” the “Company” or “Deswell” refers to Deswell Industries, Inc. and, in the context of describing our operations, also include our operating subsidiaries;

	•		“shares” refer to our common shares, no par value;

	•		“China” or “PRC” refers to the People’s Republic of China, excluding Taiwan, Hong Kong and Macao;

	•		“Hong Kong” refers to the Hong Kong Special Administrative Region of the People’s Republic of China;

	•		“Macao” refers to the Macao Special Administrative Region of the People’s Republic of ~~China,~~China;

	•		all references to “renminbi,” “RMB” or yuan are to the legal currency of China, of which yuan is the base unit;

	•		all references to “HK dollars” or “HK$” are to the legal currency of Hong ~~Kong.~~Kong; and

	•		all references to “U.S. dollars,” “dollars”, “$” or “US$” are to the legal currency of the United States.

FINANCIAL STATEMENTS AND CURRENCY PRESENTATION

The Company prepares its consolidated financial statements in accordance with generally accepted accounting principles in the United States of America and publishes such statements in United States dollars. See “Report of Independent Registered Public Accounting Firm” included elsewhere herein. The Company publishes its financial statements in United States dollars as the Company is incorporated in the British Virgin Islands, where the currency is the U.S. dollar, and the functional currency of the Company’s subsidiaries are Hong Kong dollar and Chinese RMB.

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

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, ~~2007,~~2009, and the balance sheet data as of March 31, ~~2006~~2008 and ~~2007~~2009 are derived from our audited consolidated financial statements included in this Report. The selected income statement data for the years ended March 31, ~~2003~~2005 and ~~2004,~~2006, and the balance sheet data as of March 31, ~~2003, 2004~~2005, 2006 and ~~2005~~2007 are derived from our audited consolidated financial statements, which are not included in this Report.

Selected Financial Data (1)⁽¹⁾


																(in thousands except per share data)
																Year ended March 31,
	(in thousands except per share data)															2005			2006			2007			2008			2009
Income Statement Data:	Year ended March 31,
	2003			2004			2005			2006			2007
Net sales	$	90,905		$	97,195		$	125,590		$	115,276		$	136,779		$	125,590		$	115,276		$	136,779		$	143,806		$	131,738
Cost of sales		61,006			66,105			92,072			89,850			105,506			92,072			89,850			105,506			117,373			111,570

Gross profit		29,899			31,090			33,518			25,426			31,273			33,518			25,426			31,273			26,433			20,168
Selling, general and administrative expenses		15,354			14,718			15,759			15,052			18,957			15,759			15,052			18,957			19,601			19,291
Other income (expenses), net		496			90			(106	)		(823	)		1,376			(106	)		(823	)		1,376			1,838			(132	)

Operating income (4)		15,041			16,462			17,653			9,551			13,692			17,653			9,551			13,692			8,670			745
Interest expense		(6	)		(16	)		(12	)		(6	)		—			(12	)		(6	)		—			—			—
Non-operating income (expenses), net		322			820			448			447			547			448			447			547			521			168

Income before income taxes		15,357			17,266			18,089			9,992			14,239			18,089			9,992			14,239			9,191			913
Income taxes		3,826			589			576			(27	)		1,239			576			(27	)		1,239			104			(282	)

Income before minority interests		11,531			16,677			17,513			10,019			13,000			17,513			10,019			13,000			9,087			1,195
Minority interests		1,288			1,957			2,330			1,240			833			2,330			1,240			833			228			—

Net income	$	10,243		$	14,720		$	15,183		$	8,779		$	12,167		$	15,183		$	8,779		$	12,167		$	8,859		$	1,195
Basic earnings per share (2)(3)	$	0.79		$	1.08		$	1.04		$	0.59		$	0.81		$	1.04		$	0.59		$	0.81		$	0.57		$	0.08
Average number of shares outstanding—basic (2)(3)		13,008			13,664			14,656			14,908			14,956			14,656			14,908			14,956			15,517			15,791
Diluted earnings per share (3)	$	0.77		$	1.04		$	1.02		$	0.59		$	0.81		$	1.02		$	0.59		$	0.81		$	0.57		$	0.08
Average number of shares outstanding—diluted (2)(3)		13,278			14,160			14,933			14,936			15,048			14,933			14,936			15,048			15,566			15,805

Statistical Data:
Gross margin		32.9	%		32.0	%		26.7	%		22.1	%		22.9	%		26.7	%		22.1	%		22.9	%		18.4	%		15.3	%
Operating margin (4)		16.5	%		16.9	%		14.1	%		8.3	%		10.0	%		14.1	%		8.3	%		10.0	%		6.0	%		0.6	%
Dividends per share (3)	$	0.51		$	0.63		$	0.65		$	0.63		$	0.65		$	0.65		$	0.63		$	0.65		$	0.61		$	0.24

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 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. These risks have become particularly acute in the current adverse economic environment.

Historically, a substantial percentage of our sales have been to a small number of customers. Customers that individually accounted for ten percent or more of our net sales during the years ended March 31, 2007, 2008 and 2009, accounted for 51.5%, 53.3%, and 41.3%, respectively, of our total net sales during those years. Our two largest customers during the year ended March 31, 2009 accounting for ten percent or more were N&J Company Limited and Digidesign Inc. Each of these customers individually accounted for 10% or more of our total net sales during the year ended March 31, 2009.

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. Current economic conditions have had a negative impact on our results of operations during fiscal 2009 and are expected to continue to have a negative impact on our operations over the next several quarters and possibly beyond. We cannot assure you that present or future customers will not cease using us as the source of the injection-molded plastic parts and components we manufacture, for electronic manufacturing services of electrical products and subassemblies or for metallic molds and accessories or significantly change, reduce or delay the amount of products and services ordered from us. Substantial decreases in sales from any of our larger customers, or the loss of any major customers, would adversely impact our sales and financial performance. For example, two of our customers, which accounted for more than ten percent of our total net sales during fiscal 2008, each reduced the volume of their orders during the year ended March 31, 2009 to below ten percent of our total sales. In addition, another major customer, which accounted for 17.0% of our total net sales during fiscal 2008, reduced the volume of its orders during the year ended March 31, 2009 to 12.7% of our total sales. These reductions in sales to our major customers contributed to the decrease in our total sales during fiscal 2009 as compared to fiscal 2008.

The global economic weakness has adversely affected our earnings, liquidity and financial condition and, until global economic conditions improve, is expected to continue to do so.

Global financial and credit markets have been, and continue to be, extremely unstable and unpredictable. Worldwide economic conditions have been weak and may be further deteriorating. The instability of the markets and weakness of the global economy has adversely affected, and could continue to effect adversely, the demand for our customers’ products, the amount, timing and stability of their orders to us, the financial strength of our customers and suppliers, their ability or willingness to do business with us, our willingness to do business with them, and/or our suppliers’ and customers’ ability to fulfill their obligations to us and/or the ability of our customers, our suppliers or us to obtain credit. These factors have and could continue to affect our operations, earnings and financial condition adversely. This instability also could affect the prices at which we could make any such sales, which also could adversely affect our earnings and financial condition. These conditions could also negatively affect our ability to secure funds or raise capital, if needed.

Our exposure to financially troubled customers or suppliers may adversely affect our financial results.

We manufacture and sell injection-molded plastic parts and components and provide manufacturing services for electrical products and subassemblies to companies and industries that have in the past, and may in the future, experience financial difficulty, particularly in light of conditions in the credit markets and the overall worldwide economy. Our suppliers may also experience financial difficulty in this environment. If our customers experience financial difficulty, we could have difficulty recovering amounts owed to us from these customers, or demand for our products and services from these customers could decline. Additionally, if our suppliers experience

financial difficulty we could have difficulty sourcing supply necessary to fulfill production requirements and meet scheduled shipments. The current global financial crisis is continuing to adversely affect our customers’ and suppliers’ access to capital and liquidity. If one or more of our customers were to become insolvent or otherwise were unable to pay for the products or services provided by us on a timely basis, or at all, our operating results and financial condition could be adversely affected. Such adverse effects could include one or more of the following: a provision for doubtful accounts, a charge for inventory write-offs, a reduction in revenue, and increases in working capital requirements due to increases in days in inventory and increases in days in accounts receivable. For the year ended March 31, 2009, we recognized approximately $3.0 million in charges for provisions of accounts receivable, the write-down of inventory and recognition of related obligations for certain financially distressed customers.

Our gross margins fluctuate from year to year and may be adversely affected by a number of factors.

The following chart shows, for the years indicated, our gross margins from our two principal operating segments and for our company as a whole:

Gross Margins Percentage

Fluctuations in our margins have been affected, often adversely, and may continue to be affected, by numerous factors, including:

	•		increasing competition in our market segments, which has forced us to maintain or reduce unit prices or attempt to pass on our costs of materials and components on to customers;

	•		costs of labor, particularly in recent years, which such costs have increased substantially as consequence of increasing governmental regulation directed at labor practices and policies;

	•		continuing appreciation of the RMB, in which we pay our labor and manufacturing costs, against the U.S. dollar, in which we present our financial statements;

	•		our cost of raw materials, especially our cost of plastic resins;

	•		changes in the prices or the availability of components needed to manufacture our electronic products;

	•		changes in our customer mix or the mix of higher and lower margin products, or a combination of both in any year;

	•		increases in value-added taxes as result of changes in the value-added tax policy of the Chinese government for various categories of export products; and

	•		increased costs of conforming our products to consumer and product safety laws and regulations of the various countries in which our products are sold.

We expect gross margins generally and for specific products to continue to fluctuate from year to year. As a result of the confluence of above-factors, as well as the overall decline in our sales caused by the global recession, our gross margins declined substantially in the year ended March 31, 2009 from levels during fiscal 2008. Our gross margins may continue to decline. If we cannot stem the decline in our gross margins, our operating results would suffer, dividend payments to shareholders may be decreased or eliminated, our financial position may be harmed and our stock price may fall.

If OEMs stop or reduce their manufacturing outsourcing, our business could suffer.

Our revenues depend on outsourcing by OEMs to us and to other contract manufactures for which we manufacture end-products or parts and components. Current and prospective customers continuously evaluate our capabilities against other providers as well as against the merits of manufacturing products themselves. Our business would be adversely affected if OEMs decide to perform these functions internally. Similarly, we depend on new outsourcing opportunities to mitigate against lost revenues arising from the decline in demand for our customers’ products as a consequence of the current global economic slowdown, and our business would be adversely affected if we are not successful in gaining additional business from these opportunities or if OEMs do not outsource additional manufacturing business.

Our industry is extremely competitive, with aggressive pricing dynamics, and; if we are not able to continue to provide competitive products and services, we may lose business.

We compete with a number of different companies in producing of injection-molded plastic parts and components, electrical products and subassemblies and metallic molds and accessories. For example, we compete with Asian-based suppliers of injection-molded plastic parts and components, major global electronic manufacturing services, or EMS, providers, other smaller EMS companies that have a regional or product-specific focus, and original design manufacturers with respect to some of the services that we provide. We also compete with our current and prospective customers, who evaluate our capabilities in light of their own capabilities and cost structures. Our market segments are extremely competitive, many of our competitors have achieved substantial market share and many have lower cost structures and greater manufacturing, financial or other resources than we do. We face ~~numerous risks~~particular competition from Asian-based competitors, including Taiwanese EMS providers which compete in our end markets. If we are unable to provide comparable manufacturing services and improved products at lower cost than the other companies in our market, our net sales could decline.

The current global economic crisis may also increase the competitive environment in our market segments which could also impact our operating results. In addition, the EMS industry is currently experiencing excess manufacturing capacity and has seen increased competition. These factors have exerted and will continue to exert additional pressures on pricing for injection-molded plastic parts and components and for our electronic manufacturing services, thereby increasing the competitive pressures in our market segments generally. We may not be able to compete successfully against our current and future competitors, and the competitive pressures we face may have a material adverse effect on us.

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, 2007, 2008 and 2009:

Year ended March 31, 2009
Average cost of ABS as a percentage of the total cost of: 2007 2008 2009
Plastic products sold 52 % 46 % 45 %
Goods sold 20 % 17 % 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 have no written agreements with suppliers to obtain components and our profit margins and net income could suffer from an increase in component prices and our results of operations could suffer from shortages of required electronic components.

We have no written agreements with our component suppliers and for certain customers, we are responsible for purchasing components used in ~~China.~~manufacturing their products. This could result in our bearing the risk of component price increases because we may be unable to procure the required materials at a price level necessary to generate anticipated margins. Accordingly, our financial performance could be materially or adversely affected by any increase in component prices.

From time to time, we have experienced shortages of some of the electronic components that we need and use in our electronics manufacturing market segment. These shortages can result from strong demand for those components or from problems experienced by suppliers. These unanticipated component shortages could result in curtailed production or delays in production, which may prevent us from making scheduled shipments to customers. Our inability to make scheduled shipments could cause us to experience a reduction in sales, increase in inventory levels and costs, and could adversely affect relationships with existing and prospective customers. Component shortages may also increase our cost of goods sold because we may be required to pay higher prices for components in short supply and redesign or reconfigure products to accommodate substitute components. As a result, component shortages could adversely affect our operating results. Our performance depends, in part, on our ability to incorporate changes in component costs into the selling prices for our products.

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.

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.~~

China. Over the past several years, the Chinese government has pursued economic reform policies including the encouragement of private economic activity and greater economic decentralization. The Chinese government may not continue to pursue these policies or may significantly alter them to our detriment from time to time without notice. Changes in policies by the Chinese government resulting in changes in laws, regulations, or their interpretation, or the imposition of confiscatory taxation, restrictions on currency conversion or imports and sources of supply could materially and adversely affect us. The nationalization or other expropriation of private enterprises by the Chinese government could result in the total loss of our investment in that country.

There may be a lack of remedies and impartiality under the Chinese legal system that prevents us from enforcing the agreements under which we operate our factories.

We do not own the land on which our factories in China are located. We occupy our manufacturing facilities under land use agreements or under tenancy agreements with the local Chinese government. These agreements may be difficult to enforce in China, which could force us to accept terms that may not be as favorable as those provided in our agreements. Unlike the U.S., China has a civil law system based on written statutes in which judicial decisions have little precedential value. The Chinese government has enacted some laws and regulations dealing with matters such as corporate organization and governance, foreign investment, commerce, taxation and trade. However, their experience in implementing, interpreting and enforcing these laws and regulations is limited, and our ability to enforce commercial claims or to resolve commercial disputes is unpredictable. These matters may be subject to the exercise of considerable discretion by agencies of the Chinese government, and forces unrelated to the legal merits of a particular matter or dispute may influence their determination.

If our business licenses in China were not renewed, we would be required to move our operations out of China, which would impair our profitability, competitiveness and market position and jeopardize our ability to continue operations.

Our activities in China require business ~~licenses. This requires a~~licenses, the scope of which is limited to our present activities, and require 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, grant or renew our licenses or grant or renew licenses to expand our ~~licenses.~~existing activities. Our inability to obtain needed approvals or licenses could prevent us from continuing to conduct operations in China. If for any reason we were required to move our manufacturing operations

outside of China, our profitability would be substantially impaired, our competitiveness and market position would be materially jeopardized and we may not be able to continue operations.

~~A fire, severe weather, flood,~~Our insurance coverage may not be adequate to cover loss related to major accidents or ~~other act~~acts of ~~God could cause significant damage to our properties in China and disrupt our business operations.~~God.

Firefighting and disaster relief or assistance in China are primitive by Western standards. At March 31, ~~2007,~~2009, we maintained fire, casualty and theft insurance aggregating approximately ~~$59,151,000~~ $145,509,000covering 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 in the future, such as the recent earthquake that has devastated areas in Sichuan province in China, the epicenter of which is about 800 to 900 miles from Dongguan, China, or other cause. We do not maintain any business interruption insurance.

We may be faced with product liability claims and have no product liability insurance.

Despite quality assurance measures, there remains a risk that defects may occur in our products. The occurrence of any defects in our products could give rise to liability for damages caused by such defects. They could, moreover, impair the market’s acceptance of our products. At March 31, 2009, we did not maintain any product liability insurance. Although we have not experienced any product quality claims from our major customers, if future claims do arise, costs to defend, adverse judgments or amounts we may be forced to pay in settlement would increase our expenses. Damages to our reputation resulting from such claim(s) could cause our customers to use other vendors which would hurt our revenues.

Payment of dividends by our subsidiaries in the PRC to us is subject to restrictions under PRC law. The new PRC tax law could force us to reduce the amount of dividends we have historically paid to our shareholders or possibly eliminate them or we may decide not pay dividends in the future.

Under PRC law, dividends may be paid only out of distributable profits. Distributable profits with respect to our subsidiaries in the PRC refers to after-tax profits as determined in accordance with accounting principles and financial regulations applicable to PRC enterprises (“China GAAP”) less any recovery of accumulated losses and allocations to statutory funds that it is required to make. Any distributable profits that are not distributed in a given year are retained and available for distribution in subsequent years. The calculation of distributable profits under China GAAP differs in many respects from the calculation under U.S. GAAP. As a result, our subsidiaries in PRC may not be able to pay any dividend in a given year as determined under U.S. GAAP. The China’s tax authorities may require changes in determining income of the Company that would limit its ability to pay dividends and make other distributions. PRC law requires companies, including our PRC subsidiaries, to reserve about 11% of their profits for future development and staff welfare, which amounts are not distributable as dividends. These rules and possible changes to them could restrict our PRC subsidiaries from repatriating funds ultimately to us and our stockholders as dividends.

Prior to the new unified enterprise income tax (“EIT”) law which became effective in China on January 1, 2008, PRC-organized companies were exempt from withholding taxes with respect to earnings distributions, or dividends, paid to shareholders of PRC companies outside the PRC, such as was the case when our PRC subsidiaries distributed portions of their earnings to our offshore subsidiaries. However, under the new EIT Law, dividends payable to foreign investors which are derived from sources within the PRC are subject to income tax at the rate of 10% by way of withholding unless the foreign investors are companies incorporated in countries which have a tax treaty agreement with PRC and rate agreed by both parties will be applied. As a result of this new PRC withholding tax, amounts available to us in earnings distributions from our PRC enterprises have been reduced. Since we derive most of our profits from our subsidiaries in the PRC, the reduction in amounts available for distribution from our PRC enterprises could, depending on the income generated by our PRC subsidiaries, force us to reduce, or possibly eliminate, the dividends we have paid to our shareholders historically. For this reason, or other factors, we may decide not to declare dividends in the future. If we do pay dividends, we will determine the amounts when they are declared and even if we do declare dividends in the future, we may not continue them in any future period.

Under the new EIT Law, we may be classified as a “resident enterprise” for PRC tax purposes, which may subject us to PRC enterprise income tax for any dividends we receive from our Chinese subsidiaries and to PRC income tax withholding for any dividends we pay to our non-PRC stockholders.

Under the PRC’s new EIT Law, an enterprise established outside of China whose “de facto management bodies” are located in China is considered a “resident enterprise” and is subject to the 25% enterprise income tax

~~Possible changes~~rate on its worldwide income. The new EIT Law and ~~uncertainties in economic policies~~its implementing rules are relatively new, and currently, no official interpretation or application of this new “resident enterprise” classification is available. Therefore, it is unclear how tax authorities will determine the tax residency of enterprises established outside of China.

All of our manufacturing operations are conducted and managed in the ~~Special Economic Zones~~PRC. Our corporate structure, illustrating our incorporation in British Virgin Islands and our ownership of companies inside and outside of China, ~~in which~~is set forth on page 17 of this Report. If the PRC tax authorities determine that our holding company structure utilizing companies outside of China is a “resident enterprise” for PRC enterprise income tax purposes, 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.

~~We are~~may be subject to ~~the risk of increased income and other taxes in China.~~

~~Deswell has enjoyed preferential tax concessions in the PRC as a high-tech~~an enterprise ~~and has benefited from favorable overall effective income tax rates of 3.2%, 0.27% and 8.7 % for the years ended March 31, 2005, 2006 and 2007, respectively.~~

~~In March 2007, China enacted the PRC Enterprise Income Tax Law, or EIT Law, under which, effective January 1, 2008, China will adopt a uniform~~ income tax rate of ~~25.0% for all enterprises (including foreign-invested enterprises)~~25% on our worldwide taxable income. The “resident enterprise” classification also could subject us to a 10% withholding tax on any dividends we pay to our non-PRC stockholders if the relevant PRC authorities determine that such income is PRC-sourced income. In addition to the uncertainties regarding the interpretation and cancel several tax incentives enjoyed previously by foreign-invested enterprises such as Deswell. However, for foreign-invested enterprises like Deswell that were established before the promulgation of the EIT Law, a five-year transition period is provided during which reduced income tax rates will apply but gradually be phased out. Since the PRC government has not announced implementation measures for the transitional policy concerning such preferential tax rates, we cannot at this time reasonably estimate the financial impactapplication of the new ~~tax law on Deswell or to us at this time.~~

~~The~~“resident enterprise” classification, the new EIT Law ~~further includes provisions relating to withholding on interest, royalties, dividends or other passive income, including dividend payments from companies~~may change in the ~~PRC like Deswell.~~

Wefuture, possibly with retroactive effect. If we are ~~in the process of analyzing EIT Law to determine,~~classified as a “resident enterprise” and ~~whether by, and the feasibility of, changing Deswell’s corporate structure,~~ we ~~can reduce the impact of the new PRC enterprise~~incur these tax law. However, there may be no solution, and if there is one, it may be short-lived. It currently appears that the EIT Law and its associated new income tax rates and withholding provisions will reduce Deswell’s after-taxliabilities, our net income ~~for distribution to us from our China subsidiaries.~~would decrease accordingly.

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. For example, in the six months ended September 30, 2005, we recorded a provision of approximately $1 million for doubtful sales transactions, consisting of orders primarily from three customers for products of the metallic parts division of our electronic & metallic parts business segment that had been shown as shipped to, and received by, the customers but in fact had been surreptitiously cancelled without shipment. Documentation reflecting the cancellation of the orders was uncovered following the departure of the General Manager of the Company’s metallic parts division who, with the assistance of a Production and Materials Control Supervisor in that division (who since left Deswell), had previously concealed such documentation. We could suffer additional losses from similar or other fraudulent 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. This risk has increased in recent years as our sales into the United States have accounted for increasing amounts of our global sales, culminating with our year ended March 31, 2007, when, for the first time, the United States became the largest geographic market for our products.

Changes in currency rates involving the RMB implemented in July 2005 have increased our expenses since they were implemented. Changes in currency rates involving the Hong Kong dollar could increase our expenses or cause economic or political problems affecting our business. ~~Changes in currency rates involving the RMB implemented in July 2005 increased our expenses in the year ended March 31, 2007.~~

Our sales are mainly in United States dollars and Hong Kong dollars and our expenses are mainly in United States dollars, Hong Kong dollars and Chinese RMB. The Chinese government may not continue to maintain the present currency exchange mechanism, which fixes the Hong Kong dollar at approximately the range of 7.78 to 7.80 to each United States dollar and has not in the past presented a currency exchange risk. ~~This could change~~Although an announcement in May 2009 by the Chief Executive of the Hong Kong Monetary Authority indicated that he does not expect changes in the currency peg between the Hong Kong dollar and the U.S. dollar in the near future, if ~~those in~~ Hong Kong ~~arguing for~~does change if Hong Kong follows China to a floating currency system ~~prevail in~~or otherwise changes the ~~ongoing debate over whether to continue to peg the~~exchange rate system of Hong Kong dollars to the U.S. dollars. ~~For approximately three~~

Approximately 46.6%, 48.7% and 35.1% of our total costs and expenses were in RMB during the years ~~prior to~~ended March 31, 2007, 2008 and 2009, respectively. Between 1994 and July 2005, the ~~exchange rate between the Chinese currency, the renminbi,~~market and official RMB rates were unified and the value of the RMB was essentially pegged to the U.S. ~~dollars varied by less than one-tenth of one percent. However, on~~dollar and was relatively stable. On July 21, 2005, the People’s Bank of China adjusted the exchange rate of RMB to the U.S. dollar by linking the RMB to a basket of currencies and simultaneously setting the exchange rate of RMB to U.S. dollars, ~~to RMB~~ from 1:8.27, to a narrow band of around 1:8.11, resulting in an ~~approximately 2%~~approximate 2.4% appreciation in the value of the RMB against the

U.S. ~~dollar. As a result,~~dollars at the end of calendar 2005 from July 21, 2005. For the calendar years 2006, 2007 and 2008, there were approximately 3.3%, 6.4% and 6.6% further appreciation in ~~addition to increases in~~each respective year. In our plastic resin and labor costs, our operating costs increased from levels in 2005 and 2006. Since we were not able to pass most of these cost increases on to our customers by increasing sales prices of our products, our gross margins, operating income and net income were adversely affected in thefiscal year ended March 31, ~~2007. If~~2009, the ~~Chinese government allows~~RMB appreciated from 1:7.01 at March 31, 2008 to 1:6.83 at March 31, 2009, a ~~further~~difference of 2.5%, to the U.S. dollar, resulting in an increase in our total costs and ~~significant~~expenses of approximately 1.2% as compared to our fiscal year ended March 31, 2008.

The following chart illustrates the appreciation of the RMB to the US dollar from July 21, 2005 by showing the exchange ratio at the end of each quarter beginning on July 21, 2005 to March 31, 2009.


(1)		RMB (yuan) to US dollar data presented in this chart were derived from the historical currency converter available at http://forex-history.net.

(2)		If the end of a quarter fell on a Saturday or Sunday, datum is provided as of the previous Friday.

At June 30, 2009, the exchange ratio of RMB to the US dollar was 1:6.831. The percentage difference between the exchange ratio of RMB to the US dollar at June 30, 2008 and at June 30, 2009 was 0.3%, slight when compared to percentage changes during various prior periods since July 25, 2005. However, because of the prevailing global economic recession, it is uncertain whether the relatively slight appreciation ~~and there are indications that~~experienced during the ~~Chinese government has accelerated~~twelve months ended June 30, 2009 can be expected to continue following an economic recovery. In any event, if the ~~RMB’s~~RMB continues its appreciation to the U.S. dollar, ~~with it reaching 7.5712:1 on July 20, 2007,~~ our operating costs ~~could~~would further increase and ~~could further adversely affect~~ our financial ~~results.~~results would be adversely affected.

If we determined to pass onto our customers through price increases the effect of increases in the RMB relative to the U.S. dollars, it would make our products more expensive in global markets, such as the United States and the European Union. This could result in the loss of customers, who may seek, and be able to obtain, products and services comparable to those we offer in lower-cost regions of the world. If we did not increase our prices to pass on the effect of increases in the RMB relative to the U.S. dollars, our margins and profitability would suffer.

~~Any~~Restrictions on the convertibility of RMB into foreign currency may limit our ability to transfer excess funds or dividends to the company’s subsidiaries outside China.

Our manufacturing operations are conducted by our subsidiaries located in China and funds are frequently transferred into our subsidiaries in China. Thus, any future ~~outbreak~~restrictions on currency exchanges may limit our ability to transfer excess funds or dividends outside China. Although the PRC government introduced regulations in 1996 to allow greater convertibility of RMB for current account transactions, significant restrictions still remain, including primarily the restriction that foreign-invested enterprises may only buy, sell and/or remit foreign currencies at those banks authorized to conduct foreign exchange business after providing valid commercial documents. The Chinese regulatory authorities may impose more stringent restrictions on the convertibility of RMB, especially with respect to foreign exchange transactions.

We face risks related to health epidemics and other outbreaks that may disrupt our operations and have a material adverse effect on our business and results of operations.

Our business could be materially and adversely affected by the effects of swine flu, avian flu, severe acute respiratory syndrome or other ~~diseases may have~~epidemics or outbreaks. In April 2009, an outbreak of H1N1 flu, a ~~negative impact on our business~~new strain of influenza virus, commonly referred to as “swine flu” by the media, first occurred in Mexico and ~~operating results.~~

quickly spread to other countries, including the U.S. and China. In the ~~first calendar quarter of 2003, several economies in Asia, including Hong Kong, where our logistic support office and some of our customers are located, and southern~~last decade, China ~~where our factories are located, were affected by~~has suffered health epidemics related to the outbreak of avian influenza and severe acute respiratory syndrome. Any prolonged occurrence or recurrence of swine flu, avian flu, severe acute respiratory syndrome or ~~SARS. If there is~~other adverse public health developments in China may have a ~~recurrence of an outbreak of SARS, it may adversely affect~~material adverse effect on our business and ~~operating results. For example, a future SARS outbreak~~operations. These health epidemics could result in ~~quarantines~~ severe travel restrictions and closures that would restrict our ability to ship our products. Potential outbreaks could also lead to temporary closure of our manufacturing facilities, our suppliers’ facilities and/or ~~closure~~our end-user customers’ facilities, leading to reduced production, delayed or cancelled orders, and decrease in demand for our ~~office in Hong Kong~~products. Any future health epidemic or ~~factories in China if~~outbreaks that could disrupt our ~~employees are infected with SARS and ongoing concerns regarding SARS, particularly its~~operations and/or restrict our shipping abilities may have a material adverse effect on ~~travel, could negatively impact our customers and suppliers based in Hong Kong or China and~~ our business and ~~operating results.~~

~~In addition, there has recently been an outbreak~~results of avian influenza in humans in Asian countries, including Vietnam, South Korea and Japan, which has proven fatal in some instances. As the human death toll continues to grow, many are concerned that the virus will mutate and trigger a human pandemic. If such an outbreak were to spread to southern China, it may adversely affect our business operating results.operations.

Political and economic instability of Hong Kong and Macao could harm our operations.

