UNITED
STATES


SECURITIESANDEXCHANGE
COMMISSION


Washington,D.C.20549


______________





FORM10-Q


(MARKONE)


x
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
      OF 1934




For the quarterly period endedMarch 31,
2008


or


o
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
      OF 1934




For the transition period from
to








Commission File Number:
0-15930


___________________








SOUTHWALL
TECHNOLOGIES INC.


(Exact name of registrant as specified
in its charter)





Delaware
              (State or other jurisdiction of
      incorporation or organization)
            
            94-2551470
              (I.R.S. Employer Identification
      Number)3788 Fabian Way,Palo Alto,California
              (Address of principal executive
      offices)
            
            94303
              (Zip
  Code)








Registrant's telephone number, including
area code:(650) 798-1200


___________________




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. YesxNoo





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  ̈         
Accelerated filer  ̈        
Non-accelerated filer  x





Indicate by check mark whether the
registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).YesoNox





As ofApril 21, 2008, there were 27,819,622shares of the registrant's Common Stock
outstanding.







1





SOUTHWALL
TECHNOLOGIES INC.





INDEX








PagePART
      I – FINANCIAL INFORMATIONItem
      1
            Financial StatementsUnaudited Condensed Consolidated Balance Sheets – March 31,
      2008 and December 31, 2007
            3Unaudited Condensed Consolidated Statements of Operations –
      Three month periods ended March 31, 2008 and March 31,
      2007
            4Unaudited Condensed Consolidated Statements of Cash Flows
      – Three month periods ended March 31, 2008 and March 31,
      2007
            5Notes to the Unaudited Condensed Consolidated Financial
      Statements
            6Item
      2
            Management’s Discussion and Analysis of Financial Condition
      and Results of Operations
            13Item
      3
            Quantitative and Qualitative Disclosures about Market
      Risk
            21Item
      4
            Controls and Procedures
            22PART
      II – OTHER INFORMATIONItem
      1
            Legal Proceedings
            23Item
      1A
            Risk Factors
            23Item
      2
            Unregistered Sales of Equity Securities and Use of
      Proceeds
            23Item
      3
            Defaults upon Senior Securities
            23Item
      4
            Submission of Matters to a Vote of Security
      Holders
            23Item
      5
            Other Information
            23Item
      6
            Exhibits
            24Signatures
            24





2
 Table of Contents




PARTI.FINANCIAL
INFORMATION





Item 1--Financial
Statements:


SOUTHWALL
TECHNOLOGIES INC.


UNAUDITED CONDENSED CONSOLIDATED BALANCE
SHEETS


(in thousands, except per share
data)





March
      31,
            
            
            December
      31,2008
            
            
            2007ASSETSCurrent
      assets:Cash
      and cash equivalents
            
            $
            4,362
            
            
            $
            6,492Restricted
      cash
            
            
            316
            
            
            
            294Accounts
      receivable, net of allowance for doubtful accounts of $134 at March 31,
      2008 and $66 at December 31, 2007
            
            
            8,183
            
            
            
            4,346Inventories,
      net
            
            
            7,241
            
            
            
            5,640Other
      current assets
            
            
            1,106
            
            
            
            837Total
      current assets
            
            
            21,208
            
            
            
            17,609Property,
      plant and equipment, net
            
            
            17,916
            
            
            
            17,071Restricted
      cash loans
            
            
            1,348
            
            
            
            1,242Other
      assets
            
            
            254
            
            
            
            1,345Total
      assets
            
            $
            40,726
            
            
            $
            37,267LIABILITIES,
      PREFERRED STOCK AND STOCKHOLDERS’ EQUITYCurrent
      liabilities:Current
      portion of long term debt
            
            $
            1,262
            
            
            $
            1,149Accounts
      payable
            
            
            3,353
            
            
            
            964Accrued
      compensation
            
            
            595
            
            
            
            1,267Other
      accrued liabilities
            
            
            4,826
            
            
            
            6,350Total
      current liabilities
            
            
            10,036
            
            
            
            9,730Term
      debt
            
            
            8,463
            
            
            
            8,277Other
      long term liabilities
            
            
            2,578
            
            
            
            2,567Total
      liabilities
            
            
            21,077
            
            
            
            20,574Commitments
      and contingencies (Note 5)Series
      A 10% cumulative convertible preferred stock, $0.001 par value; $1.00
      stated value; 5,000 shares authorized, 4,893 shares outstanding at March
      31, 2008 and December 31, 2007, respectively (Liquidation preference:
      $6,399 and $6,277 at March 31, 2008 and December 31, 2007,
      respectively)
            
            
            4,810
            
            
            
            4,810Stockholders’
      equity:Common
      stock, $0.001 par value per share; 50,000 shares authorized, 27,820 shares
      outstanding at March 31, 2008 and December 31,
      2007,   respectively
            
            
            28
            
            
            
            28Capital
      in excess of par value
            
            
            78,215
            
            
            
            78,290Accumulated
      other comprehensive income: Accumulated translation
    adjustment
            
            
            5,762
            
            
            
            4,776Accumulated
      deficit
            
            
            (69,166
            )
            
            
            (71,211
            )Total
      stockholders’ equity
            
            
            14,839
            
            
            
            11,883Total
      liabilities, preferred stock and stockholders’ equity
            
            $
            40,726
            
            
            $
            37,267








See
accompanying notes to unaudited condensed consolidated financial
statements.





3
 Table of Contents





SOUTHWALL
TECHNOLOGIES INC.


UNAUDITED CONDENSED CONSOLIDATED
STATEMENTS OF OPERATIONS


(in thousands, except per share
data)




Three
      months endedMarch
      31,
            
            
            March 31,2008
            
            
            2007Net
      revenues
            
            $
            10,570
            
            
            $
            10,505Cost
      of revenues
            
            
            5,719
            
            
            
            6,095Gross
      profit
            
            
            4,851
            
            
            
            4,410Operating
      expenses:Research
      and development
            
            
            709
            
            
            
            1,369Selling,
      general and administrative
            
            
            2,038
            
            
            
            2,529Recoveries
      for long-lived assets, net
            
            
            -
            
            
            
            (8
            )Total
      operating expenses
            
            
            2,747
            
            
            
            3,890Income
      from operations
            
            
            2,104
            
            
            
            520Interest
      expense, net
            
            
            (139
            )
            
            
            (113
            )Other
      income, net
            
            
            193
            
            
            
            6Income
      before provision for income taxes
            
            
            2,158
            
            
            
            413Provision
      for income taxes
            
            
            113
            
            
            
            181Net
      income
            
            
            2,045
            
            
            
            232Deemed
      dividend on preferred stock
            
            
            122
            
            
            
            122Net
      income attributable to common stockholders
            
            $
            1,923
            
            
            $
            110Net
      income per share:Basic
            
            $
            0.07
            
            
            $
            0.00Diluted
            
            $
            0.06
            
            
            $
            0.00Shares
      used in computing net income per share:Basic
            
            
            27,820
            
            
            
            27,139Diluted
            
            
            33,520
            
            
            
            27,566






See accompanying notes to unaudited
condensed consolidated financial statements.





4
 Table of Contents





SOUTHWALL
TECHNOLOGIES INC.


