SOUTHWALL TECHNOLOGIES INC /DE/ - 10-K Annual Report

SOUTHWALL TECHNOLOGIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(dollars and shares in thousands, except per share data)

NOTE 1 - THE COMPANY AND A SUMMARY OF ITS SIGNIFICANT ACCOUNTING POLICIES:

The Company

Southwall Technologies Inc. (“Southwall”, “we”, “us”, “our”, and the “Company” refer to Southwall Technologies Inc. and its subsidiaries) is a global developer, manufacturer and marketer of thin film coatings on flexible substrates for the automotive glass, electronic display, window film, and architectural glass 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; anti-reflective films for computer screens, including flat panel displays, plasma displays, and transparent conductive films for use in touch screen and liquid crystal displays; energy control films for architectural glass; and various other coatings.

Principles of consolidation

The consolidated financial statements include the accounts of Southwall and its wholly-owned subsidiaries. All significant inter-company balances and transactions have been eliminated in consolidation.

Foreign currency translation

The Company's German subsidiary uses the EURO as its functional currency. Accordingly, the financial statements of this subsidiary are translated into U.S. dollars in accordance with Statement of Financial Accounting Standards ("SFAS") No. 52, "Foreign Currency Translation." Assets and liabilities are translated at exchange rates in effect at the balance sheet date and revenue and expense accounts at average exchange rates during the quarter. Exchange gains or losses from the translation of assets and liabilities of $1,159 in fiscal 2004 are included in the cumulative translation adjustment component of accumulated other comprehensive income (loss). Gains arising for transactions denominated in currencies other than the functional currency were $457, $37 and $305 in 2004, 2003 and 2002, respectively, and were included in other income, net.

Management estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Cash and cash equivalents

The Company considers all highly liquid instruments with an original maturity of three months or less from the date of purchase to be cash equivalents.

Restricted cash

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

Revenue recognition

We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been provided, the sale price is fixed or determinable, and collectibility is reasonably assured. Accordingly, we generally recognize revenue from product sales when the terms of sale transfer title and risk of loss, which occurs either upon shipment or upon receipt by customers. In connection with product sales, we make allowances for estimated returns and warranties. We adjust these allowances periodically to reflect our actual and anticipated experience. If any of these conditions to recognize revenue is not met, we defer revenue recognition.

The Company has agreements under which it receives fees for certain licensing rights to technology and products. The Company does not allocate cost of sales to license revenues because such costs are insignificant. License revenues associated with these agreements are recognized ratably over the period of the contract when collection of the resulting receivable is probable. License revenues were $191, $525 and $287 for the years 2004, 2003 and 2002, respectively.

Accounts receivable and allowances for doubtful accounts

Accounts receivable are recorded at the invoiced amount and are not interest bearing. We establish allowances for doubtful accounts for specifically identified, as well as anticipated, doubtful accounts based on credit profiles of our customers, current economic trends, contractual terms and conditions and historical payment. As of December 31, 2004 and 2003, our balance sheet included allowances for doubtful accounts of $292 and $778, respectively.

Accrual for sales returns and warranties

We establish allowances for sales returns for specifically identified product quality claims based on our sales returns and warranty experience. We offer a ten-year quality claim period for certain of our products. As of December 31, 2004 and 2003, our consoldiated balance sheets included accrual for sales returns and warranties of $2,701and $1,851, respectively.

Concentration of credit risk

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash and cash equivalents and trade accounts receivable.

The Company invests in a variety of financial instruments such as certificates of deposits and money market funds. By policy, the Company limits the amount of credit exposure to any one financial institution or commercial issuer.

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The Company sells its products throughout the world. The Company performs ongoing credit evaluations of its customers' financial condition and, generally, requires no collateral from its customers. The Company maintains an allowance for doubtful accounts based upon anticipated collectibility of all accounts receivable.

The Company's ten largest customers accounted for approximately 79%, 84% and 84% of net revenues in 2004, 2003 and 2002 respectively. During 2004, Mitsui Chemicals, Saint Gobain Sekurit and Pilkington accounted for 28.4%, 17.8% and 10.9%, respectively, of our net revenues. During 2003, Mitsui Chemicals, Saint Gobain Sekurit, Pilkington PLC and V-Kool accounted for 21.4%, 17.2%, 13.7% and 10.0%, respectively, of our net revenues. During 2002, Saint Gobain Sekurit, Mitsubishi, Mitsui Chemicals and Pilkington PLC accounted for 18.7%, 18.0%, 15.7% and 10.8%, respectively, of our net revenues.

The Company expects to continue to derive a significant portion of its net product revenues from a relatively small number of customers. Accordingly, the loss of a large customer could materially hurt the Company's business, and the deferral or loss of anticipated orders from a small number of customers could materially reduce its revenue, operating results and cash flows in any period.

At December 31, 2004, receivables from three customers represented 27%, 25% and 12% of the Company's accounts receivable. At December 31, 2003, receivables from five customers represented 24%, 14%, 13%, and 12% of the Company's accounts receivable.

Inventories

Inventories are stated at the lower of cost (determined by the first-in, first-out 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 sales.

Property, plant and equipment

Property, plant and equipment are stated at cost. The Company uses the units-of-production method for calculating depreciation on certain of its production machines and the straight-line method for all other property, plant and equipment. Estimated useful lives of the assets range from five to ten years. On its large-scale production machines for which the units-of- production depreciation method is used, the Company records minimum annual depreciation of at least one-half of the depreciation that would have been recorded utilizing the straight-line depreciation method over a ten-year life. Leasehold improvements are amortized using the term of the related lease or the economic life of the improvements, if shorter.

Additions, major improvements and enhancements are included in the asset accounts at cost. Ordinary maintenance and repairs are charged to expense as incurred. Gains or losses from disposal are included in earnings.

Depreciation and amortization expense related to property, plant and equipment for the years ended December 31, 2004, 2003 and 2002 was $2,503, $6,071 and $6,053, respectively.

Impairment of long-lived assets

Long-lived assets held and used by the Company are reviewed for impairment whenever events or circumstances indicate that the carrying amount of an asset may not be recoverable. Factors that could trigger an impairment review include the following: (i) significant negative industry or economic trends; (ii) exiting an activity in conjunction with a restructuring of operations; (iii) current, historical or projected losses that demonstrate continuing losses associated with an asset; or (iv) a significant decline in our market capitalization, for an extended period of time, relative to net book value. When we determine that there is an indicator that the carrying value of long-lived assets may not be recoverable, we measure impairment based on estimates of future cash flows. These estimates include assumptions about future conditions such as future revenues, gross margins, operating expenses within our company, the fair values of certain assets based on appraisals, and industry trends. All long-lived assets to be disposed of are reported at the lower of carrying amount or fair market value, less expected selling costs.

Fair value disclosures of financial instruments

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 have determined that the book value of those instruments at December 31, 2004 and 2003 approximates fair value. Based on borrowing rates currently available to the Company for debt and capital leases with similar terms, the carrying value of its term debt and capital leases approximate fair value.

Derivative financial instruments

The Company accounts for derivative financial instruments under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133 establishes methods of accounting for derivative financial instruments and hedging activities related to those instruments as well as other hedging activities.

Stock-based compensation expense

SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure, an Amendment of FASB Statement No. 123" amends the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based Compensation," to require more prominent disclosures in both annual and interim financial statements regarding the method of accounting for stock-based employee compensation and the effect of the method used on reported results.

The Company accounts for stock-based employee compensation arrangements in accordance with provisions of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations. Under APB 25, compensation expense is based on the difference, if any, on the date of the grant, between the fair value of the Company's stock and the exercise price.

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The following table illustrates the effect on net loss and net loss per share if the Company had applied the fair value recognition provisions of SFAS 123 and SFAS 148 to stock-based employee compensation:

	Years Ended December 31,
	2004			2003			2002
Net loss
As reported	$	(185	)	$	(42,292	)	$	(4,191	)

Add: Stock-based employee compensation expense included in reported net income (loss), net of related tax effects		--			34			42
Deduct: Total stock-based employee compensation determined under fair value based method for all awards, net of related tax effects		(693	)		(695	)		(1,288	)
Pro forma	$	(878	)	$	(42,258	)	$	(4,149	)
Net loss per share:
As reported - basic and diluted	$	(0.01	)	$	(3.38	)	$	(0.40	)
Pro forma - basic and diluted	$	(0.06	)	$	(3.37	)	$	(0.53	)

For the stock option plans, the fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model, for the multiple option approach, with the following weighted average assumptions used for grants in 2004, 2003 and 2002, respectively: expected volatility of 116 %, 99% and 96%; risk-free interest rate of 2.9%, 2.3% and 3.8%; and expected lives from vesting date of 1.70, 2.77, and 3.49 years. Southwall has not paid dividends and assumed no dividend yield. The weighted-average fair value of stock options granted in 2004, 2003 and 2002 was $0.54, $1.00 and $4.95 per share, respectively.

For the employee stock purchase plans, the fair value of each purchase right is estimated at the beginning of the offering period using the Black-Scholes option pricing model with the following weighted-average assumptions used in 2004, 2003 and 2002 respectively: expected volatility of 116%, 99% and 96%; risk-free interest rate of 3.6%, 2.7% and 4.1%; and expected lives of 0.5 years in each year. The Company has not paid dividends and assumed no dividend yield. The weighted-average fair value of those purchase rights granted in 2004, 2003 and 2002 was $0.23, $0.56 and $2.65 per right, respectively.

Research and development expense

Research and development costs are expensed as incurred.

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 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).

Suppliers

The Company manufactures all of its products using materials procured from third-party suppliers. Certain of these materials are obtained from a limited number of sources. Delays or reductions in product shipments could damage the Company's relationships with customers. Further, a significant increase in the price of one or more of the materials used in the Company's products could have a material adverse effect on the Company's cost of goods sold and operating results.

The Company relies on third-party subcontractors to add properties, such as adhesives, to some of its products. There are only a limited number of qualified subcontractors that can provide some of the services the Company requires. Qualifying alternative subcontractors could take a great deal of time or cause the Company to change product designs. The loss of a subcontractor could adversely affect the Company's ability to meet its scheduled product deliveries to customers, which could damage its relationships with customers. If the Company's subcontractors do not produce a quality product, the Company's yield will decrease and its margins will be lower. Further, a significant increase in the price charged by one or more of the Company's subcontractors could force it to raise prices on its products or lower its margins, which could have a material adverse effect on its operating results.

The Company's production machines are large, complex and difficult to manufacture. It can take up to a year from the time the Company orders a machine until it is delivered. Following delivery, it can take the Company, with the assistance of the manufacturer, up to six additional months to test and prepare the machine for commercial production. There are a very limited number of companies that are capable of manufacturing these machines. The Company's inability in the future to have new production machines manufactured and prepared for commercial production in a timely manner would prevent the Company from delivering product on a timely basis and limit the Company's capacity for revenue growth.

Restructuring costs

For restructuring activities initiated prior to December 31, 2002, Southwall recorded restructuring costs when the Company committed to a plan to exit certain facilities, and significant changes to the exit plan were not likely to occur. For restructuring activities initiated after December 31, 2002, the Company records restructuring reserves when management has approved a plan to restructure operations and a liability has been incurred in accordance with SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities".

Income taxes

The Company accounts for deferred income taxes under the liability approach whereby the expected future tax consequences of temporary differences between the book and tax basis of assets and liabilities are recognized as deferred tax assets and liabilities. A valuation allowance is established for any deferred tax assets for which realization is uncertain.

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Net income (loss) per share

Basic net income (loss) per share is computed by dividing net income (loss) available to common shareholders (numerator) by the weighted average number of common shares outstanding (denominator) for the period. Diluted net income (loss) per share gives effect to all dilutive potential common shares outstanding during the period using the treasury stock method. The computation of diluted net income (loss) per share uses the average market prices during the period. The total amount of the difference in the basic and diluted weighted average shares of common stock and potentially dilutive securities in the periods where there is net income is attributable to the effect of dilutive stock options and warrants.

In net loss periods, the basic and diluted weighted average shares of common stock and common stock equivalents are the same because inclusion of stock options and warrants would be anti-dilutive. At December 31, 2004, 2003 and 2002, there was no difference between the denominators used for calculation of basic and diluted net loss per share. There were 4,039, 2,087 and 1,953 anti-dilutive options outstanding in 2004, 2003 and 2002, respectively, that were excluded in the net income (loss) per share calculation. There were 360, 2,384 and zero anti-dilutive warrants outstanding in 2004, 2003 and 2002, respectively, that where excluded in the net income (loss) per share calculation.

Reclassifications

Certain reclassifications have been made to the prior years’ amounts to conform to the current year’s presentation. These reclassifications did not change previously reported net loss, total assets, or cash flows.

