UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549







FORM
10-Q


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





For
the quarterly period ended March 31, 2010


or


£
            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) has filed all reports required to be filed by Section 13 or 15(d)
of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days. YesTNo£





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).  Yes £     No
£





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





Large
      accelerated filer £
            Accelerated
      filer £
            Non-accelerated
      filer £
            Smaller
      reporting company T





Indicate by check mark whether the
registrant is a shell company (as defined in Rule 12b-2 of the ExchangeAct).Yes£NoT





As
of  May 5, 2010, there were 28,831,089 shares of the registrant's
Common Stock outstanding.







1


SOUTHWALL TECHNOLOGIES INC.





INDEX





PART
      I – FINANCIAL INFORMATION
            
            PageItem
      1
            
            Financial
      StatementsUnaudited Condensed Consolidated Balance Sheets -March 31,
      2010 and December 31, 2009
            
            3Unaudited Condensed Consolidated Statements of
      Operations -Three month periods ended March 31, 2010 and March 31,
      2009
            
            4Unaudited Condensed Consolidated Statements of Cash
      Flows -Three month periods ended March 31, 2010 and March 31,
      2009
            
            5Notes to the Unaudited Condensed Consolidated Financial
      Statements
            
            6Item
      2
            
            Management’s Discussion and Analysis of Financial Condition and
      Results of Operations
            
            15Item
      3
            
            Quantitative and Qualitative Disclosures about Market
      Risk
            
            22Item
      4
            
            Controls and Procedures
            
            22PART
      II – OTHER INFORMATIONItem
      1
            
            Legal Proceedings
            
            23Item
      1A
            
            Risk Factors
            
            23Item
      2
            
            Unregistered Sales of Equity Securities and Use of
      Proceeds
            
            23Item
      3
            
            Defaults upon Senior Securities
            
            23Item
      5
            
            Other Information
            
            23Item
      6
            
            Exhibits
            
            24Signatures
            
            25




2
 Index


PART
I. FINANCIAL INFORMATION





Item
1--Financial Statements:


SOUTHWALL TECHNOLOGIES INC.


UNAUDITED
CONDENSED CONSOLIDATED BALANCE SHEETS


(in
thousands, except per share data)





March 31,
      2010
            
            
            December 31,
      2009ASSETSCurrent
      assets:Cash
      and cash equivalents
            
            $
            13,309
            
            
            $
            12,454Accounts
      receivable, net of allowance for doubtful accounts of $145 at March 31,
      2010 and $115 at December 31, 2009
            
            
            6,645
            
            
            
            5,907Inventories,
      net
            
            
            3,839
            
            
            
            4,522Other
      current assets
            
            
            1,216
            
            
            
            1,479Total
      current assets
            
            
            25,009
            
            
            
            24,362Property,
      plant and equipment, net
            
            
            13,166
            
            
            
            14,393Other
      assets
            
            
            439
            
            
            
            156Total
      assets
            
            $
            38,614
            
            
            $
            38,911LIABILITIES,
      PREFERRED STOCK AND STOCKHOLDERS’ EQUITYCurrent
      liabilities:Current
      portion of long term debt  and capital lease
      obligations
            
            $
            685
            
            
            $
            808Accounts
      payable
            
            
            1,419
            
            
            
            1,258Accrued
      compensation
            
            
            895
            
            
            
            1,395Other
      accrued liabilities
            
            
            4,698
            
            
            
            4,881Total
      current liabilities
            
            
            7,697
            
            
            
            8,342Term
      debt and capital lease obligations
            
            
            3,115
            
            
            
            3,358Other
      long term liabilities
            
            
            29
            
            
            
            58Total
      liabilities
            
            
            10,841
            
            
            
            11,758Commitments
      and contingencies (Note 6)Series
      A 10% cumulative convertible preferred stock, $0.001 par value;
      $1.00stated value; 5,000 shares authorized, 4,893 shares outstanding at
      March 31, 2010 and December 31, 2009 respectively (Liquidation preference:
      $7,377 and $7,255 atMarch 31, 2010 and December 31, 2009,
      respectively)
            
            
            4,810
            
            
            
            4,810Stockholders’
      equity:Common
      stock, $0.001 par value per share; 50,000 shares authorized, 28,811 shares
      outstanding at March 31, 2010 and 28,791 shares outstanding
      at  December 31, 2009
            
            
            29
            
            
            
            29Capital
      in excess of par value
            
            
            78,300
            
            
            
            78,291Accumulated
      other comprehensive income
            
            
            3,656
            
            
            
            4,382Accumulated
      deficit
            
            
            (59,022
            )
            
            
            (60,359
            )Total
      stockholders’ equity
            
            
            22,963
            
            
            
            22,343Total
      liabilities, preferred stock and stockholders’ equity
            
            $
            38,614
            
            
            $
            38,911








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 endedMarch 31,
      2010
            
            
            March 31,
      2009Net
      revenues
            
            $
            10,481
            
            
            $
            6,496Cost
      of revenues
            
            
            5,768
            
            
            
            4,051Gross
      profit
            
            
            4,713
            
            
            
            2,445Operating
      expenses:Research
      and development
            
            
            792
            
            
            
            682Selling,
      general and administrative
            
            
            2,000
            
            
            
            1,690Total
      operating expenses
            
            
            2,792
            
            
            
            2,372Income
      from operations
            
            
            1,921
            
            
            
            73Interest
      expense, net
            
            
            (94
            )
            
            
            (70
            )Other
      income (expense), net
            
            
            (481
            )
            
            
            2,433Income
      before provision for income taxes
            
            
            1,346
            
            
            
            2,436Provision
      for income taxes
            
            
            9
            
            
            
            157Net
      income
            
            
            1,337
            
            
            
            2,279Deemed
      dividend on preferred stock
            
            
            122
            
            
            
            122Net
      income attributable to common stockholders
            
            $
            1,215
            
            
            $
            2,157Net
      income per common share:Basic
            
            $
            0.04
            
            
            $
            0.08Diluted
            
            $
            0.04
            
            
            $
            0.07Weighted
      Average shares used in computing net income per common
    share:Basic
            
            
            28,792
            
            
            
            28,707Diluted
            
            
            35,906
            
            
            
            33,770








See
accompanying notes to unaudited condensed consolidated financial
statements.


