10-Q

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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(MARK ONE)

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

For the quarterly period ended March 31, 2002

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                              to                             

Commission File Number: 0-15930

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

DELAWARE (State or other jurisdiction of incorporation or organization)	94-2551470 (I.R.S. Employer Identification Number)
1029 Corporation Way, Palo Alto, California (Address of principal executive offices)	94303 (Zip Code)

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

        Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

        As of May 9, 2002 there were 8,618,657 shares of the Registrant's Common Stock outstanding.

SOUTHWALL TECHNOLOGIES INC.

INDEX

		Page
PART I FINANCIAL INFORMATION
Item 1	Financial Statements:
	Unaudited Consolidated Balance Sheets—March 31, 2002 and December 31, 2001	3
	Unaudited Consolidated Statements of Operations—Three month period ended March 31, 2002 and April 1, 2001	4
	Unaudited Consolidated Statements of Cash Flows—Three month period ended March 31, 2002 and April 1, 2001	5
	Notes to Unaudited Consolidated Financial Statements	6
Item 2	Management's Discussion and Analysis of Financial Condition and Results of Operations	15
Item 3	Quantitative and Qualitative Disclosures about Market Risk	19
PART II OTHER INFORMATION
Item 1	Legal Proceedings and Other Matters	29
Item 2	Changes in Securities	29
Item 3	Defaults upon Senior Securities	29
Item 4	Submission of Matters to a Vote of Stockholders	29
Item 5	Other Information	29
Item 6	Exhibits and Reports on Form 8-K	29
	Signatures	30

2

PART I FINANCIAL INFORMATION

Item 1-Financial Statements:

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

				March 31, 2002			December 31, 2001
ASSETS
Current assets
	Cash and cash equivalents			$	2,713		$	3,362
	Restricted cash				1,120			1,602
	Accounts receivable, net of allowance for bad debts of $411 and $389				10,239			9,020
	Inventories, net				7,053			6,151
	Other current assets				2,932			3,471
		Total current assets			24,057			23,606
Property, plant and equipment, net					47,326			47,841
Restricted loan proceeds					741			738
Other assets					943			973
		Total assets		$	73,067		$	73,158
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
	Current portion term debt			$	7,579		$	8,315
	Line of credit				4,606			2,974
	Accounts payable				8,757			10,338
	Accrued compensation				2,535			2,794
	Other accrued liabilities				5,567			5,656
		Total current liabilities			29,044			30,077
Term debt					13,800			14,513
Government grants advanced					771			941
Other					1,166			1,175
		Total liabilities			44,781			46,706
Stockholders' equity:
	Common stock, $0.001 par value, 20,000 shares authorized; issued and outstanding 8,562 and 8,332				9			8
	Capital in excess of par value				53,467			52,614
	Notes receivable				(103	)		(88	)
	Other comprehensive income
		Translation loss on subsidiary			(356	)		(172	)
	Accumulated deficit				(24,731	)		(25,910	)
		Total stockholders' equity			28,286			26,452
			Total liabilities and stockholders' equity	$	73,067		$	73,158

See accompanying notes to condensed consolidated financial statements.

3

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

			March 31, 2002			April 1, 2001
Net revenues			$	19,269		$	17,713
Cost of sales				12,425			14,849
Gross profit				6,844			2,864
Operating expenses
	Research and development			1,777			1,425
	Selling, general and administrative			3,745			2,656
		Total costs and expenses		5,522			4,081
Income (loss) from operations				1,322			(1,217	)
Interest expense, net				(466	)		(757	)
Other income, net				378			864
Income (loss) before provision for income taxes				1,234			(1,110	)
Provision for income taxes				53			21
Net income (loss)			$	1,181		$	(1,131	)
Net income (loss) per share:
	Basic		$	0.14		$	(0.15	)
	Diluted		$	0.13		$	(0.15	)
Weighted average shares of common stock and dilutive potential common stock:
	Basic			8,417			7.743
	Diluted			9,277			7,743

See accompanying notes to condensed consolidated financial statements.

4

SOUTHWALL TECHNOLOGIES INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
Increase (Decrease) in cash

		Three Months Ended,
		March 31, 2002			April 1, 2001
Cash flows (used in) or provided by operating activities:
	Net income (loss)	$	1,181		$	(1,131	)
	Adjustments to reconcile net income (loss) to net cash provided by operating activities:
	Depreciation and amortization		1,375			1,382
Change in assets and liabilities:
	Accounts receivable, net		(1,219	)		3,678
	Inventories, net		(902	)		897
	Other current and non-current assets		556			(329	)
	Accounts payable, and accrued liabilities		(1,938	)		(2,275	)
Cash provided by (used in) operating activities			(947	)		2,222
Cash flows from investing activities:
	Restricted cash		482			1,300
	Expenditures for property, plant and equipment and other assets		(849	)		(360	)
Net cash provided by (used in) investing activities			(367	)		940
Cash flows from financing activities:
	Principal payments on borrowings		(1,449	)		(1,211	)
	Borrowings (payments) on line of credit		1,632			(1,413	)
	Proceeds from exercise of stock options		838			65
Net cash provided by (used in) financing activities			1,021			(2,559	)
	Effect of foreign exchange rate changes on cash		(356	)		(446	)
Net increase (decrease) in cash and cash equivalents			(649	)		157
Cash and cash equivalents, beginning of year			3,362			61
Cash and cash equivalents, end of period		$	2,713		$	218
Supplemental cash flow disclosures:
	Cash paid for interest	$	233		$	501
	Cash paid for income taxes	$	21		$	22
Supplemental schedule of non-cash investing and financing activities:
	Notes receivable issued to exercise stock options	$	15		$	19

See accompanying notes to condensed consolidated financial statements.

5

SOUTHWALL TECHNOLOGIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands)
(Unaudited)

Note 1—Interim period reporting:

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

        Certain information and footnote disclosures normally contained in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. It is suggested that these consolidated financial statements be read in conjunction with the financial statements contained in the Company's Form 10-K for the year ended December 31, 2001 filed on April 1, 2002. The results of operations for the interim periods presented are not necessarily indicative of the operating results of the full year.

Note 2—Balance sheet:

Cash and cash equivalents

        The Company deposits its excess cash in an interest bearing bank account. The Company considers all highly liquid investments with an original or remaining maturity of three months or less at the date of purchase to be cash equivalents. Cash equivalents consist of money-market accounts.

Restricted cash

        Restricted cash consists of the unapplied portion of grants received from the Saxony government in Germany 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 grants. (See Note 6).

Inventories, net

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

Inventories, net		March 31, 2002		December 31, 2001
Raw materials		$	3,033	$	3,545
Work-in-process			3,279		2,430
Finished goods			741		176
	Total Inventories	$	7,053	$	6,151

Government grants advanced

        Government grants advanced consist of grant monies received from the Saxony government in Germany that are subject to certain conditions. Upon receipt and approval of qualified invoices by the Saxony government, funds from the grants are applied as a reduction of the costs of the Dresden manufacturing facility. In the event the Company fails to meet certain conditions related to the grants, the Saxony government has the right to reclaim the grants. (See Note 6).

6

Note 3—Net income (loss) per share:

        Basic net income (loss) per share is computed by dividing income available to common shareholders (numerator) by the weighted average number of common shares outstanding (denominator) for the period. Diluted net income (loss) per share gives effect to all dilutive potential common shares outstanding during the period. The computation of diluted earnings per share uses the average market prices during the period. At March 31, 2002, the dilutive stock options were 9,277 shares for dilutive earnings per share, and 8,417 shares for basic earnings for share. The total amount of the difference in the basic and diluted weighted average shares of common stock and common stock equivalents in the periods when there is net income is attributable to the effect of dilutive stock options. In net loss periods, the basic and diluted weighted average shares of common stock and common stock equivalents are the same because inclusion of stock options would be anti-dilutive. For the quarter ending April 1, 2001, there was no difference between the denominators used for the calculation of basic and dilutive net income (loss) per share. For quarters ended March 31, 2002 and April 1, 2001, options totalling 1,117 and 2,079, respectively, were excluded from the calculation of diluted earnings per share because they were anti-dilutive.

