**UNITED
      STATES**


**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****For
                the quarterly period ended September 30, 2007****or**o
            **TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
                OF 1934****For
                the transition period from
                to**








**Commission
      File Number: 0-15930**


___________________








**SOUTHWALL
      TECHNOLOGIES INC.**


(Exact
      name of registrant as specified in its charter)





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











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


___________________




Indicate
      by check mark whether the
      registrant (1) as filed all reports required to be filed by Section 3 or 15(d)
      of the Securities Exchange Act of 1934 during the preceding 12 months (or for
      such shorter period that the registrant was required to file such reports),
      and
      (2) has been subject to such filing requirements for the past 90
      days.   YesxNoo





Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer. See definition of “accelerated
      filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
      One).





Large
      accelerated filer   ̈Accelerated
      filer   ̈Non-accelerated
      filer  x





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





As
      of
      October 15, 2007, there were 27,819,622 shares of the registrant's Common Stock
      outstanding.







1
 *Index*




**SOUTHWALL
      TECHNOLOGIES INC.**





**INDEX**




PagePART
                I – FINANCIAL INFORMATIONItem
                1
            Financial
                StatementsUnaudited
                Condensed Consolidated Balance Sheets – September
                30, 2007 and December 31, 2006
            3Unaudited
                Condensed Consolidated Statements of Operations
                – Three and nine month periods ended September 30, 2007 and September
                30,
                2006
            4Unaudited
                Condensed Consolidated Statements of Cash Flows
                – Nine month periods ended September 30, 2007 and September 30,
                2006
            5Notes
                to the Unaudited Condensed Consolidated Financial
                Statements
            6Item
                2
            Management’s
                Discussion and Analysis of Financial
                Condition and Results of Operations
            13Item
                3
            Quantitative
                and Qualitative Disclosures about Market
                Risk
            23Item
                4
            Controls
                and Procedures
            24PART
                II – OTHER INFORMATIONItem
                1
            Legal
                Proceedings
            25Item
                1A
            Risk
                Factors
            25Item
                2
            Unregistered
                Sales of Equity Securities and Use of
                Proceeds
            26Item
                3
            Defaults
                upon Senior Securities
            26Item
                4
            Submission
                of Matters to a Vote of Security
                Holders
            26Item
                5
            Other
                Information
            26Item
                6
            Exhibits
            26Signatures
            27





2
 *Index*








PART I.
      FINANCIAL
      INFORMATION





Item
      1--Financial Statements:


**SOUTHWALL
      TECHNOLOGIES INC.**


**UNAUDITED
      CONDENSED CONSOLIDATED BALANCE SHEETS**


**(in
      thousands, except per share data)**





September 30,
            
            
            December 31,2007
            
            
            2006**ASSETS**Current
                assets:
            
            
            $
            4,775
            
            
            $
            5,524Cash
                and cash equivalents
            
            
            
            657
            
            
            
            209Restricted
                cashAccounts
                receivable, net of allowance for doubtful accounts of $88at
                September 30, 2007 and $102 at December 31, 2006
            
            
            
            5,764
            
            
            
            3,608Inventories,
                net
            
            
            
            5,971
            
            
            
            5,598Other
                current assets
            
            
            
            781
            
            
            
            1,064Total
                current assets
            
            
            
            17,948
            
            
            
            16,003Property,
                plant and equipment, net
            
            
            
            17,045
            
            
            
            17,232Restricted
                cash loans
            
            
            
            1,196
            
            
            
            1,111Other
                assets
            
            
            
            1,330
            
            
            
            1,155Total
                assets
            
            
            $
            37,519
            
            
            $
            35,501**LIABILITIES,
                PREFERRED STOCK AND STOCKHOLDERS’ EQUITY**Current
                liabilities:Current
                portion of long term debt
            
            
            $
            1,118
            
            
            $
            1,059Line
                of credit
            
            
            
            3,000
            
            
            
            2,996Accounts
                payable
            
            
            
            1,411
            
            
            
            955Accrued
                compensation
            
            
            
            863
            
            
            
            859Government
                grants advanced
            
            
            
            234
            
            
            
            -Other
                accrued liabilities
            
            
            
            6,306
            
            
            
            6,448Total
                current liabilities
            
            
            
            12,932
            
            
            
            12,317Term
                debt
            
            
            
            8,288
            
            
            
            8,568Government
                grants advanced
            
            
            
            -
            
            
            
            220Other
                long term liabilities
            
            
            
            2,619
            
            
            
            2,550Total
                liabilities
            
            
            
            23,839
            
            
            
            23,655Commitments
                and contingencies (Note 5)Series
                A 10% cumulative convertible preferred stock, $0.001 par value; $1.00
                stated
                value; 5,000 shares authorized, 4,893 shares outstanding at September
                30,
                2007 and December
                31, 2006, respectively (Liquidation preference: $6,154 and $5,788
                at September
                30, 2007 and December 31, 2006,
                respectively)
            
            
            
            4,810
            
            
            
            4,810Stockholders’
                equity:Common
                  stock, $0.001 par value per share; 50,000 shares authorized, 27,820
                  shares
                  and 27,139 shares outstanding at September 30, 2007 and December
                  31, 2006,
                  respectively
            
            
            
            28
            
            
            
            27Capital
                in excess of par value
            
            
            
            78,345
            
            
            
            78,081Accumulated
                other comprehensive income: Accumulated translation
                adjustment
            
            
            
            4,321
            
            
            
            3,696Accumulated
                deficit
            
            
            
            (73,824
            )
            
            
            (74,768
            )Total
                stockholders’
                equity
            
            
            
            8,870
            
            
            
            7,036Total
                liabilities, preferred stock and stockholders’ equity
            
            
            $
            37,519
            
            
            $
            35,501




See
      accompanying notes to unaudited condensed consolidated financial
      statements.





3
 *Index*




**SOUTHWALL
      TECHNOLOGIES INC.**


**UNAUDITED
      CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**


**(in
      thousands, except per share data)**




Three
                months ended
            
            
            Nine
                months endedSeptember 30,
            
            
            September 30,
            
            
            September 30,
            
            
            September 30,2007
            
            
            2006
            
            
            2007
            
            
            2006Net
                revenues
            
            $
            9,249
            
            
            $
            9,597
            
            
            $
            29,005
            
            
            $
            30,968Cost
                of revenues
            
            
            6,070
            
            
            
            5,667
            
            
            
            18,673
            
            
            
            19,301Gross
                profit
            
            
            3,179
            
            
            
            3,930
            
            
            
            10,332
            
            
            
            11,667Operating
                expenses:Research
                and development
            
            
            934
            
            
            
            1,659
            
            
            
            3,173
            
            
            
            5,376Selling,
                general and administrative
            
            
            2,122
            
            
            
            4,674
            
            
            
            6,932
            
            
            
            9,761Impairment
                charge (recoveries) for long-lived assets
            
            
            (17
            )
            
            
            (325
            )
            
            
            (25
            )
            
            
            (117
            )Restructuring
                charges
            
            
            -
            
            
            
            263
            
            
            
            -
            
            
            
            974Total
                operating expenses
            
            
            3,039
            
            
            
            6,271
            
            
            
            10,080
            
            
            
            15,994Income
                (loss) from operations
            
            
            140
            
            
            
            (2,341
            )
            
            
            252
            
            
            
            (4,327
            )Interest
                expense, net
            
            
            (191
            )
            
            
            (169
            )
            
            
            (471
            )
            
            
            (550
            )Other
                income (expenses), net
            
            
            513
            
            
            
            (18
            )
            
            
            1,561
            
            
            
            161Income
                (loss) before provision for income taxes
            
            
            462
            
            
            
            (2,528
            )
            
            
            1,342
            
            
            
            4,716
            )Provision
                for income taxes
            
            
            212
            
            
            
            193
            
            
            
            398
            
            
            
            719Net
                income (loss)
            
            
            250
            
            
            
            (2,721
            )
            
            
            944
            
            
            
            (5,435
            )Deemed
                dividend on preferred stock
            
            
            122
            
            
            
            123
            
            
            
            366
            
            
            
            367Net
                income (loss) attributable to common stockholders
            
            $
            128
            
            
            $
            (2,844
            )
            
            $
            578
            
            
            $
            (5,802
            )Net
                income (loss) per share:Basic
            
            $
            0.00
            
            
            $
            (0.11
            )
            
            $
            0.02
            
            
            $
            (0.22
            )Diluted
            
            $
            0.00
            
            
            $
            (0.11
            )
            
            $
            0.02
            
            
            $
            (0.22
            )Shares
                used in computing net income (loss) per share:Basic
            
            
            27,820
            
            
            
            26,957
            
            
            
            27,493
            
            
            
            26,907Diluted
            
            
            28,867
            
            
            
            26,957
            
            
            
            28,313
            
            
            
            26,907




See
      accompanying notes to unaudited condensed consolidated financial
      statements.