UNAUDITED CONDENSED CONSOLIDATED
STATEMENTS OFCASHFLOWS


(in thousands)




Three
      months endedMarch
      31,
            
            
            March
      31,2008
            
            
            2007Cash
      flows from  operating activities:Net
      income
            
            $
            2,045
            
            
            $
            232Adjustments
      to reconcile net income to net cash used in operating
      activities:Deferred
      income tax
            
            
            -
            
            
            
            (36
            )Impairment
      recoveries from long-lived assets
            
            
            -
            
            
            
            (8
            )Depreciation
      and amortization
            
            
            746
            
            
            
            696Stock
      compensation
            
            
            48
            
            
            
            113Changes
      in operating assets and liabilities:Accounts
      receivable, net
            
            
            (4,099
            )
            
            
            (1,872
            )Inventories,
      net
            
            
            (1,601
            )
            
            
            (117
            )Accrued
      restructuring
            
            
            -
            
            
            
            (10
            )Other
      current and non-current assets
            
            
            790
            
            
            
            57Accounts
      payable and accrued liabilities
            
            
            74
            
            
            
            (530
            )Net
      cash used in operating activities
            
            
            (1,997
            )
            
            
            (1,475
            )Cash
      flows from investing activities:Restricted
      cash
            
            
            (13
            )
            
            
            (13
            )Proceeds
      from sale of property, plant and equipment
            
            
            -
            
            
            
            8Expenditures
      for property, plant and equipment
            
            
            (369
            )
            
            
            (299
            )Net
      cash used in investing activities
            
            
            (382
            )
            
            
            (304
            )Cash
      flows from financing activities:Borrowings
      on line of credit
            
            
            -
            
            
            
            3,000Repayments
      on line of credit
            
            
            -
            
            
            
            (2,996
            )Repayments
      of notes payable
            
            
            (293
            )
            
            
            (267
            )Net
      cash used in financing activities
            
            
            (293
            )
            
            
            (263
            )Effect
      of foreign exchange rate changes on cash
            
            
            542
            
            
            
            (95
            )Net
      decrease in cash and cash equivalents
            
            
            (2,130
            )
            
            
            (2,137
            )Cash
      and cash equivalents, beginning of period
            
            
            6,492
            
            
            
            5,524Cash
      and cash equivalents, end of period
            
            $
            4,362
            
            
            $
            3,387Supplemental
      cash flows disclosures:Interest
      paid
            
            $
            263
            
            
            $
            176Income
      taxes paid
            
            $
            131
            
            
            $
            181Supplemental
      schedule of non-cash investing and financing activities:Dividends
      accrued
            
            $
            122
            
            
            $
            122








See accompanying notes to unaudited
condensed consolidated financial statements.





5
 Table of Contents





SOUTHWALL
TECHNOLOGIES INC.


NOTES TO UNAUDITED CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS


(dollar and share amounts in thousands,
except per share data)




Note 1—Basis of
Presentation:





Southwall Technologies Inc., including
its wholly owned subsidiaries, Southwall Europe GmbH and Southwall IG Holdings,
Inc., are hereafter referred to as the “Company,” “Registrant,” “We,” “Our” or
“Us.”





The accompanying interim condensed
consolidated financial statements of Southwall Technologies Inc. (“Southwall” or
the “Company”) are unaudited and have been prepared in accordance with
accounting principles generally accepted in theUnited States of Americafor interim financial information and
with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, certain information and footnote disclosure normally included in
financial statements prepared in accordance with accounting principles generally
accepted in theUnited
States of Americahave been
condensed or omitted. In the opinion of management, the unaudited condensed
consolidated financial statements reflect all adjustments, consisting only of
normal recurring adjustments, considered necessary to present fairly the
financial position, results of operations and cash flows of Southwall and its
subsidiaries for all periods presented. The year-end consolidated balance sheet
data was derived from audited financial statements, but does not include all
disclosures required by accounting principles generally accepted in theUnited States of
America. The Company
suggests that these condensed consolidated financial statements be read in
conjunction with the consolidated financial statements and notes thereto
contained in the Company's Form 10-K for the year endedDecember 31, 2007filed with the Securities and Exchange
Commission onMarch 31,
2008. The results of
operations for the interim periods presented are not necessarily indicative of
the operating results to be expected for any future periods.





The preparation of consolidated
financial statements in conformity with accounting principles generally accepted
in the United States requires management to make estimates and assumptions,
based on all known facts and circumstances that affect the reported amounts of
assets and liabilities, disclosure of contingent assets and liabilities at the
date of consolidated financial statements and the reported amounts of revenues
and expenses during the periods.  Management makes these estimates
using the best information available at the time of the
estimates.  The estimates included in preparing our financial
statements include:  the accrual for product returns and warranties,
allowance for doubtful accounts, quarterly taxes, inventory valuations
(including reserves for excess and obsolete and impaired inventories), reserves
for decommissioning costs associated with leasehold asset retirement obligations
and valuation of stock-based compensation.  Actual results could
differ from those estimates.





6
 Table of Contents





Note
2–Fair Value Measurement – Cash and Cash Equivalents:





Southwallinvests its excess cash primarily in
money market funds.  We utilize the market approach to measure fair
value of our financial assets





All cash
equivalents and marketable securities are classified as available-for-sale and
are summarized as follows:





March
      31, 2008Fair Value
            
            
            Book Value
            
            
            Unrealized
      Gain, netMoney
      Market funds, Level 1
            
            $
            300
            
            
            $
            300
            
            
            $
            -Money
      Market funds, Level 1
            
            
            1,700
            
            
            
            1,700
            
            
            
            -Total
      cash equivalents and marketable securities
            
            
            2,000
            
            
            
            2,000
            
            
            
            -Cash
            
            
            2,362
            
            
            
            2,362
            
            
            
            -Total
      cash, cash equivalents and marketable securities
            
            $
            4,362
            
            
            $
            4,362
            
            
            $
            -December
      31, 2007Fair Value
            
            
            Book Value
            
            
            Unrealized
      Gain, netMoney
      Market funds, Level 1
            
            $
            400
            
            
            $
            400
            
            
            $
            -Money
      Market funds, Level 1
            
            
            4,682
            
            
            
            4,682
            
            
            
            -Total
      cash equivalents and marketable securities
            
            
            5,082
            
            
            
            5,082
            
            
            
            -Cash
            
            
            1,410
            
            
            
            1,410
            
            
            
            -Total
      cash, cash equivalents and marketable securities
            
            $
            6,492
            
            
            $
            6,492
            
            
            $
            -









Level 1
              -
              Inputs are quoted prices in
      active markets for identical assets or
  liabilities.
 Level 2
              -
              Inputs are quoted prices for
      similar assets or liabilities in an active market, quoted prices for
      identical or similar assets or liabilities in markets that are not active,
      inputs other than quoted prices that are observable and
      market-corroborated inputs which are derived principally from or
      corroborated by observable market
  data.
 Level 3
              -
              Inputs are derived from valuation
      techniques in which one or more significant inputs or value drivers are
      unobservable.




Note 3—Inventories,
Net:





Inventories are stated at the lower of
cost (determined by the average cost method) or market. Cost includes materials,
labor and manufacturing overhead. The Company establishes provisions for excess
and obsolete inventories to reduce such inventories to their estimated net
realizable value. Such provisions are charged to cost of revenues. AtMarch 31, 2008andDecember 31, 2007, inventories consisted of the
following:








March
      31,
            
            
            December
      31,2008
            
            
            2007Raw
      materials
            
            $
            3,719
            
            
            $
            3,076Work-in-process
            
            
            1,702
            
            
            
            787Finished
      goods
            
            
            1,820
            
            
            
            1,777$
            7,241
            
            
            $
            5,640





Note 4--Net Income Per
Share:





Basic net
income per share is computed by dividing net income attributable to common
stockholders (numerator) by the weighted average number of common shares
outstanding (denominator) for the period. Diluted net income per share gives
effect to all dilutive common shares potentially outstanding during the period,
including stock options, warrants to purchase common stock and convertible
preferred stock.