4
 Index


SOUTHWALL TECHNOLOGIES INC.


UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


(in
thousands)





Three
      months endedMarch
      31,2010
            
            
            March
      31,2009Cash
      flows from operating activities:Net
      income
            
            $
            1,337
            
            
            $
            2,279Adjustments
      to reconcile net income to net cash provided by (used in) operating
      activities:Gain
      on settlement of liability
            
            
            -
            
            
            
            (2,359
            )Deferred
      income tax
            
            
            (36
            )
            
            
            24Loss
      on disposal of property, plant and equipment
            
            
            4
            
            
            
            25Depreciation
      and amortization
            
            
            601
            
            
            
            622Stock-based
      compensation
            
            
            112
            
            
            
            92Changes
      in operating assets and liabilities:Accounts
      receivable, net
            
            
            (679
            )
            
            
            (1,053
            )Inventories,
      net
            
            
            537
            
            
            
            (361
            )Other
      current and non-current assets
            
            
            (34
            )
            
            
            (15
            )Accounts
      payable and accrued liabilities
            
            
            (553
            )
            
            
            (501
            )Net
      cash provided by (used in) operating activities
            
            
            1,289
            
            
            
            (1,247
            )Cash
      flows from investing activities:Restricted
      cash
            
            
            -
            
            
            
            261Proceeds
      from sale of property, plant and equipment
            
            
            -
            
            
            
            28Expenditures
      for property, plant and equipment
            
            
            (194
            )
            
            
            (371
            )Net
      cash used in investing activities
            
            
            (194
            )
            
            
            (82
            )Cash
      flows from financing activities:Proceeds
      from stock option exercises
            
            
            20
            
            
            
            -Repayments
      of term debt and capital lease obligations
            
            
            (133
            )
            
            
            (1,228
            )Net
      cash used in financing activities
            
            
            (113
            )
            
            
            (1,228
            )Effect
      of foreign exchange rate changes on cash and cash
    equivalents
            
            
            (127
            )
            
            
            (435
            )Net
      increase (decrease) in cash and cash equivalents
            
            
            855
            
            
            
            (2,992
            )Cash
      and cash equivalents, beginning of period
            
            
            12,454
            
            
            
            10,768Cash
      and cash equivalents, end of period
            
            $
            13,309
            
            
            $
            7,776








See
accompanying notes to unaudited condensed consolidated financial
statements.


5
 Index


SOUTHWALL TECHNOLOGIES INC.


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


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




Note
1—Basis of Presentation:





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





The
accompanying interim condensed consolidated financial statements of Southwall
are unaudited and have been prepared in accordance with accounting principles
generally accepted in the United States of America (GAAP) 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 GAAP 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 for all
periods presented. The year-end consolidated balance sheet data was derived from
audited financial statements, but does not include all disclosures required by
GAAP. 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, 2009 filed with the Securities and Exchange Commission on March 25, 2010.
The results of operations for the interim periods presented are not necessarily
indicative of the operating results to be expected for any future
periods.





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




Note
2–Fair Value Measurements:





The
Company has estimated the fair value amounts of its financial instruments,
including cash and cash equivalents, accounts receivable, accounts payable and
accrued liabilities using available market information and valuation
methodologies considered to be appropriate and has determined that the book
value of those instruments at March 31, 2010 approximates fair
value.




Based on
borrowing rates currently available to the Company for debt and capital lease
obligations with similar terms, the carrying value of our term debt and capital
lease obligations approximates fair value.




6
 Index


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





Cash and
cash equivalents are summarized as follows:





March 31,
      2010Fair Value
              
              
              Book ValueMoney
      Market Funds, Level I
              
              $
              11,079
              
              
              $
              11,079Total
      cash equivalents
              
              
              11,079
              
              
              
              11,079Cash
              
              
              2,230
              
              
              
              2,230Total
      cash and cash equivalents
              
              $
              13,309
              
              
              $
              13,309
   December 31,
      2009Fair Value
            
            
            Book ValueMoney
      Market Funds, Level I
            
            $
            8,027
            
            
            $
            8,027Certificates
      of Deposit, Level I
            
            
            1,750
            
            
            
            1,750Total
      cash equivalents
            
            
            9,777
            
            
            
            9,777Cash
            
            
            2,677
            
            
            
            2,677Total
      cash and cash equivalents
            
            $
            12,454
            
            
            $
            12,454





The
Company’s financial assets and liabilities are valued using market prices on
active markets (Level 1).  Level 1 instrument valuations are obtained
from real-time quotes for transactions in active exchange markets involving
identical assets.  As of March 31, 2010, the Company did not have any
Level 2 instrument valuations which were obtained from readily available pricing
sources for comparable instruments or any Level 3 instruments without observable
market values that would require a high level of judgment to determine fair
value.




Note
3—Inventories, Net:





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





At March
31, 2010 and December 31, 2009, inventories consisted of the
following:





March 31
            
            
            December 312010
            
            
            2009Raw
      materials
            
            $
            1,618
            
            
            $
            2,010Work-in-process
            
            
            1,002
            
            
            
            1,176Finished
      goods
            
            
            1,219
            
            
            
            1,336$
            3,839
            
            
            $
            4,522


7
 Index


Note
4--Net Income Per Common Share:





Basic net income per
common share is computed by dividing net income attributable to common
stockholders (numerator) by the weighted average number of common shares
outstanding (denominator) for the period. Diluted net income per common share
gives effect to all dilutive common shares potentially outstanding during the
period, including stock options 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 net income per share. The Company also excludes preferred
shares convertible into common stock from the computation of diluted weighted
average shares outstanding when the effect would be anti-dilutive.




