SECURITIES AND EXCHANGE COMMISSIONWashington,
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 April 1, 2001 o
  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(State or other jurisdiction of incorporation or organization)
  94-2551470(I.R.S. Employer
  Identification Number)1029 Corporation
  Way, Palo Alto, California(Address of
  principal executive offices)
  94303(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. Yesx  No o As
of May 10, 2001 there were 8,173,543 shares of the Registrant's Common
Stock outstanding.   SOUTHWALL TECHNOLOGIES INC.INDEX



PART I FINANCIAL INFORMATION

Item 1
  Financial
  Statements:Unaudited Consolidated
  Balance SheetsApril 1, 2001 and December 31, 2000Unaudited
  Consolidated Statements of OperationsThree month period ended April 1,
  2001 and April 2, 2000Unaudited
  Consolidated Statements of Cash FlowsThree month period ended April 1,
  2001 and April 2, 2000Notes
  to Unaudited Consolidated Financial StatementsItem 2
  Management's
  Discussion and Analysis of Financial Condition and Results of OperationsItem 3
  Quantitative
  and Qualitative Disclosures about Market RiskPART
  II OTHER INFORMATIONItem
  1
  Legal
  ProceedingsItem 2
  Changes in SecuritiesItem 3
  Defaults Upon
  Senior SecuritiesItem 4
  Submission
  of Matters to a Vote of StockholdersItem 5
  Other InformationItem 6
  Exhibits
  and Reports on Form 8-KSignaturesPART I FINANCIAL INFORMATION

Item 1Financial Statements:

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

April 1, 2001
  December 31,
  2000(Unaudited)ASSETSCurrent AssetsCash and cash equivalents
  $218
  $61Restricted cash
  549
  1,849Accounts Receivable, net of allowance
  for bad debts of $576 and $640
  9,638
  13,317Inventories, net
  9,277
  10,174Other current assets
  2,311
  2,008Total current assets
  $21,993
  $27,409Property, plant and
  equipment, net
  48,876
  49,884Other assets
  3,180
  3,169Total assets
  $74,049
  $80,462LIABILITIES AND
  STOCKHOLDERS' EQUITYCurrent liabilities:Bank line of credit
  $7,306
  $8,719Accounts payable
  14,047
  16,857Accrued compensation
  1,400
  1,915Other accrued liabilities
  5,607
  4,551Government grants advanced (Note 6)
  1,007
  1,085Current portion long-term debt (Note 5)
  6,276
  5,806Long-term debt reclassified to current
  (Note 5)
  18,943
  20,624Total current liabilities
  54,586
  59,557Long-term debt (Note 5)
  -
  -Other
  761
  767Total liabilities
  55,347
  60,324Commitment and
  Contingencies (Note 8)Stockholders' equity:Common stock, $0.001 par value, 20,000
  shares authorized;      issued and outstanding 7,889 and
  7,889
  8
  8Capital in excess of par value
  51,690
  51,764Less cost of treasury stock, 138 and166 shares outstanding
  (693)
  (839)Notes receivable
  (107)
  (99)Other Comprehensive IncomeTranslation loss on subsidiary
  (520)
  (151)Accumulated deficit
  (31,676)
  (30,545)Total stockholders' equity
  18,702
  20,138Total liabilities and
  stockholders' equity
  $74,049
  $80,462

See accompanying notes to
consolidated financial statements.

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

Three Months
  EndedApril 1,2001
  April 2,2000Net revenues
  $17,713
  $17,109Costs and expensesCost of sales
  14,849
  14,783Research and development
  1,425
  1,511Selling, general and administrative
  2,656
  1,992Total costs and expenses
  18,930
  18,286Income (loss) from
  operations
  (1,217)
  (1,177)Interest (expense), net
  (757)
  (413)Other income (expense, net)
  864
  (57)Income (loss) before
  provision for income taxes
  (1,110)
  (1,647)Provision for income
  taxes
  21
  36Net income (loss)
  ($1,131)
  ($1,683)Net income (loss) per
  share:Basic
  ($0.15)
  ($0.22)Diluted
  ($0.15)
  ($0.22)Weighted average shares
  of common stock and dilutive common stock equivalents:Basic
  7,743
  7,567Diluted
  7,743
  7,567See accompanying notes to
consolidated financial statements.

SOUTHWALL TECHNOLOGIES INCCONSOLIDATED STATEMENTS OF CASH
FLOWS(in thousands)
(Unaudited)

Three Months
  Ended,April 1, 2001
  April 2, 2000Cash flows provided by
  (used in) operating activities:Net (loss)
  ($1,131)
  ($1,683)Adjustments to reconcile net (loss) to
  net cash provided by operating activitiesDepreciation and amortization
  1,382
  1,123Decrease (increase) in accounts
  receivable, net
  3,678
  (3,165)Decrease (increase) in inventories, net
  897
  (1,843)Decrease (increase) in other current
  and non-current assets
  (329)
  (66)Increase (decrease) in accounts
  payable, and accrued liabilities
  (2,275)
  2,760Cash provided by (used
  in) operating activities
  2,222
  (2,874)Cash flows from
  investing activities:(Increase) decrease in restricted cash
  1,300
  69Expenditures for property, plant and
  equipment and other assets
  (360)
  (4,280)Net cash provided by
  (used in) investing activities
  940
  (4,211)Cash flows from
  financing activities:Proceeds from borrowings
  -
  5,795Principal payments on borrowings
  (2,624)
  (1,073)Repayment (net increase) of
  stockholder's note receivable
  (7)
  309Issuance of common stock upon exercise
  of stock options, net
  (74)
  -Issuance (purchase) of treasury stock,
  net
  146
  284Net cash provided by
  (used in) financing activities
  (2,559)
  5,315Foreign exchange fluctuation
  (446)
  -Net increase (decrease)
  in cash and cash equivalents
  157
  (1,770)Cash and cash
  equivalents, beginning of year
  61
  1,772Cash and cash
  equivalents, end of period
  $218
  $2See accompanying notes to
consolidated financial statements.

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\A for the year ended December 31, 2000 filed on April 11,
2001. The results of operations for the interim periods presented are not
necessarily indicative of the operating results of the full year.

Note 2Balance Sheet:

Restricted Cash

Restricted cash consists of the
unapplied portion of grants received from the German government to co-finance
the costs of the construction of the Company's German facility. In the event
the Company fails to meet certain conditions related to the grants, the German
government has the right to reclaim the grant. (See Note 6)

Inventories, net

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



April 1, 2001
  December 31,
  2000Raw Materials
  $4,050
  $4,394Work-in-process
  4,190
  4,799Finished goods
  1,037
  981Total Inventories
  $9,277
  $10,174

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. During each of the periods presented there were no
differences between the denominators used for 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 when there is net income is attributable to the
effect of dilutive 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 anti-dilutive. Stock options
aggregating 166 thousand shares at April 1, 2001 were not included in
the computations of net loss for the first quarter of 2001 because the effect
on the calculation would be anti-dilutive.

Note 4Financing
Line of Credit:

The Company has a $10 million
receivable financing line of credit with a bank. Availability under the line of
credit is based on 80% of the approved account receivable balance and bears a
finance fee of 0.88% per month of the average daily account balance outstanding
during the settlement period. In connection with the line of credit, the
Company has granted the bank, a continuing lien upon and security interest in,
and right of set off with respect to all of the Company's rights, title and
interest in all accounts receivable, inventory, monies, remittances and fixed
assets. There was $7.3 million of borrowings outstanding under this line of
credit at April 1, 2001. (See Note 9Going Concern and Loan Covenants)

Note 5Long-term debt:

The Company's long-term debt
consisted of the following at April 1, 2001:

Description
  Rate
  Maturity
  Balance at April
  1, 2001
  Annual Principal
  Amortization
  Start DateFinancing Line of
  Credit
  
