Deswell (DSWL) Risk Analysis

As permitted by the law of the BVI, many provisions of our Memorandum and Articles of Association, which are the terms used in the BVI for a corporation's charter and bylaws, may be amended by our board of directors by resolution 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 the shares we are authorized to issue. Our board's ability to amend certain provisions of our charter documents without shareholder approval, including its ability to create and issue further common 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.

We prepare our financial statements in conformity with the generally accepted accounting principles of the United States of America "U.S. GAAP." A change in these accounting principles and policies, especially as interpreted by the Securities and Exchange Commission and The NASDAQ Stock Market, may have an impact on our future financial position and results of operations. Historically, regulatory changes, such as the requirement of the Financial Accounting Standards Board to expense stock options grants, and other legislative initiatives have increased our general and administrative costs and future changes could have a similar adverse impact on our financial results.

We generate all revenues from sales of products that we manufacture at our facilities located in Dongguan, Guangdong Province, in the PRC. The economy in China has grown significantly over the past 20 years, which has resulted in an increased inflation and the average cost of labor. According to the National Bureau of Statistics of China, the year-over-year percent changes in the consumer price index for December 2020, 2021 and 2022 were increases of 0.2%, 1.5% and 1.8% respectively despite a national inflation increase, the Company's actual cost of operations has significantly exceeded the overall inflation rate in China. The rapid growth of China's economy in the past few years has in general increased the Company's operating costs, including energy prices and labor costs. These increased costs have adversely affected the Company's cost of operations, caused the Company to increase its prices, and resulted in the loss of some customers. There is no fixed minimum wage which is applicable to all of China; local governments in China adopt different amounts based on the situation in their area. China's Guangdong Province, where our manufacturing facilities are located, raised minimum wages by approximately 10% in December 2021. Effective May 1, 2015, minimum wage levels across Guangdong Province, including Dongguan, where our manufacturing facilities are located, were increased by an average of 15.3%. Effective December 2021, the Guangdong Provincial Government increased the Province's statutory minimum wage by around RMB180 per month. The Provincial Government sets different tiers of minimum wages according to the developmental status of the Province's urban clusters. In the City of Dongguan, where our manufacturing facilities are located, the minimum wage as of May 2023 remained at RMB 1,900 per month since its last increase from RMB 1,720 per month in July 1, 2018. Regions may want to freeze local wages in order to maintain their economic competitiveness amid the economic slowdown. In China, regional governments are authorized to set their own minimum wages according to local conditions. Increases in wages also result in increases in our and other employer's contributions for various mandatory social welfare benefits for Chinese employees that are based on percentages of their salaries. Continuing material increases in our cost of labor will continue to increase our operating costs and will adversely affect our financial results unless we pass on such increases to our customers by increasing the prices of our products and services. The effect of increases in the prices of our products and services would make our products more expensive in global markets, such as the United States and the European Union. This could result in the loss of customers, who may seek, and be able to obtain, products and services comparable to those we offer in lower-cost regions of the world. If we do not increase our prices to pass on the effect of increases in our labor costs, our margins and financial results would suffer.

Historically, the United States has been the major or significant geographical area of our product sales in terms of shipping destinations. The United States was our number four and the third largest market in fiscal years ended March 31, 2022 and 2023. See ITEM 4 "Information on the Company – Customers and Marketing" on page 33 of this Report for information regarding our net sales as a percentage of total sales to customers by geographic area. During fiscal year 2020, the U.S.-China relation during the Trump-administration had hit a low point. The United States fell out of the top three significant geographical markets of the Company's products. Following the swearing in of Joseph Biden as the new United States President in January 2021, the United States and China held the first high-level meeting in March 2021, however the meeting ended in heated arguments. Between March 2021 and June 2023, our understanding is there had been no meeting between the two countries, though several telephone conversations between high-level officials from both sides took place. On June 19, 2023, U.S. Secretary of State Antony Blinken ended a high-stakes visit to Beijing with an unexpected meeting with Chinese President Xi Jinping. This meeting makes Blinken the highest-level American official to visit China since U.S. President Joe Biden assumed leadership as well as the first U.S. Secretary of State to make the trip in nearly five years. We believe that this visit has paved the way for more positive contributions to stabilizing U.S.-China relations. 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. Recently, political and trade friction between the United States and China has escalated. In July 2018 and again in September 2018, the United States imposed tariffs on a wide range of products and other goods from China. Over the four years that have followed since, the two countries have been embroiled in countless back-and-forth negotiations, introduced foreign technology restrictions, fought several WTO cases, consequently leading U.S.-China trade tensions to the brink of a full-blown trade war. So far, the U.S. has slapped tariffs on U.S.$550 billion worth of Chinese products. China, in turn, has set tariffs on U.S.$185 billion worth of U.S. goods. For many months, neither China nor the United States showed signs of wanting to back down. But finally, on January 15, 2020, the first signs of a truce were seen, when the two sides signed the Phase One Deal, which officially agreed to the rollback of tariffs and expansion of trade purchases. China agreed to expand purchases of certain U.S. goods and services by an additional U.S.$200 billion for the two-year period from January 1, 2020, through December 31, 2021 as part of the Phase One Deal; however; China purchased only 57% of this committed amount. The two countries have provided minimal updates on extending the Phase One Deal or negotiating a Phase Two Deal and it remains uncertain if or when a new deal will be reached. Most of the elevated tariffs imposed at the height of the U.S.-China trade war have remained in place and affect over half of all trade flows between the two countries. Inside the United States, it is argued that the tariffs on China are harming the U.S. economy. Though President Joseph Biden, after taking office, has admitted that he disagreed with Donald Trump's approach to China, he is not in a hurry to reverse his predecessor's policies. His administration had suggested that it is open to using tariffs to fight China's unfair trade practices and the tariffs have remained in place. The trade controversy between the United States and China is still evolving, and we cannot predict future trade policy. However, future tariffs could cover more or all of our products, resulting in an adverse effect on our operations, including customer demand, or on the prevailing market price of our common shares.