Our administration and accounting office are located in Macao, formerly a Portuguese Colony and some of our customers and suppliers are located in Hong Kong, formerly a British Crown Colony. Sovereignty over Macao and Hong Kong was transferred to China effective on December 20, 1999 and July 1, 1997, respectively. Since their transfers, Macao and Hong Kong have become Special Administrative Regions of China, enjoying a high degree of autonomy except for foreign and defense affairs. Moreover, China’s political system and policies are not practiced in Macao or Hong Kong. Under the principle of “one country, two systems,” Macao and Hong Kong maintain legal systems that are different from that of China. Macao’s legal system is based on the Basic Law of the Macao Special Administrative Region and, similarly, Hong Kong’s legal system is based on the Basic Law of the Hong Kong Special Administrative Region. It is generally acknowledged as an open question whether Hong Kong’s future prosperity in its role as a hub and gateway to China after China’s accession to the World Trade Organization (introducing market liberalization in China) will be diminished. The continued stability of political, economic or commercial conditions in Macao and Hong Kong remain uncertain, and any instability could have an adverse impact on our business.

~~A recent~~Recent changes in the PRC’s labor ~~shortage~~law restrict our ability to reduce our workforce in ~~southern China could adversely affect our gross margins or decrease revenue.~~the event of an economic downturn.

~~The Company carries out all of its manufacturing operations in Southern China, where it has been able to take advantage~~In June 2007, the National People’s Congress of the ~~lower overhead costs~~PRC enacted new labor law legislation called the Labor Contract Law, which became effective on January 1, 2008. It formalizes workers’ rights concerning overtime hours, pensions, layoffs, employment contracts and ~~inexpensive~~the role of trade unions. Considered one of the strictest labor ~~rates~~laws in the world, among other things, this new law requires an employer to conclude an “open-ended employment contract” with any employee who either has worked for the employer for 10 years or more or has had two consecutive fixed-term contracts. An “open-ended employment contract” is in effect a lifetime, permanent contract, which is terminable only in specified circumstances, such as ~~compared~~a material breach of the employer’s rules and regulations, or for a serious dereliction of duty. Such employment contracts with qualifying workers would not be terminable if, for example, Deswell determined to ~~Hong Kong. Historically, there has been~~downsize its workforce in the event of an ~~abundance~~economic downturn. Under the new law, downsizing by 20% or more may occur only under specified circumstances, such as a restructuring undertaken pursuant China’s Enterprise Bankruptcy Law, or where a company suffers serious difficulties in production and/or business operations. Also, if we lay off more than 20 employees or 10% at one time, we have to communicate with the labor union of ~~labor in southern China, but factories in southern China~~our Company and report to the District Labor Bureau. Deswell’s entire staff, who are ~~facing a labor shortage as migrant workers seek better wages and working conditions elsewhere. In an effort~~employed to ~~counter this trend, minimum wages for workers in Southern China were increased during~~work exclusively within the PRC, is covered by the new law. During the year ~~ended~~ending March 31, ~~2007, adversely impacting~~2009, we reduced our ~~gross margins, operating income~~workforce by about 2,000 at March 31, 2009 in response to the current global economic crisis. We may be forced to further downsize the workforce if global economic conditions do not improve or worsen and ~~net income. If~~may incur much higher costs under China’s labor laws if we are forced to do so. Accordingly, this ~~trend continues,~~new law can be expected to exacerbate the ~~Company’s~~adverse effect of the economic environment on Deswell’s results of operations could again be adversely affected. Independent of any regional increases imposed by the government on minimum wages, the Company’s business could also be adversely affected by, for example, having insufficient workers to permit the Company from manufacturing at peak capacity or forcing the Company to increase wages in order to recruit from aand financial condition.

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~~smaller pool of available workers. This could result in lower revenues and/or increased manufacturing costs, which would adversely affect gross margins, operating income and net income.~~

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, 2007 were Digidesign Inc., VTech Telecommunication Ltd., Peavey Electronics Corp. and Line 6 Manufacturing. Each of these customers individually accounted for 10% or more of our total net sales during the year ended March 31, 2007 and accounted for an aggregate of 51.0%, 48.3% and 51.5%, respectively, of our total net sales during the years ended March 31, 2005, 2006 and 2007, 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.~~

Year ended March 31,
2005 2006 2007
Resins cost as a % of plastic products sold 58 % 53 % 52 %
Resins cost as a % of total cost of goods sold 24 % 21 % 20 %

~~We have no written agreements with suppliers to obtain components and our profit margins and net income could suffer from an increase in component prices.~~

We have no written agreements with our component suppliers and for certain customers, we are responsible for purchasing components used in manufacturing their products. This could result in our bearing the risk of component price increases because we may unable to procure the required materials at a price level necessary to generate anticipated margins. Accordingly, our financial performance could be materially or adversely affected by any increase in component prices.

~~We are facing increasing competition, which has had an adverse effect on our gross profit margins.~~

Over the last several years, we have been forced to lower our prices as a result of increasing competition in our market segments, resulting in lower gross profit margins. The following tables shows our gross margins for each of our last four fiscal years and percentage decline from the previous fiscal year for each of last three fiscal years:

March 31
Year ended March 31, 2007 Year ended March 31, 2006 Year ended March 31, 2005 2004
Percentage Percentage Percentage
increase from decline from decline from
Percent previous year Percent previous year Percent previous year Percent
Gross margin 22.9 % 3.6 % 22.1 % (17.2 )% 26.7 % (16.6 )% 32.0 %

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.

Protecting, seeking licenses for or asserting claims over, intellectual property could be costly.

We usually rely on trade secrets, industry expertise and the sharing with us by our customers of their intellectual property. However, there can be no assurance that intellectual property that we use in our business does not violate rights in such property belonging to others. We may be notified that we are infringing patents, copyright or other intellectual property rights owned by other parties. In the event of an infringement claim, we may be required to spend a significant amount of money to develop a non-infringing alternative or to obtain licenses. We may not be successful in developing alternatives or in obtaining licenses on reasonable terms, if at all. Any litigation, even without merit, could result in substantial costs and could adversely affect our business and operating results.

Our strategy has been to evaluate trade names and trademarks, and to consider seeking patents, where we believe that such trade names, trademarks or patents would be available and adequate to protect our rights to products or processes that we consider material to our business. To the extent we do seek to obtain trade names, trademarks or patents, we may be required to institute litigation in order to enforce them or other intellectual property rights to protect our business interests. Such litigation could result in substantial costs and could adversely affect sales, profitability and growth.

We are dependent on customers operating in highly competitive markets and the inability of our customers to succeed in their markets can adversely impact our business, operating results and financial condition.

The end markets we serve can experience major swings in demand which, in turn, can significantly impact our operations. Our financial performance depends on our customers’ ability to compete and succeed in their markets, which, apparently has been, and could continue to be, affected directly by the current global economic conditions. The majority of our customers’ products are characterized by rapid changes in technologies, increased standardization of technologies and shortening of product lifecycles. In many instances, our customers have experienced severe revenue erosion, pricing and margin pressures, and excess inventories during the past few years.

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, ~~2007,~~2009, approximately ~~70.3%~~71.7% 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, China, United Kingdom, Hong Kong, Europe and ~~Hong Kong.~~Southeast Asia. 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 former Chief Executive Officer, who retired from this post in January 2007 , and remains Chairman of our Board of Directors;~~

	•		~~Franki S.F. Tse, our Chief Executive Officer, who in February 2007 succeeded Richard Lau, who remains Chairman of our Board of Directors;~~

	•		~~C. P. Li, our Executive Director, General Manager in charge of manufacturing and administrative operations for plastic products;~~

	•		~~C. W. Leung, Executive Director of Engineering in charge of the mold division and engineering for our plastic manufacturing operations;~~

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	•		~~S. K. Lee, our Director of Administration and Marketing and General Manager in charge of administrative and marketing operations for electronic and metallic products; and~~

	•		~~M. C. Tam, our Director of Engineering and Manufacturing, in charge of manufacturing and operations for electronic and metallic products.~~

~~Mr. Richard Lau, who retired as~~We depend on our ~~Chief Executive Officer in February 2007,~~executive officers, senior managers and ~~Messrs. Li and Leung founded~~skilled personnel. We lost three of our ~~company~~top executives during fiscal 2009 and have ~~each played integral roles~~not yet replaced them, which has increased the pressure and responsibilities on our remaining senior managers.

Our success depends largely upon the continued services of our executive officers as well as upon our ability to attract and retain qualified technical, manufacturing and marketing personnel. During the year ended March 31, 2009, we lost three of our executive officers, two to retirement: Chi Wai Leung, our Executive Director of Engineering for Plastic Operations and Shu Kwan Lee, our Director of Administration and Marketing for Electronic Operations; and the other to an untimely death, Man Chi Tam, our Director of Engineering and Manufacturing for Electronic Operations. We have not yet replaced these executive officers but have divided their duties among other members of our management team, which has increased the responsibilities and pressures on them and made us even more dependent on our remaining managers

Generally, our executive officers and senior managers are not bound by employment or non-competition agreements and we cannot assure you that we will be able retain them. The loss of service of any of these officers or key management personnel could have a material adverse effect on our business and operating results. We maintain no key person insurance on our executive officers. With the loss of three of our executive officers, we need to recruit and retain additional skilled management personnel. The recruitment of skilled executives and managers required to live and work nearly full time in the PRC is difficult and highly competitive. We believe that our future success will depend, in part, on our ability to attract and retain highly skilled executive, technical and management ~~growth~~personnel and ~~development of~~if we are not able to do so, our company in general and our plastic injection molding business in particular. They have developed and maintain relationships with several of our key customers in our plastic injection molding business. Mr. S. K. Lee and Mr. M. C. Tam founded our electronic products manufacturing business and have developed and continue to manage it since we acquired control of the business from them. We have no employment contracts with Messrs. Li, Leung, Lee and Tam and their loss would require us to find executives suitable to replace them, whichoperating results 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.harmed.

Compliance with current and future environmental regulations may be costly which could impact our future earnings. Our results could be adversely affected if we have to comply with new environmental regulations.

Our operations create some environmentally sensitive waste that may increase in the future depending on the nature of our manufacturing operations. The general issue of the disposal of hazardous waste has received increasing attention from Chinese national and local governments and foreign governments and agencies and has been subject to increasing regulation. Currently, relevant Chinese environmental protection laws and regulations impose fines on discharge of waste materials and empower certain environmental authorities to close any facility which causes serious environmental problems. Although it has not been alleged that we have violated any current environmental regulations by China government officials, the Chinese government could amend its current environmental protection laws and regulations. Our business and operating results could be materially and adversely affected if we were to increase expenditures to comply with environmental regulations affecting our operations.

In addition, we could face significant costs and liabilities in connection with product take-back legislation, which enables customers to return a product at the end of its useful life and charge us with financial and other responsibility for environmentally safe collection, recycling, treatment and disposal. We also face increasing complexity in our product design and procurement operations as we adjust to new and upcoming requirements relating to the materials composition of our electronic products, including the restrictions on lead and certain other substances in electronics that apply to specified electronics products put on the market in the European Union as of July 1, 2006 (Restriction of Hazardous Substances in Electrical and Electronic Equipment Directive (RoHS). The labeling provisions of similar legislation in China went into effect on March 1, 2007. Consequently, many suppliers of products sold into the EU countries have required their suppliers to be compliant with the new directive. Many of these customers in our electronic division have adopted this approach and have required our full compliance. Though we have devoted a significant amount of resources and effort planning and executing our RoHS program, it is possible that some of our products might be incompatible with such regulations. In such event, we could experience the loss of revenue, damaged reputation, diversion of resources, monetary penalties, and legal action. Other environmental regulations may require us to reengineer our products to utilize components that are more environmentally compatible. Such reengineering and component substitution may result in additional costs to us. Although we currently do not anticipate any material adverse effects based on the nature of our operations and the effect of such laws, there is no assurance that such existing laws or future laws will not have a material adverse effect on us. Power shortages in China could affect our business.

We consume substantial amounts of electricity in our manufacturing processes at our production facilities in China. Certain parts of China, including areas where our manufacturing facilities are located, have been subject to power shortages in recent years. We have experienced a number of power shortages at our production facilities in China to date. We are sometimes given advance notice of power shortages and in relation to this we currently have a backup power system. However, there can be no assurance that in the future our backup power system will be

completely effective in the event of a power shortage, particularly if that power shortage is over a sustained period of time and/or we are not given advance notice of it. Any power shortage, brownout or blackout for a significant period of time may disrupt our manufacturing, and as a result, may have an adverse impact on our business.

A material failure of internal control over financial reporting could materially impact the Company’s financial results.

In designing and evaluating its internal control over financial reporting, management recognizes that any internal control or procedure, no matter how well designed and operated, can provide only reasonable assurance of achieving desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Management believes that the Company’s internal control over financial reporting currently provides reasonable assurance of achieving their control objectives. However, no system of internal controls can be designed to provide absolute assurance of effectiveness. See Item 15 Controls and Procedures, below. A material failure of internal control over financial reporting could materially impact the Company’s reported financial results and the market price of its stock could significantly decline. Additionally, adverse publicity related to a material failure of internal control over financial reporting could have a negative effect on the Company’s reputation and business.

Potential new accounting pronouncements are likely to impact our future financial position and results of operations and in the case of FASB’s pronouncement regarding the expensing of stock options have adversely impacted, and will in the future, adversely impact our financial results.

Deswell prepares its financial statements in conformity with the generally accepted accounting principles of the United States of America “US GAAP”. A change in these accounting principles and policies, especially as interpreted by the Securities and Exchange Commission and The NASDAQ Stock Market, may have an impact on our future financial position and results of operations. These regulatory changes and other legislative initiatives have increased general and administrative costs. The Financial Accounting Standards Board’s recent change to mandate the expensing of stock options requires us to record charges to earnings for stock option grants to employees and directors have adversely affected our financial results. As required, we implemented the new pronouncement effective on April 1, 2006 and the impact of that implementation has been reflected in our financial results beginning with for the first quarter of 2007, i.e., the quarter ended June 30, 2006

The concentration of share ownership in our senior management allows them to control or substantially influence the outcome of matters requiring shareholder approval.

~~Our~~On June 30, 2009, members of our senior management and Board of Directors as a group ~~each of whom are also members and constitute a majority~~beneficially owned approximately 20.4% of our ~~board of directors, and our Chairman of the Board, directly or indirectly through an affiliated company beneficially own approximately 28.2 % our shares at June 30, 2007.~~outstanding common shares. As a result, acting together, they may be able to control ~~and they can~~or at least 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.

Compliance with the first phase of Section 404 of the Sarbanes-Oxley Act of 2002 has increased our general and administrative expenses; if we do not receive an unqualified opinion on the adequacy of our internal control over financial reporting, investors could lose confidence in the reliability of our financial statements, which could result in a decrease in the value of our shares.

As directed by Section 404 of the Sarbanes-Oxley Act of 2002, the SEC adopted rules requiring public companies to include a report of management on the company’s internal control structure and procedures over financial reporting in their annual reports on Form 20-F that contains an assessment by management of the effectiveness of the company’s internal control structure and procedures over financial reporting. Our efforts to comply with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 governing internal controls and procedures for financial reporting, which started in connection with this Annual Report on Form 20-F for the year ended March 31, 2007, have resulted in increased general and administrative expense and a diversion of management time and attention, and we expect these efforts to require the continued commitment of significant resources.

Our management’s assessment of the effectiveness of Deswell’s internal controls over financial reporting appears in Item 15 of this Annual Report. However, this Annual Report does not include an attestation report of Deswell’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission (“SEC”) that permit us to provide only management’s report in this annual report. Under the SEC’s current rules, beginning with our Annual Report for the year ended March 31, 2008, we will be required to have our public accounting firm that audits the company’s financial statements attest to and report on our management’s assessment of the effectiveness of the company’s internal control structure and procedures over financial reporting. If our independent auditors interpret Section 404 requirements and the related rules and regulations differently from us or if our independent auditors are not satisfied with our internal control structure and procedures over financial reporting or with the level at which it is documented, operated or reviewed, they may decline to attest to management’s assessment or issue a qualified report. This could result in an adverse reaction in the financial markets due to a loss of confidence in the reliability of our financial statements, which could cause the market price of our shares to decline.

Legislative actions and potential new accounting pronouncements are likely to impact our future financial position and results of operations and in the case of FASB’s new pronouncement regarding the expensing of stock options will adversely impact our financial results.

There have been regulatory changes, including the Sarbanes-Oxley Act of 2002, new SEC regulations and Nasdaq Stock Market rules and there may be potential new accounting pronouncements or regulatory rulings, which will have an impact on our future financial position and results of operations. These regulatory changes and other legislative initiatives have increased general and administrative costs. The Financial Accounting Standards Board’s recent change to mandate the expensing of stock options will require us to record charges to earnings for stock option grants to employees and directors and will adversely affect our financial results after we implement the new pronouncement. As required, we implemented the new pronouncement effective on April 1, 2006 and the impact of that implementation has been reflected in our financial results beginning with for the first quarter of 2007, i.e., the quarter ended June 30, 2006

Our board’s ability to amend our charter without shareholder approval could have anti-takeover effects that could prevent a change in control.

As permitted by the law of the British Virgin Islands, our Memorandum and Articles of Association, which are the terms used in the British Virgin Islands for a corporation’s charter and bylaws, may be amended by our board of directors without shareholder approval provided that a majority of our independent directors do not vote against the amendment. This includes amendments to increase or reduce our authorized capital stock or to create from time to time and issue one or more classes of preference shares (which are analogous to preferred stock of corporations

restriction in early April 2009 and we have been advised that 364,000 of these shares were sold since then through July 31, 2009. We believe that the 362,225 shares held by the estate of our deceased former executive became freely transferable on February 23, 2009 and that the 331,040 shares held by the third former executive became freely transferable on August 2, 2009. If the remaining shares held by our former executives are sold at or about the same time or from time to time, or merely because their shares are eligible for sale without the restrictions otherwise imposed on a company’s affiliates by Rule 144 under the US Securities Act of 1933, the prevailing market price of our shares may decrease.

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 or excluded 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;

	•		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); and

	•		Regulation FD, the SEC’s rules regulating disclosure of information by publicly traded companies and other issuers and requiring that when an issuer discloses material nonpublic information to certain individuals or entities such as stock analysts, or holders of the issuer’s securities who may trade on the basis of the information, the issuer must make public disclosure of that information.

In addition, because we are a foreign private issuer, certain of the corporate governance standards of The ~~Nasdaq~~NASDAQ Stock Market that are applied to domestic companies having securities included on The ~~Nasdaq~~NASDAQ Stock Market are not applicable to us. For example, as a foreign private issuer organized under the law of the British Virgin Islands, we may follow our home company practice in lieu of some of the corporate governance provisions of sections 5600et. seq. of NASDAQ’s Marketplace ~~Rule 4350.~~Rules. Accordingly, as the law of the British Virgin Islands does not prohibit us from doing so and since our practices are in compliance with our Memorandum and Articles of Association, we follow our home company practices with respect to the following ~~Nasdaq~~NASDAQ Market Place rules:

	•		Rule ~~4350(c)(1)~~:~~A majority of our Board of Directors are not “independent” directors within the definition of “independent director” in Nasdaq Marketplace Rule 4200(a)(15);~~

	•		~~Rule~~ ~~4350(c)~~5605(b)(2): Our independent directors do not meet in executive session;

	•		Rule ~~4350(c)(3)~~5605(d): Our board does not have a compensation ~~committee;~~committee and compensation of our Chief Executive Officer and other executive officers is neither determined nor recommended to the board by a majority of our independent directors; and

	•		Rule ~~4350(c)(4)~~5605(e): Nominees for appointment as our directors are not selected or recommended by ~~(i)~~either a majority of our independent directors, or a nominating committee composed solely of independent directors.

Until the retirement of Chi Wai Leung effective January 1, 2009, who, in addition to serving as our Executive Director of Engineering for Plastic Operations, also served on our board of directors, a majority of our Board of Directors were not “independent” directors within the definition of “independent director” in NASDAQ Marketplace Rule 4200(a)(15) (which was in effect at the time of such resignation and has since been replaced without material change by NASDAQ Marketplace Rule 5605(a)(2)) and accordingly we did not theretofore comply with then applicable NASDAQ Market place Rule 4350(c)(1). Although our Board now consists of a majority of independent directors, if we choose to fill Mr. Leung’s former position on our Board with a member of our management team or a person not otherwise deemed “independent” under NASDAQ’s Marketplace Rules, we would not then comply with NASDAQ Marketplace Rule 5605(b)(1) (which replaced NASDAQ Marketplace Rule 4350(c)(1) effective on April 13, 2009) and our corporate governance standards would again differ in this regard from those applied to US domestic issuers under NASDAQ’s Marketplace Rules.

ITEM 4. INFORMATION ON THE COMPANY

History and Development of Deswell

~~The Company~~Corporate Information

Deswell Industries Inc. was ~~incorporated~~founded in 1987 in Hong Kong and moved its manufacturing operations to China in 1990 to take advantage of lower overhead cost, competitive labor rate and tax concessions available in Shenzhen, China as compared with Hong Kong. We were reincorporated 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~~Harneys Corporate 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) 28322096 and its facsimile number is (853) 28323265. Our principal manufacturing facilities and operations are currently based in Dongguan, Guangdong, China.

~~Deswell developed from the initial incorporation of Jetcrown Industrial Limited (“JIL”), a Hong Kong limited liability company,~~Important Events in February 1987. Richard Lau, C. P. Li and C. W. Leung founded JIL to manufacture injection-molded plastic parts for OEMs and contract manufacturers. JIL is the ultimate predecessor of the Company as restructured in March 1994. In January 1990, Jetcrown Industrial (Shenzhen) Limited, a limited liability China foreign operation (“Jetcrown Shenzhen”), was organized to conduct the Company’s manufacturing operations in China and JIL’s manufacturing operations were relocated to China in 1990. Marcon Enterprises Limited, a British Virgin Islands International Business Company (“Marcon”), was organized in July 1991 to hold the beneficial ownership of Jetcrown Shenzhen and to supervise the latter’s manufacturing operations. Marcon has been dormantDeswell’s Development that Have Occurred since April ~~2003 and was sold to~~1, 2008

In August 2009, Deswell entered into an agreement with a third party to sell real property in ~~October 2003. Richtex Services Limited (“Richtex”), a Hong Kong limited liability company,~~Shekou, Shenzhen, China that was ~~organized~~formerly used for its plastic injection molding operations for RMB50,000,000 (approximately $7.3 million, based on an exchange rate of 1:6.8309 on August 5, 2009 as reported on http://forex-history.net). The Company originally purchased the property, which consists of approximately 112,900 square feet of manufacturing space, in ~~November 1991 to serve as Marcon’s local agent and to discharge Marcon’s duties to supervise~~fiscal 2000 for approximately $1,461,000. In 2007, the ~~manufacturing operations~~Company completed the transition of Jetcrown Shenzhen. Richtex was deregistered from the Companies Registry in March 2004. JIL has been dormant since January 2004. Jetcrown Shenzhen has been dormant since January 2007. Since then, the Company’sits injection molding plastic manufacturing operations to a newly constructed and substantially larger facility in Houjie, Dongguan, China, closed the Shekou plant and since then has held it for sale.

The sale is expected to close after required local government transfer and other approvals have been ~~conducted primarily~~obtained and is targeted to occur by ~~Jetcrown Dongguan.~~

~~In October 1992,~~ the ~~Company purchased a controlling interest~~end of November 2009. If the sale of the ~~outstanding stock~~Shekou property closes as currently anticipated, Deswell expects to record a gain on the sale, net 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 interesttransaction costs, 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,financial statements during its third fiscal quarter ending December 31, 2009. If the ~~parties to~~sale is unexpectedly delayed, however, 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 interestsale will be recorded 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 interestCompany’s financial statements in the joint venture enterprise with Lang Wang guaranteed an annual rental income for the buy out. In March 2004, Kwanasia’s 85% interest in Kwan Hong was transferred to Integrated International Limited (see discussion of Integrated below) and in May 2004, Lang Wang’s 15% interest in Kwan Hong was also transferred to Hong Xin Electronics Company Limited (“Hong Xin”), a new independent Chinese party. The registrations of Integrated and Hong Xin with the Chinese Government were approved in April and July 2004, respectively. In a supplemental agreement signed on July 1, 2004, both parties agreed that Intergrated’s wholly-owned subsidiary would have in substance a 100% economic interest in the joint venture enterprise with Hong Xin guaranteed an annual rental income for the buy out.

~~The Company’s incorporation in the British Virgin Islands in December 1993 was part of a restructuring~~quarter in which ~~Deswell Industries, Inc. was organized to become~~ the ~~ultimate parent holding company of the companies~~sale is completed.

[Continued on Page 18]

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engaged in actual business operations and to spin off to Messrs. Lau, Li and Leung other companies that hold real estate in Hong Kong. This restructuring, which was completed in March 1994, involved the following steps. First, on December 13, 1993, the Company (i) allotted a total of 2,539 common shares to provide the initial capital of the Company and (ii) acquired the entire issued share capital of Leesha Holdings Limited, the former ultimate parent company, in exchange for which it issued a total of 3,387,304 common shares. These shares were issued in equal portions to Messrs. Lau, Li and Leung, the former shareholders of Leesha Holdings Limited. Second, on March 22, 1994, the Company acquired the entire issued share capitals of JIL, Marcon (including its interest in Jetcrown Shenzhen) and Richtex from Leesha Enterprises Limited, a wholly owned subsidiary of Leesha Holdings Limited and a second-tier holding company, in exchange for which the Company issued an aggregate of 7,618 common shares in equal proportions to Messrs. Lau, Li and Leung. Third, also on March 22, 1994, the Company acquired Leesha Enterprises Limited’s 50.00005 percent interest in Kwanasia in exchange for the issue of 2,539 common shares in the Company in equal proportions to Messrs. Lau, Li and Leung and the assignment of a debt due to JIL of approximately $465,000 relating to the original purchase of Kwanasia. Finally, on March 22, 1994, the Company made a distribution in specie of the entire share capital of Leesha Holdings Limited to Messrs. Lau, Li and Leung.

The immediate effect of this restructuring was that the Company wholly owned JIL, Marcon (which wholly owned Jetcrown Shenzhen) and Richtex and also owned 51% of the outstanding capital stock of Kwanasia (which, in turn had a 100% economic interest in Shenzhen Kwanam). Messrs. Lee and Tam owned the balance of Kwanasia. In 1995, this restructuring was fine-tuned further, with the Company forming two new corporations, Union International Limited (which changed its name to Integrated International Limited on May 1, 1996) (“Integrated”) and Oriental Enterprises Limited (which changed its name to Bright Oriental Enterprises Limited on May 1, 1996) (“Oriental Enterprises”), both corporations organized under the laws of Samoa. Integrated issued its shares proportionately to Deswell and Messrs. Lee and Tam in exchange for all outstanding capital stock of Kwanasia respectively held by them, with the result that through February 1998, Integrated was 51%-owned by Deswell and 49%-owned by Messrs. Lee and Tam.

In March 1998, Messrs. Lee and Tam together sold 5% shareholding interest in Integrated to Micropower Enterprises, Ltd. In January 2003, the Company increased its interest in Integrated to 71% by purchasing an additional 20% from Messrs. Lee and Tam in exchange for the issuance to Messrs. Lee and Tam of an aggregate of 251,880 common shares of Deswell. In April 2005, the Company increased its interest in Integrated to 76% by purchasing the 5% interest owned by Micropower Enterprises Ltd. in exchange for the issuance to Micropower Enterprises Ltd. of 120,000 common shares of Deswell. Integrated in turn owns all of the outstanding capital stock of Kwanasia. Messrs. Lee and Tam still own, in equal shares, 24% of the capital stock of Integrated and continue to serve as the executives in charge of administrative and manufacturing operations, respectively, for the Company’s contract manufacturing operations for electronic products and subassemblies. See Item 6 Directors, Senior Management and Employees.

As part of the Company’s restructuring, Oriental Enterprises was organized as a wholly-owned subsidiary of Integrated and it was assigned Kwanasia’s joint venture interest in Shenzhen Kwanam and assumed Kwanasia’s rights and responsibilities under the Shenzhen Kwanam joint venture. With the completion during the year ended March 31, 1998 of the purchase of CTC’s 30% joint venture interest in Shenzhen Kwanam pursuant to the Buy-out Agreement, Shenzhen Kwanam became a wholly owned subsidiary of Oriental Enterprises. Shenzhen Kwanam was closed on January 1, 2004 upon the expiration of its 10-year business license. Oriental Enterprises has been dormant since April 2002 and was sold to a third party in October 2003.

In October 1996, Integrated acquired a 64.9% interest in Kwanta Precision Metal Products Co., Ltd. (“Kwanta”), a corporation organized under the laws of Hong Kong, for $64,000, which was paid in cash. In April and July 1999, Integrated acquired the remaining 35.1% interest in Kwanta for $6,000, which was paid in cash. Kwanta manufactures metallic molds and accessory parts for use in audio equipment, copying machines and fax machines. Kwanta supplies metallic molds for the Company’s plastic and electronic operations and manufactures metal parts for OEMs and contract manufacturers, including the Company. Since September 2002, the Company’s metallic manufacturing operation was shifted to Kwan Hong and Kwanta has been dormant since then.

~~In January 1999, the Company organized Star Peace Limited, a British Virgin Islands International Business Company, in order to hold securities the Company acquires for investment.~~

In January 2000, the Company organized Blue Collar Holdings Limited (“Blue Collar”), a British Virgin Islands International Business Company to hold the beneficial ownership of Jetcrown Industrial (Dongguan) Limited (“Jetcrown Dongguan”). Jetcrown Dongguan, a limited liability China Foreign Enterprise registered in January 2000, was organized to conduct the Company’s plastic injection molding manufacturing operations in Dongguan, China. Jetcrown Dongguan commenced production in July 2000.

In April 2000, Integrated organized Digiwave Limited (originally named Wisetop Technology Limited), a limited liability Hong Kong Company, to carry on original design manufacturing, or ODM, in connection with our electronic manufacturing business. Digiwave was deregistered from the Companies Registry in March 2004.