At March
31, 2010 and 2009, 374 and 3,280 outstanding options, respectively, were
excluded from the dilutive net income per common share calculation, as they were
anti-dilutive because the option prices were higher than the average market
price during each of the three-month periods.





The
Company has accrued a deemed dividend on preferred stock of $122 for each of the
three month periods ended March 31, 2010 and 2009.  The dilutive
effect of convertible securities shall be reflected in diluted net income per
share 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 anti-dilutive.





Tables
summarizing net income attributable to common stockholders, basic and diluted
net income per common share, and weighted shares outstanding are shown
below:





Three
      months endedMarch 31,
      2010
            
            
            March 31,
      2009Net
      income attributable to common stockholders - basic
            
            $
            1,215
            
            
            $
            2,157Add:  Deemed
      dividend on preferred stock
            
            
            122
            
            
            
            122Net
      income attributable to common stockholders - diluted
            
            $
            1,337
            
            
            $
            2,279Weighted
      average common shares outstanding - basic
            
            
            28,792
            
            
            
            28,707Dilutive
      effect of Series A preferred shares
            
            
            4,893
            
            
            
            4,893Dilutive
      effect of stock options
            
            
            2,221
            
            
            
            170Weighted
      average common shares outstanding - diluted
            
            
            35,906
            
            
            
            33,770Basic
      net income per common share
            
            $
            0.04
            
            
            $
            0.08Diluted
      net income per common share
            
            $
            0.04
            
            
            $
            0.07


8
 Index


Note
5 – Product Reporting:





Southwall
operates in one segment.  The total net revenues for the automotive
glass, window film, architectural and electronic display product lines for the
three month periods ended March 31, 2010 and 2009 were as follows:





Three
      months endedMarch 31,
      2010
            
            
            March 31,
      2009Automotive
      glass
            
            $
            4,460
            
            
            $
            3,073Window
      film
            
            
            4,696
            
            
            
            2,293Architectural
            
            
            1,298
            
            
            
            1,040Electronic
      display and other
            
            
            27
            
            
            
            90Total
      net revenues
            
            $
            10,481
            
            
            $
            6,496





The
following is a summary of net revenues by geographic area (based on the location
of the Company's customers) for the three month periods ended March 31, 2010 and
2009:





Three
      months endedMarch 31,
      2010
            
            
            March 31,
      2009Europe
            
            $
            4,358
            
            
            $
            2,949Asia
      Pacific
            
            
            4,592
            
            
            
            1,397United
      States
            
            
            893
            
            
            
            1,444Rest
      of the world
            
            
            638
            
            
            
            706Total
      net revenues
            
            $
            10,481
            
            
            $
            6,496




Note
6--Commitments and Contingencies:





Commitments





The
Company leases certain property and equipment as well as its facilities under
noncancellable operating leases.  These leases expire at various dates
through 2011.





In
January 2006, the Company renewed a lease agreement for its research and
development facility in Palo Alto, California. The lease was renewed in January
2010 for an additional twelve months.  Under this lease agreement, the
Company had accrued $480 for leasehold retirement obligations, which is included
in other accrued liabilities in the accompanying condensed consolidated balance
sheets.  The method and timing of payments are not yet finalized, and
therefore, this estimate of our liability could differ from the actual future
settlement amount.


9
 Index


Term
Debt and Capital Lease Obligations





As of
March 31, 2010, the Company's term debt and capital lease obligations consisted
of the following:





Description
              
              Rate
              
              
              Term
      Debt Balance at March 31, 2010
              
              
              Capital
      Lease Balance at March 31, 2010
              
              
              Total
      Debt Balance at March 31, 2010
              
              
              Due
      Over Next 12 Months
              
              
              Balance
      at December 31, 2009German
      bank loan dated May 12, 1999 (10 year)
              
              
              6.13
              %
              
              $
              -
              
              
              $
              --
              
              
              $
              -
              
              
              $
              -
              
              
              $
              6German
      bank loan dated May 28, 1999 (20 year)
              
              
              5.73
              %(1)
              
              
              3,195
              
              
              
              --
              
              
              
              3,195
              
              
              
              336
              
              
              
              3,403German
      bank loan dated May 28, 2000 (10 year)
              
              
              7.15
              %(2)
              
              
              159
              
              
              
              --
              
              
              
              159
              
              
              
              159
              
              
              
              254Total
      term debt
              
              
              
              
              
              
              3,354
              
              
              
              --
              
              
              
              3,354
              
              
              
              495
              
              
              
              3,663German
      bank financed lease dated June 1, 2008
              
              
              7.518
              %(3)
              
              
              --
              
              
              
              184
              
              
              
              184
              
              
              
              88
              
              
              
              220US
      financing agreement dated May 20, 2008
              
              
              13.60
              %(4)
              
              
              --
              
              
              
              343
              
              
              
              343
              
              
              
              157
              
              
              
              382Total
      capital leases
              
              
              
              
              
              
              --
              
              
              
              527
              
              
              
              527
              
              
              
              245
              
              
              
              602Less
      interest on capital leases
              
              
              
              
              
              
              --
              
              
              
              81
              
              
              
              81
              
              
              
              55
              
              
              
              99Total
      term debt and capital lease obligations
              
              
              
              
              
              
              3,354
              
              
              
              446
              
              
              
              3,800
              
              
              $
              685
              
              
              
              4,166Less
      current portion
              
              
              
              
              
              
              495
              
              
              
              190
              
              
              
              685
              
              
              
              
              
              
              
              808Total
      term debt and capital lease obligations, non-current
              
              
              
              
              
              $
              2,859
              
              
              $
              256
              
              
              $
              3,115
              
              
              
              
              
              
              $
              3,358





(1)
Interest rate was reset on September 16, 2009 to 5.73%.





(2)
Interest rate is fixed at 7.15% until final repayment in 2010.





(3)
Interest rate is fixed at 7.518% until payoff.





(4)
Implied interest rate based on a lease rate factor.





