SecProbe.io

CORRESP
1
filename1.htm

corresp

Deswell Industries, Inc.

17B, Edificio Comercial Rodrigues

599 Avenida da Praia Grande

Macao, Special Administrative Region, PRC

Tel: (853) 322096

Fax: (853) 323265

February 17, 2008

Via EDGAR

John M. Hartz,

Senior Assistant Chief Accountant

Securities and Exchange Commission

100 F Street, NE

Washington, DC 20549-7010

    Re:

    Deswell Industries, Inc. (“Deswell” or the “Company”)

    Form 20-F for the fiscal year ended March 31, 2007

    Filed August 1, 2007

    Forms 6-K filed August 17, 2007 and November 20, 2007

    File No. 0-26448

Dear Mr. Hartz:

This is in response your comment letter of January 14, 2008 to the undersigned as Chief Financial
Officer of the Company. For the convenience of the staff, each comment is repeated verbatim with
the Company’s response immediately following.

Form 20-F for the year ended March 31, 2007

Property, Plants and Equipment, page 24

    1.

    We note that you closed the Shenzhen plastic plant during the year ended March 31, 2007, and
that it is held for sale. Please provide us with a timeline explaining the underlying events
leading up to this action and address the classification on your balance sheet, the timing of
such classification, and the appropriate measurement of this asset through FY 2007. Please see
paragraphs 30-39 and 46 of SFAS 144, for further guidance.

     In addition, tell us what consideration you gave to reporting such activity as discounted
operations. Please see paragraph 41-45 of SFAS 144, for further guidance.

Response:

The timeline was substantially as follows:

John M. Hartz

Senior Assistant Chief Accountant

February 17, 2008

Page 2

    Q3 2007

    Oct to Dec. 2006

    We closed our injection molding and
assembly departments and dismissed or
relocated our employees to our
Dongguan manufacturing plant

    Q4 2007

    Jan to Mar 2007

    We continued to sell our remaining
inventory and sell and/or transferred
fixed assets to our Dongguan plant.

    Q1 2008

    April to June 2007

    We determined to sell the
Company-owned premises located in
Block G, Wing Village Industrial
Estate, Shekou, Shenzhen, China,
(which could be used for industrial
and commercial purposes) through
commercial property agencies. At that
time, the property market in Shekou,
Shenzhen was very active and robust.
We listed the premises for RMB80
million (approximately US$10.4
million), based on our board’s best
estimate. A property valuation
report was completed by a qualified
real estate appraisal company in PRC,
which was prepared in accordance with
the guidance and regulations of the
local tax bureau for the purpose of
assessing the “value added taxes on
property transfers.” The valuation
report, which was completed in June
2007, is effective for one year until
June 6, 2008. By the end of June
2007, a potential buyer was
identified, negotiations ensued and
an understanding was reached to sell
the premises to the prospective buyer
for RMB75 million (approximately
US$9.8 million). We then had the
agreements for the sale prepared and
presented them to the prospective
buyer.

    Fiscal 2007
Accounting

    As we disclosed in our financial
statements for the year ended March
31, 2007, this property was
classified as long-lived assets held
for use at March 31, 2007 because the
criteria for reclassifying such
property as held for sale (as
specified in paragraph 20 of SFAS
144) had not been met until after the
end of our fiscal year on March 31.
At the time of our preparation of our
Form 20F, management had committed to
a sale plan; the property was
available for immediate sale in its
then present condition; an active
program to locate a buyer had been
initiated; sale of the property was
believed probable and the transfer of
the property was expected to be
completed within one year; the
property was actively marketed for
sale at a price that we believed
reasonable at that time and it was
unlikely at that time that
significant changes would occur to
the plan of sale or that the plan
would be withdrawn.

    Q2 2008

    July to Sept. 2007

    By the end of July, we still had not
received the signed agreements and
the prospective buyer notified us
that it had been arranging funding.
Thereafter, we then received no
further communication from the
prospective buyer and considered that
transaction as proposed had been
abandoned by the prospective buyer.
We then requested our property agents
to solicit other potential buyers for
the premises.

Since the criteria required by paragraph 20 of SFAS 144 was no longer satisfied, we
reclassified the premises as held for use.

The closure of our Shekou manufacturing plant was not reported as a discontinued operation in our
financial statements for the year ended March 31, 2007 based on paragraphs 41-45 of SFAS 144.
Previously, our injection molding manufacturing operations were conducted in two plants, one in
Dongguan and one in Shekou. Gradually during fiscal 2007, we expanded our operations in Dongguan,
which began handling the manufacturing we formerly conducted at our Shekou plant. Hence, our
operations and cash flows from manufacturing operations formerly conducted at our Shekou factory
will not be eliminated from our ongoing manufacturing operations — they have been transferred to
our Dongguan factory. In this situation, the conditions specified in paragraph 42 of SFAS 144 for
reporting discontinued operations would not be met.