Note 4—Line of credit:

        The Company has a $10 million receivable financing line of credit with a financial institution that expires on June 30, 2003. Availability under the line of credit is based upon 80% of the approved accounts receivable balances and bears a finance fee per month of 0.88% of the average daily accounts receivable balance against which the Company is borrowing during the settlement period. The Company is required to repay the lender the amounts borrowed when it receives payments of these accounts receivable. In connection with the line of credit, the Company has granted the lender a continuing lien upon and security interest in, and right of set off with respect to, all of the Company's interest in all accounts receivable, inventory, monies, remittances and fixed assets. As of March 31, 2002, the Company had approximately $7.8 million of availability under the line of credit, of which it had borrowed $4.6 million, which is classified as current on the accompanying balance sheet.

7

Note 5—Term debt:

        The Company's indebtedness consisted of the following at March 31, 2002:

Description			Rate		Balance at March 31, 2002		Remaining Due in 2002
Line of credit			(1	)	$	4,606		(1	)
Term debt:
	Japanese bank loan guaranteed by Teijin		3.16	%	$	7,500	$	2,500
	German bank loan dated May 12, 1999		6.13	%(2)		2,321		225
	German bank loan dated May 28, 1999		7.10	%(3)		2,196		—
	German bank loan dated May 28, 1999		3.75	%		1,129		188
	German bank loan dated December 1, 1999		7.15	%		1,761		155
	German bank loan due June 30, 2009		5.75	%		1,482		—
	German bank loan dated June 29, 2000		5.75	%		299		113
	German bank loan dated July 10, 2000		7.10	%		299		112
	German bank loan dated December 18, 2000		7.50	%		208		57
	German bank loan dated December 19, 2000		7.50	%		190		52
	Note Payable dated September 21, 2001		8.00	%		520		450
	Other equipment financings					207		68
		Total term debt				18,112		3,920
Capital leases:
	Sales-leaseback dated July 19, 1999		13.00	%		2,321		2,321
	Sales-leaseback dated October 19, 1999		13.00	%		946		946
		Total capital leases				3,267		3,267
Total term debt and capital leases						21,379		7,187
		Less current portion				7,579
		Term debt, non current			$	13,800

(1)

This line of credit expires in June 2003. Under the line, the Company can borrow an amount equal to 80% of eligible accounts receivable. The Company pays a finance fee per month equal to 0.88% of the average daily balance of the amount of accounts receivable against which the Company has borrowed. The Company is required to repay the lender amounts borrowed when it receives payments of these accounts receivable.

(2)

Interest rate will be reset to the then prevailing market rate in 2004.

(3)

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

        The Japanese bank loan is guaranteed by a Japanese company, Teijin Limited (Teijin). Teijin is a stockholder and supplier of substrate materials to the Company. The Teijin guarantee is collateralized by certain equipment located in Southwall's Tempe and Palo Alto manufacturing facilities and inventory, to the extent necessary to provide 120% net book value coverage of the outstanding loan balance. The interest rate on the loan is re-set semi-annually at LIBOR plus 1.0%, (7.41% at April 1, 2001, and 3.16% March 31, 2002). The Company is also subject to certain financial covenants under the guarantee. A loan guarantee service fee is payable to Teijin semi-annually on the outstanding balance at the rate of 0.5625%. The note provides for semi-annual payments of interest only during the first four years, followed by semi-annual installments plus interest for the remaining three and one half year term. The scheduled principal payments for 2002 are $2.5 million. Teijin also received warrants in 1997 to purchase 158,000 shares of Southwall's common stock at $9 per share. These warrants were not exercised and expired on May 30, 2000. At March 31, 2002, the Company was not in compliance with certain of the financial covenants with Teijin pertaining to this promissory note. Southwall has received a waiver from Teijin and the Japanese bank of any defaults that may exist through and including September 30, 2003 arising out of its failure to comply with the financial covenants of the guarantee agreement relating to minimum quick ratio, tangible net worth and maximum debt/tangible net worth.

8

The waiver was conditioned on the Company's agreement to prepay $2.5 million of the debt in the event that it raises additional equity from the sale of common stock in a public offering or to prepay an amount equal to 10% of the proceeds from a sale of stock other than in a public offering. Accordingly, the Company has classified $5.0 million as long-term debt on the balance sheet at March 31, 2002. All payments due on the loan have been paid when due.

        During 1999, Southwall entered into a master equipment sale-leaseback agreement with a leasing company ("lessor"). Because the Company has an option to purchase the equipment at a price to be determined between Southwall and the lessor at the end of the lease period, the sale-leaseback agreements have been treated as a financing. One lease has a lease term of three years and the other lease has an initial lease term of two years with an option to extend it for an additional year. At March 31, 2002, the Company had a total of $3.3 million outstanding and due under these leases. The leased equipment and certain other production equipment owned by the Company collateralize the sale-leaseback agreements. The effective interest rate of both is approximately 13% per annum and the leases are repayable over the lease term commencing in May 2000. Additionally, Southwall had provided the lessor with an irrevocable standby letter of credit in the amount of $0.5 million to collateralize all of its obligations under these agreements. The lessor drew down the $0.5 million, which was classified as restricted cash at December 31, 2001, on January 2, 2002. $1.0 million of the amounts due from the Lessor was not funded, but will be released upon the Company satisfying certain financial conditions. The Company is in dispute with the lessor over interpretation of certain terms of the lease agreement and has withheld lease payments due since March 2001. The lessor has notified the Company that it is in default and the Company is in negotiations with the lessor to buy out the lease, reduced by the $1.0 million holdback not funded by the lessor. The Company has classified $3.3 million due under the leases as a current liability at March 31, 2002.

        On May 12, 1999, the Company entered into a loan agreement with a German bank that provides for borrowings up to euro 3.1 million ($2.9 million). 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 for the first five years, and will be revised to the prevailing rate at the end of the fifth year. The Company is current in all principal and interest payments due under the loan; the agreement contains various covenants with which the Company was in compliance at March 31, 2002. Of the borrowings outstanding of $2.3 million under this bank loan at March 31, 2002, $2.0 million was classified as noncurrent in the accompanying balance sheet.

9

        On May 28, 1999, the Company entered into a general loan agreement with a German bank. Under the terms of the loan agreement, funds are available in three tranches, and shall be used solely for the purpose of capital investment by the Company's German subsidiary. The agreement contains various covenants with which the Company was in compliance at March 31, 2002; the Company is current with respect to all principal and interest payments due under the loan agreement. The first tranche provides for borrowings of euro 2.5 million ($2.2 million) for a term of twenty years. The principal is repayable in euros 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 is adjusted to a current prevailing rate. Of the borrowings outstanding under this tranche of $2.2 million at March 31, 2002, $2.2 million is classified as noncurrent in the accompanying balance sheet. The second tranche provides for borrowings of euro 1.7 million ($1.5 million) for a term of seven years and the principal is repayable after one year in twelve equal, semi-annual payments. The loan bears fixed interest at 3.75% per annum for the period of seven years. At March 31, 2002, the amount due was $1.1 million, and $0.9 million is classified as a noncurrent liability. The third tranche, dated December 1, 1999, provides for borrowings of euro 2.121 million ($1.87 million) for a term of ten years, and the principal is repayable after one year, in thirty-six equal quarterly payments. The loan bears fixed interest of 7.15% per annum for the entire loan period of ten years. At March 31, 2002, the amount due was $1.8 million; of this amount, $1.6 million was classified as noncurrent.