  
  $7,306Long-term debtPromissory note dated May 6, 1997
  LIBOR +.4375
  (1)
  10,000
  $2,500
  May 2001Sales-leaseback agreement dated July
  19, 1999
  13.0%
  (2)
  2,321
  711
  April 2000Sales-leaseback agreement dated
  October 19, 1999
  13.0%
  (3)
  2,446
  1,374
  March 2000German bank loan dated May 12, 1999
  6.1%
  (4)
  2,607
  223
  March 2001German bank loan dated May 28, 1999
  7.1%
  (5)
  2,185
  -
  December 2009German bank loan dated May 28, 1999
  3.8%
  (6)
  1,373
  125
  March 2001German bank loan dated December 1,
  1999
  7.2%
  (7)
  1,855
  52
  December 2001German bank loan dated August 14, 1999
  5.8%
  (8)
  1,475
  -
  June 2009German bank loan dated June 29, 2000
  5.8%
  (9)
  492
  115
  June 2001German bank loan dated July 20, 2000
  7.1%
  (10)
  447
  112
  June 2001Other equipment financings
  
  
  18
  4Total long-term debt
  
  
  25,219
  5,216Less current portion
  
  
  6,276Less long-term
  portion-reclassified to current (11)
  
  
  18,943Long-Term Debt
  
  
  ($0)The promissory note dated
May 6, 1997 is payable to Sanwa Bank. The note payments are guaranteed by
Teijin Limited in Japan (Teijin), a stockholder and supplier of the Company.
The Teijin guarantee is collateralized by certain equipment located in the Company's
Tempe manufacturing facility and inventory, to the extent necessary to provide
120% net book value coverage of the outstanding loan balance. The interest rate
on the loan is re-set semi-annually at LIBOR plus 0.4375% (6.1313% and 7.7856%
at April 2, 2000 and April 1, 2001 respectively). The Company is also subject
to certain financial covenants. A loan guarantee service fee is payable to
Teijin semi-annually on the outstanding balance at the rate of 0.5625%. The
note provides for semi-annual payments of interest only during the first
four years, followed by semi-annual principal installments plus interest
for the remaining three and one half year term. The scheduled principal
payments for 2001 are $2.5 million. Teijin also received warrants in 1997
to purchase 158,000 shares of the Company's common stock at $9 per share. These
warrants were not exercised and expired on May 30, 2000. At April 1, 2001
the Company was not in compliance with certain of the financial covenants with
Teijin, the guarantor, pertaining to this promissory note. The Company received
a waiver from Teijin through October 1, 2001. Teijin did not agree to
extend the waiver beyond this date. Accordingly, the Company has reclassified
the balance from long-term debt to current liabilities in the balance sheet.
(See Note 9-GOING
CONCERN AND LOAN COVENANTS)

During 1999, the Company entered into two equipment sale-leaseback
agreements with a leasing company ("Lessor"). Because the Company has
an option to purchase the equipment at a price to be determined between the
Company and the Lessor at the end of the lease period, the sale-leaseback
agreements have been treated as financing. One lease agreement has a lease term
of three years and the other lease agreement has an initial lease term of
two years with an option to extend it for an additional year. At April 1,
2001, the Company had a total of $4.4 outstanding and due under these leases.
The leases are collateralized by the leased equipment and certain other
production equipment of the Company. The effective interest rate of both leases
is approximately 13% per annum and they are repayable over their lease term
commencing in May 2000. Additionally, the Company has provided the Lessor
an irrevocable standby letter of credit in the amount of $0.5 million to
collateralize all of the Company's obligations under these agreements. The
letter of credit shall not expire before January 1, 2002. In addition,
$1 million of the amounts due from the Lessor was not funded, but will be
released upon the Company satisfying certain financial conditions. Due to the
uncertainty of compliance with these financial conditions, the Company has
classified this amount under non-current "Other Assets." However, the
amount payable to the Lessor under the capitalized leases includes the unfunded
amount of $1.0 million. (See Note 9GOING
CONCERN AND LOAN COVENANTS)

On May 12, 1999, the Company
entered into a loan agreement with a German bank that provides for borrowings
up to $2.9 million (DM 6.0 million). Under the terms of this
agreement, the funds were used solely for the purpose of capital investment by
the German subsidiary. The term of the loan is for a period of 10 years
and the principal is repayable in Deutschemarks after the end of one year in 36
quarterly payments. The loan bears interest at 6.125% per annum for the first
five years, and will be adjusted to the prevailing rate at the end of the
fifth year. At April 1, 2001, the amount due under this bank loan is $2.6
million. (See Note 9 - ADJUSTED CONCERN AND LOAN COVENANTS)

On May 28, 1999, the Company
entered into a general loan agreement with a German bank. Under the terms of
the loan agreement, funds are available in three tranches, and shall be used
solely for the purpose of capital investment by the German subsidiary. The
first tranche provides for borrowings of $2.2 million (DM
4.89 million) for a term of twenty years. The principal is repayable
after ten years in ten equal, semi-annual payments. The loan bears fixed
interest of 7.1% per annum for the first ten years. At April 1, 2001, the
amount due is $2.2 million. The second tranche provides for borrowings of
$1.5 million (DM 3.35 million) for a term of seven years and the
principal is repayable after one year in twelve equal, semi-annual payments.
The loan bears fixed interest at 3.75% per annum for the period of
seven years. At April 1, 2001, the amount due is $1.4 million. The
third tranche, dated December 1, 1999, provides for borrowings of
$1.87 million (EURO 2.121 million) for a term of ten years, and
the principal is repayable after one year, in thirty six equal quarterly
payments. The loan bears fixed interest of 7.15% per annum for the first
five years. At April 1, 2001, the amount due is $1.9 million. All of
the proceeds from the loans were received during 1999. (See Note 9 - GOING
CONCERN AND LOAN COVENANTS)

On August 14, 1999, the
Company entered into a loan agreement with a German bank that provides for
borrowings up to $1.7 million (DM 3.3 million). Under the terms of
this agreement, the funds will be used solely for the purpose of capital
investment by the German subsidiary. The principal balance is due in a single
payment on June 30, 2009 and bears interest at a rate of 5.75% per annum.
The interest is payable quarterly in Deutschemarks. 50% of the loan proceeds
are restricted in an escrow account for the duration of the loan period and are
classified as non-current "Other Assets." At April 1, 2001, the
amount due under this bank loan is $1.5 million (See Note 9 - GOING CONCERN
AND LOAN COVENANTS)

On June 29, 2000, the Company
entered into a loan agreement with a German bank that provides for borrowings
up to $481 (DM 1.0 million). Under the terms of this agreement, the funds
will be used solely for the purpose of capital investment by the German
subsidiary. The principal balance is repayable in 12 quarterly payments
beginning June 2001 and bears interest at a rate of 7.10% per annum. The
interest is payable quarterly in Deutschemarks. At April 1, 2001, the amount
due under this bank loan is $0.5 million. (See Note 9 - GOING CONCERN AND
LOAN COVENANTS)

On July 20, 2000, the Company
entered into a loan agreement with a German bank that provides for borrowings
up to $480 (EU 511). Under the terms of this agreement, the funds will be used
solely for the purpose of capital investment by the German subsidiary. The
principal balance is repayable in 12 quarterly payments beginning
June 2001 and bears interest at a rate of 7.10% per annum. The interest is
payable quarterly in EURO dollars. At April 1, 2001, the amount due under this
bank loan is $0.4 million. (See Note 9 - GOING CONCERN AND LOAN COVENANTS)

The preceding German bank loans are
collateralized by the production equipment, building and land owned by the
German subsidiary.

Other long-term debt consists of
capitalized leases related primarily to certain computer equipment used by the
Company.

Scheduled principal
  reductions of long-term debt for the next five years and thereafter, are as
  follows:Year
  Amount2001
  $5,2162002
  5,6072003
  4,2182004
  3,3432005
  754Thereafter
  6,081Total
  $25,219

The Company incurred total
interest expense of $0.80 million and $1.15 million in the first quarter
of 2001 and 2000, respectively. Of these amounts, the Company capitalized $0.04
and $0.74 million in the first quarter of 2001 and 2000 respectively as part of
the costs related to the construction of new production machines and
facilities.

Note 6Government Grant:

The Company has an agreement to
receive a grant award (the "Grant"), which was approved by the State
Government of Saxony in Germany (the "Grantor") in May 1999. The
agreement provides for investment grants to a maximum amount of $9.9 million
(DM 20.3 million). As of April 1, 2001, the Company had received approximately
$4.9 million (DM 9.7 million) under this Grant and accounted for the
Grant by applying the proceeds received against the cost of the German
manufacturing facility. During 2000, the Company also received
$1.0 million (DM 2.1 million) in investment allowances from the
German government and those proceeds were applied against the cost of the
German manufacturing facility. The Company expects to receive an additional
$1.0 million in investment allowances from the German government in 2001.
Those funds will also be applied against the cost of the German manufacturing
facility. Additionally, the Company has received $1.0 million of government
grants that have been recorded as an advance until the Company earns the grant
through future expenditures.  The
Company's total investment in the German operations, net of government grants,
at April 1, 2001, was DM 32.4 million.

