SECURITIES AND EXCHANGE COMMISSION
                             Washington, D. C. 20549

                                    FORM 10-Q


         (MARK ONE)

/X/      QUARTERLY  REPORT  PURSUANT  TO SECTION  13 OR 15(d) OF THE  SECURITIES
 -       EXCHANGE ACT OF 1934 [NO FEE REQUIRED]


                For the quarterly period ended September 27, 1998

/_/      TRANSITION  REPORT  PURSUANT  TO SECTION 13 OR 15(d) OF THE  SECURITIES
         EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

         For the transition period from ______ to ________


                         Commission File Number: 0-15930


                           SOUTHWALL TECHNOLOGIES INC.
             ------------------------------------------------------
             (Exact name of registrant as specified in its charter)


                      DELAWARE                        94-2551470
           -------------------------------      ----------------------
           (State or other jurisdiction of         (I.R.S. Employer
            incorporation or organization)      Identification Number)


         1029 Corporation Way, Palo Alto, California      94303
         -------------------------------------------   ----------
          (Address of principal executive offices)     (Zip Code)


       Registrant's telephone number, including area code: (650) 962-9111
                                                           --------------

       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.

                                 Yes    X          No        
                                     -------          -------

       As of  September  27,  1998  there  were  7,705,965  shares of the
       Registrant's Common Stock outstanding.

       This report, including all attachments, contains 13 pages.


<PAGE>


                           SOUTHWALL TECHNOLOGIES INC.

                                      INDEX





                          PART 1 FINANCIAL INFORMATION

                                                                           Page
                                                                          Number
                                                                          ------
Item 1   Financial Statements:

         Consolidated Balance Sheets - September 27, 1998
         and December 31, 1997.............................................. 3

         Consolidated Statements of Operations -
         three month and nine month periods ended
         September 27,1998 and September 28, 1997............................4

         Consolidated Statements of Cash Flows -
         nine months ended September 27, 1998
         and September 28,1997...............................................5

         Notes to Consolidated Financial Statements..........................6

Item 2   Management's Discussion and Analysis
         of Financial Condition and Results of Operations....................8


                            PART II OTHER INFORMATION

Item 1   Legal Proceedings and Other Matters................................12

Item 2   Changes in Securities..............................................12

Item 3   Defaults Upon Senior Securities....................................12

Item 4   Submission of Matters to a Vote of Stockholders....................12

Item 5   Other Information..................................................12

Item 6   Exhibits and Reports on Form 8-K...................................12

         Signatures.........................................................13


                                       2

<PAGE>


                          PART 1 FINANCIAL INFORMATION

Item 1  Financial Statements
----------------------------

                           SOUTHWALL TECHNOLOGIES INC.
                           CONSOLIDATED BALANCE SHEETS
                      (in thousands, except per share data)


                                                     Sept. 27,          Dec. 31,
                                                       1998               1997
                                                       ----               ----
                                                   (Unaudited)
           ASSETS

Current assets:
    Cash and cash equivalents                        $ 7,757            $10,524
    Short-term investments                                 7                  7
    Accounts receivable, net of allowance
     for doubtful accounts of $1,169 and $834         12,236             11,926
    Inventories                                        8,046             10,118
    Other current assets                               1,025              1,118
                                                      ------             ------
       Total current assets                           29,071             33,693
Property and equipment, net                           26,658             26,272
Other assets                                           1,460              1,504
                                                      ------             ------
       Total assets                                  $57,189            $61,469
                                                      ======             ======

           LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
    Accounts payable                                 $ 4,230            $ 4,835
    Accrued compensation                               2,233              2,009
    Other accrued liabilities                          1,820              1,546
    Current portion of long-term debt                  1,502              1,304
                                                      ------             ------
       Total current liabilities                       9,785              9,694
Long-term debt                                        14,582             15,539
Deferred income taxes                                    496                496
                                                      ------             ------
       Total liabilities                              24,863             25,729
                                                      ------             ------

Commitments (Note 4)

Stockholders' equity:
    Common stock, $.001 par value,
     20,000 shares authorized;
     Issued and outstanding: 7,861 and 7,636               8                  8
    Capital in excess of par value                    51,925             51,513
    Notes receivable                                  (1,028)              (656)
    Accumulated deficit                              (17,802)           (14,631)
    Less cost of Treasury stock, 155 and 123
     shares outstanding                                 (777)              (494)
       Total stockholders' equity                     32,326             35,740
                                                      ------             ------
    Total liabilities and
       stockholders' equity                          $57,189            $61,469
                                                      ======             ======

       See accompanying notes to consolidated financial statements.