The outcome of the trade controversy between the United States and China is not predictable as of this time. In order to mitigate the uncertainties caused by the issue, we have been studying the feasibility of reallocating part of our production to Southeast Asian countries since 2018. Last year, we 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 (the "FIE"). However, we were advised that our proposed investment plan might not fulfil the requirement for the application of the certificate of origin in Vietnam, the incorporation procedures in Vietnam were suspended. We are exploring the possibilities to reallocate part of our production to other Southeast Asian countries. We may face difficulties and possibly be unsuccessful in the future. We may fail to select appropriate manufacturing plants in other Southeast Asian countries. Some of our competent and experienced employees and management may not be willing to relocate and work in other Southeast Asian countries. The quality of the products manufactured and assembled in other Southeast Asian countries may not be accepted by our customers. A new manufacturing plant in other Southeast Asian countries could require significant management attention and could result in a diversion of resources away from our existing business. We may also need to obtain approvals and licenses from relevant government authorities to comply with applicable laws and regulations, which could result in increased costs and delays.

Our success depends largely upon the continued services of our Board of Directors, executive officers as well as upon our ability to attract and retain qualified technical, manufacturing and marketing personnel. Generally, our executive officers and senior managers are not bound by employment or non-competition agreements and we cannot assure you that we will be able retain them. On June 12, 2023, Richard Pui Hon Lau, our chairman of the Board of Directors and majority shareholder passed away, and subsequently Chin Pang Li, a longtime member of our Board of Directors and prior executive officer of the Company, was appointed as chairman of the Board of Directors and Ben Yiu Sing Poon was appointed as interim director on the Board of Directors until the Company's 2023 Annual General Meeting or other shareholders' meeting called before such date. The loss of Mr. Lau or the loss of service of any of our officers or key management personnel could have a material adverse effect on our business and operating results. We do not have key person insurance on our executive officers or members of our Board of Directors. However, Mr. Lau and the Board had taken care over the years to ensure that the Company and its subsidiaries would be prepared to continue in his absence. There will be no changes in the operation of the Company, and at this time the Lau family has no plans to dispose of the shares under their ownership. We believe that our future success will depend, in part, on our ability to attract and retain highly skilled executive, technical and management personnel and if we are not able to do so, our business and operating results could be harmed.

Risks associated with our business include risk of damage to our stock in trade, goods and merchandise, furniture and equipment and factory buildings in China. At March 31, 2023, we maintained fire, casualty and theft insurance aggregating approximately $138 million covering damages to fixed and movable assets, equipment, manufacturing facilities in China and furniture and fixtures at our facilities. 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, forces of nature, such as major earthquakes, which are common in China, or other natural disasters. We may experience difficulty or delays in receiving compensation from the insurance companies and may not receive insurance proceeds adequate to compensate us fully for a potential loss. Although we maintain insurance addressing damage to and destruction to our facilities and equipment, we do not have business interruption insurance. Despite quality assurance measures, there remains a risk that defects may occur in our products. The occurrence of any defects in our products could give rise to liability for damages caused by such defects. They could, moreover, impair the market's acceptance of our products. At March 31, 2023, we had only limited product liability insurance. Although we have not experienced any product quality claims from significant customers, if future claims do arise, costs to defend, adverse judgments or amounts we may be forced to pay in settlement would increase our expenses. If we incur losses which are not covered under our insurance, or the amount of compensation that we receive from the insurer is significantly less than the actual loss, our financial condition and results of operations could be materially and adversely affected.

We compete with a number of different companies in production of injection-molded plastic parts and components, electrical products and subassemblies and metallic molds and accessories. For example, we compete with Asian-based manufacturers and/or suppliers of injection-molded plastic parts and components, major global electronic manufacturing services ("EMS") providers, other smaller EMS companies that have a regional or product-specific focus, and original design manufacturers with respect to some of the services that we provide. We also compete with our current and prospective customers, who evaluate our capabilities in light of their own capabilities and cost structures. Our market segments are extremely competitive, many of our competitors have achieved substantial market share and many have lower cost structures and greater manufacturing, financial or other resources than we do. We face particular competition from Asian-based competitors, including Taiwanese EMS providers which compete in our end markets. If we are unable to provide comparable manufacturing services and improved products at lower cost than the other companies in our market, our net sales could decline. Uncertainty and adverse changes in the economy and financial markets may also increase the competitive environment in our market segments which could also impact our operating results. In addition, the EMS industry is currently experiencing excess manufacturing capacity and has seen increased competition. To stay technologically competitive, we have replaced some of our existing manufacturing machineries with up to date and advanced ones in order to enhance efficiency, precision, quality as well as productivity. Nonetheless, the above factors have exerted and will continue to exert additional pressures on pricing for injection-molded plastic parts and components and for our electronic manufacturing services, thereby increasing the competitive pressures in our market segments generally. We may not be able to compete successfully against our current and future competitors, and the competitive pressures we face may have a material adverse effect on us. We have no long-term contracts to obtain plastic resins and our profit margins and operating results 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, 2021, 2022 and 2023: 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. Over the past several years, oil prices have experienced significant volatility. In addition, 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 operating margins. A significant increase in resin prices in the future could likewise adversely affect our operating margins and results of operations.

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.