Recently issued accounting pronouncements

In November 2004, the Financial Accounting standards Board issued SFAS No. 151, “Inventory Costs - An Amendment of ARB No. 43, Chapter 4” (“SFAS 151”). SFAS 151 amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Among other provisions, the new rule requires that items such as idle facility expense, excessive spoilage, double freight and re-handling costs must be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal” as stated in ARB No. 43. Additionally, SFAS 151 requires that the allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFAS 151 is effective for fiscal years beginning after June 15, 2005 and is required to be adopted by the Company in the first quarter of 2006, beginning on January 1, 2006. The Company is currently evaluating the effect that the adoption of SFAS 151 will have on its consolidated results of operations and financial condition but does not expect SFAS 151 to have a material financial statement impact.

In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), which replaces SFAS No. 123, “Accounting for Stock-Based Compensation,” (“SFAS 123R”), and supercedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values beginning with the first interim or annual period after June 15, 2005, with early adoption encouraged. The pro forma disclosures previously permitted under SFAS 123 no longer will be an alternative to financial statement recognition. The Company is required to adopt SFAS 123R in the third quarter of fiscal 2005, beginning June 27, 2005. Under SFAS 123R, the Company must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at date of adoption. The transition methods include prospective and retroactive adoption options. Under the retroactive option, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The prospective method requires that compensation expense be recorded for all unvested stock options and restricted stock at the beginning of the first quarter of adoption of SFAS 123R, while the retroactive methods would record compensation expense for all unvested stock options and restricted stock beginning with the first period restated. The Company is evaluating the requirements of SFAS 123R and expects that the adoption of SFAS 123R will have a material impact on the Company’s consolidated results of operations and earnings per share. The Company has not yet determined the method of adoption or the effect of adopting SFAS 123R, and it has not determined whether the adoption will result in amounts that are similar to the current pro forma disclosures under SFAS 123.

In December 2004, the FASB issued SFAS No. 153, “Exchanges of Non-monetary Assets - An Amendment of APB Opinion No. 29,” (“SFAS 153”). SFAS 153 eliminates the exception from fair value measurement for non-monetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29, “Accounting for Non-monetary Transactions,” and replaces it with the exception for exchanges that do not have commercial substance. SFAS 153 specifies that a non-monetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS 153 is effective for the fiscal periods beginning after June 15, 2005 and is required to be adopted by the Company in the first quarter of fiscal 2006, beginning on January 1, 2006. The Company is currently evaluating the effect that the adoption of SFAS 153 will have on its consolidated results of operations and financial condition but does not expect it to have a material financial statement impact.

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NOTE 2 - BALANCE SHEET DETAIL

	December 31,
	2004		2003
Inventories, net:
Raw materials	$	4,755	$	2,677
Work-in-process		2,059		3,148
Finished goods		1,541		1,005
	$	8,355	$	6,830

	December 31,
	2004			2003
Property, plant and equipment, net:
Land, buildings and leasehold improvements...	$	8,363		$	7,737
Machinery and equipment		32,242			31,019
Furniture and fixtures		1,737			1,110
		42,343			39,866
Less - accumulated depreciation		(21,233	)		(18,079	)
Total property, plant and equipment	$	21,110		$	21,787

Restructuring costs.

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 $2,624 in 2002 relating to employee severance packages and the remaining rents due on excess facilities in Palo Alto that we no longer occupy. In 2003, we recorded an accounting adjustment of $65 as a result of modifications to the severance packages of certain employees. As part of the restructuring plan commenced in the fourth quarter of 2003, we implemented a reduction in force at our Palo Alto and closed our Tempe facilities; however, there were no restructuring charges recorded in the fourth quarter associated with this action. The plan is expected to be completed in fiscal 2007.

The remaining outstanding obligations at December 31, 2003 and 2004 were:

	Workforce			Excess
	Reduction			Facilities			Total

Balance at January 1, 2003	$	125		$	2,281		$	2,406
Provisions		143			--			143
Adjustment to reserve		(65	)		--			(65	)
Cash payments		(203	)		(712	)		(915	)
Balance at December 31, 2003		--			1,569			1,569

Adjustment to reserve		--			(926	)		(926	)
Cash payments		--			(369	)		(369	)
Balance at December 31, 2004	$	--		$	274		$	274

At December 31, 2004, $74 was included in other accrued liabilities and $200 was included in other long-term liabilities on the consolidated balance sheet.

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Guarantees.

The Company establishes a reserve for sales returns and warranties for specifically identified, as well as, anticipated sales return and warranties claims based on experience. As of December 31, 2004, our reserve for sales returns and warranties was as follows:

	Balance at							Balance at
	December 31,							December 31,
	2003		Provision		Utilized			2004

Accrued sales returns and warranties	$	1,851	$	2,359	$	(1,509	)	$	2,701

As of December 31, 2003, our reserve for sales returns and warranties were as follow:

	Balance at							Balance at
	December 31,							December 31,
	2002		Provision		Utilized			2003

Accrued sales returns and warranties	$	2,069	$	2,271	$	(2,489	)	$	1,851

These amounts are included in other accrued liabilities in the Company’s consolidated balance sheets.

Indemnification obligations.

The Company's By-Laws require it to indemnify its officers and directors, as well as those who act as directors and officers of other entities, against expenses, judgments, fines, settlements and other amounts actually and reasonably incurred in connection with any proceedings arising out of their services to the Company. The indemnification obligations are more fully described in the By-Laws . The Company purchases insurance to cover claims made against its directors and officers. Since a maximum obligation is not explicitly stated in the Company's By-Laws and will depend on the facts and circumstances that arise out of any future claims, the overall maximum amount of the obligations cannot be reasonably estimated. Historically, the Company has not made payments related to these indemnifications and the estimated fair value of these indemnifications is not considered to be material.

As is customary in the Company's industry and as provided for in local law in the U.S. and other jurisdictions, many of the Company's standard contracts provide remedies to customers and other third parties with whom the Company enters into contracts, such as defense, settlement, or payment of judgment for intellectual property claims related to the use of its products. From time to time, the Company indemnifies customers, as well as suppliers, contractors, lessors, lessees, and others with whom it enters into contracts, against combinations of loss, expense, or liability arising from various triggering events related to the sale and the use of the Company's products and services, the use of their goods and services, the use of facilities and state of Company-owned facilities, and other matters covered by such contracts, usually up to a specified maximum amount. In addition, from time to time, the Company sometimes also provides protection to these parties against claims related to undiscovered liabilities, additional product liability, or environmental obligations. To date, claims made under such indemnifications have been insignificant and the estimated fair value of these indemnifications is not considered to be material.

NOTE 3 - FINANCING AGREEMENTS

On December 18, 2003, the Company entered into definitive investment agreements for a new bank loan guarantee and equity-financing package of up to $7.5 million with Needham, & Company, Inc. ("Needham") and Dolphin Direct Equity Partners, L.P. ("Dolphin") (collectively the "Investors") and Pacific Business Funding ("PBF"). The agreements enabled the Company to receive up to $3,000 in new borrowings under its line of credit facility with PBF, supported by guarantees provided by Needham, in two separate allotments of $2,250 and $750; and to receive $4,500 from the issuance of equity in two separate tranches of $1,500 and $3,000. The new borrowings and the purchase of each equity tranche were subject to certain conditions, including, among other things, the receipt of concessions by the Company from creditors and landlords, the completion of certain restructuring actions and the achievement of cash flow break-even at quarterly revenue levels below those of third quarter 2003.

Needham provided the $2,250 and $750 guarantees on December 18, 2003 and January 15, 2004, respectively. In exchange for the guarantees the Company issued two allotments of warrants, both for 941 shares of common stock, on the date of the guarantees (See Note 9- Warrants).

On February 20, 2004, the parties amended and restated the investment agreement to provide that the Company would issue and sell to the Investors an aggregate of $4,500 of convertible notes in one tranche instead of Series A convertible preferred shares in two separate tranches. The convertible notes are convertible into Series A convertible preferred stock, which is convertible into common stock. In connection with the convertible notes, the Company issued warrants for 1,694 shares of common stock.

On November 4, 2004, Needham and its Affiliates received a total of 9,155 shares of the Company’s common stock upon exercise of the warrants. In exercising the warrants, the Needham entities elected to use a “cashless exercise option” in which 99 of the shares underlying the warrants were surrendered in lieu of paying the exercise price in cash. The warrants were originally exercisable for 9,254 shares of the Company’s common stock at an exercise price of $0.01 per share. The value of the 99 shares of common stock surrendered was based upon the average trading price on November 3, 2004 of the Company’s common stock on the Over-the-Counter Bulletin Board Market.

On November 24, 2004, Dolphin exercised warrants to purchase a total of 4,627 shares of the Company’s common stock. The exercise price was $0.01 per share of common stock. Dolphin paid $46 in cash as the exercise price.

On December 31, 2004, Needham and its Affiliates and Dolphin elected to convert all outstanding principal of, and accrued but unpaid interest on, their secured convertible promissory notes of the Company into shares of the Company’s Series A 10% cumulative preferred stock. The convertible notes by their terms were convertible at the option of the holders into Series A stock at a rate of one share for each $1.00 of principal or interest converted. The aggregate principal amount of the convertible notes converted by the note holders was $4,500 and interest accrued thereon as of the time of conversion was $392. The aggregate number of shares of Series A stock issued as a result of the conversion was 4,892. In particular, Needham Company and its affiliates received 3,261 shares; and Dolphin received 1,631 shares.

The Series A shares have a stated value of $1.00 per share and are entitled to cumulative dividends of 10% per year, payable at the discretion of the Company’s board of directors. Each share of Series A stock is convertible at any time at the option of the holder into a number of shares of common stock equal to the sum of its stated value plus any accumulated but unpaid dividends, divided by the conversion price of the Series A shares. The conversion price of the Series A shares is $1.00 per share and is subject to adjustment in the event of any stock dividend, stock split, reverse stock split or combination affecting such shares. The Series A shares also have anti-dilution protection that adjusts the conversion price downwards using a weighted-average calculation in the event Southwall issues certain additional securities at a price per share less than the closing price per share of the common stock. Each share of Series A stock is initially convertible into one share of common stock.

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So long as any Series A shares are outstanding, unless all accrued dividends have been paid, the Company is generally prohibited from taking certain actions. Except for certain matters with respect to which the approval of the holders of a majority of the Series A shares voting separately as a class is required, the holders of the Series A stock have no voting rights. Upon a liquidation or dissolution of the Company (and for these purposes a sale of all or substantially all of the Company’s assets or the acquisition of the Company by another entity are considered liquidation events), the holders of the Series A stock are entitled to be paid a liquidation preference equal to $1.00 per share plus accumulated but unpaid dividends, out of assets legally available for distribution to stockholders.

NOTE 4 - LINE OF CREDIT

On May 16, 2003, the Company entered into credit agreements for a $10,000 receivables financing line of credit (which were amended on June 16, 2003, December 18, 2003 and April 29, 2004) with a financial institution, Pacific Business Funding (“PBF”), that were due to expire on May 5, 2004, subject to automatic one-year renewals unless terminated at any time by either party. In March 2004, the agreement was extended to May 5, 2005. Borrowings under the line of credit bear an annual interest rate of 7% above the financial institution’s base rate (which was 5.25% at December 31, 2004), and was calculated based on the average daily accounts receivable against which the Company has borrowed. Half of the $10,000 line of credit was represented by a $5,000 credit line, guaranteed by the United States Export-Import Bank (“EXIM”). Availability under the EXIM line was limited to 80% of eligible foreign receivables acceptable to the lender. The remaining $5,000 portion of the $10,000 credit line was supported by domestic receivables. Availability under the domestic line of credit was limited to 70% of eligible domestic receivable acceptable to the lender. PBF reserved the right to lower the 70% and 80% of eligible receivable standards for borrowings under the credit agreements. In connection with the line of credit, the Company granted to the bank a lien upon and security interest in, and right of offset with respect to all of the Company’s right, title and interest in all personal property and other assets, other than certain of the Company’s German property or assets. The borrowing arrangements required the Company to comply with financial covenants to maintain minimum tangible net worth of $33,000, a current ratio of assets to liabilities of at least 0.70, and revenues equal to or greater than 80% of revenues projected. As part of the agreements, the Company incurred and paid a one-time commitment fee of $100, in the second quarter of 2003, which was amortized over the term of the agreements.

As a result of the impairment charge recorded at the end of the third quarter of 2003 and a deterioration in our working capital position during the fourth quarter of 2003, the Company was in violation of the minimum tangible net worth covenant and current ratio covenant set forth in each of the credit agreements, and, therefore, in default there under. On December 18, 2003, the Company entered into a Forbearance Agreement with PBF to forbear from exercising the rights and remedies available to it owing to the default condition. Concurrent with the Forbearance Agreement, the credit agreement was amended to reduce the facility to $7,000 subject to the same restrictions in borrowing capacity. The amendment to the credit facility was made following an agreement reached with Needham to guarantee an additional $3,000 facility with PBF. The guarantee was provided in two separate allotments of $2,250 on December 18, 2003 and $750 on January 15, 2004. In exchange for the guarantees, the Company issued two separate allotments of warrants for 941 shares of common stock each to Needham (See Note 9 - Warrants). In connection with the forbearance and amended credit facility, the Company also issued warrants exercisable for 360 shares of common stock to PBF.