Contingencies





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


10
 Index


Note
7--Stock-Based Compensation:





The
Company has a stock-based compensation program that provides its Board of
Directors broad discretion in creating employee equity incentives. The Company
has granted stock options under various option plans and agreements in the past
and currently grants stock options under the 2007 Long Term Incentive Plan
(“2007 Plan”) which authorizes the granting of up to 10,000 shares of common
stock. Under the terms of the 2007 Plan, the Company can grant both Incentive
Stock Options and Nonstatutory Stock Options.  Grants issued under the
2007 Plan vest and become exercisable at a rate of 25% on each anniversary of
the date of grant and become fully vested on the fourth anniversary of the date
of grant provided that the participant remains an employee or service provider
of the Company or a related company.  Each option granted under the
2007 Plan is non-transferable and expires over terms not exceeding ten years
from the date of grant or 30 days after an option holder’s voluntary termination
from the Company.  If an option holder’s employment is terminated
involuntarily for misconduct, the option will terminate immediately and may no
longer be exercised.  Involuntary termination not for misconduct
allows for the option holder to exercise options within a period of three months
after such termination of service occurs.  The 2007 Plan provides for
longer expiration periods for employees who terminate, but who were employed
with the Company in excess of five years.  Pursuant to the provisions
set forth in the 2007 Plan, the option expiration will be extended anywhere from
three months to one year, dependent upon the employee’s years of
service.  These provisions apply to options that expire as the result
of involuntary termination not for misconduct. As of March 31, 2010, there were
6,727 shares of common stock available for grant under the 2007
Plan.





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





Three
      months endedMarch 31,
      2010
            
            
            March 31,
      2009Cost
      of revenues
            
            $
            2
            
            
            $
            3Research
      and development
            
            
            19
            
            
            
            14Selling,
      general and administrative
            
            
            91
            
            
            
            75Stock-based
      compensation expense before income taxes
            
            
            112
            
            
            
            92Provision
      for income taxes
            
            
            -
            
            
            
            -Total
      stock-based compensation expense after income taxes
            
            $
            112
            
            
            $
            92





There was
$20 of cash proceeds from the exercise of stock options for the three-month
period ended March 31, 2010.  There were no exercises of stock options
for the three-month period ended March 31, 2009.  The Company presents
excess tax benefits from the exercise of stock options, if any, as financing
cash flows.





The fair
value of stock-based awards was estimated using the Black-Scholes model with the
following weighted-average assumptions for stock options granted during the
three month periods ended March 31, 2010 and 2009, respectively:





Three
      months endedMarch 31,
      2010
            
            
            March 31,
      2009Expected
      life (in years)
            
            
            5.00
            
            
            
            6.25Risk-free
      interest rate
            
            
            2.62
            %
            
            
            2.00
            %Volatility
            
            
            104
            %
            
            
            107
            %Dividend
            
            
            -
            
            
            
            -Per
      share weighted-average fair value at grant date
            
            $
            1.22
            
            
            $
            0.48


11
 Index


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.





The
Company has not in the past and does not plan to issue dividends in the
future.





Stock
option activity for the three months ended March 31, 2010 was as
follows:





Shares
            
            
            Weighted-Average
      Exercise Price
            
            
            Remaining
      Contractual Weighted-Average Term(in years)
            
            
            AggregateIntrinsic ValueOutstanding
      at December 31, 2009
            
            
            5,654
            
            
            $
            0.78Grants
            
            
            912
            
            
            $
            1.59Exercises
            
            
            (20
            )
            
            $
            0.98Forfeitures
      or expirations
            
            
            (34
            )
            
            $
            2.20Outstanding
      at March 31, 2010
            
            
            6,512
            
            
            $
            0.88
            
            
            
            7.01
            
            
            $
            4,437Vested
      and expected to vest at March 31, 2010
            
            
            5,625
            
            
            $
            0.86
            
            
            
            6.70
            
            
            $
            3,947Exercisable
      at March 31, 2010
            
            
            3,580
            
            
            $
            0.81
            
            
            
            5.52
            
            
            $
            2,717





The
aggregate intrinsic value in the table above represents the total pretax
intrinsic value (i.e.: the difference between Southwall’s closing stock price on
the last trading day of its first quarter of fiscal 2010 and the exercise price,
times the number of shares) that would have been received by the option holders
had all option holders exercised their options on March 31, 2010  This
amount changes based on the fair market value of Southwall’s
stock.  Total intrinsic value of options exercised was $11 for the
three month period ended March 31, 2010. Total fair value of options granted was
$1,114 for the three month period ended March 31, 2010.




As of
March 31, 2010, $1,160 of total unrecognized compensation cost, net of
forfeitures, related to stock options was expected to be recognized over a
weighted-average period of approximately 3.27 years.





Note
8 - Warranties:





The
Company establishes a reserve for sales returns and warranties for specifically
identified, as well as anticipated sales returns and warranties based on
experience. The activity in the reserve for sales returns and warranties account
during the three month periods ended March 31, 2010 and 2009 was as
follows:





Balance
      atDecember 31,2008
            
            
            Provision
            
            
            Utilized
            
            
            Balance
      atMarch 31,2009Accrued
      sales returns and warranty
            
            $
            1,321
            
            
            $
            8
            
            
            $
            (186
            )
            
            $
            1,143








Balance
      atDecember 31, 2009
            
            
            Provision
            
            
            Utilized
            
            
            Balance
      atMarch 31,2010Accrued
      sales returns and warranty
            
            $
            607
            
            
            $
            419
            
            
            $
            (266
            )
            
            $
            760





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


12
 Index


Note
9 – Comprehensive Income:





Accounting
Standards Codification (“ASC”) 220, Comprehensive Income establishes standards
for reporting and display in the financial statements of total net income and
the components of all other non-owner changes in equity, referred to as
comprehensive income. Accordingly, the Company has reported the translation gain
(loss) from the consolidation of its foreign subsidiary in comprehensive
income.