In June 2000, the Company organized Jetcrown Industrial Sdn. Bhd. (“JISB”), a limited liability Malaysian Company, to establish a representative office in Dongguan, China to handle our overseas plastic injection product sales. On May 22, 2001, the Company’s representative office successfully obtained a registration certificate to allow it to do business from the Chinese Government and it commenced business in August 2001. The representative office was deregistered with the Chinese Government in January 2004 and JISB has been dormant since December 2003. The Company has applied for strike off from the Company Register with the Companies Commission of Malaysia in June 2006 and the approval is now in process.

In August 2001, the Company organized Jetcrown & Kwanasia (OEM) Specialist Limited (“J&K OEM”), a limited liability Hong Kong Company, to conduct marketing for Deswell’s plastic and electronic businesses. The capital stock of J&K OEM was owned 51% by Deswell, 39% by Dickson Lam, Deswell’s former Director of Marketing for plastic and electronic products, and 10% by two other individuals who were then 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”), as a wholly-owned subsidiary of Triumph Wise. In August 2003, J&KMCO obtained business license approval to carry out offshore marketing service activities in Macao. J&K OEM’s operations were transferred to J&KMCO in September 2003 and J&K OEM has been dormant since then. In March 2005, the Hong Kong Companies Registry approved the application to deregister J&K OEM from the Companies Registry. J&KMCO has been dormant since January 2005 following the retirement of Dickson Lam and in June 2005, the Macao Company Registry approved the application of Deswell and the minority shareholders of Triumph Wise to deregister J&KMCO from the Company Registry. In July 2005, Deswell acquired the minority 49% interest in the capital stock of Triumph Wise from Mr. Lam and the two other individuals and since then. Triumph Wise has been dormant.

In March 2003, Deswell also organized Rainbow Hill Limited, a 100% owned British Virgin Islands International Business Company, in order to establish another new 100% owned Macao incorporated company, namely Jetcrown Industrial (Macao Commercial Offshore) Limited (“JIMCO”). In August 2003, JIMCO was incorporated and obtained business license approval to carry out offshore trading activities in Macao.

In October 2003, Deswell organized Ideatop Holdings Limited (“Ideatop”), a British Virgin Islands International Business Company to hold the beneficial ownership of Jetcrown Shenzhen. The registration of Ideatop with the Chinese Government was approved in December 2003. In September 2004, Ideatop reinvested retained earnings of $1,800,000 from Jetcrown Shenzhen to Jetcrown Dongguan, a sister subsidiary. At the same time, Ideatop also invested an additional cash capital of $1,800,000 in Jetcrown Dongguan, making its total investment holdings in Jetcrown Dongguan to approximately 26.1%. As a result, Blue Collar’s holdings in Jetcrown Dongguan were reduced from 100% to approximately 73.9%.

In October 2003, the Company also organized Joint Harvest Industries Limited, a British Virgin Islands International Business Company and 100% owned by Integrated, in order to establish another new 100% owned Macao incorporated company, namely Kwanasia Electronics (Macao Commercial Offshore) Limited (“KEMCO”). In April 2004, KEMCO was incorporated and obtained business license approval to carry out offshore trading activities in Macao. Kwanasia has been dormant since June 2004 when KEMCO commenced operations.

~~In December 2003, the Company also organized Spring Fountain Investments Limited, a British Virgin Islands International Business Company and 100% owned by Integrated for investment holding purpose.~~

In March 2006, the Company received approval to establish Shenzhen Kwan Wing Trading Company Limited (“Kwan Wing”), as a limited liability China Foreign Enterprise wholly owned by KEMCO. Kwan Wing was registered in March 2006 to engage in the distribution of audio, lightings and network visual equipments operations and import and export operations in China.

Organizational Structure

The following diagram illustrates the organizational structure of the Company and its active subsidiaries at March 31, ~~2007.~~2009.

~~[Organizational structure on next page]~~ (ORGANIZATIONAL STRUCTURE)

	•		toner cartridges and cases for photocopy and printer machines;

	•		parts for electrical products such as air-conditioning 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.

Electronic products manufactured by the Company include

	•		sophisticated professional audio equipment including digital audio workstation, digital or analogue mixing consoles, instrument amplifiers, signal processors, firewire/USB audio interfaces, keyboard controllers and synthesizers, etc.

	•		complex printed circuit board assemblies using surface mount technology (“SMT”), ball grip assembly (“BGA”) and pin-through-hole (“PTH”) interconnection technologies and

	•		finished products which include business communication products such as digital phone systems, or digital keysets and voice over IP, or VoIP, phones, and

	•		sophisticated professional audio equipment including digital audio workstation, digital or analogue mixing consoles, instrument amplifiers, signal processors, firewire/USB audio interfaces, keyboard controllers and synthesizers, 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, vending 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, this advantage has been difficult to maintain as a result of increased competition and increased production overheads during the ~~years ended March 31, 2005, 2006 and 2007.~~last three fiscal 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,

Operations

Plastic Injection Molding

Plastic injection molding manufacturing accounted for ~~47.5%~~43.5%, ~~41.9%~~40.9% and ~~43.5 %~~55.7% of the Company’s total sales during the years ended March 31, ~~2005, 2006~~2007, 2008 and ~~2007,~~2009, respectively. At March 31, ~~2007,~~2009, the Company conducted its plastic manufacturing operations in approximately 1,070,000 square feet of factory space in its factory located in Dongguan, Guangzhou, China. The factory space of approximately 113,000 square feet located in Shekou, Shenzhen, China, which Deswell formerly used for contract manufacturing, was being used for clerical and offices operations at March 31, ~~2007~~2009 and Deswell currently intends to sell its land lease on this property.

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.~~production

The plastic injection-molding process begins when a customer provides the Company with specifications for a product or part, which specifications are often created in consultation with the Company’s technical staff. Next the Company designs and produces the mold, using great care in the design process and in the selection of materials to produce the mold in an effort to create a high quality appearance of the completed product by reducing or eliminating potential flaws such as the sinkage of materials and irregularities in the knit line of joints.

The mold-making process ranges from 2530 to 75110 days, , depending on the size and complexity of the mold. Mold making requires specialized machines and is capital intensive. At March 31, ~~2007,~~2009, the Company used 30 EDMs (electrical discharge machines), 32 CNC (computer numerical control) milling machines and 83 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 the year ended March 31, 2005, the Company continued to expand its production capabilities, purchasing and installing approximately $2.9 million of machines and equipment, including four sets of EDMs; five sets of CNC milling machines; seven sets of NC milling machines; sixteen sets of Chen Hsong hydraulic injection machines with clamping force of 128 tons to 268 tons; and six sets of injection molding machines with clamping force of 85 to 200 tons, replacing 10 sets of old injection machines and one set of EDMs.

During the year ended March 31, 2006, the Company acquired machines and equipment costing approximately $1.9 million, including three sets of EDMs, three sets of CNC milling machines and 29 sets of injection machines with clamping forces of 86 tons to 160 tons; replacing one set of CNC milling machines and 19 sets of old injection machines.

During the year ended March 31, 2007, the Company acquired machines and equipment costing approximately $2.2 million, including 83 sets of injection molding machines with clamping force of 86 tons to 1,300 tons; replacing 69 sets of old injection machines, two sets of old EDMs and three sets of old NC milling machines.

During the year ended March 31, 2008, the Company acquired machines and equipment costing approximately $1.6 million, including 22 sets of injection molding machines with clamping force of 86 tons to 250 tons; replacing 20 sets of old injection machines.

During the year ended March 31, 2009, the Company acquired machines and equipment costing approximately $1.7 million, including 53 sets of injection molding machines with clamping force of 90 tons to 1,600 tons; replacing 25 sets of old injection machines.

Molds produced by the Company generally weigh from 110 to 17,600 pounds and generally cost between $2,000 and $200,000.

The customer generally bears the cost of producing the molds and, as is customary in the industry, the customer owns them. However, the Company maintains and stores the molds at its factory for use in production and it is Deswell’s policy generally not to make molds for customers unless the customer undertakes to store its molds at the Company’s factory and uses Deswell to manufacture the related parts. In that way, the Company seeks to use its mold-making expertise to create dependence on it for the customer’s parts requirements. Beginning in 2005, however, through its then newly created Export Tooling Department, Deswell’s began producing molds for export to customers and thus does not use those molds to manufacture related parts.

During the year ended March 31, ~~2007,~~2009, the Company made on average about 50 to ~~100~~60 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.~~Injection

During the mold-making process, suitable plastic resin for the particular product is selected and purchased. See “Raw Materials, Component Parts and Suppliers, below.” The completed mold is mounted onto injection machines, which are classified according to the clamping force (the pressure per square inch required to hold a mold

configurations and the Company has machines, which permit the Company to fabricate plastic parts as small as a button and as large as a 3 ft. x 2 ft. case for a copy machine.

Using separate shifts, injection molding is generally conducted 24 hours a day, five to seven days per week, other than normal down time for maintenance and changing of product molds. Molding of products requiring extra concerns for appearance, such as cases for calculators, personal organizers and telephones are conducted in an isolated and dust free section of the factory. In a continuous effort to assure quality, the Company’s quality control personnel inspect the products produced from each machine generally at hourly intervals during production. When defects are discovered, the Company’s maintenance personnel inspect the mold and the machine to determine which is responsible. If the mold is the cause of the defect, it will be immediately removed from the machine and serviced or repaired by one of a team of technicians employed to maintain molds. The mold will then be remounted on the machine and production will continue. If the machine is the source of the defect, the Company’s technicians and engineers service the machine immediately. Through this continuous vigilance to molds and machines, the Company has experienced what it believes to be a relatively low scrap rate and has been able to maintain a high level of productivity of its injection molding machines.

Finishing

After injection molding, products are finished. Finishing consists of smoothing and polishing, imprinting letters, numbers and signs through silk screening process, pad printing or epoxy ultra violet cutting, and treating the product with an anti-fog coating for a lasting and attractive appearance. Most of these functions are conducted by hand.

Electronic Products and Assemblies

In an aggregate of approximately 223,000 square feet of factory space at March 31, ~~2007~~2009 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, ~~2005, 2006~~2007, 2008 and ~~2007,~~2009, manufacturing of electronic products accounted for approximately ~~48.1%~~54.8%, ~~54.5%~~56.7% and ~~53.4%~~43.4%, respectively, of the Company’s total sales. During the same periods, manufacturing of finished products accounted for 99%, 99% and 99%, respectively, of electronic product sales and assembling of printed circuit boards accounted for the balance of such sales during those periods.

In assembling printed circuit boards the Company purchases printed circuit boards, surface mounted components and chips and uses PTH, BGA and SMT interconnection technologies to assemble various components onto the PCBs. Before delivery, completed PCBs are checked by in-circuit-testers and outgoing quality assurance inspections are performed.

PTH is a method of assembling printed circuit boards in which component leads are inserted and soldered into plated holes in the board. While this technology is several decades old and is labor intensive, it still has a significant market, particularly for consumer product applications.

BGA is a method of mounting an integrated circuit or other component to a PCB. Rather than using pins that consume a large area of the PCB, the component is attached to the circuit board with small balls of solder at each contact. This method allows for greater component density and is used in more complex PCBs.

SMT is the automatic process of printed circuit board assembly in which components are mounted directly to the surface of the board, rather than being inserted into holes. With this process, solder is accurately stenciled in paste form on pads located on the printed circuit board and the components are then placed onto the solder paste and fused to the melting point of the paste to establish a strong solder joint between components and the printed circuit board. The SMT process allows miniaturization of PCBs, cost savings and shorten lead paths between components (which results in faster signal speed and improved reliability). Additionally, it allows components to be placed on both sides of the printed circuit board, a major factor for the purpose of miniaturization.

Manufacturing operations include PCB assembly, wiring and testing. The process is completed by assembling the PCBs into a plastic or metal housing that comprises the finished product. Quality assurance is then conducted in accordance with the customers’ requirements before the shipment.

equipment, routers, payphones, multimedia stations and ATMs. The Company’s metal molds and metal parts (products) manufacturing accounted for approximately ~~4.4%~~1.9%, ~~2.1%~~2.4% and ~~1.9%~~0.9% of Deswell’s total sales during the years ended March 31, ~~2005, 2006~~2007, 2008 and ~~2007,~~2009, respectively.

Quality Control

The Company maintains strict quality control procedures for its products. At hourly intervals, the Company’s quality control personnel monitor machines and molds to assure that plastic parts are free from defects.

For electronic operations, the Company’s quality control personnel check all incoming components. Moreover, during the production stage, the Company’s quality control personnel check all work in process at several points in the production process. Finally, after the final assembly and before shipment, the Company conducts quality assurance inspections in accordance with the customers’ Acceptable Quality Level, or AQL, requirements.

Plastic, electronic and metal products manufactured and assembled at the Company’s facilities have a low level of product defects, and aggregate returns represented less than 3% of total net sales during each of the years ended March 31, ~~2005, 2006~~2007, 2008 and ~~2007.~~2009

In 1995, the Company earned ISO 9001 certifications for both its plastic and electronic products manufacturing operations. In April 2000, the Company also received ISO 9002 for its metal manufacturing operation. The “ISO” or International Organization for Standardization is a Geneva-based organization dedicated to the development of worldwide standards for quality management guidelines and quality assurance. ISO 9000, which is the first quality system standard to gain worldwide recognition, requires a company to gather, analyze, document and monitor and to make improvements where needed. ISO 9001 is the ISO level appropriate for manufacturers like the Company. The Company’s receipt of ISO 9001 certification demonstrates that the Company’s manufacturing operations meet the established world standards.

In August 2004, the Company’s plastic injection manufacturing plant in Dongguan also 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. In January 2006, the Company’s electronic and metallic manufacturing plant also obtained ISO 14001 certification.

The Company was working toward having its plastic injection manufacturing plant to obtain QS 9000 Certification but before completing that process elected to seek ISO/TS 16949 Certification. ISO/TS 16949 is an ISO Technical Specification. This specification aligns existing American (QS-9000), German (VDA6.1), French (EAQF) and Italian (AVSQ) automotive quality systems standards within the global automotive industry. Together with ISO 9001:2000, ISO/TS 16949 specifies the quality system requirements for the design/development, production, installation and servicing of automotive related products. ISO/TS 16949 has been accepted as an equivalent to QS-9000, VDA6.1, AVSQ, and EAQF. ISO/TS 16949 does not replace QS-9000; but is optional and eliminates the need for multiple certifications. Deswell obtained ISO/TS 16949 Certification in July 2006.

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). The following table shows Deswell’s average cost of ABS as a percentage of the total cost of plastic products sold and as a percentage of total cost of goods sold during its last three fiscal years.


	Year ended March 31, 2007									Year ended March 31, 2009
Average cost of ABS as a percentage of the total cost of	2005			2006			2007
										2007			2008			2009
Average cost of ABS as a percentage of the total cost of:
Plastic products sold		58	%		53	%		51	%		52	%		46	%		45	%
Goods sold		24	%		21	%		20	%		20	%		17	%		25	%

unit raw material costs and generally has enabled the Company to obtain adequate shipments of raw materials. While the Company is not generally bound by fixed price contracts with its customers, the Company has found that increases in resin prices can be difficult to pass on to its customers and, as a consequence, a significant increase in resin prices could have, and in the past has had, a material adverse effect on the Company’s operations.

The primary plastic resins used by the Company are produced from petrochemical intermediates derived from products of the natural gas and crude oil refining processes. Natural gas and crude oil markets have in the past experienced substantially cyclical price fluctuations as well as other market disturbances including shortages of supply and crises in the oil producing regions of the world. The capacity, supply and demand for plastic resins and the petrochemical intermediates from which they are produced are also subject to cyclical and other market factors. Consequently, plastic resin prices may fluctuate as a result of natural gas and crude oil prices and the capacity, supply and demand for resin and petrochemical intermediates from which they are produced.

Although the plastics industry has from time to time experienced shortages of plastic resins, the Company has not experienced to date any such shortages. Management believes that there are adequate sources available to meet the Company’s raw material needs.

Component Parts and Supplies

The Company purchases ~~over 500 different~~a wide variety of component parts from ~~more than 450~~numerous suppliers and is not dependent upon any single supplier for any essential component. The Company purchases from suppliers in ~~Japan, Taiwan, Korea,~~China, Hong Kong, the United States 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, ~~2005, 2006~~2007, 2008 and ~~2007.~~2009. 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 ~~Marketin~~Marketingg

The Company’s customers are OEMs and contract manufacturers. The Company sells its products in the United States, Asia ~~(Hong~~(China, Hong Kong ~~Japan~~ and ~~China)~~Thailand) and Europe ~~(Germany, United~~(United Kingdom, ~~France~~Holland, Norway and ~~Italy)~~Germany). 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 1715 of Notes to Consolidated Financial Statements for the dollar amounts of export sales by geographic area for each of the years ended March 31, ~~2005, 2006~~2007, 2008 and ~~2007.~~2009. Net sales as a percentage of total sales to customers by geographic area consisted of the following for the years ended March 31, ~~2005, 2006~~2007, 2008 and ~~2007:~~2009:

2224

~~business~~with major global EMS providers, other smaller EMS companies that have a regional or product-specific focus, and original design manufacturers with respect to some of the services that we provide. We also compete with our current and prospective customers, who evaluate our capabilities in light of their own capabilities and cost structures. Our market segments ~~in China. Plastic injection molding and metal molds and accessories manufacturing~~ are ~~characterized by a large number~~extremely competitive, many 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 intenseour competitors have achieved substantial market share and many ~~competitors in each industry are larger~~have lower cost structures and ~~have~~ greater manufacturing, financial ~~and~~or other resources than ~~the Company.~~we do. We face particular competition from Asian-based competitors, including Taiwanese EMS providers who compete in our end markets.

The Company believes that competition for plastic injection molding, contract electronic manufacturing and metal molds and parts manufacturing businesses are based on price, quality, service and the ability to deliver products in a timely and reliable basis. ~~The Company believes that it competes favorably in each of these areas in each business segment.~~

Patents, Licenses and Trademarks

The Company has no patents, trademarks, licenses, franchises, concessions or royalty agreements that are material to its business.

Seasonality

For information concerning the seasonality of the Company’s business, see “Seasonality” included under Item 5 “Operating and Financial Review and Prospects.”

Property, Plants and Equipment

Macao

The Company leases Units 17B and 17E, Edificio Comercial Rodrigues, 599 Avenida da Praia Grande, Macao from an unaffiliated party, each being for a term of two years to July ~~2007.~~2010. The premises are used as trading, administrative and accounting office for the Company’s plastic injection business and electronic & metallic business, respectively. The monthly rent is approximately ~~$2,020.~~$2,190.

Hong Kong

The Company ~~has~~ sold its previously owned property of Unit 10-14, 19/F., Kwong Sang Hong Centre, 151-153 Hoi Bun Road, Kwun Tong, Hong Kong to an unaffiliated party for proceeds of $1,350,000 in March 2007.

Southern ~~China~~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, ~~2007~~2009, the Company had closed this manufacturing facility and now holds it for sale. For information regarding Deswell’s pending sale of this property to a third party, see the discussion under Item 4 Information on the Company — “Important Events in Deswell’s Development that Have Occurred since April 1, 2008” and Item 10 Additional Information — “Material Contracts” at pages 17 and 45, respectively, of this Report.

In January 2000, the Company acquired under sale and purchase agreement with the local government party an aggregate of approximately 1.3 million square feet of land to construct its own manufacturing plant and dormitory buildings in Houjie, Dongguan, China. As at March 31, ~~2007,~~2009, there were built and operational 1,070,000 square feet of factory space, 91,000 square feet of amenity space, 133,000 square feet of office building space and 470,000 square feet of dormitory space. Deswell now uses this facility for its plastic manufacturing operations.

The Company leases space at various locations near its plastics manufacturing factories in Dongguan that it uses as dormitories for factory staff. Management estimates that the space leased for dormitories approximated ~~1,200 square feet and 5,600~~2,400 square feet at March 31, ~~2007~~2009 in ~~Shekou and Dongguan, respectively.~~Dongguan. The facilities are leased for periods of ~~six months to~~ one year, ~~expiring November 2007.~~with expiration dates ranging from April 2010 to June 2010. The aggregate monthly rental is approximately ~~$1,600.~~$650. During the period from July 2006 to March 2007, Deswell sold its previously owned dormitory apartments to unaffiliated parties for an aggregate proceeds of $795,000.

In July 2003, the Company completed the acquisition with a third party for 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,~~Chang An, Dongguan, China, which was previously named Kwan Hong Building. The land use period is for 50 years from February 1, 2003 to January 31,

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 ~~Result~~Resultss

The following discussion should be read in conjunction with the consolidated financial statements and notes thereto included later in this Report. The Company prepares its financial statements in accordance with U.S. GAAP.

General

The Company’s revenues are derived from the manufacture and sale of injection-molded plastic parts and components, electrical products and subassemblies and metallic molds and accessories. ~~JIMCO,~~ Jetcrown ~~Shenzhen~~Macao and Jetcrown Dongguan (wholly owned subsidiaries) carry on the plastics operations whereas Integrated carries out the electronics and metallic operations. The Company acquired a controlling interest in Integrated’s predecessor in October 1992 and has included the results of the predecessor in its consolidated financial statements from the date of acquisition. Through December 2002, the Company owned a 51% interest in Integrated. In January 2003, the Company increased its interest in Integrated to 71% by purchasing an additional 20% from its minority shareholders in exchange for the issuance to them of an aggregate of 251,880 common shares. In April 2005, the Company increased its interest in Integrated to 76% by purchasing an additional 5% from a minority shareholder in exchange for the issuance to it of 120,000 common shares. In August 2007, the Company further increased its interest in Integrated to 100% by purchasing the remaining 24% from the minority shareholder in exchange for the issuance to them of 632,080 common shares and a cash payment of $414,000.

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,~~Macao, facilitates transportation of its products through Hong Kong and provides the Company’s plastic manufacturing operations with access to electricity from Hong Kong and to nearby water, both of which resources are needed in abundance to manufacture plastic parts and are often inadequate elsewhere in China.

~~The Company’s earnings~~Under PRC tax law in effect before January 1, 2008, we have been afforded a number of tax concessions by, and tax refunds from, China’s tax authorities on a substantial portion of our operations in China by reinvesting

all or part of the profits attributable to our PRC manufacturing operations. We have enjoyed preferential tax concessions in the PRC as a high-tech enterprise and have benefited from favorable overall effective income tax rates of ~~3.2%, -0.27%~~8.70 % and ~~8.7 %~~1.13% for the years ended March 31, ~~2005, 2006~~2007 and 2008, respectively. However, on March 16, 2007, ~~respectively. The Company is~~the Chinese government enacted a new unified enterprise income tax law which became effective on January 1, 2008. Under the new income tax law most domestic enterprises and foreign invested enterprises, like Deswell, would be subject to ~~Hong Kong~~a single PRC enterprise income tax ~~on its~~rate and gradually transfer to the new tax rate of 25% within five years. Following the implementation of the Enterprise Income Tax Law effective January 1, 2008, the State Council announced the transition rules for preferential tax policies (Guofa [2007] No.39) of January 2, 2008, for eligible enterprises previously subject to a 15% tax rate or 24% tax rate. As so announced, the new enterprise income arising in, or derived from, Hong Kong. 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.”tax rates are:


	Rate under EIT for enterprises previously subject to tax rate of
Tax Year (Calendar)	15 percent			24 percent
2009		20	%		25	%
2010		22	%		25	%
2011		24	%		25	%
2012		25	%		25	%

~~With~~Accordingly, with the enactment of new PRC Enterprise Tax effective January 1, 2008, the Company expects the benefits it previously it enjoyed, ~~from a low overall effective income tax rate,~~ such as receiving tax refunds as a result of its reinvestment of profits in certain of its subsidiaries in China and favorable concession rates, will no longer be gradually reduced or phased out. Such as, the cancellation of tax refunds by reinvesting profits of certain of our subsidiaries in China under the new PRC Enterprise Tax which Deswell had previously obtained. For information on our income taxes, rates and concessions with respect to our Chinese operations, see Note 10 of Notes to Financial Statements. 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.”available.

Deswell’s material operations are generally organized in two 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 and metallic segment for the table presentation and discussion below. The Company’s reportable segments are strategic business units that offer different products and services. The following table sets forth present selected consolidated financial information stated as a percentages of net sales for each of the three years in the period ended March 31, ~~2007.~~2009.


																												Year ended March 31, 2007									Year ended March 31, 2008									Year ended March 31, 2009
	Year ended March 31, 2005									Year ended March 31, 2006									Year ended March 31, 2007									Plastic									Plastic									Plastic
	Plastic									Plastic									Plastic									Injection			Electronic						Injection			Electronic &						Injection			Electronic &
	Injection-			Electronic						Injection-			Electronic						Injection-			Electronic						Molding			& Metallic						Molding			Metallic						Molding			Metallic
	Molding			& Metallic						Molding			& Metallic						Molding			& Metallic						Segment			Segment			Total			Segment			Segment			Total			Segment			Segment			Total
	Segment			Segment			Total			Segment			Segment			Total			Segment			Segment			Total
Net sales		100.0	%		100.0	%		100.0	%		100.0	%		100.0	%		100.0	%		100.0	%		100.0	%		100.0	%		100.0	%		100.0	%		100.0	%		100.0	%		100.0	%		100.0	%		100.0	%		100.0	%		100.0	%
Cost of sales		65.2			80.6			73.3			72.5			81.9			77.9			68.1			84.1			77.1			68.1			84.1			77.1			74.4			86.6			81.6			82.4			87.6			84.7

Gross profit		34.8			19.4			26.7			27.5			18.1			22.1			31.9			15.9			22.9			31.9			15.9			22.9			25.6			13.4			18.4			17.6			12.4			15.3
Selling, general and administrative expenses		16.6			8.9			12.5			17.7			9.7			13.1			17.4			11.2			13.9			17.4			11.2			13.9			18.4			10.3			13.6			16.3			12.6			14.6
Other income, net		—			(0.1	)		(0.1	)		(1.4	)		(0.3	)		(0.7	)		2.5			(0.1	)		1.0			2.5			(0.1	)		1.0			4.0			(0.6	)		1.3			0.5			(0.8	)		(0.1	)

Operating income		18.2			10.3			14.1			8.5			8.1			8.3			17.0			4.6			10.0			17.0			4.6			10.0			11.2			2.5			6.1			1.8			(1.0	)		0.6
Interest expense		—			—			—			—			—			—			—			—			—			—			—			—			—			—			—			—			—			—
Non-operating income, net		0.2			0.5			0.4			0.8			—			0.4			0.8			0.1			0.4			0.8			0.1			0.4			0.8			0.1			0.4			0.3			(0.1	)		0.1

Income before income taxes and minority interst		18.4			10.8			14.4			9.4			8.2			8.7			17.8			4.8			10.4
Income before income taxes and minority interest																													17.8			4.8			10.4			12.0			2.6			6.5			2.1			(1.1	)		0.7
Income taxes		0.3			0.6			0.5			(0.6	)		0.4			(0.0	)		1.8			0.2			0.9			1.8			0.2			0.9			0.5			(0.2	)		0.1			(0.1	)		(0.4	)		(0.2	)

Income before minority interests		18.1			10.2			13.9			10.0			7.8			8.7			15.9			4.6			9.5			15.9			4.6			9.5			11.5			2.8			6.4			2.2			(0.7	)		0.9
Minority interests		0.7			2.9			1.9			—			1.9			1.1			—			1.1			0.6			—			1.1			0.6			—			0.3			0.2			—			—			—


Net income		17.4	%		7.3	%		12.1	%		10.0	%		5.9	%		7.6	%		15.9	%		3.5	%		8.9	%		15.9	%		3.5	%		8.9	%		11.5	%		2.5	%		6.2	%		2.2	%		(0.7	)%		0.9	%

Customers, above. The decrease was related to a decrease in sales revenue at our electronic and metallic segment of $26,637,000 offsetting the increase in sales at our plastic segment of $14,569,000. This represented a decrease of 31.3% and an increase of 24.8% respectively, as compared with the respective net sales from these segments in fiscal 2008.

The revenue increase at the plastic segment was mainly due to the increase in orders from existing and new customers of $23,321,000 offsetting the decrease in orders from other existing customers of $8,751,000. The increase was principally due to a $20,671,000 increase in plastic component sales of electronic entertainment products. The increase in orders in our plastic segment was largely from N&J, one of our major customers during both fiscal 2008 and 2009, which accounted for 28.6% of our total net sales during the year ended March 31, 2009, up from 11.8% of our total net sales during the year ended March 31, 2008.

The revenue decrease in the electronic and metallic segment was mainly due to the decrease in orders of electronics and metallic products from existing customers of $35,175,000 and $2,075,000, respectively, offsetting the increase in orders from existing and new customers for professional audio instrument products of $10,651,000. The increase in total orders for professional audio instrument products largely came from existing customers other than Digidesign. The overall decrease in orders of electronics and metallic products from existing customers was due to the combined factors of a decline in demand as a result of the global economic recession, persistent pressure of losing orders to competitors which provide lower-priced products, and a change in product mix from low-end to high-end products. We believe that these factors resulted in the reduction in orders from Digidesign, down to 12.7% of our total net sales the year ended March 31, 2009, from 17.0% of our total net sales during 2008, and the decline in orders from each of Line 6 Manufacturing (“Line 6”) and Inter-Tel Incorporated (“Inter-Tel”) to below 10% of our total net sales during the year ended March 31, 2009. Line 6 and Inter-Tel accounted for 14.3% and 10.2%, respectively, of our total net sales during the year ended March 31, 2008. These declines in net sales to Digidesign, ~~Inc. (“Digidesign”)~~Line 6 and Inter-Tel during the year ended March 31, 2009 illustrates our dependence on a few major customers and that substantial decreases in sales from any of our larger customers adversely impacts our sales and financial performance. See the discussion under “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. These risks have become particularly acute in the current adverse economic environment” in Item 3 Key Information — Risk Factors, above.