The Grant is subject to the
following requirements:

a)          The
grant is earmarked to co-finance the costs of the construction of a facility to
manufacture Heat Mirror XIR®
film for the automotive glass industry, located at Grossroehrsdorf, Germany.

b)          The
construction period for the project is from March 15, 1999 to
March 14, 2002.

c)          The
total investment should be at least $39.2 million (DM 80.3 million).

d)          The
project must create at least 143 permanent jobs and 7 apprenticeships by
March 14, 2002.

In
the event that the Company fails to meet the above requirements, the Grantor
has the right to reclaim the Grant. The Company does not currently have
financing in place to purchase a third machine in Germany and it has postponed
the placing of this order until financing can be secured. Presently, the
Company can not determine the ultimate total investment that will be made in
the German facility and is in the process of reviewing the total investment and
timing thereof with the grantor.  The
Company is unable to determine the outcome of discussions with the Saxony
government, and the impact, if any, on the Company's obligations under the
grant.

The Company is eligible for
additional investment allowances calculated based on the capital investment of
$39.2 million (DM 80.3 million) amounting to $3.7 million (DM
7.7 million), subject to European Union regulatory approval.

The investment allowance is subject
to the following requirements:

a)          The
movable and immovable assets which acquisition costs are taken into account in
determining the investment allowance shall be employed within the subsidized
territory for a period of at least five years following the acquisition or
production.

b)          The
movable assets which acquisition costs are taken into account in determining
the increased investment allowance shall remain in a business that is engaged
in the processing industry, or in a similar production industry for a period of
at least five years following the acquisition or production.

In the event that the Company fails
to meet the above requirements, the investment allowance must be paid back with
interest.





Note 7Segment Reporting:

In 1998, the Company adopted Statement
of Financial Accounting Standards No. 131 ("SFAS 131"),
"Disclosures about Segments of an Enterprise and Related
Information." SFAS 131 supercedes SFAS 14, "Financial Reporting for
Segments of a Business Enterprise" replacing the "industry
segment" approach with the "management" approach. The management
approach designates the internal organization that is used by management for
making operating decisions and assessing performance as the source of the
Company's reportable segments. SFAS 131 also requires disclosures about
products and services, geographic areas, and major customers. The adoption of
SFAS 131 did not affect results of operations or financial position or the
segments reported in 1997. The Company is organized on the basis of products and
services.The Company considers itself to operate in one
segment which is in the advanced film coatings.  The Company derives revenue from three sources.The total net
revenues from the three sources, Electronic Display, Automotive Glass and
Architectural product lines, were as follows:



Three Months
  EndedApril 1, 2001
  April 2, 2000Electronic display
  $6,724
  $8,277Automotive glass
  8,007
  4,956Architectural
  2,982
  3,876Total net revenues
  $17,713
  $17,109



The following is a summary of net revenues by geographic area for the
first quarter of 2001 and 2000 respectively.



Three Months
  EndedApril 1, 2001
  April 2, 2000United States
  $3,211
  $2,846South America
  136
  233Pacific Rim
  1,972
  2,511Japan
  4,989
  6,374Europe
  7,295
  5,105Canada
  110
  40Total net revenues
  $17,713
  $17,109





Note 8Contingencies:

The company is a defendant in an
action filed on April 5, 1996, Four Seasons Solar Products Corp vs.
Black & Decker, Bostik, Inc. and Southwall Technologies, Inc., No.
5 CV 1695, pending in the United States District Court for the Eastern District
of New York. Plaintiff is a manufacturer of insulated glass units which
incorporate the Company's Heat Mirror®
film. Plaintiff alleges that a sealant provided by  co-defendant is defective, asserts causes of action for breach of
contract, unfair competition, and fraudulent concealment, and seeks monetary
damages of approximately $36.0 million for past and future replacement
costs, loss of customer goodwill, and punitive damages against all defendants.
The Company has filed a motion to dismiss. The Court has dismissed the unfair
competition and fraudulent concealment claims against the Company.  It still has under advisement the Company's
motion to dismiss the breach of contract claim. The Company believes the claim
to be without merit and will vigorously defend the action, should the breach of
contract claim survive the motion to dismiss.

The Company was named a defendant
in a class action lawsuit filed on March 9, 1998 by Richard McKernan in
the Superior Court of California, County of Santa Clara. The Company has
reached a settlement with plaintiffs in the amount of $3.75 million. The
entire amount will be funded by Southwall's insurance carrier. That settlement
received final approval and statutory approval as a good faith settlement from
the Court on February 22, 2001. The insurance carrier has not indicated
whether it intends to pursue Southwall for reimbursement of the settlement
amount. The defense of the McKernan action is being paid by the Company's
insurer.

The Company's German subsidiary is
a defendant in a lawsuit filed by one of its suppliers on March 21, 2000
in a German court to seek payment of $0.9 million for engineering services
rendered in connection with developing the initial plans for the German
facility. The Company issued letters of award to the plaintiff amounting to
$0.3 million prior to terminating plaintiff's services for not meeting the
Company's expectations. The plaintiff claims fees for services rendered,
including the costs of significant modifications and revisions requested by the
Company calculated in accordance with the German Federal Schedule of
Architects' fees. The plaintiff further alleges that the Company utilized
plaintiff's planning work in further developing the plant. The Company believes
that the suit is without merit and intends to vigorously defend its position.
Although the Company believes that it will prevail, a $0.3 million portion
of the claim was accrued as a liability on the December 31, 2000 balance
sheet as it is likely that this amount will be awarded to the plaintiff.

In August 2000, the Company,
its Chief Executive Officer, Thomas G. Hood, and former Chief Financial
Officer, Bill R. Finley, have been named as defendants in seven lawsuits, all
filed in the United States District Court for the Northern District of
California (Docket Nos: C-00-2792-MMC; C-00-2795-BZ; C-00-2834-SC;
C-00-20856-EAI; C-00-3007-EDL; C-00-3027-JCS; and C-00-3079-MMC) (the
"Actions") all alleging violations of the federal securities laws.
Each of the plaintiffs in the Actions alleges that he purchased shares of the
Company's common stock and seeks to represent a class of shareholders who
purchased shares during the period April 26, 2000 through August 1,
2000, such dates constituting the period from the Company's release of its
financial results for the first quarter of FY 2000, to the date that it issued
its press release announcing that it would be restating its financial
statements for that quarter. The substantive allegations in each of the Actions
are essentially the same, i.e., that the defendants knew, or were reckless in
not knowing, that the Company's first quarter financial statements were in
error and violated Generally Accepted Accounting Principles, and that as a
result the putative class members purchased stock at artificially inflated
prices and were damaged.  The Company
believes the Actions to be wholly without merit.  Nonetheless, the Company has engaged in preliminary discussions
with the plaintiffs with a view towards possible resolution of the Actions.
Unless these discussions result in resolution, the Company intends to defend
the claims vigorously.

In October 2000, the Company
was served with a complaint entitled Hurd Millwork, Inc. v. Southwall
Technologies, Inc., et. al., United States District Court, Northern
District of California, Case No. C00-3820 (CRB). Hurd is a manufacturer of
insulated glass units which incorporate Heat Mirror® film. Hurd alleges that various failures
and deficiencies associated with the insulated glass units give rise to
warranty and other consumer claims. Hurd is seeking monetary damages for past
and future replacement costs, litigation expenses, and punitive damages. The
complaint alleges $32 million in damages and $25 million in
restitution. The Company believes Hurd's action to be without merit and intends
to strenuously defend against it.

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.

Note 9Going Concern and Loan Covenants

Loan Covenants

Pursuant to the guaranty, the
German bank loans, and lease agreements listed above, and related terms,
conditions and covenants the Company requested waivers from Teijin, Limited,
the German banks and the leasing company as discussed below, related to the
Company's default, or event of default pursuant to these respective agreements
or otherwise arising in connection with the Company's requirement to restate
prior financial periods, the financial position of the Company reflected in
such restated financial statements, the Company's failure to file its
Form 10-Q for the second quarter of 2000 in a timely manner and trading
halts or other actions taken or threatened to be taken by NASDAQ, or any law
suits filed or threatened to be filed in connection with such restatements or
late filings.