John M. Hartz

Senior Assistant Chief Accountant

February 17, 2008

Page 3

Operating and Financial Review and Prospects, page 26

Operating Results, page 26

    2.

    We note your explanation for the substantial increase in sales for the most recent fiscal
year. In future filings please expand such explanations as follows:

    –

    Explain whether the increases described (for example, from the
telecommunications customer and new customers) are expected to continue at this level
for the foreseeable future;

    –

    Explain whether the loss of sales from existing customers is expected to
continue at the lower level for the foreseeable future;

    –

    Quantify how much of the increases and decreases were due to price changes,
and/or volume;

    –

    Explain whether the significant gains and losses in sales were due to new
products and/or the phasing out of older products. In other words, provide more detail
about the underlying reasons behind the changes, and their expected future trends.

Response:

Your comments are noted and disclosures expanding explanations for any substantial increases in
sales in the manner requested in your comments will be added to future filings, as applicable and,
as to your comments in the first two bullets, to the extent we have reasonable bases for any
forward-looking statements.

10. Income Taxes, page F-12

    3.

    As previously requested in comment 2 in our letter dated February 28, 2006, please expand
your disclosures to discuss the nature of those entities and jurisdictions which you have
determined are not subject to income taxes, as disclosed on page F-13, and the amounts
associated with each for each period presented.

Response:

Our companies that are in tax-free jurisdictions are primarily investment holding companies that
are registered in the British Virgin Islands. Moreover, our two major trading subsidiaries,
incorporated in the jurisdiction of Macao, are both income tax exempted by their business licenses
obtained since their incorporation in August 2003 and April 2004. Please refer to page 15 in the
discussion of “Information of the Company — History and Development of Deswell.” The amounts
associated are

John M. Hartz

Senior Assistant Chief Accountant

February 17, 2008

Page 4

reflected in the continuation of Note 10 on Income Taxes on page F-14 “Effect of income for which
no income tax is chargeable.”

    4.

    We note your discussion on page 6 of the impact that the EIT Law will have effective January
1, 2008. Please tell us and disclose in future filings in MD&A the rates you have used to
measure your income taxes for the fourth quarter of fiscal 2008, for each separate taxable
entity.

Response:

Following the implementation of the EIT Law effective January 1, 2008, the State Council recently
announced the transition rules for preferential tax policies (Guofa [2007] No.39) of January 2,
2008, for eligible enterprises previously subject to a 15% tax rate or 24% tax rate. As so
announced, the new enterprise income tax rates are:

    Rate under EIT for

    Rate under EIT for

    enterprises previously

    enterprises previously

    Tax Year

    subject to 15% tax rate

    subject to 24% tax rate

                2008

    18%

    25%

    2009

    20%

    25%

    2010

    22%

    25%

    2011

    24%

    25%

    2012

    25%

    25%

The standard tax rates applicable to our subsidiary, Jetcrown Industrial (Dongguan) Limited, will
be 25% from 2008. Our subsidiary, Dongguan Kwan Hong Electronics Co. Limited, was approved as a
“High-tech Enterprise” by the local tax authority in April 2007 and accordingly was to enjoy a
lower national tax rate of 15% for two years until April 2009. We have consulted the local tax
bureau with regard to the tax rate applicable in this situation and were advised to prepay at a
standard tax rate of 25% until the final assessment for preferential tax rate of 15% in our 2008
annual tax return.

    5.

    We note your statement on page 31 under the discussion of the change in income taxes during
fiscal 2006 that 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 $1,000,006 and the
decrease in operating income during the year ended March 31, 2006. Please tell us and disclose
in future filings the following:

    –

    Please explain to us more clearly what you mean by “doubtful sales.” In other
words was this a write-off of doubtful accounts receivable? If so, was it in excess of
your normal allowance for doubtful accounts? Confirm that your revenue recognition
policies were and are consistent with Staff Accounting Bulletin 101;

John M. Hartz

Senior Assistant Chief Accountant

February 17, 2008

Page 5

    –

    The underlying history and reason(s) for the write off;

    –

    How you write-off for tax purposes in the reporting period.