4
 *Index*




**SOUTHWALL
      TECHNOLOGIES INC.**


**UNAUDITED
      CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**


**(in
      thousands)**




Nine
                months endedSeptember 30,
            
            
            September 30,2007
            
            
            2006Cash
                flows from operating activities:Net
                income (loss)
            
            $
            944
            
            
            $
            (5,435
            )Adjustments
                to reconcile net income (loss) to net cash provided by (used
                in)operating
                activities:Deferred
                income tax
            
            
            (56
            )
            
            
            54Impairment
                charge (recoveries) from long-lived assets
            
            
            (25
            )
            
            
            (117
            )Depreciation
                and amortization
            
            
            2,087
            
            
            
            1,836Stock
                compensation
            
            
            273
            
            
            
            487Change
                in assets and liabilities:Accounts
                receivable, net
            
            
            (2,129
            )
            
            
            1,982Inventories,
                net
            
            
            (373
            )
            
            
            638Other
                current and non current assets
            
            
            161
            
            
            
            (524
            )Accrued
                liabilities—deferred rent
            
            
            0
            
            
            
            (1,192
            )Accounts
                payable and accrued liabilities
            
            
            10
            
            
            
            2,123Net
                cash provided by (used in) operating activities
            
            
            892
            
            
            
            (148
            )Cash
                flows from investing activities:Restricted
                cash
            
            
            (417
            )
            
            
            181Proceeds
                from sale of property, plant and equipment
            
            
            25
            
            
            
            422Expenditures
                for property, plant and equipment
            
            
            (635
            )
            
            
            (781
            )Net
                cash used in investing activities
            
            
            (1,027
            )
            
            
            (178
            )Cash
                flows from financing activities:Proceeds
                from exercise of stock options
            
            
            357
            
            
            
            32Repayments
                of term debt
            
            
            (837
            )
            
            
            (1,133
            )Payments
                on line of credit
            
            
            (2,996
            )
            
            
            0Borrowings
                on line of credit
            
            
            3,000
            
            
            
            0Investment
                credit in Germany
            
            
            (3
            )
            
            
            (219
            )Net
                cash used in financing activities
            
            
            (479
            )
            
            
            (1,320
            )Effect
                of foreign exchange rate changes on cash
            
            
            (135
            )
            
            
            78Net
                decrease in cash and cash equivalents
            
            
            (749
            )
            
            
            (1,568
            )Cash
                and cash equivalents, beginning of period
            
            
            5,524
            
            
            
            6,600Cash
                and cash equivalents, end of period
            
            $
            4,775
            
            
            $
            5,032Supplemental
                cash flow disclosures:Interest
                paid
            
            $
            670
            
            
            $
            725Income
                taxes paid
            
            $
            398
            
            
            $
            719Supplemental
                schedule of non-cash investing and financing activities:Dividends
                accrued
            
            $
            366
            
            
            $
            367




See
      accompanying notes to unaudited condensed consolidated financial
      statements.




5
 *Index*




**SOUTHWALL
      TECHNOLOGIES INC.**


**NOTES
      TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**




**Note 1--Interim
      Period Reporting:**





The
      accompanying interim condensed consolidated financial statements of Southwall
      Technologies Inc. (“Southwall” or the “Company”) are unaudited and have been
      prepared in accordance with accounting principles generally accepted in the
      United States of America for interim financial information and with the
      instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain
      information and footnote disclosure normally included in financial statements
      prepared in accordance with accounting principles generally accepted in the
      United States of America have been condensed or omitted. In the opinion of
      management, the unaudited condensed consolidated financial statements reflect
      all adjustments, consisting only of normal recurring adjustments, considered
      necessary to present fairly the financial position, results of operations and
      cash flows of Southwall and its subsidiaries for all periods presented. The
      year-end condensed consolidated balance sheet data was derived from audited
      financial statements, but does not include all disclosures required by
      accounting principles generally accepted in the United States of America. The
      Company suggests that these condensed consolidated financial statements be
      read
      in conjunction with the consolidated financial statements and notes thereto
      contained in the Company's Form 10-K for the year ended December 31, 2006 filed
      with the Securities and Exchange Commission on April 2, 2007. The results of
      operations for the interim periods presented are not necessarily indicative
      of
      the operating results to be expected for any future periods..





**Note 2—Inventories,
      Net:**





Inventories
      are stated at the lower of cost (determined by the average cost method) or
      market. Cost includes materials, labor and manufacturing overhead. The Company
      establishes provisions for excess and obsolete inventories to reduce such
      inventories to their estimated net realizable value. Such provisions are charged
      to cost of revenues. At September 30, 2007 and December 31, 2006, inventories
      consisted of the following (in thousands):





September 30,
            
            
            December 31,2007
            
            
            2006Raw
                materials
            
            $
            3,111
            
            
            $
            3,850Work-in-process
            
            
            1,254
            
            
            
            221Finished
                goods
            
            
            1,606
            
            
            
            1,527$
            5,971
            
            
            $
            5,598




**Note 3--Net
      Income (Loss) Per Share:**





Basic
      net
      income (loss) per share is computed by dividing net income (loss) attributable
      to common stockholders (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 common shares potentially outstanding during
      the period, including stock options, warrants to purchase common stock and
      convertible preferred stock. The
      Company excludes options from the computation of diluted weighted average shares
      outstanding if the exercise price of the options is greater than the average
      market price of the shares because the inclusion of these options would be
      anti-dilutive to earnings per share. The company also excludes preferred
      shares convertible into common stock from the computation of diluted weighted
      average shares outstanding, per SFAS 128, “Earnings Per Share”, when the effect
      would be antidilutive. At September 30, 2007, 4,893,000 shares were excluded
      as
      their effect was antidilutive when combined with the effect of other
      potential dilutive common shares.


6
 *Index*




In
      net
      loss periods, the basic and diluted weighted average shares of common stock
      and
      common stock equivalents are the same because inclusion of common stock
      equivalents would be anti-dilutive. For the third quarter of 2007, a net income
      period, there were 5,238,000 options outstanding of which 2,403,000 were
      excluded from the net income per share calculation as they were anti-dilutive
      because the option prices were higher than the average market value during
      the
      three-month period ended September 30, 2007.





The
      company has accrued a deemed dividend on preferred stock of
      $122,000  and $366,000  for the three and nine-month periods
      ended September 30, 2007 and September 30, 2006, respectively. Per SFAS 128,
      the
      dilutive effect of convertible securities shall be reflected in diluted EPS
      by
      application of the if-converted method. Under this method, if an entity has
      convertible preferred stock outstanding, the preferred dividends applicable
      to
      convertible preferred stock shall be added back to the numerator unless their
      effect is antidilutive. Tables summarizing net income (loss) attributable to
      common stockholders, for diluted net income (loss) per share, and shares
      outstanding are shown below (in thousands):





Three
                months ended
            
            
            Nine
                months endedSeptember 30,
            
            
            September 30,
            
            
            September 30,
            
            
            September 30,2007
            
            
            2006
            
            
            2007
            
            
            2006Net
                income (loss) attributable to common stockholders-basic
            
            $
            128
            
            
            $
            (2,844
            )
            
            $
            578
            
            
            $
            (5,802
            )Add:  Deemed
                dividend on preferred stock
            
            
            122
            
            
            
            123
            
            
            
            366
            
            
            
            367Net
                income (loss) attributable to common stockholders-diluted
            
            $
            250
            
            
            $
            (2,721
            )
            
            $
            944
            
            
            $
            (5,435
            )Weighted
                average common shares outstanding-basic
            
            
            27,820
            
            
            
            26,957
            
            
            
            27,493
            
            
            
            26,907Dilutive
                effect of warrants
            
            
            356
            
            
            
            -
            
            
            
            355
            
            
            
            -Dilutive
                effect of stock options
            
            
            691
            
            
            
            -
            
            
            
            465
            
            
            
            -Weighted
                average common shares outstanding – diluted
            
            
            28,867
            
            
            
            26,957
            
            
            
            28,313
            
            
            
            26,907




**Note 4
      – Product  Reporting:**





The
      total
      net revenues for the automotive glass, electronic display, window film and
      architectural product lines for the three and nine- month periods ended
      September 30, 2007 and September 30, 2006 were as follows (in
      thousands):




Three
                months ended
            
            
            Nine
                months endedSeptember 30,
            
            
            September 30,
            
            
            September 30
            
            
            September 30,2007
            
            
            2006
            
            
            2007
            
            
            2006Automotive
                glass
            
            $
            3,763
            
            
            $
            3,019
            
            
            $
            11,162
            
            
            $
            9,726Electronic
                display
            
            
            46
            
            
            
            2,564
            
            
            
            2,597
            
            
            
            8,325Window
                film
            
            
            4,036
            
            
            
            2,424
            
            
            
            10,629
            
            
            
            8,880Architectural
            
            
            1,404
            
            
            
            1,590
            
            
            
            4,617
            
            
            
            4,037Total
                net revenues
            
            $
            9,249
            
            
            $
            9,597
            
            
            $
            29,005
            
            
            $
            30,968





The
      following is a summary of net revenues by geographic area (based on the location
      of the Company's customers) for the three and nine- month periods ended
      September 30, 2007 and September 30, 2006. (in thousands):