        On August 14, 1999, the Company entered into a loan agreement with a German bank that provides for borrowings up to euro 1.7 million ($1.5 million). Under the terms of this agreement, the funds will be 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. 50% 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 agreement contains various covenants with which the Company was in compliance at March 31, 2002. The amount due under this bank loan at March 31, 2002 was $1.5 million, which was classified as noncurrent.

        On June 29, 2000, the Company entered into a loan agreement with a German bank that provides for borrowings up to euro 0.5 million ($0.481 million). Under the terms of this agreement, the funds will be used solely for the purpose of capital investment by the Company's German subsidiary. The principal balance is repayable in 12 quarterly payments beginning June 2001 and bears interest at a rate of 5.8% per annum. The interest is payable quarterly in euros. The agreement contains various covenants with which the Company was in compliance at March 31, 2002. The amount due under this bank loan was $0.3 million at March 31, 2002; of this amount, $0.2 million was classified as noncurrent.

        On July 10, 2000, the Company entered into a loan agreement with a German bank that provides for borrowings up to euros 0.511 million ($0.480 million). Under the terms of this agreement, the funds will be used solely for the purpose of capital investment by the Company's German subsidiary. The principal balance is repayable in 12 quarterly payments beginning June 2001 and bears interest at a rate of 7.10% per annum. The interest is payable quarterly in euros. The agreement contains various covenants with which the Company was in compliance at March 31, 2002. The amount due under this bank loan was $0.3 million; of this amount, $0.2 million was classified as noncurrent at March 31, 2002.

        On December 18, 2000, the Company entered into a loan agreement with a German bank that provides for borrowings up to euro 0.3 million ($0.2 million). Under the terms of this agreement, the funds will be used solely for the purpose of capital investment by the Company's German subsidiary. The principal balance is repayable in 9 quarterly payments beginning March 2002 and bears interest at a rate of 7.5% per annum. The interest is payable quarterly in euros. At March 31, 2002, the amount outstanding under this bank loan was $0.2 million; of this amount, $0.1 million was classified as noncurrent at March 31, 2002.

10

        On December 19, 2000, the Company entered into a loan agreement with a German bank that provides for borrowings up to euro 0.3 million ($0.2 million). Under the terms of this agreement, the funds will be used solely for the purpose of capital investment by the Company's German subsidiary. The principal balance is repayable in 12 quarterly payments beginning March 2002 and bears interest at a rate of 7.5% per annum. The interest is payable quarterly in euros. At March 31, 2002, the amount outstanding under this bank loan was $0.2 million; of this amount, $0.1 million was classified as noncurrent at March 31, 2002.

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

        On September 21, 2001, the Company entered into a note payable agreement with the manufacturer of the Company's production machinery, PM 7, located at the Company's Tempe facility, for the remaining balance of $1.0 million owed on the machine. The first installment on the note was paid on September 26, 2001 in the amount of $0.1 million. The remaining balance of the note is payable in 16 monthly installments of $0.1 million. The note bears interest at 8.0% per annum. At March 31, 2002, the amount outstanding under this note payable was $0.5 million; of this amount, $0.1 million was classified as noncurrent at March 31, 2002. Other term debt consists of capitalized leases related primarily to certain computer equipment used by the Company.

        Scheduled principal reductions of total debt and capital leases for the balance of 2002 and the four years following and thereafter, are as follows:

Year	Amount
2002-remaining	$	7,187
2003-annual		3,849
2004-annual		3,537
2005-annual		758
2006-annual		695
Thereafter		5,353
Total	$	21,379

        The Company incurred total interest expense of $0.5 million and $0.8 million in the first quarters of 2002 and 2001, respectively. Of these amounts, the Company capitalized nothing and $0.04 million in each of the first quarters of 2002 and 2001, respectively, as part of the costs related to the construction of new production machines and facilities.

Note 6—Government grant and investment allowances:

        The Company has an agreement to receive a grant award (the "Grant"), which was approved by the Saxony government in May 1999. As of March 31, 2002, the Company had received approximately euros 5.6 million ($4.7 million) 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, the Company received euros 1.1 million ($0.9 million) of government grants that have been recorded as an advance and are held as restricted cash until the Company earns the grant through future expenditures.

        Initially, the Grant was 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 was from March 15, 1999 to March 14, 2002.

(c)

The total investment should be at least euros 47.0 million ($39.2 million).

(d)

The project must create at least 143 permanent jobs and 7 apprenticeships by December 2003.

11

        However, on February 20, 2002, the Saxony government extended the date by which the Company must comply with the requirements to June 30, 2006. In the event that the Company fails to meet the above requirements, the Saxony government has the right to reclaim the Grant.

        In addition to the Grant, the Company has received and is further eligible to receive investment allowances from the Saxony government as partial reimbursement for the Company's capital investment of euro 47.0 million ($39.2 million) in its Dresden facility, subject to European Union regulatory approval. During the year 2000, the Company received euro 1.2 million ($1.0 million) in investment allowances from the Saxony government for capital expenditures made by the Company on its Dresden facility in 1999. The Company received an additional euro 2.5 million ($2.1 million) in investment allowances from the Saxony government in the year 2001 for capital expenditures made by the Company on its Dresden facility in 2000. The proceeds from these investment allowances were applied to reduce the capitalized construction cost of the Dresden facility by $1.0 million and $2.1 million, in 2000 and 2001, respectively. The Company has also applied for approximately euros 1.2 million ($1.0 million) in investment allowances in 2002. 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.

        In the event that the Company fails to meet the above requirements, the Saxony government has the right to reclaim the allowances.

        The investment grants and investment allowances, if any, that the Company is entitled to seek varies 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—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. The total net revenues for the automotive glass, electronic display, and architectural product lines were as follows:

		March 31, 2002		April 1, 2001
Automotive glass		$	7,003	$	8,007
Electronic display			7,925		6,724
Architectural			4,341		2,982
	Total net revenues	$	19,269	$	17,713

12

        The following is a summary of net revenues by geographic area (based on location to which product is shipped) for the first quarters of 2002 and 2001, respectively.

		March 31, 2002		April 1, 2001
United States		$	2,710	$	3,211
Japan			7,600		4,989
France			4,034		3,763
Pacific Rim			1,856		1,972
Rest of world			1,549		1,421
Germany			1,520		2,357
	Total net revenues	$	19,269	$	17,713

        Four customers accounted for net sales in the respective quarters as follows:

Customer		March 31, 2002		April 1, 2001
A		20.9	%	20.9	%
B		20.9	%	26.0	%
C		14.6	%	4.9	%
D		10.8	%	18.5	%
	Total	67.2	%	70.3	%

Note 8—Contingencies:

        The Company is a defendant in an action filed on April 5, 1996 entitled "Four Seasons Solar Products Corp vs. Black & Decker, Bostik, Inc. and Southwall Technologies Inc.", No. 5 CV1695 pending in the United States District Court for the Eastern District of New York. Plaintiff is a manufacturer of insulated glass units which incorporate our Heat Mirror film. Plaintiff alleges that a sealant provided by the co-defendant is defective, asserts causes of action for breach of contract, unfair competition, and fraudulent concealment, and seeks monetary damages of approximately $36 million for past and future replacement costs, loss of customer goodwill, and punitive damages against all defendants. The Company has filed a motion to dismiss. The Court has dismissed the unfair competition and fraudulent concealment claims against the Company. It still has under advisement the Company's motion to dismiss the breach of contract claim. The Company believes the claim to be without merit.