On September 7, 2000, Teijin
provided Southwall with a letter waiving any defaults through October 1,
2001 arising out of the Company's failure to comply with the Minimum Quick
Ratio and Maximum Debt-to-Tangible Net Worth financial covenants. Further,
Teijin waived any Event of Default related to the Company's requirement to
restate prior financial periods, the financial position of the Company to be
reflected in such restated financial statements, the Company's failure to file
its Form 10-Q for the second quarter of 2000 in a timely manner, any
trading halts or other actions taken or threatened by NASDAQ, or any lawsuits
filed or threatened in connection with such restatements or late filings or otherwise.
Teijin has not agreed to extend this waiver beyond the October 1, 2001
date. As a result, the Company has reclassified the Sanwa Loan, to which this
guaranty applies, from long-term to current liabilities in the balance sheet.

The Company received in
October, 2000 from the German banks a waiver of the Events of Default
pursuant to the agreements but the German banks did not provide a waiver of the
Events of Default or any rights it may have with respect to any further
material adverse change in the financial condition of the Company resulting
from the Events of Default and the German banks have reserved the right to
terminate the loan agreements after the third and fourth quarter of 2000 if the
expectations relating to turnover and profit as provided by the Company don't
occur and provide a cause for termination. The Company cannot currently
determine with reasonable certainty whether it will be able to comply with
these provisions and accordingly has reclassified these loans from long-term to
current liabilities in the balance sheet.

In November, 2000, the Company
received from the leasing company for the sale-leaseback agreements dated
July 19, 1999 and October 19, 1999 a partial waiver of the Events of
Default pursuant to the agreements. However it reserved its right to declare an
Event of Default based on the Company's financial condition. Accordingly the
Company has reclassified these agreements from long-term to current liabilities
in the balance sheet.

Going Concern

These consolidated financial
statements have been prepared assuming that the Company will continue as a
going concern. The Company has experienced recurring losses from operations,
has significant current and long-term debt containing certain covenants, with
which the Company has not complied, requiring the Company to obtain waivers and
to classify, as a current liability, the debt for which waivers have not been
obtained. The Company must meet certain commitments for debt service payments
that raise substantial doubt about its ability to continue as a going concern.
These consolidated financial statements do not include any adjustments that
might result from the outcome of this uncertainty. As a result of this
uncertainty, the Company may not be able to meet its debt service obligations
without additional financing. However, the Company can give no assurances it
will be successful in obtaining the required additional financing and cash from
operations.

Note 10-Subsequent Events

On
April 23, 2001, the Company issued to GMX Associates, a Singapore company,
422,119 restricted shares of the Company's common stock for $1.0 million in
cash.  Net sales to GMX were $0.7
million and $0.6 million for the quarter ended April 1, 2001 and April 2, 2000
respectively. At April 1, 2001, the Company had a total outstanding accounts
receivable with GMX in the amount of $0.6 million.

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

Except for the historical
information contained herein, certain 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\A. 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

We are a designer and manufacturer
of technologically advanced thin-film coatings that selectively absorb, reflect
or transmit light and electromagnetic and infrared emissions. Our products are
used in a number of electronic, automotive and building products to enhance
optical and thermal performance characteristics, improve user comfort and
reduce energy costs. From our founding in 1979 through the early 1990's, we
developed and produced thin-film coated substrates primarily for residential
and commercial buildings, and for military applications. In the early 1990's,
we began to develop products for the electronic display and automotive markets.

In 1996, we realized our first
material revenue from the electronic display and automotive markets. For the
three months ended April 1, 2001 the automotive sector account for 45% of
our revenues, with the electronic display products contributing 38% of our
revenues. We expect most of our revenue growth to come from the electronic
display and automotive markets.

Several
factors affect our gross margins, including manufacturing efficiencies, product
mix, product differentiation, inventory management, volume pricing, and the
start-up of equipment and new plants. Over the past several years, each of
these factors has contributed to margin volatility as we have added new
capacity to meet the demand of our electronics and automotive markets.



Three
Months Ended April 2, 2000 Compared with Three Months Ended April 1, 
2001

Net revenues

Net revenues
increased by $0.6 million, or 3.5%, from $17.1 million for the first
quarter of 2000 to $17.7 million for the first quarter of 2001. Sales to
the Automotive market increased by $3.0 million, or 60.0%, from $5.0 million
for the first quarter of 2000 to $8.0 million for the first quarter of 2001. In
the first quarter of 2001, the Company realized revenues of $2.0 million from
its German operations, which began limited production of commercial product in
December 2000.  Sales to the Electronic
Display market decreased by $1.6 million, or 19.3%, from $8.3 million for the
first quarter of 2000 to $6.7 million for the first quarter of 2001. The
decrease was the result of a worldwide slowdown in sales of personal computers.
Sales to the Architectural market decreased $0.9 million, or 23.1%,  from $3.9 million for the first quarter of
2000 to $3.0 million for the first quarter of 2001. The decrease was
primarily the result of the loss of a North American manufacturer that
represented approximately 6% of the Companys Heat Mirror sales.

Cost and expenses

Cost of sales.  Cost of sales expense consists primarily of materials, production
labor and machine overhead. Cost of sales remained essentially flat in the
first quarter of 2001, at $14.8 million, when compared to the first quarter of
2000. As a percentage of net revenues, cost of sales decreased from 86.6% of
net revenues in the first quarter of 2000, to 83.6% of net revenues in the
similar period of 2001. The higher costs in 2000, as a percentage of revenues,
was due to greater start-up costs in the Company's Tempe and German operations,
and higher display revenues, which yield lower margins as a result of outside
processing costs.



Research and development expenses.  Research and development spending decreased
$0.1 million, or 6.7%,  from
$1.5 million in the first quarter of 2000 to $1.4 million in the
first quarter of 2001. Research and development expenses decreased from 8.8% of
net revenues for the first quarter of 2000, to 7.9% of net revenues for the
similar period in 2001, principally due to cost control measures introduced by
the Company.



Selling, general and administrative expenses.  Selling, general and administrative expenses
normally consist primarily of corporate and administrative overhead, selling
commissions, advertising costs and occupancy costs. These expenses increased
$0.7 million, or 35.0%, from $2.0 million in the first quarter of
2000 to $2.7 million in the first quarter of 2001. Selling, general and
administrative expenses increased from 11.7% of net revenues for the first
quarter of 2000 to 15.3% of net revenues for the similar period of 2001. The
increase in the first quarter 2001, over last year, was due to higher personnel
costs in the Companys German operations and higher consulting costs.

Income
(loss) from operations

Loss from operations was
$1.2 million for the first quarter of 2000 compared to a loss of  $1.2 million for the first quarter of
2001 due to profitable operations of the German operations, offset by increased
reserves for product returns and doubtful accounts, and severance payments resulting
from the reduction in force of the Tempe and Palo Alto operations.

Interest (expense), net

The Company incurred
interest expense on borrowings of $0.80 million and $1.15 million in the first
quarter of 2001 and 2000, respectively, and capitalized interest incurred in
connection with construction in process of $0.04 million and $0.74 million in
the first quarter of 2001 and 2000, respectively. The increase in interest
expense principally results from completion of construction in process related
to the German and Tempe plants in late 2000.

Other income (expense), net

Other income (expense), net includes rental income, interest income,
and foreign exchange transaction gains and losses. The Company recorded other
income of $0.86 million in the quarter ended April 1, 2001 compared with other
expense of $0.06 million in the corresponding 2000 period, principally due to
foreign exchange gains. Certain transactions with foreign suppliers are
denominated in foreign currencies rather than U.S. dollars. As exchange rates
fluctuate relative to the U.S. dollar, exchange gains and losses occur.