Gross Profit— Our gross profit for the year ended March 31, 2009 was $20,168,000, representing a gross profit margin of 15.3%. This compared with the overall gross profit and gross profit margin of $26,433,000 or 18.4%, ~~VTech Telecommunications~~respectively, for the year ended March 31, 2008.

Gross profit in the plastic segment decreased by $2,118,000 to $12,952,000, or 17.6% of net sales, for the year ended March 31, 2009, as compared to $15,070,000, or 25.6% of net sales, for the year ended March 31, 2008. The decrease in gross margin for the plastic segment was mainly due to the shift of product mix to lower margin products, as compared with the prior year. The decrease in gross margin was also driven by higher material costs as a result of a 10% rise in resin price and an approximate 9.05% appreciation of RMB, plus an increase in labor costs caused by a 17% rise in labor rates in spite of headcount reductions, when compared to fiscal 2008.

Gross profit in the electronic and metallic segment decreased by $4,147,000 to $7,216,000, or 12.4% of net sales, for the year ended March 31, 2009 compared to $11,363,000, or 13.4% of net sales, for the year ended March 31, 2008. The decrease in gross margin was primarily attributable to relatively higher labor cost caused by a 28.4% increase in labor rates despite headcount reductions throughout the year together with a general decline in sales demand in the year ended March 31, 2009, as compared with last year.

Selling, general and administrative expenses —SG&A expenses for the year ended March 31, 2009 were $19,291,000, amounting to 14.6% of total net sales, as compared to $19,601,000 or 13.6% of total net sales for the year ended March 31, 2009. There was a decrease in selling, general and administrative expenses of $310,000 or 1.6% over the corresponding period.

The SG&A expenses in the plastic segment increased by $1,142,000 to $11,965,000, or 16.3% of net sales, for the year ended March 31, 2009 compared to $10,823,000, or 18.4% of net sales, for the year ended March 31, 2008. The increase in the SG&A expenses was primarily related to the increase in salaries and bonuses of $516,000 as a result of 17.3% increase in pay rates, and $132,000 in social insurance, and $100,000 in value-added taxes and property taxes , as compared with the year ended March 31, 2008.

The SG&A expenses in the electronic and metallic segment decreased by $1,452,000 to $7,326,000 or 12.6% of net sales, for the year ended March 31, 2009 compared to $8,778,000 or 10.3% of net sales for the prior

a year. The decrease was primarily due to the continued cost control measures resulting in a decrease of $612,000 in salaries and bonuses, $410,000 in social insurance and staff welfare expenses, $80,000 in travelling expenses and $52,000 in rental expenses as compared with the corresponding period in the prior year. There was also a decrease of $73,000 in selling expense as well as $65,000 in depreciation expense when compared to the year ended March 31, 2008.

Other operating income —Other operating expense was $132,000 for the year ended March 31, 2009, representing a decrease of $1,970,000 as compared with last year.

On a segment basis, other operating income attributable to our plastic segment for the year ended March 31, 2009 was $348,000, a decrease of $1,996,000 as compared with the prior year. The decrease was principally the result of a lower revaluation of monetary assets by $1,370,000 due to a less volatile exchange rate of United States Dollar to the RMB. The decrease in other operating income was also attributable to an additional provision for doubtful debt of $258,000, asset impairment for $176,000 and loss on disposal of fixed assets of $134,000 during the year ended March 31, 2009.

Other operating expense attributable to our electronic and metallic segment for the year ended March 31, 2009 was $480,000, as compared to the other operating expense of $508,000 in fiscal 2008. The decrease was primarily the result of no impairment on the goodwill relating to the metallic division during fiscal 2009 as compared to $318,000 impairment loss recognized during fiscal 2008. During fiscal 2009, there was also a decrease in foreign exchange loss by $176,000, partially offsetting an increase of $437,000 in allowance for doubtful receivables, as compared to fiscal 2008.

Operating Income —Operating income was $745,000 for the year ended March 31, 2009, as compared with the operating income of $8,670,000 from the corresponding year in the prior year.

On a segment basis, operating income of the plastic division was $1,335,000, or 1.8% of net sales, in the year ended March 31, 2009, as compared to operating income of $6,593,000, or 11.2% of net sales, for the year ended March 31, 2008. Operating income in the plastic division decreased primarily from the decrease in gross margin as a result of higher material usage and cost, factory overhead, and the decrease in other operating income as described above.

The operating loss of the electronic & metallic segment was $589,000, or 1.0% of net sales, in the year ended March 31, 2009, compared to operating income of $2,077,000, or 2.4% of net sales, in fiscal 2008. Electronic & metallic operating income decreased due to the decrease in sales revenue and gross margin as well as a relative increase in SG&A expenses as a percentage of sales as described above.

Non-operating income— Non-operating income for the year ended March 31, 2009 decreased by $353,000 to $168,000, as compared with fiscal 2008. This is mainly attributable to the decrease in interest income of $38,000 and an unrealized gain on the revaluation of marketable securities of $25,000 in the electronic and metallic segment, as well as the decrease in interest income of $243,000 in the plastic division during fiscal 2009.

Income Taxes —Income taxes for the year ended March 31, 2009 were comprised of income tax expenses of $234,000 and a deferred tax asset of $516,000, as compared with the income tax expenses of $654,000 and a deferred tax asset of $550,000 fiscal 2008.

Minority Interest —There was no minority interest for the year ended March 31, 2009. In August 2007, the Company acquired the remaining 24% minority interest in Integrated International Limited, ~~(“VTech”), Peavey Electronics Coop. (“Peavey”),~~the holding company holding the capital stock of Deswell’s electronic and metallic subsidiaries, thereby increasing Deswell’s interest in that company from 76% to 100%. As a result, the dollar amount of minority interest decreased to zero for the year ended in March 31, 2009 from $228,000 for fiscal 2008.

Net Income —The Company reported net income of $1,195,000 for the year ended March 31, 2009, a decrease of $7,664,000, as compared to a net income of $8,859,000 for the year ended March 31, 2008. Net income for the year ended March 31, 2009 represented 0.9% of net sales, compared to 6.2% of net sales for the net income the prior year. The decrease in net income was mainly the result of the decrease in sales revenue, gross profit margin, and other operating income as described above.

Net income for the plastic segment for the year ended March 31, 2009 totaled $1,620,000, as compared to net income of $6,735,000 for the prior year. The decrease in net income of the plastic segment was primarily the result of lower gross profit margin and the decrease in other operating income as described above.

Net loss for the electronic and metallic segment for the year ended March 31, 2009 was $425,000, compared to net income of $2,124,000 for the prior year. The decrease in net income of the electronic and metallic

segment was principally the result of the decrease in sales revenue, lower gross profit margin, and relatively higher SG&A expenses as a percentage of sales as described above.

Year ended March 31, 2008 Compared to Year Ended March 31, 2007

Net Sales— The Company’s net sales for the year ended March 31, 2008 were $143,806,000, an increase of $7,027,000 or 5.1% as compared to the year ended March 31, 2007. Sales to Digidesign, Line 6, N&J and Inter-Tel, the Company’s four largest customers during the year ended March 31, ~~2007,~~2008, represented approximately ~~51.5%~~53.3% of net sales for the year. ~~See Item 4 “Information on the Company – Major Customers”.~~

The increase in ~~total~~ sales was mainly related to the increase in sales at our ~~plastic segment and~~ electronics and metallic segment of ~~$11,161,000 and $10,342,000 respectively.~~$7,634,000 offsetting the decrease in sales at our plastic segment of $607,000. This represented ~~increases~~an increase of ~~23.1%~~9.9% and ~~15.4%~~a decrease of 1.0% respectively, as compared with the net sales from ~~these~~the segments in ~~fiscal 2006.~~the prior year.

Revenue from our plastics segment during fiscal ~~2007~~2008 amounted to ~~$59,737,000,~~$58,858,000, including ~~$150,000~~$28,000 of intersegment revenue, as compared to revenue in this segment during fiscal ~~2006~~2007 of ~~$50,581,000,~~$59,587,000, including ~~$1,152,000~~$150,000 of intersegment revenue. The revenue ~~increase in~~decrease at our plastic segment was primarily a result of the increase in orders from a telecommunications customer of $7,991,000 and from other existing customers of $3,988,000 over the corresponding period in the prior year; and from orders from new customers during fiscal 2007 of $9,125,000. Together the aggregate of these increases and additions from new customers offsetmainly due to the decrease in orders from existing customers of ~~$9,943,000. Accordingly,~~$12,984,000 of which $4,655,000 was related to plastic component sales of printer products and $5,402,000 was related to telecommunication products, offsetting the ~~net~~ increase ~~resulted~~in orders from ~~a change in customer mix as compared with fiscal 2006.~~other existing and new customers of $11,397,000 and $981,000 respectively. Of the increase, $8,811,000 was related to plastic component sales of electronic entertainment products.

Revenue from our electronic and metallic segment during fiscal ~~2007~~2008 amounted to ~~$83,280,000,~~$88,916,000, including ~~$2,969,000~~$3,940,000 of intersegment sales of electronic products as compared to revenue in this segment during fiscal ~~2006~~2007 of ~~$70,851,000,~~$80,311,000, including ~~$1,926,000~~$2,969,000 of intersegment sales of electronic products. The revenue increase inat our electronic and metallic segment was ~~principally caused by~~mainly due to an increase in OEM orders ~~for~~of electronic and metallic products from ~~both~~ existing and new customers of ~~$11,262,000~~$12,958,000 and ~~$2,185,000,~~$2,887,000 respectively, and an increase in distribution sales of $682,000 during the year, offsetting the decrease in orders from existing customers of ~~$2,462,000~~$8,452,000 in electronic sales ~~$638,000~~and $442,000 in metallic sales respectively. Of the increases, $9,037,000 and $5,000 in distribution sales respectively. The net increase was the result of a change in products and customer mix during fiscal 2007 as compared with fiscal 2006. The increase in OEM product sales was mainly from sales$5,403,000 were related to orders of professional audio equipment ~~products.~~and telecommunication equipment, respectively.

Gross Profit-— The gross profit for the year ended March 31, ~~2007~~2008 was ~~$31,273,000,~~$26,433,000, representing a gross profit margin of ~~22.9%~~18.4%. This compares with the overall gross profit and gross profit margin of ~~$25,426,000~~$31,273,000 or ~~22.1%~~22.9% for the year ended March 31, ~~2006.~~2007.

Gross profit in the plastics segment ~~increased~~decreased by ~~$5,647,000,~~$3,867,000 to $15,070,000 or 25.6% of net sales, for the year ended March 31, 2008 compared to $18,937,000 or 31.9% of net sales, for the year ended March 31, ~~2007~~2007. The decrease in gross margin was mainly attributed to the combined effect of a change in customer and product mix and the increase in resin cost during the year and the increase in labor cost and overhead cost of 2.4% and 4.0% of net sales, respectively, as compared with prior year, as a result of the RMB appreciation and implementation of a new China Labor Ordinance commencing January 1, 2008.

Gross profits in the electronic & metallic segment decreased by $973,000 to ~~$13,290,000~~$11,363,000, or ~~27.5%~~13.4% of net sales, for the year ended March 31, 2006. The improved gross margin was mainly attributed to a change in customer and product mix where lower margin assembly sales decreased by approximately 36% and higher margin orders increased during the year as2008 compared ~~with prior year; and our continued tight control of factory overhead; despite the 40.5% increase in labor cost as a~~

result of the approximately $1,005,000 in severance expenses paid upon the closure of our Shenzhen plastic plant during the year ended March 31, 2007 and an average 14% increase in labor rate as compared with fiscal 2006.

~~Gross profit in the electronic and metallic segment increased by $200,000~~ to $12,336,000 or 15.9% of net sales, for the ~~year ended March 31, 2007 compared to $12,136,000 or 18.1% of net sales, for fiscal 2006.~~last year. This was mainly attributed to the change in customer and product mix and the increased material pricing pressure on some of our electronic materials; ~~an approximately 32%~~the increase in labor ~~rates~~cost of 1.4% of net sales, the increase in value added tax cost as a result of the change in value added tax policy by the government of China for different categories of export products in the first quarter of fiscal 2008 and an average of ~~3.8%~~8.7% appreciation in ~~Chinese renminbi~~RMB currency ~~during fiscal~~in the year ~~2007~~ where most of our direct ~~overheads~~overhead and increased local material ~~sourcing~~souring are denominated, as compared with ~~fiscal 2006.~~last year.

Selling, General and Administrative Expenses–— SG&A expenses for the year ended March 31, ~~2007~~2008 were ~~$18,957,000,~~$19,601,000, amounting to ~~13.9%~~13.6% of total net sales, as compared to ~~$15,052,000~~$18,957,000 or ~~13.1%~~13.9% of total net sales for the year ended March 31, ~~2006.~~2007.

The SG&A expenses in the plastic segment increased by ~~$1,795,000~~$506,000 or ~~21.1%~~4.9% to ~~$10,317,000~~$10,823,000 or ~~17.4%~~18.4% of net sales, for the year ended March 31, ~~2007~~2008 compared to ~~$8,522,000~~$10,317,000 or ~~12.7%~~17.4% of net sales, for the prior year. The increase was primarily related to aan increase in staff and welfare cost of $712,000, audit and professional expenses of $170,000, depreciation expenses of $161,000 and selling expenses of 153,000 and estate duty and usage tax of $168,000. Together these offset the decrease in director remuneration of $526,000 and decrease in stock based compensation ~~charges~~cost of $820,000, an increase in management remuneration of $402,000 and approximately $388,000 in severance expenses paid upon the closure of one of our plastic manufacturing facilities during fiscal 2007, coupled with an increase in selling expenses of $140,000 and depreciation expense of $162,000 as a result of the increase in sales activities and our investment machinery investment during the year ended March 31, 2007$509,000 as compared with last year.

The SG&A expenses in the electronic ~~and~~& metallic segment increased by ~~$2,110,000~~$138,000 or ~~32.3%~~1.6% to $8,778,000 or 10.3% of net sales, for the year ended March 31, 2008 compared to $8,640,000 or 11.2% of net sales for the ~~year ended March~~ prior

31 ~~2007 compared to $6,530,000 or 9.7% of net sales for fiscal 2006.~~

year. The increase was primarily related to the increase in ~~salary expenses~~management and staff salary and welfare expenses of ~~$1,265,000~~$305,000 and ~~$61,000; as a result~~staff commission expenses of ~~both increase in staff rate and headcounts in various departments. Moreover, there were an increase~~$92,000 offsetting the decrease in selling logistic expenses of ~~$438,000 and increase in other general expense of $338,000 during the year, as a result of the increase in sales activities~~$289,000 as compared with last year.

Other operating income-— Other operating income was $1,838,000 for the year ended March 31, 2008, an increase of $462,000 as compared with the other operating income of $1,376,000 for the year ended March 31, ~~2007, an increase of $2,199,000 as compared with the other operating expenses of $823,000 for the year ended March 31, 2006.~~2007.

On a segment basis, other operating income attributable to the plastic segment increased ~~$2,140,000~~$861,000 to ~~$1,484,000~~$2,346,000 in the year ended March 31, ~~2007,~~2008, as compared to other expenses of ~~$656,000~~$1,485,000 for the year ended March 31, ~~2006.~~2007. The increase was ~~primarily attributable~~mainly attributed to an increase in exchange ~~transaction adjustment~~translation gain of ~~$1,166,000 of~~$1,193,000 relating to a subsidiary having ~~non-United States dollar~~RMB functional ~~currencies~~currency, and a decrease in allowance for doubtful ~~accounts receivable provision~~receivables of ~~$766,000, of which $970,000 was related to financial issues of a telecommunication customer due stemming from a failed European product launch~~$168,000, offsetting decrease in ~~the year ended March 31, 2006. This, together with the~~ gain on disposal of fixed assets of $560,000 which mainly resulted from our disposal of premises we owned that we used to house employees, upon closure of plastic manufacturing facilities during fiscal 2007, offset a $173,000 tax refund we received on our reinvestment of certain retained earnings in one of our PRC subsidiaries and the increase in other exchange loss of $163,000 as compared with the prior ~~year in 2006.~~year.

Other operating ~~income~~expenses attributable to the electronic & metallic segment increased ~~$60,000,~~$400,000, to operating expenses of ~~$108,000~~$508,000 in the year ended March 31, ~~2007,~~2008, as compared to other operating expenses of ~~$168,000~~$108,000 for the year ended March 31, ~~2006.~~2007. This increase in other operating expenses was primarily ~~due~~attributable to an impairment in goodwill relating to a metallic subsidiary of $317,000 as described in Note 7 of Notes to the Consolidated Financial Statements, the increase in exchange loss of $231,000 and the decrease in gain on disposal of fixed assets of ~~$128,000 and~~$126,000 offsetting the decrease ~~in bad debt write off of $169,000 offsetting the increase~~ in allowance for doubtful receivables of ~~$206,000~~$204,000 during the year ended March 31, ~~2007.~~2008.

Operating Income-— Operating income was ~~$13,692,000~~$8,670,000 for the year ended March 31, ~~2007, an increase~~2008, a decrease of ~~$4,141,000,~~$5,022,000, or ~~43.3%~~36.7% as compared with ~~fiscal 2006.~~the prior year.

On a segment basis, the operating income of the plastics segment ~~increased $5,992,000~~decreased $3,512,000 to ~~$10,104,000~~$6,593,000 or ~~17.0%~~11.2% of net sales in the year ended March 31, ~~2007~~2008 compared to ~~$4,112,000~~$10,105,000 or ~~8.5%~~17.0% of net sales in ~~fiscal 2006.~~the prior year. The ~~increase~~decrease in operating income in this segment was attributable to the ~~increase~~decrease in gross profit and ~~other operating income~~the increase in SG&A offsetting the increase in ~~SG&A expenses~~other operating income as described above.

The operating income of the electronics & metallic segment decreased ~~$1,850,000~~$1,511,000 to $2,077,000 or 2.4% of net sales, in the year ended March 31, 2008 compared to $3,588,000 or 4.6% of net sales in the ~~year ended March 31, 2007 compared to $5,438,000 or 8.1% of net sales in fiscal 2006.~~prior year. The decrease in operating income in this segment was attributable to the decrease in gross profit, coupled with the increase in SG&A expenses ~~offsetting the increase in gross profit~~ and ~~decrease in~~ other operating expenses as described above.

Non-operating income— Non-operating income for the year decreased by $26,000 to $521,000 for the year ended March 31, 2008 as compared with last year. This is mainly attributed to the decrease in interest income of $20,000 and rental income of $70,000 offsetting the decrease in impairment loss on marketable securities of $67,000 as compared with prior year.

Income Taxes–— Income tax for the year ended March 31, ~~2007~~2008 is comprised of income tax expenses of ~~$945,000~~$654,000 and ~~realization~~a deferred tax asset of ~~deferred income tax assets of $294,000,~~$550,000, compared with income tax expenses of ~~$267,000~~$624,000 and a deferred ~~income~~ tax ~~credit~~provision of ~~$294,000~~$615,000 in ~~fiscal 2006.~~the prior year.

On a segment basis, the income tax of the plastic segment is comprised of income tax expenses of ~~$472,000, realization of deferred income tax of $294,000~~$637,000 and a deferred tax ~~provision~~asset of $321,000 for the year ended March 31, ~~2007,~~2008, as compared with income tax expenses of ~~$8,000~~$472,000 and a deferred tax provision of $615,000 in the prior year. The decrease in income tax ~~credit of $294,000 in fiscal 2006. The increase~~expense was ~~primarily related~~mainly attributed to the ~~realization of deferred income~~additional tax ~~assets of $294,000; an under-provision of $253,000 for taxable~~provision made during the corresponding year ~~2004 and 2005 and a current year provision of $197,000~~ended March 31, 2007 as a result of an additional tax assessment in connection with the ~~reassessment~~amounts of assessable profits and the date of commencement of the first profitable year for our Dongguan plastic subsidiary. As a result, we made a tax provision of approximately $154,000, $92,000 and $166,000 for taxable ~~year from~~calendar years 2004, 2005 and 2006 respectively, at an applicable tax rate of 24% with a 50% tax exemption for the calendar years 2004 to ~~2002 by the PRC Tax Bureau~~2006. The tax assessment and payment for ~~a plastic manufacturing subsidiary~~calendar years 2004, 2005 and 2006 were settled during the year ended March 31, 2008. For taxable calendar year 2007, we initially provided an applicable national tax rate of 24% and 3% local tax rate but we have recently been approved as an “Export-oriented Enterprises” by the local tax authority and enjoyed a ~~deferred~~lower tax rate of 12%. Hence, an over-provision of income tax ~~provided of $321,000.~~was made in the last quarter. The income tax expenses for the electronic & metallic segment ~~decreased $107,000, to~~is comprised of income tax expenses of $18,000 and a deferred tax asset of $230,000 as compared with income tax expenses of $152,000 in the prior year.

Minority Interest— There was no minority interest as of March 31, 2008, whereas the minority interest for the five months ended August 31, 2007 and year ended March 31, ~~2007. This was mainly due to the recognition of refundable income taxes of $124,000 for the year ended March 31, 2007.~~

~~Minority Interest~~~~- Minority interests represent~~2008 represented a 24% minority interest in Integrated International Limited, the holding company holding the capital stock of Deswell’s electronic &and metallic subsidiaries. In ~~April 2005,~~August 2007, the Company acquired an additional 5%24% interest in Integrated, increasing its

ownership in that subsidiary from ~~71%~~76% to ~~76%~~100%. ~~In June 2005,~~As a result of the ~~Company liquidated its marketing subsidiary in which it held a 49% minority interest. The~~ decrease in Minority interest in Deswell’s electronic & metallic segment during the year, the dollar amount of minority interest todecreased by $605,000 from $833,000 for the year ended March 31, ~~2007, from $1,240,000 for fiscal 2006, represented the decrease in operating income in the electronics and metallic subsidiaries during the year.~~2007.

Net Income-— Net income was ~~$12,167,000~~$8,859,000 for the year ended March 31, ~~2007, an increase~~2008, a decrease of ~~$3,388,000~~$3,308,000 or ~~38.6%,~~27.2 %, as compared to net income of ~~$8,779,000~~$12,167,000 for the year March 31, ~~2006.~~2007. Net income as a percentage of net sales ~~increased~~decreased from ~~7.6%~~8.9% to ~~8.9%~~6.2 % for the year ended March 31, ~~2007.~~2008. The ~~increase~~decrease in net income was mainly the result of the ~~increase~~decrease in operating income ~~and~~offsetting the decrease in ~~minority interest offsetting the increase in~~ income tax expenses and decrease in minority interest, as described above.

Net income for the plastic segment ~~increased~~decreased by ~~$4,660,000~~$2,732,000 or ~~96.9%~~28.9 % to ~~$9,467,000~~$6,735,000 for the year ended March 31, ~~2007~~2008 compared to ~~$4,807,000~~$9,467,000 for ~~fiscal 2006.~~the prior year 2007. The ~~increase~~decrease in net income of the plastic segment was mainly the result of the ~~increase~~decrease in operating income offsetting the ~~increase~~decrease in income tax expenses, as described above.

Net income for the electronic & metallic segment decreased by ~~$1,271,000~~$577,000 or ~~32.0%~~21.4% to ~~$2,701,000~~$2,124,000 for the year ended March 31, ~~2007~~2008 compared to ~~$3,972,000~~$2,701,000 for ~~fiscal 2006.~~the prior year 2007. The decrease in net income of the electronic & metallic segment was mainly the result of the decrease in operating income offsetting ~~an increase in other income, a~~the decrease in income tax expenses and in ~~minority interest, as described above.~~

~~Year ended March 31, 2006 Compared to Year Ended March 31, 2005~~

~~Net Sales~~- Deswell’s net sales for the year ended March 31, 2006 were $115,276,000, a decrease of $10,314,000 or 8.2% as compared to the year ended March 31, 2005. Sales to Digidesign Inc. (“Digidesign”), Epson Precision (H.K.) Ltd. (“Epson”), and Line 6 Manufacturing (Line 6), the Company’s three largest customers during the year ended March 31, 2006, represented approximately 46.5% of net sales for the year. See Item 4 “Information on the Company – Major Customers”.

The decrease in sales was primarily related to a decrease in sales at our plastic segment of $11,366,000 or 19.1% offsetting an increase in sales of electronics and metallic segment of $1,052,000 or 1.6%, as compared with fiscal 2005.

The revenue decrease at our plastic segment during fiscal 2006 was principally the result of the decrease in telecommunication product orders from VTech Telecommunications Limited, formerly one of major customers, of $5,796,000, which we chose not to accept because of the significantly lower margins from fabricating the products would produce; a decrease in orders from another major customer of $6,378,000 as a result of delays by that customer in the progress of its new model production; a decrease in orders from another telecommunication customer of $4,846,000 as a result its discontinuation of a product it had launched in Europe due to product design revisions; and the decrease in orders from other existing customers of $1,873,000. These decreases combined to offset increases in orders from both new and other existing customers aggregating $3,066,000 and $4,461,000.

The increase in net sales in the electronic & metallic segment during fiscal 2006 was for the most part due to an increases in orders for electronic products from both existing and new customers aggregating $3,352,000 and $3,392,000, respectively, and the addition of a full-year’s sales from our audio equipment distribution business in China, which we began in January 2005, of $1,822,000. These factors together offset a net decrease in orders from existing customers of electronic products and metallic products of $3,507,000 and $4,007,000, respectively. We attribute the overall net increase in fiscal 2006 to changes in business focus to more on professional audio equipment than telecommunication products and our strategy of offering volume discount pricing in an effort to counter the intense competition in this market and to induce large orders for our electronics division and our addition of more

~~new customers compared with fiscal 2005 as well the full year’s impact from our new business of distributing of OEM’s professional audio equipment products in China.~~

~~Gross Profit~~- Our overall gross profit for the year ended March 31, 2006 was $25,426,000, representing a gross profit margin of 22.1%. This compares with and overall gross profit and gross profit margin of $33,518,000, or 26.7%, for the year ended March 31, 2005.

Gross profit in our plastics segment decreased by $7,462,000, to $13,290,000, or 27.5% of net sales, for the year ended March 31, 2006 compared to $20,752,000, or 34.8% of net sales, for the year ended March 31, 2005. As compared to fiscal 2005, we attribute the fiscal 2006 decrease in this gross profit mainly to increased plastic resin costs resulting from the rise in oil prices that we could not pass on to customers by raising selling prices; an average of an approximate 27% increase in our labor costs resulting primarily from the increase in the minimum wage in Southern China where are factories are located, and increases aggregating approximately 2% from the appreciation, when translated to US dollars, in the RMB, the currency we use to pay substantially all of our direct overhead expenses.

Gross profit in the electronic & metallic segment decreased by $630,000 to $12,136,000 or 18.1% of net sales, for the year ended March 31, 2006 compared to $12,766,000 or 19.4% of net sales, for fiscal 2005. We attribute the fiscal 2006 decrease in gross profit from fiscal 2005 principally from the combined effects of our strategy of offering volume discount pricing in an effort to counter the intense competition in this market and to induce large orders for our electronics division and an increase in our labor costs due to the minimum wage increases because of the increase of an average 14% as compared with prior year. These decreases were offset slightly by savings we were able to make by improving our material sourcing strategy and improved procurement efficiency.

~~Selling, General and Administrative Expenses~~– Selling, General and Administrative Expenses, or SG&A, expenses for the year ended March 31, 2006 were $15,052,000, amounting to 13.1% of total net sales, as compared to $15,759,000 or 12.5% of total net sales for the year ended March 31, 2005.

SG&A expenses in the plastic segment decreased by $1,368,000, or 13.8%, to $8,522,000, or 17.7% of net sales, for the year ended March 31, 2006 compared to $9,890,000, or 15.0% of net sales, for fiscal 2005. The decrease was primarily related to savings we realized in administration expenses of $816,000 as a result of the closure of one of our marketing subsidiaries at the beginning of calendar 2005; decreases in salaries, selling and depreciation expenses of $478,000, $15,000 and $117,000, respectively; and our continuing efforts to reduce SG&A general expenses of $58,000. These savings together offset an increase in employee benefits during fiscal 2006 of approximately $115,000.

SG&A expenses in our electronic & metallic segment increased by $661,000, or 11.3%, to $6,530,000 or 9.7% of net sales, for the year ended March 31, 2006 compared to $5,869,000, or 8.9% of net sales, for fiscal 2005. The increase was principally related to increases in salaries and welfare expenses of $269,000, selling and logistic expenses of $185,000, traveling expenses of $54,000, rental expenses of $50,000, financial expenses of $24,000 and other general expenses of $79,000 as a result of our expansion into the distribution of audio equipment in China and a general increase in sales activities in this segment during the year.

~~Other operating income~~~~- Other operating expenses was $823,000 for the year ended March 31, 2006, an increase of $717,000 as compared with the other operating expenses of $106,000 for the year ended March 31, 2005.~~

On a segment basis, other operating expenses attributable to the plastic segment increased $633,000 to $656,000 in the year ended March 31, 2006, as compared to other expenses of $23,000 for the year ended March 31, 2005. The increase was mainly attributed to an increase in doubtful account receivables provision of $1,015,000 of which $970,000 was related to a telecommunication customer’s financial issues due to a failed European product launch in the year ended March 31, 2006, offsetting the decrease in loss on disposal of fixed assets of $66,000, a $173,000 tax refund received on our reinvestment of certain retained earnings in one of our PRC subsidiaries, an increase in exchange gain of $25, 000 and gain on reversal of doubtful account payables of $95,000 during the year as compared with the prior year in 2005.

Other operating expenses attributable to the electronic & metallic segment increased $84,000, to operating expenses of $167,000 in the year ended March 31, 2006, as compared to other expenses of $83,000 for the year ended March 31, 2005. This increase was primarily due to the increase in allowance for doubtful receivables of $136,000 during the year ended March 31, 2006.