        The Company's German subsidiary was a defendant in a lawsuit filed by one of our suppliers on March 21, 2000 in a German court to seek payment of $0.9 million for engineering services rendered in connection with developing the initial plans for the Dresden facility. The Company issued letters of award to the plaintiff amounting to $0.3 million prior to terminating plaintiff's services for not meeting expectations. The plaintiff claimed fees for services rendered, including the costs of significant modifications and revisions requested by us calculated in accordance with the German Federal Schedule of Architects' fees. The plaintiff further alleged that the Company utilized plaintiff's planning work in further developing the plant. In December 2001, a judgment was reached by the German court, in favor of the plaintiff, for approximately $0.3 million. In February 2002, the plaintiff elected to accept the court's ruling in lieu of an appeal. The award for engineering services has been included in accrued liabilities at December 31, 2001 and March 31, 2002 as additional construction costs.

        In addition, the Company is involved in certain other legal actions arising in the ordinary course of business. The Company believes, however, that none of these actions, either individually or in the aggregate, will have a material adverse effect on the Company's business, its consolidated financial position, its results of operations, or its cashflows.

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Note 9—Subsequent events:

        On April 24, 2002, the Company signed a ten-year supply and distribution agreement with Globamatrix Holdings Pte. Ltd (previously known as GMX) that includes commitments by Globamatrix to purchase, and by Southwall to supply, minimum quantities of the Company's architectural film product. Subject to Southwall meeting volume and quality standards, the contract provides that Globamatrix will purchase an aggregate of approximately $75.0 million of Southwall film during the first five years of the agreement. At March 31, 2002, Globamatrix owned 422,119 restricted shares of the Company's common stock, equal to approximately 5% of the Company's outstanding common stock.

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

        The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and notes thereto appearing elsewhere in this report. This discussion and analysis contains forward-looking statements that involve risks and uncertainties, including those discussed below under "Risk Factors" and in the Company's Annual Report on Form 10-K. Actual results may differ materially from those projected. These forward-looking statements represent the Company's judgment as of the date of the filing of this Form 10-Q Report. We disclaim, however, any intent or obligation to update these forward-looking statements.

General

        We are a global developer, manufacturer and marketer of thin film coatings for the automotive glass, electronic display and architectural markets. We have developed a variety of products that control sunlight in automotive glass, reduce light reflection 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.

        From our founding in 1979 through the early 1990's, we developed and produced thin film coated substances primarily for residential and commercial building applications, and for military applications. In the early 1990's, we began to develop products for the automotive and electronic display markets. In 1996, we realized our first material revenue from the automotive and electronic display markets. In 2001, automotive glass products accounted for approximately 45% of our revenues, electronic display products accounted for approximately 36% of our revenues, and architectural products accounted for approximately 19% of our revenues. Revenues from international customers accounted for 78%, 85%, 87%, and 86% of our net revenues in 1999, 2000, 2001, and the first quarter of 2002, respectively.

Three Months Ended March 31, 2002 compared with Three Months Ended April 1, 2001

Net revenues.    Our net revenues increased $1.6 million, or 9.0%, from $17.7 million for the first quarter of 2001, to $19.3 million for the first quarter of 2002. Our sales to the automotive market decreased by $1.0 million, or 12.5%, from $8.0 million in the first quarter of 2001, to $7.0 million in the first quarter of 2002. The decline was due to lower sales volume as a result of a slowdown in sales by several european automobile manufacturers. Our sales to the electronic display market increased by $1.2 million, or 17.9%, from $6.7 million in the first quarter of 2001, to $7.9 million in the first quarter of 2002. The increase in sales was primarily the result of revenues from sales of our new plasma display film product. Our sales to the architectural market increased $1.4 million, or 46.7%, from $3.0 million in the first quarter of 2001, to $4.4 million in the first quarter of 2002. The increase was primarily attributable to additional available manufacturing capacity.

Cost of sales.    Cost of sales consists primarily of materials and subcontractor services, labor and manufacturing overhead. Cost of sales decreased $2.4 million, or 16.2%, from $14.8 million in the first quarter of 2001, to $12.4 million in the first quarter of 2002. Cost of sales decreased from 83.6% of net revenues in the first quarter of 2001, to 64.2% of net revenues for the same period in 2002. The higher costs in 2001 in dollars and as a percentage of revenues were primarily due to greater start-up costs in our Dresden operation. We also realized improved manufacturing yields in our Palo Alto, Tempe and Dresden facilities during the first quarter of 2002, compared to the first quarter of 2001. In addition, we also benefited in the first quarter of 2002, compared with the same period in 2001, from producing a greater portion of our products at our Dresden plant. The Dresden plant, which began production of significant volumes of commercial product during the first quarter of 2001, has lower manufacturing

15

costs as a result of lower payroll and operating expenses, as well as lower depreciation charges due to the grants provided for plant and equipment by the Saxony government.

Gross profit and gross margin.    Our gross profit increased $4.0 million, or 137.9%, from $2.9 million in the first quarter of 2001, to $6.9 million in the first quarter of 2002. Our gross margin improved from 16.4% in the first quarter of 2001, to 35.8% in the first quarter of 2002. The increase in gross profit and gross margin in 2002 was due to increased revenues from the Dresden plant with its lower cost base, and cost savings and yield improvements in our Palo Alto, Tempe and Dresden facilities.

Operating Expenses

Research and development.    Research and development spending increased $0.4 million, or 28.6%, from $1.4 million in the first quarter of 2001, to $1.8 million in the first quarter of 2002. Research and development expenses increased from 7.9% of net revenues in the first quarter of 2001, to 9.3% of net revenues in the first quarter of 2002. The increase in our research and development spending during the first quarter of 2002 was primarily attributable to the costs associated with the use of a production machine (PM1) that has been dedicated primarily to on-going research and development activities.

Selling, general and administrative.    Selling, general and administrative expenses consist primarily of corporate and administrative overhead, selling commissions, advertising costs and occupancy costs. These expenses increased $1.0 million, or 37.0%, from $2.7 million in the first quarter of 2001, to $3.7 million in the first quarter of 2002. Selling, general and administrative expenses, as a percentage of revenue, increased from 15.3% in the first quarter of 2001, to 19.4% in the first quarter of 2002. The higher expenses in the first quarter of 2002 were mainly the result of increased outside professional fees, and accrued costs associated with performance-based compensation as a result of our improved profitability.

Income (loss) from operations.    Income (loss) from operations increased from an operating loss of $1.2 million in the first quarter of 2001, to an operating profit of $1.3 million for the same period in 2002. The improvement was due to higher revenues, reduced start-up costs from our Dresden operations, and improved manufacturing yields, partially offset by increased outside professional fees, and accrued costs associated with performance-based compensation as a result of our improved profitability.

Interest expense, net.    Net interest expense decreased $0.3 million, or 37.5%, from $0.8 million in the first quarter of 2001, to $0.5 million in the first quarter of 2002. The reduction in interest expense was primarily attributable to lower interest rates and the reduction of our overall debt and line of credit by $6.5 million from $32.5 million at April 1, 2001, to $26.0 million at March 31, 2002.

Other income, net.    Other income, net includes interest income, rental income and foreign exchange transaction gains and losses. We recorded other income of $0.9 million in the first quarter of 2001, compared with $0.4 million in the first quarter of 2002. The reduction was primarily attributable to foreign currency fluctuations. Some of our transactions with foreign suppliers are denominated in foreign currencies, principally Japanese yen. As exchange rates fluctuate relative to the U.S. dollar, exchange gains and losses occur.