                                       3

<PAGE>


                           SOUTHWALL TECHNOLOGIES INC.
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                      (in thousands, except per share data)
                                   (Unaudited)


                               Three Months Ended  Nine Months Ended
                               ------------------  -----------------
                                Sept. 27  Sept. 28  Sept. 27 Sept. 28
                                  1998      1997      1998     1997
                                  ----      ----      ----     ----

Net revenues                    $14,011   $12,083   $38,484  $34,622
                                 ------    ------    ------   ------

Costs and expenses:
   Cost of sales                 10,056     8,289    31,293   22,878
   Tempe start up costs            -          528      -       1,076
   Research and development         928       794     2,901    2,228
   Selling, general and
    administrative                2,260     2,300     6,932    6,845
                                  -----     -----    ------   ------

    Total costs and expenses     13,244    11,911    41,126   33,027
                                 ------    ------    ------   ------

Income (loss) from operations       767       172    (2,642)   1,595

Interest income (expense),net      (202)       57      (492)      72
                                 ------    ------    ------   ------

Income (loss) before
    income taxes                    565       229    (3,134)   1,667

Provision for income taxes           13        19        37       89
                                 ------    ------    ------   ------

Net income (loss)               $   552   $   210   $(3,171) $ 1,578
                                 ======    ======    =======  ======

Net income (loss) per share:
    Basic                       $   .07   $  0.03   $ (0.41) $  0.23
    Diluted                     $   .07   $  0.03   $ (0.41) $  0.21

Weighted average shares of
    common stock and common
    stock equivalents:

    Basic                         7,761     7,380     7,664    6,989
    Diluted                       7,964     8,039     7,664    7,671




          See accompanying notes to consolidated financial statements.

                                       4

<PAGE>



                           SOUTHWALL TECHNOLOGIES INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (in thousands)
                                   (Unaudited)

                                                         Nine Months Ended
                                                        --------------------
                                                        Sept. 27,   Sept. 28,
                                                          1998        1997
                                                          ----        ----
Cash flows from operating activities:
    Net income (loss)                                   $(3,171)     $1,578
    Adjustments to reconcile net income
    (loss) to net cash provided by
    (used in) operating activities:
     Depreciation and amortization                        3,142       1,892
    (Increase) in accounts receivable                      (310)     (2,859)
     Decrease (increase) in inventories                   2,072      (2,051)
     Decrease (increase) in other
       current assets                                        93        (208)
    (Decrease) increase in accounts payable
       and accrued liabilities                              (14)      2,119
                                                        -------      ------
Cash provided by operating activities                     1,812         471
                                                        -------      ------

Cash flows from investing activities:
    Expenditures for property and equipment
     and other assets                                    (3,484)     (9,251)
Net cash used in investing activities                    (3,484)     (9,251)

Cash flows from financing activities:
    Increase in (reduction of) long-term debt              (759)      4,110
   (Issuance) of stock option loans, net                   (372)        (83)
     Sale of common stock, net                              352       4,931
    Issuance (repurchase) of
     treasury stock, net                                   (316)        520
                                                        -------      ------
Net cash (used in) provided
  by financing activities                                (1,095)      9,478
                                                        -------      ------

Net increase (decrease) in cash and cash
  equivalents                                            (2,767)        698

Cash and cash equivalents, beginning of year             10,524       7,419
                                                        -------      ------
Cash and cash equivalents, end of period                $ 7,757      $8,117
                                                        =======      ======


Supplemental schedule of non-cash
  investing and financing activities:
  Treasury stock used for payment
     of interest                                        $   93       $   93


          See accompanying notes to consolidated financial statements.

                                       5

<PAGE>

                           SOUTHWALL TECHNOLOGIES INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                 (in thousands)
                                   (Unaudited)

Note 1 - Interim Period Reporting:

While the  information  presented  in the  accompanying  consolidated  financial
statements is unaudited,  it includes all adjustments (consisting only of normal
recurring  adjustments)  which,  in the opinion of management,  are necessary to
present fairly the Company's  financial position and results of operations,  and
changes in financial position as of the dates and for the periods indicated.

Certain  information and footnote  disclosures  normally  contained in financial
statements prepared in accordance with generally accepted accounting  principles
have  been  condensed  or  omitted.  It is  suggested  that  these  consolidated
financial  statements  be read in  conjunction  with  the  financial  statements
contained in the Company's  Form 10-K for the year ended  December 31, 1997. The
results of operations  for the interim  periods  presented  are not  necessarily
indicative of the operating results of the full year.