On April 29, 2004, the Company amended its credit agreements with its senior lender, PBF, to extend the facilities’ maturity date to May 5, 2005. The amended agreements provide for a maximum borrowing capacity of $9,000 for the Company. The credit facilities consist of a $3,000 revolving line of credit facility, which is guaranteed by Needham, and a $6,000 receivables factoring line of credit. The $3,000 revolving line of credit facility bears an annual rate of 2% above PBF’s base rate (which was 5.25% at December 31, 2004), and is calculated based on the borrowings outstanding under the line. The $6,000 facility bears an annual rate of 7% above PBF’s base rate and the annual interest is calculated based on the average daily accounts receivable against which the Company has borrowed. Availability under the $6,000 line is limited to 75% of the value of accounts receivables acceptable to PBF. PBF continues to reserve the right to reduce the percentage of eligible accounts receivable against which the Company may borrow under this facility or to terminate the facility at any time. The amendments also deleted the requirements that the Company maintain a listing on the NASDAQ National Market and maintain minimum net tangible net worth of $33,000, a current ratio of assets to liabilities of at least 0.70, and revenues equal to or greater than 80% of revenues projected.

At December 31, 2004, the Company had $2,975 of borrowings outstanding and $2,400 available to borrow under the credit agreements.

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NOTE 5 - TERM DEBT AND CAPITAL LEASES

The Company's term debt and capital leases consisted of the following:

				Balance at
				December 31,		Due in
Description	Rate			2004		2005
Term debt:
Teijin loan dated January 19, 2004		--	%	$	419 $		150
German bank loan dated May 12, 1999		6.13%	(1)		2,321		464
German bank loan dated May 28, 1999		7.10%	(2)		3,405		--
German bank loan dated May 28, 1999		3.75	%		778		389
German bank loan dated May 28, 2000		7.15%	(3)		1,843		317
German bank loan dated
August 14, 1999 (due June 30, 2009		5.75	%		2,298		--
Settlement agreement dated February 20 2004			(4)		2,000		100
Total term debt					13,064		1,420
Capital leases:
Other equipment financings					43		43

Total term debt and capital leases					13,107	$	1,463
Less current portion					1,463
Term debt, non-currrent				$	11,644

(1) Interest rate was reset to the then prevailing market rate.

(2) Interest rate will be reset to the then prevailing market rate in 2009.

(3) Interest rate will be reset to the then prevailing market rate in 2005.

(4) Stepped interest rate starting at 3% for 2004, which will increase by one percentage point per year until 2010.

The Teijin loan represents the unpaid principal and accrued interest owed by the Company on a loan with a Japanese bank, dated May 6, 1997, which had been guaranteed by Teijin Limited (Teijin), a Japanese company. Teijin is a stockholder of and supplier of substrate materials to the Company. The Teijin guarantee was collateralized by certain equipment located in Southwall's Tempe, Arizona manufacturing facility and inventory, to the extent necessary, to provide 120% net book value coverage of the outstanding loan balance. The Company was also subject to certain financial covenants under the guarantee. The Company paid Teijin semi-annually a loan guarantee service fee equal to 0.5625% of the outstanding balance. The loan with the Japanese bank required semi-annual payments of interest only during the first four years, followed by semi-annual principal installments plus interest, beginning in May 2001, for the remaining three and one half year term. The Company made each of its scheduled principal and interest payments to the Japanese bank through May 2003, representing principal payments of $8,800. However, the Company did not make the scheduled payment of $1,250 due on November 5, 2003, thereby defaulting on the debt. Teijin honored its guarantee by satisfying the obligation. Under the terms of Teijin’s guarantee, the Company was obligated to immediately repay the amounts paid by Teijin. As part of the restructuring plan implemented by the Company in the fourth quarter of 2003, the Company entered into a guaranteed Loan Agreement with Teijin on January 19, 2004 to satisfy Teijin’s claim. The agreement includes a payment schedule that spreads the aggregate payments of $1,250 over a period of four years through 2008. The obligations owed to Teijin will not accrue interest if paid according to the payment schedule. The Company’s obligations to Teijin are guaranteed by its subsidiary, Southwall Europe GmbH.

In June 2004, the January 19, 2004 agreement with Teijin was amended as the Company sold one of its machines to a third party. The amendment provided that the Company would pay to Teijin the proceeds from the sale of the equipment. In June 2004, the Company paid $560 and in September 2004, the Company paid $290 to Teijin from the proceeds of the disposal of a fixed asset. The remaining balance due to Teijin under the agreement of $419 at December 31, 2004 will be paid in accordance with the agreement, as amended. In February and March 2005, the Company paid $150 and $269, respectively, of the remaining balance.

The Company performed an assessment under SFAS No.15, “Accounting by Debtors and Creditors for Troubled Debt Restructurings” (“SFAS 15”) and Emerging Issues Task Force 02-04, “Debtors Accounting for a Modification or an Exchange of Debt Instruments” ("EITF02-04") in accordance with SFAS 15 to assess whether the debt restructuring constituted a troubled debt restructuring. The Company concluded that the debt restructuring was in fact a troubled debt restructuring as the Company was in financial difficulty and Teijin had granted a concession to the Company, under the definitions of such conditions in the EITF 02-04 guidance. The concession resulted from the non-interest bearing nature of the debt. As the carrying value of the original debt approximates the new debt and bears no interest, the gain on restructuring was considered insignificant. The carrying value of the debt will be reduced as payments are made.

Settlement agreement

During 1999, Southwall entered into a master equipment sale-leaseback agreement with a leasing company, Matrix Funding Corporation ("lessor"). The Company was in dispute with the lessor over the interpretation of certain terms of the lease agreement and withheld lease payments due from March 2001 until February 2004. The lessor notified the Company that it considered the Company to be in default and in January 2002 drew down on a letter of credit in the amount of $0.5 million that collateralized the Company's obligations. In May 2002, a suit was filed against the Company by an agent of the successor to the lease demanding payment of unpaid lease payments and alleged residual values. (See Note 11- Commitments and Contingencies.) In February 2004, the Company entered into a settlement agreement with the agents pursuant to which the Company agreed to pay an aggregate of $2.0 million bearing interest at a stepped rate. The settlement requires the Company to make an interest payment in 2004, and beginning in 2005, to make quarterly principal and interest payments until 2010. At December 31, 2004, the carrying value of the liability was $4,400 ($2,000 of principal, plus $2,400 of accrued interest). The agreement included a confession of judgment, whereby the Company acknowledges that it would owe damages of $5,900 in the event of payment defaults under the settlement agreement.

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The Company performed an assessment under SFAS 15 and EITF 02-04 to assess whether this debt restructuring constituted a troubled debt restructuring. The Company concluded that the debt restructuring was in fact a troubled debt restructuring as the Company was in financial difficulty and the lessors had granted a concession to the Company, under the definitions of such conditions as set forth in EITF 02-04. The reduction in the amount of the debt indicated that a concession had been granted. SFAS 15 requires an assessment of the total future cash payments specified by the new terms of the debt, including principal, interest and contingent payments. If the payments are less than the carrying amount of the payable, the Company should reduce the carrying amount to an amount equal to the total future cash payments specified by the new terms and should recognize a gain on restructuring of payables equal to the amount of the reduction. In its assessment, management factored in the $5,900 confession of judgment as a contingent payment, thereby eliminating any potential gain on restructuring. The carrying value of the debt remains on the consolidated balance sheet and the liability will be reduced as payments are made, with a potential gain to be recorded at the date of the final payment and the expiry of the confession of judgment. Based on a SFAS 5 determination, when the Company considers default probable, the liability would be increased to the $5,900 confession of judgment value reduced for any payment made. The excess of the carrying value over the $2,000 is recorded in other long-term liabilities on the balance sheet.

Loans from German Banks

On May 12, 1999, the Company entered into a loan agreement with a German bank that provides for borrowings up to 3,100 Euros ($3,900). Under the terms of this agreement, the funds were used solely for the purpose of capital investment by Southwall's German subsidiary. The term of the loan is for a period of 10 years and the principal is repayable in euros after the end of one year in 36 quarterly payments. The loan bears interest at 6.125% per annum until December 31, 2004, after which it will be revised to the prevailing rate. Of the borrowings outstanding of $2,321under this bank loan at December 31, 2004, $1,857 was classified as non-current in the accompanying consolidated balance sheet.

On May 28, 1999, the Company entered into a general loan agreement with a German bank. Under the terms of the loan agreement, funds were made available in three tranches, and were used solely for the purpose of capital investment by the Company's German subsidiary. The agreement contains various covenants with which the Company was in compliance at December 31, 2004; the Company is current with respect to all principal and interest payments due under the loan agreement. Under the first tranche, the Company borrowed 2,500 Euros ($3.2 million) for a term of twenty years beginning on May 28, 1999. The principal is repayable in euros beginning after ten years in ten equal, semi-annual payments. The loan bears fixed interest of 7.1% per annum for the first ten years, after which time the rate will be adjusted to a current prevailing rate. Of the borrowings outstanding under this tranche of $3,405 at December 31, 2004, $3,405 was classified as non-current in the accompanying consolidated balance sheet. Under the second tranche, the Company borrowed 1,700 Euros ($2,100) for a term of seven years beginning May 28, 1999 and the principal is repayable after one year in twelve equal, semi-annual payments. The loan bears fixed interest at 3.75% per annum for the period of seven years. At December 31, 2004, the amount due under this second tranche was $778, and $389 was classified as a non-current liability. Under the third tranche, the Company borrowed 2,100 Euros ($2,700) for a term of ten years beginning on July 25, 2000, and the principal is repayable after one year, in thirty-six equal quarterly payments. The loan bears fixed interest of 7.15% per annum for the first five years, after which time the rate will be adjusted to a current prevailing market rate. At December 31, 2004, the amount due was $1,843; of this amount, $1,526 was classified as non-current.

On August 14, 1999, the Company entered into a loan agreement with a German bank that provides for borrowings up to 1,700 Euros ($2,300). As required by this agreement, the funds were used solely for the purpose of capital investment by the Company's German subsidiary. The principal balance is due in a single payment on June 30, 2009 and bears interest at a rate of 5.75% per annum. The interest is payable quarterly in Euros. Fifty percent of the loan proceeds are restricted in an escrow account for the duration of the loan period and are classified as non-current "Restricted loan proceeds." The amount due under this bank loan at December 31, 2004 was $2,298, which was classified as non-current.

The preceding German bank loans are collateralized by the production equipment, building and land owned by the Company's German subsidiary. The dollar equivalent value for the preceding German bank loans has been calculated using the Euro exchange rate as of December 31, 2004.

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

Scheduled principal payments of term debt for the next five years and thereafter, are as follows:

	Amount

2005	$	1,420
2006		1,474
2007		1,143
2008		1,467
2009		4,265
Thereafter		3,295
Total	$	13,064

The Company incurred total interest on indebtedness of $2,300, $1,600 and $1,700 in 2004, 2003 and 2002, respectively.

NOTE 6 - GOVERNMENT GRANTS AND INVESTMENT ALLOWANCES

The Company has an agreement to receive cash grant awards (the "Grant"), which was approved by the Saxony government in May 1999. As of December 31, 2004, the Company had received approximately 5,000 Euros ($6,800) under this Grant and accounted for the Grant by applying the proceeds received to reduce the cost of fixed assets of the Dresden manufacturing facility. Additionally, as of December 31, 2004, the Company has a balance remaining from the government grants received in May 1999 of 400 Euros ($500), which has been recorded as an advance and held as restricted cash until the Company receives approval from the Saxony government to apply the funds to reduce its capital expenditures.

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Giving effect to an amendment of the terms of the Grant in 2002, the Grant is subject to the following requirements:

(a)

The grant was earmarked to co-finance the costs of the construction of a facility to manufacture XIR® film for the automotive glass industry.

(b)

The construction period for the project is from March 15, 1999 to June 30, 2006.

(c)

The total investment during the construction period should be at least 47,000 Euros ($59,400).

(d)

The project must create at least one hundred forty-three permanent jobs and seven apprenticeships by June 30, 2006.

If the Company fails to meet the above requirements, the Saxony government has the right to demand repayment of the Grant.