Income (loss) before provision for income taxes.    We recorded a pre-tax loss of $1.1 million in the first quarter of 2001, compared to a pre-tax profit of $1.2 million in the first quarter of 2002. Our improvement from a loss in 2001 to profitability in 2002 was due to higher revenue, reduced start-up costs from our Dresden operations, and improved manufacturing yields in our Palo Alto, Tempe and Dresden facilities, partially offset by costs attributable to an increase in performance based compensation as a result of our improved profitability, outside professional fees and a reduction in income derived from foreign currency fluctuations.

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Liquidity and Capital Resources

        Our cash increased by $2.5 million from $0.2 million at April 1, 2001, to $2.7 million at March 31, 2002. Cash from operating activities in the first quarter declined by $3.2 million, from $2.2 million generated during the first quarter of 2001, to $0.9 million used during the first quarter of 2002. The decline in cash from operating activities was primarily the result of an increase in accounts receivable and inventory, and a reduction in accounts payable, partially offset by net income in the first quarter of 2002, compared to a loss in the first quarter of 2001. We increased the cash used in investing activities by $1.3 million, to $0.4 million in the first quarter of 2002, from cash provided by investing activities of $0.9 million in the first quarter of 2001. The increase was primarily attributable to higher capital expenditures, offset by a reduction in restricted cash. We increased cash from financing activities by $3.6 million, to $1.0 million during the first quarter of 2002, from $2.6 million in cash used in financing activities during the first quarter of 2001. The increase was primarily attributable to additional borrowings on our line of credit, and cash received through the exercise of employee stock options during the first quarter of 2002. As a result of our compliance with various loan covenants, and obtaining a waiver from Teijin for the Sanwa debt, $13.8 million of long-term debt was classified as noncurrent at March 31, 2002. Accordingly, our working capital deficit decreased from $32.6 million at April 1, 2001 to $5.6 million at March 31, 2002. We reduced our total liabilities from $55.3 million at April 1, 2001 to $44.8 million at March 31, 2002, and stockholders' equity increased from $18.7 million at April 1, 2001 to $28.3 million at March 31, 2002.

        We entered into an agreement with the Saxony government in May 1999 under which we receive investment grants and investment allowances. Through March 31, 2002, we had received $4.7 million of the grants and accounted for these grants by applying the proceeds received to reduce the cost of the fixed assets at our Dresden manufacturing facility. During the year 2000, we also received $1.0 million in investment allowances, which are reimbursements for capital expenditures, from the Saxony government and those proceeds were also applied to reduce the cost of the fixed assets at our Dresden manufacturing facility. We received an additional $2.1 million in investment allowances from the Saxony government in the year 2001, and we applied for and expect to receive approximately $1.0 million in investment allowances in 2002, although we cannot assure you that we will receive these amounts. Those funds have been or will also be applied to reduce the cost of the fixed assets at our Dresden manufacturing facility. Additionally, we have received $0.8 million of Saxony investment grants that have been recorded as an advance until we earn the grant through future capital expenditures. The total annual amount of investment grants and investment allowances that we are entitled to seek varies from year to year based upon the amount of our capital expenditures that meet certain requirements of the Saxony government. Generally, we are not eligible to seek total investment grants and allowances for any year in excess of 33% of our eligible capital expenditures for that year. We expect to continue to finance a portion of our capital expenditures in Dresden with additional grants from the Saxony government and additional loans from German banks, some of which may be guaranteed by the Saxony government. However, we cannot guarantee that we will be eligible for or receive additional grants in the future from the Saxony government.

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Borrowing arrangements:

        The following table (with dollars in thousands) sets forth the material terms of our indebtedness at March 31, 2002:

Description			Rate		Balance at March 31, 2002		Remaining Due in 2002
Line of credit			(1	)	$	4,606		(1	)
Term debt:
	Japanese bank loan guaranteed by Teijin		3.16	%	$	7,500	$	2,500
	German bank loan dated May 12, 1999		6.13	%(2)		2,321		225
	German bank loan dated May 28, 1999		7.10	%(3)		2,196		—
	German bank loan dated May 28, 1999		3.75	%		1,129		188
	German bank loan dated December 1, 1999		7.15	%		1,761		155
	German bank loan due June 30, 2009		5.75	%		1,482		—
	German bank loan dated June 29, 2000		5.75	%		299		113
	German bank loan dated July 10, 2000		7.10	%		299		112
	German bank loan dated December 18, 2000		7.50	%		208		57
	German bank loan dated December 19, 2000		7.50	%		190		52
	Note Payable dated September 21, 2001		8.00	%		520		450
	Other equipment financings					207		68
		Total term debt				18,112		3,920
Capital leases:
	Sales-leaseback dated July 19, 1999		13.00	%		2,321		2,321
	Sales-leaseback dated October 19, 1999		13.00	%		946		946
		Total capital leases				3,267		3,267
Total term debt and capital leases						21,379		7,187
		Less current portion				7,579
		Term debt, non current			$	13,800

(1)

This line of credit expires in June 2003. Under the line, we can borrow an amount equal to 80% of eligible accounts receivable. We pay a finance fee per month equal to 0.88% of the average daily balance of the amount of accounts receivable against which we have borrowed. We are required to repay the lender amounts borrowed when we receive payments of the accounts receivable.

(2)

Interest rate will be reset to the then prevailing market rate in 2004.

(3)

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

        At March 31, 2002, we were not in compliance with certain of the covenants of the guarantee by Teijin of the Japanese bank loan. Southwall has received a waiver from Teijin and the Japanese bank of any defaults that may exist for any measurement period through and including September 30, 2003 arising out of our failure to comply with the minimum quick ratio, tangible net worth and maximum debt/tangible net worth covenants. The Teijin waiver is conditioned on our agreement to prepay $2.5 million of the debt in the event we raise additional equity from the sale of our common stock in a public offering or to repay an amount equal to 10% of the proceeds from a sale of stock other than in a public offering. Accordingly, the non-current portion of the amount outstanding under this loan of $5.0 million has been classified as a long-term liability at March 31, 2002.

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        We are in default under a master sale-leaseback agreement with respect to two of our production machines. We have withheld lease payments in connection with a dispute with the leasing company. As a result, we have classified all $3.3 million outstanding under those agreements, net of the $1.0 million holdback, as short-term capital lease liabilities, as of March 31, 2002.

        Under the original terms of our grant agreement with the Saxony government, we were required to meet investment and hiring targets by March 31, 2002. If we failed to meet those targets, the Saxony government was permitted to require us to repay all grants and investment allowances from the Saxony government previously received by us. In February 2002, the Saxony government extended the date by which we must comply with these targets to June 2006.

Capital expenditures

        We anticipate spending approximately $7.0 million in capital expenditures in 2002, approximately $4.0 million of which will consist of progress payments for PM 10 in Dresden, approximately $1.5 million to replace our current enterprise resource planning system, and approximately $1.5 million to maintain and upgrade our production facilities in Palo Alto and Tempe. We spent approximately $0.8 million in capital expenditures during the first quarter of 2002.

        We believe that our existing liquidity sources, including our expected cash flows from operations, our existing cash reserves and existing credit facilities, will satisfy our cash requirements for the next twelve months. We may need to raise additional funds if our estimates change, or prove inaccurate, in order for us to respond to unforeseen technological, marketing or other problems, or to take advantage of unanticipated opportunities.

Alternative financing sources

        We are in discussions with potential lenders regarding the establishment of new credit facilities to meet our projected working capital and capital expenditure needs in 2002. Additionally, we have filed a registration statement with the Securities and Exchange Commission for the proposed sale of 3.5 million shares of common stock in a firm commitment public offering currently expected to close in the third quarter of 2002. We cannot provide any assurance that alternative sources of financing will be available at all or on terms acceptable to us. Our ability to raise additional funds may be adversely affected by a number of factors relating to us, as well as factors beyond our control.