Note 2 - Inventories:

Inventories  are  stated  at the  lower  of cost  (determined  by the  first-in,
first-out method) or market. Inventories consisted of the following:

                                      September 27, 1998       December 31, 1997
                                      ------------------       -----------------

                 Raw materials             $3,753                   $4,502
                 Work-in-process            2,547                    2,551
                 Finished goods             1,746                    3,065
                                            -----                   ------
                          Total            $8,046                  $10,118
                                            =====                   ======


Note 3 - Net Income (Loss) per Share

Basic net income  (loss) per share is computed by dividing  income  available to
common shareholders  (numerator) by the weighted average number of common shares
outstanding  (denominator)  for the period.  Diluted net income (loss) per share
gives effect to all dilutive  potential  common  shares  outstanding  during the
period.  The  computation of diluted  earnings per share uses the average market
prices during the period.

                                       6

<PAGE>

During  each of the  periods  presented  there were no  differences  between the
numerators  used for the  calculation of basic and diluted net income (loss) per
share.  The total  amount of the  difference  in the basic and diluted  weighted
average shares of common stock and common stock equivalents in the periods where
there is net income is attributable  to the effect of diluted stock options.  In
net loss periods,  the basic and diluted weighted average shares of common stock
and common stock  equivalents  are the same because  inclusion of stock  options
would be antidilutive.

Note 4 - Commitments

During 1996, the Company entered into an addendum to a previous supply agreement
with a major  customer  for  the  sale of the  Company's  anti-reflective  film.
Beginning  July 1, 1997,  the Company is committed to supply and the customer is
committed to purchase fixed volumes  thereafter until December 31, 2000.  Should
either the Company fail to supply or the customer fail to purchase the specified
quantities,  a penalty,  based on the sales price to the customer from the prior
period,  must be paid to the other. In order to meet the supply commitment,  the
Company  opened  a  new  manufacturing  facility,  initially  dedicated  to  the
production of anti-reflective film.

Note 5 - Line of Credit Agreement

The Company has secured a $6 million revolving line of credit which was extended
during the second  quarter  of 1998 and now  expires in June 1999.  This line of
credit may be extended  further for  additional  one-year  terms with the bank's
approval.  The amount of  borrowings  is based  upon a  percentage  of  accounts
receivable, which at September 27, 1998, did not limit available borrowing under
the  line.  The line is  secured  by  certain  assets of the  Company  and bears
interest at an annual rate of prime plus .5%.  Under the terms of the agreement,
the Company is required to maintain certain  financial  ratios.  As of September
27, 1998, there were no borrowings under this line of credit.

Note 6 - Recent Accounting Pronouncements

In June 1997,  the  Financial  Accounting  Standards  Board issued  Statement of
Financial  Accounting Standards No. 131 (FAS 131) "Disclosures about Segments of
an Enterprise and Related  Information." FAS 131 revises  information  regarding
the reporting of certain operating segments for periods beginning after December
15, 1997. The Statement also establishes standards for related disclosures about
products and services,  geographic areas, and major customers.  The Company will
adopt FAS 131 in its 1998 annual report.  The Company has not yet determined the
impact, if any, of adopting this new standard.

                                       7

<PAGE>

Item 2 - Management's Discussion and Analysis of Financial Condition and Results
of Operations

Except for the historical information contained herein, the matters discussed in
this Form 10-Q Report are  forward-looking  statements  that  involve  risks and
uncertainties,  including  those  discussed  below and in the  Company's  Annual
Report on Form 10-K.  Actual results may differ materially from those projected.
These forward-looking statements represent the Company's judgment as of the date
of the filing of this Form 10-Q  Report.  The Company  disclaims,  however,  any
intent or obligation to update these forward-looking statements.

General

The Company has experienced  significant  fluctuations  in quarterly  results of
operations.  Revenues  have varied from  quarter to quarter due to the  seasonal
buying patterns for the Company's Heat Mirror(TM) products, which typically have
been strongest in the second and third  quarters.  Additionally,  sales of these
energy conservation products are significantly influenced by the residential and
commercial construction industries,  and reduction in construction has generally
resulted in a reduction in the sales of the Company's Heat Mirror(TM)  products.
In addition,  operating results have historically varied from quarter to quarter
as a function of the  utilization of the Company's  production  machines and the
start  up  of  manufacturing   operations  in  Tempe,   Arizona.   Manufacturing
inefficiencies  have  resulted  from the  development  and  introduction  of new
products and the changing mix of products manufactured. Primarily as a result of
these  factors and in view of the Company's  strategy of  developing  additional
applications for its thin-film technology, and its ongoing practice of upgrading
its manufacturing  processes,  the Company may continue to experience  quarterly
fluctuations in its results of operations.