Income
(loss) before provision for income taxes

The Company reported a pre-tax loss
of $1.7 million for the first quarter of 2000, compared to a pre-tax loss
of $1.1 million for the corresponding period in 2001 due to the additional
revenue generated by the Company's German operations and foreign currency
gains.Liquidity and Capital Resources

Capital expenditures

Since 1998, we have used
borrowings, German government grants and cash from operations to fund our
capital expenditures, and working capital requirements have been funded using
lines of credit. During 1999, we invested approximately $24.0 million in
capital expenditures, including approximately $13.5 million of progress
payments for our new manufacturing facility and first production machine (PM8)
in Germany, approximately $7.5 million for two new production machines
(PM6 and PM7) and leasehold improvements for our Tempe facility, and
approximately $2.5 million for the upgrade of two production machines (PM1
and PM2) in Palo Alto. These investments were financed by $13.6 million of
short and long-term debt, $4.9 million in German government grants,
$4.5 million of cash from operations, and cash on hand. The German government
grants subject us to a number of covenants (See Note 5 to Notes to Consolidated
Financial Statements.).

We spent approximately
$12.9 million for capital expenditures in 2000, of which $7.0 million
represented final progress payments on our two new production machines (PM8 and
PM9) in Germany and the completion of our German facility. We financed our
capital expenditures in Germany primarily through the receipt of
$4.0 million of additional bank loans and $1.0 million of subsidies
from the German government and the release of $2.6 million of cash
restricted by the German government to use in financing the completion of our
German facility. The German government may reclaim the grants if we fail to
meet any of the covenants (See Note 5 to Notes of the Consolidated Financial
Statements.). In 2000, the Company invested approximately $9.8 million in
its German facility including the above described progress payments. We
invested an additional $3.1 million in our Tempe and Palo Alto operations
for leasehold improvements, computer equipment and improvements on our
production machines.

In the first quarter of 2000, our
second machine at Tempe (PM6) began to produce limited amounts of film for
commercial use. An additional machine (PM7) was delivered to Tempe in the third
quarter of 2000. Additionally, we took possession of our new facility in
Germany in May 2000, where PM8 was installed in the third quarter and the
PM9 installation will be completed in 2001. PM8 commenced production of
commercial product in December, and we expect PM9 to commence commercial
production in the second quarter of 2001. The remaining installments on the
machines will be paid from committed German bank loans. The Company does not
currently have financing in place to purchase a third machine in Germany and it
has postponed the placing of this order until financing can be secured.
Presently, the Company can not determine the ultimate total investment that
will be made in the German facility and is in the process of reviewing the total
investment and timing thereof with the Saxony government.  The Company is unable to determine the
outcome of discussions with the Saxony government, and the impact, if any, on
the Company's obligations under the grant.

In the first quarter of 2001, the Company
spent approximately $0.4 million in capital expenditures, primarily in its
German operations. The expenditures were incurred on PM8 and to complete the
certification of PM9. In 2001, the Companys capital expenditures are expected
to be less than $4.0 million, and the expenditures will be used to expand
production capacity, acquire personal computers for additional employees and
upgrade its computer network

Liquidity

Operating activities used
$2.9 million during the first quarter of 2000, but generated $2.2 million
in net cash during the first quarter of 2001. 
Included in capital lease obligations on the balance sheets is
$1.0 million of proceeds from a sale-leaseback transaction in 1999.  This amount was withheld by the lessor and
classified in "Other assets", and will not be released until the
Company meets certain financial covenants. Furthermore, 50% of the proceeds
from a $1.6 million loan from a German bank are restricted in an escrow
account for the duration of the loan period and are classified in "Other
assets." The Company has reclassified to "Restricted cash" that
portion of cash,  $0.5 million,
that is restricted to payments for the facility in Germany.



The following table sets forth the
material terms of our short and long- term indebtedness at April 1, 2001:

Description

  Rate

  Maturity

  Balance at April 1, 2001

  Annual
  Principal
  Amortization

  Start
  Date$7,306Long-term debtPromissory note dated May 6, 1997

  LIBOR +.4375

  (1)

  10,000

  $2,500

  May 2001Sales-leaseback agreement dated July 19, 1999

  13.0%

  (2)

  2,321

  711

  April 2000Sales-leaseback agreement dated
  October 19, 1999

  13.0%

  (3)

  2,446

  1,374

  March 2000German bank loan dated May 12, 1999

  6.1%

  (4)

  2,607

  223

  March 2001German bank loan dated May 28, 1999

  7.1%

  (5)

  2,185

  -

  December 2009German bank loan dated May 28, 1999

  3.8%

  (6)

  1,373

  125

  March 2001German bank loan dated December 1,
  1999

  7.2%

  (7)

  1,855

  52

  December 2001German bank loan dated August 14, 1999

  5.8%

  (8)

  1,475

  -

  June 2009German bank loan dated June 29, 2000

  5.8%

  (9)

  492

  115

  June 2001German bank loan dated July 20, 2000

  7.1%

  (10)

  447

  112

  June 2001Other equipment financings

  

  

  18

  4Total long-term debt

  

  25,219

  5,216Less current portion

  

  6,276Less long-term
  portion-reclassified to current (11)

  

  

  18,943Long-Term Debt

  

  ($0)





(1)
  We
  are required to make equal semi-annual repayments from May 2001 through
  November 2004.(2)
  We
  are required to make equal monthly principal payments over the 36-month term
  of this financing.(3)
  We
  are required to make equal monthly principal payments over the 24-month term
  of this financing.(4)
  We
  are required to make equal quarterly principal payments over the 9-year
  repayment term of this financing starting March 31, 2001.(5)
  We
  are required to make equal semi-annual principal payments for ten years
  from December 2009 through June 2019.(6)
  We
  are required to make semi-annual principal payments for six years from
  March 2001 through September 2006.(7)
  We
  are required to make equal quarterly principal payments for nine years
  from December 2001 through September 2010.(8)
  We
  are required to make one principal payment on June 2009.(9)
  We
  are required to make equal quarterly principal payments for three years
  from April 2001 through June 2005.(10)
  We
  are required to make equal quarterly principal payments for three years
  from June 2001 through April 2004.(11)
  Represents
  the portion of long-term debt that has been reclassified into current
  liabilities as a result of lenders not granting waivers or failure to meet
  certain covenants.We have granted the lender of
the financing line of credit a security interest in our receivables, inventory
and other assets not otherwise collateralized. Our loans from German banks also
subject us to covenants, including covenants relating to the progress of the
development of our Dresden facility and the minimum number of our employees at
Dresden by 2003. We have granted the German banks security interests in our
Dresden facility and the assets located at the facility.

The promissory note dated
May 6, 1997 is payable to a bank and guaranteed by Teijin Limited, a
stockholder and one of our suppliers. The Teijin guarantee is collateralized by
certain equipment in the Company's Tempe manufacturing facility, and our
inventory to the extent necessary to cover 120% of the outstanding loan balance
based on the net book value of the inventory. The guarantee subjects us to
certain financial and other covenants, including covenants relating to our
tangible net worth, our debt to tangible net worth, profitability, and the
ratio of our cash, cash equivalents and short term investments to our total
current liabilities. At December 31, 2000, we were not in compliance with
the financial covenants relating to our minimum net worth, the ratio of our
debt to equity, the ratio of our cash, cash equivalents and short-term
investments to current liabilities, and the requirement that Company be
profitable. The Company received a waiver for failure to comply with these
covenants through October 1, 2001. Teijin did not extend the waiver.
Accordingly, the Company has reclassified the long-term balance from long-term
debt to current liabilities in the balance sheet. The Company is obligated to
make two principal payments of $1.25 million each in May and
November, 2001. The Company will also make principal payments of
$2.5 million each in 2002, 2003 and 2004.

We have provided the lessor under our sales-leaseback financings a
$0.5 million irrevocable standby letter of credit to collateralize our
obligations under the sales-leaseback agreements. The letter of credit will not
expire before January 1, 2002. In addition, $1.0 million of the
amount to be received from the lessor was withheld pending our meeting certain
financial conditions.

Loan Covenants

Pursuant to the guaranty, the
German bank loans, and lease agreements listed above, and related terms,
conditions and covenants the Company requested waivers from Teijin, Limited,
the German banks and the leasing company as discussed below, related to the
Company's default, or event of default pursuant to these respective agreements
or otherwise arising in connection with the Company's requirement to restate
prior financial periods, the financial position of the Company reflected in
such restated financial statements, the Company's failure to file its
Form 10-Q for the second quarter of 2000 in a timely manner and trading
halts or other actions taken or threatened to be taken by NASDAQ, or any law
suits filed or threatened to be filed in connection with such restatements or
late filings.

