SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 20-F

o		Registration Statement Pursuant to Section 12(b) or (g) of the Securities Exchange Act of 1934

þ		Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Fiscal Year Ended: March 31, 2007

		DESWELL INDUSTRIES, INC.

(Exact name of registrant as specified in its charter)

British Virgin Islands
(Jurisdiction of incorporation or organization)
17B, Edificio Comercial Rodrigues
599 Avenida da Praia Grande, Macao
(Address of principal executive offices)

Securities registered or to be registered pursuant to Section 12(b) of the Act: Common shares, no par value

Securities registered pursuant to Section 12(g) of the Act: NONE

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: per share NONE

As of March 31, 2007, there were 15,038,730 common shares of the registrant outstanding.

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

     o Yes þ No

     If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. o Yes þ No

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

     þ Yes o No

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o      Accelerated filer þ      Non-accelerated filer o

     Indicate by check mark which financial statement item the registrant has elected to follow: o Item 17 þ Item 18

     If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes þ No

 

 

TABLE OF CONTENTS

		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			13
ITEM 4A. UNRESOLVED STAFF COMMENTS			25
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS			26
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES			36
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS			37
ITEM 8. FINANCIAL INFORMATION			41
ITEM 9. THE OFFER AND LISTING			42
ITEM 10. ADDITIONAL INFORMATION			43
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. CONTROLS AND PROCEDURES			50
ITEM 16. RESERVED			51
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT			51
ITEM 16B. CODE OF ETHICS			51
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES			52
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR THE AUDIT COMMITTEE.			52
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATE PURCHASERS.			52
PART III			53
ITEM 17. FINANCIAL STATEMENTS			53
ITEM 18. FINANCIAL STATEMENTS			53
ITEM 19. EXHIBITS			54
SIGNATURES			55
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
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
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
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM	Exhibit 14.1
EXHIBIT 12.1
EXHIBIT 12.2
EXHIBIT 13.1
EXHIBIT 14.1

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,
	•		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$” are to the legal currency of Hong Kong.
	•		all references to “U.S. dollars,” “dollars”, “$” 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, and the balance sheet data as of March 31, 2006 and 2007 are derived from our audited consolidated financial statements included in this Report. The selected income statement data for the years ended March 31, 2003 and 2004, and the balance sheet data as of March 31, 2003, 2004 and 2005 are derived from our audited consolidated financial statements, which are not included in this Report.

Selected Financial Data ⁽¹⁾

		(in thousands except per share data)
Income Statement Data:		Year ended March 31,
		2003				2004				2005				2006				2007
Net sales		$	90,905			$	97,195			$	125,590			$	115,276			$	136,779
Cost of sales			61,006				66,105				92,072				89,850				105,506
Gross profit			29,899				31,090				33,518				25,426				31,273
Selling, general and administrative expenses			15,354				14,718				15,759				15,052				18,957
Other income (expenses), net			496				90				(106	)			(823	)			1,376
Operating income (4)			15,041				16,462				17,653				9,551				13,692
Interest expense			(6	)			(16	)			(12	)			(6	)			—
Non-operating income (expenses), net			322				820				448				447				547
Income before income taxes			15,357				17,266				18,089				9,992				14,239
Income taxes			3,826				589				576				(27	)			1,239
Income before minority interests			11,531				16,677				17,513				10,019				13,000
Minority interests			1,288				1,957				2,330				1,240				833
Net income		$	10,243			$	14,720			$	15,183			$	8,779			$	12,167
Basic earnings per share (2)(3)		$	0.79			$	1.08			$	1.04			$	0.59			$	0.81
Average number of shares outstanding—basic (2)(3)			13,008				13,664				14,656				14,908				14,956
Diluted earnings per share (3)		$	0.77			$	1.04			$	1.02			$	0.59			$	0.81
Average number of shares outstanding—diluted (2)(3)			13,278				14,160				14,933				14,936				15,048
Statistical Data:
Gross margin			32.9	%			32.0	%			26.7	%			22.1	%			22.9	%
Operating margin (4)			16.5	%			16.9	%			14.1	%			8.3	%			10.0	%
Dividends per share (3)		$	0.51			$	0.63			$	0.65			$	0.63			$	0.65

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

Risk Factors

     We may from time to time make written or oral forward-looking statements. Written forward-looking statements may appear in this document and other documents filed with the Securities and Exchange Commission, in press releases, in reports to shareholders, on our website, and other documents. The Private Securities Reform Act of 1995 contains a safe harbor for forward-looking statements on which we rely in making such disclosures. In connection with this “safe harbor”, we are hereby identifying important factors that could cause actual results to differ materially from those contained in any forward-looking statements made by us or on our behalf. Any such statement is qualified by reference to the following cautionary statements:

We face numerous risks as a result of our operations in China.

     Our manufacturing facilities are located in China. As a result, our operations and assets are subject to significant political, economic, legal and other uncertainties associated with doing business in China, which are discussed in more detail below.

The Chinese government could change its policies toward or even nationalize private enterprise, which could result in the total loss of our investment in that country.

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

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

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

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

     Our activities in China require business licenses. This requires a review and approval of our activities by various national and local agencies of Chinese government. The Chinese government may not continue to approve our activities or grant or renew our licenses. Our inability to obtain needed approvals or licenses could prevent us from continuing to conduct operations in China. If for any reason we were required to move our manufacturing operations outside of China, our profitability would be substantially impaired, our competitiveness and market position would be materially jeopardized and we may not be able to continue operations.

A fire, severe weather, flood, or other act of God could cause significant damage to our properties in China and disrupt our business operations.

     Firefighting and disaster relief or assistance in China are primitive by Western standards. At March 31, 2007, we maintained fire, casualty and theft insurance aggregating approximately $59,151,000 covering certain of our stock in trade, goods and merchandise, furniture and equipment and factory buildings in China. The proceeds of this insurance may not be sufficient to cover material damage to, or the loss of, any of our factories due to fire, severe weather, flood, or other act of God or cause. We do not maintain any business interruption insurance.

Possible changes and uncertainties in economic policies in the Special Economic Zones of China in which we operate could harm our operations by eliminating benefits we currently enjoy.

     As part of its economic reform, China has designated certain areas, including Shenzhen where we have certain manufacturing facilities, as Special Economic Zones. Foreign enterprises in these areas benefit from greater economic autonomy and more favorable tax treatment than enterprises in other parts of China. Changes in the policies or laws governing Special Economic Zones could eliminate these benefits. Moreover, economic reforms and growth in China have been more successful in certain provinces than others, and the continuation or increase of these disparities could affect the political or social stability of China.

We are 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 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) 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 impact of the new tax law on Deswell or to us at this time.

     The EIT Law further includes provisions relating to withholding on interest, royalties, dividends or other passive income, including dividend payments from companies in the PRC like Deswell.

     We are in the process of analyzing EIT Law to determine, and whether by, and the feasibility of, changing Deswell’s corporate structure, we can reduce the impact of the new PRC enterprise 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-tax net income for distribution to us from our China subsidiaries.

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 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 7.78 to each United States dollar and has not in the past presented a currency exchange risk. 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 dollars to the U.S. dollars. For approximately three years prior to July 2005, the exchange rate between the Chinese currency, the renminbi, and the U.S. dollars varied by less than one-tenth of one percent. However, on July 21, 2005, the People’s Bank of China adjusted the exchange rate of U.S. dollars to RMB from 1:8.27 to 1:8.11, resulting in an approximately 2% appreciation in the value of the RMB against the U.S. dollar. As a result, and in addition to increases 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 the year ended March 31, 2007. If the Chinese government allows a further and significant RMB appreciation, and there are indications that the Chinese government has accelerated the RMB’s appreciation to the dollar with it reaching 7.5712:1 on July 20, 2007, our operating costs could further increase and could further adversely affect our financial results.

Any future outbreak of severe acute respiratory syndrome or other diseases may have a negative impact on our business and operating results.

     In the first calendar quarter of 2003, several economies in Asia, including Hong Kong, where our logistic support office and some of our customers are located, and southern China, where our factories are located, were affected by the outbreak of severe acute respiratory syndrome, or SARS. If there is a recurrence of an outbreak of SARS, it may adversely affect our business and operating results. For example, a future SARS outbreak could result in quarantines or closure to our office in Hong Kong or factories in China if our employees are infected with SARS and ongoing concerns regarding SARS, particularly its effect on travel, could negatively impact our customers and suppliers based in Hong Kong or China and our business and operating results.

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

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

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

A recent labor shortage in southern China could adversely affect our gross margins or decrease revenue.

     The Company carries out all of its manufacturing operations in Southern China, where it has been able to take advantage of the lower overhead costs and inexpensive labor rates as compared to Hong Kong. Historically, there has been an abundance of labor in southern China, but factories in southern China are facing a labor shortage as migrant workers seek better wages and working conditions elsewhere. In an effort to counter this trend, minimum wages for workers in Southern China were increased during the year ended March 31, 2007, adversely impacting our gross margins, operating income and net income. If this trend continues, the Company’s 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 a

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.

We are dependent on a few major customers and have no long-term contracts with them. Our sales would substantially decrease and we would suffer decreases in net income or losses if we lose any of our major customers, if they substantially reduce their orders or if they are unable to pay us.