In addition to the Grant, the Company is further eligible for cash investment allowances from the Saxony government calculated based on the total projected capital investment by the Company in its Dresden facility of 47,000 Euros ($59,400), subject to European Union regulatory approval. During 2000, 2001, 2002, 2003 and 2004, the Company received 1,200 Euros ($1,500), 2,500 Euros ($3,200), 1,200 Euros ($1,500), 1,300 Euros ($1,600) and 400 Euros ($500) respectively, in investment allowances from the Saxony government, and those proceeds were applied to reduce the capitalized construction cost of the Dresden facility. These investment allowances are subject to the following requirements:

(a)

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

(b)

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

If the Company fails to meet the above requirements, the Saxony government has the right to demand repayment of the allowances. The Grants and investment allowances, if any, that the Company is entitled to seek from the Saxony government vary from year to year based upon the amount of capital expenditures that meet the above requirements. Generally, Southwall is not eligible to seek total investment grants for any year in excess of 33% of its eligible capital expenditures for that year. The Company cannot guarantee that it will be eligible for or receive additional grants or allowances in the future.

NOTE 7 - INCOME TAXES

For financial reporting purposes, “Income (loss) before provision for (benefit from) income taxes” included the following components for the years then ended December 31:

	2004			2003			2002

Domestic	$	( 1,893	)	$	(43,847	)	$	(4,278	)
Foreign		2,322			2,236			--

Total	$	429		$	(41,611	)	$	(4,278	)

The provision for (benefit from) income taxes for the years then ended December 31, 2004, 2003 and 2002 consist of the following:

	2004		2003		2002
Current:
Federal	$	--	$	--	$	--
State		32		18		17
Foreign		525		316		(104	)

Total current		557		334		(87	)

Deferred:
Federal		--		--		--
State		--		--		--
Foreign		57		347		--

Total deferred		57		347		--

Total provision	$	614	$	681	$	(87	)

The income tax provision relates primarily to foreign taxes, foreign withholding taxes on royalty payments and state minimum tax obligations.

The effective income tax rate differs from the federal statutory rate as a result of foreign taxes and valuation allowances established for deferred tax assets.

Deferred income taxes reflect the next tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s deferred tax assets are as follows:

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	December 31,
	2004			2003
Deferred Tax Assets (Liabilities):

Federal and state net operating losses	$	12,112		$	14,241
Research and MIC credits		2,422			1,971
Non-deductible and accrued expenses		9,503			5,238
Impairment expense		3,868			11,987
Depreciation		(5,557	)		(5,057	)
Foreign temporary differences		(397	)		(304	)
Other		--			1,141

Net deferred tax assets		21,951			29,217
Deferred tax assets valuation allowance		(22,348	)		(29,521	)

Net deferred tax liability	$	(397	)	$	(304	)

The net deferred tax liability is included in other long term liabilities on the consolidated balance sheets.

Realization of deferred tax assets is dependent upon future earnings, if any, the timing and amount of which are uncertain. Accordingly, the net deferred tax assets have been fully offset by a valuation allowance. The valuation allowance decreased by $7,173 for the period ended December 31, 2004.

As of December 31, 2004, the Company has net operating loss carry forwards for federal income tax purposes of approximately $33,511, which expire beginning in the year 2005. The Company also has California net operating loss carry forwards of approximately $6,657, which expire beginning in the year 2005.

The Company has federal and California research and development tax credits of $686 and $1,279, respectively. The federal research credits began to expire in the year 2004 and the California research credits have no expiration date. The Company also has California Manufacturers’ Investment Credit of $456, a portion of which is currently expiring yearly.

Utilization of the Company’s net operating loss and credits may be subject to substantial annual limitation due to the ownership change limitations provided by the Internal Revenue Code and similar state provisions. Such an annual limitation could result in the expiration of the net operating loss or credits before utilization.

NOTE 8 - STOCK OPTION AND EMPLOYEE STOCK PURCHASE PLANS COMPENSATION

Stock Option Plans

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 Plan for employees and consultants on August 6, 1998. The Human Resources 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.

Generally, options granted under the plans 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 October 2004, the board of directors changed the vesting. Grants after October 2004 under both plans vest at a rate of 25% after six months and then evenly monthly thereafter for the remaining 42 months.

From 1998 to 2002 a certain officer of Southwall exercised stock options under the plans by issuing full recourse notes with an annual rate of interest of generally 7%, as discussed in Note 12.

As of December 31, 2004, there were 4,151 shares of common stock available for grant under the two stock option plans.

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The activity under the option plans, combined, was as follows:

			Weighted
		Range of	Average
		Exercise	Exercise
	Options	Price	Price
Options outstanding at January 1, 2002	1,911	$1.56 - $11.50	$ 4.81
Granted	655	$2.25 - $15.00	7.81
Exercised	(322)	$2.13 - $11.50	5.10
Cancelled or expired	(291)	$2.13 - $15.00	5.65
December 31, 2002	1,953	$2.13 - $15.00	5.64

Granted	719	$0.88 - $ 2.28	1.65
Exercised	--	--	--
Cancelled or expired	(585)	$1.92 - $15.00	5.18
December 31, 2003	2,087	$1.56 - $11.50	4.39

Granted Adjustments	300	$0.88 - $ 0.88	0.88
Granted	2,379	$0.50 - $ 1.81	0.95
Exercised	--	--	--
Cancelled or expired	(727)	$0.50 - $15.00	4.01
December 31, 2004	4,039	$2.13 - $15.00	$ 4.19

The following table summarizes information about stock options outstanding at December 31, 2004:

	Options Outstanding						Options Exercisable
			Weighted
			Average
			Remaining		Weighted				Weighted
Range of	Number		Contractual		Average				Average
Exercise	Out-		Life		Exercise		Number		Exercise
Prices	standing		(years)		Price		Exercisable		Price
$ 0.50 -- $0.50		1,425		9.60	$	0.50		0	$	0.00
$ 0 52 -- $0.98		405		8.26		0.87		190		0.90
$ 1.05 -- $1.58		374		8.22		1.26		67		1.33
$ 1.81 -- $1.81		597		6.15		1.81		0		0.00
$ 1.92 -- $3.49		425		5.14		2.40		232		2.56
$ 3.71 -- $5.21		418		2.21		4.64		410		4.63
$ 5.75 -- $8.72		322		4.16		7.64		231		7.45
$ 9.90 -- $9.90		61		4.32		9.90		31		9.90
$11.50 --$11.50		10		2.18		11.50		10		11.50
$15.00 --$15.00		2		4.30		15.00		1		15.00
$ 0.50 --$15.00		4,039		7.06	$	2.17		1,172	$	4.19

Employee Stock Purchase Plan

In March 1997, the Company adopted the 1997 Employee Stock Purchase Plan ("the 1997 Plan") and reserved 100 shares of common stock for issuance there under. 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. During 2004, 2003 and 2002, 7, 21 and 59 shares, respectively, were sold under the 1997 Plan. At December 31, 2004, there were 70 shares available for issuance under the 1997 Plan.

401(k) Plan

In 1998, the Company sponsored a 401(k) defined contribution plan covering eligible employees who elect to participate. Southwall is allowed to make discretionary profit sharing and 401(k) matching contributions as defined in the plan and as approved by the board of directors. The Company matches 25% of each eligible participant's 401(k) contribution up to a maximum of 20% of the participant's compensation, not to exceed one thousand dollars per year. Southwall's actual contribution may be reduced by certain available forfeitures, if any, during the plan year. No discretionary or profit sharing contributions were made for the years ending December 31, 2004, 2003 and 2002. Matching contributions for the years ended December 31, 2004, 2003 and 2002 were $100 for each year.

NOTE 9 - WARRANTS

The warrants described below are for common stock at an exercise price of $0.01. With the exception of the warrants issued in connection with the letter of intent, the term of the warrants is five years from the date of issuance. As a result of the nominal exercise price of the warrants, the warrant value is based on the value of the common stock on the date of issuance.

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The quoted market price of the Company’s common stock was not regarded as an appropriate basis for warrant values, on account of the dilution of the stock and the thin trading of the stock. The fair value of the common stock was based on a Company valuation performed by management and a third party using accepted valuation methodologies.

Balance sheet classification of warrants:

Emerging Issues Task Force 00-19 identifies conditions necessary for equity classification of warrants. One condition is that a sufficient number of authorized and un-issued shares exist at the classification assessment date to control settlement by delivering shares. In that evaluation, a company must compare (a) the number of currently authorized but un-issued shares, less the maximum number of shares that could be required to be delivered during the contract period under existing commitments with (b) the maximum number of shares that could be required to be delivered under share settlement (either net-share or physical) of the contract. If the amount in (b) exceeds the amount in (a), share settlement is not within the control of the company and asset or liability classification is required.

As of December 31, 2003, the Company satisfied the conditions necessary for equity classification of its warrants, including the availability of sufficient authorized and un-issued shares to satisfy existing commitments.

On January 19, 2004, in addition to issuing warrants to purchase 75 shares of common stock to PBF, the Company obligated itself to issue 1,597 warrants to Needham and Dolphin, the Investors, as a result of entering into a debt agreement with Teijin, as detailed below. As a result, as of January 19, 2004, the Company had insufficient authorized and un-issued shares to satisfy existing commitments had all outstanding warrants been exercised on that date, thereby triggering liability classification for all outstanding warrants.

The Company was required to re-measure all outstanding warrants as of January 19, 2004 and to transfer the fair value of the warrants to liabilities with the difference between the equity carrying value and the re-measured fair value of the liability recorded as non-operating expense. The charge recorded on January 19, 2004 totaled $151.

The warrants were classified as liabilities until the shareholders approved the increase in authorized shares on October 5, 2004. The warrants were re-measured as of the end of the first quarter of 2004, resulting in a charge of $23, which was recorded as non-operating expense. The warrants were again re-measured as of the end of the second quarter of 2004, resulting in a charge of $1,282, and as of the end of the third quarter of 2004, resulting in a charge $427, which was recorded as non-operating expense.

Warrants issued in connection with the Letter of Intent:

In connection with the November 11, 2003 Letter of Intent signed between Needham and the Company outlining the proposed debt guarantee and equity financing the Company issued warrants for 1,254 shares of common stock, representing 10% of the outstanding common stock of the Company, with an exercise price of $0.01 per share. The warrants were to expire on November 11, 2008 or the execution of definitive investment agreements, whichever was earlier. The warrants expired on December 18, 2003, the date of the signing of the definitive investment agreements.

The warrants included anti-dilution protection whereby the number of warrants would be increased to 10% of the fully diluted number of shares of the Company in the event that the Company entered into a financing agreement with an alternate investor before the end of the first quarter of 2004.

Needham did not seek exclusive negotiations with the Company and the warrants were considered as compensation for Needham investing time in negotiating and structuring the potential transaction.

The Company valued the warrants at $100; and, that value reflected the relative probabilities of an agreement being reached and the anti-dilution feature being triggered. The fair value of the warrant was recorded as a non-operating expense in the fourth quarter of 2003.

Warrants issued in connection with the investment agreement:

In accordance with the investment agreement, warrants were to be issued to the Investors on the closing of each guarantee and equity tranche. However, the investment agreement provided that the Investors were entitled to receive warrants to purchase 753 shares of common stock associated with the second tranche of equity regardless of whether the second equity closing occurred. This term was included in the agreements as further incentive for the Investors to enter into definitive agreements. As the Company had an enforceable obligation to issue the warrants and as the terms of the warrants were known as of the date of the investor agreement, the warrants were considered issued for accounting purposes as of December 18, 2003.

As the warrants were issued as an incentive to enter into definitive agreements for transactions that the Investors were not necessarily committed to consummate, the Company determined that the value of the warrants should be recorded as a non-operating expense, which was recorded in the fourth quarter of 2003. The Company considered that the Investors were not necessarily committed to the contemplated transactions because of the arguably subjective nature of determining whether certain conditions to closing were satisfied. Management determined the value of the warrants to be $309.

The investment agreement also included terms that required the Company to issue additional warrants to the Investors if, as part of its restructuring plan, the Company issued any equity instruments, notes or other debt instruments to any creditor, landlord, employee, director, agent or consultant.

Following the issuance of equity instruments as part of its restructuring plans the Company is required to issue to each of the Investors warrants in such amounts as would allow the Investors to maintain their aggregate ownership percentage (on a fully-diluted basis) as if such issuance had not occurred. Such warrants represent anti-dilution protection for the investor and are therefore not valued as stand-alone instruments.

Following note or debt issuances to creditors as part of its restructuring plan the Company is required to issue additional warrants to each of the Investors representing the right to purchase that number of shares of common stock equal to the product of (x) 1.25 and (y) the original principal amount of such note or debt instrument. Such warrants represent protection for the investors for the Company failing to eliminate obligations to creditors, and are regarded as issued for accounting purposes as of the date of the agreement triggering legal entitlement.