On September 7, 2000, Teijin
provided Southwall with a letter waiving any defaults through October 1,
2001 arising out of the Company's failure to comply with the Minimum Quick
Ratio and Maximum Debt-to-Tangible Net Worth financial covenants. Further,
Teijin waived any Event of Default related to the Company's requirement to restate
prior financial periods, the financial position of the Company to be reflected
in such restated financial statements, the Company's failure to file its
Form 10-Q for the second quarter of 2000 in a timely manner, any trading
halts or other actions taken or threatened by NASDAQ, or any lawsuits filed or
threatened in connection with such restatements or late filings or otherwise.
Teijin has not agreed to extend this waiver beyond the October 1, 2001
date. As a result, the Company has reclassified the Sanwa Loan, to which this
guaranty applies, from long-term to current liabilities in the balance sheet.

The Company received in
October 2000 from the German banks a waiver of the Events of Default
pursuant to the agreements but the German banks did not provide a waiver of the
Events of Default or any rights it may have with respect to any further
material adverse change in the financial condition of the Company resulting
from the Events of Default and the German banks have reserved the right to
terminate the loan agreements after the third and fourth quarter of 2000 if the
expectations relating to turnover and profit as provided by the Company don't
occur and provide a cause for termination. The Company cannot currently
determine with reasonable certainty whether it will be able to comply with
these provisions and accordingly has reclassified these loans from long-term to
current liabilities in the balance sheet.

In November 2000, the Company
received from the leasing company for the sale-leaseback agreements dated July 19,
1999 and October 19, 1999 a partial waiver of the Events of Default
pursuant to the agreements. However it reserved its right to declare an Event
of Default based on the company's financial condition. Accordingly the Company
has reclassified these agreements from long-term to current liabilities in the
balance sheet.

Going Concern

These consolidated financial
statements have been prepared assuming that the Company will continue as a
going concern. The Company has experienced recurring losses from operations,
has significant current and long-term debt containing certain covenants, with
which the Company has not complied, requiring the Company to obtain waivers and
to classify, as a current liability, the debt for which waivers have not been
obtained. The Company must meet certain commitments for debt service payments
that raise substantial doubt about its ability to continue as a going concern.
These consolidated financial statements do not include any adjustments that
might result from the outcome of this uncertainty. As a result of this
uncertainty, the Company may not be able to meet its debt service obligations
without additional financing. However, the Company can give no assurances it
will be successful in obtaining the required additional financing and cash from
operations.



Item 3Quantitative and
Qualitative Disclosures about Market Risk

The Company is exposed to the
impact of interest rate changes, foreign currency fluctuations, and changes in
the market values of its investments.

FINANCING RISK.  The Company's exposure to market rate risk
for changes in interest rates relates primarily to the Company's term loans
which are tied to the London Interbank Offered Rate ("LIBOR") and
bank line of credit which is tied to the prime rate. The Company's German
subsidiary also has several fixed-rate term loans that are denominated and
repayable in Deutschemarks. Fluctuations in interest rates may adversely impact
the interest expense expected for the Company. At April 1, 2001, the Company
had one loan with a variable interest rate. The effect of a 10% increase in the
interest rate for this loan would have an adverse impact of less than
($0.1) million. The effect of interest rate fluctuations on the Company
during the first quarter of 2001 was not material.

INVESTMENT RISK.  The Company invests its excess cash in
certificates of deposit and money market accounts and, by policy, limits the
amount of exposure to any one institution. Investments in both fixed rate and
floating rate interest earning instruments carries a degree of interest rate
risk. Fixed rate securities may have their fair market value adversely impacted
due to a rise in interest rates, while floating rate securities may produce
less income than expected if interest rates fall.

FOREIGN CURRENCY RISK.  International revenues amounted to 82% of
the Company's total sales in the first quarter of 2001 and, by policy, the
Company limits foreign currency risk by requiring all sales to be denominated
in U.S. dollars. Sales from the German subsidiary will likely be denominated in
EUROs. Certain purchases of raw materials and services from foreign suppliers
are denominated in foreign currencies; the Company does not hedge these
transactions. The Company's international business is subject to risks typical
of an international business, including, but not limited to differing economic
conditions, changes in political climate, differing tax structures, other
regulations and restrictions, and foreign exchange rate volatility.
Accordingly, the Company's future results could be materially adversely
impacted by changes in these or other factors.

RISK FACTORS

Our quarterly revenue and operating
results are volatile and difficult to predict. If we fail to meet the
expectations of public market analysts or investors, the market price of our
common stock may decrease significantly.

Our quarterly revenue and operating
results have varied significantly in the past and will likely vary
significantly in the future. Our revenue and operating results may fall below
the expectations of securities analysts or investors in future periods. Our
failure to meet these expectations would likely adversely affect the market
price of our common stock.

Our quarterly revenue and operating
results may vary depending on a number of factors, including:

manufacturing and operational
difficulties that may arise due to, among other things, expansion of our
production capacity, the transfer of equipment and personnel to our
international manufacturing facility, and the hiring and training of additional
staff;our possible ability to introduce new
products and technologies on a timely basis, and the increased research,
development and engineering costs and marketing expenses associated with new
product introductions;fluctuating customer demand, which is
influenced by a number of factors, including general economic conditions in the
sputtered thin-film coatings industry, market acceptance of our products and
the products of our customers and end-users, changes in the product mix demanded
and offered, and the timing, cancellation or delay of customer orders and
shipments;competition, including the
introduction or announcement of new products by competitors, the adoption of
competitive technologies by our customers, the addition of new production
capacity by competitors and competitive pressures on prices of our products and
those of our customers;the timing of our recognition of
revenues from product orders which can materially affect our operating results
on a quarterly basis due to the size of a particular order; andobligations to foreign suppliers
denominated in foreign currencies, which are not hedged, exposing us to foreign
currency fluctuation risk.Future growth of our business may place
a strain on our financial, management and production resources.

In order to grow, we must expand
our manufacturing capacity by adding additional production machines, which will
place a strain on our financial resources. Unless the Company secures
additional financing, it will not be able to expand its manufacturing capacity.
We will need to finance a large portion of these future expenditures through
external sources, including borrowings. We do not have credit facilities in
place to provide this financing. We cannot assure you that we will be able to
secure credit facilities or other sources of financing that will address our
future capital needs or that such credit facilities will not be on terms less
favorable to us than we have budgeted.

In addition, growth of our business
will increase the work load and responsibilities of our existing management and
require us to expand our management team. We cannot assure you that the present
size of our management team will enable us to expand our business or that we
will be able to recruit enough experienced managers.

Many of our machines are the only
manufacturing sources for certain of our products and are running at or near
capacity. We do not have plans to develop redundancy for much of our production
capability. Therefore, a breakdown or catastrophic damage to certain machines
would severely and adversely affect our business. In addition, it can take up
to 12-18 months to replace certain production machines. If our plans to
expand our manufacturing capacity are not implemented on a timely basis, we
could face production shortfalls. Rapid increases in production levels to meet
unanticipated demand could result in higher costs and other expenses. These
higher expenditures could lower our profit margins. Further, if production is
increased rapidly, there may be decreased manufacturing yields, which may also
lower our margins.

We may not be able to bring new
machines online effectively in our manufacturing operations to meet increasing
capacity requirements.

We expanded our manufacturing
capacity through the purchase of two new productions machines for our Tempe
facility in 1999, one of which began production in the first quarter of 2000
and the other of which is scheduled to begin production in the second half of
2001. The first machine in our new Dresden manufacturing facility began
commercial production in the fourth quarter of 2000. We expect the second
machine to begin production in the second quarter of 2001. In the past, we have
experienced significant problems during the initial phases of operating a new
machine. We have taken substantial write-offs of inventory and incurred
substantial expenses in connection with the resolution of these problems. If we
encounter similar problems with new machines, our production capability and our
operating results will suffer.

Our success will depend on our ability
to service our borrowings and maintain credit facilities.

We have financed a large portion of our capital expenditures and
working capital requirements through borrowings and expect to continue to do
so. Our inability to make timely payments of interest or principal under these
facilities could materially adversely affect our ability to borrow money under
existing credit facilities or to secure additional borrowings. In addition, our
current credit facilities contain, and our future credit facilities will
contain, financial and operating covenants that will limit our discretion with
respect to business matters. Among other things, these covenants will restrict
our ability to incur additional indebtedness, create liens or other
encumbrances, and make certain payments including dividends and investments.
These credit facilities will also contain financial covenants and events of
default that could require us to pay off indebtedness before its scheduled
maturity. The restrictions imposed by these credit facilities or the failure of
lenders to advance funds under these facilities could adversely affect us. You
should read the sections entitled "Loan Covenants";
"Liquidity"; and "Going Concern" in the "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
for more information.