     Historically, a substantial percentage of our sales have been to a small number of customers. Our four largest customers during the year ended March 31, 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.

     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, 2005, 2006 and 2007:

		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 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.

     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.

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, approximately 70.3% of the net book value of our total identifiable fixed assets was located in China. We sell our products to customers principally in China, the United States, Europe and Hong Kong. Our international operations may be subject to significant political and economic risks and legal uncertainties, including:

	•		changes in economic and political conditions and in governmental policies,
	•		changes in international and domestic customs regulations,
	•		wars, civil unrest, acts of terrorism and other conflicts,
	•		changes in tariffs, trade restrictions, trade agreements and taxation,
	•		difficulties in managing or overseeing foreign operations, and
	•		limitations on the repatriation of funds because of foreign exchange controls.

     The occurrence or consequences of any of these factors may restrict our ability to operate in the affected region and decrease the profitability of our operations in that region.

Our loss of certain members of our senior management could cause disruptions in our business and harm our customer relationships thereby adversely affecting sales.

     We depend to a large extent on the abilities and continued participation of

	•		Richard Lau, our 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;

	•		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 our Chief Executive Officer in February 2007, and Messrs. Li and Leung founded our company and have each played integral roles in the management, growth and development of our company in general and our plastic injection molding business in particular. They have developed and maintain relationships with several of our key customers in our plastic injection molding business. Mr. S. K. Lee and Mr. M. C. Tam founded our electronic products manufacturing business and have developed and continue to manage it since we acquired control of the business from them. We have no employment contracts with Messrs. Li, Leung, Lee and Tam and their loss would require us to find executives suitable to replace them, which could be difficult and disruptive to our business. Customers with whom they have relationships may cease to deal with us or choose to use a competitor for a greater portion of their business, resulting in our loss of sales.

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.

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

     Our senior management as a group, each of whom are also members and constitute a majority of our board of directors, and our Chairman of the Board, directly or indirectly through an affiliated company beneficially own approximately 28.2 % our shares at June 30, 2007. As a result, acting together they may be able to control, and they can substantially influence, the outcome of all matters requiring approval by our shareholders, including the election of directors and approval of significant corporate transactions. This ability may have the effect of delaying or preventing a change in control of Deswell, or causing a change in control of Deswell that may not be favored by our other shareholders.

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

organized in the United States). Our board’s ability to amend our charter documents without shareholder approval, including its ability to create and issue preference shares, could have the effect of delaying, deterring or preventing a change in control of Deswell, including a tender offer to purchase our common shares at a premium over the then current market price.

Our exemptions from certain of the reporting requirements under the Exchange Act limits the protections and information afforded to investors.

     We are a foreign private issuer within the meaning of rules promulgated under the Securities Exchange Act of 1934. As a foreign private issuer, we are exempt 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 Stock Market that are applied to domestic companies having securities included on The 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 provisions of NASDAQ’s Marketplace Rule 4350. 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 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)(2): Our independent directors do not meet in executive session;
	•		Rule 4350(c)(3): Our board does not have a compensation committee;
	•		Rule 4350(c)(4): Nominees for appointment as our directors are not selected or recommended by (i) a majority of our independent directors, or a nominating committee composed solely of independent directors.

     Because of these exemptions or exclusions, investors are not afforded the same protections or information generally available to investors in public companies organized in the United States or with securities included on The NASDAQ Stock Market.

We may not pay dividends in the future.

     Although we have declared dividends during each of the last nine fiscal years, we may not be able to declare them or may decide not to declare them in the future. We will determine the amounts of the dividends when they are declared and even if dividends are declared in the future, we may not continue them in any future period.

ITEM 4. INFORMATION ON THE COMPANY

History and Development of Deswell

     The Company was incorporated in December 1993 as a limited liability International Business Company under the laws of the British Virgin Islands. The Company’s registered agent in the British Virgin Islands is HWR Services Limited, P.O. Box 71, Craigmuir Chambers, Road Town, Tortola, British Virgin Islands. The Company’s principal administrative office is located in 17B, Edificio Comercial Rodrigues, 599 Avenida da Praia Grande, Macao, and its telephone number is (853) 28322096 and its facsimile number is (853) 28323265.

     Deswell developed from the initial incorporation of Jetcrown Industrial Limited (“JIL”), a Hong Kong limited liability company, in February 1987. Richard Lau, C. P. Li and C. W. Leung founded JIL to manufacture injection-molded plastic parts for OEMs and contract manufacturers. JIL is the ultimate predecessor of the Company as restructured in March 1994. In January 1990, Jetcrown Industrial (Shenzhen) Limited, a limited liability China foreign operation (“Jetcrown Shenzhen”), was organized to conduct the Company’s manufacturing operations in China and JIL’s manufacturing operations were relocated to China in 1990. Marcon Enterprises Limited, a British Virgin Islands International Business Company (“Marcon”), was organized in July 1991 to hold the beneficial ownership of Jetcrown Shenzhen and to supervise the latter’s manufacturing operations. Marcon has been dormant since April 2003 and was sold to a third party in October 2003. Richtex Services Limited (“Richtex”), a Hong Kong limited liability company, was organized in November 1991 to serve as Marcon’s local agent and to discharge Marcon’s duties to supervise the manufacturing operations of Jetcrown Shenzhen. Richtex was deregistered from the Companies Registry in March 2004. JIL has been dormant since January 2004. Jetcrown Shenzhen has been dormant since January 2007. Since then, the Company’s plastic manufacturing operations in China have been conducted primarily by Jetcrown Dongguan.

     In October 1992, the Company purchased a controlling interest of the outstanding stock of Kwanasia Electronics Company Limited, a Hong Kong limited liability company (“Kwanasia”) and an independent contract manufacturer of electronic products, components and subassemblies, from two former shareholders. In December 1994, the Company increased its interest in Kwanasia to 51% of the outstanding Kwanasia shares by purchasing the requisite stock from Mr. S. K. Lee and Mr. M. C. Tam, Kwanasia’s then remaining two shareholders. The total price paid by the Company in 1994 for its majority interest in Kwanasia’s shares was approximately $517,000, which was paid in cash.

     Kwanasia originally conducted the Company’s contract electronic manufacturing operations through a joint venture enterprise (organized as a limited liability China company) called Shenzhen Kwanam Electronics, Co., Ltd. (“Shenzhen Kwanam”). Shenzhen Kwanam was initially established as a 70%-30% joint venture company pursuant to a Joint Venture Agreement between Kwanasia and Commercial Trading Corporation (“CTC”), an independent Chinese party. However, the parties to the Joint Venture Agreement subsequently elected to modify such arrangement. Such modification took various forms but in each case essentially provided that Kwanasia and its successor (through the subsidiaries which held the joint venture interest) would have in substance a 100% economic interest in the joint venture enterprise, subject to a RMB60,000 (approximately $7,200 at May 30, 1996) annual payment by it to CTC. In May 1996, Kwanasia and CTC agreed that Kwanasia would purchase CTC’s 30% interest in Shenzhen Kwanam (the “Buy-out Agreement”) for RMB180,000 (approximately $22,000 at May 30, 1996, the day the purchase price was paid). This transaction was completed during the year ended March 31, 1998 and resulted in Shenzhen Kwanam becoming a wholly owned subsidiary. Following reorganization in electronic operations and its move into a new manufacturing plant in Dongguan, China, the manufacturing operations of Shenzhen Kwanam were switched to another wholly owned subsidiary, Dongguan Kwan Hong Electronics Co. Ltd. (“Kwan Hong”) commencing April 1, 1999. Kwan Hong was initially established as an 85%-15% joint venture company pursuant to a Joint Venture Agreement dated January 31, 1997 between Kwanasia and Dongguan Cheung On Lang Wang Electronics Development Company (“Lang Wang”), an independent Chinese party. Pursuant to a subsequent supplemental agreement signed on February 27, 1997 between Kwanasia and Lang Wang, both parties agreed that Kwanasia would have in substance a 100% economic interest in the joint venture enterprise with Lang Wang guaranteed an annual rental income for the buy out. In March 2004, Kwanasia’s 85% interest in Kwan Hong was transferred to Integrated International Limited (see discussion of Integrated below) and in May 2004, Lang Wang’s 15% interest in Kwan Hong was also transferred to Hong Xin Electronics Company Limited (“Hong Xin”), a new independent Chinese party. The registrations of Integrated and Hong Xin with the Chinese Government were approved in April and July 2004, respectively. In a supplemental agreement signed on July 1, 2004, both parties agreed that Intergrated’s wholly-owned subsidiary would have in substance a 100% economic interest in the joint venture enterprise with Hong Xin guaranteed an annual rental income for the buy out.

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

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

[Organizational structure on next page]

Capital Expenditures

     Principal capital expenditures and divestitures made by Deswell during the three years in the period ended March 31, 2007 include the following:

		2005				2006				2007
Purchase of property, plant and equipment		$	17,003,000			$	6,940,000			$	7,812,000
Proceeds from the sale of property, plant and equipment			36,000				50,000				3,232,000

     Principal capital expenditures made and currently in progress relate to improvements we are constructing and have constructed on the land we purchased in Dongguan, China to build a new factory. The construction of our new Dongguan factory and dormitories is planned to occur in three to four phases. The pace of construction depends on our financial situation and future operating results.