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In December 2003, the issuance to the Investors of additional warrants exercisable for 409 shares of common stock was required by note or debt issuances under the restructuring plan. The Company determined the value of the warrants to be $168. The fair value of the warrants was recorded as non-operating expense in the fourth quarter of 2003. In the first quarter of 2004, the Company issued 9,849 additional warrants to the Investors as a result of note or debt issuances under the restructuring plan. The Company determined the fair value of the warrants to be $4,256, which was recorded as a non-operating expense in the first quarter of 2004.

Warrants issued in connection with the guarantee from Needham and line of credit from PBF:

In connection with the first guarantee from Needham and as additional incentive to complete the financing closings, as contemplated in the investment agreement, the Company issued warrants for 941 shares of common stock in the fourth quarter of 2003. Management determined the value of the guarantee and warrants at $98 and $386, respectively.

The Company recorded the amount of the warrant value equal to the fair value of the guarantee, $98, as debt issuance costs to be amortized over the life of the line of credit. The residual value of the warrants, $288 was recorded as a non-operating expense in the fourth quarter of 2003, as representing an incentive to enter into definitive agreements for transactions to which Needham was not committed. A total of $274 of debt issuance cost was expensed in fiscal 2004 and there was no debt issuance cost on the consolidated balance sheet at December 31, 2004.

In connection with the second guarantee from Needham and as additional incentive to complete the financing closings, as contemplated in the investment agreement, the Company issued warrants for 941 shares of common stock in the first quarter of 2004. Management determined the value of the guarantee and warrants at $33 and $356, respectively.

The Company recorded the amount of the warrant value equal to the fair value of the guarantee, $33, as debt issuance costs to be amortized over the life of the line of credit. The residual value of the warrants, $334 was recorded as a non-operating expense in the first quarter of 2004, as representing an incentive to enter into definitive agreements for transactions to which Needham was not committed.

In November 2003, the Company defaulted under its Factoring Agreements with PBF. As a result of the default, PBF was entitled to demand immediate repayment of all outstanding obligations, or to foreclose its security interest in the Company’s collateral. In consideration of PBF’s forbearance from exercising its rights and as incentive to provide $3.0 million of borrowings under the line credit, the Company agreed to issue warrants for 250 shares of the Company’s common stock. In addition, the Company paid a forbearance fee of $70 and reimbursed PBF for $31 of legal fees. The Company determined that the fair value of the warrants was $103. The Company recorded the fair value of the warrants and the fees to debt issuance costs and is amortizing the amount over the life of the line of credit.

On January 19, 2004, the Company issued 75 warrants to PBF in consideration of PBF’s consent to the execution by Southwall Europe GmbH (“Southwall Europe”) of a written Guaranty Agreement in favor of Teijin Limited (“Teijin”). The Guaranty by Southwall Europe was to guarantee the Company’s obligations to pay Teijin $1.3 million in full settlement of the Company’s debts and obligations to Teijin stemmed from the Company’s default on a Japanese bank loan for which Teijin was the guarantor. The Company determined the fair value of the warrants was $33 and has recorded the cost as debt issuance costs in the first quarter of 2004.

On January 30, 2004, the Company issued 35 warrants to PBF in exchange for PBF granting a two-week extension of its forbearance to enable the Company to execute the investment agreement. The Company determined the fair value of the warrants to be $15. The Company recorded the fair value of the warrants to debt issuance costs and is amortizing the amount over the life of the line of credit.

Issuance Of Warrants In Connection With The Convertible Debt:

In connection with the issuance of the convertible notes the Company issued warrants for 1,694 shares of common stock to the investors on February 20, 2004.

As discussed above, the terms of the original investment agreement was such that the Investors were entitled to receive the 753 warrants associated with the second tranche of equity regardless of whether the second equity closing occurred. As the Company had an enforceable obligation to issue the warrants and because the terms of the warrants were known as of the date of the investor agreement, the warrants were considered issued for accounting purposes as of December 18, 2003. As discussed above, the Company valued the 753 warrants at $309 and recorded the amount as non-operating expense in the fourth quarter of 2003. As a result, the number of warrants issued for accounting purposes on February 20, 2004 in connection with the issuance of convertible debt was 941 (that is, 1,694 shares underlying the warrants actually issued less the 753 shares underlying the warrants deemed previously issued on December 18, 2003).

The fair value of the 941 warrants was determined by management to be $414 and is recorded as discount on the convertible notes in the first quarter of 2004 and was expensed as interest expense over the life of the debt instrument using the effective interest rate method. During 2004, $115 of the debt discount was amortized to interest expense.

Embedded Derivatives:

The features of the convertible notes include the right to convert the notes into Series A preferred stock (“Conversion Right”). This right was evaluated by the Company to determine if it gave rise to an embedded derivative instrument that would need to be accounted for separately in accordance with SFAS 133 and EITF 00-19.

The Company concluded that the Conversion Right qualified as an embedded derivative and did not meet the SFAS 133 scope exceptions. Therefore, the Company bifurcated and fair valued the conversion feature. The fair value of the Conversion Right was determined by management to be $820 and was recorded as a discount on the convertible notes and will be amortized as interest expense over the life of the debt instrument using the effective interest rate method.

The embedded derivative was classified as a liability and was re-measured at the end of the first quarter, second quarter and third quarter of 2004. In accordance with DIG Issue A18, “Application of Market Mechanism and Readily Convertible to Cash Subsequent to the Inception or Acquisition of a Contract”, when the contract ceased to be a derivative as a result of the stockholder approval for the increase in authorized shares, the Company discontinued accounting for the conversion option at fair value separate from the debt. The liability balance for the conversion option recorded on the books resulted in an adjustment of the basis of the debt. The liability balance at October 5, 2004, the date the stockholders approved the increase in authorized shares, was $1,036. The balance of the debt discount when the debt was converted on December 31, 2004 to Series A redeemable convertible preferred stock was $1,119. The net amount between the balance of the liability and the debt discount of $83 was re-classed to Series A redeemable convertible preferred stock as a reduction of the total value of the Series A redeemable convertible preferred stock.

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The total net value of the warrants recorded in long-term liability of $8,055 before the stockholders’ approval to increase the number of authorized and un-issued shares was re-classed to capital in excess of par value after the approval in October 2004.

NOTE 10 - SEGMENT REPORTING

Southwall reports segment information using the management approach to determine segment information. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the source of its reportable segments. The Company is organized on the basis of products and services. However, we do not separately track costs associated with our segments. The total net revenues for the automotive glass, electronic display, architectural and window film product lines were as follows:

	2004		2003		2002
Automotive glass	$	20,584	$	20,297	$	20,374
Electronic display		20,554		19,019		26,555
Architectural		7,010		6,297		11,183
Window film		9,425		7,713		10,647
Total net revenues	$	57,573	$	53,326	$	68,759

The following is a summary of net revenue by geographic area:

	2004		2003		2002
United States	$	12,186	$	5,707	$	10,597
Japan		18,387		17,118		24,853
France		10,283		9,327		12,922
Pacific Rim		7,228		7,335		9,326
Germany		5,787		7,079		5,425
Rest of the world		3,702		6,760		5,636
Total net revenues	$	57,573	$	53,326	$	68,759

Southwall operates from facilities located in the United States and Germany. Identifiable assets were as follows:

	December 31,
		2004		2003
United States	$	20,871	$	15,392
Germany		24,076		26,329
Consolidated	$	44,947	$	41,721

NOTE 11 - COMMITMENTS AND CONTINGENCIES

Commitments

The Company leases certain property and equipment as well as its facilities under noncancellable operating and capital leases. These leases expire at various dates through 2008. As of December 31, 2004, the future minimum payments under these leases are as follows:

Year Ending December 31,	Capital Leases		Operating Leases
2005	$	43	$	674
2006		--		1,511
2007		--		99
2008		--		11
Future minimum lease payments		43	$	2,295
Less - amounts representing interest		--
Present value of future minimum lease payments		43
Current maturities		43
Long-term lease obligations	$	--

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Rent expense under operating leases was approximately $1,600, $2,200 and $3,700 in 2004, 2003 and 2002, respectively. In December 2003 we reached an agreement with the landlord of one of our Palo Alto buildings to change the terms of the lease. As we intend to occupy the premises through December 2004, we accounted for the change as a lease modification in accordance with SFAS No. 13, Accounting for Leases. The modification is reflected in the above table. In January and February 2004, we reached agreements with two further landlords to reduce, or extend the payment periods of our contractual obligations

We have a supply agreement with Saint Gobain that expires December 31, 2005 and have a contractual commitment to deliver products on time. Shipment delays can result in maximum penalties up to 11.5% of the purchase price depending on the duration of the delay. To date, we have not incurred any late shipment penalties against this Agreement.

We have a supply agreement with Globamatrix that runs through December 31, 2011. We have a contractual commitment to deliver products on time. Shipment delays can result in maximum penalties up to 36% of the undelivered portion of the order depending on the percentage of product that is delayed. We incurred a penalty in 2002, the amount of which was immaterial.

At December 31, 2004, we had a purchase commitment in the amount of $435 to purchase Indium from one of our suppliers in 2005.

Contingencies

The Company is named as a defendant, along with Bostik, Inc., in an action captioned WASCO Products, Inc. v. Southwall Technologies, Inc. and Bostik, Inc., Div. Action No. C 02 2926 SBA, which was filed in Federal District Court for the Northern District of California on June 18, 2002. We were served with the Complaint in this matter on July 1, 2002. The plaintiff filed the matter as a class action on behalf of all entities and individuals in the United States who manufactured and/or sold and warranted the service life of insulated glass units manufactured between 1989 and 1999, which contained Southwall Heat Mirror film and were sealed with a specific type of sealant manufactured by Bostik, Inc. The plaintiff alleged that the sealant provided by Bostik, Inc. was defective, resulting in elevated warranty replacement claims and costs. The plaintiff asserted claims against us for breach of an implied warranty of fitness, misrepresentation, fraudulent concealment, negligence, negligent interference with prospective economic advantage, breach of contract, unfair business practices and false or misleading business practices. The plaintiff sought recovery on behalf of the class of $100 million for damages allegedly resulting from elevated warranty replacement claims, restitution, injunctive relief, and non-specific compensation for lost profits. By Order entered December 22, 2003, the Court dismissed all claims against us. The plaintiff has filed a notice of appeal to the Ninth Circuit Court of Appeals. Our insurance carriers under reservation of rights are paying a percentage of our defense costs.

We are a defendant in the action captioned Four Seasons Solar Products Corp. v. Black & Decker Corp., Bostik, Inc. and Southwall Technologies Inc., No. 5 CV 1695, in the United States District Court for the Eastern District of New York. Plaintiff was a manufacturer of insulated glass units, which incorporate Heat Mirror film. Plaintiff alleged that a sealant produced by a co-defendant is defective, asserts causes of action for breach of contract, unfair competition, and fraudulent concealment, and sought monetary damages of approximately $36 million for past and future replacement costs, loss of customer goodwill, and punitive damages against all defendants. On April 8, 2003, the Court issued an order granting final judgment in our favor. Four Seasons filed a Notice of Appeal. On appeal, the judgment in our favor was affirmed. Our insurance carriers under reservation of rights paid a percentage of our defense costs.

The insurance carriers in some of the litigation related to allege product failures and defects in window products manufactured by others in which we were 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 us. 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 our insurance policies. We intend to vigorously defend any attempts by these insurance carriers to seek reimbursement. We are 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, 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.

NOTE 12 - RELATED PARTY TRANSACTIONS

Teijin

On April 9, 1997, Southwall signed collaborative agreements with a major supplier of the Company's raw materials, Teijin Limited. The agreements provided for, among other things, the purchase by Teijin of 667 shares of the Company's common stock at a price of $7.50 per share; a guarantee by Teijin of a $10,000 loan to the Company; and an agreement to collaborate to achieve closer marketing and product development ties between the two companies. The Company paid an annual loan guarantee fee to Teijin of 0.5625% of the outstanding principal balance of the loan guaranteed by Teijin. The Company paid a loan guarantee fee of approximately $39 and $7 to Teijin in 2002 and 2003, respectively. Pursuant to a letter agreement dated March 28, 2002, the Company was obligated to prepay $2,500 of the loan guaranteed by Teijin with the proceeds from common stock sold in a public offering or an amount equal to 10% of the proceeds from a sale of stock other than in a public offering. As a result of the Company's successful follow-on public offering in 2002, the Company paid $2,500, in addition to the scheduled principal payment of $1,250, on November 6, 2002. The Company made the scheduled payment of $1,250 in May 2003. However, the Company did not make the scheduled payment of $1,250 due on November 5, 2003 under the loan and Teijin paid the $1,250 to the Japanese bank in November 2003. Teijin honored its guarantee and satisfied the obligation. On January 19, 2004, the Company entered into a Guaranteed Loan Agreement with Teijin to satisfy Teijin's claim. In February and March 2005, the Company paid $100 and $300, respectively, which was the remaining balance on the loan with Teijin. (See Note 5 - Term Debt and Capital Leases.)