7
 *Index*




Three
                months ended
            
            
            Nine
                months endedSeptember 30,
            
            
            September 30,
            
            
            September 30
            
            
            September 30,2007
            
            
            2006
            
            
            2007
            
            
            2006United
                States
            
            $
            2,466
            
            
            $
            3,231
            
            
            $
            7,410
            
            
            $
            10,408Japan
            
            
            111
            
            
            
            2,639
            
            
            
            2,669
            
            
            
            7,948France
            
            
            769
            
            
            
            855
            
            
            
            2,932
            
            
            
            2,283Pacific
                Rim
            
            
            2,756
            
            
            
            1,916
            
            
            
            7,630
            
            
            
            6,617Germany
            
            
            952
            
            
            
            667
            
            
            
            2,915
            
            
            
            2,612Rest
                of the world
            
            
            2,195
            
            
            
            289
            
            
            
            5,449
            
            
            
            1,100Total
                net revenues
            
            $
            9,249
            
            
            $
            9,597
            
            
            $
            29,005
            
            
            $
            30,968





**Note 5--Commitments
      and Contingencies:**





*Commitments*





On
      January 19, 2006, we commenced restructuring actions with the intention of
      improving our cost structure for 2006 and beyond. These actions have included
      the closure of our Palo Alto, California manufacturing facility and a reduction
      in force at our Palo Alto site during the first half of 2006. We accrued $1.5
      million in the third quarter of 2006 as a leasehold asset retirement obligation
      in connection with this plan. On
      February 19, 2004, the Company entered into the second amendment to the lease
      for one of its Palo Alto, California facilities. The amendment reflected a
      payment schedule for a rent deferral for this lease agreement. In January of
      2006, the Company paid off approximately $1.2 million in deferred rent. As
      of
      September 30, 2007, there was no deferred rent outstanding.





*Contingencies*





The
      insurance carriers in some of the litigation related to alleged product failures
      and defects in window products manufactured by others in which the Company
      was a
      defendant in the past paid the defense and settlement costs related to such
      litigation. Those insurance carriers reserved their rights to recover a portion
      or all of such payments from the Company. As a result, those insurance carriers
      could seek from us up to an aggregate of $12.9 million plus defense costs,
      although any such recovery would be restricted to claims that were not covered
      by the Company’s insurance policies.  In the case where the insurance
      carriers might seek reimbursement, the Company would vigorously defend any
      attempts by these insurance carriers to seek reimbursement. The Company is
      not
      able to estimate the likelihood that these insurance carriers will seek to
      recover any such payments, the amount, if any, they might seek, or the outcome
      of such attempts.





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 its business, consolidated financial position, results of operations
      or cash flows.





**Note 6--Stock-Based
      Compensation:**





The
      Company has a stock-based compensation program that provides its Board of
      Directors broad discretion in creating employee equity incentives. The Company
      has granted stock options under various option plans and agreements in the
      past
      and currently grants stock options under the 1997 Stock Incentive Plan and
      the
      1998 Stock Option Plan for employees, board members and consultants. The Board
      of Directors adopted the 1998 Stock Option Plans on August 6, 1998. The
      Compensation Committee of the Board of Directors administers the plans and
      agreements. The exercise price of options granted under the 1997 and 1998 plans
      must be at least 85% of the fair market value of the stock at the date of grant.
      Options granted under the 1998 and 1997 plans generally vest at a rate of 25%
      per year, are non-transferable and expire over terms not exceeding ten years
      from the date of grant or three months after the optionee terminates his
      relationship with the Company.  In March 1997, the Company adopted the
      1997 Employee Stock Purchase Plan (“ESPP”). Under the terms of the ESPP,
      employees, subject to certain limitations, may purchase shares at 85% of the
      lower of the fair market value of the Common Stock at the beginning of the
      six-month offering period, or the last day of the purchase period. The ESPP
      plan
      was subsequently eliminated in the first half of 2007.  All shares of
      common stock reserved for future issuance under such plan were
      cancelled.   On April 30, 2007, the Company’s shareholders
      approved the Company’s Long Term Incentive Plan, which authorizes the granting
      of up to 10 million shares of Common Stock.





8
 *Index*




On
      January 1, 2006, the Company adopted the provisions of SFAS 123R, “Shared-Based
      Payment” (SFAS 123R), requiring it to recognize expense related to the fair
      value of its stock-based compensation awards. The Company elected to use the
      modified prospective transition method as permitted by SFAS 123R and therefore
      has not restated its financial results for prior periods. Under this transition
      method, stock-based compensation expense for the three and nine- month periods
      ended September 30, 2007 and September 30, 2006 includes compensation expense
      for all stock-based compensation awards granted prior to, but not yet vested
      as
      of January 1, 2006, based on the grant date fair value estimated in accordance
      with the original provisions of SFAS 123. Stock-based compensation expense
      for
      all stock-based compensation awards granted subsequent to January 1, 2006 was
      based on the grant-date fair value estimated in accordance with the provisions
      of SFAS 123R. The Company recognized compensation expense for stock option
      awards on a graded vesting basis over the requisite service period of the
      award.





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





Three
                months ended
            
            
            Nine
                months endedSeptember 30,
            
            
            September 30,
            
            
            September 30,
            
            
            September 30,2007
            
            
            2006
            
            
            2007
            
            
            2006Cost
                of sales
            
            $
            1
            
            
            $
            -
            
            
            $
            3
            
            
            $
            11Research
                and development
            
            
            23
            
            
            
            21
            
            
            
            68
            
            
            
            109Selling,
                general and administrative
            
            
            64
            
            
            
            56
            
            
            
            202
            
            
            
            296Stock-based
                compensation expense before income taxes
            
            
            88
            
            
            
            77
            
            
            
            273
            
            
            
            416Income
                tax benefit
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Total
                stock-based compensation expense after income taxes
            
            $
            88
            
            
            $
            77
            
            
            $
            273
            
            
            $
            416





There
      were $357 thousand and $32 thousand of cash proceeds from the exercise of stock
      options for the nine- month period ended September 30, 2007 and September 30,
      2006, respectively. No income tax benefit was realized from stock option
      exercises during the nine- month periods ended September 30, 2007 and September
      30, 2006. In accordance with SFAS 123R, the Company presents excess tax benefits
      from the exercise of stock options, if any, as financing cash flows rather
      than
      operating cash flows.





The
      fair
      value of stock-based awards was estimated using the Black-Scholes model with
      the
      following weighted-average assumptions for the three and nine- month periods
      ended September 30, 2007 and September 30, 2006, respectively:





Three
                months ended
            
            
            Nine
                months endedSeptember 30,
            
            
            September 30,
            
            
            September 30,
            
            
            September 30,2007
            
            
            2006
            
            
            2007
            
            
            2006Expected
                life (in years)
            
            
            6.00
            
            
            
            2.59
            
            
            
            6.00
            
            
            
            2.44Risk-free
                interest rate
            
            
            4.43
            %
            
            
            4.84
            %
            
            
            4.70
            %
            
            
            4.87
            %Volatility
            
            
            80
            %
            
            
            109
            %
            
            
            80
            %
            
            
            109
            %Dividend
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Per
                share weighted-average fair value at grant date
            
            $
            0.75
            
            
            $
            0.38
            
            
            $
            0.35
            
            
            $
            0.41





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





Stock
      option activity for the nine months ended September 30, 2007 was as follows
      (in
      thousands, except per share amounts):





9
 *Index*




Shares
            
            
            Weighted-Average
                Exercise Price
            
            
            Weighted-Average
                Remaining Contractual Term (in years
            
            
            Aggregate
                Instrinsic ValueOutstanding
                at December 31, 2006
            
            
            5,837
            
            
            
            1.28Grants
            
            
            1,373
            
            
            
            0.48Exercises
            
            
            (678
            )
            
            
            0.53Forfeitures
                or expirations
            
            
            (1,293
            )
            
            
            1.63Outstanding
                at September 30, 2007
            
            
            5,239
            
            
            $
            1.08
            
            
            
            6.13
            
            
            $
            379Vested
                and expected to vest at September 30, 2007
            
            
            3,958
            
            
            $
            1.25
            
            
            
            5.29
            
            
            $
            230Exercisable
                at September 30, 2007
            
            
            3,227
            
            
            $
            1.40
            
            
            
            4.55
            
            
            $
            143





The
      aggregate intrinsic value in the table above represents the total pretax
      intrinsic value (i.e., the difference between Southwall’s closing stock price on
      the last trading day of its third quarter of fiscal 2007 and the exercise price,
      times the number of shares) that would have been received by the option holders
      had all option holders exercised their options on September 30, 2007. This
      amount changes based on the fair market value of Southwall’s stock. Total
      intrinsic value of options exercised was immaterial for the three and $135,000
      for nine- month period ended September 30, 2007. Total fair value of options
      granted is $29,808 and $473,919 for the three and nine- month periods ended
      September 30, 2007, respectively.




As
      of
      September 30, 2007, $835,950 of total unrecognized compensation cost related
      to
      stock options was expected to be recognized over a weighted-average period
      of
      approximately 2.43 years.