     Through March 31, 2007, Deswell spent an aggregate of approximately $8.0 million on the first phase of construction of its new plastic injection molding plant. The facility comprises approximately 466,000 square feet of factory space, an approximately 91,000 square foot amenity center and approximately 116,000 square feet of dormitory space. Construction began in October 2001 and was completed in March 2003 with the interior build-out finished in June 2003. After installation of machinery and final touch up, Phase I of the new factory became operational at the end of November 2003. During the same period, approximately $19.9 million were used to expand the Company’s injection molding and tool-making capacity through the purchase of additional injection molding and tooling machinery and $7.4 million were used to acquire and install furniture and fixtures for operations.

     Following completion of space built through Phase I, we spent an aggregate of approximately $7.3 million for the second phase of construction, which comprises two additional factory building units covering approximately 227,000 square feet and three additional dormitory units of approximately 216,000 square feet. During the same period, we spent approximately $4.7 million to expand our injection molding and tool-making capacity through the purchase of additional injection molding and tooling machinery and spent approximately $2.1 million to acquire and install furniture and fixtures for operations.

     Phase III of construction, with a planned investment of $10 million, of which we spent an aggregate of $6.9 million through March 31, 2007, will consist of an estimated 133,000 square foot office building, an estimated 377,000 square feet of additional factory space and one additional dormitory unit of approximately 120,000 square feet. During the same period, we spent approximately $1.6 million to acquire and install furniture and fixtures for operation.

     Phase IV of construction, to consist of planned additional two dormitory units and two other buildings, is planned for the long-term, is pending for construction to begin , as resources become available and further capacity is needed.

     In July 2003, Deswell’s electronic & metallic subsidiary completed the $4.1 million acquisition of approximately 240,000 square feet of land and approximately 400,000 square feet of factory buildings and accommodations in Cheung On, Dongguan. These premises were previously leased from a local government unit for the Company’s electronics and metallic operations.

     All of the foregoing capital expenditures were financed principally from internally generated funds and our current plan is to continue to use internally generated funds principally to finance future capital expenditures. However, we may choose to obtain debt or equity financing if we believe it appropriate to accelerate the phases of construction of our facilities.

Business Overview

     Introduction to Deswell

     We are an independent manufacturer of injection-molded plastic parts and components, electronic products and subassemblies and metallic molds and accessory parts for original equipment manufacturers, or “OEMs” and contract manufacturers. We conduct all of our manufacturing activities at separate plastics, electronics and metallic operation factories located in the People’s Republic of China. Beginning in January 2005, we also began to engage in the business of distributing audio equipment in China.

     We produce a wide variety of plastic parts and components that are used in the manufacture of consumer and industrial products, using different plastic injection technologies, such as film injection, integrated injection and insert injection. The products include

	•		cases and key tops for personal organizers and remote controls;
	•		cases for flashlights, telephones, paging machines, projectors and alarm clocks;
	•		grips and rods for fishing tackle;
	•		toner cartridges and cases for photocopy and printer machines;
	•		parts for electrical products such as air-conditioning and ventilators;
	•		parts for audio equipment;
	•		double injection caps and baby products;
	•		laser key caps; and
	•		automobile components.

     Electronic products manufactured by the Company include

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

     Industry Overview

     Management believes that the injection molding and metal molds and parts manufacturing industries have each benefited in recent years from a trend among major users of injection molded and metal products to outsource an increasing portion of the parts requirements and to select a small number of suppliers or a sole supplier to provide those products. The Company is not aware of any empirical data defining the manufacturing industry in China, however, management believes that injection molding and metal manufacturing firms which are much smaller than the Company make up the largest segment of the industry in China. The Company’s experience indicates that such smaller firms are often unable to react quickly and responsively to the diverse demands of many customers and are not capable of furnishing the level of quality that high-end plastic and metal products require. Management believes that this inability on the part of these smaller manufacturers has created opportunities for the Company to increase sales by catering to the outsourcing requirements of OEMs and contract manufacturers that manufacture such high-end products.

     Similarly, as a result of the recognition by OEMs in the electronics industry of the rising costs of operating a manufacturing site and the need to add more sophisticated and expensive manufacturing processes and equipment, OEMs have turned increasingly to outside contract manufacturers. By doing so, OEMs are able to focus on research, product conception, design and development, marketing and distribution, and to rely on the production expertise of contract manufacturers. Other benefits to OEMs of using contract manufacturing include: access to manufacturers in regions with low labor and overhead costs, reduced time to market, reduced capital investment,

improved inventory management, improved purchasing power and improved product quality. In addition, the use of contract manufacturers has helped OEMs manage production in view of increasingly shorter product life cycles.

Operations

Plastic Injection Molding

     Plastic injection molding manufacturing accounted for 47.5%, 41.9% and 43.5 % of the Company’s total sales during the years ended March 31, 2005, 2006 and 2007, respectively. At March 31, 2007, 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 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.

     The plastic injection-molding process begins when a customer provides the Company with specifications for a product or part, which specifications are often created in consultation with the Company’s technical staff. Next the Company designs and produces the mold, using great care in the design process and in the selection of materials to produce the mold in an effort to create a high quality appearance of the completed product by reducing or eliminating potential flaws such as the sinkage of materials and irregularities in the knit line of joints. The mold-making process ranges from 25 to 75 days , depending on the size and complexity of the mold. Mold making requires specialized machines and is capital intensive. At March 31, 2007, 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.

     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, the Company made on average about 50 to 100 different molds every month. Management believes that the Company’s skills and expertise in mold-making, coupled with having its facilities and operations in China, allow the Company to produce molds at costs substantially less than molds of comparable quality made in Japan, Korea and Taiwan.

     Plastic Injection.

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

in place during the injection molding process). At March 31, 2007, the Company had 397 injection molding machines, ranging from 50 to 1,600 tons of clamping force, with most machines in the range of from 88 to 268 tons. Each of the Company’s machines is capable of servicing a variety of applications and product configurations and the Company has machines, which permit the Company to fabricate plastic parts as small as a button and as large as a 3 ft. x 2 ft. case for a copy machine.

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

     Finishing

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

Electronic Products and Assemblies

     In an aggregate of approximately 223,000 square feet of factory space at March 31, 2007 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 and 2007, manufacturing of electronic products accounted for approximately 48.1%, 54.5% and 53.4%, 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.

Metal Parts Manufacturing

     In an aggregate of approximately 111,000 square feet of factory space at March 31, 2007 located at facilities in Dongguan, China in the same complex and next to the Company’s electronic products assembly facilities, Deswell’s metal forming division manufactures metallic molds and accessory parts for use in audio equipment, routers, payphones, multimedia stations and ATMs. The Company’s metal molds and metal parts (products) manufacturing accounted for approximately 4.4%, 2.1% and 1.9% of Deswell’s total sales during the years ended March 31, 2005, 2006 and 2007, 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 and 2007.

     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
Average cost of ABS as a percentage of the total cost of		2005				2006				2007
Plastic products sold			58	%			53	%			51	%
Goods sold			24	%			21	%			20	%

     Because plastic resins are commodity products, the Company selects its suppliers primarily based on price. The Company has no long-term supply agreements for plastic resins. The Company currently obtains its plastic

resins from suppliers in Hong Kong, Japan and Taiwan and normally maintains a three to four month inventory supply.

     The Company used in excess of 13,406,000 pounds of plastic resins during the year ended March 31, 2007. Management believes that the Company’s large volume purchases of plastic resin have generally resulted in lower unit raw material costs and generally has enabled the Company to obtain adequate shipments of raw materials. While the Company is not generally bound by fixed price contracts with its customers, the Company has found that increases in resin prices can be difficult to pass on to its customers and, as a consequence, a significant increase in resin prices could have, and in the past has had, a material adverse effect on the Company’s operations.

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

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

     Component Parts and Supplies

     The Company purchases over 500 different component parts from more than 450 suppliers and is not dependent upon any single supplier for any essential component. The Company purchases from suppliers in Japan, Taiwan, Korea, Hong Kong and elsewhere. At various times there have been shortages of parts in the electronics industry, and certain components, including PCBs and semiconductors, have been subject to limited allocations. Although shortages of parts and allocations have not had a material adverse effect on the Company’s results of operations, there can be no assurance that any future shortages or allocations would not have such an effect.

     Raw Metal

     The primary materials used by the Company in metal molds and parts manufacturing are various metals, but purchases of raw metal were immaterial to the Company’s total operations during the years ended March 31, 2005, 2006 and 2007. Typically the Company buys metals from a variety of suppliers in Hong Kong and China and has no long-term contracts with metal suppliers.

Transportation

     Transportation of components and finished products to customers in Shenzhen and to and from Hong Kong and Shenzhen and Dongguan is by truck. Generally, the Company sells its products F.O.B. China or F.O.B. Hong Kong. To date, the Company has not been materially affected by any transportation problems and has found that the transition of Hong Kong to Chinese control in July 1997 has not had an adverse impact on the Company’s ability to transport goods to and from Hong Kong and China.