During 2004, 2003 and 2002, the Company paid Teijin approximately $1,200, $2,200 and $6,300, respectively, for purchases of raw material substrates. At December 31, 2004 and 2003, accounts payable to Teijin were $400 and $200, respectively.

Transactions Involving Directors

In April 1997, the Company entered into a development and technology agreement with Energy Conversion Devices, Inc., or ECD. This agreement provides that the Company will pursue with ECD the commercialization of the process of sputter coating on flexible substrates using PECVD processes. The agreement further provides that the Company will pay ECD a royalty in an amount based upon the sales volume of product produced through the PECVD process. Southwall agreed to pay to ECD 2.25% of its net sales in connection with PECVD technology for five years and 1.25% of net sales after that. Through December 31, 2003, the process had not been commercialized and the Company had not paid ECD royalties under the agreement. In February 1999, the Company entered into an equipment purchase contract with ECD pursuant to which ECD agreed to modify one of the Company's production machines (PM 7) so that the machine would produce products by means of the PECVD process. The Company paid ECD approximately $10 in 2000, $290 in 2001 and nothing in 2002 and 2003 in connection with its conversion of PM 7 to the use of PECVD technology. A former director of Southwall is the Chairman of ECD. As a requirement of the settlement reached with Portfolio Financial Servicing Company (See Note 10), the Company transferred possession of PM 7 to Portfolio Financial Servicing Company, the lien holder of PM 7. At December 31, 2002, the Company owed ECD approximately $70 in connection with the conversion of PM 7, which was represented by a note payable. A final payment of $70 was made in 2003.

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During 1998, 1999, 2000, 2001 and 2002, we lent $44, $25, $0, $19 and $15, respectively, to Thomas G. Hood, our President and Chief Executive Officer and a director, to permit him to exercise stock options that were about to expire at a time when he was not able to sell the shares issuable upon exercise to pay the exercise price. The indebtedness is represented by full recourse notes payables to us, which are due on June 30, 2003 each bearing interest at the rate of 7.0% per annum. The largest amount of indebtedness outstanding under these notes at any time during 2003 was $131, including interest. While the board of director's intention was to enforce collection of the notes, on June 30, 2003, the Company's board of directors forgave all of the outstanding loans, totaling $130 including interest, in lieu of a bonus earned which otherwise would have been paid in cash. The Company recorded this transaction as compensation expense during the second quarter of 2003.

NOTE 13 - IMPAIRMENT OF LONG-LIVED ASSETS

During 2003, the Company experienced shortfalls in revenue compared to its budgeted and forecast revenues. In addition, in the third quarter of 2003, the Company determined that, due to reduced demand for its products, anticipated revenues through the remainder of 2003 and 2004 would be substantially below expected as well as historical levels. The Company believed that the reduced demand for its products was caused by the decline in PC sales worldwide, competition from alternative technologies in the automotive glass segment, as well as declines in certain residential and commercial construction markets as a result of the economic recession in the U.S. As the Company's U.S. operations have a higher operating cash break-even point compared to its Dresden operations, it believed that the lower anticipated revenues indicated that an impairment analysis of the assets of its U.S. operations was necessary at September 28, 2003. As a result of the Company's decision to close the Tempe operations in the fourth quarter, it concluded that a further impairment analysis of the long-lived assets of the U.S. operations was necessary at December 31, 2003. The Company, therefore, performed an evaluation of the recoverability of long-lived assets related to its U.S. business at September 28, 2003 and December 31, 2003 in accordance with the SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". For long-lived assets to be held and used, the determination of recoverability is based on an estimate of undiscounted cash flows expected to result from the use and eventual disposition of the assets. The Company's evaluation concluded that the undiscounted expected future cash flows were less than the carrying values of these assets, and an impairment charge was required. The impairment charge represents the amount required to write-down long-lived assets to the Company's best estimate of fair value. For long-lived assets to be disposed of by sale or abandonment principally the long-lived assets located at the Tempe operation, the impairment loss is estimated as the excess of the carrying value of the assets over fair value. As a result of the Company's assessment it recorded non-cash, impairment charges of $19,380 and $8,610 for the periods ended September 28, 2003 and December 31, 2003, respectively. The factors considered by the Company in performing this assessment included current operating results, trends, and prospects, the closure of its Tempe operation, as well as the effects of obsolescence, demand, competition, and other economic factors.

During 2004, the Company recovered $1,513 from the sale of a previously written-down machine.

NOTE 14 - SUBSEQUENT EVENTS

On January 19, 2005, we received the final payment of $170 on the sale of PM5 from a third party. From these proceeds, we paid Teijin Limited, a major supplier $150. On March 21, 2005, we paid the remaining balance of our loan to Teijin of $269.

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None

ITEM 9A. 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 chief 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 December 31, 2004. Based on this evaluation, our chief executive officer and chief financial officer concluded as of the Evaluation Date that our disclosure controls and procedures were effective such that the information relating to the Company, including our consolidated subsidiaries, required to be disclosed in our Securities and Exchange Commission (“SEC”) reports (i) is recorded, processed, summarized and reported with the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to our management, including our chief executive officer and chief 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 and an attestation from an independent registered public accounting firm in our Annual Report on Form 10-K beginning with the filing for our fiscal year ending December 31, 2006.

(c)

Changes in Internal Controls. There were no changes in our internal controls over financial reporting identified that are reasonably likely to affect the internal controls over financial reporting.

ITEM 9B. OTHER INFORMATION

Not applicable.

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PART III

Certain information required by Part III is omitted from this annual report as we intend to file a proxy statement for our Annual Meeting of Stockholders, pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, not later than 120 days after the end of the fiscal year covered by this Report, and certain information included in that proxy statement is incorporated herein by reference.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT

The information required by this item is contained under the heading “Executive Officers of the Registrant” in Part I of this Annual Report on Form 10-K, and the remainder is contained in our proxy statement for our 2005 Annual Stockholders Meeting under the heading “Election of Directors,” and is incorporated herein by reference. Information relating to certain filings on Forms 3, 4, and 5 is contained in our 2005 proxy statement under the heading “Section 16(a) Beneficial Ownership Reporting Compliance,” and is incorporated herein by reference. Information required by this item pursuant to Items 401(h), 401(i), and 401(j) of Regulation S-K relating to an audit committee financial expert, the identification of the audit committee of our board of directors and procedures of security holders to recommend nominees to our board of directors is contained in our 2005 proxy statement under the heading “Corporate Governance” and is incorporated herein by reference.

We have adopted a written code of conduct that applies to all of our employees, including our principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions.

ITEM 11. EXECUTIVE COMPENSATION

Information regarding the Company’s compensation of its named executive officers is set forth under “Executive Compensation” in the Proxy Statement, which information is incorporated herein by reference. Information regarding the Company’s compensation of its directors is set forth under “Director Compensation” in the Proxy Statement, which information is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Information regarding security ownership of certain beneficial owners, directors and executive officers is set forth under “Security Ownership of Certain Beneficial Owners and Management” in the Proxy Statement, which information is incorporated herein by reference.

Information regarding the Company’s equity compensation plans, including both stock holder approved plans and non-stockholder approved plans, is set forth in the section entitled “EXECUTIVE OFFICER COMPENSATION—Securities Authorized for Issuance Under Equity Compensation Plans” in the Proxy Statement, which information is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information regarding certain relationships and related transactions is set forth under “Certain Relationships and Related Transactions” in the Proxy Statement, which information is incorporated herein by reference.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

Information regarding principal auditor fees and services is set forth under “Independent Auditor Fees and Services” in the Proxy Statement, which information is incorporated herein by reference.

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PART IV

ITEM 15. EXHIBITS, AND FINANCIAL STATEMENT SCHEDULES

The following documents are filed as part of this Form 10-K:

(a) (1) Financial Statements. The following Financial Statements of Southwall Technologies Inc. are filed as part of this Form 10-K:

	Form 10-K Page Number
Reports of Independent Registered Public Accounting Firms	38, 39
Consolidated Balance Sheets as of December 31, 2004 and 2003	40
Consolidated Statements of Operations for the years ended December 31, 2004, 2003 and 2002	41
Consolidated Statements of Stockholders' Equity for the years ended December 31, 2004, 2003 and 2002	42
Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003 and 2002	43
Notes to Consolidated Financial Statements	44

(2) Financial Statement Schedule.

Schedule II - Valuation and qualifying accounts and reserves (amounts in thousands):

Description	Balance at Beginning of Year		Additions			Deductions			Balance at End of Year
2004
Inventory reserves	$	1,440	$	2,129		$	2,315	(2)	$	1,254
Allowance for doubtful accounts	$	778	$	--		$	486	(2)	$	292
Reserves for warranty and sales returns	$	1,851	$	2,359	(1)	$	1,509	(2)	$	2,701
Tax valuation allowance	$	29,521		--			7,173	(2)		22,348

2003
Inventory reserves	$	988	$	908		$	456	(2)	$	1,440
Allowance for doubtful accounts	$	552	$	275		$	49	(2)	$	778
Reserves for warranty and sales returns	$	2,069	$	2,271	(1)	$	2,489	(2)	$	1,851
Tax valuation allowance	$	14,671	$	14,850		$	--		$	29,521

2002
Inventory reserves	$	1,001	$	255		$	268	(2)	$	988
Allowance for doubtful accounts	$	388	$	353		$	189	(2)	$	552
Reserves for warranty and sales returns	$	2,642	$	2,229	(1)	$	2,802	(2)	$	2,069
Tax valuation allowance	$	10,969	$	3,702		$	--		$	14,671

Notes : (1) Charged against revenue.

(2) Reserves utilized during the year.

(3) Exhibits.

Reference is made to the Exhibit Index, which follows the signature pages of this Form 10-K.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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, as of the day of March 29, 2005.


	SOUTHWALL TECHNOLOGIES INC.

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

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities indicated, as of March 29, 2005.

Signature		Title

/s/Thomas G. Hood		President, Chief Executive Officer and Director
Thomas G. Hood		(Principal Executive Officer)

/s/Maury Austin		Senior Vice President, Chief Financial Officer and
Maury Austin		Secretary (Principal Accounting Officer)