~~Operating Income~~~~- Operating income was $9,551,000 for the year ended March 31, 2006, a decrease of $8,102,000, or 45.9% as compared with the prior year.~~

On a segment basis, operating income of our plastics segment decreased $6,727,000, to $4,112,000, or 8.5% of net sales, in the year ended March 31, 2006 compared to $10,839,000 or 18.2% of net sales in the prior year. The decrease in operating income was attributable to the decrease in gross profit offsetting the improvement in SG&A expenses described above.

Operating income in our electronics & metallic segment decreased $1,375,000, to $5,439,000, or 8.1% of net sales, in the year ended March 31, 2006 compared to $6,814,000 or 10.3% of net sales in the prior year. The decrease in operating income was attributable to the decrease in gross profit and the increase in SG&A expenses described above.

~~Income Taxes~~– Income taxes for the year ended March 31, 2006 comprised of income tax expenses of $267,000 and deferred income tax assets of $294,000, compared with income tax expenses of $576,000 in fiscal 2005.

On a segment basis, income taxes of the plastic segment comprised income tax expenses of $8,000 and deferred income tax assets of $294,000 for the year ended March 31, 2006, as compared with income tax expenses of $202,000 in fiscal 2005. The increase was a result of the recognition of such deferred income tax assets of $294,000 arising from the taxable losses incurred in one of our plastic manufacturing subsidiaries during fiscal year and the decrease in income tax expenses of $194,000 from another of our subsidiaries as a result of its operating losses incurred during the year.

The income tax expenses for the electronic & metallic segment decreased $115,000, to $259,000 for the year ended March 31, 2006. The decrease in income tax expenses in the electronic & metallic segment was primarily due to the write off of doubtful sales of the metal division of $1,006,000 and the decrease in operating income during the year ended March 31, 2006.

~~Minority Interest~~- Minority interests represent a 24% minority interest in Integrated International Limited, the company holding the capital stock of Deswell’s electronic and metallic subsidiaries. In April 2005, the Company acquired an additional 5% interest in Integrated, increasing its ownership in that subsidiary from 71% to 76%. In June 2005, the marketing subsidiary in which the Company had held a 51% shareholding interest was liquidated by its stockholders. As a result of the decrease in minority interests in Deswell’s electronic & metallic segment and the marketing subsidiary, the dollar amount of minority interest decreased to $1,240,000 for the year ended March 31, 2006, from $2,330,000 for fiscal 2005. This represented a decrease in minority interest of $700,000 in the electronics and metallic subsidiaries, and a decrease in the minority interest in the company’s marketing subsidiary from $390,000 to nil.

~~Net Income~~- Net income was $8,779,000 for the year ended March 31, 2006, a decrease of $6,404,000 or 42.2%, as compared to net income of $15,183,000 for the year March 31, 2005. Net income as a percentage of net sales decreased from 12.1% to 7.6% for the year ended March 31, 2006. The decrease in net income was mainly the result of the decrease in operating income and other income offsetting the decrease in income tax expenses and minority interest, as described above.

Net income for the plastic segment decreased by $5,567,000 or 53.7% to $4,807,000 for the year ended March 31, 2006 compared to $10,374,000 for fiscal 2005. The decrease in net income of the plastic segment was mainly the result of the decrease in operating profits and other income, offsetting the decrease in income tax expenses and minority interest, as described above.

Net income for the electronic & metallic segment decreased by $837,000 or 17.4% to $3,972,000 for the year ended March 31, 2006 compared to $4,809,000 for fiscal 2005. The decrease in net income of the electronic & metallic segment was mainly the result of the decrease in operating profit and other income offsetting the decrease in income tax expenses and minority interest, as described above.

Seasonality

The following table sets forth certain unaudited quarterly financial information sequentially for the twelve quarters in the three-year period ended March 31, ~~2007~~2009 (in thousands):

									��
	Year ended March 31,
	2007								2008								2009
	Q1		Q2		Q3		Q4		Q1		Q2		Q3		Q4		Q1		Q2			Q3		Q4
Net sales	$	31,689	$	35,715	$	39,002	$	30,373	$	38,452	$	38,414	$	35,416	$	31,524	$	35,039	$	32,241		$	37,101	$	27,357
Gross profit		8,446		8,865		8,754		5,208		6,762		6,698		7,923		5,050		5,901		3,524			6,413		4,330
Operating income		3,866		3,973		4,016		1,837		3,304		1,681		3,033		652		1,310		(1,663	)		878		220
Net income		3,403		3,597		3,605		1,562		3,111		1,755		2,955		1,038		1,293		(1,675	)		987		590

The following table sets forth the same unaudited quarterly information presented in the above table but by quarterly comparisons by year in the three-year period ended March 31,

2009 (in thousands):


	Year ended March 31,																								Three months ended
	2005								2006								2007								June 30,						September 30							December 31						March 31
	Q1		Q2		Q3		Q4		Q1		Q2		Q3		Q4		Q1		Q2		Q3		Q4		2007		2008		2009		2007		2008		2009			2007		2008		2009		2007		2008		2009
Net sales	$	28,788	$	31,924	$	36,185	$	28,693	$	30,075	$	29,046	$	29,972	$	26,183	$	31,689	$	35,715	$	39,002	$	30,373	$	31,689	$	38,452	$	35,039	$	35,715	$	38,414	$	32,238		$	39,002	$	35,416	$	37,101	$	30,373	$	31,524	$	27,357
Gross profit		8,318		8,461		9,402		7,337		7,640		6,209		6,561		5,016		8,446		8,865		8,754		5,208		8,446		6,762		5,901		8,865		6,698		3,522			8,754		7,923		6,413		5,208		5,050		4,330
Operating income		4,822		4,502		4,832		3,497		3,600		3,126		2,632		193		3,866		3,973		4,016		1,837
Net income		3,995		3,628		4,207		3,353		3,151		2,795		2,380		453		3,403		3,597		3,605		1,562
Operating income (loss)																										3,866		3,304		1,310		3,973		1,681		(1,663	)		4,016		3,033		878		1,837		652		220
Net income (loss)																										3,403		3,111		1,293		3,597		1,755		(1,675	)		3,605		2,955		987		1,562		1,038		590

The first calendar quarter (the fourth fiscal quarter ending March 31 of ~~the~~our 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. Labor cost and overhead expenses of the Company are paid primarily in Hong Kong dollars and RMB, respectively.

Since 1983, the exchange rate of the Hong Kong dollar to the U.S. dollar has been fixed by the Hong Kong government at approximately HK$7.80 to US$1.00 and accordingly Hong Kong Dollars has not, to date, represented a currency exchange risk to U.S. dollars. This could change in the future if those in Hong Kong arguing for a floating currency system prevail in the ongoing debate over whether to continue to peg the Hong Kong dollar to the U.S. dollar. There can be no assurance that the Chinese government will continue to maintain the present currency exchange mechanism in Hong Kong and if the currency exchange mechanism between the Hong Kong dollar and the U.S. dollar were changed, the Company’s results of operations and financial condition could be materially adversely affected.

Until ~~August~~July 21, 2005, exchange rate fluctuations between the RMB and the US dollar had not had a significant impact on the Company’s operating results. In 1994, China adopted a floating currency system whereby the official exchange rate is equal to the market rate. Between 1994 and July 2005, the market and official RMB rates were unified and the value of the RMB was essentially pegged to the US dollar and was relatively stable. During its fiscal years ended March 31, 2004 and 2005, the average exchange rate was 8.28 Yuan per US$1.00. On July 21, 2005, the People’s Bank of China adjusted the exchange rate of RMB to the U.S. dollar by linking the RMB to a basket of currencies and simultaneously setting the exchange rate of RMB to U.S. dollars, from 1:8.27, to a narrow band of around 1:8.11, resulting in an approximately 2% appreciation in the value of the RMB against the U.S. ~~dollars.~~dollar. The ~~exchange rates of~~four main currencies in the basket to which the RMB was linked were the US dollar, the Euro, the Japanese yen and the Korean won. In the months since July 2005, further appreciation against the US dollar continued to occur and by July 31, 2009, the RMB had risen to 6.8321 to the ~~U.S. dollars have further appreciated during the period since August 2005 to 1:7.61 as at June 30, 2007.~~US dollar. As a consequence, and in addition to increases in plastic resin and labor costs, in each of the ~~year~~years ended March 31, ~~2006~~2007, 2008 and 2009, Deswell’s operating costs increased from levels existing prior to the exchange rate adjustment. Since the Company was not able to pass on to its customers most of these cost increases by price increases of its products, Deswell’s gross margins, operating income and net income were adversely affected.

~~The four main currencies in~~If the ~~basket~~trend of RMB appreciation to ~~which the RMB was linked in July 2005 were~~ the US dollar the euro, the Japanese yen and the Korean won. In the months since July 2005, a further small but steady appreciation against the US dollar continued to occur and by the middle of May 2006, the RMB had risen to 8.02 to the US dollar. If this trend continues or the Chinese government allows a further and significant RMB appreciation, Deswell’s operating costs would further increase and its financial results would be adversely affected by such increase. If Deswell determined to pass onto its customers through price increases the effect of increases in the Chinese RMB relative to the U.S. dollar, it would make the Company’s products more expensive in global markets, such as the United States and the European Union. This could result in the loss of customers, who may seek, and be able to obtain, products comparable to those Deswell offers in lower-cost regions of the world.

For additional information regarding the appreciation of the exchange rate of the RMB to the U.S. dollar from July 21, 2005 to March 31, 2009, please see the chart on page 11 of this Report.

We did not hedge our currency risk during the years ended March 31, ~~2005, 2006~~2007, 2008 and ~~2007~~2009 and at March 31, ~~2007 ,~~2009, we had no open forward currency contracts. We continually review our hedging strategy and there can be

no assurance that hedging techniques we may implement will be successful or will not result in charges to our results of operations.

Liquidity and Capital Resources

For the year ended March 31, ~~2007,~~2009, net cash generated from operations totaled ~~$15,807,000,~~$11,669,000, including net income of ~~$12,167,000~~$1,195,000 and depreciation and amortization of ~~$5,274,000.~~$7,264,000. Accounts receivable increased by ~~$2,745,000,~~$918,000, over levels at March 31, ~~2006,~~2008, primarily as a result of the increase in credit sales ~~offsetting~~to our largest customer despite the increase in provision of doubtful ~~account~~accounts receivable of ~~$260,000.~~$275,000. Inventories ~~increased~~decreased by ~~$7,650,000,~~$4,923,000 over levels at March 31, ~~2006,~~2008, primarily resulting from the ~~increase~~decrease in ~~sale~~our inventory of electronic ~~parts and shortage in supplies of some materials we use in the manufacture of electronic parts during the last quarter ended March 31, 2007 which delayed our production and delivery schedule.~~parts. Accounts payable ~~increased~~decreased by ~~$4,979,000~~$2,157,000 over levels at March 31, ~~2006,~~2008, primarily because of the ~~increase~~decrease in materials purchases. For the year ended March 31, ~~2006,~~2008, net cash generated from operations totaled ~~$12,322,000,~~$16,418,000, including net income of ~~$8,779,000~~$8,859,000 and depreciation and amortization of ~~$5,299,000.~~$6,940,000.

Net cash used in investing activities amounted to ~~$4,580,000~~$7,057,000 and ~~$6,890,000~~$7,369,000 for the ~~years~~year ended March 31, ~~2007~~2009 and ~~2006,~~2008, respectively. Capital expenditures during these periods totaled ~~$7,812,000~~$7,402,000 and ~~$6,940,000,~~$7,288,000, respectively. There were no acquisitions of marketable securities during either of these periods. Our capital

expenditures were primarily related to the ~~construction~~acquisition of ~~our new Dongguan manufacturing~~property, plant and ~~our acquisition of plant and machinery~~equipment for our ~~production facilities~~two manufacturing plants in Dongguan, China.

Net cash used in financing activities for the years ended March 31, ~~2007~~2009 and ~~2006~~2008 were ~~$10,792,000~~$3,789,000 and ~~$7,967,000,~~$8,537,000, respectively. Net cash we used in financing activities during the year ended March 31, ~~2007~~2009 was primarily to fund ~~the our~~ dividend payments to shareholders of $11,809,000, dividend payments to minority shareholders of subsidiaries of $582,000 netting off the proceeds of $950,000 from the exercise of stock options from directors and employees and the release of restricted cash of $649,000.shareholders. Net cash we used in financing activities during the year ended March 31, ~~2006~~2008 was primarily to fund ~~our~~the dividend payments to shareholders of ~~$7,311,000, dividend payments to minority shareholders~~$9,523,000, net of ~~subsidiaries of $1,229,000, increase in restricted cash of $391,000 netting off~~ the proceeds of ~~$352,000~~$986,000 from the exercise of stock options from directors and employees.

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 decreased from ~~8.25%~~5.25% to ~~7.75%~~5.0% during the year ended March 31, ~~2007.~~2009.

At March 31, ~~2007,~~2009, the Company had cash and cash equivalents of ~~$24,549,000.~~$23,134,000. At that date, Deswell had no committed credit facilities and no restricted cash. Deswell expects that working capital requirements and capital additions will continue to be funded through cash on hand and internally generated funds. However, Deswell may choose to seek to obtain additional debt or equity financing if it believes it to be appropriate and available on reasonable terms. The Company’s working capital requirements are expected to increase in line with the growth in the Company’s business.

WeAt March 31, 2009, the Company had capital commitments for ~~construction of our Dongguan plastic injection-molding manufacturing plant,~~ purchase of plant and machinery ~~and system improvement of $1,100,000 as of~~totaling $130,000 which are expected to be disbursed during the year ending March 31, ~~2007. We expect that internally generated funds will~~2010. Also, the Company had capital commitments for a new enterprise resource planning software system upgrade project at March 31, 2009 totaling $216,000 of which $82,000 are expected to be sufficient to satisfy its cash needs for at least the next 12 months. However, we may choose to obtain debt or equity financing if we believe it appropriate to accelerate the phase IV construction of its Dongguan plastic plant.disbursed by March 31, 2010 and $134,000 by March 31, 2011, respectively.

A summary of our contractual obligations and commercial commitments as of March 31, ~~2007~~2009 is as follows:


	Payments due by period
					(In thousands)						Payments due by period (in thousands)
					Period from		Period from		Period						Period from		Period from		Period
			Year ending		April 1, 2008		April 1, 2010		after				Year ending		April 1, 2010		April 1, 2012		after
			March 31,		to March 31,		to March 31,		March 31,				March 31,		to March 31,		to March 31,		March 31,
Contractual obligations	Total		2008		2010		2012		2012		Total		2010		2012		2014		2014
Long-term bank borrowing	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Capital (finance) lease obligations		—		—		—		—		—		—		—		—		—		—
Operating lease payments		131		112		19		—		—		154		136		18		—		—
Capital expenditures		1,100		1,088		12		—		—		346		212		134		—		—
Purchase obligations		14,595		14,593		2		—		—		5,854		5,854		—		—		—
Other long-term liabilities		—		—		—		—		—		—		—		—		—		—

Total	$	15,826	$	15,793	$	33	$	—	$	—	$	6,354	$	6,202	$	152	$	—	$	—

Off Balance Sheet Arrangements

We do not use off-balance sheet financing arrangements, such as securitization of receivables or obtaining access to assets through special purpose entities.

Critical Accounting Policies

The Company prepares its consolidated financial statements in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. On an on-going basis, the Company evaluates its estimates and judgments, including those related to inventories and the valuation of long-lived assets. The Company bases its estimates and judgments on historical experience and on various other factors that the Company believes are reasonable. Actual results may differ from these estimates under different assumptions or conditions.

~~The following critical accounting policies affect the more significant judgments and estimates used in the preparation of the Company’s consolidated financial statements.~~

~~Inventories~~– Inventories, consisting of raw materials, work-in-progress and finished goods, are stated at the lower of market or cost, with cost determined by 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.

~~Foreign currency translation~~- The Company is incorporated in the British Virgin Islands where the currency is the U.S. dollar and the financial statements are in U.S. dollar. The Company’s subsidiaries conduct substantially all of their business in Hong Kong dollars, Chinese Renminbi or U.S. dollars. The exchange rate of Hong Kong dollars has been fixed to the U.S. dollar at approximately HK$7.78 to $1.00 since April 2005. 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.

On consolidation, the financial statements of subsidiaries are translated from Hong Kong dollars and Chinese Renminbi, being the functional currencies 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 rates between the Hong Kong dollar and the U.S. dollar were approximately 7.75, 7.78 and 7.78 as of March 31, 2005, 2006 and 2007 respectively. The exchange rates between the Chinese Renminbi and the U.S. dollar were approximately 8.29, 8.09 and 7.78 as of March 31, 2005, 2006 and 2007 respectively. All exchange differences arising from translation of subsidiaries financial statements are recorded as a component of comprehensive income.

~~Allowance for doubtful account~~- The Company regularly monitors and assesses the risk of not collecting amounts owed to the Company by customers. This evaluation is based upon a variety of factors including: an analysis of amounts current and past due along with relevant history and facts particular to the customer. Based upon the results of this analysis, the Company records an allowance for uncollectible accounts for this risk. This

~~analysis requires the Company to make significant estimates, and changes in fact and circumstances could result in material changes in the allowance for doubtful accounts.~~

Recent Changes in Accounting Standards

~~In June 2006, the FASB ratified the consensus reached by the EITF on Issue No. 06-3, How Taxes Collected from Customers~~For a discussion of critical accounting policies and ~~Remitted~~recently issued and changes in accounting standards relevant to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation) (“ EITF 06-3”). EITF 06-3 includes any tax assessed by a governmental authority that is directly imposed on a revenue-producing transaction between a sellerour financial performance and a customer and may include, but is not limited to, sales, use, value added, and some excise taxes. EITF 06-3 concludes that the presentation of taxes on either a gross (included in revenues and costs) or a net (excluded from revenues) basis is an accounting policy decision that should be disclosed. In addition, for any such taxes that are reported on a gross basis, a company should disclose the amounts of those taxes in interim and annual financial statements, ~~for each period for which an income statement is presented if those amounts are significant. The provisions~~see Note 2 of ~~EITF 06-3 should be applied~~Notes to financial reports for interim and annual reporting periods beginning after December 15, 2006, with earlier adoption permitted. The Company’s policy to record revenue is net of sales taxes. The adoption of EITF 06-3 does not have a material impact on its consolidated financial position, results of operations or cash flows.

~~In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty~~Consolidated Financial Statements included in ~~Income Taxes (“FIN 48”). FIN 48 clarifies the accounting for uncertainty~~Part III, Item 18, in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. This Interpretation is effective for fiscal years beginning after December 15, 2006, with earlier adoption permitted. The adoption of FIN 48 does not have a material impact on its consolidated financial position, results of operations or cash flows.

In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements. SFAS No. 157 establishes a common definition for fair value to be applied to US GAAP guidance requiring use of fair value, establishes a framework for measuring fair value, and expands disclosure about such fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The Company is currently assessing the impact of SFAS No. 157 on its consolidated financial position and results of operations.

In September 2006, the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements. SAB 108 is effective for fiscal years ending on or after November 15, 2006 and addresses how financial statement errors should be considered from a materiality perspective and corrected. The literature provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. Historically there have been two common approaches used to quantify such errors: (i) the “rollover” approach, which quantifies the error as the amount by which the current year income statement is misstated, and (ii) the “iron curtain” approach, which quantifies the error as the cumulative amount by which the current year balance sheet is misstated. The SEC Staff believes that companies should quantify errors using both approaches and evaluate whether either of these approaches results in quantifying a misstatement that, when all relevant quantitative and qualitative factors are considered, is material. The adoption of SAB 108 does not have a material impact on its consolidated financial position, results of operations or cash flows.

In February 2007, the FASB issued SFAS No. 159 “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115” (“SFAS No. 159”), which permits entities to choose to measure many financial instruments and certain other items at fair value. The fair value option established by this Statement permits all entities to choose to measure eligible items at fair value at specified election dates. A business entity shall report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. Adoption is required for fiscal years beginning after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided the entity also elects to apply the provisions of SFAS Statement No. 157. The Company is currently evaluating the impact of SFAS No. 159 on its consolidated financial statements and is currently not yet in a position to determine such effects.Report.

ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

Directors and Senior Management

The directors and executive officers of the Company at ~~June 30, 2006~~July 31, 2009 are as follows:


Name	Age		Position(s) with Company
~~Lau~~Richard Pui Hon ~~(Richard Lau)~~Lau		6264	Chairman of the Board of Directors
Franki ~~S. F.~~Shing Fung Tse		4345	Chief Executive Officer
Li Chin Pang ~~(C. P. Li)~~Li		61	~~Executive Director and General Manager of Manufacturing and Administration for Plastic Operations, Secretary and Member of the Board of Directors~~
~~Leung Chi Wai (C. W. Leung)~~		5263	Executive Director of ~~Engineering~~Manufacturing and Administration for Plastic
			Operations and Member of the Board of Directors
Hung-Hum Leung		6163	Non-Executive Director and Member of ~~Board of Directors and~~ Audit ~~Committees~~Committee
Allen Yau-Nam Cham		6062	~~Member~~Non-Executive Director and Chairman of ~~Board of Directors and~~ Audit ~~Committees~~Committee
Wing-Ki Hui		6163	Non-Executive Director and Member of ~~Board of Directors and~~ Audit ~~Committees~~Committee
~~Eliza Y. P. Pang~~Betty Ching Han Lam		4547	Chief Financial Officer
~~Lee Shu Kwan (S. K. Lee)~~		61	~~Director of Administration and Marketing for Electronic Operations~~
~~Tam Man Chi (M. C. Tam)~~		57	~~Director of Engineering and Manufacturing for Electronic Operations~~

Richard PUI HON Lau. Mr. Lau served as Chief Executive Officer and Chairman of the Board of Directors of the Company and its predecessors since their inception in 1987 until February 2007, at which time he retired as Chief Executive Officer. Mr. Lau remains as Chairman of the Board.

Franki ~~S. F.~~SHING FUNG Tse. Mr. Tse joined Deswell in February 2007 at its Chief Executive Officer, bringing with him over 19 years experience in the tool-making, plastic injection and electronic service provider, or EPS, industry. From July 2005 until joining Deswell, he served as Vice President of Operations for Goodbaby Child Products Co. Ltd., a leading baby-products manufacturing company in Shanghai, China with approximately 15,000 workers. From May 2001 to June 2005 Mr. Tse served as Director of Marketing of Deswell’s plastic subsidiary, Jetcrown Industrial (Dongguan) Ltd. From 1988 to 2000, Mr. Tse was in charge of the China Sales Business Division of Qualidux Industrial Co., Ltd., a group of companies engaged in original design and original equipment plastics manufacturing. Mr. Tse received his MBA in Business Finance from the University of Lincoln, United Kingdom in 2002.

~~C. P.~~CHIN PANG 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, a position which he held until March 31, 2006. As Executive Director ~~and General Manager~~ of Manufacturing and Administration for Plastic Operations, Mr. Li is in charge of the ~~day-to-day~~ manufacturing and administrative operations for the Company’s plastic products. Mr. Li received his Bachelor of Science degree from Chun Yan Institute College, Taiwan in 1967.

~~C. W. Leung.~~ Mr. Leung has served the Company as a Member of the Board of Directors and in various executive capacities with the Company and its predecessors since their inception in 1987. As Executive Director of Engineering for Plastic Operations, Mr. Leung is in charge of the mold division and engineering for the Company’s plastic manufacturing operations.

Hung-Hum Leung. Mr. Leung has been a non-executive 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 non-executive 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,

Deswell, Ms. ~~Pang is~~Lam served as Finance Director from August 2007 until July 2008, and as Financial Controller from March 2000 to July 2007, for Paxar (China) Limited, a ~~registered fellow member~~multinational corporation manufacturing packaging items, hang tags, woven and paper labels for the garment industries. During the fifteen years preceding her tenure at Paxar, Ms. Lam served in the finance departments of ~~The Hong Kong Institute~~other enterprises, including over three years with Deloitte Haskins & Sells, an international public accounting firm that was one of ~~Certified Public Accountants. Ms. Pang has worked at KPMG~~the predecessors of Deloitte & Touche (Deloitte, Touche Tohmatsu in Asia). Ms Lam received her Master of Business in Accounting and ~~Ernst & Young~~Finance from the University of Technology, Sydney in ~~Hong Kong. Ms. Pang received~~1996 and her Professional Diploma in Accountancy ~~and her MBA degree~~ from ~~The~~the Hong Kong Polytechnic ~~University~~ in ~~1985 and 1996, respectively.~~

~~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 1973.1985.

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 Executive Officers

Executive Officers

The aggregate amount of compensation (including non-cash benefits) paid by the Company and its subsidiaries during the year ended March 31, ~~2007~~2009 to all directors and executive officers as a group for services in all service capacities was approximately ~~$3,172,000. This~~ $1,940,000, which

	•		excludes amounts paid by the Company or its subsidiaries as dividends to directors and executive officers in their capacity as shareholders of the Company during the year ended March 31, 2009; and

	•		includes compensation amounts paid to one former director and executive officer and two other executive officers, all of whom we lost at different dates during the year ended March 31, 2009.

See the ~~Company or its subsidiaries as dividends to shareholders~~discussion under “We depend on our executive officers, senior managers and skilled personnel. We lost three of our top executives during fiscal 2009 and have not yet replaced them, which has increased the ~~year ended March 31, 2007.~~pressure and responsibilities on our remaining senior managers” in Item 3 Key Information — Risk Factors, above.

Directors

Effective August 1, 2003, directors who are not employees of the Company or any of its subsidiaries are paid $2,000 per month for services as a director, and are reimbursed for all reasonable expenses incurred in connection with services as a director and member of Board committees. The Board has determined that Messrs. Hung-Hum Leung, Allen Yau-Nam Cham and Wing-Ki Hui are each “independent” within the meaning of Rule ~~4200~~5605(a)(2) of the ~~Nasdaq~~NASDAQ Marketplace Rules.

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.~~Company.

Audit Committee

The Audit Committee meets from time to time to review the financial statements and matters relating to the audit and has full access to management and the Company’s auditors in this regard. The Audit Committee recommends the engagement or discharge of the Company’s independent accountants, consults on the adequacy of the Company’s internal controls and accounting procedures and reviews and approves financial statements and reports. Deswell’s audit committee consists of Messrs. Hung-Hum Leung, Allen Yau-Nam Cham and Wing-Ki Hui,

Although such board practices or committees, consisting of independent directors as defined by ~~the Nasdaq~~NASDAQ’s Marketplace Rules, are required of U.S. domestic public companies ~~having~~with securities ~~included~~listed on The Nasdaq Stock Market, they are not required of foreign private issuers such as Deswell if such issuers follow their home country practice. In addition to not having a compensation committee or a nominating committee consisting of independent directors, Deswell also follows home country practice of not having nominees to its board selected or recommended by a majority of its independent directors; not having the compensation of its Chief Executive Officer and other executive officers determined or recommended to the board by a majority of ~~its Board of Directors are not “independent” directors within the definition of “independent director” in the Nasdaq Marketplace Rules~~our independent directors; and Deswell’s independent directors do not meet in executive session.

Until the retirement of Chi Wai Leung effective January 1, 2009, who, in addition to serving as our Executive Director of Engineering for Plastic Operations, also served on our board of directors, a majority of our Board of Directors were not “independent” directors within the definition of “independent director” in NASDAQ Marketplace Rule 4200(a)(15) (which was in effect at the time of such resignation and has since been replaced without material change by NASDAQ Marketplace Rule 5605(a)(2)) and accordingly we did not theretofore comply with then applicable NASDAQ Market place Rule 4350(c)(1). Although our Board now consists of a majority of independent directors, if we choose to fill Mr. Leung’s former position on our Board with a member of our management team or a person not otherwise deemed “independent” under NASDAQ’s Marketplace Rules, we would not then comply with NASDAQ Marketplace Rule 5605(b)(1) (which replaced NASDAQ Market place Rule 4350(c)(1) effective April 13, 2009) and our corporate governance standards would again differ in this regard from those applied to US domestic issuers under NASDAQ’s Marketplace Rules. See also “Our exemptions from certain of the reporting requirements under the Exchange Act limits the protections and information afforded to investors” on page 17 in the Risk Factors section of this Report for a further discussion of how our SEC reporting and corporate governance practices differ from those applicable to US domestic issuers and US NASDAQ-listed companies.

Employees

At March 31, ~~2007,~~2009, the Company employed ~~6,351~~3,622 persons on a full-time basis, of which 1110 were located in Macao and ~~6,340~~3,612 located in and travel to and from China. Of the Company’s employees ~~3,980~~2,703 and ~~2,371were~~909 engaged in plastic injection molding manufacturing and contract electronic manufacturing, metal molds and parts manufacturing, respectively, at March 31, ~~2007.~~2009. 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~~directors and ~~Senior Management~~senior management and major shareholders, see Item 7 of this Report.

Employee Stock Option Plans

In 1995, the Company adopted its 1995 Stock Option Plan permitting the Company to grant options to purchase up to 1,012,500 common shares to employees, officers, directors and consultants of the Company. On September 29, 1997, the Company’s Board of Directors and shareholders approved an increase of 549,000 shares in the number of shares that can be optioned and sold under the Option Plan bringing to a total of 1,561,500 shares the number of common shares that can be optioned and sold under the 1995 Stock Option Plan.

On August 15, 2001 the Board approved the adoption of the 2001 Stock Option Plan permitting the Company to grant options to purchase up to an additional 1,125,000 common shares to employees, officers, directors and consultants of the Company. On January 7, 2002 shareholders approved the 2001 plan.

On August 20, 2003, the Board approved the adoption of the 2003 Stock Option Plan permitting the Company to grant options to purchase up to an additional 900,000 common shares to employees, officers, directors, consultants and advisors of the Company. On September 30, 2003 shareholders approved the 2003 plan. On August 1, 2005, the Company’s Board of Directors, subject to shareholder approval, approved amendments to the 2003 Stock Option to increase by 500,000 shares in the number of shares that can be optioned and sold under the 2003 Stock Option Plan, bringing to a total of 1,400,000 shares the number of common shares that can be optioned and sold under the 2003 Stock Option Plan. The Company’s shareholders approved this amendment at the Company’s Annual ~~Shareholders~~Shareholders’ Meeting held on September 19, 2005.