The
components of comprehensive income for the three month periods ended March 31,
2010 and March 31, 2009 were as follows:





Three
      months endedMarch 31,
      2010
            
            
            March 31,2009Net
      income
            
            $
            1,337
            
            
            $
            2,279Foreign
      currency translation adjustment
            
            
            (726
            )
            
            
            (944
            )Other
      comprehensive income
            
            $
            611
            
            
            $
            1,335





The
components of accumulated other comprehensive income were as follows at March
31, 2010:




Accumulated
      Other Comprehensive Income at December 31, 2009
              
              $
              4,382Foreign
      Currency Translation Adjustment
              
              
              (726
              )Accumulated
      Other Comprehensive Income at March 31, 2010
              
              $
              3,656


Note
10 - Income Tax:





The
decrease in the provision for income taxes in the three months ended March 31,
2010 compared to the same period in 2009 is primarily related to tax refunds
collected for prior tax returns filed by our foreign subsidiary, Southwall
Europe GmbH, or SEG.





For the
three months ended March 31, 2010, the Company’s effective tax rate was a
provision of 0.6%.  As allowed by ASC 740, Income Taxes, we have used
the actual effective tax rate for the three months ended March 31, 2010 as our
best estimate for the tax rate for the year ending December 31, 2010, as a
reliable estimate for the full year cannot be made at this time.  In
addition, to the extent our expected profitability changes during the year, the
effective tax rate would be revised to reflect any changes in the projected
profitability. This rate differs from the statutory federal rate of 34%
primarily due to the realization of a portion of the Company’s valuation
allowance on the U.S. deferred tax asset due to the income generated by the U.S.
operations through the first three months of 2010.





Realization
of deferred tax assets is dependent upon the existence of sufficient taxable
income.  The Company continues to maintain a valuation allowance
against its remaining net deferred tax assets in the United States, as
management does not believe the realization of those net deferred tax assets is
“more likely than not”.  Management has made this determination based
upon a number of factors, including the reversal of existing taxable temporary
differences, historical earnings, expected future taxable income, and the
availability of tax planning strategies.


13
 Index


Note
11-Joint Venture:





On April
8, 2008, Southwall IG Holdings, Inc., a wholly owned subsidiary of Southwall
Technologies Inc., entered into a Joint Venture Agreement with Sound Solutions
Window & Doors, LLC (“Sound Solutions”), creating Southwall Insulating
Glass, LLC (“SIG”), which manufactures insulated glass units for the domestic
market.  As of December 31, 2009, Southwall IG Holdings, Inc. had a
50% investment in SIG.  In 2009, Southwall IG Holdings, Inc. advanced
a total of $300, in the form of a promissory note, to Sound
Solutions.  Pursuant to the terms of the promissory note dated May 11,
2009, the principal and accrued interest was due and payable to Southwall IG
Holdings, Inc. by January 1, 2010.  Under terms of the note, in the
event of default, the outstanding principal shall be paid in the form of a
credit to the Southwall IG Holdings, Inc. capital account.





Effective
January 1, 2010, Sound Solutions had not paid the principal balance of $300 and
was in default of the joint venture agreement. The equity consideration of $300
in SIG that Sound Solutions had received upon execution of the promissory note
in May 2009, was credited to Southwall IG Holdings, Inc.’s capital account in
SIG; thereby increasing the Company’s equity ownership to 66.3%.  This
change in equity ownership did not result in Southwall IG Holdings, Inc.
acquiring a controlling interest in the joint venture, as governance did not
change as a result of the equity event.  The joint venture is being
accounted for under the equity method of accounting.





For the
quarters ended March 31, 2010 and 2009, our share of SIG’s net losses of
approximately $225 and $189, respectively, is included in “other income
(expense), net” in the condensed consolidated statements of
operations.  As of March 31, 2010, Southwall IG Holdings, Inc. had
invested an aggregate amount of $1,220 in SIG (including the $300 note described
above), and its share of cumulative net losses from inception to date was
$1,178.  The Company incurred non-reimbursable expenses in the amount
of approximately $75 and $90 in the quarters ended March 31, 2010 and 2009,
respectively, related to the set up and operations of the joint venture, in
accordance with the contractual terms of the joint venture agreement, which is
reflected in selling, general and administrative expenses in the condensed
consolidated statements of operations.  In addition, as of March 31,
2010, we have other current receivables of $457 due from SIG for transactions
incurred in the ordinary course of business.  In March 2010, Southwall
IG Holdings, Inc. advanced $150 to SIG, which is reflected in other assets in
the condensed consolidated balance sheet.  As of March 31, 2010, the
assets, liabilities, and results of operations of SIG were $2,513, $2,987, and a
net loss of $322, respectively.





Note
12 – Gain on Settlement of Contingency:





As of
December 31, 2002, we were in default under a master sale-leaseback agreement
with respect to two of our production machines. We had withheld lease payments
in connection with a dispute with the leasing company, Matrix Funding
Corporation.  In February 2004, we reached a settlement agreement for
approximately $2,000 to be repaid over six years at a stepped rate of interest,
and we returned the equipment in question.  The agreement included a
confession of judgment, whereby the Company acknowledged that it would owe
damages of $5,900 in the event of payment defaults under the settlement
agreement. At December 31, 2004, the carrying value of the liability was
$4,354.  In its assessment of the restructured debt, management
factored in the $5,900 confession of judgment as a contingent payment, thereby
eliminating any potential gain on restructuring at the time. The carrying value
of the debt remained on the consolidated balance sheet and the liability was to
be reduced as payments were made, with a potential gain to be recorded at the
date of the final payment and the expiry of the confession of
judgment.  At December 31, 2008, the carrying value of the liability
was $3,354.  On January 21, 2009, we paid $995, which was full and
final payment of principal and interest.  Upon final payment of
principal and interest, a formal release of the obligation under the 2004
settlement agreement was obtained from Portfolio Financial Servicing Company,
the successor to Matrix Funding Corporation on January 21, 2009, and a gain of
$2,359 was recognized in the first quarter of 2009 in other income in the
accompanying condensed consolidated statements of operations.