The Company is  committed to  increasing  revenues by  expanding  capacity,  and
introducing new applications and technologies. Although the Company has recently
completed a major  expansion of its  capacity  and is seeking to further  expand
existing  applications,  to develop new  applications  and to continue to expand
international  marketing and sales  efforts,  there can be no assurance that the
Company will be able to continue to increase revenues. The Company has ordered a
new production machine, PM6, in July 1998 at an approximate cost of $5.7 million
plus installation and leasehold improvement costs to accommodate the system. The
Company believes that the additional capacity will allow continued growth in its
Heat Mirror XIR(R) films sold to OEM automotive  glass  manufacturers as well as
to after market automotive and architectural customers.

                                       8

<PAGE>



Year 2000

In October 1996 the Company began reviewing year 2000 issues, prepared a plan to
address those issues and began systematically modifying,  upgrading or replacing
software as  necessary  and then testing and  implementing  those  changes.  The
Company  has  completed  major  upgrades  and  modifications,  which  have  made
essentially all mainframe  accounting and inventory  control  software year 2000
compliant.  All systems not yet compliant are scheduled to be made  compliant by
December  31,  1998.  All  projects  relating  to the year 2000  issue have been
handled  with  existing  staff,  and the total  expense  is not  expected  to be
material to the  Company.  The year 2000  problem  creates  risk for the Company
should any unforeseen  problems arise,  both in its own systems and those of key
customers  and  suppliers.  The  greatest  risk within the Company is related to
custom  data base  software.  Currently,  the  Company  is  discussing  with key
customers and suppliers their plans to address year 2000 issues during 1998, but
management has not yet assessed this related  potential  effect on the Company's
earnings, if any.


Nine Months Ended September 27, 1998 and September 28, 1997

Net revenues increased $3.9 million (or 11%) to $38.5 million for the first nine
months of 1998,  compared to $34.6 million for the similar  period of 1997.  The
sales increase was  attributable  primarily to increases of $5.5 million in Heat
Mirror XIR(R) film used principally by OEM automotive glass  manufacturers and a
$0.7 million  increase in  anti-reflective  film which was  partially  offset by
decreases  of $0.9 million due to  discontinued  sales of after market CRT glass
filters and $0.7 million of Solar Control  products  compared to the same period
last year. The balance of the decrease, net, relates to several products.

Cost of  sales  for the  first  nine  months  of 1998  was 81% of net  revenues,
compared to 69% for the similar  period of 1997.  The increase in cost of sales,
as a  percentage  of net  revenues,  for 1998 from 1997 was due to  process  and
mechanical problems in the first quarter of 1998, primarily at the Company's new
Tempe, Arizona facility.  The problems resulted in low yields on anti-reflective
film for  computer  monitors.  Production  yields on the  Company's  Heat Mirror
XIR(R) automotive film produced in the Palo Alto,  California facility were also
lower than in the same period last year,  requiring  additional machine time and
increased  material  to  meet  customer  demands.   Additionally,   the  Company
experienced  slightly higher overhead costs in the first nine months of 1998 due
to the renovation of an existing production  machine,  PM2, to increase capacity
for Heat Mirror(TM) products.

Research and development expenses, as a percent of net revenues, were 8% for the
first nine months of 1998,  compared to 6% for the similar  period in 1997.  The
absolute  dollars  increased  $0.7  million

                                       9

<PAGE>

to $2.9  million in 1998 from $2.2  million  in 1997.  The  increase  in 1998 is
attributable to higher new product development costs,  primarily for products in
the  electronic  display  market and, to a lessor extent,  the  development  and
testing of new deposition technology.

Selling,  general and administrative expense decreased to 18% of net revenues in
the  first  nine  months of 1998 from 20% for the  similar  period in 1997.  The
absolute  dollars  increased  $0.1  million  to $6.9  million  in 1998 from $6.8
million in 1997. The increase in absolute dollars was due primarily to severance
payments  associated  with  the  realignment  of  organizations  and  additional
staffing associated with the reorganizations.

Net  interest  expense  increased  for the first nine months of 1998 to $492,000
from $72,000 net interest  income in the first nine months of 1997 due primarily
to interest incurred on long-term debt for capacity expansion improvements.


Three Months Ended September 27, 1998 and September 28, 1997

Net revenues increased to $14.0 million for the third quarter of 1998,  compared
to $12.1 million for the similar  period of 1997. The increase was due primarily
to a $2.5 million  increase in sales of Heat Mirror XIR(R) film partially offset
by a decrease of $0.5  million  due to  discontinued  sales of after  market CRT
glass filters compared to the same period last year.