On August 17, 2007, the Company’s Board of Directors, subject to shareholder approval, approved amendments to the 2003 Stock Option to increase by 400,000 shares in the number of shares that can be optioned and sold under the 2003 Stock Option Plan, bringing to a total of 1,800,000 shares the number of common shares

ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

Major Shareholders

~~Except as disclosed in the footnotes to the table below with respect to Leesha Holdings Limited (“Leesha”), the~~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, ~~2007,~~2009, the beneficial ownership of the Company’s ~~Common Shares~~common shares by each person known by the Company to beneficially own 5% or more of the ~~Common Shares~~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.~~common shares.

Number of shares
beneficially owned (1)
Name of beneficial owner or identity of group Amount Percent
Richard Lau 3,891,760 25.3 %
C. P. Li 3,688,750 24.0 %
C. W. Leung 3,688,750 24.1 %
Leesha Holdings Ltd. 3,453,750 22.8 %
Wellington Management Company, LLP⁽⁶⁾
1,602,505 10.6 %
Royce & Associates, Inc.⁽⁷⁾
1,228,996 8.1 %
Micropower Enterprises Limited 1,143,750 7.6 %
FMR Corp./ Edward C. Johnson 3d⁽⁸⁾
907,214 6.0 %
Franki S. K. Tse * *
M. C. Tam * *
S. K. Lee * *
Eliza Y. P. Pang * *
Hung-Hum Leung * *
Allen Yau-Nam Cham * *
Wing-Ki Hui * *


	Number of shares
	beneficially owned (1)
Name of beneficial owner or identity of group	Amount			Percent
Richard Pui Hon Lau		1,716,045	⁽²⁾		10.6
Chin Pang Li		1,520,750	⁽³⁾		9.4
Royce & Associates, Inc.		836,771	⁽⁴⁾		5.3
Franki Shing Fung Tse		*			*
Betty Ching Han Lam		*			*
Hung-Hum Leung		—			—
Allen Yau-Nam Cham		—			—
Wing-Ki Hui		—			—


*		Less than 1%.

(1)		Based on ~~15,143,730~~15,790,810 shares outstanding on June 30, ~~2007.~~2009. However, in accordance with Rule 13d-3(d)(1) under the Securities Exchange Act of 1934, 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 shares owned by the listed person holding such options, but are not considered outstanding for the purpose of computing the percentage of shares owned by any of the other listed persons.

(2)		Consists of ~~3,453,750 shares held of record by Leesha, 203,010 shares~~1,346,545 held of record by Mr. Lau and options to purchase ~~235,000~~369,500 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 ~~$11.61~~$10.39 per share until ~~June 25, 2016. As a director of Leesha, Mr. Lau shares the voting and investment power of the shares held by Leesha.~~April 8, 2019.

(3)		Consists of ~~3,453,750 shares held of record by Leesha, nil shares~~1,151,250 held of record by Mr. Li and options to purchase ~~235,000~~369,500 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 ~~$11.61~~$10.39 per share until ~~June 25, 2016. As a director of Leesha, Mr. Li shares the voting and investment power of the shares held by Leesha.~~April 8, 2019.

(4)		Consists of 3,453,750 shares held of record by Leesha, 100,000 shares held of record by Mr. Leung and options to purchase 135,000 shares granted to Mr. Leung under the Company’s stock option plans. Mr. Leung’s options are exercisable at a weighted average exercise price of $14.10 per share until September 30, 2013. As a director of Leesha, Mr. Leung shares the voting and investment power of the 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

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 July 1996, when Deswell announced that it planned to pay cash dividends semi-annually. 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,

	•		2005 aggregating $9,234,000, $2,196,000 of which was based on results for the last quarter of the year ended March 31, 2004 and $7,038,000 of which was based on results for the first three quarters of the year ended March 31, 2005; and

	•		2006 aggregating $9,400,000, $2,535,000 of which was based on results for the last quarter of the year ended March 31, 2005 and $6,865,000 of which was based on results for the first three quarters of the year ended March 31, 2006.

	•		2007 aggregating $9,720,000, $2,089,000 of which was based on results for the last quarter of the year ended March 31, 2006 and $7,631,000 of which was based on results for the first three quarters of the year ended March 31, ~~2007.~~2007;

	•		2008 aggregating $9,523,000, $2,574,000 of which was based on results for the last quarter of the year ended March 31, 2007 and $6,949,000 of which was based on results for the first three quarters of the year ended March 31, 2008; and

	•		2009 aggregating $3,790,000, $1,895,000 of which was based on results for the last quarter of the year ended March 31, 2008 and $1,895,000of which was based on results for the first three quarters of the year ended March 31, 2009.

The Company currently plans to continue its quarterly dividend policy as announced, but such plans and policy for future dividends consist of forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Whether future dividends will be declared will depend upon the Company’s future growth and earnings, of which there can be no assurance, and the Company’s cash flow needs for future development, which growth, earning or cash flow needs may be adversely affected by one or more of the factors discussed in Item 3. Key Information — Risk Factors. Accordingly, there can be no assurance that future cash dividends on the Company’s common shares will be declared, what the amounts of such dividends will be or whether such dividends, once declared for a specific period will continue for any future period or at all.

ITEM 10. ADDITIONAL INFORMATION

Share Capital

Not applicable.

Memorandum and Articles of Association

In December 2007, we filed with the Registrar of Corporate Affairs of the British Virgin Islands, the jurisdiction of registrant’s organization, an amended and restated Memorandum and Articles of Associations (collectively the “2007 Charter”), the instruments governing a company organized under the law of the British Virgin Islands, which are comparable in purpose and effect to certificates or articles of incorporation and bylaws of corporations organized in a state of the United States. The 2007 Charter, which became effective on December 13, 2007, amended and restated our Memorandum and Articles of Association, as amended that were in effect prior to the 2007 Charter. The purpose of adopting the 2007 Charter was to:

(a) make our shares eligible for a direct registration system operated by a securities depository in accordance with Nasdaq Marketplace Rule 4350(1) that became effective on January 1, 2008 (renumbered, without material change, as NASDAQ Marketplace Rule 5210(c) operative April 13, 2009) as to companies, like us, having had equity securities listed on the NASDAQ Stock Market prior to January 1, 2007;

(b) make various consequential amendments to our Memorandum and Articles of Association in accordance with the advice from our US and BVI counsel so as to make them (a) consistent with the BVI Business Companies Act, 2004, as amended (the “Act”), the Act having come into force on January 1, 2004 superseding in certain respects the International Business Companies Act, 1984, the relevant legislation which had previously governed us and (b) make conforming changes resulting from the transition of the NASDAQ Stock Market’s operations on August 1, 2006 to that of a national securities exchange in the United States;

(c) continue certain special provisions of our Memorandum and Articles of Association that we adopted in preparation for our initial public offering of securities in the United States; and

(d) provide recognition of, and assure compliance with, certain laws, rules and regulations of the United States applicable to us, including the Sarbanes-Oxley Act of 2002, and the Marketplace Rules of the NASDAQ Stock Market.

Under our 2007 Charter, holders of our shares

	•		Continue to be entitled to one vote for each whole share on all matters to be voted upon by shareholders, including the election of directors;

	•		Continue not to have cumulative voting rights in the election of directors; and

	•		Continue to be entitled to receive dividends if and when declared by our board of directors out of funds legally available under British Virgin Islands law.

	•		The 2007 Charter did not change that

	•		all of common shares are equal to each other with respect to liquidation and dividend rights;

	•		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; or

	•		holders of our common shares have no preemptive rights to purchase any additional, unissued common shares.

Objects and Purposes

Our objects and purposes are described in Clause 45 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

Our Articles of Association (Regulation 12.4) provides that except as otherwise provided in the BVI Business Companies Act, 2004 (No. 16 of 2004) — the British Virgin Islands corporate law ~~and our Articles of Association provide~~ that governs BVI companies like Deswell — no agreement or transaction between ~~Deswell~~the Company and one or more of its directors or any ~~entity~~person in which any director has a financial interest or to whom any director is related, ~~(including~~including as a director of that other ~~entity)~~person, 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~~that 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 such agreement or transaction has been approved by the irrevocable vote of a majority of the Company’s directors, ~~(at~~including at least, one ~~whom is an “Independent Director”) approve such transaction. Alternatively,~~Independent Director. In addition, the interest in the transaction may be disclosed or known to or ratified by the shareholders. (British Virgin Islands law does not use the term “shareholder” or “stockholder” but rather refers to holders of sharesfavorable vote 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.) 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 opinionmajority of the directors, ~~would interfere with~~including at least one Independent Director, shall be required to approve any transaction or agreement between the ~~exercise~~Company and any officer of ~~independent judgment in carrying out~~ the ~~responsibilities~~Company or any person or entity holding 10 percent or more of ~~a director.~~the outstanding Shares.

Our Articles of Association (Regulation 7.11) 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.

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 ~~15,143,730~~15,790,810 common shares were outstanding on June 30, ~~2007.~~2009.

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

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~~a 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.~~meeting (Regulation 6.3).

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~~time (Regulation 6.1) 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 athe 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%~~entitled to exercise ten percent or more of the ~~outstanding~~ voting ~~shares.~~rights in respect of the matter for which the meeting is requested, the directors shall convene a meeting of Shareholders (Regulation 6.2).

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. (Regulation 6.6)

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. (Regulation 6.7)

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~~amendment and provided further that our directors may not make an amendment that

(a) to ~~increase~~restrict the rights or ~~reduce~~powers of the shareholders to amend the Memorandum or the Articles;

(b) to change the percentage of shareholders required to pass a Resolution of Shareholders to amend the Memorandum or the Articles;

(d) change Clause 7 of our ~~authorized capital stock.~~Articles of Association conferring the rights of our shareholders to one vote per share, the right to equal share in dividend paid by the company or to surplus assets on liquidation.; or

(e) change Clause 9 of our Articles of Association which sets forth rights of our shareholders and directors to amend our Memorandum and Articles of Association.

Our directors’ 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.

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.~~approval and with respect to potential anti-takeover deterrence. Delaware law requires shareholders to approve any amendments to a corporation’s Certificate of ~~Incorporation.~~Incorporation and contains provisions restricting a Delaware corporation’s rights to engage in a business combination with an interested stockholder for a period of three years after the date of the transaction in which the person became an interested stockholder unless the business combination is approved in the manner prescribed under Delaware law.

Material Contracts

~~There were no~~The following summarizes each material ~~contracts,~~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.

On August 17, 2007, Deswell entered into a Stock Purchase Agreement with Shu Kwan Lee and Man Chi Tam, minority shareholders of Integrated International Ltd. (“Integrated”) to acquire the remaining 24% equity interest of Integrated, agreeing to pay for such interest consideration of $6,734,378, consisting of (a) 632,080 common shares of Deswell (based on the closing price per share of Deswell’s shares on August 17, 2008) and (b) a cash payment of HK$3,234,180 (approximately US$413,578) to Messrs. Lee and Tam. A copy of this Stock Purchase Agreement is included as Exhibit 4.3 to this Report.

On August 5, 2009, Deswell entered into a Sale and Purchase Agreement with a third party to sell real property Deswell owns in Shekou, Shenzhen, China that it formerly used for its plastic injection molding operations for RMB50,000,000 (approximately $7.3 million, based on an exchange rate of 1:6.8309 on August 5, 2009 as reported on http://forex-history.net). The sale is expected to close after required local government transfer and other approvals have been obtained. An English summary of this Sale and Purchase Agreement is included as Exhibit 4.4 to this Report.

Taxation

United States Federal Income Tax Consequences

The discussion below is for general information only and is not, and should not be interpreted to be, tax advice to any holder of our common shares. Each holder or a prospective holder of our common shares is urged to consult his, her or its own tax advisor.

General

This section is a general summary of the material ~~U.S.~~United States federal income tax consequences to U.S. Holders, as defined below, of the ownership and disposition of our common shares as of the date of this ~~Report.~~report. This summary is based on the provisions of the Internal Revenue Code of 1986, as amended, or the Code, the applicable Treasury regulations promulgated and proposed thereunder, judicial decisions and current administrative rulings and practice, all of which are subject to change, possibly on a retroactive basis. The summary applies to you only if you hold our common shares as a capital asset ~~for~~within the meaning of Section 1221 of the Code. In addition, this summary generally addresses certain U.S. federal income tax ~~purposes (that is, for investment purposes), and it does not purport~~consequences to U.S. Holders if we were to be classified as a ~~comprehensive description of all the tax considerations that may be relevant to the ownership of our common shares.~~PFIC. 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.~~United States Internal Revenue Service, ~~(“IRS”) will not~~or the IRS, may 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.~~United States federal income tax consequences of acquiring, holding or disposing of our common shares. ~~The~~This summary does not purport to be a comprehensive description of all the tax considerations that may be relevant to the ownership of our common shares. In particular, the discussion below does not cover tax consequences that depend upon your particular tax circumstances ~~and~~nor does 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.~~the United States federal estate or gift tax. You are urged to consult your own tax advisors regarding the application of the ~~U.S.~~United States federal income tax laws to your particular situation as well as any state, local, foreign and ~~the U.S.~~United States 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.~~United States federal income tax rules that apply to a particular U.S. or Non-U.S. holder of our common shares, including, without limitation, the following:

a dealer in securities or currencies;


	•		an estate whose income is subject to ~~U.S.~~United States federal income tax regardless of its source; or

	•		a trust (x) if a ~~U.S.~~United States court can exercise primary supervision over the trust’s administration and one or more ~~U.S.~~United States 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.~~United States person prior to that date and has a valid election in effect under applicable ~~treasury~~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.~~United States person.

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” (“PFIC”) 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. Dividends received by individuals and certain other non-corporate taxpayers in ~~their~~ tax years before January 1, 2011 from “qualified foreign corporations” are taxed at the rate of either 5 percent (zero, for tax years beginning in 2008, 2009 and 2010) or 15 percent, depending upon the particular taxpayer’s U.S. federal income tax bracket; provided that the recipient-shareholder has held his or her shares as a beneficial owner for more than 60 days during the 121-day period beginning on the date which is 60 days before the shares’ ex-dividend date. Dividends received in tax years beginning after December 31, 2010 will be taxed at higher ordinary income tax rates. A foreign corporation is a “qualified foreign corporation” if the stock with respect to which it pays dividend is traded on an established securities market in the United States, provided that the foreign corporation is not a PFIC. Our stock is traded on an established securities market in the United States, although we cannot guarantee that our stock will be so traded in the future. We believe that we were

not a PFIC for U.S. federal income purposes for our fiscal years ended March 31, ~~2006~~2008 or ~~2007;~~2009; and, although we cannot provide assurances in this regard, we do not anticipate becoming a PFIC in the future. If we are a PFIC with respect to a particular U.S. Holder, dividends received from us will be taxed at regular ordinary income tax ~~rates, currently, up to 35 percent.~~rates. Holders of our shares should consult their own tax advisers regarding the availability of the reduced dividend tax rate in light of their own particular circumstances.

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, Exchange 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.

For United States foreign tax credit limitation purposes, dividends received on our common shares will be treated as foreign source income and will generally be “passive category income”, or in the case of certain holders, “general category income.” You may be eligible, subject to a number of complex limitations, to claim a foreign tax credit in respect of foreign withholding taxes, if any, imposed on dividends paid on our common shares. The rules governing United States foreign tax credits are complex, and we recommend that you consult your tax advisor regarding the applicability of such rules to you.

Sale, Exchange or Other Disposition of Our Common Shares

Subject to the PFIC rules discussed below, generally, in connection with the sale, exchange or other taxable disposition of our common shares:

	•		you will recognize capital gain or loss equal to the difference (if any) between:

	•		the amount realized on such sale, exchange or other taxable disposition and

	•		your adjusted tax basis in such common shares (your adjusted tax basis in the shares you hold generally will equal your U.S. dollar cost of such shares);

	•		such gain or loss will be ~~capital gain or loss and will be~~ long-term capital gain or loss if your holding period for our common shares is more than one year at the time of such sale or other disposition;

	•		net long-term capital gains derived by individual U.S. Holders from sales or other taxable dispositions of our shares before January 1, 2011 will generally be taxed at the rate of 5 percent (zero, in 2008, 2009 and 2010) or 15 percent, depending upon the particular taxpayer’s U.S. federal income tax bracket;

	•		such gain or loss will generally be treated as ~~having U.S.~~United States source for ~~U.S.~~United States foreign tax credit purposes; and

	•		your ability to deduct capital losses is subject to limitations.

Passive Foreign Investment Company (PFIC)

A U.S. Holder generally would be subject to a special tax regime (that differs in certain material respects from that described above) if we were a PFIC at any time during which such Holder held our shares.

An actual determination of PFIC status is factual in nature and cannot be made until the close of the applicable tax year. We ~~are~~believe that we were not a PFIC for U.S. federal income purposes for our fiscal ~~year~~years ended March 31, 2008 or 2009; and, although we cannot provide assurances in this regard, we do not anticipate becoming a PFIC in the future. A foreign corporation will be treated as a PFIC for United States federal income tax purposes if, ~~either:~~

	•		~~75 percent~~after applying relevant look-through rules with respect to the income and assets of subsidiaries, 75% or more of its gross income consists of certain types of passive income or 50% or more of our gross income in that 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 that 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~~gross value of its assets is attributable to assets that produce passive income or are held for the production of passive income. For this purpose, passive income generally includes dividends, interest, royalties, rents (other than rents and royalties derived in the active conduct of a trade or business), annuities and gains from assets that produce passive income. As a result ~~in our~~of the classification as a PFIC, ~~even in a year in which we have substantial gross revenues from product sales. If you own common shares during any year in which we are a PFIC, you must file IRS Form 8621.~~

~~If we are or were classified as a PFIC during the time you hold our shares, unless you timely make one of the available elections,~~ a special tax regime would apply to ~~both:~~

	•		any “excess distribution,” which would be your share of distributions in any year that are greater than 125 percent of the average annual distributions received by you in the three preceding years before the current taxable year (or during your holding period for the shares, if shorter), and

	•		~~any gain realized on the sale or other disposition of our common~~both (a) any “excess distribution” by us (generally, the U.S. Holder’s ratable share of distributions in any year that are greater than 125% of the average annual distributions received by such U.S. Holder in the three preceding years or its holding period, if shorter) and (b) any gain recognized on the sale or other disposition of your ordinary shares.

Under ~~this~~the PFIC regime, any excess distribution and ~~realized~~recognized gain would be treated as ordinary income. The U.S. federal income ~~and would be subject~~tax on such ordinary income is determined under the following steps: (i) the amount of the excess distribution or gain is allocated ratably over the US Holder’s holding period for our ordinary shares; (ii) tax is determined for amounts allocated to ~~tax generally~~the first year in the ~~following manner:~~

	•		holding period in which we were classified as a PFIC and all subsequent years (except 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,~~

	•		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, as if the tax had been due for the tax year to which such amounts were allocated under these rules.

~~Subject~~the excess distribution was received or the sale occurred) by applying the highest applicable tax rate in effect in the year to ~~certain limitations, if you own common shares~~which the income was allocated; (iii) an interest charge is added to this tax calculated by applying the underpayment interest rate to the tax for each year determined under the preceding sentence from the due date of the income tax return for such year to the due date of the return for the year in which the excess distribution or sale occurs; and (iv) amounts allocated to a year prior to the first year in the U.S. Holder’s holding period in which we were classified as 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 subjector to the ~~PFIC rules described above. Instead,~~year in ~~general, you would include~~which the excess distribution or the disposition occurred are taxed as ordinary income and no interest charge applies.

A U.S. Holder may generally avoid the PFIC regime by making a “qualified electing fund” election which generally provides that, in lieu of the foregoing treatment, our earnings, on a pro rata basis, would be currently included in their gross income. However, we may be unable or unwilling to provide information to our U.S. Holders that would enable them to make a “qualified electing fund” election; thus, such election may not be available.

In addition, U.S. Holders may generally avoid the PFIC regime by making the “mark-to-market” election with respect to our common shares as long as we are a PFIC and our common shares are considered to be readily tradable on an established securities market within the United States. “Marking-to-market,” in this context, means including in ordinary income each taxable year the excess, if any, of the fair market value of our common shares over your tax adjusted basis in such common shares atas of the end of each year. This “mark-to-market” election generally enables a U.S. Holder to avoid the ~~taxable year over~~deferred interest charge that would otherwise be imposed on them if we were to be classified as a PFIC.

An actual determination of PFIC status is factual in nature. Given the ~~adjusted tax basis in your shares. You would also be allowed to take an ordinary loss in respect~~complexity 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~~issues regarding our classification 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~~U.S. Holders are urged to consult ~~your~~their own tax ~~advisor concerning the potential application of the~~advisors for guidance as to our PFIC ~~rules to your ownership and disposition of our common shares, as well as a mark-to-market and other elections that may be available to you.~~status.

~~Tax Consequences to~~ Non-U.S. Holders

If you are not a U.S. Holder, you are a “Non-U.S. Holder.”

Distributions on Our Common Shares

You generally will not be subject to U.S. federal income tax, including withholding tax, on distributions made on our common shares unless:

	•		you conduct a trade or business in the United States and

	•		the distributions are effectively connected with the conduct of that trade or business (and, if an applicable income tax treaty so requires as a condition for you to be subject to U.S. federal income tax on a net income basis in respect of income from our common shares, such distributions are attributable to a permanent establishment that you maintain in the United States).

If you meet the two tests above, you generally will be subject to tax in respect of such dividends in the same manner as a U.S. Holder, as described above. In addition, any effectively connected dividends received by a non-U.S. corporation may also, under certain circumstances, be subject to an additional “branch profits tax” at a 30 percent rate or such lower rate as may be specified by an applicable income tax treaty.

Sale, Exchange 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 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,~~Holder, as described above. Effectively connected gains realized by a non-U.S. corporation may also, under certain circumstances, be subject to an

Backup Withholding and Information Reporting

Payments, ~~(or other taxable distributions)~~including dividends and proceeds of sales, in respect of our common shares that are made in the United States or by a ~~U.S.-related~~United States related financial intermediary will be subject to ~~U.S.~~United States information reporting rules. In addition, such payments may be subject to ~~U.S.~~United States federal backup withholding ~~currently at a rate of 28 percent.~~tax. 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.~~United States federal taxpayer identification number and certify, under penalties of perjury, that ~~no loss of exemption from~~you are not subject to backup ~~withholding has occurred.~~withholding.

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.~~United States federal income tax, ~~liability,~~ and you may obtain a refund of any excess amounts withheld under the backup withholding rules by filing the appropriate claim for refund with the ~~IRS.~~

The discussions above are for general information only. You should consult your own tax advisors regarding the application of the U.S. federal income tax laws to your particular situation as well as any state, local, foreign tax and the U.S. federal estate and gift tax consequences of the ownership and disposition of our common shares.IRS in a timely manner.

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.

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 Macao, 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~~non resident 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, with the exception of a requirement that 11% of profits to be reserved for future developments and staff welfare, 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 Macao 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 10 of Notes to Consolidated Financial Statements.

Foreign Currency Risk

At March 31, ~~2005, 2006~~2007, 2008 and ~~2007,~~2009, the Company had no open forward exchange contracts or option contracts.

Cash on hand at March 31, ~~2007~~2009 of ~~$24,549,000~~$23,134,000 was held in the following currencies:

Equivalent
U.S. Dollar
Holdings
United States dollars $ 11,352,000
Hong Kong dollars 8,384,000
Euro 24,000
Chinese RMB 4,500,000
Japanese yen 246,000
Macao dollars 43,000


	Equivalent
	U.S. Dollar
	Holdings
United States dollars		13,695,000
Chinese RMB		7,395,000
Hong Kong dollars		2,002,000
Macao dollars		13,000
Euro		16,000
Japanese yen		11,000
Pounds sterling		2,000

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 ~~$14,931,000~~$23,134,000 as at March 31, ~~2007~~2009 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, ~~2007~~2009 we had no long-term debt or short-term bank loans outstanding on our credit facilities.

ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

Not applicable.

PART II

ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

Not Applicable.

ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS

Not Applicable.

ITEM ~~15T.~~15. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

~~As of the end of the period covered by this Report, the~~The Company’s management, with the participation of its Chief Executive Officer and Chief Financial Officer, conducted an evaluation ~~pursuant to~~of our disclosure controls and procedures as required by paragraph (c) of Rule 13a-15 or 15d-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of ~~the effectiveness of the design and operation of Deswell’s disclosure controls and procedures.~~March 31, 2009.

Based on this evaluation, the Company’s management, including its Chief Executive Officer and Chief Financial Officer concluded that as of ~~the end of the period covered by this report~~March 31, 2009 such disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by the Company in reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and include controls and procedures designed to ensure that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Report of Management on Internal Control over Financial Reporting

Deswell’s management is responsible for establishing and maintaining adequate internal control over financial reporting. Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.

controls must be considered relative to their costs. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, a control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

A deficiency in internal control over financial reporting exists, as defined under Standards of the Public Company Accounting Oversight Board, when the design or operation of a control does not allowance management or employees, in the normal course of performing their assigns functions, to prevent or detect misstatements on a timely basis. A significant deficiency is a deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of the company’s financial reporting.

Deswell’s management, including its Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of our internal control over financial reporting as of March 31, ~~2007.~~2009. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway ~~commission~~Commission (“COSO”) in Internal Control Integrated Framework.

Based on ~~this~~the assessment, Deswell’s management, including its Chief Executive Officer and Chief Financial Officer, ~~believes~~concluded that, as of March 31, 2009, the Company’s internal control over financial reporting was effective based on above described criteria.

Attestation Report of the Registered Public Accounting Firm

The effectiveness of internal control over financial reporting as of March 31, 2009 has been audited by BDO Limited, an independent registered public accounting firm with a report to the Shareholders and the Board of Directors of Deswell Industries, Inc., which is set forth immediately below.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders and the Board of Directors of
Deswell Industries, Inc.

We have audited the internal control over financial reporting of Deswell Industries, Inc. and its subsidiaries (the “Company”) as of March 31, 2009, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 15, Report of Management on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting 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 effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of the inherent limitation, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of the effectiveness to future periods are subject to the risk that the ~~Company~~controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, Deswell Industries, Inc. and its subsidiaries maintained, in all material respects, effective internal control over financial reporting as of March 31, ~~2007.~~2009, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Deswell Industries, Inc. and its subsidiaries as of March 31, 2008 and 2009, and the related consolidated statements of income and comprehensive income, shareholders’ equity and cash flows for each of the three years in the period ended March 31, 2009 and our report dated August 14, 2009 expressed an unqualified opinion thereon.


	/s/ BDO Limited
	BDO Limited

Hong Kong, August 14, 2009

Remediation of Material Weaknesses in Internal Control Over Financial Report Identified in Fiscal 2008

~~This~~In our annual report does not include an attestation report of Deswell’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the company to provide only management’s report in this annual report.

~~Changes in Internal Controls~~

~~During the period covered by this Report, and in preparation for the audit of our consolidated financial statements at and~~on Form 20-F for the year ended March 31, ~~2007,~~2008, our management ~~discovered two opportunities to improve Deswell’s~~identified a material weakness in our internal ~~controls~~control over financial reporting ~~one relating~~which related to ~~our plastic manufacturing operations~~the design in determining the valuation of work in progress and ~~the other to our electronic manufacturing. The opportunity~~finished goods in inventories in our plastic manufacturing operations ~~involved~~business segment. There was a change in the valuation basis in work in progress and finished goods inventories in the fourth quarter of our fiscal year ended March 31, 2008. The design of the controls in changing the process was inadequate to detect valuation errors. In order to rectify such design deficiency, we re-designed the control procedures and implemented a revised inventory valuation method ~~used~~in our plastic manufacturing operations to ~~determine~~more accurately record the ~~valuation~~cost of work in process and finished goods inventories which, following identification and evaluation by management, was improved by our implementation of more effective controls in our material resource planning system in order to more accurately record the cost of those portions of our inventory in the preparation of our financial statements. ~~The opportunity~~At September 17, 2008, the date we filed our annual report on Form 20-F for the year ended March 31, 2008 with the U.S. Securities and Exchange Commission that included our audited financial statements for the year ended March 31, 2008 and reported on our internal control over financial reporting for fiscal 2008, we were assessing the effectiveness of this new control design to assure our financial reporting reliability and the preparation of consolidation financial statements in accordance with U.S. GAAP.

We believe that the foregoing corrective action resolved the material weaknesses that existed as of March 31, 2008 and that as of March 31, 2009, it was no longer reasonably possible that our ~~electronic manufacturing operations involved perceived inadequacies~~financial statements will be materially misstated. Accordingly, as stated in management’s report on internal control over financial reporting included above, we have concluded that our ~~material resource planning system relating to the aging~~internal control over financial reporting was effective as of the inventory of electronic products. We plan to improve this by implementing a new resource planning software system that we expect will provide a more accurate aging analysis for our electronic products inventory.March 31, 2009.

Changes in Internal Controls

Except as mentioned above there were no changes in the Company’s internal controls during the period covered by this Report that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.

We are in the process of strengthening the information technology in our corporate office by installing a new enterprise resource planning, or ERP, software system which the Company committed to acquire from SAP Hong Kong Co., Ltd. in July 2008

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, ~~2007~~2009 was BDO ~~McCabe Lo~~ Limited (“BDO”).

The following table presents the aggregate fees for professional services and other services rendered by the principal accountant to Deswell in the years ended March 31, ~~2006~~2008 and ~~2007.~~2009.