14
 Index


Note
13 – Recent Accounting Pronouncements:





Since
December 31, 2009, there are no recently issued accounting standards that are
expected to have a material effect on our financial condition, results of
operations or cash flows.





Note
14 – Subsequent Events





The
Company has evaluated subsequent events and has concluded that no subsequent
events have occurred since the quarter ended March 31, 2010 that would require
recognition or disclosure in the condensed consolidated financial
statements.





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





The
following discussion and analysis of our financial condition and results of
operations should be read in conjunction with our unaudited condensed
consolidated financial statements and notes thereto appearing elsewhere in this
report. This discussion and analysis contains forward-looking statements that
involve risks and uncertainties, including those discussed below under
"Forward-Looking Statements" and "Risk Factors”, set forth in Part I, Item 1A,
of our Annual Report on Form 10-K for the year ended December 31, 2009 and in
Part II, Item 1A of our Quarterly Report on Form 10-Q for the quarter ended
March 31, 2010. 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





Cautionary
Statement For the Purpose of the “Safe Harbor” Provisions of the Private
Securities Litigation Reform Act of 1995





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





·
            our
      strategy, expected future operations and financial
  plans;





·
            our
      revenue expectations and potential financial
  results;





·
            impact
      of current economic conditions on our
business;





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





·
            future
      applications of thin film coating
technologies;





·
            our
      development of new technologies and
products;


15
 Index


·
            the
      properties and functionality of our
products;





·
            our
      projected need for additional borrowings and future
    liquidity;





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





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





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





·
            the
      possibility of patent and other intellectual property
      infringement;





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





·
            pending
      and threatened litigation and its
outcome;





·
            our
      competition and our ability to compete in the markets we serve;
      and





·
            our
      projected capital expenditures.





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





XIRÒ, XUVÒ, Triangle DesignÒ, Superglass®, Heat MirrorÒ, California SeriesÒ, SolisÒ, ETCH-A-FLEXÒ, and SouthwallÒare registered trademarks of Southwall.
V-KOOLÒis a registered trademark of V-Kool International
Holdings Pte. Ltd.  All other trade names and trademarks referred to
in this Quarterly Report on Form 10-Q are the property of their respective
owners.





Overview





Southwall
is a developer and manufacturer of high performance films and, beginning in
2008, glass products that improve energy efficiency in architectural and
automotive glass applications.  Founded in response to the oil embargo
of 1973, Southwall has approximately 30 years of experience and commercial
adoption of its products worldwide.  Our products are designed to
assist our green building construction and transportation customers in their
efforts to decrease carbon emissions which may reduce the use of oil and
electricity in the heating and cooling of buildings and vehicles.





Our
customers were not immune to the global economic downturn of 2009.  We
believe both the architectural and automotive industries experienced material
sales declines, which negatively impacted our financial results in 2009 and may
continue to have an effect in 2010.   In April 2008, we entered
into a joint venture with Sound Solutions Windows & Doors, LLC to begin
production of insulated glass units to meet the increasing demand for higher
energy efficiency glass in residential and commercial
buildings.  Southwall Insulating Glass, LLC (“SIG” or “Southwall
Insulating Glass”), the joint venture, produces and sells energy efficient,
dual-pane insulated glass units which are primarily used in the production of
completed window units for the residential housing and commercial building
industries. SIG incorporates proprietary design and automated manufacturing in
its production of insulated glass units.   The joint venture’s
facility is located in Chicago, Illinois and began production of Heat Mirror
insulating glass units and other high performance insulated glass units in the
second half of 2008.


16
 Index


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 market, and
architectural glass markets include: Saint Gobain Sekurit, Pilkington PLC and
GlobaMatrix Holdings Pte. Ltd., or GlobaMatrix, which collectively accounted for
approximately 72% and 64% of our total revenues during the first three months of
2010 and 2009, respectively.





Under our
agreement with GlobaMatrix, as amended, GlobaMatrix agreed to a 2004 minimum
purchase commitment of $9,000 of product.    For
each year after 2004 through the term of the contract, GlobaMatrix contracted to
purchase an amount of product equal to 110% of the amount of product it was
required to purchase in the prior year.  It is unlikely that
GlobaMatrix will fulfill its 2010 contractual obligation.





Sales returns and
allowances. Our gross margins and profitability have been adversely
affected from time to time by product quality claims. As of March 31, 2010, our
sales returns provision was approximately 2.1% of our gross revenues over a
rolling twelve month period. From 2005 to 2009, our sales returns provision has
averaged approximately 2.7% of gross revenues.





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





We
believe there have been no significant changes during the first three months of
fiscal 2010 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 2009 Form 10-K.


17
 Index


Three
Months Ended March 31, 2010 compared with Three Months Ended March 31,
2009





Results
of Operations





Net revenues.Our net
revenues for the quarter ended March 31, 2010 were $10,481, an increase of
$3,985 or 61%
compared to $6,496 for the same period ended March 31, 2009 primarily due to the
recovery from the global economic downturn in 2008 and 2009.





Net
revenues in the automotive market increased by $1,387, or 45%, to $4,460
compared to $3,073 for the
first quarters ended March 31, 2010 and 2009, respectively. The increase was
primarily due to increased demand by several of our large
customers.





Window
film net revenues increased by $2,403, or 105%, to $4,696 from $2,293 for the
first quarters ended March 31, 2010 and 2009, respectively.  This was
primarily due to increased overall demand for the window film
business.





Architectural
net revenues increased by $258, or 25%, to $1,298 from $1,040 for the first
quarters ended March 31, 2010 and 2009, respectively.  This was
primarily due to increased worldwide demand.





Cost of
revenues.Cost of revenues increased $1,717, or 42%, to $5,768
compared with $4,051 for the first quarters ended March 31, 2010 and 2009,
respectively.  This was primarily due to higher sales volume in the
first quarter of 2010 as compared to the first quarter of 2009.