Customers and Marketing

     The Company’s customers are OEMs and contract manufacturers. The Company sells its products in the United States, Asia (Hong Kong, Japan and China) and Europe (Germany, United Kingdom, France and Italy). Net sales to customers by geographic area are determined by reference to shipping destinations as directed by the Company’s customers. For example, if the products are delivered to the customer in Hong Kong, the sales are recorded as generated in Hong Kong; if the customer directs the Company to ship its products to Europe, the sales are recorded as sold to Europe. See Note 17 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 and 2007. 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 and 2007:

		Year ended March 31,
Geographic Areas		2005				2006				2007
United States			40.5	%			49.0	%			42.4	%
China			44.8				37.5				39.2
Europe			10.9				7.0				11.2
Hong Kong			0.8				3.0				3.4
Others			3.0				3.5				3.8
Total			100.0	%			100.0	%			100.0	%

     The Company markets its products and services to existing customers through direct contact with the Company’s management and direct sales personnel. The Company’s sales personnel attend trade shows and the Company advertises in trade publications such as Modern Plastics International and Injection Molding. Collecting information from trade-show, as well as websites, Deswell’s marketing staffs contacts existing and potential customers directly by telephone, mail, fax, e-mail via the Internet and in person, stressing Deswell’s capability as a complete solution provider for plastic injection mold design, tooling and molding as well as an electronics manufacturing services, or EMS, provider of advanced technology manufacturing processes and flexible logistic services.

Major Customers

     The table below sets forth each of the Company’s customers which accounted for 10% or more of net sales during the year ended March 31, 2007 the products purchased and the percentage of total Company net sales accounted for by such customers during the years ended March 31, 2005, 2006 and 2007.

				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

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

     The Company’s sales transactions with all of its customers are based on purchase orders received by the Company from time to time. Except for these purchase orders, the Company has no written agreements with its customers. Sales of plastic parts, electronic products and metallic products are primarily made on credit terms, with payment in United States dollars or Hong Kong dollars expected within 30 to 90 days of shipment. In certain cases, primarily new customers of electronic products, sales are supported by letters of credit and are payable in United States dollars. To date, the Company has not experienced any significant difficulty in collecting accounts receivable on credit sales. Management communicates regularly with credit sale customers and closely monitors the status of payment and in this way believes it has kept the default rate low. Additionally, plastic parts deliveries are made in several installments over a lengthy period of time, which permits the Company to withhold delivery in the event of any delinquency in payment for past shipments. While the Company has not experienced any difficulty in being paid by its major customers, there can be no assurance that the Company’s favorable collection experience will continue in every case or at all. The Company could be adversely affected if a major customer were unable to pay for the Company’s products or services.

Competition

     Management believes that the plastic injection molding, contract electronic manufacturing and metal molds and accessories industries are each highly fragmented, although it is not aware of any empirical data defining the

business segments in China. Plastic injection molding and metal molds and accessories manufacturing are characterized by a large number of relatively small operators and divisions of larger companies and contract electronic manufacturing by numerous independent manufacturers whose capabilities are evaluated by customers against each other and against the merits of in-house production. Competition in each industry is intense and many competitors in each industry are larger and have greater financial and other resources than the Company.

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

Patents, Licenses and Trademarks

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

Seasonality

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

Property, Plants and Equipment

     Macao

     The Company leases Units 17B and 17E, Edificio Comercial Rodrigues, 599 Avenida da Praia Grande, Macao from an unaffiliated party for a term of two years to July 2007. 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.

     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

     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 the Company had closed this manufacturing facility and now holds it for sale.

     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, 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 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 square feet at March 31, 2007 in Shekou and Dongguan, respectively. The facilities are leased for periods of six months to one year, expiring November 2007. The aggregate monthly rental is approximately $1,600. 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 an aggregate of approximately 244,000 square feet of land and approximately 420,000 square feet of buildings, including six blocks of dormitory buildings, a canteen, a factory building, a car park and a guard room, at Cheung On, Dongguan, China, which was previously named Kwan Hong Building. The land use period is for 50 years from February 1, 2003 to January 31, 2053. The Company paid approximately $4,186,000 to acquire this property and uses the facilities for its electronic products manufacturing operations.

     At March 31, 2007, the Company leased approximately 69,400 square feet of manufacturing space in Kwanta Building, Cheung On, Dongguan, China for its contract metal manufacturing operations. These premises are

leased from third party expired in May 2007 and is in the process of being renewed. The aggregate monthly rental is approximately $8,600.

     In addition, the Company leases approximately 36,500 square feet of space at various locations near its contract electronics and metal manufacturing factories in Dongguan, Shenzhen, which are used as staff quarters. The facilities are leased from third parties for periods of one to two years and expire from April 2007 to November 2008. The aggregate monthly rental is approximately $8,600.

     Management believes that Deswell will be able to renew each of the leases described above as it expires for periods comparable to the current term or find alternative space as needed.

     The Company believes that its existing offices and manufacturing space, and manufacturing space in close proximity to its existing facilities, which management believes will be available as needed for limited expansion, will be adequate for the operation of its business for at least the next two years.

ITEM 4A. UNRESOLVED STAFF COMMENTS

     We do not have any unresolved comments from the staff of the Securities and Exchange Commission regarding our periodic reports under the Exchange Act.

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

     Except for statements of historical facts, this section contains forward-looking statements involving risks and uncertainties. You can identify these statements by forward looking words including “expect”, “anticipate”, “believe” “seek”, “estimate”. Forward looking statements are not guarantees of Deswell’s future performance or results and the Company’s actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth under the section of this Report entitled Item 3. Key Information – “Risk Factors”. This section should be read in conjunction with the Company’s Consolidated Financial Statements included under Item 18 of this Report.

Operating Results

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

General

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

     The Company’s plastics operations are the mainstay of its business and have historically accounted for the majority of its sales. The Company carries out all of its manufacturing operations in Southern China, where it is able to take advantage of the lower overhead costs and inexpensive labor rates as compared to Hong Kong. At the same time, the proximity of the Company’s factories in Southern China to Hong Kong permits the Company to manage easily its manufacturing operations from Hong Kong, facilitates transportation of its products through Hong Kong and provides the Company’s plastic manufacturing operations with access to electricity from Hong Kong and to nearby water, both of which resources are needed in abundance to manufacture plastic parts and are often inadequate elsewhere in China.

     The Company’s earnings have benefited from favorable overall effective income tax rates of 3.2%, -0.27% and 8.7 % for the years ended March 31, 2005, 2006 and 2007, respectively. The Company is subject to Hong Kong income tax on its 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.”

     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, will 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.”

     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.

		Year ended March 31, 2005												Year ended March 31, 2006												Year ended March 31, 2007
		Plastic												Plastic												Plastic
		Injection-				Electronic								Injection-				Electronic								Injection-				Electronic
		Molding				& Metallic								Molding				& Metallic								Molding				& Metallic
		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	%
Cost of sales			65.2				80.6				73.3				72.5				81.9				77.9				68.1				84.1				77.1
Gross profit			34.8				19.4				26.7				27.5				18.1				22.1				31.9				15.9				22.9
Selling, general and administrative expenses			16.6				8.9				12.5				17.7				9.7				13.1				17.4				11.2				13.9
Other income, net			—				(0.1	)			(0.1	)			(1.4	)			(0.3	)			(0.7	)			2.5				(0.1	)			1.0
Operating income			18.2				10.3				14.1				8.5				8.1				8.3				17.0				4.6				10.0
Interest expense			—				—				—				—				—				—				—				—				—
Non-operating income, net			0.2				0.5				0.4				0.8				—				0.4				0.8				0.1				0.4
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 taxes			0.3				0.6				0.5				(0.6	)			0.4				(0.0	)			1.8				0.2				0.9
Income before minority interests			18.1				10.2				13.9				10.0				7.8				8.7				15.9				4.6				9.5
Minority interests			0.7				2.9				1.9				—				1.9				1.1				—				1.1				0.6
Net income			17.4	%			7.3	%			12.1	%			10.0	%			5.9	%			7.6	%			15.9	%			3.5	%			8.9	%

Year ended March 31, 2007 Compared to Year Ended March 31, 2006

     Net Sales – Deswell’s net sales for the year ended March 31, 2007 were $136,779,000, an increase of $21,503,000 or 18.7% as compared to year ended March 31, 2006. Sales to Line 6 Manufacturing (“Line 6”), Digidesign Inc. (“Digidesign”), VTech Telecommunications Limited (“VTech”), Peavey Electronics Coop. (“Peavey”), the Company’s four largest customers during the year ended March 31, 2007, represented approximately 51.5% 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. This represented increases of 23.1% and 15.4% respectively, as compared with the net sales from these segments in fiscal 2006.

     Revenue from our plastics segment during fiscal 2007 amounted to $59,737,000, including $150,000 of intersegment revenue, as compared to revenue in this segment during fiscal 2006 of $50,581,000, including $1,152,000 of intersegment revenue. The revenue increase in 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 offset the decrease in orders from existing customers of $9,943,000. Accordingly, the net increase resulted from a change in customer mix as compared with fiscal 2006.