Item 3—Quantitative and Qualitative Disclosures about Market Risk

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

        FINANCING RISK.    Our exposure to market rate risk for changes in interest rates relates primarily to our term loans, specifically our loan from Sanwa Bank, which is tied to the London Interbank Offered Rate ("LIBOR"), and our line of credit which bears a finance fee equal to 0.88% per month of the average daily balance of the accounts receivable against which we have borrowed. Our Dresden subsidiary also has several fixed-rate term loans that are denominated and repayable in euros. Fluctuations in interest rates may adversely affect our expected interest expense. The effect of a 10% fluctuation in the interest rate on our loan from Sanwa Bank would have an effect of less than $75,000 or interest expense for the quarter ended March 31, 2002. The effect of interest rate fluctuations during the first quarter of 2002 was not material.

        INVESTMENT RISK.    We invest our excess cash in money market accounts and, by practice, limit the amount of exposure to any one institution. Investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely affected due to a rise in interest rates, while floating rate securities may produce less

19

income than expected if interest rates fall. The effect of a 10% fluctuation in the interest rate of any floating rate securities would have an adverse effect of less than $100,000.

        FOREIGN CURRENCY RISK.    International revenues (defined as sales to customers located outside of the United States) accounted for approximately 86% of our total sales in the first quarter of 2002. Of this amount, approximately 15% were denominated in euros relating to sales from our Dresden operation. The other 85% of our international sales were denominated in US dollars. We expect that approximately 10% to 15% of our total sales in 2002 will be denominated in euros. In addition, certain transactions with foreign suppliers are denominated in foreign currencies (principally Japanese Yen). The effect of a 10% fluctuation in the euro exchange rate would have had an effect of $0.3 million on net revenues for the three months ended March 31, 2002 and the effect of a 10% fluctuation in the Yen exchange rate would have an effect of approximately $0.1 million. Our international business operations are subject to risks typical of an international business, including, but not limited to differing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions, and foreign exchange rate volatility.

RISK FACTORS

Financial Risks

Our negative working capital position, leverage and historical performance may prevent us from obtaining additional loans and equity.

        We have a working capital deficit, significant debt and substantial ongoing debt service obligations. These and other factors related to our business during recent years, including the restatement in 2000 of our financial statements for prior periods, operating losses in 1998, 1999 and 2000, our failure to comply with covenants in our financing agreements and suspension of trading of our common stock on Nasdaq in 2000, may make it difficult for us to raise funds through the sale of equity in the public markets, or to secure additional borrowings on favorable terms or at all. We intend to seek additional borrowings and difficulties in borrowing money or selling equity in the public market could have a material adverse effect on our operations, planned capital expenditures, ability to comply with the terms of government grants and future growth.

Covenants or defaults under our credit agreements may prevent us from borrowing or force us to curtail our operations.

        As of March 31, 2002, we had total outstanding obligations under our credit agreements of $21.6 million. Our inability to make timely payments of interest or principal under these facilities could materially adversely affect our ability to borrow money under existing credit facilities, to secure additional borrowings or to function as a going concern. Our current credit facilities contain financial covenants that will require us to meet certain financial performance targets and operating covenants that limit our discretion with respect to business matters. Among other things, these covenants restrict our ability to borrow additional money, create liens or other encumbrances, and make certain payments including dividends and capital expenditures. Many of these loans contain provisions that permit the lender to declare the loans immediately due if there is a material adverse change in our business. These credit facilities also contain events of default that could require us to pay off indebtedness before its maturity. The restrictions imposed by these credit facilities or the failure of lenders to advance funds under these facilities could force us to curtail our operations or have a material adverse effect on our liquidity.

Our ability to borrow is limited by the nature of our equipment and some of our accounts receivable.

        Our equipment is custom designed for a special purpose. In addition, a large portion of our accounts receivable are from foreign sales, which are often more difficult to collect than domestic

20

accounts receivable. As a result of the nature of our equipment and accounts receivable, lenders will generally allow us to borrow less against these items as collateral than they would for other types of equipment or domestic accounts receivable.

If we default under our secured credit facilities and financing arrangements, the lenders could foreclose on the assets we have pledged to them requiring us to significantly curtail or even cease our operations.

        In connection with our current borrowing facilities and financing arrangements, we have granted security interests in and liens on substantially all of our assets, including our production machines and our Dresden facility, to secure the loans. Our obligations under our secured credit facilities contain cross-default and cross-acceleration provisions and provisions that allow the lenders to declare the loans immediately due if there is a material adverse change in our business. If we default under the credit facilities or financing arrangements the lenders could declare all of the funds borrowed thereunder, together with all accrued interest, immediately due and payable. If we are unable to repay such indebtedness, the lenders could foreclose on the pledged assets. If the lenders foreclose on our assets, we would be forced to significantly curtail or even cease our operations.

Our first quarter revenues are generally lower than revenues in the following quarters due to seasonal demand for our products.

        Our revenue from the electronic display and architectural markets are affected by seasonality patterns with the highest sales occurring during the second, third and fourth fiscal quarters. 21% of our total sales during the past three fiscal years have occurred during the first quarter, with 25%, 29% and 25% of our total sales occurring during the second, third and fourth quarters, respectively. Demand in the electronic display market is generally at its highest before the holiday season, in our second and third quarters, when production of electronic goods is at its highest. Demand for architectural glass generally increases when the weather is warmer in northern climates and construction activity increases. Lower demand for our products during the first quarter generally result in lower sales and operating results during that quarter. We believe this seasonality in the demand for our products affected our results for the first quarter of 2002 and will continue in the future.

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

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

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

•

fluctuating customer demand, which is influenced by a number of factors, including market acceptance of our products and the products of our customers and end-users, changes in product mix, and the timing, cancellation or delay of customer orders and shipments;



•

the timing of shipments of our products by us and by independent subcontractors to our customers;



•

manufacturing and operational difficulties that may arise due to, among other things, quality control, capacity utilization of our production machines, unscheduled equipment maintenance, and the hiring and training of additional staff;



•

our ability to introduce new products on a timely basis; and

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•

competition, including the introduction or announcement of new products by competitors, the adoption of competitive technologies by our customers, the addition of new production capacity by competitors and competitive pressures on prices of our products and those of our customers.

We expect to be subject to increased foreign currency risk in our international operations.

        In 2002, we expect that 10% to 15% of our revenues will be denominated in euros, primarily related to sales from our Dresden operation, including sales to one of our largest customers, a European automotive glass manufacturer. As a result, our operating results and cash flows may vary based on fluctuations in the exchange rate of the euro against the dollar. In addition, other customers may also make payments in foreign currencies. Certain transactions with foreign suppliers are also denominated in foreign currencies; primarily yen, rather than dollars.

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

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Operational Risks

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

        Our ten largest customers accounted for approximately 69%, 85%, 85%, and 85% of net product sales in 1999, 2000, 2001, and the first quarter of 2002, respectively. We have contracts extending past 2002 with only two of these customers. We expect to continue to derive a significant portion of our net product sales from this relatively small number of customers. Accordingly, the loss of a large customer could materially hurt our business, and the deferral or loss of anticipated orders from a large customer or a small number of customers could materially reduce our revenue and operating results in any period.

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

        Our future success depends upon our ability to introduce new products, improve existing products and processes to keep pace with technological and market developments, and to address the increasingly sophisticated and demanding needs of our customers, especially in the electronic display and automotive markets. Technological changes, process improvements, or operating improvements that could adversely affect us include:

•

the development of competing technologies to our anti-reflective and silver reflector films for liquid crystal displays in the flat panel display industry;



•

changes in the way coatings are applied to alternative substrates such as tetra acetate cellulose, or TAC;



•

the development of new technologies that improve the manufacturing efficiency of our competitors;



•

the development of new materials that improve the performance of products that could compete with our products; and



•

improvements in the alternatives to the sputtering technology we use to produce our products, such as plasma enhanced chemical vapor deposition, or PECVD.