Year ended March 31,
2006 2007
(US $ (in thousands))
Audit Fees(1) $ 115 $ 122
Audit-related Fees(2) — —
Tax Fees(3) — —
All Other Fees(4) — —

$ 115 $ 122


	Year ended March 31,
	2008		2009
	(In thousands)
Audit fees⁽¹⁾	$	244	$	226
Audit-related fees⁽²⁾		—		—
Tax fees⁽³⁾		—		—
All other fees⁽⁴⁾		—		—

	$	244	$	226


(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~~Management will periodically report to the Audit Committee regarding the extent of services provided and the fees for the services performed by the independent auditors in accordance with this pre-approval policy. The Audit Committee may also pre-approve particular services on a case-by-case basis.

ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR THE AUDIT COMMITTEE.

As of the date of this Report, Deswell is not availing itself of an exemption from the independence standards contained in paragraph (b)(1)(iv) of Rule 10A-3 under the Securities Exchange Act of 1934 (except paragraph (b)(1)(iv)(B) of that Rule), the general exemption contained in paragraph (c)(3) of that Rule or the last sentence of paragraph (a)(3) of that Rule.

ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATE PURCHASERS.

Not ~~applicable.~~applicable

5253

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, ~~2006~~2008 and ~~2007,~~2009, and the related consolidated statements of income and comprehensive income, shareholders’ equity and cash flows for each of the three years in the period ended March 31, ~~2007.~~2009. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. ~~The Company is not required to have, nor were we engaged to perform, an~~An audit of its internal control over financial reporting. Our audits include consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. Our audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Deswell Industries, Inc. and subsidiaries as of March 31, ~~2006~~2008 and ~~2007,~~2009, and the consolidated results of their operations and their cash flows for each of the three years in the period ended March 31, ~~2007,~~2009, in conformity with accounting principles generally accepted in the United States of America.

~~/s/~~~~BDO McCabe Lo Limited~~
~~BDO McCabe Lo Limited~~We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Deswell Industries, Inc.’s internal control over financial reporting as of March 31, 2009, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated August 14, 2009 expressed an unqualified opinion thereon.


	/s/ BDO Limited
	BDO Limited

Hong Kong, ~~June 28, 2007~~August 14, 2009

F-1

DESWELL INDUSTRIES, INC.

CONSOLIDATED BALANCE SHEETS

(U.S. dollars in thousands)


	March 31,				March 31,
	2006		2007		2008		2009

ASSETS

Current assets:
Cash and cash equivalents	$	25,369	$	24,549	$	22,718	$	23,134
Restricted cash (note 7)		649		—
Marketable securities (note 3)		164		107		116		100
Accounts receivable, less allowances for doubtful amounts of $970 and $1,230 at March 31, 2006 and 2007, respectively		18,318		21,063
Accounts receivable, less allowances for doubtful amounts of $74 and $349 at March 31, 2008 and 2009, respectively						21,397		22,227
Inventories (note 4)		21,845		29,495		26,462		21,445
Assets held for sale (note 6)						—		987
Prepaid expenses and other current assets (note 5)		5,035		4,999		3,205		1,887
Income taxes receivable		—		130		3		—

Total current assets		71,380		80,343		73,901		69,780
Property, plant and equipment-net (notes 6)		58,286		60,157
Deferred income tax assets (note 10)		294		—
Goodwill (note 8) (note 8)		710		710
Property, plant and equipment-net (note 6)						65,885		66,564
Deferred income tax assets (note 9)						230		746
Goodwill (note 7)						391		392

Total assets	$	130,670	$	141,210	$	140,407	$	137,482


LIABILITIES AND SHAREHOLDERS’ EQUITY

Current liabilities:
Accounts payable	$	10,886	$	15,865	$	12,527	$	10,370
Dividend payable		2,089		—
Accrued payroll and employee benefits		1,415		2,746		2,769		2,473
Customer deposits		674		783		1,125		1,460
Other accrued liabilities (note 9)		1,018		1,506
Other accrued liabilities (note 8)						2,100		2,167
Income taxes payable		184		450		629		705
Deferred income tax liability (note 10)		—		321

Total current liabilities		16,266		21,671		19,150		17,175


Commitments and contingencies (note 11)		—		—

Minority interests		7,636		7,884

Commitments and contingencies (note 10)						—		—

Shareholders’ equity:
Common shares nil par value-authorized 30,000,000 shares, shares issued and outstanding March 31, 2006 - 14, 923,730; March 31, 2007 – 15,038,730 (note 12)		41,254		42,393
Common shares nil par value-authorized 30,000,000 shares, shares issued and outstanding March 31, 2008 — 15,790,810; March 31, 2009 — 15,790,810						49,923		49,923
Additional paid-in capital		6,970		7,601		7,709		7,771
Accumulated other comprehensive income		436		1,106		3,734		5,316
Retained earnings		58,108		60,555		59,891		57,297

Total shareholders’ equity		106,768		111,655		121,257		120,307

Total liabilities and shareholders’ equity	$	130,670	$	141,210	$	140,407	$	137,482

DESWELL INDUSTRIES, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(U.S. dollars in thousands, except ~~share and~~ per share data)


	Common stock									Accumulated															Accumulated
							Additional			other								Common stock				Additional			other
	Shares						paid-in			comprehensive		Retained			Shareholders’			Shares				paid-in			comprehensive		Retained			Shareholders’
	outstanding			Amount			capital			income		earnings			equity			outstanding		Amount		capital			income		earnings			equity

Balance at March 31, 2004		13,723,627			29,980			6,970			—		52,780			89,730
Exercise of stock options		1,055,250			9,092			—			—		—			9,092
Odd share redemption upon stock split		(147	)		(4	)		—			—		—			(4	)
Net income		—			—			—			—		15,183			15,183
Dividends ($0.65 per share)		—			—			—			—		(9,234	)		(9,234	)

Balance at March 31, 2005		14,778,730			39,068			6,970			—		58,729			104,767
Exercise of stock options		25,000			352			—			—		—			352
Issue of common stock for acquisition of additional interest in a subsidiary		120,000			1,834			—			—		—			1,834
Foreign currency translation adjustment		—			—			—			436		—			436
Net income		—			—			—			—		8,779			8,779
Dividends ($0.63 per share)		—			—			—			—		(9,400	)		(9,400	)

Balance at March 31, 2006		14,923,730			41,254			6,970			436		58,108			106,768			14,923,730		41,254		6,970			436		58,108			106,768
Stock-based compensation		—			—			820			—		—			820			—		—		820			—		—			820
Exercise of stock options		115,000			1,139			(189	)		—		—			950			115,000		1,139		(189	)		—		—			950
Foreign currency translation adjustment		—			—			—			670		—			670			—		—		—			670		—			670
Net income		—			—			—			—		12,167			12,167			—		—		—			—		12,167			12,167
Dividends ($0.65 per share)		—			—			—			—		(9,720	)		(9,720	)		—		—		—			—		(9,720	)		(9,720	)

Balance at March 31, 2007		15,038,730			42,393			7,601			1,106		60,555			111,655			15,038,730		42,393		7,601			1,106		60,555			111,655
Stock-based compensation																			—		—		310			—		—			310
Exercise of stock options																			120,000		1,188		(202	)		—		—			986
Issue of common stock for acquisition of additional interest in a subsidiary																			632,080		6,342		—			—		—			6,342
Foreign currency translation adjustment																			—		—		—			2,628		—			2,628
Net income																			—		—		—			—		8,859			8,859
Dividends ($0.61 per share)																			—		—		—			—		(9,523	)		(9,523	)

Balance at March 31, 2008																			15,790,810		49,923		7,709			3,734		59,891			121,257
Stock-based compensation																			—		—		62			—		—			62
Foreign currency translation adjustment																			—		—		—			1,582		—			1,582
Net income																			—		—		—			—		1,195			1,195
Dividends ($0.24 per share)																			—		—		—			—		(3,789	)		(3,789	)

Balance at March 31, 2009																			15,790,810		49,923		7,771			5,316		57,297			120,307

DESWELL INDUSTRIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(U.S. dollars in thousands)


	Year ended March 31,
	2005			2006			2007			Year ended March 31,
										2007			2008			2009
Cash flows from operating activities
Net income	$	15,183		$	8,779		$	12,167		$	12,167		$	8,859		$	1,195
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		4,970			5,299			5,274			5,274			6,940			7,264
Impairment of property, plant and equipment											—			—			176
Loss (gain) on sale of property, plant and equipment		125			45			(643	)		(643	)		43			216
Realized gain on disposal of other investments		(295	)		—			—
Unrealized holding loss on marketable securities		53			80			57
Unrealized holding (gain) loss on marketable securities											57			(9	)		16
Impairment loss on goodwill											—			317			—
Stock-based compensation		—			—			820			820			310			62
Minority interests		2,330			1,215			833			833			228			—
Deferred tax		(15	)		(294	)		615			615			(551	)		(517	)
Changes in operating assets and liabilities:
Accounts receivable		(6,134	)		6,773			(2,745	)		(2,745	)		(334	)		(918	)
Inventories		(4,962	)		(709	)		(7,650	)		(7,650	)		3,033			4,923
Prepaid expenses and other current assets		(1,809	)		(274	)		36			36			(345	)		1,306
Income taxes receivable		107			20			(130	)		(130	)		127			3
Accounts payable		5,281			(5,563	)		4,979			4,979			(3,338	)		(2,157	)
Accrued payroll and employee benefits		(246	)		(605	)		1,331			1,331			23			(376	)
Customer deposits		109			(194	)		109			109			342			335
Other accrued liabilities		1,533			(2,109	)		488			488			594			67
Income taxes payable		195			(141	)		266			266			179			74

Net cash provided by operating activities		16,425			12,322			15,807			15,807			16,418			11,669


Cash flows from investing activities
Purchase of property, plant and equipment		(17,003	)		(6,940	)		(7,812	)		(7,812	)		(7,288	)		(7,402	)
Acquisition of minority interest in a subsidiary											—			(414	)		—
Proceeds from sale of property, plant and equipment		36			50			3,232			3,232			333			345

Net cash used in investing activities		(16,967	)		(6,890	)		(4,580	)		(4,580	)		(7,369	)		(7,057	)


Cash flows from financing activities
Dividends paid		(9,234	)		(7,311	)		(11,809	)		(11,809	)		(9,523	)		(3,789	)
Dividends paid to minority shareholders of a subsidiary		(756	)		(1,229	)		(582	)		(582	)		—			—
Exercise of stock options		9,092			352			950			950			986			—
Odd shares redemption		(4	)		—			—
(Increase) decrease in restricted cash		(650	)		391			649
Loan to minority shareholders of subsidiaries		(26	)		(170	)		—
Decrease in restricted cash											649			—			—

Net cash used in financing activities		(1,578	)		(7,967	)		(10,792	)		(10,792	)		(8,537	)		(3,789	)


Effect of exchange rate changes		—			(169	)		(1,255	)		(1,255	)		(2,343	)		(407	)

Net decrease in cash and cash equivalents		(2,120	)		(2,704	)		(820	)
Net increase/ (decrease) in cash and cash equivalents											(820	)		(1,831	)		416
Cash and cash equivalents, beginning of year		30,193			28,073			25,369			25,369			24,549			22,718

Cash and cash equivalents, end of year	$	28,073		$	25,369		$	24,549		$	24,549		$	22,718		$	23,134


Supplementary disclosures of cash flow information:
Cash paid during the year for:
Interest	$	12		$	6		$	—		$	—		$	—		$	—
Income taxes	$	289		$	387		$	487		$	487		$	365		$	79


Supplementary disclosures of significant non-cash transactions:
Issuance of common stock in connection with acquisition of additional 5% shareholding in a subsidiary	$	—		$	1,834		$	—
Issuance of common stock in connection with acquisition of additional 24% shareholding in a subsidiary										$	—		$	6,342		$	—
Excess of acquisition cost over the fair value of acquired net assets of additional shareholding of a subsidiary	$	—		$	234		$	—		$	—		$	(1,314	)	$	—

DESWELL INDUSTRIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(U.S. dollars in thousands, except per share data)

1. Organization and Basis of Financial Statements

Deswell Industries, Inc. was incorporated in the British Virgin Islands on December 2, 1993.

The principal activities of the Company comprise the manufacture and sale of injection-molded plastic parts and components, electronic products assembling and metallic parts manufacturing. The manufacturing activities are subcontracted to subsidiaries operating in Mainland China. The selling and administrative activities were originally performed in the Hong Kong Special Administrative Region (“Hong Kong”) of the People’s Republic of China (“China”). From August 2003, these activities were moved to the ~~Macau~~Macao Special Administrative Region (“~~Macau”~~Macao”) of China.

As the Company is a holding company, the amount of any dividends to be declared by the Company will be dependent upon the amount which can be ~~dividended up~~distributed from its subsidiaries. Dividends from subsidiaries are declared based on profits as reported in their statutory accounts. Such profits differ from the amounts reported under U.S. GAAP. At March 31, ~~2007,~~2009, the retained earnings available for distribution as reflected in the statutory books of the subsidiaries were ~~$67,066.~~$50,467.

On January 20, 2003, the Company acquired a further 20% of the outstanding stock of Integrated International Limited (“Integrated”), a subsidiary of the Company, from the minority shareholders. After the acquisition, the Company increased its ownership in Integrated to 71% of the outstanding stock. The purchase consideration for the 20% of the outstanding stock of Integrated is 251,880 common shares of the Company. The value of the purchase consideration is based on the market price of the stocks issued which is lower than the fair value of net assets acquired by $115. The excess has been allocated as a pro rata reduction of the amounts that would have been assigned to certain acquired assets.

On April 20, 2005, the Company acquired a further 5% of the outstanding stock from one of the minority shareholders of Integrated. After the acquisition, the Company increased its ownership in Integrated to 76% of the outstanding stock. The purchase consideration for the 5% of the outstanding stock of Integrated is 120,000 common shares of the Company. The value of the purchase consideration is based on the market price of the stocks issued which is higher than the fair value of net assets acquired by $232. The excess purchase price has been recorded on the balance sheet as goodwill.

On August 17, 2007, the Company acquired the remaining 24% of the outstanding stock from minority shareholders of Integrated. After the acquisition, the Company increased its ownership in Integrated to 100% of the outstanding stock. The aggregate purchase consideration for the 24% of the outstanding stock of Integrated is 632,080 common shares of the Company and a cash payment of $414. The value of the purchase consideration is based on the market price of the stocks issued and the cash payment, which is lower than the fair value of net assets acquired by $1,314. The excess has been allocated 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~~— 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~~— 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~~The Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 142 “Goodwill and other Intangible Assets”, which ~~established new standards for goodwill acquired in a business combination, eliminates the amortization of goodwill and~~ requires the carrying value of goodwill to be evaluated for impairment on an annual basis.

~~In accordance with SFAS No. 142, goodwill is evaluated to determine if fair value of the asset has decreased below its carrying value.~~ The Company regularly conducted annual impairment ~~evaluation and determined that there was no impairment in goodwill.~~evaluation.

Cash and cash equivalents~~-Cash~~— 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-~~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 non-operating income. The cost of investments sold is based on the average cost method and interest earned is included in non-operating income.

Inventories —~~-Inventories~~Inventories are stated at the lower of cost or market value. Prior to April 1, 2007, cost were determined byon the first-in, first-out ~~method, or market.~~basis. On April 1, 2007, the Company changed the cost determination basis, cost are determined on the weighted average basis. The change to using a cost determination basis for the year ended March 31, 2008 had no material impact on the net income reported on the consolidated statement of income for that year and would have no material effect on net income reported on the consolidated statements of income for the year ended March 31, 2007 if the cost-determination basis had been used for that year. 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~~ Write down of ~~rental deposits, prepaid expenses and other miscellaneous receivables.~~potentially obsolete or slow-moving inventory are recorded based on management’s analysis of inventory levels.

F-6

DESWELL INDUSTRIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except per share data)

2. Summary of Significant Accounting Policies — continued

Property, plant and equipment~~-Property,~~— 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 years
Plant and machinery		4 -– 10 years
Furniture, fixtures and equipment		4 -– 5 years
Motor vehicles		3 -– 4 years
Leasehold improvements ~~the lease term~~		the shorter of 5 years or
		the lease term

Valuation of long-lived assets~~-The~~— 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~~-Sales~~— Sales of goods are recognized when goods are shipped, title of goods sold has passed to the purchaser, the price is fixed or determinable as stated on the sales contract, and its ~~collectibility~~collectability is reasonably assured. Customers do not have a general right of return on products shipped. The Company permits the return of damaged or defective products and accounts for these returns as deduction from sales. Products returns to the Company were insignificant during past years.

Comprehensive ~~income-~~income~~The comprehensive income of the Company for the year ended March 31, 2005 was represented by the net income of the year.~~— Other comprehensive income for the years ended March 31, ~~2006~~2007, 2008 and ~~2007~~2009 represented foreign currency translation adjustments and were included in the consolidated statement of ~~shareholders’ equity.~~income.

Allowance for doubtful account-— The Company regularly monitors and assesses the risk of not collecting amounts owed to the Company by customers. This evaluation is based upon a variety of factors including: ongoing credit evaluations of its customers’ financial condition, an analysis of amounts current and past due along with relevant history and facts particular to the customer. Based upon the results of this analysis, the Company records an allowance for uncollectible accounts for this risk. This analysis requires the Company to make significant estimates, and changes in facts and circumstances could result in material changes in the allowance for doubtful accounts.

~~Reclassification of financial statements-~~~~Other operating income/(expenses) are reclassified~~ Unanticipated changes in the ~~consolidated statement~~liquidity or financial position of ~~income~~the Company’s customers may require additional provisions for the year ended March 31, 2007 for better presentation. Comparative figures for the year ended March 31, 2005 and 2006 were reclassified accordingly. The reclassification of operating income has no impact on the net income on the consolidated statement of income for the years ended March 31, 2005, 2006 and 2007.doubtful accounts.

Shipping and handling ~~cost-~~cost —Shipping and handling costs related to the delivery of finished goods are included in selling expenses. During the year ended March 31, ~~2005, 2006~~2007, 2008 and ~~2007,~~2009, shipping and handling costs expensed to selling expenses were ~~$549, $658~~$1,037, $1,005 and ~~$1,037,~~$1,714, respectively.

Income taxes~~-Income~~— Income taxes are provided on an asset and liability approach for financial accounting and reporting of income taxes. Any China tax paid by subsidiaries during the year is recorded. Deferred income ~~tax liabilities~~taxes are recognized for all significant temporary differences at enacted rates and classified as current or ~~assets are recorded to reflect~~non-current based upon the ~~tax consequences~~classification of the related asset or liability in ~~future years of differences between the tax basis of assets and liabilities and~~ the financial ~~reporting amounts at each year end.~~statements. A valuation allowance is ~~recognized~~provided to reduce the amount of deferred tax assets if it is considered more likely than not that some portion of, or all, ~~of a~~the deferred tax asset will not be realized. The Company classifies interest and/or penalties related to unrecognized tax benefits, if any, as a component of income tax provisions.

The Company adopted the provisions of Financial Accounting Standard Board (“FASB”) Interpretation No.48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No.109 (“FIN 48”), which clarifies the accounting for uncertainty in income taxes recognized by prescribing a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides accounting guidance on de-recognition, classification, interest and penalties, disclosure and transition.

F-7

~~2. Summary of Significant Accounting Policies — continued~~

Aggregate net foreign currency transaction ~~(losses)~~ gain included in other income ~~(expenses)~~ were ~~($111), ($86)~~$976, $2,047 and ~~$976~~$704 for the years ended March 31, ~~2005, 2006~~2007, 2008 and ~~2007,~~2009, respectively.

Prior to January 1, 2009, the functional currencies of the Company’s subsidiaries were Hong Kong dollars and Chinese renminbi. Effective January 1, 2009, the Company’s subsidiaries’ functional currencies were all changed to U.S. dollars. U.S. dollars are considered by management to be the most appropriate functional currencies of the Company’s subsidiaries as the customer mix of the Group has changed and a majority of the customers now contracted with the Company’s subsidiaries in U.S. dollars. On consolidation, the financial statements of subsidiaries ~~are~~up to December 31, 2008 were translated from Hong Kong dollars and Chinese renminbi ~~being the functional currencies of the Company’s subsidiaries,~~ into U.S. dollars in accordance with SFAS No. 52, “Foreign Currency Translation”. ~~Accordingly all~~As a result of this change, as of January 1, 2009, the Company re-measured its subsidiaries’ assets and liabilities ~~are translated at~~and expense items which related to non-monetary assets and liabilities to U.S. dollars. The Company recorded 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, 2005 was HK$7.75 to US$1.00 and 2006 and 2007 was HK$7.78 to US$1.00, respectively. The exchange rate between the Chinese renminbi and the U.S. dollar used for the three years ended March 31, 2005, 2006, and 2007 was RMB 8.29 to US$1.00, RMB8.09 to US$1.00 and RMB7.78 to US$1.00, respectively. All exchange differences arisingnet gain resulting from ~~translation of subsidiaries financial statements are recorded as a component of~~re-measurement in other comprehensive income.

Post-retirement and post-employment benefits~~-The~~— The Company and its subsidiaries contribute to a state pension scheme in respect of its Chinese ~~employees and a mandatory provident fund scheme in respect of its Hong Kong~~ employees. ~~Neither the Company nor its subsidiaries provide any other post-retirement or post-employment benefits.~~

Stock-based compensation~~- Prior to March 31, 2006, as permitted under SFAS No. 123 “Accounting for Stock-Based Compensation”, the~~— The Company accounted for its stock option plan following the recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”, and related interpretations. Accordingly, no stock-based compensation expense was reflected in the Company’s income statement as all options granted had an exercise price equal to the market value on the underlying common share on the date of grant and the related number of shares granted was fixed at that point of time. And the pro forma effect on net income and net income per share assuming the compensation cost had been recognized in accordance with SFAS No.123 were disclosed.

~~In December 2004, the Financial Accounting Statements Board (“FASB”) issued~~adopts SFAS No. 123 (revised 2004) (“SFAS No. 123(R)”), ~~“Share-Based~~“Share-based Payment”~~. The statement revised SFAS No.123 by eliminating~~, which requires that share-based payment transactions with employees, such as share options, be measured based on the ~~option~~grant-date fair value of the equity instrument issued and recognized as compensation expense over the requisite service period, with a corresponding addition to ~~account for employee stock options under APB No. 25 and requiring companies to recognize the~~equity. Under this method, compensation cost ~~of all stock-based payments to employees, including grants~~related to employee ~~stock~~share options inor similar equity instruments is measured at the ~~income statement~~grant date based on ~~their fair values.~~

~~Effective April 1, 2006, the Company adopted~~ the fair value ~~recognition provisions~~ of ~~SFAS No.123(R) using~~ the ~~modified prospective method. No pro forma financial information~~award and is recognized over the period during which an employee is required to provide service in exchange for the award, which generally is the vesting period.

For the years ended March 31, ~~2005~~2007, 2008 and ~~2006 were disclosed as~~2009, the Company ~~had not granted any options to its employees during these years.~~

~~For the year ended March 31, 2007, the Company accounts for its stock-based awards to employees under SFAS No. 123(R) and~~ records stock-based compensation expenses amounted to $820, $310 and $62 in the statement of income ~~statement.~~respectively. There ~~was~~is no tax benefit recognized in relation to the stock-based compensation expenses incurred for the ~~year.~~three years.

The fair value of options granted in the ~~year~~years ended March 31, 2007, ~~was~~2008 and 2009 were estimated using the Binomial option pricing model with the following assumptions:


	~~2007~~
~~Risk-free interest rate – weighted average~~		~~5.22~~	%
~~Expected life of options – weighted average~~	~~10 years~~
~~Stock volatility~~		~~44.10~~	%
~~Expected dividend yield~~		~~4.75~~	%


	2007			2008			2009

Risk-free interest rate — weighted average		5.22	%		3.63	%		2.90	%
Expected life of options — weighted average	10 years			10 years			10 years
Stock volatility		44.1	%		41.28	%		40.49	%
Expected dividend yield		4.75	%		5.04	%		7.35	%

The Company applied judgment in estimating key assumptions in determining the fair value of the stock options on the date of grant. The Company used historical data to estimate the expected life of options, stock volatility and expected dividend yield. The risk-free interest rate of the option was based on the 10 years U.S. Treasury yield at time of grant.

F-8

instruments — In September 2006, the FASB issued ~~Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements.~~ SFAS No. 157, ~~establishes a common definition for fair value to be applied to US GAAP guidance requiring use of~~“Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and expands disclosure about such fair value measurements. In October 2008, the FASB issued FASB Staff Position (“FSP”) 157-3 “Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active”. FSP SFAS 157-3 clarifies the application of SFAS in a market that is not active, and provides guidance on the key considerations in determining the fair value of a financial asset when the market for the financial asset is not active. Effective April 1, 2008, the Company adopted the measurement and disclosure requirements related to financial assets and financial liabilities. The adoption of SFAS 157 for the financial assets and financial liabilities did not have a material impact on the Company’s results of operation or the fair values of its financial assets and liabilities. FSP SFAS 157-2, “Effective Date of FASB Statement No. 157” delayed the effective date of SFAS 157 ~~is effective~~ for non-financial assets and liabilities that are recognized or disclosed at fair value in the consolidated financial statements on a non-recurring basis, until the fiscal ~~years~~year beginning after November 15, ~~2007.~~2008. The Company is currently assessing the impact of SFAS No. 157 for non-financial assets and liabilities that are recognized or disclosed on a non-recurring basis on its ~~consolidated financial position and~~ results of ~~operations.~~operation and financial position.

Recent changes in accounting standards— In ~~September 2006,~~December 2007, FASB issued SFAS No. 141 (revised 2007) “Business Combinations” (“SFAS No. 141R”). The objective of SFAS No. 141R is to improve the ~~SEC issued Staff Accounting Bulletin (“SAB”)~~relevance, presentational faithfulness, and comparability of the information that a reporting entity provides in its financial reports about a business combination and its effects. SFAS No. ~~108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements. SAB 108~~141R is effective for financial statements issued for fiscal years ~~ending~~beginning on or after ~~November~~December 15, ~~2006~~2008 and ~~addresses how financial statement errors should~~is required to be ~~considered from a materiality perspective and corrected.~~adopted by the Company in the first quarter of fiscal year 2010. The ~~literature provides interpretive guidance on how~~Company is evaluating the ~~effects~~impact, if any, of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. Historically there have been two common approaches used to quantify such errors: (i) the “rollover” approach, which quantifies the error as the amount by which the current year income statement is misstated, and (ii) the “iron curtain” approach, which quantifies the error as the cumulative amount by which the current year balance sheet is misstated. The SEC Staff believes that companies should quantify errors using both approaches and evaluate whether either of these approaches results in quantifying a misstatement that, when all relevant quantitative and qualitative factors are considered, is material. The adoption of ~~SAB 108 does~~SFAS No. 141R. The impact will depend on future acquisitions. It is not expected to have a material impact on ~~its consolidated~~the Company’s financial position, results of operations orand cash flows.

~~unrealized gains~~DESWELL INDUSTRIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except per share data)

2. Summary of Significant Accounting Policies — continued

In December 2007, FASB issued SFAS No. 160 “Non-controlling Interest in Consolidated Financial Statements” (“SFAS 160”). SFAS 160 amends Accounting Research Bulletin No. 51, Consolidated Financial Statements, to establish accounting and ~~losses~~reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 defines “a non-controlling interest, sometimes called a minority interest, is the portion of equity in a subsidiary not attributable, directly or indirectly, to a parent”. The objective of SFAS 160 is to improve the relevance, comparability, and transparency of the financial information that a reporting entity provides in its consolidated financial statements. SFAS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on ~~items for which the fair value option has been elected in earnings at each subsequent reporting date. Adoption~~or after December 15, 2008 and is required to be adopted by the Company in the first quarter of fiscal year 2010. The Company is evaluating the impact, if any, of the adoption of SFAS 160. It is not expected to have material impact on the Company’s financial position, results of operations and cash flows.

In March 2008, the FASB issued SFAS 161 “Disclosures about Derivative Instruments and Hedging Activities amendment of FASB Statement No. 133” (“SFAS 161”). This statement changes the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures stating how and why an entity uses derivative instruments; how derivatives and related hedged items are accounted for under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”) and its related interpretations; and how derivative instruments and related hedge items affect an entity’s financial position, financial performance and cash flows. SFAS 161 is effective in fiscal years beginning after November 15, ~~2007. Early~~2008 and is required to be adopted by the Company in the first quarter of fiscal year 2010. The Company does not expect the adoption of SFAS 161 will have a material impact on the Company’s disclosures.

In April 2009, the FASB issued FSP 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly” (“FSP 157-4”). FSP 157-4 provides additional guidance for estimating fair value in accordance with SFAS 157 when the volume and level of activity for the asset or liability have significantly decreased. FSP 157-4 also includes guidance on identifying circumstances that indicate a transaction is not orderly. FSP 157-4 is effective for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. FSP 157-4 does not require disclosures for earlier periods presented for comparative purposes at initial adoption. In periods after initial adoption, FSP 157-4 requires comparative disclosures only for periods ending after initial adoption. The adoption of the provisions of FSP 157-4 is not anticipated to materially impact on the Company’s results of operations or the fair values of its assets and liabilities.

In May 2009, the FASB issued SFAS No. 165 “Subsequent Events” (“SFAS 165”), which provides guidance to establish general standards of accounting for and disclosures of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. SFAS 165 also requires entities to disclose the date through which subsequent events were evaluated as well as the rationale for why that date was selected. This disclosure should alert all users of financial statements that an entity has not evaluated subsequent events after that date in the set of financial statements being presented. SFAS 165 is effective for interim and annual periods ending after June 15, 2009 and is required to be adopted by the Company in the first quarter of fiscal year 2010. Since SFAS 165 at most requires additional disclosures, the Company does not expect the adoption to have a material impact on the Company’s financial position, results of operations and cash flows.