     Revenue from our electronic and metallic segment during fiscal 2007 amounted to $83,280,000, including $2,969,000 of intersegment sales of electronic products as compared to revenue in this segment during fiscal 2006 of $70,851,000, including $1,926,000 of intersegment sales of electronic products. The revenue increase in our electronic and metallic segment was principally caused by an increase in orders for electronic products from both existing and new customers of $11,262,000 and $2,185,000, respectively, offsetting the decrease in orders from existing customers of $2,462,000 in electronic sales, $638,000 in metallic sales 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 of professional audio equipment products.

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

     Gross profit in the plastics segment increased by $5,647,000, to $18,937,000 or 31.9% of net sales, for the year ended March 31, 2007 compared to $13,290,000 or 27.5% 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 as 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. 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% increase in labor rates and an average of 3.8% appreciation in Chinese renminbi currency during fiscal year 2007 where most of our direct overheads and increased local material sourcing are denominated, as compared with fiscal 2006.

     Selling, General and Administrative Expenses – SG&A expenses for the year ended March 31, 2007 were $18,957,000, amounting to 13.9% of total net sales, as compared to $15,052,000 or 13.1% of total net sales for the year ended March 31, 2006. The SG&A expenses in the plastic segment increased by $1,795,000 or 21.1% to $10,317,000 or 17.4% of net sales, for the year ended March 31, 2007 compared to $8,522,000 or 12.7% of net sales, for the prior year. The increase was primarily related to a stock based compensation charges 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 as compared with last year.

     The SG&A expenses in the electronic and metallic segment increased by $2,110,000 or 32.3% to $8,640,000 or 11.2% of net sales, for the year ended March 31, 2007 compared to $6,530,000 or 9.7% of net sales for fiscal 2006. The increase was primarily related to the increase in salary expenses and staff welfare expenses of $1,265,000 and $61,000; as a result of both increase in staff rate and headcounts in various departments. Moreover, there were an increase 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 as compared with last year.

     Other operating income - Other operating income was $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.

     On a segment basis, other operating income attributable to the plastic segment increased $2,140,000 to $1,484,000 in the year ended March 31, 2007, as compared to other expenses of $656,000 for the year ended March 31, 2006. The increase was primarily attributable to an exchange transaction adjustment of $1,166,000 of a subsidiary having non-United States dollar functional currencies and a decrease in doubtful accounts receivable provision of $766,000, of which $970,000 was related to financial issues of a telecommunication customer due stemming from a failed European product launch 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.

     Other operating income attributable to the electronic & metallic segment increased $60,000, to operating expenses of $108,000 in the year ended March 31, 2007, as compared to other expenses of $168,000 for the year ended March 31, 2006. This increase was primarily due to the increase in gain on disposal of fixed assets of $128,000 and the decrease in bad debt write off of $169,000 offsetting the increase in allowance for doubtful receivables of $206,000 during the year ended March 31, 2007.

     Operating Income - Operating income was $13,692,000 for the year ended March 31, 2007, an increase of $4,141,000, or 43.3% as compared with fiscal 2006.

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

     The operating income of electronics & metallic segment decreased $1,850,000 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. The decrease in operating income was attributable to the increase in SG&A expenses offsetting the increase in gross profit and decrease in other operating expenses as described above.

     Income Taxes – Income tax for the year ended March 31, 2007 comprised of income tax expenses of $945,000 and realization of deferred income tax assets of $294,000, compared with income tax expenses of $267,000 and a deferred income tax credit of $294,000 in fiscal 2006.

     On a segment basis, the income tax of the plastic segment comprised of income tax expenses of $472,000, realization of deferred income tax of $294,000 and a deferred tax provision of $321,000 for the year ended March 31, 2007, as compared with income tax expenses of $8,000 and deferred income tax credit of $294,000 in fiscal 2006. The increase was primarily related to the realization of deferred income tax assets of $294,000; an under-provision of $253,000 for taxable year 2004 and 2005 and a current year provision of $197,000 as a result of the reassessment of the first taxable year from 2004 to 2002 by the PRC Tax Bureau for a plastic manufacturing subsidiary during the year and a deferred income tax provided of $321,000. The income tax expenses for the electronic & metallic segment decreased $107,000, to $152,000 for the 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 a 24% minority interest in Integrated International Limited, the holding company holding the capital stock of Deswell’s electronic & 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 Company liquidated its marketing subsidiary in which it held a 49% minority interest. The decrease in the dollar amount of minority interest to $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.

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

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

     Net income for the electronic & metallic segment decreased by $1,271,000 or 32.0% to $2,701,000 for the year ended March 31, 2007 compared to $3,972,000 for fiscal 2006. 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 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 for the twelve quarters in the three-year period ended March 31, 2007 (in thousands):

		Year ended March 31,
		2005																2006																2007
		Q1				Q2				Q3				Q4				Q1				Q2				Q3				Q4				Q1				Q2				Q3				Q4
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
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
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

     The first calendar quarter (the fourth quarter of the fiscal year) is typically the Company’s slowest sales period because, as is customary in China, the Company’s manufacturing facilities in China are closed for two weeks for the Chinese New Year holidays. The Company does not experience any other significant seasonal fluctuations.

     Impact of Inflation

     The Company believes that inflation has not had a material effect on its business. Although the Company has found it difficult to increase the prices of its products in order to keep pace with inflation, particularly in its plastics operations, the Company believes that the location of its manufacturing operations in Southern China has resulted in a lower cost base which still provides it with a competitive advantage. Accordingly, the Company is reliant upon increasing its transaction volume in order to compensate for the effects of inflation.

     Exchange Rates

     The Company sells most of its products and pays for most components in either Hong Kong dollars or U.S. dollars. 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 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. The exchange rates of RMB to the U.S. dollars have further appreciated during the period since August 2005 to 1:7.61 as at June 30, 2007. As a consequence, and in addition to increases in plastic resin and labor costs, in the year ended March 31, 2006 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 the basket 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.

     We did not hedge our currency risk during the years ended March 31, 2005, 2006 and 2007 and at March 31, 2007 , 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, net cash generated from operations totaled $15,807,000, including net income of $12,167,000 and depreciation and amortization of $5,274,000. Accounts receivable increased by $2,745,000, over levels at March 31, 2006, primarily as a result of the increase in sales offsetting the increase in provision of doubtful account receivable of $260,000. Inventories increased by $7,650,000, over levels at March 31, 2006, primarily resulting from the increase in sale 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. Accounts payable increased by $4,979,000 over levels at March 31, 2006, primarily because of the increase in materials purchases. For the year ended March 31, 2006, net cash generated from operations totaled $12,322,000, including net income of $8,779,000 and depreciation and amortization of $5,299,000.

     Net cash used in investing activities amounted to $4,580,000 and $6,890,000 for the years ended March 31, 2007 and 2006, respectively. Capital expenditures during these periods totaled $7,812,000 and $6,940,000, respectively. There were no acquisitions of marketable securities during either of these periods. Our capital expenditures were primarily related to the construction of our new Dongguan manufacturing plant and our acquisition of plant and machinery for our production facilities in China.

     Net cash used in financing activities for the years ended March 31, 2007 and 2006 were $10,792,000 and $7,967,000, respectively. Net cash we used in financing activities during the year ended March 31, 2007 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. Net cash we used in financing activities during the year ended March 31, 2006 was primarily to fund our dividend payments to shareholders of $7,311,000, dividend payments to minority shareholders of subsidiaries of $1,229,000, increase in restricted cash of $391,000 netting off the proceeds of $352,000 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% to 7.75% during the year ended March 31, 2007.

     At March 31, 2007, the Company had cash and cash equivalents of $24,549,000. 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. The Company’s working capital requirements are expected to increase in line with the growth in the Company’s business.

     We 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 March 31, 2007. We expect that internally generated funds will be sufficient to satisfy its cash needs for at least the next 12 months. However, we may choose to obtain debt or equity financing if we believe it appropriate to accelerate the phase IV construction of its Dongguan plastic plant.

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

		Payments due by period
										(In thousands)
										Period from				Period from				Period
						Year ending				April 1, 2008				April 1, 2010				after
						March 31,				to March 31,				to March 31,				March 31,
Contractual obligations		Total				2008				2010				2012				2012
Long-term bank borrowing		$	—			$	—			$	—			$	—			$	—
Capital (finance) lease obligations			—				—				—				—				—
Operating lease payments			131				112				19				—				—
Capital expenditures			1,100				1,088				12				—				—
Purchase obligations			14,595				14,593				2				—				—
Other long-term liabilities			—				—				—				—				—
Total		$	15,826			$	15,793			$	33			$	—			$	—

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 and Remitted 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 seller 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 of EITF 06-3 should be applied 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 in Income Taxes (“FIN 48”). FIN 48 clarifies the accounting for uncertainty 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.

ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

Directors and Senior Management

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

Name		Age				Position(s) with Company
Lau Pui Hon (Richard Lau)			62			Chairman of the Board of Directors
Franki S. F. Tse			43			Chief Executive Officer
Li Chin Pang (C. P. 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)			52			Executive Director of Engineering for Plastic Operations and Member of the Board of Directors
Hung-Hum Leung			61			Member of Board of Directors and Audit Committees
Allen Yau-Nam Cham			60			Member of Board of Directors and Audit Committees
Wing-Ki Hui			61			Member of Board of Directors and Audit Committees
Eliza Y. P. Pang			45			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 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. 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. 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 director of the Company and member of the Audit Committee since December 1999. Mr. Leung has over 25 years of experience in the manufacture of electronic products. Mr. Leung was the founder of Sharp Brave Holdings Ltd., a Hong Kong public company listed on the Hong Kong Stock Exchange, and from 1991 to 1995 served as the Chairman of Sharp Brave Holdings Ltd. Since 1995, Mr. Leung has been an independent consultant to the electronics industry. He received his Bachelor of Science degree in Physics from the National Taiwan University in 1971.

     Allen Yau-Nam Cham. Mr. Cham has been a director of the Company and member of the Audit Committee since August 2003. Mr. Cham has been the Managing Director and shareholder of Kwong Fat Hong (Securities) Limited since 1995. He has over 20 years of experience in the securities industry. He is a Certified General Accountant in Canada. He obtained his Bachelor of Science degree from St. Mary’s University, Halifax,

Canada, Bachelor of Engineering (Electrical) degree from Nova Scotia Technical College, Halifax, Canada and Master of Business Administration degree from University of British Columbia, Canada.

     Wing-Ki Hui. Mr. Hui has been a director of the Company and member of the Audit Committee since October 2004. Since 1995 he has been the Operation Director of Tomorrow International Holdings Limited, a company listed on the Hong Kong Stock Exchange engaged in manufacturing of consumer electronics and printed circuit boards. Prior to serving in this capacity, Mr. Hui was Executive Director of Sharp Brave International Holdings Limited from 1991 to 1995 and Director of Sharp Brave Electronics Co., Ltd. from 1984 to 1995. Mr. Hui possesses over 20 years of experience in the electronic manufacturing industry, and is a graduate of South East Electronic College in Hong Kong.

     Eliza Y. P. Pang. Ms. Pang served as the Company’s Financial Controller from January 1995 until March 31, 2006 and was appointed as Deswell’s Chief Financial Officer effective on April 1, 2006. Ms. Pang is a registered fellow member of The Hong Kong Institute of Certified Public Accountants. Ms. Pang has worked at KPMG and Ernst & Young in Hong Kong. Ms. Pang received her Professional Diploma in Accountancy and her MBA degree from The Hong Kong Polytechnic University in 1985 and 1996, respectively.

     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.

     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 to all directors and executive officers as a group for services in all capacities was approximately $3,172,000. This excludes amounts paid by the Company or its subsidiaries as dividends to shareholders during the year ended March 31, 2007.

     Directors

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

     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.

     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,

each of whom is an independent director within the meaning of that term under the Nasdaq Stock Market Rules. Mr. Allen Yau-Nam Cham currently acts as the Chairman of the Audit Committee.

     Other Committees; Nasdaq Compliance

     In August 2005, Deswell determined to disband and no longer have either a compensation committee or a nominating committee as the law of the British Virgin Islands, Deswell’s place of organization, and Deswell’s Memorandum and Articles of Association do not require it to have such committees. Although such committees, consisting of independent directors as defined by the Nasdaq Marketplace Rules, are required of domestic companies having securities included 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; a majority of its Board of Directors are not “independent” directors within the definition of “independent director” in the Nasdaq Marketplace Rules and Deswell’s independent directors do not meet in executive session.

     Employees

     At March 31, 2007, the Company employed 6,351 persons on a full-time basis, of which 11 were located in Macao and 6,340 located in and travel to and from China. Of the Company’s employees 3,980 and 2,371were engaged in plastic injection molding manufacturing and contract electronic manufacturing, metal molds and parts manufacturing, respectively, at March 31, 2007. The Company has not experienced significant labor stoppages. Management believes that relations with the Company’s employees are satisfactory.

Share Ownership

     Share Ownership of Directors and Senior Management

     For information concerning the beneficial ownership of the Company’s common shares by Directors and Senior Management and major shareholders, see Item 7 of this Report.

     Employee Stock Option Plans

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

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

     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 Meeting held on September 19, 2005.

     The Company’s option plans are administered by the Board of Directors, which determines the terms of options granted, including the exercise price, the number of shares subject to the option and the option’s exercisability. The exercise price of all options granted under the option plans must be at least equal to the fair market value of such shares on the date of grant. The maximum term of options granted under the option plans is 10 years.

     At June 30, 2007, options to purchase an aggregate of 4,086,500 shares had been granted under the option plans, options to purchase an aggregate of 924,000 common shares were outstanding and no options to purchase common shares were available for future grant under the option plans.

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 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, the beneficial ownership of the Company’s Common Shares by each person known by the Company to beneficially own 5% or more of the Common Shares of the Company and by each of the Directors and Senior Management of the Company who beneficially own in excess of one percent of the Company’s Common Shares.

		Number of 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			*				*

Change in the Percentage Ownership Held by Major Shareholders

     The following table reflects the percentage ownership of Deswell’s common shares by its major shareholders during the past three years:

		Percentage Ownership (1) at
		June 28,
		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	%
Leesha Holdings Ltd.			23.2	%			23.1	%			22.8	%
Wellington Management Company, LLP			8.4	%			9.6	%			10.6	%
Royce & Associates, Inc.			9.3	%			10.4	%			8.1	%
Micropower Enterprises Limited			7.7	%			7.7	%			7.6	%
FMR Corp./ Edward C. Johnson 3d/ Abigail P. Johnson			7.6	%			6.3	%			6.0	%

     All of the holders of the Company’s common shares (including Deswell’s major shareholders) have equal voting rights with respect to the common shares held. As of June 30, 2007, approximately 25 holders of record, who, management believes, held for more than 3,000 beneficial owners, held Deswell’s common shares. According to information supplied to the Company by its transfer agent, at June 30, 2007, 19 holders of record with addresses in the United States held approximately 10.1 million of our outstanding common shares.

Related Party Transactions

     Deswell owns 76 percent of its subsidiary, Integrated, which, through subsidiaries, conducts Deswell’s electronic manufacturing operations. The balance of Integrated is owned equally by S. K. Lee, our Director of Administration and Marketing for Electronic Operations, and M. C. Tam, our Director of Engineering and Manufacturing for Electronic Operations. During the years ended March 31, 2006 and 2007, Integrated made distributions to its shareholders, including Deswell, aggregating approximately $5,122,000 and $2,425,000 respectively, with Messrs. Tam and Lee’s share of these distributions (which were divided between them equally) amounting to $1,229,000 and 582,000 respectively.

     Since Deswell completed its initial public offering in the United States, it has been Deswell’s policy that all transactions between Deswell and any interested director or executive officer be approved by a majority of the disinterested directors and be on terms that are no more favorable than would be available from an independent third party.

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.

     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 9. THE OFFER AND LISTING

     The Company’s shares are traded exclusively on the Nasdaq Global Market (before July 4, 2006, known as the Nasdaq National Market) under the symbol “DSWL”.

     The following table sets forth the high and low sale prices per share as reported by The Nasdaq Global Market (the Nasdaq National Market before July 4, 2006) for each of the years in the five-year period ended March 31, 2007 (adjusted for per share prices before April 2005, for the Company’s three-for-two stock splits effected in March 2005):

Year Ended March 31,		High				Low
2007		$	12.50			$	8.10
2006			16.48				9.00
2005			18.167				12.867
2004			20.40				10.43
2003			27.23				7.33

     The following table sets forth the high and low sale prices per share of Deswell’s shares as reported by the Nasdaq Global Market (the Nasdaq National Market before July 4, 2006) during each of the quarters in the two-year period ended March 31, 2007).

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

     The following table sets forth the high and low sale prices per share of Deswell shares as reported by The Nasdaq Global Market during each of the six months ended June 30, 2007.

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

ITEM 10. ADDITIONAL INFORMATION

Share Capital

     Not applicable.

Memorandum and Articles of Association

     Objects and Purposes

     Our objects and purposes are described in Clause 4 of our Memorandum of Association and are generally to engage in any act or activity that is not prohibited under the laws of the British Virgin Islands.

     Directors

     British Virgin Islands law and our Articles of Association provide that no agreement or transaction between Deswell and one or more of its directors or any entity in which any director has a financial interest or to whom any director is related (including as a director of that other entity) is void or voidable for this reason only or by reason only that the director is present at the meeting of directors, or at the meeting of the committee of directors, that approves the agreement or transaction or that the vote or consent of the director is counted for the purpose if the material facts of the interest of each director in the agreement or transaction and his or her interest in or relationship to any other party to the agreement or transaction are disclosed in good faith or are known by the other directors and a majority of the Company’s directors (at least one whom is an “Independent Director”) approve such transaction. Alternatively, the interest in the transaction may be disclosed or known to or ratified by the shareholders. (British Virgin Islands law does not use the term “shareholder” or “stockholder” but rather refers to holders of shares of a company, like Deswell, organized under the International Business Companies Act as “members.” In this Report, for the convenience of our U.S. holders, we use the term “shareholders” rather than members.) In addition, a director who has an interest in any particular business to be considered at a meeting of directors or shareholders may be counted for the purposes of determining whether the meeting is duly constituted. An “Independent Director” is defined in our Articles of Association as a director other than an officer or employee of Deswell or any of its subsidiaries, a person related to an officer or employee of Deswell or any of its subsidiaries, a person representing family or concentrated (more than 10%) holdings of Deswell’s outstanding voting shares or any other individual having a relationship which, in the opinion of the directors, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director.