Gross profit. Our gross
profit increased $2,268, or 93%, to $4,713 compared with $2,445 for the first
quarters ended March 31, 2010 and 2009, respectively.  As a percentage
of sales, gross profit increased to 45% compared to 38% for the first quarters
ended March 31, 2010 and 2009, respectively.  This was primarily due
to more effective absorption of fixed costs due to the increased volume of
production.





Operating
expenses





Research and development.
Research and development expenses increased $110, or 16%, to $792 compared with
$682 for the first quarters ended March 31, 2010 and 2009.  This was
primarily due to increased research and development activities in new
technologies.





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 increased $310, or
18%, to $2,000 compared to $1,690 for the first quarters ended March 31, 2010
and 2009, respectively. This increase was primarily due to the first quarter of
2009 having a $100 bad debt recovery and the first quarter of 2010 having higher
consulting expenses of $79 and higher bonus expense of $107.





Income from
operations.  Income from operations increased $1,848 to an
operating income of $1,921 compared to operating income of $73 for the first
quarters ended March 31, 2010 and 2009, respectively.  This increase
was primarily due to higher sales volume.





Interest expense, net.Interest expense, net increased $24, or 34%, to $94 compared to $70 for
the first quarters ended March 31, 2010 and 2009, respectively.  This
increase in net interest was primarily due to the lower interest income earned
in the quarter ended March 31, 2010.


18
 Index


Other income (expense),
net.   For the quarter ended March 31, 2009, the other
income (expense), net of $2,433 income is primarily comprised of a gain
associated with the reversal of a $2,359 liability related to settlement of the
2004 Matrix debt agreement.  Additionally, we recognized a net gain of
$346 from the sale of precious metal targets remaining after our Palo Alto,
California manufacturing facility was closed and moved to
Germany.  These targets had been previously expensed in
2006.  These non-recurring gains were offset by our 50% share of net
losses incurred by our joint venture, Southwall Insulating Glass, LLC of $189
and a foreign exchange loss, relating to transactions with foreign customers
that were denominated in foreign currencies, principally the Euro, of
$87.





For the
quarter ended March 31, 2010, the other income (expense), net of $481 expense is
comprised of our 66.3% share of net losses incurred by Southwall Insulating
Glass, LLC of $225 and a foreign exchange loss, relating to transactions with
foreign customers that were denominated in foreign currencies, principally the
Euro, of $283.





Income before provision for income
taxes.  Pre-tax income decreased $1,090, or 45%, to $1,346 in
the first quarter of 2010 compared to $2,436 for the first quarter ended March
31, 2009. This decrease was primarily due to the non-recurring gains recorded in
other income (expense) in the first three months of 2009 from the reversal of
the long term reserve associated with Matrix lease settlement and sale of
precious metal targets offset by the increase in income from the higher sales
volume.





Provision for income taxes.The decrease in the provision for income taxes in the three months ended
March 31, 2010 compared to the same period in 2009 is primarily related to tax
refunds collected for prior tax returns filed by our foreign subsidiary,
Southwall Europe GmbH, or SEG.





For the
three months ended March 31, 2010, the Company’s effective tax rate was a
provision of 0.6%.  We have used the actual effective tax rate for the
three months ended March 31, 2010 as our best estimate for the tax rate for the
year ending December 31, 2010, as a reliable estimate for the full year cannot
be made at this time.  In addition, to the extent our expected
profitability changes during the year, the effective tax rate would be revised
to reflect any changes in the projected profitability. This rate differs from
the statutory federal rate of 34% primarily due to the realization of a portion
of the Company’s valuation allowance on the U.S. deferred tax asset due to the
income generated by the U.S. operations through the first three months of
2010.





Realization
of deferred tax assets is dependent upon the existence of sufficient taxable
income.  The Company continues to maintain a valuation allowance
against its remaining net deferred tax assets in the United States, as
management does not believe the realization of those net deferred tax assets is
“more likely than not”.  Management has made this determination based
upon a number of factors, including the reversal of existing taxable temporary
differences, historical earnings, expected future taxable income, and the
availability of tax planning strategies.





Deemed dividend on preferred
stock. We accrued $122 of deemed dividend on preferred stock in each of
the first quarters of 2010 and 2009, 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 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 increased $855 from $12,454 at December 31, 2009 to $13,309
at March 31, 2010.  The increase in cash is primarily due to net
income offset by payments for capital expenditures and debt and capital lease
obligations.





Specifically,
cash provided by operating activities of $1,289 for the first three months of
2010 was primarily the result of net income of $1,337, non-cash depreciation of
$601, non-cash stock compensation expense of $112, and a decrease in inventory
of $537 partially offset by an increase in accounts receivable of $679 resulting
from the increase in first quarter 2010 sales and a decrease in accounts payable
and accrued liabilities of $553.





Cash used
in investing activities for the first three months of 2010 of $194 was the
result of capital expenditures.





Cash used
in financing activities for the first three months of 2010 of $113 was primarily
related to scheduled payments of $133 of other term debt and capital lease
obligations, partially offset by proceeds from stock option
exercises.





Borrowing
arrangements





Credit
Agreement with Wells Fargo Bank





In June
2009, we entered into a Credit Agreement with Wells Fargo Bank
(“Bank”).  The Credit Agreement provides for a $3,000 revolving line
of credit.  Advances under the line exceeding $1,500 will be limited
to 80% of eligible accounts receivable.  The Company will not be
eligible for additional borrowings if the Company’s consolidated cash balance
falls below $3,500.  Amounts borrowed under the facility bear interest
at either prime plus 0.75% or LIBOR plus 3.5%, determined at the discretion of
the Company, and is annualized on the average daily financed amount
outstanding.  All borrowings under the facilities are collateralized
by our assets in the United States and are subject to certain covenants
including minimum quarterly net income and minimum liquid asset
requirements.





Generally,
if any 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 facility is June 2010.  Although we expect to
renew the credit line, we can provide no assurance that we will be successful in
obtaining a new or replacement credit facility due to restrictive credit
markets.  As of March 31, 2010, we had no balance outstanding on our
line of credit, and we were in compliance with all covenants under the Credit
Agreement.  The foregoing 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 material terms
thereof.