/s/George Boyadjieff		Chairman, Board of Directors
George Boyadjieff

/s/William A. Berry		Director
William A. Berry

/s/Jami K. Nachtsheim		Director
Jami K. Nachtsheim

/s/Joseph B. Reagan		Director
Joseph B. Reagan

/s/Walter C. Segdwick		Director
Walter C. Segdwick

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EXHIBIT INDEX

Exhibit No.	Exhibit
3.1(1)	Restated Certificate of Incorporation of the Company.
3.1.1(30)	Amendment to Amended and Restated Certificate of Incorporation of the Company
3.2(1)	By-laws of the Company.
3.3(26)	Amended and Restated Certificate of Designation, Preferences and Rights of Series A 10% Cumulative Preferred Stock of the Company filed with the Secretary of State of Delaware on January 30, 2004.
10.35.1(11)	Lease Agreement for the facilities at 3941 East Bayshore Road, dated October 7, 1999, between the Company and Straube Associates, Inc.
10.36(1)	Lease Agreement for the facilities at 3961 East Bayshore Road, dated March 20, 1979, between the Company and Allan F. Brown and Robert V. Brown.
10.36.1(11)	Amendment, dated October 12, 1999, between the Company and Brown Investment Company to the Lease Agreement for the facilities at 3961 East Bayshore Road, dated March 20, 1979, between the Company and Allan F. Brown and Robert V. Brown.
10.52(2)	Marketing and Distribution Agreement dated as of May 20, 1988, among Mitsui, Marubeni Corporation and the Company, as amended.
10.52.1(19)	Amendment to the Marketing and Distribution Agreement dated as of May 20, 1988, among Mitsui, Marubeni Corporation and the Company, dated December 28, 1990.
10.59(3)	Lease Agreement for the facilities at 3969-3975 East Bayshore Road Palo Alto, California, dated January 1, 1989, between the Company and Bay Laurel Investment Company.
10.59.1(11)	Amendment, effective January 1, 2000, between the Company and Judd Properties, LLC to the Lease Agreement for the facilities at 3969-3975 East Bayshore Road Palo Alto, California, dated January 1, 1989, between the Company and Bay Laurel Investment Company.
10.59.2(27)	Second Amendment to Lease for the facilities at 3969-3975 East Bayshore Road Palo Alto, California, dated February 19, 2004, between the Company and Judd Properties, LLC.
10.60(3)	Lease Agreements for the facilities at 3977-3995 East Bayshore Road Palo Alto, California, dated January 1, 1989, between the Company and Bay Laurel Investment Company.
10.60.1(11)	Amendment, effective January 1, 2000, between the Company and Judd Properties, LLC to the Lease Agreements for the facilities at 3977-3995 East Bayshore Road Palo Alto, California, dated January 1, 1989, between the Company and Bay Laurel Investment Company.
10.60.2(27)	Surrender and Termination Agreement for the facilities at 3977- 3995 East Bayshore Road Palo Alto, California, dated February 19, 2004, between the Company and Judd Properties, LLC.
10.71(4)	Lease Agreement for the facilities at 3780 Fabian Way, Palo Alto, California, dated June 11, 1990, between the Company and The Fabian Building.
10.72(4)	License Agreement between Mitsui and the Company, dated December 28, 1990.
10.72.1(19)	Amendment to the License Agreement dated as of December 28, 1990 between Mitsui and the Company, dated August 2000.
10.78(5)	Amendment to property lease dated February 2, 1994 to extend lease period on building at 3961 E. Bayshore Road, Palo Alto, California. Original lease filed as Exhibit No. 10.36 above.
10.80(6)	Lease Agreement between Frank Gant, as Lessor, and the Company, as Lessee, effective September 1, 1994.
10.84(7)	Lease Agreement between Chamberlain Development, L.L.C., as Lessor and the Company, as Lessee, effective August 22, 1996.
10.88(8)	Basic Agreement dated April 9, 1997, for the sale of 667,000 shares of the Company's common stock to Teijin Limited, a Japanese corporation, and for mutually beneficial cooperation and collaboration between Teijin and the Company.
10.90(8)	Reimbursement and Security Agreement dated May 6, 1997, between Teijin Limited, a Japanese corporation, and the Company.
10.92(9)*	The Company's 1997 Stock Incentive Plan.
10.93(10)*	The Company's 1997 Employee Stock Purchase Plan, as amended.
10.94(12)*	The Company's October 22, 1999 Severance Policy in the Event of a Merger.
10.95(12)	Amendment to property lease dated August 22, 1996, to increase rent on building located at 8175 South Hardy Drive, Tempe, Arizona effective December 1, 2000. Original lease was filed as Exhibit 10.84 above.
10.95.1(27)	Letter Agreement dated January 29, 2004 between the Company and Greenwood & Son Real Estate Investments relating to the building located at 8175 South Hardy Drive, Tempe, Arizona.
10.96(13)	Digeo, Inc. sublease agreement.
10.97(13)	Energy Conversion Devices note payable.
10.98(14)	Globamatrix Purchase Agreement.
10.99(15)*	1998 Stock Plan for Employees and Consultants.
10.100(15)	Receivables Financing Agreement between Pacific Business Funding and the Company, dated June 30, 1999.
10.101(16)	Supply Agreement between Saint Gobain Sekurit France and the Company, dated December 19, 2001 (portions of this exhibit have been omitted based on a request for confidential treatment; the non-public information has been filed with the Commission).
10.103(15)	German bank loan dated May 12, 1999.
10.104(15)	German bank loan dated May 28, 1999.
10.105(22)	German bank loans dated May 28, 1999 and December 1, 1999.
10.106(15)	German bank loan due June 30, 2009.
10.107(15)	German bank loan dated June 29, 2000.
10.108(15)	German bank loan dated July 10, 2000.
10.109(15)	German bank loans dated December 18, 2000 and December 19, 2000.
10.111(19)	Master Lease Agreement between Matrix Funding Corporation and the Company, dated July 19, 1999.
10.112(15)	Development and Technology Agreement between Energy Conversion Devices, Inc. dated April 11, 1997.
10.115(20)	Teijin Waiver Letter dated March 28, 2002.
10.116(18)	Distribution Agreement between Globamatrix Holdings Pte. Ltd. and the Company, dated as of January 1, 2002 (portions of this exhibit have been omitted based on a request for confidential treatment; the non-public information has been filed with the Commission).
10.116.1(27)	Letter Agreement dated August 28, 2003 between Globamatrix Holdings Pte. Ltd. and the Company amending the Distribution Agreement between the parties dated January 1, 2002.
10.116.2(27)	Letter Agreement dated December 17, 2003 between Globamatrix Holdings Pte. Ltd. and the Company amending the Distribution Agreement between the parties dated January 1, 2002.

Table of Contents

10.117(17)	Teijin Waiver Letter dated May 9, 2002.
10.118(17)	Sanwa Bank Waiver Letter dated May 15, 2002.
10.119(19)	Standard Industrial Lease dated October 1999 for the facilities at 1029 Corporation Way, Palo Alto, California between the Company and C&J Development.
10.120(19)	Guarantee Agreement Regarding 10 million US$ Credit Facility between Teijin Limited and the Company, dated May 6, 1997.
10.120.1(21)	Memorandum Amendment to the Guarantee Agreement between Teijin Limited and the Company, dated August 1999.
10.121. (23)	Pilkington Supply and Purchase Agreement dated September 1, 2002.
10.122. (23)	Xinyi Group (Glass) Co. LTD. Purchase Agreement dated September 5, 2002.
10.123 (24)	Domestic Factoring Agreement dated May 16, 2003, between Pacific Business Funding and the Company.
10.123.1 (24)	Amendment to the Domestic Factoring Agreement dated June 16, 2003, between Pacific Business Funding and the Company.
10.124 (24)	Intellectual Property Security Agreement dated May 16, 2003, between Pacific Business Funding and the Company.
10.125 (24)	Export-Import Working Capital Guarantee Program Borrower Agreement, between Pacific Business Funding and the Company.
10.126 (24)	Export-Import Factoring Agreement dated May 16, 2003, between Pacific Business Funding and the Company.
10.126.1 (24)	Amendment to the Export- Import Factoring Agreement dated June 16, 2003, between Pacific Business Funding and the Company.
10.127 (24)	Manufacturing and Supply Agreement between the Company and Mitsui Chemicals, Inc. dated July 19, 2003 (portions of this exhibit have been omitted based on a request for confidential treatment; the non-public information has been filed with the Commission).
10.128(27)	Guaranteed Loan Agreement dated January 19, 2004, between Teijin Limited and the Company.
10.128.1(29)	Amendment No. 1, dated June 9, 2004, to Guaranteed Loan Agreement by and between Southwall and Teijin, Limited.
10.129(27)	Guaranty Agreement dated January 19, 2004, between Teijin Limited and Southwall Europe GmbH.
10.130(27)	Supply Agreement between Saint Gobain Sekurit France and the Company, effective January 1, 2004 (portions of this exhibit have been omitted based on a request for confidential treatment; the non-public information has been filed with the Commission).
10.131 (26)	Amended and Restated Investment Agreement, dated February 20, 2004, by and among the Company and Needham & Company, Inc., Needham Capital Partners II, L.P., Needham Capital Partners II (Bermuda), L.P., Needham Capital Partners III, L.P., Needham Capital Partners IIIA, L.P., Needham Capital Partners III (Bermuda), L.P., and Dolphin Direct Equity Partners, LP (collectively, the "Investors").
10.132 (26)	Amended and Restated Registration Rights Agreement, dated February 20, 2004, by and among the Company, Pacific Business Funding, Judd Properties, LLC, and the Investors.
10.133 (26)	Form of Secured Convertible Promissory Note issued by the Company to the Investors.
10.134 (26)	Pledge Agreement, dated February 20, 2004, between the Company and Needham & Company, Inc.
10.135 (25)	Form of Warrant to purchase shares of the Company's common stock.
10.136 (25)	Loan and Security Agreement, dated December 18, 2003, between the Company and Pacific Business Funding.
10.136.1(28)	First Amendment to Loan and Security Agreement dated as of December 18, 2003, dated April 29, 2004.
10.137 (25)	Forbearance Agreement, dated December 18, 2003, between the Company and Pacific Business Funding.
10.137.1(27)	First Amendment to Forbearance Agreement, dated December 29, 2003, between the Company and Pacific Business Funding.
10.137.2 (26)	Second Amendment to Forbearance Agreement, dated February 20, 2004, between the Company and Pacific Business Funding.
10.138(27)	Mutual Release and Settlement Agreement dated February 20, 2004, by and among the Company and Bank of America, N.A., Portfolio Financial Servicing Company and Lehman Brothers. Agreement relates to the Master Lease Agreement between Matrix Funding Corporation and the Company filed as Exhibit 10.111.
10.139(28)	Third Amendment to Domestic Factoring Agreement, dated April 29, 2004.
14(27)	Code of Ethics.
21(15)	List of Subsidiaries of the Company.
23.1	Consent of Independent Registered Public Accounting Firm.
23.2	Consent of Independent Registered Public Accounting Firm.
31.1	Certification pursuant to Exchange Act Rules 13a-14 and 15d-14 of the Chief Executive Officer
31.2	Certification pursuant to Exchange Act Rules 13a-14 and 15d-14 of the Chief Financial Officer
32.1	Certification pursuant to 18 U.S.C. Section 1350 of the Chief Executive Officer
32.2	Certification pursuant to 18 U.S.C. Section 1350 of the Chief Financial Officer

_____

* Relates to management contract or compensatory plan or arrangement.

(1) Filed as an exhibit to the Registration Statement on Form S-1 filed with the Commission on April 27, 1987 (Registration No. 33- 13779) (the "Registration Statement") and incorporated herein by reference.

(2) Filed as an exhibit to the Form 10-Q Quarterly Report for Quarter Ended June 30, 1988, filed with the Commission on August 15, 1988 and incorporated herein by reference. Our 1934 Act registration number is 000-15930.

(3) Filed as an exhibit to the Form 10-Q Quarterly Report for Quarter Ended July 2, 1989, filed with the Commission on August 16, 1989 and incorporated herein by reference.

(4) Filed as an exhibit to the Form 10-K Annual Report 1990, filed with the Commission on March 25, 1991 and incorporated herein by reference.

(5) Filed as an exhibit to the Form 10-K Annual Report 1992, filed with the Commission on March 15, 1993 and incorporated herein by reference.

(6) Filed as an exhibit to the Form 10-Q Quarterly Report for Quarter Ended July 3, 1994, filed with the Commission on August 15, 1994 and incorporated herein by reference.

(7) Filed as an exhibit to the Form 10-K Annual Report 1996, filed with the Commission on March 27, 1997 and incorporated herein by reference.

(8) Filed as an exhibit to the Form 10-Q Quarterly Report for Quarter Ended June 29, 1997, filed with the Commission on August 14, 1997 and incorporated herein by reference.

Table of Contents

(9) Filed as Proposal 3 included in the 1997 Proxy statement filed with the Commission on April 14, 1997 and incorporated herein by reference.

(10) Filed as Proposal 3 included in the 2002 Proxy statement filed with the Commission on April 22, 2002 and incorporated herein by reference.

(11) Filed as an exhibit to the Form 10-K Annual Report 1999, filed with the Commission on April 6, 2000 and incorporated herein by reference.

(12) Filed as an exhibit to the Form 10-K Annual Report 2000, filed with the Commission on April 9, 2001 and incorporated herein by reference.

(13) Filed as an exhibit to the Form 10-Q Quarterly Report for Quarter Ended September 30, 2001, filed with the Commission on November 12, 2001 and incorporated herein by reference.

(14) Filed as an exhibit to the Form 10-Q Quarterly Report for the Quarter Ended April 1, 2001, filed with the Commission on May 16, 2001 and incorporated herein by reference.

(15) Filed as an exhibit to the Form 10-K Annual Report 2001, filed with the Commission on April 1, 2002 and incorporated herein by reference.

(16) Filed as an exhibit to the Form 10-K/A Annual Report 2001, filed with the Commission on June 14, 2002 and incorporated herein by reference.

(17) Filed as an exhibit to the Form 10-Q Quarterly Report for the Quarter Ended March 31, 2002, filed with the Commission on May 17, 2002 and incorporated herein by reference.

(18) Filed as an exhibit to the Form 10-Q/A Quarterly Report for the Quarter Ended March 31, 2002, filed with the Commission on June 19, 2002 and incorporated herein by reference.

(19) Filed as an exhibit to Amendment No. 3 to the Registration Statement on Form S-1 filed with the Commission on June 25, 2002 (Registration No. 333-85576) and incorporated herein by reference.

(20) Filed as an exhibit to the Registration Statement on Form S-1 filed with the Commission on April 5, 2002 (Registration No. 333- 85576) and incorporated herein by reference.

(21) Filed as an exhibit to Amendment No. 1 to the Registration Statement on Form S-1 filed with the Commission on May 31, 2002 (Registration No. 333-85576) and incorporated herein by reference.

(22) Filed as an exhibit to the Form 10-K/A Annual Report 2001, filed with the Commission on June 27, 2002 and incorporated herein by reference.

(23) Filed as an exhibit to the Form 10-K Annual Report 2002, filed with the Commission on March 31, 2003 and incorporated herein by reference.