The
Company excludes options from the computation of diluted weighted average shares
outstanding if the exercise price of the options is greater than the average
market price of the shares because the inclusion of these options would be
anti-dilutive to earnings per share. The Company also excludes preferred
shares convertible into common stock from the computation of diluted weighted
average shares outstanding, per Statement of Financial Accounting Standard
(“SFAS”) 128, “Earnings Per Share”, when the effect would be
antidilutive.





7
 Table of Contents





For the
first quarter of 2008, there were 5,667 options outstanding of which 2,991 were
excluded from the dilutive net income per share calculation, as they were
anti-dilutive because the option prices were higher than the average market
value during the three-month period ended March 31, 2008.  In net loss
periods, the basic and diluted weighted average shares of common stock and
common stock equivalents are the same because inclusion of common stock
equivalents would be anti-dilutive.





The
Company has accrued a deemed dividend on preferred stock of $122 for each period
in the  three-month periods ended March 31, 2008 and March 31,
2007.  Per SFAS 128, the dilutive effect of convertible securities
shall be reflected in diluted EPS by application of the if-converted method.
Under this method, if an entity has convertible preferred stock outstanding, the
preferred dividends applicable to convertible preferred stock shall be added
back to the numerator unless their effect is antidilutive. For the three month
period ended March 31, 2007, both the Series A Preferred shares and the
preferred deemed dividend had an antidilutive effect and therefore, were
excluded from the denominator and numerator in the calculation of diluted EPS in
the table below.  Tables
summarizing net income attributable to common stockholders, for diluted net
income per share, and shares outstanding are shown below:





Three months
      endedMarch 31,
            
            
            March 31,2008
            
            
            2007Net income attributable to common
      stockholders-basic
            
            $
            1,923
            
            
            $
            110Add:  Deemed dividend on
      preferred stock
            
            
            122
            
            
            
            -Net income attributable to common
      stockholders-diluted
            
            $
            2,045
            
            
            $
            110Weighted average common shares
      outstanding-basic
            
            
            27,820
            
            
            
            27,139Dilutive effect of
      warrants
            
            
            355
            
            
            
            354Dilutive effect of Series A
      preferred shares
            
            
            4,893
            
            
            
            -Dilutive effect of stock
      options
            
            
            452
            
            
            
            73Weighted average common shares
      outstanding – diluted
            
            
            33,520
            
            
            
            27,566Basic EPS
            
            $
            0.07
            
            
            $
            0.00Diluted EPS
            
            $
            0.06
            
            
            $
            0.00








Note 5 – Product
Reporting:





The total net revenues for the
automotive glass, window film, architectural and electronic display product
lines for the three month periods endedMarch 31, 2008andMarch 31, 2007were as follows:





Three
      months endedMarch
      31,
            
            
            March
      31,2008
            
            
            2007Automotive
      glass
            
            $
            5,969
            
            
            $
            3,866Window
      film
            
            
            2,956
            
            
            
            2,993Architectural
            
            
            1,522
            
            
            
            1,537Electronic
      display
            
            
            123
            
            
            
            2,109Total
      net revenues
            
            $
            10,570
            
            
            $
            10,505




8
 Table of Contents





The following is a summary of net
revenues by geographic area (based on the location of the Company's customers)
for the three month periods endedMarch 31, 2008and March 31, 2007:





Three
      months endedMarch
      31,
            
            
            March
      31,2008
            
            
            2007United
      States
            
            $
            2,406
            
            
            $
            2,374Europe:
      France, Germany
            
            
            4,209
            
            
            
            2,154Asia
      Pacific: Japan, Pacific Rim
            
            
            2,159
            
            
            
            4,692Rest
      of the world
            
            
            1,796
            
            
            
            1,285Total
      net revenues
            
            $
            10,570
            
            
            $
            10,505








Note 6--Commitments and
Contingencies:





Commitments





On
January 19, 2006, we commenced restructuring actions to attempt to improve our
cost structure for 2006 and beyond.  These actions included the
closure of our Palo Alto, California manufacturing facility during
2006.  We accrued $1,509 for the closure of our manufacturing facility
and an additional $153 in the fourth quarter of 2007 as a leasehold asset
retirement obligation in connection with the surrender of our manufacturing
facility to the landlord.  In January 2008, a $1,000 letter of credit
and $100 cash security deposit were released to the landlord, and in February
2008, we entered into a settlement agreement with the landlord under which we
paid the landlord an additional $400, thereby releasing us from any further rent
or building restoration obligations under the lease for that specific
manufacturing facility, leaving only environmental related costs to be
incurred.  The remaining accrued obligation of $153 represents
additional environmental sampling costs and legal fees estimated to be incurred
in 2008.





In
January 2006, the Company renewed a lease agreement for its research and
development facility.  Under this lease agreement, the Company accrued
$200 as a current leasehold retirement obligation in the first quarter of
2006.  In the fourth quarter of 2007, the Company increased the
accrual to $500, which is included in other accrued liabilities in the
accompanying consolidated balance sheet.  The method and timing of
payments are not yet finalized and therefore, this estimate of our liability
could differ from the actual future settlement amount.





Contingencies





The Company is involved in certain other
legal actions arising in the ordinary course of business. The Company believes,
however, that none of these actions, either individually or in the aggregate,
will have a material adverse effect on its business, consolidated financial
position, results of operations or cash flows.





Note 7--Stock-Based
Compensation:





The
Company has a stock-based compensation program that provides its Board of
Directors broad discretion in creating employee equity incentives. The Company
has granted stock options under various option plans and agreements in the past
and currently grants stock options under the 2007 Long Term Incentive Plan which authorizes the granting of up to
10,000 shares of Common Stock. Under the terms of this plan, the Company can
grant both Incentive Stock Options and Nonstatutory Stock
Options.  Grants issued under the 2007 plan vest and become
exercisable at a rate of 25% on each anniversary of the date of grant and become
fully vested on the fourth anniversary of the date of grant provided that the
participant remains an employee or service provider of the Company or a related
company.  Each option granted under the plan is non-transferable and
expires over terms not exceeding ten years from the date of grant or 30 days
after an option holder’s voluntary termination from the Company.  If
an option holder’s employment is terminated involuntarily for misconduct, the
option will terminate immediately and may no longer be
exercised.  Involuntary termination not for misconduct allows for the
option holder to exercise options within a period of three months after such
termination of service occurs.  The plan provides for longer
expiration periods for employees who terminate but who were employed with the
Company in excess of five years.  Pursuant to the provisions set forth
in the 2007 Plan, the option expiration will be extended anywhere from three
months to one year, dependent upon the employee’s years of
service.  These provisions apply to options that expire as the result
of involuntary termination not for misconduct. As of March 31, 2008, there
were 8,837 shares of common stock available for grant under the 2007 stock
option plan.





9
 Table of Contents





On
January 1, 2006, the Company adopted the provisions of SFAS 123R, “Share-Based
Payment” (SFAS 123R), requiring it to recognize expense related to the fair
value of its stock-based compensation awards.  The Company elected to
use the modified prospective transition method as permitted by SFAS 123R and
therefore has not restated its financial results for prior
periods.  Stock-based compensation expense for awards granted prior to
January 1, 2006 was based on the fair value estimated in accordance with SFAS
123, “Accounting for Stock-based Compensation.”  Stock-based
compensation expensed for all stock-based compensation awards granted subsequent
to January 1, 2006 was based on the grant-date fair value estimated in
accordance with the provisions of SFAS 123R.  The Company recognized
compensation expense for stock option awards on a graded vesting basis over the
requisite service period of the award.