We depend on a small number of
customers for a substantial portion of our sales, and the loss of a large
customer could hurt our revenues or operating results.

Our ten largest customers accounted
for approximately 74%, 69% and 85% of net product sales in 1998, 1999 and 2000,
respectively. During 2000, our three largest customers were Mitsubishi Electric
Corporation, Sekurit St. Gobain and Samsung, each of which accounted for more
than 10% of our net product sales. We expect to continue to derive a
significant portion of our net product sales from a relatively small number of
customers. Accordingly, the loss of a large customer could materially hurt our
business, and the deferral or loss of anticipated orders from a small number of
customers could materially damage our revenue and operating results in any
period. In addition, we do not have long-term contracts or purchase orders with
many of our customers, and customers may cancel their orders, change production
quantities from forecast volumes or delay production for any reason.

We depend on our OEM customers for the
sale of our products and for information relating to the development of new products.

We sell a substantial portion of
our products to a relatively small number of original equipment manufacturers,
or OEMs. The timing and amount of sales to these customers ultimately depend on
sales levels and shipping schedules for the OEM products into which our
products are incorporated. We have no control over the shipping dates or volume
of products shipped by our OEM customers, and we cannot be certain that our OEM
customers will continue to ship products that incorporate our products at current
levels or at all. Failure of our OEM customers to achieve significant sales of
products incorporating our products and fluctuations in the timing and volume
of such sales could be harmful to our business. Failure of these customers to
inform us of changes in their production needs in a timely manner could also
hinder our ability to effectively manage our business.

In addition, we rely on our OEM customers to inform us of opportunities
to develop new products that serve end-user demands. If our OEM customers do
not present us with market opportunities early enough for us to develop
products to meet end-user needs in a timely fashion, or if the OEMs fail to
anticipate end-user needs at all, we may fail to develop new products or modify
our existing products for our end-user markets. In addition, if our OEM
customers fail to accurately anticipate end-user demands, we may spend
resources on products that are not commercially successful.

We are dependent on key suppliers of
materials which may prevent us from delivering product in a timely manner.

We manufacture all of our products
using materials procured from third-party suppliers. Certain of these materials
are obtained from a limited number of sources. For example, the substrates we
use in the manufacture of our Heat Mirror product is only currently available
only from one qualified source, Teijin, holder of approximately 8.2% of our
common stock. The substrates used in the manufacture of our anti-reflective
film is currently available from only two qualified sources, Teijin and Di
Nippon Printing. The loss of either of these current sources could adversely
affect our ability to meet our scheduled product deliveries to customers. In
addition, any interruption in the operations of vendors of certain other materials
could also adversely affect our ability to meet our scheduled product
deliveries to customers. If we are unable to obtain a sufficient supply of
materials from our current sources, we could experience difficulties in
obtaining alternative sources quickly or in altering product designs to use
alternative materials. In the case of several materials, it takes a great deal
of time to qualify new suppliers. Delays or reductions in product shipments
could damage our relationships with our customers. Further, a significant
increase in the price of one or more of these materials could have a material
adverse effect on our operating results.

We are dependent on key suppliers of
production machines which may prevent us from delivering an acceptable product
on a timely basis.

Our production machines are large,
complex and difficult to manufacture. It can take up to a year from the time we
order a machine until it is delivered. Following delivery, it can take us, with
the assistance of the manufacturer, up to six additional months to test
and prepare the machine for commercial production. There are a very limited
number of companies that are capable of manufacturing these machines. Our
inability in the future to have new production machines manufactured and prepared
for commercial production in a timely manner would have a material adverse
effect on our business.

We must continue to develop new
products or enhance existing products on a timely basis to compete successfully
in a rapidly changing marketplace.

The market for thin-film coated glass and coating equipment is
characterized by rapid change, especially in the electronic display market. Our
future success depends upon our ability to introduce new products, improve
existing products and processes to keep pace with technological and market
developments, and to address the increasingly sophisticated and demanding needs
of our customers. Technological changes, process improvements, or operating
improvements that could adversely affect us include:

the development of new technologies
that improve the manufacturing efficiency of our competitors;changes in product requirements of our
customers;changes in the way coatings are
applied to alternative substrates such as tetra acetate cellulose, or TAC;the development of new materials that
improve the performance of thin-film coated glass; andimprovements in the alternatives to
the sputtering technology we use to produce our products, 
             such as plasma enhanced
chemical vapor deposition, or PECVD.We may not have sufficient funds to
devote to research and development, or our research and development efforts may
not be successful in developing products in the time, or with the
characteristics, necessary to meet customer needs. If we do not adapt to
technological changes, or process or operating improvements, our competitive
position, operations and prospects would be materially adversely affected.

We face intense competition, which
could affect our ability to increase our revenue, maintain our margins and
increase our market share.

The market for each of our products
is intensely competitive and we expect competition to increase in the future.
Competitors vary in size and in the scope and breadth of the products they
offer. Many of our current and potential competitors have significantly greater
financial, technical, marketing and other resources than we have. In addition,
many of our competitors have well-established relationships with our current
and potential customers and have extensive knowledge of our industry. Current
and potential competitors have established or may establish cooperative
relationships among themselves or with third parties to increase the ability of
their products to address customer needs.

Electronic Information Display Market.  Competitors in the anti-reflective coatings
market include customers who have the capability to use wet coating technology,
as well as competitors, who supply sputter coated films similar to those
produced by us. One of the largest manufacturers of flat-face computer display
tubes, or CDTs, Sony Corporation of Japan, has its own sputter coating film
technology which is used to provide anti-reflective characteristics on its own
CDTs. Customers' selection of anti-reflective products is driven by quality,
price and capacity.

Automotive Glass Market.  Solar control products in the automotive OEM
market are provided by large, worldwide glass laminators who typically have
divisions also selling products to the commercial flat glass industry. Several
of these companies, such as PPG, Pilkington PLC, Sekurit St. Gobain, Asahi,
Guardian, and Glaverbel, have direct to glass sputtering capability. In the
applied film segment of the automotive market, companies such as 3M, Material
Sciences Corporation, CP Films, and Courtaulds PLC produce competitive solar
control products that are widely accepted in the market.

Residential and Commercial Window Market.  Products that provide solar control and
energy conservation have been available to this market for almost 20 years.
Since our introduction of our Heat Mirror suspended film product in 1979, large
glass producers like Guardian, PPG, Viracon, Glaverbel, and Asahi, have
produced their own direct-to-glass sputtered products that perform similarly to
our Heat Mirror product.

If we fail to recruit and retain a
significant number of qualified technical personnel, we may not be able to
develop, enhance and introduce our products on a timely basis, and our business
will be harmed.

We require the services of a
substantial number of qualified technical personnel. The market for skilled
technical personnel is characterized by intense competition and aggressive
recruiting, as well as a high-level of employee mobility. These characteristics
make it particularly difficult for us to attract and retain the qualified
technical personnel we require. We have experienced, and we expect to continue
to experience, difficulty in hiring and retaining highly skilled employees with
appropriate technical qualifications. It is especially difficult to recruit
qualified personnel to move to the location of our in Palo Alto, California,
offices because of the high-cost of living. If we are unable to recruit and
retain a sufficient number of qualified technical employees, we may not be able
to complete the development of, or enhance, our products in a timely manner. As
a result, our business may be harmed and our operating results may suffer.

We may be unable to attract or retain
the other highly skilled employees that are necessary for the success of our
business.

In addition to our dependence on
our technical personnel, our success also depends on our continuing ability to
attract and retain other highly skilled employees. We depend on the continued
services of our senior management, particularly Thomas G. Hood, our President
and Chief Executive Officer, and Robert Freeman, our Chief Financial Officer,
and other personnel. We do not have any key person life insurance covering any
officer or employee. Competition for personnel in our industry where we operate
is intense. We have experienced, and we expect to continue to experience
difficulty in hiring and retaining highly skilled employees with appropriate
qualifications. If we do not succeed in attracting or retaining the necessary
personnel, our business could be adversely affected.

Our success depends in part upon our
ability to protect our intellectual property, but we may not be able to do so
adequately.