Response:

We disclosed in our press release of December 14, 2005, which we furnished to the SEC under cover
of Form 6-K on December 19, 2005, the circumstances and details of the doubtful sales immediately
upon their discovery when we reported our results for the quarter and six months ended September
30, 2005. The disclosure was included in Note 2 to our financial statements for the quarter and
nine months ended December 31, 2005 included in our press release of March 13, 2006, which we
furnished to the SEC under cover of Form 6-K on March 15, 2006, and in Note 2 to our financial
statements for the quarter and year ended March 31, 2006 included in our press release of June 23,
2006 (and in the narrative portion of such press release), which we furnished to the SEC under
cover of Form 6-K on June 26, 2006. Ultimately, such doubtful sales resulted in a write-off of
doubtful accounts receivable as disclosed and reported in our financial statements included in our
Annual Report on Form 20-F for the year ended March 31, 2006 filed on July 14, 2006. Please see the
Risk Factor on page 5 entitled We could suffer losses from corrupt or fraudulent business
practices. Conducting business in China is inherently risky,” pages 30 and 34 in MD&A and on pages
56 to 57 under Item 15 “Controls and Procedures — Changes in Internal Controls.”

We confirm that our revenue recognition policies were and are consistent with Staff Accounting
Bulletin 101. The write off of doubtful sales in the metallic division had reduced the taxable
profit of our subsidiary, Dongguan Kwan Hong Electronics Limited, which was comprised of electronic
and metallic divisions.

    6.

    We note your statement on page F-13 that Jetcrown Dongguan has revised its first and second
tax exemption year from the calendar year ended December 31, 2004, and 2005 respectively, to
the calendar years ended December 31, 2002, and 2003 respectively. Please address the
following:

    –

    Please tell us and disclose in future filings the tax rate that Jetcrown
Dongguan used for each period presented.

    –

    You state that an amount of $450,000 additional income tax assessments which
are likely to arise has been charged to the consolidated income statement for the year
ended March 31, 2007, relating to the taxable calendar years ended December 31, 2004,
2005 and 2006, and for the quarter ended March 31, 2007. Please tell us and disclose in
future filings in MD&A the nature of the assessments, and reconcile the recognition of
this amount to your provision for income taxes on page F-13.

John M. Hartz

Senior Assistant Chief Accountant

February 17, 2008

Page 6

Response:

The tax rate applicable for Jetcrown Dongguan for calendar years 2002 to 2005 is 24%. Jetcrown
Dongguan was entitled to a full tax exemption for each of the calendar years ended December 31,
2002 and 2003 and a 50% tax exemption for each of the calendar years ended December 31, 2004, 2005
and 2006.

The nature of the assessment is in connection with the amounts of assessable profits and the date
of commencement of the first profitable year. Management believed that it would be in Deswell’s
best interests to reach an immediate resolution with the tax authorities on these issues in order
to avoid expending substantial time, effort and expenses that would have been involved in lengthy
negotiations with the tax authorities. As a result, we made a tax provision of an aggregate of
$450,000, which comprised approximately $154,000, $92,000, $166,000 and $38,000 for taxable
calendar years 2004, 2005 and 2006 and the quarter ended March 31, 2007, respectively.

The assessment and payment for income taxes for calendar years 2004 and 2005 were settled and
concluded in September 2007 at the amount, which as provided. The assessment and payment for
calendar year 2006 were finalized and settled at $101,000 in January 2008 with an over-provision of
$65,000.

Your comments are noted and we will add disclosures in future filings in MD&A the nature of
assessments, and will reconcile the recognition of this amount to our provision for income taxes in
our notes regarding income taxes in our financial statements.

Form 6-K dated August 17, 2007

    7.

    We note you recorded a stock provision of $500,000 as a result of “the two customers
pushing-out orders.” Please provide us with a comprehensive explanation of the following:

    –

    What is meant by pushing out orders;

    –

    Identify the customers;

    –

    Why this caused an inventory provision;

    –

    How you accounted for this provision;

    –

    The literature in support of your accounting.

Response:

We and our customers refer to “push out orders” to describe when a customer informs us that it
wishes us to delay the shipment of products the customer has ordered from us after we have ordered
raw materials and components on the basis of its purchase order and have commenced production.

During the quarter ended June 30, 2007, our customers Digidesign Inc. and Peavey Electronics Corp.
informed our Marketing Department that they were pushing out

John M. Hartz

Senior Assistant Chief Accountant

February 17, 2008

Page 7

delivery of orders. Based on experience, our Marketing Department anticipated that a portion of the
product orders covered by the push outs might ultimately be cancelled as consequence of the lower
than expected commercial acceptance of the products we manufacture for them by their customers. We
have been reviewing our inventory and engaged in negotiations with both Digidesign