The
following table sets forth the total stock-based compensation expense resulting
from stock options included in the condensed consolidated statements of
operations:





Three
      months endedMarch
      31,
            
            
            March
      31,2008
            
            
            2007Cost
      of sales
            
            $
            2
            
            
            $
            1Research
      and development
            
            
            13
            
            
            
            27Selling,
      general and administrative
            
            
            33
            
            
            
            85Stock-based
      compensation expense before income taxes
            
            
            48
            
            
            
            113Income
      tax benefit
            
            
            -
            
            
            
            -Total
      stock-based compensation expense after income taxes
            
            $
            48
            
            
            $
            113





There
were no exercises of stock options for the three- month period ended March 31,
2008 and March 31, 2007.  In accordance with SFAS 123R, the Company
presents excess tax benefits from the exercise of stock options, if any, as
financing cash flows rather than operating cash flows.





The fair
value of stock-based awards was estimated using the Black-Scholes model with the
following weighted-average assumptions for the three month periods ended March
31, 2008 and March 31, 2007, respectively:




Three
      months endedMarch
      31,
            
            
            March
      31,2008
            
            
            2007Expected
      life (in years)
            
            
            5.7
            
            
            
            6.0Risk-free
      interest rate
            
            
            3.07
            %
            
            
            4.71
            %Volatility
            
            
            81
            %
            
            
            80
            %Dividend
            
            
            -
            
            
            
            -Per
      share weighted-average fair value at grant date
            
            $
            0.51
            
            
            $
            0.33




10
 Table of Contents





The
Company’s computation of expected volatility was based on historical volatility.
The Company’s computation of expected life was based on historical exercise
patterns. The interest rate for periods within the expected life of the award is
based on the U.S. Treasury yield in effect at the time of grant.




Stock
option activity for the three months ended March 31, 2008 was as
follows:





Shares
            
            
            Weighted-Average
              Exercise Price
            
            
            Weighted-Average
              Remaining
              Contractual
      Term
              (in years)
            
            
            Aggregate
              Intrinsic ValueOutstanding
      at December 31, 2007
            
            
            5,209
            
            
            $
            1.08Grants
            
            
            1,023
            
            
            
            0.84Exercises
            
            
            -
            
            
            
            -Forfeitures
      or expirations
            
            
            (565
            )
            
            
            2.27Outstanding
      at March 31, 2008
            
            
            5,667
            
            
            $
            0.92
            
            
            
            6.79
            
            
            $
            628Vested
      and expected to vest at March 31, 2008
            
            
            4,474
            
            
            $
            0.99
            
            
            
            6.18
            
            
            $
            487Exercisable
      at March 31, 2008
            
            
            3,248
            
            
            $
            1.09
            
            
            
            5.06
            
            
            $
            361





The
aggregate intrinsic value in the table above represents the total pretax
intrinsic value (i.e.: the difference between Southwall’s closing stock price on
the last trading day of its first quarter of fiscal 2008 and the exercise price,
times the number of shares) that would have been received by the option holders
had all option holders exercised their options on March 31,
2008.  This amount changes based on the fair market value of
Southwall’s stock. Total intrinsic value of options exercised was zero for the
three month period ended March 31, 2008. Total fair value of options granted was
$520 for the three month period ended March 31, 2008.




As of
March 31, 2008, $560 of total unrecognized compensation cost, net of
forfeitures, related to stock options was expected to be recognized over a
weighted-average period of approximately 2.93 years.




Note 8 - Warranties:





The Company establishes a reserve for
sales returns and warranties for specifically identified, as well as anticipated
sales returns and warranties based on experience. The activity in the reserve
for sales returns and warranties account during the three month periods endedMarch 31, 2008andMarch 31, 2007was as follows:




Balance
      at
              December
      31,
              2006
            
            
            Provision
            
            
            Utilized
            
            
            Balance
      at
              March
      31,
              2007Accrued
      sales returns and warranty
            
            $
            1,415
            
            
            $
            (305
            )
            
            $
            (262
            )
            
            $
            848Balance
      at
              December
      31,
              2007
            
            
            Provision
            
            
            Utilized
            
            
            Balance
      at
              March
      31,
              2008Accrued
      sales returns and warranty
            
            $
            1,102
            
            
            $
            202
            
            
            $
            (179
            )
            
            $
            1,125




These
amounts are included in other accrued liabilities in the condensed consolidated
balance sheets.





11
 Table of Contents





Note 9 – Comprehensive
Income:





The Company has adopted the provisions
of SFAS No. 130 "Reporting Comprehensive Income". SFAS 130 establishes
standards for reporting and display in the financial statements of total net
income and the components of all other non-owner changes in equity, referred to
as comprehensive income. Accordingly, the Company has reported the translation
gain from the consolidation of its foreign subsidiary in comprehensive
income.





The components of comprehensive incomefor the three month periods
endedMarch 31,
2008andMarch 31, 2007were as follows:





Three
      months endedMarch
      31,
            
            
            March
      31,2008
            
            
            2007Foreign
      Currency Translation Adjustment
            
            $
            986
            
            
            $
            17Net
      Income
            
            
            2,045
            
            
            
            232Other
      Comprehensive Income
            
            $
            3,031
            
            
            $
            249






The components of accumulated other
comprehensive income were as follows at March 31, 2008:




Accumulated
      Other Comprehensive Income at December 31, 2007
            
            $
            4,776Foreign
      Currency Translation Adjustment
            
            
            986Accumulated
      Other Comprehensive Income at March 31, 2008
            
            $
            5,762




Note
10 - Income Tax:





The
decrease in the provision for income taxes in the three months ended March 31,
2008 compared to the same period in 2007 is primarily related to lower taxable
income in 2007 in our foreign subsidiary, Southwall Europe GmbH, or
SEG.





For the
three months ended March 31, 2008, the Company’s effective tax rate was
5.25%.  This rate differs from the statutory federal rate of 35%
primarily due to the impact of the benefit received from a reduction of the
valuation allowance on the Company’s deferred tax asset due to the current year
U.S. income.  The amount of this reduction is approximately $658 or
30.48%.





For the
three months ended March 31, 2007, the Company’s effective tax rate was a
provision of 43.80%.  This rate differs from the statutory federal
rate of 35% primarily due to applying a full valuation allowance on the U.S.
deferred tax asset created by the U.S. losses incurred through the first three
months of 2007.  The amount of the charge related to this increase in
valuation allowance was approximately $75 or 18.2%.  While the Company
had a worldwide profit before tax of $413 through March 31, 2007, a full
valuation allowance was applied against the U.S. tax benefit that results from
losses incurred in the U.S. of $212.  Additionally, the Company had a
benefit related to the foreign rate differential with respect to the German tax
expense as compared to the U.S. statutory rate.  This benefit was
9.13% and primarily related to benefits associated with tax subsidies received
from the German government resulting from research and development efforts in
Germany and benefits received as a result of additional investments in our
German manufacturing facilities.