**Note
      7 - Restructuring:**





On
      January 19, 2006, we commenced restructuring actions to improve our cost
      structure. These actions included the closure of our Palo Alto, California
      manufacturing facility and a reduction in force at our Palo Alto site in the
      first half of 2006. As a result of these actions, we incurred a restructuring
      charge of $974,000 during the first nine months of 2006 relating to employee
      severance packages, and related charges.





In
      December 2002, we implemented a reduction in force at our Palo Alto
      location and elected to vacate certain buildings in Palo Alto. As a result
      of these actions, we incurred a restructuring charge of $2.6 million in 2002
      relating to employee severance packages and the remaining rents due on excess
      facilities in Palo Alto that we no longer occupy.




The
      following tables set forth the beginning and ending liability balances relating
      to the above described restructuring activities as well as activity during
      the
      nine month periods endedSeptember 30, 2007 and
      September 30, 2006 (in thousands):








Restructuring
            
            
            RestructuringPlan
                2006
            
            
            Plan
                2002Severance
                and
                Benefits
            
            
            Facilities
                Related
                and
                  Other
            
            
            Facilities
                Related
            
            
            TotalBalance
                at December 31, 2005
            
            $
            -
            
            
            $
            -
            
            
            $
            199
            
            
            $
            199Provisions
            
            
            375
            
            
            
            753
            
            
            
            -
            
            
            
            1,128Adjustment
                to reserve
            
            
            (5
            )
            
            
            (149
            )
            
            
            -
            
            
            
            (154
            )Cash
                payments
            
            
            (349
            )
            
            
            (449
            )
            
            
            (53
            )
            
            
            (851
            )Balance
                at September 30, 2006
            
            $
            21
            
            
            $
            155
            
            
            $
            146
            
            
            $
            322





Severance
                      and
                    Benefits
            
            
            Facilities
                      Related
                    and
                      Other
            
            
            Facilities
              Related
            
            
            TotalBalance
                at December 31, 2006
            
            $
            19
            
            
            $
            9
            
            
            $
            93
            
            
            $
            121Provisions
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Adjustment
                to reserve
            
            
            -
            
            
            
            (2
            )
            
            
            -
            
            
            
            (2
            )Cash
                payments
            
            
            (19
            )
            
            
            (7
            )
            
            
            (52
            )
            
            
            (78
            )Balance
                at September 30, 2007
            
            
            0
            
            
            $
            $ -
            
            
            
            41
            
            
            $
            41





10
 *Index*




At
      September 30, 2007, $41,000 was included in other accrued liabilities in the
      condensed consolidated balance sheet.





**Note
      8 - Warranties:**





The
      Company establishes a reserve for sales returns and warranties for specifically
      identified, as well as anticipated sales returns and warranties based on
      experience. The activity in the reserve for sales returns and warranties account
      during the nine month periods ended September 30, 2007 and September 30, 2006
      was as follows (in thousands):




Balance
                at
            
            
            
            
            
            
            
            
            Balance
                atDecember 31,
            
            
            
            
            
            
            
            
            September 30,2005
            
            
            Provision
            
            
            Utilized
            
            
            2006Accrued
                sales returns and warranty
            
            $
            1,556
            
            
            $
            571
            
            
            $
            (570
            )
            
            $
            1,557








Balance
                at
            
            
            
            
            
            
            
            
            Balance
                atDecember 31,
            
            
            
            
            
            
            
            
            September 30,2006
            
            
            Provision
            
            
            Utilized
            
            
            2007Accrued
                sales returns and warranty
            
            $
            1,415
            
            
            $
            1,156
            
            
            $
            (1,550
            )
            
            $
            1,021





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





**Note
      9 – Comprehensive Income (Loss):**





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





The
      components of comprehensive income (loss) for the three and nine- month periods
      ended September 30, 2007 and September 30, 2006 were as follows (in
      thousands):





Three
                months ended
            
            
            Nine
                months endedSeptember 30,
            
            
            September 30,
            
            
            September 30,
            
            
            September 30,2007
            
            
            2006
            
            
            2007
            
            
            2006Foreign
                Currency Translation Adjustment
            
            $
            523
            
            
            $
            (141
            )
            
            $
            625
            
            
            $
            704Net
                Income (Loss)
            
            
            250
            
            
            
            (2,721
            )
            
            
            944
            
            
            
            (5,435
            )Other
                Comprehensive Income (Loss)
            
            $
            773
            
            
            $
            (2,862
            )
            
            $
            1,569
            
            
            $
            (4,731
            )





11
 *Index*




The components of accumulated other comprehensive income
      were
      as follows at September 30, 2007 (in thousands):




Accumulated
                Other Comprehensive Income at December 31, 2006
            
            $
            3,696Foreign
                Currency Translation Adjustment
            
            
            625Accumulated
                Other Comprehensive Income at September 30, 2007
            
            $
            4,321




**Note
      10 – Recent Accounting Pronouncements:**





In
      September 2006, the Financial Accounting Standards Board issued Interpretation
      No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB
      Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty
      in income taxes recognized in an enterprise’s financial statements in accordance
      with SFAS 109. It prescribes a recognition threshold and measurement attribute
      for the financial statements recognition and measurement of a tax position
      taken
      or expected to be taken in a tax return. FIN 48 also provides guidance on
      derecognition, classification, interest and penalties, accounting in interim
      periods and disclosures. We adopted FIN 48 on January 1, 2007. The impact of
      FIN
      48 did not have a material effect on our financial statements.





In
      September 2006, the Financial Accounting Standards Board (“FASB”) issued
      Statement of Financial Accounting Standards No. 157, “Fair Value Measurements”
(“SFAS 157”). This statement defines fair value, establishes a framework for
      measuring fair value in generally accepted accounting principles and expands
      disclosures about fair value measurements. SFAS 157 is effective for financial
      statements issued for fiscal years beginning after November 15, 2007, and
      interim periods within those fiscal years. We are currently evaluating the
      effect that the adoption of SFAS 157 will have on our financial position and
      results of operations.





On
      September 13, 2006, the Securities and Exchange Commission (“SEC”) issued Staff
      Accounting Bulletin No. 108 (“SAB 108”). The interpretations in SAB 108 were
      issued to address diversity in practice in quantifying financial statement
      misstatement and the potential under current practice for the build up
      of  improper amounts on the balance sheet. The adoption of SAB 108 did
      not have a significant impact on our financial position and results of
      operations.





In
      February 2007, the Financial Accounting Standards Board (“FASB”) issued
      Statement of Financial Accounting Standards No. 159, “The Fair Value Option for
      Financial Assets and Financial Liabilities-Including an amendment of FASB
      Statement No. 115” (“SFAS 159”). The objective of this statement is to improve
      financial reporting by providing entities with the opportunity to mitigate
      volatility in reported earnings caused by measuring related assets and
      liabilities differently without having to apply complex hedge accounting
      provisions. SFAS 159 is effective as of the beginning of an entity’s first
      fiscal year that begins after November 15, 2007. We are currently evaluating
      the
      effect that the adoption of SFAS 159 will have on our financial positions and
      results of operations.





In
      addition, the Company is reviewing the Emerging Issues Task Force 06-03 (“EITF
      06-03”) issued in September 2006, effective to financial reporting for interim
      and annual reporting periods beginning after December 15, 2006. This EITF
      applies to taxes assessed by various governmental authorities on many different
      types of transactions. These taxes range from sales taxes that are applied
      to a
      broad class of transactions involving a wide range of goods and services to
      excise taxes that are applied only to specific types of transactions or items.
      We are currently evaluating the effect that the adoption of EITF 06-3 will
      have
      on our financial position and results of operations.





12
 *Index*




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





The
      following discussion and analysis of our financial condition and results of
      operations should be read in conjunction with our unaudited condensed
      consolidated financial statements and notes thereto appearing elsewhere in
      this
      report. This discussion and analysis contains forward-looking statements that
      involve risks and uncertainties, including those discussed below under
      "Forward-Looking Statements" and "Risk Factors”, set forth in Part I, Item 1A,
      and in our Annual Report on Form 10-K for the year ended December 31,
      2006 and in Part II, Item 1A of our Quarterly Report on Form 10-Q for the
      quarter ended September 30, 2007. You should not place undue reliance on these
      forward-looking statements. Actual results may differ materially from those
      anticipated in the forward-looking statements. These forward-looking statements
      represent our judgment as of the date of the filing of this
      Form 10-Q.





**Forward
      Looking Statements**





Certain
      statements contained in this section, in Quantitative and Qualitative Disclosure
      About Market Risk and elsewhere in this report, are intended to be covered
      by
      the Safe Harbor provided for under Section 27A of the Securities Act of
      1933, as amended, and Section 21E of the Securities Act of 1934, as amended.
      This Quarterly Report contains forward-looking statements, which are subject
      to
      a number of risks and uncertainties. All statements other than statements of
      historical facts are forward-looking statements. These statements are identified
      by terminology such as but not limited to "may," "will," "could," "should,"
      "expects," "plans," "intends," "seeks," "anticipates," "believes," "estimates,"
      "potential," or "continue," or the negative of such terms or other comparable
      terminology, although not all forward-looking statements contain these
      identifying words. Forward-looking statements are only predictions and include
      statements relating to:





·
            our
                ability to remain as a going
                concern;




·
            our
                strategy, future operations and financial plans, including, without
                limitation, our plans to install and commercially produce products
                on new
                machines;




·
            the
                success of our restructuring activities and our expectations as to
                expense
                reductions;




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




·
            our
                projected need for, and ability to obtain, additional borrowings
                and our
                future liquidity;




·
            future
                applications of thin-film technologies and our development of new
                products;




·
            our
                competition;




·
            statements
                about the future size of markets;




·
            our
                expectations with respect to future grants, investment allowances
                and bank
                guarantees from the Saxony
                government;




·
            our
                expected results of operations and cash
                flows;




·
            pending
                and threatened litigation and its outcome;
                and




·
            our
                projected capital expenditures.