        Our research and development efforts may not be successful in developing products in the time, or with the characteristics, necessary to meet customer needs. If we do not adapt to technological changes, or process or operating improvements, our competitive position, operations and prospects would be materially adversely affected.

Failure to meet the capacity demands of our customers may result in a loss of business or contractual penalties.

        Our long-term competitive position will depend to a significant extent on our manufacturing capacity. The failure to have sufficient capacity, to fully utilize capacity when needed or to successfully integrate and manage additional capacity in the future could adversely affect our relationships with customers and cause customers to buy similar products from our competitors if we are unable to meet their needs. For example, we believe that we lost substantial potential architectural products sales in 2001 because we did not have the capacity to manufacture the required amounts of products. Also, our failure to produce required amounts of products under some of our contracts will result in price reductions on future sales under such contracts, or penalties under which we would be required to reimburse the customer for the full cost of any delayed product deliveries, which would reduce our gross margins.

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We depend on our OEM customers for the sale of our products.

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

We rely upon our OEM customers for information relating to the development of new products so that we are able to meet end-user demands.

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

We depend on a distributor for the sale of our after-market products.

        We primarily use one independent distributor to sell our after-market products. We have a distribution agreement with Globamatrix Holdings Pte. Ltd., or Globamatrix, under which we granted an exclusive worldwide license to distribute our after-market applied film in the automotive and architectural glass markets. Failure of Globamatrix to achieve significant sales of products incorporating our products and fluctuations in the timing and volume of such sales could be harmful to our business. We believe that the success of our after-market products will continue to depend upon this distributor.

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

        The market for each of our products is intensely competitive and we expect competition to increase in the future. Competitors vary in size and in the scope and breadth of the products they offer. We compete both with companies using technology similar to ours and companies using other technologies or developing improved technologies. Many of our current and potential competitors have significantly greater financial, technical, marketing and other resources than we have. In addition, many of our competitors have well-established relationships with our current and potential customers and have extensive knowledge of our industry. In fact, some of our current and expected future customers are capable of creating products that compete with our products.

We may not be able to expand our manufacturing capacity efficiently which could lead to lower gross margins.

        We have ordered for our Dresden manufacturing facility a new machine (PM 10), which we anticipate will begin commercial production in the first quarter of 2003. In addition, we anticipate that PM 7 in our Tempe facility will begin commercial production during the third quarter of 2002. During the processes of bringing PM 7 and PM 10 up to commercial production levels, we expect to have decreased manufacturing yields and higher costs, which will lower our gross margins.

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

        We manufacture all of our products using materials procured from third-party suppliers. We do not have long-term contracts with our third-party suppliers, except for an agreement, with a third-party supplier, to purchase Indium metal through the second quarter of 2003. Certain of these materials are obtained from a limited number of sources. Delays or reductions in product shipments could damage our relationships with customers. Further, a significant increase in the price of one or more of the materials used in our products could have a material adverse effect on our cost of goods sold and operating results.

We are dependent on a few qualified subcontractors to add properties to some of our products.

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

We are dependent on key suppliers of production machines, which may prevent us from delivering an acceptable product on a timely basis and limit our capacity for revenue growth.

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

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

        Our business depends in part on sales by manufacturers of products that include electronic displays. The markets for electronic display products are highly cyclical and have experienced periods of oversupply resulting in significantly reduced demand for our products. For example, due to the deteriorating economic environment, sales by flat panel cathode ray tube manufacturers decreased in 2001, contributing to our electronic display product revenues declining by 38% from the previous year. If the flat panel display and other electronic display markets in which we sell our products do not recover or experience further slowdowns in the future, it could cause revenues from our electronic display products to decrease.

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Labor strikes in Germany could disrupt the production schedule of automotive products that incorporate our films, which could have a material adverse affect on our revenues.

        On May 6, 2002, German metal workers represented by IG Metal began rolling strikes against a number of companies in Germany, including DaimlerChrysler, in connection with negotiations over a new labor contract. Our customers in the automotive glass market sell glass incorporating our products to German automotive manufacturers including DaimlerChrysler. A prolonged strike by IG Metal or other metal workers or a significant delay in DaimlerChrysler's production schedule or the production schedule of others as a result of labor matters could disrupt the demand for our products, which would adversely affect our revenues.

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

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

•

delays in collecting accounts receivable;



•

higher manufacturing costs;



•

additional warranty and service expenses; and



•

reduced or cancelled orders.

        For example, in 1998, our operating results were materially adversely affected by quality problems associated with the electronic display film produced by us for one of our largest customers.

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

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

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

        In addition to our dependence on our technical personnel, our success also depends on our continuing ability to attract and retain other highly skilled employees. We depend on the continued services of our senior management, particularly Thomas G. Hood, our President and Chief Executive Officer, Robert R. Freeman our Chief Financial Officer, Dr. Sicco W. T. Westra, our Senior Vice President, Engineering and Chief Technology Officer, Wolfgang Heinze, our plant manager in Dresden, and other personnel. We do not have employment contracts with any of our officers or key person life insurance covering any officer or employee. Our officers have technical and industry knowledge that

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cannot easily be replaced. Competition for similar personnel in our industry where we operate is intense. We have experienced, and we expect to continue to experience, difficulty in hiring and retaining highly skilled employees with appropriate qualifications. If we do not succeed in attracting or retaining the necessary personnel, our business could be adversely affected.

If we are unable to adequately protect our intellectual property, third parties may be able to duplicate our products or develop functionally equivalent or superior technology.

        Our success depends in large part upon our proprietary technology. We rely on our know-how, as well as a combination of patent, trademark and trade secret protection, to establish and protect our intellectual property rights. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. Policing unauthorized use of our products is difficult. Our means of protecting our proprietary rights may not be adequate. In addition, the laws of some foreign countries do not protect our proprietary rights to as great an extent as do the laws of the United States. During 2001, one of our U.S. patents relating to our architectural products expired. In the next three years, two more U.S. patents will expire. Expiration of these patents or our failure to adequately protect our proprietary rights may allow third parties to duplicate our products or develop functionally equivalent or superior technology. In addition, our competitors may independently develop similar technology or design around our proprietary intellectual property.

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

        We have expanded our operations and hired additional personnel to address international markets for the thin film coatings industry. International revenues amounted to approximately 78%, 85%, 87% and 86% of our net revenues during 1999, 2000, 2001, and the first quarter of 2002, respectively. The distance between Palo Alto and Dresden creates logistical and communications challenges. In addition, to achieve acceptance in international markets, our products must be modified to handle a variety of factors specific to each international market as well as local regulations. We may also be subject to a number of other risks associated with international business activities. These risks include:

•

unexpected changes in and the burdens and costs of compliance with a variety of foreign laws and regulatory requirements;



•

potentially adverse tax consequences; and



•

global economic turbulence and political instability.

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

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

We rely on our domestic sales representatives, without whom our architectural product sales may suffer.

        We use independent sales representatives to promote our Heat Mirror products to architects in the United States. If some or all of our sales representatives experience financial difficulties, or otherwise become unable or unwilling to promote our products, our business could be harmed. These sales

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representatives could reduce or discontinue promotion of our products. They may not devote the resources necessary to provide effective marketing support to us. In addition, we depend upon the continued viability and financial resources of these representatives, many of which are small organizations with limited working capital. These representatives, in turn, depend substantially on general economic conditions and other factors affecting the markets for the products they promote. We believe that our success in this market will continue to depend upon these sales representatives.