     Our Articles of Association provide that the directors may by a resolution of directors, fix the emoluments of directors with respect to services to be rendered in any capacity to the Company.

     British Virgin Islands law and our Articles of Association provide that the management of the business and the control of Deswell shall be vested in the directors, who in addition to the powers and authorities expressly conferred by the Articles of Association, may also exercise all such powers, and do all such acts and things, as may be done by Deswell and are not by the Articles of Association or British Virgin Islands law expressly directed or required to be exercised or done by a meeting of shareholders. Our Articles of Association provide that the directors may by resolution exercise all the powers of Deswell to borrow money and to mortgage or charge its undertakings and property or any part thereof, to issue debentures, debenture stock and other securities whenever money is borrowed or as security for any debt, liability or obligation of Deswell or of any third party.

     British Virgin Islands law and our Memorandum of Association and Articles of Association do not contain an age limit requirement for our directors. Under our Articles of Association, no shares are required for director’s qualification.

     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 common shares were outstanding on June 30, 2007.

     Holders of our common shares are entitled to one vote for each whole share on all matters to be voted upon by shareholders, including the election of directors. Holders of our common shares do not have cumulative voting rights in the election of directors. All of our common shares are equal to each other with respect to liquidation and dividend rights. Holders of our common shares are entitled to receive dividends if and when declared by our board of directors out of funds legally available under British Virgin Islands law. In the event of our liquidation, all assets available for distribution to the holders of our common shares are distributable among them according to their

respective holdings. Holders of our common shares have no preemptive rights to purchase any additional, unissued common shares.

     Calling Annual General Meetings and Extraordinary General Meetings of Shareholders

     British Virgin Islands law does not require an international business company, such as Deswell, to have an annual meeting. Our Articles of Association do, however, require an annual meeting of shareholders for the election of directors and for such other business as may come before the meeting.

     Under British Virgin Islands law, unless otherwise provided by a company’s Memorandum of Association or Articles of Association, the directors may call meetings of shareholders at any time. Our Memorandum and Articles of Association do not provide otherwise. Under British Virgin Islands law, unless otherwise provided by a company’s Memorandum of Association or Articles of Association, directors are required to call meetings upon a written request from shareholders holding more than 50% of outstanding voting shares. Our Articles of Association provide that meetings of shareholders may be called only upon a written request from shareholders holding 10% or more of the outstanding voting shares.

     British Virgin Islands law and our Articles of Association state that the directors may fix the date that notice is given of a meeting of shareholders, whether extraordinary or annual, as the record date for determining those shares that are entitled to vote at the meeting.

     British Virgin Islands law and our Articles of Association provide that notice of all meetings of shareholders, stating the time, place and purposes thereof, shall be given not fewer than seven days before the date of the proposed meeting to those persons whose names appear as shareholders in our share register on the date of the notice and are entitled to vote at the meeting.

     Limitations on Share Ownership

     British Virgin Islands law and our Memorandum of Association and Articles of Association do not impose any limitations on the right of anyone to own, hold or exercising voting rights to our common shares.

     Potential Anti-Takeover Deterrence

     Neither our Articles of Association nor Memorandum of Association contain provisions that would have an effect of delaying, deferring or preventing a change in control of Deswell and that would operate only with respect to a merger, acquisition or corporate restructuring involving Deswell or any of its subsidiaries. However, pursuant to our Memorandum and Articles of Association and pursuant to the laws of the British Virgin Islands, our board of directors without shareholder approval may amend our Memorandum and Articles of Association (provided that a majority of our independent directors do not vote against the amendment). This includes amendments to increase or reduce our authorized capital stock. Our ability to amend our Memorandum and Articles of Association without shareholder approval could have the effect of delaying, deterring or preventing a change in control of Deswell, including a tender offer to purchase our common shares at a premium over the then current market price.

     Ownership Information

     Neither our Articles of Association nor Memorandum of Association provide that information about our shareholders, even those owning significant percentages of our shares, must be disclosed.

     Differences from United States Law

     The laws of the British Virgin Islands governing the provisions of our Articles of Association and Memorandum of Association discussed above are not significantly different than the laws governing similar provisions in the charter documents of Delaware companies, other than with respect to amending our Memorandum of Association without shareholder approval. Delaware law requires shareholders to approve any amendments to a corporation’s Certificate of Incorporation.

Material Contracts

     There were no material contracts, 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.

Taxation

     United States Federal Income Tax Consequences

     General

     This section is a general summary of the material U.S. federal income tax consequences of the ownership and disposition of our common shares as of the date of this Report. The summary applies to you only if you hold our common shares as a capital asset for tax purposes (that is, for investment purposes), and it does not purport to be a comprehensive description of all the tax considerations that may be relevant to the ownership of our common shares. The summary is based on current law. Changes in the law may alter your tax treatment of holding our common shares, possibly on a retroactive basis. There can be no assurance that the U.S. Internal Revenue Service (“IRS”) will not challenge the tax consequences described below, and we have not requested, nor will we request, a ruling from the IRS or an opinion of counsel with respect to the U.S. federal income tax consequences of acquiring, holding or disposing of our common shares. The discussion below does not cover tax consequences that depend upon your particular tax circumstances and it does not address any aspect of U.S. federal tax law other than U.S. federal income taxation. Specifically, it does not cover any state, local or foreign law, or the possible application of U.S. federal estate or gift tax. You are urged to consult your own tax advisors regarding the application of the U.S. federal income tax laws to your particular situation as well as any state, local, foreign and the U.S. federal estate and gift tax consequences of the ownership and disposition of the common shares. In addition, this summary does not take into account any special U.S. federal income tax rules that apply to a particular holder of our common shares, including, without limitation, the following:

	•		a dealer in securities or currencies;
	•		a trader in securities that elects to use a market-to-market method of accounting for your securities holdings;
	•		a financial institution;
	•		a life insurance company;
	•		a tax-exempt organization;
	•		a person that holds our common shares in a hedging transaction or as part of a straddle or a conversion transaction;
	•		a person whose functional currency for tax purposes is not the U.S. dollar;
	•		a person liable for alternative minimum tax;
	•		a person that owns, or is treated as owning, 10 percent or more of our common shares;
	•		certain former U.S. citizens and residents deemed to have expatriated to avoid U.S. taxation; or
	•		a person who receives our shares pursuant to the exercise of employee stock options or otherwise as compensation.

     Tax Consequences to U.S. Holders

     For purposes of the discussion below, you are a “U.S. Holder” if you are a beneficial owner of our common shares who or which is:

	•		an individual U.S. citizen or resident alien of the United States (as specifically defined for tax purposes);
	•		a corporation created or organized in or under the laws of the United States or any State or political subdivision thereof;

	•		an estate whose income is subject to U.S. federal income tax regardless of its source;
	•		a trust (x) if a U.S. court can exercise primary supervision over the trust’s administration and one or more U.S. persons are authorized to control all substantial decisions of the trust or (y) if it was in existence on August 20, 1996, was treated as a U.S. person prior to that date and has a valid election in effect under applicable treasury regulations to be treated as a U.S. person; or
	•		any other person or entity that would be subject to U.S. federal income tax on a net income basis in respect of our common shares.

     If a partnership holds our common shares, the tax treatment of a partner will generally depend upon the status of the partner and upon the activities of the partnership. If you are a partner of a partnership holding our common shares, you should consult your tax advisor.

     Distributions

     Subject to the “passive foreign investment company” (“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 or 2007; 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. 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 or Other Disposition of Our Common Shares,” below. Because we are not a U.S. corporation, no dividends-received deduction will be allowed to corporations with respect to dividends paid by us.

     Sale or Other Disposition of Our Shares

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

	•		you will recognize gain or loss equal to the difference (if any) between:
	•		the amount realized on such sale or other taxable disposition and
	•		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. source for U.S. foreign tax credit purposes; and
	•		your ability to deduct capital losses is subject to limitations.

     Passive Foreign Investment Company

     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 a PFIC for our fiscal year if either:

	•		75 percent 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 result in our 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 shares.

     Under this regime, any excess distribution and realized gain would be treated as ordinary income and would be subject to tax generally in the following manner:

	•		the excess distribution or gain would be allocated ratably to each day that you have held our common shares,
	•		the amount allocated to the taxable year in which you realize the excess distribution or gain would be taxed as ordinary income,
	•		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 to certain limitations, if you own common shares in a PFIC that are treated as marketable stock, you may make a mark-to-market election. If you make this election, for all taxable years during which you held common shares and we were a PFIC, you would not be subject to the PFIC rules described above. Instead, in general, you would include as ordinary income each year the excess, if any, of the fair market value of your shares at the end of the taxable year over the adjusted tax basis in your shares. You would also be allowed to take an ordinary loss in respect of the excess, if any, of the adjusted basis of your shares over their fair market value at the end of the taxable year, but only to the extent of the net amount of income previously included as a result of the mark-to-market election. Your basis in the shares would be adjusted to reflect any such income or loss amounts. Any gain realized upon disposition would be taxed as ordinary income. If we are or become a PFIC, we believe our shares would be treated as marketable stock for purposes of the mark-to-market election but we can give you no assurance that they in fact will be so treated.