You
      should not place undue reliance on our forward-looking statements. Actual events
      or results may differ materially. In evaluating these statements, you should
      specifically consider various factors, including the risks outlined below under
      "Risk Factors" and under “Risk Factors” in our 2006 Form 10-K. These factors may
      cause our actual results to differ materially from any forward-looking
      statement. Although we believe the expectations reflected in our forward-looking
      statements are reasonable as of the date they are being made, we cannot
      guarantee our future results, levels of activity, performance, or achievements.
      Moreover, neither we, nor any other person, assume responsibility for the future
      accuracy and completeness of these forward-looking statements.





13
 *Index*




**Overview**





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




*Restructuring
      and financing activities.* As a consequence of the decline in our revenues
      and negative cash flows in 2003, we implemented several cost cutting and
      business restructuring activities during 2002 and 2004. These activities, which
      included employee layoffs and the closure of several facilities (including
      the
      closure of our Tempe manufacturing facility in the fourth quarter of 2003),
      were
      designed to improve our cash flow from operations to allow us to continue as
      a
      going concern. During the fourth quarter of 2003 and the first quarter of 2004,
      we agreed to new payment terms with all of our major creditors and vendors,
      which extended or reduced our payment obligations. We also issued $4.5 million
      of convertible promissory notes and warrants to investors. The convertible
      promissory notes were converted to Series A preferred shares and the warrants
      were exercised for shares of common stock in the fourth quarter of 2004. In
      January 2006, we commenced further restructuring actions to improve our cost
      structure for 2006 and beyond. These actions included the closure of our Palo
      Alto, California manufacturing facility and a reduction in force at our Palo
      Alto site in the first half of 2006. Also during the first half of 2006, we
      transferred our U.S. manufacturing operations to our European site located
      near
      Dresden, Germany. As a result of these actions, we incurred a restructuring
      charge of $915,000 in 2006 relating to employee severance packages and facility
      related charges.





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





Our
      three
      largest customers in the automotive glass and window film markets include
      Pilkington PLC, Saint Gobain Sekurit and Globamatrix Holdings Pte. Ltd., or
      Globamatrix, which collectively accounted for approximately 63%, 44% and 54%
      of
      our total revenues during the first nine months of 2007, fiscal year 2006 and
      fiscal year 2005, respectively.





Under
      our
      agreement with Globamatrix, as amended, Globamatrix agreed to a 2004 minimum
      purchase commitment of $9.0 million of product**.** For each year
      after 2004 through and including 2011, Globamatrix is required to purchase
      an
      amount of product equal to 110% of the amount of product it was required to
      purchase in the prior year. Globamatrix is obligated to purchase $12.0 million
      of certain products in 2007. During the first nine months of 2007, Globamatrix
      purchased approximately $9.05 million of these products.





The
      Company has sold a highly specialized EMI filtering film for use in Plasma
      Display Panels under an exclusive Manufacturing and Supply Agreement to our
      customer, Mitsui Chemicals, for over 4 years; this agreement expires at the
      end
      of 2007 and will not be renewed.  In 2006, the EMI filtering film
      revenue accounted for approximately 25% of Southwall’s
      sales.   Due to the competitive nature of pricing in this market,
      the Company expects significantly decreased revenues on an ongoing basis
      attributable to this product line.




*Sales
      returns and allowances.* Our gross margins and profitability have been
      adversely affected from time to time by product quality
      claims.  During the first nine months of 2007, our sales returns
      provision has averaged approximately 5.35% of our gross revenues due to higher
      quality claims received during the period.   From 2002 to 2006,
      our sales returns provision has averaged approximately 2.7% to 4.5% of gross
      revenues.





14
 *Index*




**Critical
      Accounting Policies and Estimates**





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





We
      believe there have been no significant changes during the first nine months
      of
      fiscal 2007 to the items that we disclosed as our critical accounting policies
      and estimates in our discussion and analysis of financial condition and results
      of operations in our 2006 Form 10-K, except as noted below.





*Stock
      Based Compensation Expense*





We
      account for stock-based compensation in accordance with the provisions of SFAS
      123R. Under the fair value recognition provisions of SFAS 123R, stock based
      compensation cost is estimated at the grant date based on the fair value of
      the
      award and is recognized as expense ratably over the requisite service period
      of
      the award. Determining the appropriate fair value model and calculating the
      fair
      value of stock-based awards requires judgment, including estimating stock price
      volatility, forfeiture rates and expected lives.





**Three
      Months Ended September 30, 2007 compared with Three Months Ended September
      30,
      2006**





**Results
      of Operations**





*Net
      revenues.*Our net revenues for the third quarter ended September 30, 2007
      and September 30, 2006 were $9.249
      million and $9.597 million, respectively. The largest component of the revenue
      decline was reduced demand for our electronic display products and to a lesser
      degree our architectural glass products. Revenues increased from our window
      film
      and automotive products.





Our
      net
      revenues from our electronic display products decreased by $2.52 million, to
      $46,000 compared to $2.56 million for the third quarter ended September 30,
      2007
      and 2006 respectively.  This decrease was due to the decreased demand
      from our major display product customer as a result of price sensitivity in
      the
      electronic display industry.  Due to the competitive nature of pricing
      in this market, we expect significantly decreased revenues from our electronic
      display product line compared to fiscal 2006.  In 2006 our electronic
      display business comprised approximately 27% of our total
      sales.   Due to the competitive nature of pricing related
      to   EMI filtering film for use in plasma display panels, the
      Company expects significantly decreased revenues on an ongoing
      basis.





Our
      net
      revenues in the automotive market increased by $744,000, 24.6%, to $3.76 million
      compared to $3.02 million for the third quarter ended September 30, 2007 and
      2006 respectively. The increase was primarily due to the impact of the USD
      to
      Euro exchange rate and increased selling prices for some of the products the
      Company offers.





15
 *Index*




Our
      net
      revenues in the window film product line increased by $1.62 million, 66.5%,
      to
      $4.04 million compared to $2.42 million in the third quarter ended September
      30,
      2007 and 2006 respectively.  This increase was due to an increased
      demand under the Globamatrix contract and the launch of a new
      product.





Our
      net
      revenues in architectural products decreased by $186,000, 11.7%, to $1.40
      million compared to $1.59 million for the third quarter ended September 30,
      2007
      and 2006 respectively. This decrease is due to a delivery delay on a customer
      order.





*Cost
      of revenues.* Cost of revenues consists of materials and subcontractor
      services, labor and manufacturing overhead. Cost of revenues was $6.07 million
      in the third quarter ended September 30, 2007 compared to $5.67
      million in the same period of 2006.  The increase in cost of revenues was
      primarily due to an increase in inventory reserves for the window film
      products.





*Gross
      profit and gross margin.* Our gross profit decreased $751,000 to $3.18
      million compared to $3.93
      million for the third quarter ended September 30, 2007 and 2006
      respectively.  As a percentage of sales, gross profit decreased to
      34.4% compared to 40.9% for the third quarter ended September 30, 2007 and
      2006
      respectively. This was due to the lower production and sales volumes primarily
      in the electronic display product line, and an increase in inventory reserves
      for the window film products as a result of a quality and yield issue at one
      of
      our subcontractors.





*Operating
      expenses*




*Research
      and development*. Research and development expenses decreased $725,000 to
      $934,000 compared to $1.66 million for the third quarter ended September 30,
      2007 and 2006 respectively. The 43.7% decrease from year to year was due
      primarily to the timing of test runs in the third quarter of 2007 compared
      to
      the same period last year and the consumption of the associated
      materials.  Also the decrease is partially due to lower labor and
      employee benefit costs, due to a workforce reduction and the resignation of
      our
      Chief Technology Officer effective April 2, 2007.  We do not intend to
      replace this position in the near future as we believe our current R&D staff
      is sufficient for our R&D needs.  We expect expenditures relating
      to research and development for the remainder of 2007 to be slightly higher
      in
      the remaining quarter of 2007 as compared with the first three quarters of
      2007.  In the third quarter of 2007 we delivered the orders for a new
      class of window film, which we believe, will strengthen our window film
      line.