(24) Filed as an exhibit to the Form 10-Q Quarterly Report for the Quarter Ended June 29, 2003, filed with the Commission on August 15, 2003 and incorporated herein by reference.

(25) Filed as an exhibit to the Form 8-K Current Report, filed with the Commission on December 23, 2003 and incorporated herein by reference.

(26) Filed as an exhibit to the Form 8-K/A Current Report, filed with the Commission on March 3, 2004 and incorporated herein by reference.

(27) Filed as an exhibit to Form 10-K Annual Report 2003, filed with the Commission on April 14, 2004 and incorporated herein by reference.

(28) Filed as an exhibit to the Form 10-Q Quarterly Report, filed with the Commission on May 17, 2004, and incorporated herein by reference.

(29) Filed as an exhibit to the Form 10-Q Quarterly Report, filed with the Commission on August 11, 2004, and incorporated herein by reference.

(30) Filed as an exhibit to the Form 10-Q Quarterly Report, filed with the Commission on November 8, 2004, and incorporated herein by reference.

Delaware		94-2551470
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification Number)

Document Description		10-K Part

Portions of the Registrant’s Proxy Statement For the Annual Meeting of Stockholders to be held May 26, 2005		III

Part I.		Page
Item 1.	Business	5
Item 2.	Properties	12
Item 3.	Legal Proceedings	12
Item 4.	Submission of Matters to a Vote of Security Holders	12
	Executive Officers of the Registrant	13
Part II.
Item 5.	Market for Registrant's Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities	14
Item 6.	Selected Consolidated Financial Data	15
Item 7.	Management's Discussion and Analysis of Financial Condition and Results of Operations	18
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	36
Item 8.	Financial Statements and Supplementary Data	37
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosures	61
Item 9A.	Controls and Procedures	61
Item 9B.	Other Information	61
Part III.
Item 10.	Directors and Executive Officers of the Registrant	62
Item 11.	Executive Compensation	62
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	62
Item 13.	Certain Relationships and Related Transactions	62
Item 14.	Principal Accountants Fees and Services	62
Part IV.
Item 15.	Exhibits and Financial Statement Schedules	63
Signatures		64

MARKET	APPLICATION	FILM PRODUCTS	KEY FEATURES	REPRESENTATIVE CUSTOMERS
Automotive glass	Windscreens, side windows, and back windows	Infrared reflective (XIR 70 and XIR 75)	Transmits 70% or 75% visible light Reflects 85% of infrared heat energy	Saint Gobain Sekurit Pilkington PLC Asahi Guardian Glass

Electronic display	Flat screen CRT monitors and TVs	Anti-reflective absorbing (ARA)	Pigmented film 8X reduction in light reflection High picture quality	Mitsubishi Electric

	Liquid crystal display (LCD) screens	Anti-reflective clear (ARC)	Clear anti-reflective product	Berliner Glass

	Plasma display panels (PDP)	Infrared reflective (TCP)	Clear and Conductive Clear infrared blocking	Mitsui Chemicals
Architectural glass	New and retrofit residential and commercial windows and doors	Suspended Heat Mirror	Cool in summer Warm in winter UV blocking Noise reducing	Kensington Windows Zamil Glass Traco

	Commercial buildings	Laminated (XIR)	Infrared reflecting UV blocking Cool in summer Noise reducing	Gulf Glass Industries Cristales Curvados

Window film	After-market installation	Solis/V-KOOL	Transmits up to 75% visible light	Globamatrix
		Huper Optik	Reflects up to 85% of infrared heat energy Infrared reflecting UV blocking Cool in summer Noise reducing	Huper Optik

Machine Number	Location	Primary Markets For Current Production	Year Commercial Production Initiated	Estimated Annual Capacity (Millions of Sq. Ft.) ⁽¹⁾

PM 1	Palo Alto	Architectural	1980	none

PM 2	Palo Alto	Electronic display (currently not in use)	1982	6.0

PM 4A	Palo Alto	Automotive, architectural, electronic display and window film	1991	12.0

PM 4B	Palo Alto	Automotive, architectural, electronic display and window film	1991	12.0

PM 8	Dresden	Automotive, architectural, electronic display and window film	2000	16.0

PM 9	Dresden	Automotive, architectural, electronic display and window film	2001	16.0

PM 10	Dresden	Automotive, architectural, electronic display and window film	2003	16.0

Director	For	Withheld
William A. Berry	11,309,711	544,557
George Boyadjieff	11,309,711	544,557
Thomas G. Hood	11,290,611	563,657
Jami K. Nachtsheim	11,304,711	549,557
Joseph B. Reagan	11,250,411	603,857
Walter Sedgwick	11,311,211	543,057

Name	Age	Position

Thomas G. Hood	49	President, Chief Executive Officer and Director
Maury Austin	47	Senior Vice President and Chief Financial Officer and Secretary
Sicco W.T. Westra	54	Vice President, Business Development
Wolfgang Heinze	56	Vice President, General Manager Southwall Europe GmbH
Dennis Capovilla	45	Vice President, Sales and Marketing

	High		Low
2003
1st Quarter	$	3.35	$	1.01
2nd Quarter		1.39		0.82
3rd Quarter		2.63		1.04
4th Quarter		2.38		0.80
2004
1st Quarter	$	2.09	$	0.98
2nd Quarter		0.94		0.40
3rd Quarter		0.85		0.48
4th Quarter		1.72		0.48

	As of December 31,
	2004		2003			2002		2001			2000
	(in thousands)
Cash, cash equivalents and restricted cash	$	5,233	$	1,891		$	2,629	$	3,362		$	61
Working capital (deficit)		6,528		(4,210	)		588		(6,471	)		(32,148	)
Property, plant and equipment		21,110		21,787			50,251		47,841			49,884
Total assets		44,947		41,721			76,582		73,158			80,462
Term debt and capital leases including current
portion		13,107		15,700			16,752		22,828			26,430
Total liabilities		30,374		40,000			36,108		46,706			60,324
Preferred stock		4,810		--			--		--			--
Total stockholders' equity		9,763		1,721			40,474		26,452			20,138

Selected Cash Flow Data:
	Years Ended December 31,
	2004			2003			2002			2001			2000
(in thousands)

Net cash provided by (used in) operating activities	$	3,830		$	(2,990	)	$	(2,824	)	$	13,792		$	1,188
Net cash provided by (used in) investing activities		1,261			(2,775	)		(6,014	)		(5,698	)		(12,855	)
Net cash provided by (used in) financing activities		(2,249	)		5,548			7,679			(4,628	)		9,994

	Quarters Ended
	Mar. 28,			Jun. 27,		Sep. 26,		Dec. 31,
	2004			2004		2004		2004
	(in thousands, except per share amounts)
Net revenues	$	11,067		$	14,548	$	15,932	$	16,026
Gross profit		2,601			5,612		5,780		6,793

Income (loss) before provision for (benefit from) income taxes		(6,335	)		1,529		1,834		3,401
Net income (loss)	$	(6,690	)	$	1,186	$	2,132	$	3,187

Net income (loss) per share:
Basic	$	(0.53	)	$	0.09	$	0.17	$	0.16
Diluted	$	(0.53	)	$	0.04	$	0.07	$	0.10

Weighted average shares used in computing net income (loss) per share:

Basic		12,548			12,548		12,550		20,327
Diluted		12,548			31,416		31,218		32,697

	Quarters Ended
	Mar. 30,			Jun. 29,			Sep. 28,			Dec. 31,
	2003			2003			2003			2003
	(in thousands, except per share amounts)
Net revenues	$	15,221		$	15,328		$	11,902		$	10,875
Gross profit (loss)		3,038			2,923			1,664			(213	)

Loss before provision for (benefit from) income taxes		(1,644	)		(1,537	)		(22,684	)		(15,746	)
Net loss	$	(1,659	)	$	(1,713	)	$	(22,781	)	$	(16,139	)

Net loss per share:
Basic and diluted	$	(0.13	)	$	(0.14	)	$	(1.82	)	$	(1.29	)

Weighted average shares used in computing net loss per share:
Basic and diluted		12,527			12,532			12,542			12,544

	Years Ended December 31,
	2004			Percent Change			2003			Percent Change			2002
	(dollars in thousands)
Net revenues, by product
Automotive glass	$	20,584			1	%	$	20,297			0	%	$	20,374
Electronic display		20,554			8			19,019			(28	)		26,555
Architectural		7,010			11			6,297			(44	)		11,183
Window film		9,425			22			7,713			(28	)		10,647
Total net revenues		57,573			8			53,326			(22	)		68,759
Cost of revenues		36,787			(20	)		45,914			(7	)		49,614
Gross profit		20,786			180			7,412			(61	)		19,145

Operating expenses:
Research and development		3,199			(52	)		6,714			(13	)		7,685
Selling, general and administrative		10,217			(17	)		12,348			(1	)		12,450
Restructuring costs		--			--			(65	)		(102	)		2,624
Impairment charge (recoveries) for long-lived assets		(1,513	)		(105	)		27,990			--			--
Total operating expenses		11,903			(75	)		46,987			106			22,759

Income (loss) from operations		8,883			122			(39,575	)		(995	)		(3,614	)
Interest expense, net		(2,206	)		(39	)		(1,590	)		(8	)		(1,734	)
Costs of warrants issued		(6,782	)		(684	)		(865	)		--			--
Other income, net		534			27			419			(61	)		1,070
Income (loss) before provision for (benefit from) income taxes		429			101			(41,611	)		(873	)		(4,278	)
Provision for (benefit from) income taxes		614			(10	)		681			883			(87	)
Net loss	$	(185	)		(100	)%	$	(42,292	)		909	%	$	(4,191	)

									Greater
			Less than						Than
	Total		1 Year		1-3 Year		4-5 Year		5 Year
Contractual Obligations:
Term debt (1)	$	13,064	$	1,420	$	2,617	$	5,732	$	3,295
Line of credit		2,975		2,975		--		--		--
Capital lease obligations		43		43		--		--		--
Operating leases (2)		2,295		674		1,610		11		--
Total contractual cash obligations	$	18,377	$	5,112	$	4,227	$	5,743	$	3,295

	Page

Report of Independent Registered Public Accounting Firm	38
Report of Independent Registered Public Accounting Firm	39
Consolidated Balance Sheets	40
Consolidated Statements of Operations	41
Consolidated Statements of Stockholders’ Equity	42
Consolidated Statements of Cash Flows	43
Notes to Consolidated Financial Statements	44

	Common Stock
	Common Shares		Stock Amount		Capital in Excess of Par Value		Notes Receivable			Accumulated Other Comprehensive Income(Loss)			Accumulated Deficit			Total Stockholders’ Equity			Comprehensive Income (Loss)
Balances, January 1, 2002		8,333	$	8	$	52,613				$	(172	)	$	(25,910	)	$	26,451
Exercise of stock options		328		--		1,642		--			--			--			1,642
Net proceeds from follow-on public offering..		3,807		4		15,129		--			--			--			15,133
Issuance of shares to employees under stock purchase plan		59		--		231		--			--			--			231
Stock-based compensation		--		--		42		--			--			--			42
Issuance of notes receivable		--		--		--		(14	)		--			--			(14	)
Interest accrued on notes receivable		--		--		--		(24	)		--			--			(24	)
Translation loss on foreign subsidiary		--		--		--		--			1,204			--			1,204		$	1,204
Net loss		--		--		--		--			--			(4,191	)		(4,191	)		(4,191	)
Balances, December 31, 2002		12,527		12		69,657		(126	)		1,032			(30,101	)		40,474			(2,987	)
Issuance of shares to employees under stock purchase plan		21		1		21		--			--			--			22
Issuance of warrants to investors		--		--		865		--			--			--			865
Issuance of warrants to creditors		--		--		201		--			--			--			201
Issuance of shares to directors		--		--		83		--			--			--			83
Accelerated vesting on exercise of stock option		--		--		34		--			--			--			34
Forgiveness of notes receivable		--		--		--		126			--			--			126
Translation loss on foreign subsidiary		--		--		--		--			2,208			--			2,208			2,208
Net loss		--		--		--		--			--			(42,292	)		(42,292	)		(42,292	)
Balances, December 31, 2003		12,548		13		70,861		--			3,240			(72,393	)		1,721			(40,084	)
Issuance of shares to employees under stock purchase plan		7		--		2		--			--			--			2
Issuance of warrants to investors		--		--		6,990		--			--			--			6,990
Issuance of shares to directors		150		--		72		--			--			--			72
Issuance of shares from exercise of warrants.		13,783		13		32		--			--			--			45
Translation loss on foreign subsidiary		--		--		--		--			1,118			--			1,118			1,159
Net loss		--		--		--		--			--			(185	)		(185	)		(185	)
Balances, December 31, 2004		26,488	$	26	$	77,957	$	--		$	4,358		$	(72,578	)	$	9,763		$	974