12
 Table of Contents





The
following table represents the reconciliation of the statutory federal income
tax to the Company's effective tax rate:





Three
      Months Ended
            
            
            Three
      Months EndedMarch
      31, 2008
            
            
            March
      31, 2007Federal
      Statutory Rate
            
            
            35.00
            %
            
            
            35.00
            %Permanent
      Items
            
            
            0.03
            %
            
            
            0.39
            %R&D
      Credit
            
            
            0.00
            %
            
            
            (0.66
            %)Foreign
      Rate Differential
            
            
            (1.16
            %)
            
            
            (9.13
            %)Change
      in Valuation  Allowance
            
            
            (30.48
            %)
            
            
            18.20
            %Other
            
            
            1.86
            %
            
            
            0.00
            %Effective
      Tax Rate
            
            
            5.25
            %
            
            
            43.80
            %




Note
11 – Recent Accounting Pronouncements:





In
February 2008, the FASB issued FASB Staff Position No. FAS 157-2, “Effective
Date of FASB Statement No. 157” (“FSP 157-2”), to partially defer FASB Statement
No. 157, “Fair Value Measurements” (“FAS 157”).  FSP 157-2 defers the
effective date of FAS 157 for nonfinancial assets and nonfinancial liabilities,
except those that are recognized or disclosed at fair value in the financial
statements on a recurring basis (at least annually), to fiscal years, and
interim periods within those fiscal years, beginning after November 15,
2008.  We are currently evaluating the impact of adopting the
provisions of FSP 157-2.




In February2007, the FASB issued Statement No.
159, “The Fair Value Option for Financial Assets and Financial Liabilities,
Including an Amendment of FASB Statement No. 115” (SFAS 159).  This
statement allows entities to elect to measure many financial instruments and
certain other items that are similar to financial instruments at fair value that
are not currently required to be measured at fair value.  The election
is made on an instrument-by-instrument basis and is irrevocable.  If
the fair value option is elected for an instrument, the statement specifies that
all subsequent changes in fair value for that instrument shall be reported in
earnings.  Upon initial adoption, this statement provides entities
with a one-time chance to elect the fair value option for the eligible
items.  The effect of the first measurement to fair value should be
reported as a cumulative-effect adjustment to the opening balance of retained
earnings (cumulative deficit) in the year the statement is
adopted.  SFAS 159 was effective for the Company beginning January 1,
2008.  The Company did not make any elections for fair value
accounting and therefore, it did not record a cumulative-effect adjustment to
its opening deficit balance.








Item 2--Management's
Discussion and Analysis of Financial Condition and Results of Operations (in
thousands):





The following discussion and analysis of
our financial condition and results of operations should be read in conjunction
with our unaudited condensed consolidated financial statements and notes thereto
appearing elsewhere in this report. This discussion and analysis contains
forward-looking statements that involve risks and uncertainties, including those
discussed below under "Forward-Looking Statements" and "Risk Factors”, set forth
in Part I, Item 1A, of our Annual Report on Form 10-K for the year endedDecember 31,
2007and in Part II, Item
1A of our Quarterly Report on Form 10-Q for the quarter endedMarch 31, 2008. You should not place undue reliance on
these forward-looking statements. Actual results may differ materially from
those anticipated in the forward-looking statements. These forward-looking
statements represent our judgment as of the date of the filing of this
Form 10-Q.





13
 Table of Contents





Forward
Looking Statements





Cautionary Statement For the Purpose of
the “SafeHarbor”Provisionsof the Private Securities Litigation
Reform Act of 1995





As used in this report, the terms "we,"
"us," "our," "Southwall" and the "Company" mean Southwall Technologies Inc.
and its subsidiaries, unless the context indicates another meaning.This
report contains forward-looking statements as that term is defined in the
Private Securities Litigation Reform Act of 1995 that are subject to a number of
risks and uncertainties. All statements other than statements of historical
facts are forward-looking statements. These statements are identified by
terminology such as "may," "will," "could," "should," "expects," "plans,"
"intends," "seeks," "anticipates," "believes," "estimates," "potential," or
"continue," or the negative of such terms or other comparable terminology, or
similar terminology, although not all forward-looking statements contain these
identifying words. Forward-looking statements are only predictions and include,
without limitation, statements relating to:





·
            our
      strategy, future operations and financial plans
  ;





·
            our
      revenue expectations;





·
            our
      expected results of operation and cash
flows;





·
            the
      continued trading of our common stock on the Over-the-Counter Bulletin
      Board Market;





·
            future
      applications of thin film coating
technologies;





·
            our
      development of new technologies and products; including the early stage of
      our development of products for use in solar power
    generation;





·
            the
      properties and functionality of our
products;





·
            our
      expectation for the continued decline in our sales of electronic display
      products due to increased price sensitivity in this
  market;





·
            our
      expectations for future grants, investment allowances and bank guarantees
      from local and federal governments in
Germany;





·
            our
      projected need for additional borrowings and future
    liquidity;





·
            our ability to implement and
      maintain effective internal controls and
  procedures;





·
            size
      of and the markets into which we sell or intend to sell our
      products;





·
            our
      intentions to pursue strategic alliances, acquisitions and business
      transactions;





·
            the
      possibility of patent and other intellectual property
      infringement;





14
 Table of Contents





·
            our
      opinions regarding energy consumption and the loss of energy through
      inefficient glass;





·
            pending
      and threatened litigation and its
outcome;





·
            our
      competition; and





·
            our
      projected capital expenditures.





You
should not place undue reliance on our forward-looking statements. Actual events
or results may differ materially. In evaluating these statements, you should
specifically consider various factors, including the risks outlined under "Risk
Factors" below. These and other factors may cause our actual results to differ
materially from any forward-looking statement. Although we believe the
expectations reflected in our forward-looking statements are reasonable as of
the date they are being made, we cannot guarantee our future results, levels of
activity, performance or achievements. Moreover, we do not assume any
responsibility for the future accuracy and completeness of these forward-looking
statements.





XIR®, XUV®, Triangle Design®, Superglass®, Heat Mirror®, California Series®,Solis®, ETCH-A-FLEX®, and Southwall®are registered trademarks of Southwall.
V-KOOL®is a registered trademark of V-Kool
International Holdings Pte. Ltd.  All other trade names and trademarks
referred to in this Quarterly Report on Form 10-Q are the property of their
respective owners.




Overview





We are a
global developer, manufacturer and marketer of thin film coatings on flexible
substrates for the automotive glass, architectural glass, window film and
electronic display markets. We have developed a variety of products that control
sunlight in automotive glass, reduce light reflection, reduce electromagnetic
radiation and improve image quality in electronic display products and conserve
energy in architectural products. Our products consist of transparent
solar-control films for automotive glass; transparent conductive films for use
in touch screen, liquid crystal displays and plasma displays; energy control
films for architectural glass; and various other coatings.





Restructuring.On
January 19, 2006, we commenced restructuring actions to attempt to improve our
cost structure for 2006 and beyond.  These actions included the
closure of our Palo Alto, California manufacturing facility during
2006.  We accrued $1,509 for the closure of our manufacturing facility
and an additional $153 in the fourth quarter of 2007 as a leasehold asset
retirement obligation in connection with the surrender of our manufacturing
facility to the landlord.  In January 2008, a $1,000 letter of credit
and $100 cash security deposit were released to the landlord, and in February
2008, we entered into a settlement agreement with the landlord under which we
paid the landlord an additional $400, thereby releasing us from any further rent
or building restoration obligations under the lease for that specific
manufacturing facility, leaving only environmental related costs to be
incurred.  The remaining accrued obligation of $153 represents
additional environmental sampling costs and legal fees estimated to be incurred
in 2008.