*Selling,
      general and administrative*. Selling, general and administrative expenses
      consist primarily of corporate and administrative overhead, selling commissions
      and occupancy costs. Selling, general and administrative expenses decreased
      $2.55 million to $2.12 million compared to $4.67 million for the third quarter
      ended September 30, 2007 and 2006 respectively.  This decrease was
      primarily due to a $1.51 million accrual for leasehold retirement obligations
      in
      2006 coupled with the departure of the Vice President of Business
      Development and our Managing Director of Southwall Europe to Sunfilm AG in
      April
      2007, partially offset by the promotion of Dennis Capovilla to President and
      Michael Vargas to Vice President of General Administration




*Restructuring.*On January 19, 2006, we commenced restructuring actions to improve our
      cost
      structure. These actions included the closure of our Palo Alto, California
      manufacturing facility and a reduction in force at our Palo Alto site in the
      first half of 2006. As a result of these actions, we incurred additional
      restructuring charges of $263,000 during the third quarter ended September
      30,
      2006, primarily relating to outside services to decommission our manufacturing
      equipment and scrapped production materials. There was no such restructuring
      charge in the third quarter ended September 30, 2007.





16
 *Index*




*Income
      (loss) from operations*.  Income (loss) from operations improved
      $2.48 million to a $140,000 operating income compared to a loss of $2.34 million
      for the third quarter ended September 30, 2007 and 2006
      respectively.  This improvement was due to a decrease of total
      operating expenses attributable to a reduction of $2.55 million in selling,
      general and administrative expenses, $725,000 million in research and
      development expenses, and $263,000 in restructuring charges, partially offset
      by
      a decline in revenue and the margin decline.





*Interest
      expense, net.*There was no material change in interest expense from third
      quarter ended September 30, 2006 to the same period in 2007.





*Other
      income, net*.   Other income, net mainly reflects income from
      a sale to Sunfilm and foreign exchange transaction gains and losses in the
      third quarter of 2007 and 2006. Some of our transactions with foreign customers
      are denominated in foreign currencies, principally the Euro. As exchange rates
      fluctuate relative to the U.S. dollar, exchange gains and losses
      occur.  Other income increased $531,000 to $513,000 due to $ 500,000
      received from Sunfilm,compared to loss of $18,000 for the third quarter ended
      September 30, 2006 and 2007 respectively.





*Income
      (loss) before provision for income taxes*. We recorded pre-tax income of
      $462,000 in the third quarter of 2007 compared to a pre-tax loss of
      $2.53****million for the third quarter ended September 30,
      2006. This increase was the result of other income of $513,000, a decrease
      in
      total operating expenses attributable to a reduction of $2.55 million in
      selling, general and administrative expenses, $725,000 in research and
      development expenses, and $263,000 in restructuring charges, partially offset
      by
      a $308,000 reduction in recoveries for long lived assets and lower margin from
      reduced sales and higher reserves due to quality control issues.





*Provision
      for income taxes*. The increase in the provision for income taxes in the
      third quarter ended September 30, 2007 compared to the same period in 2006
      is
      related to higher taxable income in 2007 in our foreign subsidiary, Southwall
      Europe GmbH, or SEG.




*Deemed
      dividend on preferred stock.* We accrued $122,000 and $123,000 of deemed
      dividend on preferred stock in each of the third quarters of 2007 and 2006
      respectively.  The holders of our secured convertible promissory notes
      converted those notes to shares of Series A preferred stock in December 2004.
      The Series A preferred stock accrues cumulative dividends at the rate of 10%
      per
      annum.





**Nine
      months Ended September 30, 2007 compared with Nine months Ended September 30,
      2006**





*Net
      revenues.*Our net revenues for thenine months ended
      September 30, 2007 and September 30, 2006 were $29.00 million and $30.97
      million, respectively. The decline in revenues was the result of a decreased
      demand for our electronic display products, partially offset by an increase
      in
      revenue from our architectural products, automotive glass and window film
      product lines.




Our
      net
      revenues from our electronic display products decreased by $5.73 million, to
      $2.60 million compared to $8.3 million for the nine months ended September
      30,
      2007 and 2006 respectively.  This decrease was primarily due to the
      decreased demand from our major display product customer as a result of price
      sensitivity in the electronic display industry. Due to the competitive nature
      of
      pricing in this market, we expect to see significantly decreased revenues from
      our electronic display product line compared to fiscal 2006.  In 2006
      our electronic display business comprised approximately 27% of our total
      sales.  Due to the competitive nature of pricing related to EMI
      filtering film for use in plasma display panels, the Company expects
      significantly decreased revenues on an ongoing basis.





17
 *Index*




Our
      net
      revenues in the architectural product line increased by $580,000, 14.4%, to
      $4.62 million compared to $4.04 million for the nine months ended September
      30,
      2007 and 2006 respectively. This improvement is
      due to
      increased prices, the impact of the Euro exchange rate, and theincreased
      demand for Southwall's energy efficient building products.




Our
      net
      revenues in the automotive market increased by $1.44 million, 14.8%, to $11.16
      million compared to $9.73 million for the nine months ended September 30, 2007
      and 2006 respectively. The increase was primarily due to increased average
      selling prices for some products offered and the Euro exchange
      rate.   .





Our
      net
      revenues in the window film product line increased by $1.75 million, 19.7%,
      to
      $10.63 million compared to $8.88 million in the nine months ended September
      30,
      2007 and 2006 respectively.  This increase was due to increased demand
      from Globamatrix.





*Cost
      of revenues.* Cost of revenues consists of materials and subcontractor
      services, labor and manufacturing overhead. Cost of revenues was $18.67 million
      in the nine months ended September 30, 2007 compared to $19.3
      million in the same period of 2006.  The decrease in cost of revenues was
      primarily due to lower revenues, and transfer of production to our lower cost
      German manufacturing facility, partially offset by inventory reserves for the
      window film products.





*Gross
      profit and gross margin.* Our gross profit decreased $1.34 million to $10.33
      million compared to $11.67 million for the nine months ended September 30,
      2007
      and 2006 respectively.  As a percentage of sales, gross profit was
      35.6% and 37.7% for the nine month period ended September 30, 2007 and 2006
      respectively.  This was due to the lower production and sales volumes
      primarily in the electronic display product line, and an increase in inventory
      reserves for the window film products as a result of a quality and yield issue
      at one of our subcontractors.  Due to the competitive nature of
      pricing related to the EMI filtering film for use in plasma display panels,
      the
      Company expects significantly decreased revenues on an ongoing
      basis.





*Operating
      expenses*




*Research
      and development*. Research and development expenses decreased $2.2 million
      to $3.17 million compared to $5.38 million for the nine months ended September
      30, 2007 and 2006 respectively. The 41% decrease from year to year was due
      primarily to the timing of test runs in 2007 compared to the same period last
      year and the consumption of the associated materials.  Also the
      decrease is partially due to lower labor and employee benefits costs, due to
      a
      workforce reduction and the resignation of our Chief Technology Officer
      effective April 2, 2007.   In the third quarter of 2007 we
      delivered the orders for a new class of window film, which we believe, will
      strengthen our window film line.





*Selling,
      general and administrative*. Selling, general and administrative expenses
      consist primarily of corporate and administrative overhead, selling commissions
      and occupancy costs. Selling, general and administrative expenses decreased
      $2.83****million****to $6.93 million
      compared to $9.76 million
      for the nine months ended September 30, 2007 and 2006 respectively. This
      decrease was primarily due to  a $1.71 million accrual for leasehold
      retirement obligations in 2006.  In addition, labor and related costs
      were reduced by approximately $731,000 due primarily to the reduction in the
      number of employees from 29 to 21 coupled with the transition of the Vice
      President of Business Development and the Managing Director of Southwall Europe
      to Sunfilm AG in April 2007, which was partially offset by the promotion of
      Dennis Capovilla to President and Michael Vargas to Vice President of General
      Administration.  Legal expenses were reduced by $190,000 in 2007
      compared to 2006.  The Company had also settled a legal dispute in
      2006 for $130,000.  The Company reduced stock compensation expense by
      $70,000 in 2007.





18
 *Index*








*Impairment
      charge (recoveries) for long-lived assets.*   In the nine
      months ended September 30, 2007 and September 30, 2006, respectively, we
      recorded the recovery of  $25,000 and $117,000 of previously recorded
      impairment charges related to impaired long-lived assets, which were sold in
      the
      nine months ended September 30, 2006.





*Restructuring.*On January 19, 2006, we commenced restructuring actions to improve our
      cost
      structure. These actions included the closure of our Palo Alto, California
      manufacturing facility and a reduction in force at our Palo Alto site in the
      first half of 2006. As a result of these actions, we incurred additional
      restructuring charges of $974,000 during the nine months ended September 30,
      2006 primarily relating to outside services to decommission our manufacturing
      equipment and scrapped production materials and severance. There was no such
      restructuring charge in the third quarter ended September 30, 2007.





*Income
      (loss) from operations*.  Income (loss) from operations increased
      $4.58 million to a $252,000 operating income compared to a loss of $4.33 million
      for the nine months ended September 30, 2007 and 2006
      respectively.  This improvement was due to a decrease of total
      operating expenses attributable to a reduction of  $2.83 million in
      selling, general and administrative expenses, $2.2 million in research and
      development expenses, $974,000 in restructuring charges, and $92,000 in
      impairment charges.





*Interest
      expense, net.*Interest expense decreased $79,000 to $471,000 from $550,000
      in the nine months ended September 30, 2007 and 2006.  The difference
      was due to payments on outstanding debt.