In June 2009, the FASB issued SFAS No. 166 “Accounting for Transfers of Financial Assets” (“SFAS 166). This statement is intended to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial reports about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement in transferred financial assets. This Statement must be applied as of the beginning of aeach reporting entity’s first annual reporting period that begins after November 15, 2009, and is required to be adopted by the Company in the first quarter of fiscal year ~~that begins~~2011. Earlier application is prohibited. This Statement must be applied to transfers occurring on or ~~before~~after the effective date. The Company does not expect the adoption of SFAS 166 to have a material impact on the Company’s financial position, results of operations and cash flows.

F-10

DESWELL INDUSTRIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except per share data)

2. Summary of Significant Accounting Policies — continued

In June 2009, the FASB issued SFAS No. 167 “Amendments to FASB Interpretation No. 46(R)” (“SFAS 167”). SFAS 167 seeks to improve financial reporting by enterprises involved with variable interest entities. SFAS No. 167 is applicable for annual periods after November 15, ~~2007, provided~~2009 and interim periods therein and thereafter. The Company does not expect the ~~entity also elects to apply the provisions~~adoption of SFAS ~~Statement~~167 to have a material impact on the Company’s financial position, results of operations and cash flows.

In June 2009, the FASB issued SFAS No. ~~157.~~168 “The FASB Accounting Standards Codification™ and the Hierarchy of Generally Accepted Accounting Principles” (“SFAS 168”). The FASB approved the FASB Accounting Standards Codification (the “Codification”) as the single source of authoritative nongovernmental U.S. GAAP to be launched on July 1, 2009. The Codification does not change current U.S. GAAP, but is intended to simplify user access to all authoritative U.S. GAAP by providing all the authoritative literature related to a particular topic in one place. All existing accounting standard documents will be superseded and all other accounting literature not included in the Codification will be considered nonauthoritative. The Codification is effective for interim and annual periods ending after September 15, 2009. The Codification is effective for the Company in the second quarter of fiscal year 2010. The Company ~~is currently evaluating~~does not expect the ~~impact~~adoption of SFAS ~~No. 159~~168 to have a material impact on ~~its consolidated~~the Company’s financial ~~statements~~position, results of operations and ~~is currently not yet in a position to determine such effects.~~cash flows.

3. Marketable Securities

The Company acquired equity securities listed in Hong Kong.


					March 31,
	March 31,				2008		2009
	2006		2007

Cost	$	297	$	297	$	297	$	297


Market value	$	164	$	107	$	116	$	100

DESWELL INDUSTRIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except per share data)

6. Property, Plant and Equipment — continued


(a)		~~Leasehold land and buildings located in Hong Kong with lease terms of 50 years expiring in 2047 was disposed of in March 2007.~~

~~(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)~~(b)		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~~Chang An Xiaobian District Co-operation, the lessor, is the entity to whom the collectively-owned land has been granted. According to existing China laws and regulations, collectively-owned land is not freely transferable unless certain application and approval procedures are fulfilled by the Dongguan ~~Cheng~~Chang An Xiaobian District Co-operation to change the legal form of the land from collectively-owned to state-owned. As of March 31, ~~2007,~~2009, the Company is not aware of any steps being taken by the Dongguan ~~Cheng~~Chang An Xiaobian District Co-operation for such application.

~~(d)~~(c)		Other buildings represent factory premises ~~and dormitory units~~ located in China purchased by the Company with lease ~~terms from~~term of 30 ~~to 70~~ years expiring ~~from 2018~~2018. These factory premises are classified as “assets held for sale” under current assets at March 31, 2009 as the management plans to ~~2063.~~dispose them shortly.

7. ~~Credit Facilities and Pledged Assets~~Goodwill

The Company had maintained credit lines with various banks before and up to May 2006 representing trade acceptances, loans and overdrafts. At March 31, 2006 and 2007 total facilities provided by the banks were $1,285 and $nil, respectively, however, the Company had not utilized these lines. The maturities of these facilities were generally up to 90 days. Interest rates were generally based on the banks’ prime lending rates and the credit lines were normally subject to annual review. There were no significant covenants or other financial restrictions relating to the Company’s facilities except that at March 31, 2006 and 2007, cash of $649 and $nil, respectively, had been pledged as collaterals for the above facilities.

~~F-11~~

DESWELL INDUSTRIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except per share data)

9. Income Taxes — continued

Jetcrown Industrial (Dongguan) Limited (“~~Jetcrown Dongguan”~~JIDL”) (a subsidiary of the Company) ~~has~~had revised its first and second tax exemption year from the calendar year ended December 31, 2004 and 2005 respectively, to the calendar years ended December 31, 2002 and 2003 respectively. The revision was upon a tax reassessment by the PRC Tax Bureau during the year ended March 31, 2007 regarding the commencement year of exemption and inter-company sales pricing issues. The tax rate applicable for JIDL for calendar years 2002 to 2006 was 24%. JIDL was entitled to a full tax exemption for each of the ~~assessable profit amount.~~calendar years ended December 31, 2002 and 2003 and a 50% exemption for each of the calendar years ended December 31, 2004, 2005 and 2006. An aggregate amount of ~~$450,000~~$450 additional income tax ~~assessments~~provision, which ~~are likely to arise has~~comprised approximately $154, $92, $166 and $38 for taxable calendar years 2004, 2005 and 2006 and the quarter ended March 31, 2007 respectively had been charged to the consolidation income statement for the year ended March ~~2007~~2007. The assessment and payment for ~~the taxable~~income taxes for calendar years 2004 and 2005 were settled and concluded in September 2007 at the amount as provided. The assessment and payment for calendar year 2006 were settled at $101 in January 2008. However, there can be no assurance that the PRC Tax Bureau will not, in the future, further challenge (i) the reported revenue of JIDL for periods starting from the calendar year ended 31 December 2006; and (ii) revenues reported by JIDL for value-added tax filing purpose. There can also be no assurance that similar reassessments will not be extended to other PRC subsidiaries of the Company. The above reassessments, if conducted in the future, may cause an adverse impact to the net operating results of the Company.

For the calendar year ended December 31, ~~2004, 2005 and 2006 and for the quarter ended March 31, 2007.~~

~~Pursuant to a further concession in the income tax laws, the Company,~~2007, JIDL was approved as a foreign shareholder in a foreign enterprise in China, is eligible for a refund of taxes paid by its Chinese subsidiaries in proportion to the after-tax profits of these subsidiaries which are reinvestedan “Export-oriented Enterprises” by the ~~Company in these subsidiaries or in other foreign enterprises in China provided that~~local tax authority and enjoyed a lower tax rate of 12%. For the ~~reinvestment period relating to such subsidiaries or other foreign enterprises~~calendar year ended December 31, 2008 and the year ending December 31, 2009, the tax rate for JIDL is ~~for at least five years~~25%, being the unified tax rate under the New Tax Law effective 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, 2005, 2006 and 2007, the Company recorded a benefit relating to its decision to reinvest earnings of its Chinese subsidiary, Jetcrown Shenzhen, in another Chinese subsidiary, Jetcrown Dongguan totaling $nil, $173 and $nil, respectively.January 1, 2008.

Had the all above tax holidays and concessions not been available, the tax charge would have been higher by ~~$719, $92~~$351, $89 and ~~$351~~$nil and the basic net income per share would have been lower by ~~$0.05,~~$0.02, $0.01 and ~~$0.02~~$nil for the years ended March 31, ~~2005, 2006~~2007, 2008 and ~~2007~~2009 respectively, and diluted net income per share for the years ended March 31, ~~2005, 2006~~2007, 2008 and ~~2007~~2009 would have been lower by ~~$0.05,~~$0.02, $0.01 and ~~$0.02,~~$nil, respectively.

~~On March 16, 2007,~~The Company has adopted the ~~National People’s Congress~~provisions of FIN 48 on April 1, 2007. The evaluation of a tax position in accordance with FIN 48 begins with a determination as to whether it is more-likely-than-not that a tax position will be sustained upon examination based on the technical merits of the ~~People’s Republic~~position. A tax position that meets the more-likely-than-not recognition threshold is then measured at the largest amount of ~~China passed~~benefit that if greater than 50 percent likely of being realized upon ultimate settlement for recognition in the new Enterprise Income Tax Law which will effect on January 1, 2008. The new law will replace the existing Income Tax Law on Enterprises with Foreign Investment and Foreign Enterprises, which applies to foreign enterprises, and Provision Regulationsfinancial statements. There is no material impact on the ~~Enterprises in China,~~adoption of FIN 48. The Company classifies interest and/or penalties related to unrecognized tax benefits as a component of income tax provisions; however, as of March 31, 2009, there is no interest and penalties related to uncertain tax positions, and the Company has no material unrecognized tax benefit which ~~applies to domestic enterprises. From January 1, 2008,~~would favorably affect the ~~standard~~effective income tax rate in future periods. The Company does not anticipate any significant increases or decreases to its liability for ~~all companies will be reduced from~~unrecognized tax benefit within the current rate of 33% to 25%. However, for foreign enterprises, like the subsidiaries of the Company, that were established before the promulgation of the new Income tax Law, a five-year transition period will apply. Since the Chinese government has not announced the implementation measures of the transitional policy, the Company is not able to make an estimate of the expected financial effect of the New Corporate Tax Law on its deferred tax assets and liabilities. However, it is not expected to have any financial effect on the amounts accrued in the balance sheet in respect of current tax payable.

~~Others~~

~~Certain of the Company’s income accrues in tax free jurisdictions and is not subject to any income taxes.~~next twelve months.

The provision for income taxes consists of the following:


	Year ended March 31,
	2005			2006			2007		Year ended March 31,
									2007		2008			2009
Current tax
- Hong Kong	$	51		$	29		$	9
- China		540			238			615
— Hong Kong									$	9	$	—		$	—
— China										615		654			234
Deferred tax		(15	)		(294	)		615		615		(550	)		(516	)

	$	576		$	(27	)	$	1,239	$	1,239	$	104			($282	)

~~12. Shareholders’ Equity~~DESWELL INDUSTRIES, INC.

On March 15, 2005, the Company completed a three-for-two stock split. No fractional shares were issued and 147 shares were redeemed and cancelled upon the stock split. All financial statements have been retroactively restated to account for the change.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands, except per share data)

~~13.~~11. 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 the range of 8% to 11% of the average monthly salary, was ~~$310, $515~~$634, $817 and ~~$634~~$697 for the years ended March 31, ~~2005, 2006~~2007, 2008 and 2007, respectively. According to the Mandatory Provident Fund (“MPF”) legislation regulated by the Mandatory Provident Fund Schemes Authority in Hong Kong, with effect from December 1, 2000, the Company is required to participate in a MPF scheme operated by approved trustees in Hong Kong and to make contributions for its eligible employees. The contributions borne by the Company are calculated at 5% of the salaries and wages (monthly contribution is limited to 5% of $3 for each eligible employee) as calculated under the MPF legislation. The expense related to the MPF in the years ended March 31, 2005, 2006 and 2007 amounted to $2, $nil and nil,2009, respectively.

~~14.~~12. Stock Option Plan

On March 15, 1995, the Company adopted 1995 Stock Option Plan that permits the Company to grant options to officers, directors, employees and others to purchase up to 1,012,500 shares of Common Stock. On September 29, 1997, the Company approved an increase of 549,000 shares making a total of 1,561,500 shares of common stock available under the stock option plan. On January 7, 2002, the Company adopted 2001 Stock Option Plan to purchase an additional 1,125,000 shares of Common Stock. On September 30, 2003, the Company adopted 2003 Stock Option Plan to purchase an additional 900,000 shares of Common Stock. On September 19, 2005, the Company approved an increase of 500,000 shares making a total of 1,400,000 shares of common stock available under the 2003 Stock Option Plan. On August 17, 2007, the Company approved an increased of 400,000 shares making a total of 1,800,000 shares of common stock available under the 2003 Stock Option Plan.

At March 31, ~~2007,~~2009, options to purchase an aggregate of ~~4,086,500~~4,243,500 common shares had been granted under the stock option plans. Options granted under the stock option plans will be exercisable for a period of up to 10 years commencing on the date of grant, at a price equal to at least the fair market value of the Common Stock at the date of grant, and may contain such other terms as the Board of Directors or a committee appointed to administer the plan may determine. A summary of the option activity (with weighted average prices per share) is as follows:


																Year ended March 31,
	Year ended March 31,															2007					2008					2009
	2005					2006					2007								Weighted					Weighted					Weighted
				Weighted					Weighted					Weighted		Number			average		Number			average		Number			average
	Number			average		Number			average		Number			average		of stock			exercise		of stock			exercise		of stock			exercise
	of stock			exercise		of stock			exercise		of stock			exercise		options			price		options			price		options			price
	options			price		options			price		options			price

Outstanding at beginning of the year		1,724,250		$	10.74		669,000		$	14.10		644,000		$	14.10		644,000		$	14.10		1,029,000		$	11.91		1,119,000		$	11.14
Granted during the year		—			—		—			—		500,000			8.26		500,000			8.26		210,000			5.71		190,000			1.34
Exercised during the year		(1,055,250	)		8.61		(25,000	)		14.10		(115,000	)		8.26		(115,000	)		8.26		(120,000	)		8.26		—			—
Canceled or expired																	—			—		—			—		(243,000	)		12.03

Outstanding and exercisable at the end of the year		669,000			14.10		644,000			14.10		1,029,000			11.91		1,029,000			11.91		1,119,000			11.14		1,066,000			9.19


Range of exercise price per share				$	14.10				$	14.10				$8.26 to $14.10		$8.26 to $14.10					$5.71 to $14.10					$1.34 to $14.10

ITEM 19. EXHIBITS

The following documents are filed as exhibits herewith:


Exhibit
No.		Description
1.1		Memorandum and Articles of Association (as amended ~~through March 7, 1995)~~and restated on 13^th December, 2007) (incorporated by reference to Exhibit ~~3.1~~1.1 to Deswell’s Registration Statement on Form ~~F-1~~8-A 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 MarchDecember 31, ~~2001 filed with the SEC on July 10, 2001)~~2007).

~~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		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.)

4.2		2003 Stock Option Plan of Deswell Industries, Inc.~~, as~~ (as adopted August 20, 2003 and amended August 1, 2005 and August 17, 2007) (incorporated by reference to Exhibit A to the Company’s Proxy Statement filed with the Securities and Exchange Commission on Form 6-K on September 11, 2007).

4.3		Stock Purchase Agreement dated as of August ~~29, 2005)~~17, 2007 by and among Lee Shu Kwan (S. K. Lee), Tam Man Chi (M. C. Tam), shareholders of Integrated International Ltd., and Deswell Industries, Inc. (incorporated by reference to Exhibit 4.3 of Deswell’s Annual Report on Form 20-F for the year ended March 31, 2008 filed with the SEC on September 17, 2008).

4.4		Sale and Purchase Agreement dated as of August 5, 2009 by and between Jetcrown Industrial (Shenzhen) Co., Ltd., as assignor, and an unrelated third party, as assignee, to sell real property in Shekou, Shenzhen, China that was formerly used for Deswell’s plastic injection molding operations for RMB50,000,000 (approximately $7.3 million, based on an exchange rate of 1:6.8309 on August 5, 2009 as reported on http://forex-history.net).*

8.1		Diagram of the Company’s operating subsidiaries and affiliates — (see page 1619 of this report)

11.1		Code of Ethics (incorporated by reference to Exhibit 11.1 of registrant’s Form 20-F for the year ended March 31, 2004, filed with the SEC on July 16, 2004)

12.1		Certification of Chief Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) under the Securities Exchange Act of 1934

12.2		Certification of Chief Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) under the Securities Exchange Act of 1934

13.1		Certification Pursuant To 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act Of 2002

14.1		Consent of BDO ~~International~~Limited to incorporation of its report on the Company’s consolidated financial statements into Registrant’s Registration Statements on Form S-8.


*		The agreement is written in Chinese and an English Summary is included in accordance with Form 20-F Instructions to Exhibits and Rule 12b-12 (d) under the Exchange Act).

5455


		Betty Lam, Chief Financial Officer, telephone:
	17B, Edificio Comercial Rodrigues,	853-28-322096
	599 Avenida da Praia Grande, Macao	fax: 853-28-323265
British Virgin Islands	Special Administrative Region, PRC	E-mail: bettylam@jetcrown.com.mo
(Jurisdiction of incorporation or organization)	(Address of principal executive offices)	(Name, Telephone, E-mail and/or Facsimile number and
		Address of Company Contact Person)


		~~other investments, Leesha owns the 3,453,750 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. 48 to Schedule 13G filed with the SEC on ~~February 14, 2007.~~

~~(7)~~		~~Based on Amendment No. 6 to a Schedule 13G filed with the SEC on~~ January ~~19, 2007.~~

~~(8)~~		~~Based on Amendment No. 4 to a Schedule 13G filed with the SEC on February 14, 2007.~~23, 2009.


(1)		Based on ~~14,908,730, 14,923,730~~15,143,730, 15,790,810 and ~~15,143,730 and~~15,790,810 shares outstanding on June ~~28, 2005, June 30, 2006 and June~~ 30, 2007, 2008 and 2009, 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.

(2)		Leesha Holding Ltd. 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 owned 3,453,750 common shares of Deswell, which were transferred to Leesha by Messrs. Lau, Li and Leung shortly after Deswell’s initial public offering in 1996. On September 14, 2007, Leesha declared a dividend to its shareholders of all 3,453,750 common shares of Deswell, distributing 1,151,250 shares of the Company to each of Messrs. Lau, Li and Leung. Accordingly, effective when Leesha distributed its Deswell shares, the beneficial ownership of Leesha in Deswell, and the attribution of such ownership to each of Messrs. Lau, Li and Leung, as Leesha’s directors and principal shareholders, terminated.

(3)		Based on Amendment No. 8 to Schedule 13G filed with the SEC on January 23, 2009.

(4)		Mr. Leung retired as Executive Director of Engineering for Plastic Operations and a member of Deswell’s Board of Directors effective on January 1, 2009 and Deswell has been advised that since his retirement through June 30, 2009, Mr. Leung, through open market sales, has reduced his holdings of Deswell shares to below five percent.

(5)		Based on Amendment No. 7 to Schedule 13G filed with the SEC on January 12, 2009.

(6)		Based on Amendment No. 6 to Schedule 13G filed with the SEC on February 17, 2009, which disclosed that the reporting person reduced its holdings to less than five percent.


Year Ended March 31,	High		Low		High		Low
2009					$	7.65	$	1.12
2008						13.04		6.00
2007	$	12.50	$	8.10		12.50		8.10
2006		16.48		9.00		16.48		9.00
2005		18.167		12.867		18.167		12.867
2004		20.40		10.43
2003		27.23		7.33


Quarter ended	High		Low
March 31, 2007	$	12.50	$	11.21
December 31, 2006		11.70		10.46
September 30, 2006		10.96		8.40
June 30, 2006		9.90		8.10
March 31, 2006		12.67		9.00
December 31, 2005		14.87		10.20
September 30, 2005		16.00		14.09
June 30, 2005		16.48		13.67


o		REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g)OF THE SECURITIES EXCHANGE ACT OF 1934 or


þ		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


o		~~Registration Statement Pursuant to Section 12(b) or (g) of the Securities Exchange Act of~~TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


þo		~~Annual Report Pursuant to Section~~SHELL COMPANY REPORT PURSUANT TO SECTION 13 orOR 15(d) ~~of the Securities Exchange Act of~~OF THE SECURITIES EXCHANGE ACT OF 1934


		DESWELL INDUSTRIES, INC.
		(Exact name of registrant as specified in its charter)


U.S. GAAPþ		International Financial Reporting Standards as issued by the International Accounting Standards Boardo		Othero


		Page

INTRODUCTION			3
FINANCIAL STATEMENTS AND CURRENCY PRESENTATION			3
PART I			3
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS			3
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE			3
ITEM 3. KEY INFORMATION			3
ITEM 4. INFORMATION ON THE COMPANY			1317
ITEM ~~4A.~~4A UNRESOLVED STAFF COMMENTS			2527
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS			2627
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES			36
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS			3739
ITEM 8. FINANCIAL INFORMATION			41
ITEM 9. THE OFFER AND LISTING			4241
ITEM 10. ADDITIONAL INFORMATION			4342
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			49
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES			50
PART II			50
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES			50
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS			50
ITEM ~~15T.~~15. CONTROLS AND PROCEDURES			50
ITEM 16. RESERVED			5153
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT			5153
ITEM 16B. CODE OF ETHICS			5153
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES			5253
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR THE AUDIT ~~COMMITTEE.~~COMMITTEE			5253
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATE ~~PURCHASERS.~~PURCHASERS			5253
ITEM 16F. CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT			54
ITEM 16G. CORPORATE GOVERNANCE			54
PART III			5354
ITEM 17. FINANCIAL STATEMENTS			5354
ITEM 18. FINANCIAL STATEMENTS			5354
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM			F-1
ITEM 19. EXHIBITS			5455
SIGNATURES			55
			56
CERTIFICATION OF CHIEF EXECUTIVE OFFICER REQUIRED BY RULE 13A-14(A) OR RULE 15D-14(A) UNDER THE SECURITIES EXCHANGE ACT OF 1934	~~Exhibit 12.1~~
				Ex. 12.1
CERTIFICATION OF CHIEF FINANCIAL OFFICER REQUIRED BY RULE 13A-14(A) OR RULE 15D-14(A) UNDER THE SECURITIES EXCHANGE ACT OF 1934	~~Exhibit 12.2~~
				Ex. 12.2
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002	~~Exhibit 13.1~~
				Ex. 13.1
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM	~~Exhibit 14.1~~
~~EXHIBIT 12.1~~
~~EXHIBIT 12.2~~
~~EXHIBIT 13.1~~
~~EXHIBIT~~Ex. 14.1


											At March 31,
											2005		2006		2007		2008		2009
Balance Sheet Data:	At March 31,
	2003		2004		2005		2006		2007
Working capital	$	58,223	$	52,876	$	57,576	$	55,114	$	58,672	$	57,576	$	55,114	$	58,672	$	54,751	$	52,605
Total assets		106,172		113,534		136,976		130,670		141,210		136,976		130,670		141,210		140,407		137,482
Long-term debt, less current portion		—		—		—		—		—		—		—		—		—		—
Total debt		—		—		—		—		—		—		—		—		—		—
Shareholders’ equity		81,846		89,730		104,767		106,768		111,655		104,767		106,768		111,655		121,257		120,307


(1)		Our consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States of America and are stated in U.S. dollars. See “Financial Statements and Currency Presentation.”

(2)		Basic EPS excludes dilution from potential common shares and is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution from potential common shares.

(3)		Share and per share amounts presented above have been adjusted to reflect the three-for-two stock ~~splits~~split effected in ~~July 2002 and~~ March ~~2005 (see Note 12 of Notes to Consolidated Financial Statements).~~2005.

(4)		Other operating income (expenses) ~~are~~were reclassified in the consolidated statement of income for the year ended March 31, 2007 for ~~better~~a comparable presentation. Comparative figures for the years ended March 31, ~~2003 to~~2005 and 2006 were reclassified accordingly. The reclassification of operating income ~~has~~had no impact on the net income on the consolidated ~~statement~~statements of income for the years ended March 31, ~~2003 to~~2005 and 2006.

	•		~~cases and key tops for personal organizers and remote controls;~~Plastic component of electronic entertainment products;

	•		cases for flashlights, telephones, paging machines, projectors and alarm clocks;

	•		~~grips and rods for fishing tackle;~~


	Year ended March 31,									Year ended March 31,
Geographic Areas	2005			2006			2007			2007			2008			2009
China											39.2	%		37.0	%		52.8	%
United States		40.5	%		49.0	%		42.4	%		42.4			46.8			32.0
China		44.8			37.5			39.2
Europe		10.9			7.0			11.2			11.2			10.7			12.4
Others											3.8			3.8			1.5
Hong Kong		0.8			3.0			3.4			3.4			1.7			1.3
Others		3.0			3.5			3.8

Total		100.0	%		100.0	%		100.0	%		100.0	%		100.0	%		100.0	%


		Year ended March 31,
Customer	Product	2005			2006			2007
Line 6 Manufacturing	Professional audio equipment		14.9	%		14.5	%		15.1	%
Digidesign, Inc.	Professional audio equipment		19.1			17.4			13.3
Vtech Telecommunications Limited	Plastic component		12.1			*			12.7
Peavey Electronics Corp.	Professional audio equipment		*			*			10.4


	Percentage Ownership (1) at									Percentage Ownership at June 30,(1)
	June 28,									2007		2008		2009
	2005			June 30, 2006			June 30, 2007
Richard Lau		25.9	%		26.0	%		25.3	%
C. P. Li		25.6	%		25.2	%		24.0	%
C. W. Leung		24.1	%		24.3	%		24.1	%
Richard Pui Hon Lau⁽²⁾											25.3		10.2		8.5
Chin Pang Li⁽²⁾											24.0		9.0		7.3
Royce & Associates, Inc.											8.1		8.6		5.3	⁽³⁾
Chi Wai Leung⁽²⁾											24.1		8.4			⁽⁴⁾
Leesha Holdings Ltd.(2)		23.2	%		23.1	%		22.8	%		22.8		—		—
Wellington Management Company, LLP		8.4	%		9.6	%		10.6	%		10.6		11.4		—	⁽⁵⁾
Royce & Associates, Inc.		9.3	%		10.4	%		8.1	%
FMR Corp./ Edward C. Johnson 3d/ Abigail P. Johnson											6.0		5.5			⁽⁶⁾
Micropower Enterprises Limited		7.7	%		7.7	%		7.6	%		7.6		—		—
FMR Corp./ Edward C. Johnson 3d/ Abigail P. Johnson		7.6	%		6.3	%		6.0	%


Quarter ended	High		Low
March 31, 2009	$	1.90	$	1.27
December 31, 2008		3.82		1.12
September 30, 2008		6.05		3.00
June 30, 2008		7.65		5.60
March 31, 2008		6.96		6.07
December 31, 2007		7.47		6.00
September 30, 2007		10.13		9.24
June 30, 2007		13.04		10.92


Month ended	High		Low
June 30, 2007	$	13.04	$	10.92
May 31, 2007		12.62		11.25
April 30, 2007		12.32		11.40
March 31, 2007		12.22		11.40
February 29, 2007		12.50		11.21
January 31, 2007		12.49		11.30


Month ended	High		Low
June 30, 2009	$	3.59	$	2.66
May 31, 2009		2.65		2.36
April 30, 2009		2.49		1.75
March 31, 2009		1.80		1.32
February 29, 2009		1.80		1.51
January 31, 2009		1.90		1.27

	•		a trader in securities that elects to use a market-to-market method of accounting for ~~your~~its securities holdings;

	•		a financial ~~institution;~~institution or a bank;

	•		~~a life~~an 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 United States federal income tax purposes is not the U.S. dollar;

	•		a person liable for alternative minimum tax;

	•		a person that owns, or is treated as owning, ~~10 percent~~10% or more, by voting power or value, of our common shares;

	•		certain former U.S. citizens and residents ~~deemed to~~who have ~~expatriated to avoid U.S. taxation;~~expatriated; or

	•		a person who receives our shares pursuant to the exercise of employee stock options or otherwise as compensation.

	•		an individual ~~U.S.~~United States citizen or resident alien of the United States (as specifically defined for United States federal income tax purposes);

	•		a corporation, or other entity treated as a corporation for United States federal income tax purposes, created or organized in or under the laws of the United States, or any State or ~~political subdivision thereof;~~the District of Columbia;


	Page
Report of Independent Registered Public Accounting Firm		F-1
Consolidated Balance Sheets		F-2
Consolidated Statements of Income and Comprehensive Income		F-3
Consolidated Statements of Shareholders’ Equity		F-4
Consolidated Statements of Cash Flows		F-5
Notes to Consolidated Financial Statements		F-6


	March 31,
Acquisitions	2008			2009


Electronic division	$	393		$	393
Metallic division		317			317
Foreign exchange differences		(2	)		(1	)
Impairment — metallic division		(317	)		(317	)

	$	391		$	392


	Year ended March 31,
	2005			2006			2007			Year ended March 31,
										2007			2008			2009
Provision for income taxes at statutory tax rate in China	$	4,884		$	2,698		$	3,837		$	3,837		$	2,988		$	227
Effect of different tax rate in various jurisdictions		(219	)		6			212			212			—			(1	)
Tax holidays and concessions		(666	)		99			(351	)		(351	)		(89	)		—
Effect of income for which no income tax is chargeable		(3,459	)		(2,853	)		(3,007	)		(3,007	)		(3,204	)		(145	)
Increase in valuation allowances		—			—			264
Under provision of income tax in previous year		34			8			273
Net change in valuation allowances											264			(16	)		(15	)
Under (over) provision of income tax in previous year											273			477			(348	)
Others		2			15			11			11			(52	)		—

Effective tax	$	576		$	(27	)	$	1,239		$	1,239		$	104		$	(282	)


Years ending March 31
2008	$	112
2009		19
2010			$	136
2011				18

Total minimum lease payments	$	131	$	154


	Percentage of net sales									Percentage of net sales
	Year ended March 31,									Year ended March 31,
	2005			2006			2007			2007			2008			2009

Line 6 Manufacturing		14.9	%		14.5	%		15.1	%

N&J Company Limited											*			11.8	%		28.6	%
Digidesign, Inc.		19.1	%		17.4	%		13.3	%		13.3	%		17.0	%		12.7	%
VTech Telecommunications Limited		12.1	%		*			12.7	%		12.7	%		*			*
Inter-Tel Incorporated											*			10.2	%		*
Peavey Electronic Corp.		*			*			10.4	%		10.4	%		*			*
Epson Precision (H.K.) Limited		18.5	%		14.6	%		*
Line 6 Manufacturing											15.1	%		14.3	%		*


	Percentage of
	accounts
	receivable
	March 31,
	2006			2007
Largest receivable balances		59.4	%		57.8	%


	DESWELL INDUSTRIES, INC.

By:	/s/ Franki S. F. Tse
		Franki S. F. Tse,
Chief Executive Officer		~~Chief Executive Officer~~