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 Index


Borrowing
Arrangements with German Banks





Our
borrowing arrangements with various German banks as of March 31, 2010 are
described in Note 6 of the Notes to Unaudited Condensed Consolidated Financial
Statements (Item 1. “Financial Statements”) set forth herein. We are in
compliance with all of the covenants of the German bank loans and capital
leases, and we have classified $573 and $2,951 outstanding under the German bank
loans and capital leases as a short-term liability and long-term liability,
respectively, at March 31, 2010.





As of
March 31, 2010, we were in compliance with all financial covenants under all
financial instruments.





Capital
expenditures





We expect
to spend approximately $1,600 in 2010 on upgrades and refurbishment of our
production machines and research and development tools. We spent approximately
$194 in capital expenditures during the first three months of 2010.





Future
payment obligations





Our
future payment obligations on our borrowings pursuant to our term debt,
non-cancelable operating and capital leases and other non-cancelable contractual
commitments were as follows at March 31, 2010:





Total
            
            
            Less
      Than 1 Year
            
            
            1-3
      Years
            
            
            3-5
      Years
            
            
            Greater
      Than 5 YearsContractual
      Obligations:Term
      debt (1)
            
            $
            3,354
            
            
            $
            495
            
            
            $
            673
            
            
            $
            673
            
            
            $
            1,513Capital
      lease obligations (1)
            
            
            446
            
            
            
            190
            
            
            
            256
            
            
            
            -
            
            
            
            --Term
      debt and capital lease obligation interest ( 1)
            
            
            956
            
            
            
            234
            
            
            
            315
            
            
            
            212
            
            
            
            195Other
      obligations (2)
            
            
            2,569
            
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            2,569Operating
      leases (3)
            
            
            627
            
            
            
            507
            
            
            
            120
            
            
            
            --
            
            
            
            --Total
      Contractual Cash Obligations
            
            $
            7,952
            
            
            $
            1,426
            
            
            $
            1,364
            
            
            $
            885
            
            
            $
            4,277





(1)
            Represents
      the principal and interest allocations of loan and capital lease
      agreements with Varilease Finance Inc. and several German
      Banks.





(2)
            Represents
      accumulated dividends on Series A Preferred Stock (greater than five
      years).





(3)
            Represents
      the remaining rents owed on buildings we rent in Palo Alto,
      California.





As of
March 31, 2010, we maintained 30,174 square feet of office and warehouse space
at 3780-3788 Fabian Way, Palo Alto, California 94303.   In 2010,
the monthly rent payments are $39 and will increase annually at a rate of 3%
through the expiration of the lease.





As of
March 31, 2010, we also had a lease obligation for 9,200 square feet at 3961
East Bayshore Road, Palo Alto, California 94303.  The monthly rent
payments for this facility are $4.


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 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: The interest rate on one of our German loans was reset to the
prevailing market rate of 5.73% in September 2009. Fluctuations or changes in
interest rates may adversely affect our expected interest expense. The effect of
a 10% fluctuation in the interest rate on our line of credit and term debt would
have had an immaterial effect on our interest expense for the first three months
of 2010.





Investment
risk: We invest our excess cash in money market accounts and, by
practice, make every effort to limit the amount of exposure by investing with
strong, well-known institutions. Investments in both fixed rate and floating
rate interest earning instruments carry a degree of interest rate risk. Fixed
rate securities may have their fair market value adversely affected due to a
rise in interest rates, while floating rate securities may produce less income
than expected if interest rates fall. The effect of a 10% fluctuation in the
interest rate on our excess cash investments would not have had a material
effect on our interest income in the first three months of 2010.





Foreign currency
risk: International revenues (defined as sales to customers located
outside of the United States) accounted for approximately 91% of our total sales
in the first quarter of 2010. Approximately 45% of
our international revenues were denominated in Euros in the first quarter of
2010. The remaining 55% of our international sales were denominated in US
dollars.  In addition, certain transactions with foreign suppliers are
denominated in foreign currencies. The effect of a 10% fluctuation in the Euro
exchange rate would have had an effect of approximately $435 on net revenues and
$461 on expenses for the first quarter of 2010.





Item 4-Controls and Procedures





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




(b)
            Changes
      in Internal Controls.  There were no changes during the
      first three months of 2010 in our internal controls over financial
      reporting that have materially affected, or are reasonably likely to
      materially affect, the internal controls over financial
      reporting.




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




22
 Index


PART
II--OTHER INFORMATION




Item 1--Legal Proceedings




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





Item 1A—Risk Factors





The
following information updates should be read in conjunction with the information
disclosed in Item 1A, “Risk Factors,” of our Annual Report on Form 10-K for the
year ended December 31, 2009, filed with the SEC on March 25, 2010.





Financial
Risks





There
have been no significant changes in financial risk factors for the three month
period ended March 31, 2010.  See the information set forth in the
section entitled “Risk Factors” in our Annual Report on Form 10-K for the fiscal
year ended December 31, 2009.





Operational
Risks





There
have been no significant changes in operational risk factors for the three month
period ended March 31, 2010.  See the information set forth in the
section entitled “Risk Factors” in our Annual Report on Form 10-K for the fiscal
year ended December 31, 2009.




Market
Risks





There
have been no significant changes in market risk factors for the three month
period ended March 31, 2010.  See the information set forth in the
section entitled “Risk Factors” in our Annual Report on Form 10-K for the fiscal
year ended December 31, 2009.





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





None.




Item 3--Defaults upon Senior Securities





None.




Item 5--Other Information





None.


23
 Index


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


24
 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:   May
      11, 2010Southwall
      Technologies Inc.By:
            /s/
      Dennis F. CapovillaDennis
      F. CapovillaChief
      Executive OfficerBy:
            /s/
      Mallorie BurakMallorie
      BurakVice
      President, Finance and Chief Accounting
Officer






25