*Other
      income, net*.  Other income, net, includes the receipt of $2.0
      million received for milestones met under a Technology Transfer and Service
      Agreement with Sunfilm AG.  This income was partially offset by a
      cancellation charge of $484,000 on a machinery order.  Other income,
      net also reflects foreign exchange transaction gains and losses. Some of our
      transactions with foreign customers are denominated in foreign currencies,
      principally the Euro. As exchange rates fluctuate relative to the U.S. dollar,
      exchange gains and losses occur.  Other income increased $1.40 million
      to $1.56 million compared to $161,000 for the nine months ended September 30,
      2007 and 2006 respectively.





*Income
      (loss) before provision for income taxes*. We recorded pre-tax income of
      $1.34 million compared to a pre-tax loss of $4.72 million for the nine months
      ended September 30, 2007 and 2006 respectively.  This increase was the
      result of other income net of $1.56 million and to a decrease in total operating
      expenses attributable to a reduction of $2.83 million in selling, general and
      administrative expenses, $2.2 million in research and development expenses,
      $974,000 in restructuring charges,  and $92,000 in impairment
      charges.





*Provision
      for income taxes*. The decrease in the provision for income taxes in the
      nine months ended September 30, 2007 compared to the same period in 2006 is
      related to lower taxable income in 2007 in our foreign subsidiary, Southwall
      Europe GmbH, or SEG.  In addition, our foreign subsidiary completed an
      income tax audit for years 1999 to 2002 and incurred additional income tax
      expense of $200,000 in the nine months ended September 30, 2006.








*Deemed
      dividend on preferred stock.* We accrued $366,000 and $367,000 of
      deemed dividend on preferred stock in the first nine months of 2007 and 2006,
      respectively.  The holders of our secured convertible promissory notes
      converted those notes to shares of Series A preferred stock in December 2004.
      The Series A preferred stock accrues cumulative dividends at the rate of 10%
      per
      annum.





19
 *Index*


**Liquidity
      and capital resources.**





*Liquidity*




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





Our
      cash
      and cash equivalents decreased $0.7 million from $5.5 million at December 31,
      2006 to $4.8 million at September 30, 2007. Cash provided by operating
      activities of $0.9 million for the first nine months of 2007 was primarily
      the
      result of net income of $0.9 million, non-cash depreciation of $2.1 million,
      non-cash stock compensation expense of $0.3 million and a decrease in other
      current and non current assets of $0.2 million, offset by an increase in
      accounts receivable of $2.1 million, increase in inventories of $0.4 million,
      increase in deferred income tax of $0.1 million. Cash used in operations for
      the
      first nine months of 2006 of $0.1 million was primarily the result of net loss
      of $5.4 million and a deferred rent payment of $1.2 million, partially offset
      by
      non-cash depreciation of $1.8 million, decreases in accounts receivable of
      $2.0
      million, a decrease in inventories of $0.6 million, an increase in accounts
      payable and accrued liabilities of $2.0 million and non-cash stock compensation
      expense of $0.5 million.





Cash
      used
      in investing activities for the first nine months of 2007 was $1.0 million
      and
      was primarily the result of capital expenditures of $0.6 million and an increase
      in restricted cash of $0.4 million in Germany for purchase of precious metals
      used in production. Cash used in investing activities for the first nine months
      of 2006 was $0.2 million and was primarily the result of capital expenditures
      of
      $0.8 million reduced by proceeds $0.4 million from sale of assets and a decrease
      in restricted cash of $0.2 million.





Cash
      used
      in financing activities for the first nine months of 2007 was $0.5 million
      and
      was primarily the result of repayments under term debt of $0.8 million offset
      by
      $0.3 million proceeds received from exercise of stock options. Cash used in
      financing activities for the first nine months of 2006 of $1.3 million was
      primarily the result of repayments under term debt of $1.1 million and $0.2
      million investment credit in Germany.





We
      entered into an agreement with the Saxony government in May 1999 under
      which we receive investment grants. As of September 30, 2007, we had
      received grants of 5.0 million Euros or $5.0 million at the historical
      exchange rate and accounted for these grants by applying the proceeds received
      to reduce the cost of our fixed assets in our Dresden manufacturing facility.
      Additionally, as of September 30, 2007, we had a balance remaining from the
      government grants that we are entitled to receive of $0.2 million, which has
      been recorded as an advance and held as restricted cash until we receive
      approval from the Saxony government to apply the funds to reduce our capital
      expenditures. The total annual amount of investment grants and investment
      allowances that we are entitled to seek varies from year to year based upon
      the
      amount of our capital expenditures that meet certain requirements of the Saxony
      government. The measurement date of these requirements was June 30, 2006. We
      believe we met the requirements at June 30, 2006. Currently we are in audit
      meetings with the Saxony government with regard to $0.2 million unused grants
      that we have previously received and currently hold as restricted cash. We
      expect to close these grants in fourth quarter of 2007. However, we cannot
      guarantee that we will be eligible for or will receive additional grants in
      the
      future from the Saxony government.





*Borrowing
      arrangements*





20
 *Index*




On
      March
      29, 2007, we entered into a new Credit Agreement (“Credit Agreement”) with
      Bridge Bank, N.A. (“Bank”), replacing our credit agreement with Wells Fargo HSBC
      Trade Bank, N.A. The Credit Agreement provides for two facilities. The first
      facility is a revolving line of credit for the lesser of $3 million or the
      face
      value of the letter of credit used to support the facility. The proceeds of
      the
      facility were used to pay off Wells Fargo HSBC Trade Bank. Amounts borrowed
      under the first facility bear interest at the prime rate minus 1.75% and are
      collateralized by a $3 million standby letter of credit from Needham &
Company (“Needham”). At December 31, 2006, Needham and its affiliates owned
      41.7% of our outstanding common stock and series A 10% Cumulative Convertible
      Preferred Stock convertible into another 5% of our outstanding common stock.
      Because the letter of credit being provided by Needham & Co. was not
      released by August 1, 2007, the Company has accrued quarterly interest payments
      on the $3 million supporting the letter of credit at the rate of 12.8% per
      annum
      to Needham & Co..  As of  August 1, 2007, the Company
      has accrued interest expense at the rate of 12.8% per annum pursuant to the
      terms of the $3 million standby letter of credit from Needham &
Company.





The
      second facility is a $3 million revolving line of credit line under which we
      may, from time to time, borrow up to 80% of eligible accounts receivables (net
      of pre-paid deposits, pre-billed invoices, deferred revenue, offsets, and
      contras related to each specific account debtor and other requirements in the
      lender’s discretion). Amounts borrowed under the second facility bear interest
      at prime plus 1.75% annualized on the average daily finance amount outstanding.
      The second facility also provides for a $2 million letter of credit sub
      facility. All borrowings under the facilities will be collateralized by all
      our
      assets and are subject to certain covenants. These covenants include that while
      the second facility is outstanding (a) we will maintain a minimum current ratio
      of 1.00 to 1.00 for the months through May 31, 2007; thereafter, starting with
      month ending June 30, 2007, we need to maintain a current ratio of 1.25 to
      1.00
      on a monthly basis; and (b) our quarterly net loss to shareholders (including
      deemed dividend) will not exceed $0.4 million for any quarter after September
      30, 2006.





The
      terms
      of the Credit Agreement, among other things, limit our ability to (i) incur,
      assume or guarantee additional indebtedness (other than pursuant to the Credit
      Agreement), (ii) incur liens upon the collateral pledged to the bank, and (iii)
      merge, consolidate, sell or otherwise dispose of substantially all or a
      substantial or material portion of our assets.





The
      Credit Agreement provides for events of default, which include, among others,
      (a) nonpayment of amounts when due (with no grace periods), (b) the breach
      of
      our representations or covenants or other agreements in the Credit Agreement
      or
      related documents, (c) defaults or accelerations of our other indebtedness,
      (d)
      a failure to pay certain judgments, (e) the occurrence of any event or condition
      that the Bank believes impairs or is substantially likely to impair the
      prospects of payment or performance by us, and (f) certain events of bankruptcy,
      insolvency or reorganization. Generally, if an event of default occurs, the
      Bank
      may declare all outstanding indebtedness under the Credit Agreement to be due
      and payable.





The
      maturity date of the facilities is March 28, 2008.  The Company is in
      compliance with all financial covenants.




The
      foregoing description does not purport to be a complete statement of the
      parties’ rights and obligations under the Credit Agreement and the transactions
      contemplated thereby or a complete explanation of the material terms
      thereof.





*Capital
      expenditures*





We
      expect
      to spend approximately $1.4 million in 2007 on upgrades and refurbishment of
      our
      production machines and research and development tools. We spent approximately
      $0.6 million in capital expenditures during the first nine months of
      2007.