In
January 2006, the Company renewed a lease agreement for its research and
development facility.  Under this lease agreement, the Company accrued
$200 as a current leasehold retirement obligation in the first quarter of
2006.  In the fourth quarter of 2007, the Company increased the
accrual to $500, which is included in other accrued liabilities in the
accompanying consolidated balance sheet.  The method and timing of
payments have not yet been finalized, and therefore, this estimate of our
liability could differ from the actual future settlement amount.




Demand for our
customers' products.We
derive significant benefits from our relationships with a few large customers
and suppliers. Our revenues and gross profit can increase or decrease rapidly,
reflecting underlying demand for the products of one or a small number of our
customers. We may also be unable to replace a customer when a relationship ends
or demand for our product declines as a result of evolution of our customers'
products.





15
 Table of Contents





Our three largest customers in the
automotive glass and window film market, and architectural glass markets include
PilkingtonPLC, Saint Gobain Sekurit and Globamatrix
Holdings Pte. Ltd., or Globamatrix, which collectively accounted for
approximately 68%, 60% and 45% of our total revenues during the first three
months of 2008, 2007 and 2006, respectively.





Under our agreement with Globamatrix, as
amended, Globamatrix agreed to a 2004 minimum purchase commitment of $9,000 of
product.For each year after 2004
through the term of the contract, Globamatrix is required to purchase an amount
of product equal to 110% of the amount of product it was required to purchase in
the prior year. Globamatrix is obligated topurchase $13,000of certain products in 2008. During the
first three months of 2008, Globamatrix purchased approximately $3,000of theseproducts.





Sales returns and
allowances.Our
gross margins and profitability have been adversely affected from time to time
by product quality claims.  During the three months of 2008,
our rate of sales returns and allowances averaged approximately 1.9 %
of our gross revenues over a rolling twelve month period.From 2003 to
2007, our sales returns provision has averaged approximately 2.8% of gross
revenues.





Joint
Venture.OnApril 8, 2008, Southwall IG Holdings, Inc., a wholly
owned subsidiary of Southwall Technologies Inc. entered into a Joint Venture
Agreement with Sound Solutions Window & Doors, LLC; creating Southwall
Insulating Glass, LLC.  Southwall Technologies Inc. has a 50% interest
in the newly formed entity.  Southwall Insulating Glass, LLC will
manufacture insulated glass units for the domestic
market.





Critical
Accounting Policies and Estimates





The
accompanying discussion and analysis of our financial condition and results of
operations are based upon our condensed consolidated financial statements, which
have been prepared in accordance with generally accepted accounting principles
in the United States (U.S. GAAP). The preparation of these financial statements
requires us to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, and related disclosure of contingent
assets and liabilities. These estimates form the basis for making judgments
about the carrying values of assets and liabilities that are not readily
apparent from other sources. We base our estimates and judgments on historical
experience and on various other assumptions that we believe are reasonable under
the circumstances. However, future events cannot be forecasted with certainty,
and the best estimates and judgments routinely require adjustment. We are
required to make estimates and judgments in many areas, including those related
to:  the accrual for
product returns and warranties, allowance for doubtful accounts, quarterly
taxes, inventory valuations (including reserves for excess and obsolete and
impaired inventories), reserves for decommissioning costs associated with
leasehold asset retirement obligations and valuation of stock-based
compensation. We believe the policies disclosed are the most critical to
our financial statements because their application places the most significant
demands on management’s judgment. Senior management has discussed the
development, selection and disclosure of these estimates with the Audit
Committee of our Board of Directors.





We
believe there have been no significant changes during the first three months of
fiscal 2008 to the items that we disclosed as our critical accounting policies
and estimates in our discussion and analysis of financial condition and results
of operations in our 2007 Form 10-K.





16
 Table of Contents





Three Months EndedMarch 31, 2008compared with Three Months EndedMarch 31,
2007





Results of Operations (in
thousands)





Net revenues.Our net revenues for the
quarter endedMarch 31,
2008andMarch 31, 2007were $10,570 and $10,505, respectively. The
largest component of the revenue was our automotive product
line.





Our net revenues in the automotive
market increased by $2,103,or 54%, to $5,969 compared to $3,866 for the first quarter endedMarch 31, 2008and 2007, respectively. The increase
was primarily due to increased demand by several of our large customers, and to
a lesser extent the impact of the USD to Euro exchange rate.





Our net revenues in the window film
product line decreased $37, or 1.2%, to $2,956 from $2,993 in the first quarter
endedMarch 31,
2008and 2007,
respectively.  This was primarily due to the seasonality of the window
film business.





Our net revenues in architectural
products decreased $15, or 1%, to$1,522 from $1,537 inthe first quarter endedMarch 31, 2008and 2007, respectively.  This
was primarily due to a decline in sales to the European market, partially offset
by strong sales results inNorth America.





The one market with a significant
decline in revenue was our electronic display products, where sales decreased by
$1,986,or 94.2%, to $123 compared to$2,109 for the first quarter endedMarch 31, 2008and 2007, respectively.  This
decrease was due to the loss of a major customer, Mitsui, and the Company’s
decision not to pursue the plasma display panel market due to the intensively
price competitive market for those products.  Unless pricing for those
products improves, it is likely that the Company will not make significant
future sales of plasma display panels.





Cost of
revenues.Cost of revenues
consists of materials, labor and manufacturing overhead and subcontractor
services. Cost of revenues was $5,719 in the first quarter endedMarch 31, 2008compared to $6,095 for the same period of
2007.  The decrease in cost of revenues was primarily due to a 21% increase
in production volume in the first quarter of 2008, contributing to lower product
costs per square meter produced.





Gross profit and
gross margin.Our gross
profit increased $441 to $4,851 compared to $4,410 for the first quarter endedMarch 31, 2008and 2007 respectively.  As a
percentage of sales, gross profit increased to 45.9% compared to 42.0% for the
first quarter endedMarch
31, 2008and 2007,
respectively.  This was due to lower product costs in the first
quarter of 2008, which were the result of an increase in production volume
associated with increased customer demand for automotive products. Other factors
contributing to the increase in gross margin were improved yields in our window
film product line and credits received relating to the recycling of precious
metals used in the manufacturing process.





Operating expenses




Research and
development. Research and
development expenses decreased $660, or 48.2%, to $709 comparedto $1,369forthe first quarter endedMarch 31, 2008and 2007, respectively. This decrease
was primarily due to a combination of a reduction in the number of employees,
lower usage of outside service providers and lower material costs.  In
addition, in the fourth quarter of 2007, the Company initiated several customer
funded development projects and continued to engage customers in similar
projects in the first quarter of 2008.  The fees paid by customers for
these projects offsets research and development costs.  Until all
products and services are delivered to the customers pursuant to the terms set
forth in the respective development agreements, all credits to research and
development expense are deferred.  Upon satisfaction of the agreement
terms, the credits are recognized on a project by project
basis.





17
 Table of Contents





Selling, general and
administrative. Selling,
general and administrative expenses consist primarily of corporate and
administrative overhead, selling commissions and occupancy costs. Selling,
general and administrative expenses decreased $491 to $2,038 compared to $2,529
for the first quarter endedMarch 31, 2008and 2007, respectively.  This
decrease was primarily due to a reduction in the number of employees in the
first quarter of 2008 as compared to the same period in 2007 and to a lesser
extent, the elimination of rent payments associated with our manufacturing
facility inPalo
Alto,California.





Income from
operations.  Income from operations
improved $1,584, or 304%, to $2,104 compared to $520 for the first quarter endedMarch 31, 2008and 2007, respectively.  This
improvement was primarily due to improved gross profit margins and lower
operating costs.





