DESWELL INDUSTRIES INC

Deswell Industries, Inc. is an independent manufacturer of injection-molded plastic parts and components, electronic products and subassemblies, and metallic molds and accessory parts for original equipment manufacturers (OEMs) and contract manufacturers. The injection molding and parts manufacturing industries have benefited from a trend among major users to outsource an increasing portion of parts requirements and to select a small number of suppliers or a sole supplier. Management believes that injection molding firms much smaller than the Company make up the largest segment of the industry in China, and these smaller firms are often unable to react quickly to diverse demands or furnish the level of quality that high-end products require, creating opportunities for Deswell. In the electronics industry, OEMs have increasingly turned to outside contract manufacturers to focus on research, design, and marketing while relying on the production expertise of contract manufacturers, with benefits including access to low-cost regions, reduced time to market, reduced capital investment, improved inventory management, and improved product quality.

The Company competes with a number of different companies in the production of injection-molded plastic parts and components, electrical products and subassemblies, and metallic molds and accessories. Competitors include major global electronic manufacturing services (EMS) providers, other smaller EMS companies with a regional or product-specific focus, original design manufacturers, and current and prospective customers who can manufacture internally. The market segments are extremely competitive, with many competitors having achieved substantial market share and many having lower cost structures and greater manufacturing, financial, or other resources. The Company faces particular competition from Asian-based competitors, including Taiwanese EMS providers. Competition is based on price, quality, service, and the ability to deliver products in a timely and reliable basis. The Company believes its ability to manufacture high-end plastic and metallic accessory parts, its expertise in designing and manufacturing molds, and its low production costs distinguish it from most other manufacturers, though this advantage has been difficult to maintain due to increased competition and increased production overheads during the last three fiscal years.

The Company generates revenue through the manufacture and sale of injection-molded plastic parts and components, electronic products and subassemblies, and metallic molds and accessory parts. Sales are based on purchase orders received from customers from time to time, with no long-term contracts with any customer. 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. The Company's customers are OEMs and contract manufacturers, and the Company markets its products through direct contact with management and direct sales personnel, attending trade shows, exhibitions, and conventions.

Plastic injection molding manufacturing accounted for 17.9%, 16.6%, and 14.6% of the Company's total sales during the years ended March 31, 2024, 2025, and 2026, respectively. The plastic injection molding process consists of three phases: mold design and production, plastic injection, and finishing. The mold-making process ranges from 30 to 50 days depending on size and complexity. At March 31, 2026, the Company used 10 EDMs, 14 CNC milling machines, and 10 NC milling machines in the mold-making process. During the year ended March 31, 2026, the Company made an average of approximately 5 molds each month, with an average weight of about 250 pounds costing an average of $9,200 per set. At March 31, 2026, the Company had approximately 121 injection molding machines ranging from 86 to 380 tons of clamping force, with most machines in the range of 50 to 1,600 tons. During the year ended March 31, 2026, the Company disposed of 9 old plastic injection molding machines and added nil new machines. The Company conducts its plastic manufacturing operations in approximately 1,070,000 square feet of factory space in Dongguan, China.

Manufacturing of electronic products accounted for approximately 82.1%, 83.4%, and 85.4% of the Company's total sales during the years ended March 31, 2024, 2025, and 2026, respectively. The Company manufactures and assembles electronic products and electronic assemblies for OEMs in approximately 223,000 square feet of factory space at March 31, 2026 located in Dongguan, China. Finished products include consumer and sophisticated studio-quality audio equipment, IPBX and commercial telephone units, network education platforms, IP switches and routers. Assemblies consist of printed circuit boards with passive and active components mounted on them. The Company uses automatic insertion, pin-through-hole (PTH) interconnection technologies, and surface mount technology (SMT) in the assembly process. The Company conducts most of the manufacturing of electronic products on a turnkey basis, where it mainly takes care of materials procurement as well as product design and development for customers' selection and collaboration.

During the year ended March 31, 2026, the Company disposed of 9 old plastic injection molding machines and added nil new machines. The Company's major capital expenditures in fiscal 2026 included $108,000 for leasehold improvements, $301,000 for plant and machinery for plastic and electronic products, $25,000 for motor vehicles, and $47,000 for furniture, fixtures and equipment. The Company has constructed its own manufacturing plant and dormitory buildings in Houjie, Dongguan, China with an aggregate of approximately 1.3 million square feet of land. The Company has postponed additional construction consisting of previously planned additions of two dormitory units and two other buildings. Rental income, net of depreciation charges, of $498,000, $386,000, and $376,000 was earned during the years ended March 31, 2024, 2025, and 2026 respectively from leasing idle manufacturing facilities and warehouses to third parties.

Total revenues for the fiscal year ended March 31, 2026 were $55,486,000 ¹, compared to $56,706,000 ² for the fiscal year ended March 31, 2025. Net income for fiscal 2026 was $3,066,000 ³, compared to $4,087,000 ⁴ for fiscal 2025. Diluted earnings per share for fiscal 2026 was $0.19 ⁵, compared to $0.26 ⁶ for fiscal 2025. Gross profit for fiscal 2026 was $7,929,000 ⁷, compared to $8,781,000 ⁸ for fiscal 2025. The Company's gross margins for the plastic injection molding segment were 11.8% ⁹ in fiscal 2026, 13.5% ¹⁰ in fiscal 2025, and 14.0% ¹¹ in fiscal 2024. Gross margins for the electronic products segment were 14.7% ¹² in fiscal 2026, 16.0% ¹³ in fiscal 2025, and 14.5% ¹⁴ in fiscal 2024.

