Business context and reporting period
Deswell Industries, Inc. filed an annual Form 20-F for the fiscal year ended March 31, 2016. The filing is not a standalone 2015 Q4 report, although it includes unaudited quarterly data. The company manufactures injection-molded plastic components and electronic products and assemblies in Dongguan, China; figures below are U.S. dollars.
In fiscal 2015, Deswell exited its metallic-parts business and reported it as discontinued operations. Fiscal 2016 results therefore primarily reflect plastics and electronics.
Key financial metrics
| Metric | FY2016 | FY2015 |
|---|---|---|
| Net sales from continuing operations | $44.568 million | $38.076 million |
| Gross profit / margin | $4.793 million / 10.8% | $4.224 million / 11.1% |
| Operating loss | $5.347 million | $4.806 million |
| Net loss | $4.934 million | $2.808 million |
| Basic and diluted loss per share | $0.31 | $0.17 |
| Cash from (used in) operations | $0.563 million | ($2.370 million) |
| Capital expenditures | $0.591 million | $0.890 million |
| Working capital at year-end | $39.890 million | $45.864 million |
| Total assets / shareholders’ equity | $87.571 million / $76.808 million | $96.439 million / $84.063 million |
- FY2016 net sales increased 17.1%. Electronics sales rose $6.439 million; plastics sales were nearly flat, up $0.053 million.
- Gross margin declined 0.3 percentage points. Plastics segment margin increased to 17.1% from 16.9%; electronics margin improved to 5.7% from 4.9%.
- Operating margin was approximately negative 12.0%. SG&A was essentially unchanged at $9.119 million.
- Net cash used in investing activities was $1.206 million; net cash used in financing activities was $1.686 million, entirely for dividends. Cash and cash equivalents were $11.996 million at year-end.
- The company reported no short- or long-term borrowings, no committed credit facilities, and no debt maturities. Current assets were $50.653 million and current liabilities $10.763 million.
- Marketable securities were $12.020 million and available-for-sale securities $1.603 million at year-end. Time deposits totaled $9.842 million, including $4.566 million maturing after twelve months.
- Dividends paid in FY2016 totaled $1.686 million. A further $1.124 million dividend was declared but remained payable in FY2017; the selected data report dividends per share of $0.14 for FY2016.
Material changes versus the prior comparable period
- Revenue rebounded after the FY2015 decline, led by higher orders for home entertainment products and professional audio instruments. The U.S. share of sales fell to 18.2% from 26.0%, while China and Hong Kong represented 42.1% and 17.2%, respectively, based on shipping destinations.
- Despite higher gross profit, the net loss widened. Other expense was $1.021 million versus $0.093 million of other income, including $0.600 million in exchange losses, $0.426 million in fixed-asset disposal losses, and a $0.273 million doubtful-receivables provision cited in management’s discussion.
- Non-operating income declined to $0.571 million from $2.553 million, chiefly because of a $2.814 million year-over-year reduction in fair-value results on marketable securities. FY2016 included a $1.860 million unrealized loss on those securities.
- Operating cash flow improved from an outflow to an inflow, helped by a $2.966 million reduction in inventory. Working capital nevertheless declined by $5.974 million.
- Total assets fell $8.868 million; property, plant and equipment decreased to $32.352 million from $36.598 million. There were no long-lived-asset impairment charges in FY2015 or FY2016.
Outlook, commentary, risks and unusual items
- No numeric revenue, earnings, or margin guidance is provided. Management expected to fund working-capital needs and capital additions primarily from cash on hand and internally generated funds; capital commitments at year-end were approximately $18,000.
- Management cited continuing order development with existing customers. Beginning in FY2017, the company expected to release financial results semiannually and expected to pay cash dividends semiannually, subject to results, cash needs, and board decisions.
- Three customers each contributed more than 10% of FY2016 sales and together accounted for 36.7%. Sales are purchase-order based, with no long-term customer contracts; one customer represented 23.7% of year-end receivables.
- Risks include intense price competition; rising China labor and social-benefit costs; resin-price and electronic-component availability; customer concentration and credit exposure; RMB and other currency movements; and dependence on China-based manufacturing and regulatory, tax, and repatriation rules. The RMB depreciated against the U.S. dollar in FY2016, mitigating some labor-cost pressure.
- The company stated it believed it was a passive foreign investment company (PFIC) for FY2016 and could remain one, potentially creating adverse U.S. tax consequences for U.S. investors.
- Substantial cash and investment balances are exposed to bank-deposit and market-price risk. The company does not hedge currency risk and reported no open forward contracts. Management reported effective disclosure controls and internal control over financial reporting; the auditor did not audit internal control effectiveness. The filing also notes that the China-based auditor was not subject to PCAOB inspection.
- The board declared a $1.124 million dividend based on the final two quarters of FY2016, payable in FY2017. The company cautioned that future dividends are not assured and PRC restrictions and withholding taxes may limit distributions.
Important facts for investors to verify
- Reconcile the stated cash, time-deposit, and short-term-investment totals: the filing gives $11.996 million of cash and $9.842 million of time deposits, while another passage describes $17.272 million as cash invested in short-term interest-bearing investments.
- Review the composition, valuation, and investment risks of the $12.020 million marketable-securities portfolio and its effect on non-operating income.
- Track whether the sales rebound continues and whether customer concentration, order timing, and the weak electronics-segment margin improve.
- Confirm the timing and payment of the declared FY2016 dividend and assess the sustainability of future dividends given continuing losses and PRC distribution restrictions.
- Assess PFIC status and related U.S. tax reporting implications with an independent tax adviser.