Interest expense,
net.Interest expense from
the first quarter endedMarch 31, 2008to the same period in 2007 remained
materially unchanged.





Other income,
net.   Other income, net mainly reflects foreign exchange
transaction gains and losses in the first quarter of 2008 and 2007. Some of
our transactions with foreign customers are denominated in foreign currencies,
principally the Euro. As exchange rates fluctuate relative to the U.S. dollar,
exchange gains and losses occur. Other income increased$187 to $193 mainly due to exchange
gains from currency fluctuations.





Income before provision for income
taxes.  Pre-tax
income increased $1,745, or 423%, to $2,158 in the first quarter of 2008
compared to $413 for the first quarter endedMarch 31, 2007. This increase was primarily due to a
significant increase in operating income resulting from higher gross profit
margins, lower operating expenses and favorable foreign exchange rate
variances.





Provision for income
taxes.The decrease in the
provision for income taxes in the three months ended March 31, 2008 compared to
the same period in 2007 is primarily related to lower taxable income in 2007 in
our foreign subsidiary, Southwall Europe GmbH, or SEG.





For the
three months ended March 31, 2008, the Company’s effective tax rate was
5.25%.  This rate differs from the statutory federal rate of 35%
primarily due to the impact of the benefit received from a reduction of the
valuation allowance on the Company’s deferred tax asset due to the current year
U.S. income.  The amount of this reduction is approximately $658 or
30.48%.





For the
three months ended March 31, 2007, the Company’s effective tax rate was a
provision of 43.80%.  This rate differs from the statutory federal
rate of 35% primarily due to applying a full valuation allowance on the U.S.
deferred tax asset created by the U.S. losses incurred through the first three
months of 2007.  The amount of the charge related to this increase in
valuation allowance was approximately $75 or 18.2%.  While the Company
had a worldwide profit before tax of $413 through March 31, 2007, a full
valuation allowance was applied against the U.S. tax benefit that results from
losses incurred in the U.S. of $212.  Additionally, the Company had a
benefit related to the foreign rate differential with respect to the German tax
expense as compared to the U.S. statutory rate.  This benefit was
9.13% and primarily related to benefits associated with tax subsidies received
from the German government resulting from research and development efforts in
Germany and benefits received as a result of additional investments in our
German manufacturing facilities.





18
 Table of Contents





The
following table represents the reconciliation of the statutory federal income
tax to the Company's effective tax rate:





Three
      Months Ended
            
            
            Three
      Months EndedMarch
      31, 2008
            
            
            March
      31, 2007Federal
      Statutory Rate
            
            
            35.00
            %
            
            
            35.00
            %Permanent
      Items
            
            
            0.03
            %
            
            
            0.39
            %R&D
      Credit
            
            
            0.00
            %
            
            
            (0.66
            %)Foreign
      Rate Differential
            
            
            (1.16
            %)
            
            
            (9.13
            %)Change
      in Valuation  Allowance
            
            
            (30.48
            %)
            
            
            18.20
            %Other
            
            
            1.86
            %
            
            
            0.00
            %Effective
      Tax Rate
            
            
            5.25
            %
            
            
            43.80
            %




Deemed dividend on
preferred stock.We accrued
$122 of deemed dividend on preferred stock in the first three months of 2008 and
2007, respectively.  The holders of our secured convertible promissory
notes converted those notes to shares of Series A preferred stock in December
2004. The Series A Preferred Stock accrues cumulative dividends at the rate of
10% per annum.




Liquidity and capital
resources.





Liquidity




Our principal liquidity requirements are
for working capital, consisting primarily of accounts receivable and
inventories, for debt repayments and capital expenditures. We believe that
because of the production cycle of certain of our products, our inventories will
continue to represent a significant portion of our working
capital.





Our cash and cash equivalents decreased
$2,130 from $6,492 atDecember 31, 2007to $4,362 atMarch 31, 2008. Cash used in operating activities of
$1,997 for the first three months of 2008 was primarily the result of an
increase in accounts receivable of $4,099, an increase in inventories of $1,601
offset by net income of $2,045,non-cash depreciation of $746, non-cash
stock compensation expense of $48, a decrease in other current and non current
assets of $790 and an increase in accounts payable and accrued liabilities of
$74. The Company’s Days Sales Outstanding (“DSO”) increased from 45 days at
December 31, 2007 to 71 days for the three month period ending March 31,
2008.  Accelerated collections in the fourth quarter of fiscal 2007
contributed to a low DSO at December 31, 2007.  The increase in DSO in
the first quarter of 2008 is primarily due to a few payment delays, subsequently
collected in April 2008.  The payment delays are not indicative of
collection problems.The Company’s standard payment termsoffered to customers range
fromnet 45 to net 60
days.Absent
nonrecurring collection issues, as we experienced in the first quarter of 2008,
our DSO would have fallen closer to 60 days.  The Company had no bad
debt write off in the quarter ending December 31, 2007.  The Company
also had no bad debt write off in the three month period ended March 31,
2008.  Cash used in operations for the first three months of 2007 of
$1,475 was primarily the result of an increase in accounts receivable of $1,872,
an increase in inventories of $117, a decrease in deferred revenue of $99, a
decrease in accounts payable and accrued liabilities of $530 partially offset by
net income of $232, non-cash depreciation of $696 and non-cash stock
compensation expense of $113.





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Cash used in investing activities for
the first three months of 2008 was $382 and was primarily the result of capital expenditures.Cash used in investing activities for
the first three months of 2007 was $304 and was primarily due to capital
expenditures.





Cash used in financing activities for
the first three months of 2008 was $293 and was the result of payments on our
borrowings. Net cash used in financing activities for the first three months of
2007 of $263 was primarily the result of payments on our
borrowings.





We
entered into an agreement with the Saxony government in May 1999 under
which we receive investment grants. As of March 31, 2008, we had received grants
of 5,000 Euros or $5,000 at the historical exchange rate and accounted for these
grants by applying the proceeds received to reduce the cost of our fixed assets
in our Dresden manufacturing facility. As of March 31, 2008, all government
grants had been applied for or repaid.





Borrowing
arrangements





The
Company’s loan agreement with Bridge Bank, N.A. expired on March 28,
2008.  At that time, the Company had no amounts outstanding under the
loan agreement.  The Company remained in compliance with all financial
covenants through the expiration of the facilities.  The Company is
currently negotiating a new $3,000 line of credit with another bank to replace
the expired facility with Bridge Bank, N.A..





Capital expenditures





We expect
to spend approximately $1,000 in 2008 on upgrades and refurbishment of our
production machines and research and development tools.We spent approximately$369in capital expenditures during the
first three months of 2008.  In addition, we expect to spend
approximately $550 on manufacturing equipment to be used by Southwall Insulating
Glass, LLC to insert Heat Mirror into insulated glass units during the
manufacturing process.





Future payment
obligations





Our future payment obligations on our
borrowings pursuant to our term debt, non-cancelable operating leases and other
non-cancelable contractual commitments are as follows at March 31,
2008:




Less
              
              
              
              
              
              GreaterThan
              
              
              
              
              
              ThanTotal
              
              1
      Year
              
              1-3
      Years
              
              3-5
      Years
              
              5
      YearsContractual
      Obligations:Term
      debt (1)
              
              $
              9,725
              
              $      1,262
              
              $
              5,103
              
              $      791
              
              $
              2,569Term
      debt Interest (1)
              
              $
              2,228
              
              607
              
              
              667
              
              407
              
              
              547Operating
      leases (2)
              
              $
              1,522
              
              454
              
              
              948
              
              120
              
              
              -Other
      Obligations (3)
              
              $
              1,590
              
              -
              
              
              -
              
              -
              
              
              1,590Total
      contractual cash obligations
              
              $
              15,065
              
              $     2,32323
              
              $
              6,718
              
              $   1,318
              
              $
              4,706




(1)
            Represents
      the principal and interest allocations of loan agreements with Portfolio
      Financing Servicing Company and several German
  banks.