The Company has been studying the feasibility of reallocating part of its production to Southeast Asian countries since 2018 to mitigate uncertainties caused by the US-China trade controversy. In 2022, the Company engaged an internationally-recognized professional service firm to provide advice and assistance in the completion of required statutory procedures for the incorporation of a wholly foreign invested enterprise in Vietnam, but was advised that the proposed investment plan might not fulfil the requirement for the application of the certificate of origin in Vietnam, and the incorporation procedures were suspended. The Company is exploring the possibilities to reallocate part of its production to other Southeast Asian countries.

The Company has postponed additional construction consisting of previously planned additions of two dormitory units and two other buildings at its Houjie, Dongguan facility, but may choose to inaugurate this last phase of construction if additional production capacity is required in the future. The Company believes that its existing offices and manufacturing space, and manufacturing space in close proximity to its existing facilities, will be adequate for the operation of its business for at least the next two years.

The Company expects gross margins generally and for specific products to continue to fluctuate from year to year due to numerous factors including the cost of raw materials, especially electronic components; costs of labor, which have increased substantially as a consequence of increasing governmental regulation; the appreciation of the exchange rate of the RMB against the U.S. dollar; changes in customer mix or product mix; price increases for products for competitive reasons; increases in value-added taxes; increased costs to conform products to consumer and product safety laws; and rising costs due to disrupted global supply resources as a result of US-China trade tariffs.

The Company's major capital expenditures in fiscal 2026 included $108,000 for leasehold improvements, $301,000 for plant and machinery for plastic and electronic products, $25,000 for motor vehicles, and $47,000 for furniture, fixtures and equipment. All capital expenditures were financed principally from internally generated funds, and the Company's current plan is to continue to use internally generated funds principally to finance future capital expenditures. The Company expects to pay cash dividends on a semi-annual basis based on the Company's six-month results, though whether future dividends will be declared will depend upon the Company's future growth and earnings.

The Company faces structural headwinds from increasing labor costs in China, with the minimum wage in Guangdong Province where its manufacturing facilities are located at RMB1,750 per month as of March 31, 2026, and the minimum wage in the City of Dongguan at RMB2,080 per month as of March 31, 2026. Continuing material increases in labor costs will continue to increase operating costs and will adversely affect financial results unless passed on to customers through price increases, which could result in the loss of customers to lower-cost regions. The Company also faces headwinds from the US-China trade dispute, with US tariffs currently set at 55% on Chinese goods as of the filing date, and China's tariffs at 10%, following a truce reached on June 11, 2025 and a more durable truce following the Trump-Xi meeting in Busan on October 30, 2025, effective November 10, 2025, bringing the general tariff rate on Chinese goods to approximately 45-49%.

The Company faces constraints from the potential for the PCAOB to again become unable to completely inspect and investigate registered public accounting firms in Mainland China and Hong Kong. If the PCAOB's complete access is obstructed in the future and the PCAOB determines it is again unable to completely inspect or investigate such firms, and if under the HFCAA the SEC determines that the Company has filed audit reports issued by a registered public accounting firm that have not been subject to inspection by the PCAOB, then the two consecutive year count-down under the HFCAA would begin again, and after two years, the SEC could prohibit the Company's shares from being traded on Nasdaq and other U.S. securities exchanges.

The Company is dependent on a few major customers, with 2 major customers accounting for more than 10% of net sales each and together for 36.5% ¹⁵ of net sales in fiscal 2026, and the loss of or substantial reduction in orders from any major customer would adversely impact sales and operating results. Gross margins fluctuate due to factors including the cost of raw materials, labor costs, and the appreciation of the RMB, with 35.2% ¹⁶ of costs and expenses for PRC entities being in RMB during fiscal 2026. The Company faces significant risks from the US-China trade dispute, with US tariffs currently set at 55% ¹⁷ on Chinese goods and China's tariffs at 10% ¹⁸, and the general tariff rate on Chinese goods at approximately 45-49% ¹⁹ following the November 2025 truce. The Company could be delisted if the PCAOB becomes unable to completely inspect and investigate registered public accounting firms in Mainland China and Hong Kong again, which would begin a two-year count-down under the HFCAA and could result in a trading prohibition. The Company has identified material weaknesses in internal control over financial reporting related to information technology general controls, which could result in material misstatements of the financial statements if not remediated.

Management's message emphasizes the Company's position as an independent manufacturer serving OEMs and contract manufacturers, with a focus on the trend of outsourcing in the injection molding and electronics industries. Management believes that the Company's ability to manufacture high-end plastic and metallic accessory parts, its expertise in designing and manufacturing molds, and its low production costs distinguish it from most other manufacturers, though this advantage has been difficult to maintain due to increased competition and increased production overheads during the last three fiscal years. Management has identified the need to remediate material weaknesses in internal control over financial reporting related to information technology general controls, intending to engage a third party to assist in designing and implementing controls related to segregation of duties and IT general controls, design and implement controls to formalize roles and review responsibilities, and design and implement IT general controls including over program change management and user access rights. Management also notes that the Company is exploring possibilities to reallocate part of its production to other Southeast Asian countries to mitigate uncertainties from the US-China trade controversy.