Cost of sales for the third quarter of 1998 was 72% of net revenues, compared to
73% for the  similar  quarter of 1997.  The  decrease  of one percent in cost of
sales was due to process efficiency  improvements,  primarily in anti-reflective
products in Tempe, Arizona.

Research and development expenses, as a percent of net revenues, were 7% for the
third quarters of 1998 and 1997. The absolute dollars  increased to $0.9 million
in 1998 from  $0.8  million  in 1997.  The  increased  expenses  were  primarily
attributable to higher new product  development  costs  associated with film for
electronic  display  products and the  development and testing of new deposition
technology.

Selling, general and administrative expense was 16% of net revenues in the third
quarter of 1998  compared to 19% for the similar  period in 1997.  The  absolute
dollars remained constant at $2.3 million in both 1998 and 1997.

Net interest expense increased to $0.2 million in the third quarter of 1998 from
interest  income of $0.1  million in the similar  period in 1997 due to interest
costs on long-term debt. Long-term debt was higher by approximately $3.9 million
at September  27, 1998  compared to September  28,  1997,  due to borrowing  for
capital expansion.

                                       10

<PAGE>

Liquidity and Capital Resources

At September  27, 1998,  the  Company's  net working  capital was $19.3  million
compared to $24.0  million at December 31,  1997.  From  December  31, 1997,  to
September 27, 1998, cash and short-term  investments  decreased by $2.8 million.
Major uses of cash were to fund the net loss of $3.2  million for the first nine
months  of  1998,   which  was  offset  by  $3.1  million  of  depreciation  and
amortization.  Capital  expenditures were $3.5 million and payments on long-term
debt were $0.8  million for the first nine months of 1998.  The major  source of
cash was a reduction of $2.1 million in inventories for the first nine months of
1998.

Additions to property and equipment were  approximately  $1.0 million during the
third  quarter of 1998,  including  $0.6 million for the initial  payment on the
newly  ordered PM6  production  machine to be  installed  in the Tempe,  Arizona
facility.  The Company  anticipates total capital  expenditures of approximately
$6.5 million during 1998 for improvements in Tempe for PM6, general replacements
and discretionary  improvements of current facilities, and further renovation of
current production equipment.

At  September  27,  1998,  the Company had $7.8  million of cash and  short-term
investments.  Additionally,  in June  1998,  the  Company  extended a $6 million
revolving  line of credit that expires in June 1999.  The Company has no current
borrowings  under  this line of  credit.  While  the  Company  believes  that it
currently has sufficient  funds to finance its  operations  through at least the
remainder of 1998,  to the extent that such funds are  insufficient  to fund the
Company's activities, including the potential major expansion projects discussed
above,  the Company may need to raise additional funds through public or private
equity or debt financing from other  sources.  The sale of additional  equity or
convertible debt may result in additional dilution to the Company's stockholders
and such securities may have rights,  preferences or privileges  senior to those
of the Common Stock.  There can be no assurance that  additional  equity or debt
financing  will be  available  or that if  available it can be obtained on terms
favorable to the Company or its stockholders.

                                       11

<PAGE>

                            PART II OTHER INFORMATION


Item 1   Legal Proceedings and Other Matters

The Company has been named a  defendant  in a lawsuit  filed on April 5, 1996 by
one of its  customers  in the  United  States  District  Court  for the  Eastern
District of New York. The lawsuit in federal court alleges  certain  contractual
violations  by the Company and seeks relief in an aggregate  amount in excess of
$35 million. The Company believes that this lawsuit is without merit and intends
to defend against it vigorously.

In addition,  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 the Company's business or its consolidated  financial position
or results of operations.


Item 2   Changes in Securities
         Not applicable


Item 3   Defaults upon Senior Securities
         Not applicable


Item 4   Submission of Matters to a Vote of Stockholders
         No  matters  were  submitted  to a  vote of security
         holders during the quarter ended September 27, 1998.


Item 5   Other Information
         Not applicable


Item 6   Exhibits and Reports on Form 8-K

         (a)  Exhibits - None

         (b)  Reports on Form 8-K - None


                                       12

<PAGE>





                                   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:  November 12, 1998       Southwall Technologies Inc.






                      By:/s/Thomas G. Hood
                         -----------------

                         Thomas G. Hood,
                         President and
                         Chief Executive Officer





                      By:/s/Bill R. Finley
                         -----------------
                         Bill R. Finley,
                         Vice President and
                         Chief Financial Officer