(2)
            Represents the remaining rents
      owed on buildings we rent in Palo Alto,
  California.





(3)
            Represents accumulated dividends
      accrual on Series A 10% cumulative convertible preferred stock (greater
      than five years).





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 Table of Contents





Interest
expense relating to term debt increased for the three month period ending March
31, 2007 to March 31, 2008 from $176 to $209, respectively.  The
reason for the increase is mainly due to fluctuations in the Euro exchange
rate.





As of
March 31, 2008, we maintained 30,174 square feet of office and warehouse space
at 3780-3788 Fabian Way, Palo Alto, California 94303.  The terms of
the leases for these facilities continue through June 30, 2011.  The
monthly rent expense for this facility is $27 through May 31,
2008.  The monthly payment will increase to $28 for the remainder of
2008.  In 2009, the monthly rent payments will increase to $38 and
increase annually at a rate of 3% through the expiration of the
lease.





As of
March 31, 2008, we also had a lease obligation for 9,200 square feet at 3961
East Bayshore Road, Palo Alto, California 94303.  This manufacturing
space is currently being subleased to another party.  The monthly rent
payments for this facility are $9.




Item 3--Quantitative and Qualitative Disclosures about Market
Risk





We are
exposed to the impact of interest rate changes, foreign currency fluctuations,
and changes in the market values of our investments.





Financing
risk: The interest rate on one of our German loans has been reset to the
prevailing market rate of 5.75% and another of our German loans will have its
interest rate reset to the prevailing market rate in 2009. Fluctuations or
changes in interest rates may adversely affect our expected interest expense.
The effect of a 10% fluctuation in the interest rate on our line of credit and
term debt would have had an immaterial effect on our interest expense for the
first three months of 2008.




Investment
risk: We invest our excess cash in money market accounts and, by
practice, make every effort to limit the amount of exposure to any one
institution. Investments in both fixed rate and floating rate interest earning
instruments carry a degree of interest rate risk. Fixed rate securities may have
their fair market value adversely affected due to a rise in interest rates,
while floating rate securities may produce less income than expected if interest
rates fall. The effect of a 10% fluctuation in the interest rate on our excess
cash investments would not have had a material effect on our interest income in
the first three months of 2008.




Foreign currency
risk: International revenues (defined as sales to customers located
outside of the United States) accounted for approximately 77% of our total sales
in the first quarter of 2008. Approximately 66% of our international revenues
were denominated in Euros in the first quarter of 2008. The other 34% of our
international sales were denominated in US dollars. In addition, certain
transactions with foreign suppliers are denominated in foreign currencies. The
effect of a 10% fluctuation in the Euro exchange rate would have had an effect
of approximately $876 on net revenues for the first quarter of
2008.





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 Table of Contents





Item 4-Controls and
Procedures





(a)
            Evaluation
      and Disclosure Controls and Procedures.  Under the
      supervision and with the participation of our management, including our
      Principal Executive Officer and Principal Financial Officer, we conducted
      an evaluation of the effectiveness of the design and operation of our
      disclosure controls and procedures, as defined in Rules 13a-15(e) and
      15d-15(e) under the Securities Exchange Act of 1934, as
      amended.  Based on this evaluation, our Principal Executive
      Officer and Principal Financial Officer concluded as of the end of the
      period covered by this report, that our disclosure controls and procedures
      were effective, such that the information relating to our company,
      including our consolidated subsidiaries, required to be disclosed in our
      Securities and Exchange Commission (“SEC”) reports (i) is recorded,
      processed, summarized and reported with the time periods specified in SEC
      rules and forms, and (ii) is accumulated and communicated to our
      management, including our principal executive officer and principal
      financial officer, as appropriate to allow timely decisions regarding
      required disclosure.




(b)
            Changes
      in Internal Controls.  There were no changes during the
      first three months of 2008 in our internal controls over financial
      reporting that have materially affected, or are reasonably likely to
      materially affect, the internal controls over financial
      reporting.




Internal
control systems, no matter how well designed and operated, have inherent
limitations.  Consequently, even a system which is determined to be
effective cannot provide absolute assurance that all control issues have been
detected or prevented.  Our systems of internal controls are designed
to provide reasonable assurance with respect to financial statement preparation
and presentation.





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 Table of Contents





PART II--OTHER
INFORMATION




Item 1--Legal
Proceedings





We are a party to various pending
judicial and administrative proceedings arising in the ordinary course of
business.  While the outcome of the pending proceedings cannot be
predicted with certainty, based on our review, we believe that any unrecorded
liability that may result is not likely to have a material effect on our
liquidity, financial condition or results of operations.





Item 1A—Risk
Factors





The following information updates should
be read in conjunction with the information disclosed in Item 1A, “Risk
Factors,” of our Annual Report on Form 10-K for the year ended December 31,
2007, filed with theSECon March 31, 2008, and in Part II Item
1A of our Quarterly Report on Form 10-Q for the quarter ended March 31,
2007.





Financial
Risks





There
have been no significant changes in financial risk factors for the first quarter
ended March 31, 2008.  See information set forth in the section
entitled “Risk Factors” in our Annual Report on Form 10-K for the fiscal year
ended December 31, 2007.





Operational
Risks





There
have been no significant changes in operational risk factors for the first
quarter ended March 31, 2008.  See information set forth in the
section entitled “Risk Factors” in our Annual Report on Form 10-K for the fiscal
year ended December 31, 2007.




Item 2-- Unregistered
Sales of Equity Securities and Use of Proceeds





None.




Item 3--Defaults upon
Senior Securities





None




Item 4--Submission of
Matters to a Vote of Stockholders





None




Item 5--Other
Information





OnApril 8, 2008, Southwall IG Holdings, Inc., a wholly
owned subsidiary of Southwall Technologies Inc. entered into a Joint Venture
Agreement with Sound Solutions Window & Doors, LLC; creating Southwall
Insulating Glass, LLC.  Southwall Technologies Inc. has a 50% interest
in the newly formed entity.  Southwall Insulating Glass, LLC will
manufacture insulated glass units for the domestic
market.





23
 Table of Contents





Item
6--Exhibits




(a) Exhibits








ExhibitNumber
            Item31.1
            Certification
      of Principal Executive Officer pursuant to Exchange Act Rules 13a-14 and
      15d-1431.2
            Certification
      of Principal Financial Officer pursuant to Exchange Act Rules 13a-14 and
      15d-1432.1
            Certification
      of Principal Executive Officer pursuant to 18 U.S.C Section
      135032.2
            Certification of Principal
      Financial Officer pursuant to 18 U.S.C Section
  1350
















SIGNATURES




Pursuant to the requirements of the
Securities Exchange Act of 1934, the registrant has duly caused this report to
be signed on its behalf by the undersigned thereunto duly
authorized.




Dated:May15, 2008Southwall Technologies
      Inc.By:
            /s/ Dr. R. Eugene
      GoodsonDr. R. Eugene
      GoodsonPrincipal Executive
      OfficerExecutive
      ChairmanBy:
            /s/ Mallorie
      BurakMallorie
    BurakChief Accounting
      Officer






24