Our success depends in large part
upon our proprietary technology. We rely on our know-how, as well as a
combination of patent, trademark and trade secret protection, to establish and
protect our intellectual property rights. In addition, we seek to avoid
disclosure of our know-how and trade secrets through a number of means,
including requiring those persons with access to our proprietary information to
execute nondisclosure agreements with us. We seek to protect our technology,
documentation and other written materials under trade secret and copyright
laws, which afford only limited protection. We have 28 patents and 6 patent
applications pending in the United States that cover materials, processes,
products and production equipment. We also have patents and patent applications
pending in various foreign countries covering the same technology. Some foreign
countries in which we may do business provide significantly less patent and
proprietary rights protection than the United States.

Despite our efforts to protect our
proprietary rights, unauthorized parties may attempt to copy aspects of our products
or to obtain and use information that we regard as proprietary. Policing
unauthorized use of our products is difficult. In addition, the laws of some
foreign countries do not protect our proprietary rights to as great an extent
as do the laws of the United States. Our means of protecting our proprietary
rights may not be adequate. In addition, our competitors may independently
develop similar technology, duplicate our products, or design around our
proprietary intellectual property.

Our business is susceptible to numerous
risks associated with international operations.

We have expanded our operations and
hired additional personnel to address international markets for the thin-film
coatings industry. International revenues amounted to 68%, 77% and 86% of our
net revenues during 1998, 1999 and 2000, respectively. The distance between
California and Dresden create logistical and communications challenges. In
addition, to achieve acceptance in international markets, our products must be
modified to handle a variety of factors specific to each international market
as well as local regulations. We may also be subject to a number of other risks
associated with international business activities. These risks include:

unexpected changes in and the burdens
and costs of compliance with a variety or foreign laws 
             and regulatory requirements;currency exchange rate fluctuations;tariffs, export controls and other
trade barriers;longer accounts receivable payment
cycles and difficulties in collecting accounts receivable;difficulties in managing and staffing
international operations;potentially adverse tax consequences,
including restrictions on the repatriation of earnings; andglobal economic turbulence and political instability.

Our international sales are
currently invoiced and collected in U.S. dollars. A strengthening in the dollar
relative to the currencies of those countries in which we do business would
increase the prices of our products as stated in those currencies and could hurt
our sales in those countries. Significant fluctuations in the exchange rates
between the U.S. dollar and foreign currencies could cause us to lower our
prices and thus reduce our profitability. These fluctuations could also cause
prospective customers to delay orders because of the increased relative cost of
our products.

We expect that, within the next
twelve months, the customers of our Dresden operation will begin to make
payments in EUROs or other foreign currencies. In addition, in the future, other
of our customers may also make payments in foreign currencies. Such
transactions may require us to begin to hedge foreign currencies in order to
reduce the risk to us of fluctuating exchange rates.

Performance, reliability or quality
problems with our products may cause our customers to reduce their orders.

We manufacture our electronic
display and automobile glass products based on specific, technical requirements
of each of our customers. We believe that future orders of our products will
depend in part on our ability to maintain the performance, reliability and
quality standards required by our customers. If our products have performance,
reliability or quality problems, then we may experience:

            delays in collecting accounts
receivable;

            reduced orders;

            additional warranty and service
expenses; and

            higher manufacturing costs.

We may face costly damages or
litigation costs if a third party claims that we infringe its intellectual
property.

It is possible that third parties
may claim that we or our current or potential future products infringe upon
their intellectual property. Any claims, with or without merit, could be time
consuming, result in costly litigation, cause product shipment delays or
require us to enter into royalty or licensing agreements. Royalty or licensing
agreements, if required, may not be available on terms acceptable to us or at
all, which could seriously harm our business.

If we fail to comply with environmental
regulations, our operations could be suspended.

We use hazardous chemicals in
producing our products. As a result, we are subject to a variety of local,
state and federal governmental regulations relating to the storage, discharge,
handling, emission, generation,manufacture and disposal of toxic or other hazardous substances used to
manufacture our products, compliance with which is expensive. Our failure to
comply with current or future regulations could result in the imposition of
substantial fines on us, suspension of production, alteration of our manufacturing
processes or cessation of operations.

We rely on our international and
domestic sales representatives, without whom our sales may suffer.

We sell our products in Japan,
China and Korea through sales representatives. We also market and sell our Heat
Mirror products in North America primarily through sales representatives. These
sales representatives could reduce or discontinue sales of our products. They
may not devote the resources necessary to provide effective sales and marketing
support to us. In addition, we depend upon the continued viability and
financial resources of these representatives, many of which are small
organizations with limited working capital. These representatives, in turn,
depend substantially on general economic conditions and other factors affecting
the markets for the products they sell. We believe that our success will
continue to depend upon these sales representatives. If some or all of our
sales representatives experience financial difficulties, or otherwise become
unable or unwilling to promote and sell our products, our business could be
harmed.

Our stock price could fluctuate widely
in response to various factors, many of which are beyond our control.

The trading price of our common
stock may be highly volatile. Our stock price could fluctuate widely in
response to factors such as the following:

            actual or anticipated variations in
our quarterly revenues or operating results;

            announcements of new products or
services by us or our competitors, or new competing technologies;

            our addition or loss of significant
customers;

            changes in financial estimates or
recommendations by securities analysts;

            announcements by us of significant
acquisitions or strategic partnerships;

            additions or departures of our key
personnel;

            future equity or debt offerings by us
or our announcements of such offerings; and

            general market and economic
conditions.

In addition, in recent years the stock markets in general, and the
Nasdaq National Market and the market for technology companies in particular,
have experienced large price and volume fluctuations. These fluctuations have
often been seemingly unrelated or disproportionate to the operating performance
of these technology companies. These market and industry factors may materially
and adversely affect our stock price, regardless of our operating performance.
In the past, securities class action litigation has often been brought against
a company following periods of volatility in the market price of its stock. As
described herein, we are subject to such a stockholder lawsuit (see "Legal
Proceedings" Item 3 above). We may in the future be the target of similar
litigation. Securities litigation could result in substantial costs or large
judgments against us and divert management's attention and resources.

Recent accounting pronouncements

In June 1998, the Financial
Accounting Standards Board issued SFAS No. 133,"Accounting for Derivatives
and Hedging Activities" ("SFAS 133"). SFAS 133 was effective for
all fiscal quarters beginning with the quarter ending June 30, 1999. SFAS
133 establishes accounting and reporting standards of derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities. In July 1999, the Financial Accounting Standards Board
issued SFAS No. 137 "Accounting for Derivative Instruments and Hedging
ActivitiesDeferral
of the Effective Date of FASB Statement No. 133" ("SFAS 137").
SFAS 137 deferred the effective date until the first fiscal quarter for
fiscal years beginning after June 15, 2000. The Company has not
engaged in hedging activities or invested in derivative instruments.





PART II OTHER INFORMATION



Item 1 Legal Proceedings and Other
Matters

Litigation filed against the
Company was described under Item 3 in the Company's Form 10-K\A filed on
April 11, 2001. Subsequent to such filing, no material developments have
occurred with respect to the litigation described therein.

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

On April 23, 2001, the Company
issued to GMX Associates, a Singapore company, 
422,119 restricted shares of the Companys common stock for $1.0 million
in cash in reliance on the exemption to registration provided by Section 4(2)
of the Securities Act of 1933 as amended (the Act). The securities
represented by this transaction have not been registered under the Act, or
under the securities laws of any other jurisdictions. The securities are
subject to restrictions on transferability and resale and may not be
transferred or resold except as permitted under the Act and the applicable
state securities laws, pursuant to registration or exemption therefrom.  This investment represents an ownership
percentage of 5.2% of the Company.

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 April 1, 2001.

Item 5 Other
Information

Not applicable

Item 6 Exhibits

(a)                 Exhibits

Exhibit        Item             Number

10                  GMX Purchase Agreement

(b)                 Reports on Form 8-KNone

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:
May 16, 2001 Southwall Technologies Inc.



By:
  /s/ Thomas G. HoodThomas
  G. HoodPresident
  and 
  Chief Executive OfficerBy:
  /s/ Robert R. FreemanRobert
  R. FreemanSr.
  Vice President and
  Chief Financial Officer

INDEX TO EXHIBITS





Exhibit
  Description10
  GMX
  Purchase Agreement