*Future
      payment obligations*





21
 *Index*




Our
      future payment obligations on our borrowings pursuant to our term debt, line
      of
      credit, non-cancelable operating leases and other non-cancelable contractual
      commitments are as follows at September 30, 2007 (in thousands):




Less
            
            
            
            
            
            
            
            
            GreaterThan
            
            
            
            
            
            
            
            
            ThanTotal
            
            
            1
                Year
            
            
            1-3
                Years
            
            
            3-5
                Years
            
            
            5
                YearsContractual
                Obligations:Term
                debt (1)
            
            $
            9,406
            
            
            $
            1,118
            
            
            $
            4,645
            
            
            $
            984
            
            
            $
            2,659Line
                of credit (1)
            
            
            3,000
            
            
            
            3,000
            
            
            
            -
            
            
            
            -
            
            
            
            -Operating
                leases (2)
            
            
            1,752
            
            
            
            488
            
            
            
            907
            
            
            
            357
            
            
            
            -Other
                Obligations (3)
            
            
            1,601
            
            
            
            1,601
            
            
            
            
            
            
            
            
            
            
            
            -Total
                contractual cash obligations
            
            $
            15,759
            
            
            $
            6,207
            
            
            $
            5,552
            
            
            $
            1,341
            
            
            $
            2,659








(1)
            Represents
                loan agreements with Portfolio Financing Servicing Company, Bridge
                Bank
                and several German banks.





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




(3)
              Based
                  on my knowledge, the financial statements, and other financial
                  information
                  included in this report, fairly present in all material respects
                  the
                  financial condition, results of operations and cash flows of the
                  registrant as of, and for, the periods presented in this
                  report;




On
      June
      13, 2006, we signed an agreement  to sublease 3782-3788 Fabian Way,
      Palo Alto, California 94303.  The term of this sublease commenced on
      June 16, 2006 and will continue until December 31, 2008, with monthly rent
      payments of $18,000 through May 31, 2008, and $19,000 through December 31,
      2008.





On
      June 21, 2006, we amended our lease
      with Richard Christina to extend our original lease through June 30, 2011 for
      the facilities at 3780 Fabian Way, Palo Alto, California 94303. Also, on June
      21, 2006, we entered into a lease agreement with Richard Christina to lease
      3782-3788 Fabian Way, Palo Alto, California. The term of this lease extends
      the
      rental term for all premises (3780 and 3782-3788 Fabian Way, Palo Alto,
      California) to June 30, 2011 at a Base Rent of $38,000 per month. On January
      1,
      2010 and 2011, the Base Rent shall increase by 3%.





22
 *Index*




**Item
      3--Quantitative and Qualitative Disclosures about Market
      Risk**





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





***Financing
      risk:*** Our exposure to market rate risk for changes in interest
      rates relates primarily to our line of credit which bears an interest rate
      equal
      to prime rate minus 1.75% (which was 6.00% at September 30, 2007) and is
      calculated based on amounts borrowed under the facility. In addition, the
      interest rate on one of our German loans has been reset to the prevailing market
      rate of 5.75% and another of our German loans will have its interest rate reset
      to the prevailing market rate in 2009. Fluctuations or changes in interest
      rates
      may adversely affect our expected interest expense. The effect of a 10%
      fluctuation in the interest rate on our line of credit and term debt would
      have
      had an immaterial effect on our interest expense for the first nine months
      of
      2007.




***Investment
      risk:*** We invest our excess cash in money market accounts and, by
      practice, limit the amount of exposure to any one institution. Investments
      in
      both fixed rate and floating rate interest earning instruments carry a degree
      of
      interest rate risk. Fixed rate securities may have their fair market value
      adversely affected due to a rise in interest rates, while floating rate
      securities may produce less income than expected if interest rates fall. The
      effect of a 10% fluctuation in the interest rate on our excess cash investments
      would not have had a material effect on our interest income in the first nine
      months of 2007.




***Foreign
      currency risk:*** International revenues (defined as sales to
      customers located outside of the United States) accounted for approximately
      73%
      of our total sales in the third quarter of 2007. Approximately 48% of our
      international revenues were denominated in Euros in the third quarter of 2007.
      The other 52% of our international sales were denominated in US dollars. In
      addition, certain transactions with foreign suppliers are denominated in foreign
      currencies (principally Japanese Yen). The effect of a 10% fluctuation in the
      Euro exchange rate would have had an effect of approximately $0.5
      million on net revenues for the third quarter of 2007 and the effect on expenses
      of a 10% fluctuation in the Yen exchange rate would have been
      immaterial.




23
 *Index*





**Item
      4-Controls and
      Procedures**


(a)
            *Evaluation
                and Disclosure Controls and Procedures*.  Under the
                supervision and with the participation of our management, including
                our
                Chief Executive Officer and Principal Financial Officer, we conducted
                an
                evaluation of the effectiveness of the design and operation of our
                disclosure controls and procedures, as defined in Rules 13a-15(e)
                and
                15d-15(e) under the Securities Exchange Act of 1934, as amended,
                as of
                September 30, 2007.  Based on this evaluation, our Chief
                Executive Officer and Principal Financial Officer concluded as of
                the
                Evaluation Date that our disclosure controls and procedures were
                effective, such that the information relating to our company, including
                our consolidated subsidiary, required to be disclosed in our Securities
                and Exchange Commission (“SEC”) reports (i) is recorded, processed,
                summarized and reported with the time periods specified in SEC rules
                and
                forms, and (ii) is accumulated and communicated to our management,
                including our chief executive officer and principal financial officer,
                as
                appropriate to allow timely decisions regarding required
                disclosure.





*(b)*
            *Report
                on Internal Control Over Financial Reporting*. We will be required by
                the Sarbanes-Oxley Act to include an assessment of our internal
                control over financial reporting in our Annual Report on Form 10-K
                beginning with the filing for our fiscal year ending December 31,
                2007.





(c)
            *Changes
                in Internal Controls*.  There were no changes during the
                first nine months of 2007 in our internal controls over financial
                reporting that have materially affected, or are reasonably likely
                to
                materially affect, the internal controls over financial
                reporting.




24
 *Index*





**PART
      II--OTHER INFORMATION**




**Item
      1--Legal Proceedings**





Not
      applicable.





**Item
      1A—Risk Factors**





The
      following information updates, and should be read in conjunction with, the
      information disclosed in Item 1A, “Risk Factors,” of our Annual Report on Form
      10K for the year ended December 31, 2006 and filed with the SEC on April 2,
      2007
      and in Part II Item 1A of our Quarterly Report on Form 10-Q for the quarter
      ended March 31, 2007.





**Financial
      Risks**





There
      have been no significant changes in financial risk factors for the third quarter
      ended September 30, 2007.  See information set forth in the section
      entitled “Risk Factors” in our Annual Report on From 10-K for the fiscal year
      ended December 31, 2006.





**Operational
      Risks**





*We
      depend on a small number of customers for nearly all of our revenues, and the
      loss of a large customer could materially adversely affect our revenues or
      operating results.*





Our
      nine
      largest customers accounted for approximately 78%, 77%, 81% and 79% of net
      revenues during the first nine months of 2007 and in 2006, 2005 and 2004,
      respectively. We expect to continue to derive a significant portion of our
      net
      sales from this 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 large customer or a small number of customers could
      materially reduce our revenue and operating results in any period. Some of
      our
      largest automotive glass customers have used a technology—direct-to-glass
      sputtering—as an alternative to our window films, which in 2007 resulted in a
      decrease in orders from these customers. The continued or expanded use of this
      technology by our automotive glass customers would have a material adverse
      effect on our results of operations and financial position.





The
      Company has sold a highly specialized EMI filtering film for use in Plasma
      Display Panels under an exclusive Manufacturing and Supply Agreement to our
      customer, Mitsui Chemicals, for over 4 years; this agreement expires at the
      end
      of 2007 and will not be renewed.




*Fluctuations
      or slowdowns in the overall electronic display industry have and may continue
      to
      adversely affect our revenues.*





Our
      business depends in part on sales by manufacturers of products that include
      electronic displays. The markets for electronic display products are highly
      cyclical and have experienced periods of oversupply resulting in significantly
      reduced demand for our products. In addition, the continuing cost-down pressure
      in the Display markets, particularly in PDPs, limits the applications for our
      film-based filters due to increased competition, and we expect this trend to
      continue. We are also dependent on our marketing partner to successfully promote
      film-based filters. We believe that this business will continue to decline
      in
      the future.




25
 *Index*




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





None.




**Item
      3--Defaults upon Senior Securities**





Not
      applicable.





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





None




**Item
      5--Other Information**





The
      Company has sold a highly specialized EMI filtering film for use in Plasma
      Display Panels under an exclusive Manufacturing and Supply Agreement to our
      customer, Mitsui Chemicals, for over 4 years; this agreement expires at the
      end
      of 2007.   In 2006 this contract represented 25% of our business.
      Due to increased price sensitivity Mitsui Chemical and Southwall Technologies,
      Inc. are currently finalizing an agreement to terminate their contract on
      terms agreeable to both parties.




**Item
      6--Exhibits**




(a)
      Exhibits







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





26
 *Index*




**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 13, 2007**Southwall
                Technologies Inc.**By:
            /s/
              R. Eugene GoodsonDr.
                Eugene Goodson*Principal
                Executive Officer*Executive
                ChairmanBy:
            /s/
              Mallorie BurakMallorie
                Burak*Chief
                Accounting Officer*






27