     In lieu of making a mark-to-market election, you may make a qualifying electing fund election. In many situations, it would be desirable to make this election. However, even if your tax advisor determines that this election is beneficial to you, if we are or were to become a PFIC, we may not be able or willing to satisfy the record-keeping and other requirements that would enable you to make a qualified electing fund election.

     You are urged to consult your own tax advisor concerning the potential application of the PFIC rules to your ownership and disposition of our common shares, as well as a mark-to-market and other elections that may be available to you.

Tax Consequences to Non-U.S. Holders

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

     Distributions

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

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

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

     Sale or Other Disposition of Our 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, as described above. Effectively connected gains realized by a non-U.S. corporation may also, under certain circumstances, be subject to an additional “branch profits tax” at a rate of 30 percent or such lower rate as may be specified by an applicable income tax treaty.

     Backup Withholding and Information Reporting

     Payments (or other taxable distributions) in respect of our common shares that are made in the United States or by a U.S.-related financial intermediary will be subject to U.S. information reporting rules. In addition, such payments may be subject to U.S. federal backup withholding currently at a rate of 28 percent. You will not be subject to backup withholding provided that:

	•		you are a corporation or other exempt recipient, or
	•		you provide your correct U.S. federal taxpayer identification number and certify that no loss of exemption from backup withholding has occurred.

     If you are a Non-U.S. Holder, you generally are not subject to information reporting and backup withholding, but you may be required to provide a certification of your non-U.S. status in order to establish that you are exempt.

     Amounts withheld under the backup withholding rules may be credited against your U.S. federal income tax liability, and you may obtain a refund of any excess amounts withheld under the backup withholding rules by filing the appropriate claim for refund with the IRS.

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

British Virgin Islands Tax Consequences

     Under the International Business Companies Act of the British Virgin Islands as currently in effect, a holder of common equity, such as our common shares, who is not a resident of the British Virgin Islands is exempt from British Virgin Islands income tax on dividends paid with respect to the common equity and all holders of common equity are not liable to the British Virgin Islands for income tax on gains realized on sale or disposal of such shares: The British Virgin Islands does not impose a withholding tax on dividends paid by a company incorporated under the International Business Companies Act.

     There are no capital gains, gift or inheritance taxes levied by the British Virgin Islands on companies incorporated under the International Business Companies Act. In addition, our common shares are not subject to transfer taxes, stamp duties or similar charges. There is no income tax treaty or convention currently in effect between the United States and the British Virgin Islands.

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 holders of the Company’s common shares. British Virgin Islands’ law and the Company’s Memorandum and Articles of Association impose no limitations on the right of nonresident or foreign owners to hold the Company’s Securities or vote the Company’s common shares.

     China’s laws and regulations regulate dividend distribution and repatriation by the Company’s China subsidiaries. To date these controls have not had and are not expected to have a material impact on the Company’s financial results. To the extent that the Company may decide to pay cash dividends in the future, such dividends will be declared from the retained earnings, i.e., surplus, as determined by resolution of the directors of the Company. As the Company is a holding company, the amount of its retained earnings will be limited by the amount of dividends that can be declared by its subsidiaries. Dividends declared by subsidiaries will be based on the profits reported in their statutory accounts prepared in accordance with generally accepted accounting principles in the relevant countries, primarily 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.

     None of our Chinese subsidiaries had any restricted net assets at, nor restricted retained earnings for the years ended March 31, 2006 or 2007.

Foreign Currency Risk

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

     Cash on hand at March 31, 2007 of $24,549,000 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

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 as at March 31, 2007 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 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. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

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

Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of 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.

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

     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 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 for the year ended March 31, 2007, management discovered two opportunities to improve Deswell’s internal controls over financial reporting, one relating to our plastic manufacturing operations and the other to our electronic manufacturing. The opportunity in our plastic manufacturing operations involved the method used to determine the valuation 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 in our electronic manufacturing operations involved perceived inadequacies in our material resource planning system relating to the aging 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. 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.

ITEM 16. RESERVED

ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT

     Deswell’s Board of Directors has determined that at least one person serving on the Audit Committee is an “audit committee financial expert” as defined under Item 16A(b) of Form 20-F. Mr. Allen Yau-Nam Cham is an “audit committee financial expert.”

ITEM 16B. CODE OF ETHICS

     The Company has adopted a Code of Ethics for the Chief Executive Officer and Chief Financial Officer, which applies to the Company’s principal executive officer and to its principal financial and accounting officers. A copy of the Code of Ethics is attached as Exhibit 11.1 to this Annual Report on Form 20-F.

ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES

     Deswell’s principal accountants for the audit of its financial statements for each of the two years in the period ended March 31, 2007 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 and 2007.

		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

Audit Committee Pre-approval Policies and Procedures

     The Audit Committee’s policy is to pre-approve all audit and permissible non-audit related services provided by the independent auditors. These services may include audit services, audit-related services, tax services and other services. Pre-approval is generally provided for up to one year and any pre-approval is detailed as to the particular service or category of services. The management will periodically report to the Audit Committee regarding the extent of services provided and the fees for the services performed by the independent auditors in accordance with this pre-approval policy. The Audit Committee may also pre-approve particular services on a case-by-case basis.

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

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

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

     Not applicable.

PART III

ITEM 17. FINANCIAL STATEMENTS

     Not Applicable.

ITEM 18. FINANCIAL STATEMENTS

     The following financial statements are filed as part of this Report:

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

     All other schedules for which provisions are made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.

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 and 2007, 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. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

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

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

/s/ BDO McCabe Lo Limited
BDO McCabe Lo Limited

Hong Kong, June 28, 2007

DESWELL INDUSTRIES, INC.

CONSOLIDATED BALANCE SHEETS

(U.S. dollars in thousands)

		March 31,
		2006				2007
ASSETS
Current assets:
Cash and cash equivalents		$	25,369			$	24,549
Restricted cash (note 7)			649				—
Marketable securities (note 3)			164				107
Accounts receivable, less allowances for doubtful amounts of $970 and $1,230 at March 31, 2006 and 2007, respectively			18,318				21,063
Inventories (note 4)			21,845				29,495
Prepaid expenses and other current assets (note 5)			5,035				4,999
Income taxes receivable			—				130
Total current assets			71,380				80,343
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
Total assets		$	130,670			$	141,210
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	10,886			$	15,865
Dividend payable			2,089				—
Accrued payroll and employee benefits			1,415				2,746
Customer deposits			674				783
Other accrued liabilities (note 9)			1,018				1,506
Income taxes payable			184				450
Deferred income tax liability (note 10)			—				321
Total current liabilities			16,266				21,671
Commitments and contingencies (note 11)			—				—
Minority interests			7,636				7,884
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
Additional paid-in capital			6,970				7,601
Accumulated other comprehensive income			436				1,106
Retained earnings			58,108				60,555
Total shareholders’ equity			106,768				111,655
Total liabilities and shareholders’ equity		$	130,670			$	141,210

See accompanying notes to consolidated financial statements.

DESWELL INDUSTRIES, INC.

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

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

		Year ended March 31,
		2005				2006				2007
Net sales		$	125,590			$	115,276			$	136,779
Cost of sales			92,072				89,850				105,506
Gross profit			33,518				25,426				31,273
Selling, general and administrative expenses			15,759				15,052				18,957
Other income (expenses), net			(106	)			(823	)			1,376
Operating income (note 2)			17,653				9,551				13,692
Interest expense			(12	)			(6	)			—
Non-operating income, net			448				447				547
Income before income taxes and minority interests			18,089				9,992				14,239
Income taxes (note 10)			576				(27	)			1,239
Income before minority interests			17,513				10,019				13,000
Minority interests			2,330				1,240				833
Net income			15,183				8,779				12,167
Other comprehensive income
Foreign currency translation adjustment			—				436				670
Comprehensive income		$	15,183			$	9,215			$	12,837
Net income per share (note 2)
Basic:
Net income per share		$	1.04			$	0.59			$	0.81
Weighted average common shares outstanding (shares in thousands)			14,656				14,908				14,956
Diluted:
Net income per share		$	1.02			$	0.59			$	0.81
Weighted average common and potential common shares (shares in thousands)			14,933				14,936				15,048

See accompanying notes to consolidated financial statements.

DESWELL INDUSTRIES, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

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

		Common stock												Accumulated
										Additional				other
		Shares								paid-in				comprehensive				Retained				Shareholders’
		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
Stock-based compensation			—				—				820				—				—				820
Exercise of stock options			115,000				1,139				(189	)			—				—				950
Foreign currency translation adjustment			—				—				—				670				—				670
Net income			—				—				—				—				12,167				12,167
Dividends ($0.65 per share)			—				—				—				—				(9,720	)			(9,720	)
Balance at March 31, 2007			15,038,730				42,393				7,601				1,106				60,555				111,655