We may face extensive damages or litigation costs if our insurance carriers seek to have us indemnify them for settlements of past and outstanding litigation.

        Several of our insurance carriers have reserved their rights to seek indemnification from us for substantial amounts paid to plaintiffs by the insurance carriers as part of settlements of litigation relating to our architectural products. Also, our insurance carrier in the Hurd settlement has advised us that it intends to seek reimbursement for settlement and defense costs. Any claims, with or without merit, could require significant time and attention of key members of our management and result in costly litigation.

Recent accounting pronouncements

        In May 2002, the FASB issued SFAS 145, "Rescission of FAS Nos. 4, 44, and 64, Amendment of FAS 13, and Technical Corrections." Among other things, SFAS 145 rescinds various pronouncements regarding early extinguishment of debt and allows extraordinary accounting treatment for early extinguishment only when the provisions of Accounting principles Board Opinion No. 30, "Reporting the Results of Operations? Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" are met. SFAS 145 provisions regarding early extinguishment of debt are generally effective for fiscal years beginning after May 15, 2002. Management does not believe that the adoption of this statement will have a material impact on our consolidated financial statements.

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PART II OTHER INFORMATION

Item 1—Legal Proceedings and Other Matters

        Litigation filed against the Company was described under Item 3 in the Company's Form 10-K filed on April 1, 2002. No other material developments have occurred with respect to the litigation described therein.

        In addition, the Company is involved in certain other legal actions arising in the ordinary course of business. The Company believes, however, that none of these actions, either individually or in the aggregate, will have a material adverse effect on the Company's business, its consolidated financial position, its results of operations, or its operating cashflows.

Item 2—Changes in Securities

        None

Item 3—Defaults upon Senior Securities

        Not applicable

Item 4—Submission of Matters to a Vote of Stockholders

        No matters were submitted to a vote of security holders during the quarter ended March 31, 2002.

Item 5—Other Information

        Not applicable

Item 6—Exhibits and Reports on Form 8-K

(a)

Exhibits

Exhibit Number	Item
10.116	Distribution agreement between Globamatrix Holdings Pte. Ltd. and the Company, dated as of January 1, 2002.
10.117	Teijin Waiver letter.
10.118	Sanwa Waiver letter.

(b)

Reports on Form 8-K

None

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SIGNATURES

        Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

        Dated: May 17, 2002

Southwall Technologies Inc.
By:	/s/ Thomas G. Hood Thomas G. Hood President and Chief Executive Officer
By:	/s/ Robert R. Freeman Robert R. Freeman Sr. Vice President and Chief Financial Officer

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SOUTHWALL TECHNOLOGIES INC. INDEX
PART I FINANCIAL INFORMATION

Item 1-Financial Statements

SOUTHWALL TECHNOLOGIES INC. CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands, except per share data) (Unaudited)
SOUTHWALL TECHNOLOGIES INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data) (Unaudited)
SOUTHWALL TECHNOLOGIES INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (Unaudited) Increase (Decrease) in cash
SOUTHWALL TECHNOLOGIES INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (in thousands) (Unaudited)

Item 2—Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3—Quantitative and Qualitative Disclosures about Market Risk

RISK FACTORS
PART II OTHER INFORMATION

Item 1—Legal Proceedings and Other Matters
Item 2—Changes in Securities
Item 3—Defaults upon Senior Securities
Item 4—Submission of Matters to a Vote of Stockholders
Item 5—Other Information
Item 6—Exhibits and Reports on Form 8-K

SIGNATURES

EX-10.116

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Exhibit 10.116

SOUTHWALL TECHNOLOGIES INC.

DISTRIBUTION AGREEMENT

        This Agreement is made and entered into in the City of Palo Alto (California, U.S.A.) as of January 1, 2002 by and between Globamatrix Holdings Pte. Ltd. ("LICENSEE") and Southwall Technologies Inc. ("SOUTHWALL").

WITNESSETH

        WHEREAS, SOUTHWALL produces and manufactures the Film (as defined below), which is used in the manufacturing of the Product (as defined below);

        WHEREAS, SOUTHWALL is the owner of the patents registered in the US Patent and Trademark Office, which are further described in Exhibit 1 hereto, as well as of the trademarks described in Exhibit 1 hereto, including, without limitation, Solis®;

        WHEREAS, LICENSEE wishes to obtain the exclusive right to distribute SOUTHWALL's Product worldwide on the terms and subject to the conditions set forth herein;

        WHEREAS, LICENSEE has requested and SOUTHWALL has agreed to provide LICENSEE with certain minimum amounts of Product each year during the term of this Agreement;

        WHEREAS, the parties acknowledge that such a commitment by SOUTHWALL places a substantial production risk on SOUTHWALL and requires SOUTHWALL to make a substantial investment (in dollars and lost opportunities) to dedicate a material portion of its production capacity and other resources to the manufacture of such Product on behalf of LICENSEE, and, accordingly, that LICENSEE's option herein to perform its obligations by either purchasing specified levels of Product hereunder or making payment therefor is in consideration of SOUTHWALL's making available such production capacity and other resources; and

        WHEREAS, the parties acknowledge that the commitment by LICENSEE to purchase minimum amounts of Product requires LICENSEE and its appointed master franchisees and distributors to invest and employ substantial resources (human and capital) to market and build increased demand to consume the Product in the Territory and places LICENSEE at substantial risk (in dollars, loss of goodwill and damages), that SOUTHWALL's commitment to perform its obligations and in particular make timely deliveries of good quality Product to the specified levels hereunder or making payment therefor is in consideration of LICENSEE's reciprocal commitment to purchase agreed minimum amounts of Product;

        NOW, THEREFORE, in consideration of the mutual covenants set forth below, the parties hereto agree as follows:

1.

DEFINITIONS:

        For purpose of this Agreement:

(a)

Film. The term "Film" shall mean the XIR® transparent insulation solar control films as listed on Exhibit 2 attached hereto. SOUTHWALL may from time to time add or delete component types from Exhibit 2 by giving LICENSEE not less than ninety (90) days' written notice prior to such change, provided that SOUTHWALL shall add to Exhibit 2 new component types which may from time to time replace or improve the current types (in which event, such new component types shall be deemed "Film").



(b)

Market. The term "Market" shall mean the architectural market (including, without limitation, residential and commercial window, door, skylight and curtainwall markets) and the automotive and transportation markets.

(c)

Patents. The term "Patents" shall mean those patents described in Exhibit 1 hereto and any renewals or replacement thereof.



(d)

Person. The term "Person" shall mean an individual, a corporation, an association, a joint-stock company, a business trust or other similar organization, a partnership, a limited liability company, a limited liability partnership, a joint venture, a trust, an unincorporated organization or a government or any agency, instrumentality or political subdivision thereof.



(e)

Product. The term "Product" shall mean finished solar control window film that incorporates Film and that is designed and manufactured to be retrofit onto glass using preapplied adhesive(s) as listed on Exhibit 2 attached hereto. SOUTHWALL may from time to time add or delete product types from Exhibit 2 by giving LICENSEE not less than ninety (90) days' written notice prior to such change, provided that SOUTHWALL shall add to Exhibit 2 new product types which may from time to time replace or improve the current types (in which event, such new product types shall be deemed "Product").



(f)

Proprietary Information. The term "Proprietary Information" shall mean any financial, operational, technical and other information relating to the past, present and future businesses and affairs of SOUTHWALL or LICENSEE, all trade secrets and all other information of a business, financial, marketing, technical or other nature pertaining to SOUTHWALL or LICENSEE, including, without limitation, all information, technology, concepts, equipment, techniques, know-how, processes, ideas or inventions (whether or not patented or patentable) embodied or related to the Film, the Product, or the manufacturing of the same, and including, without limitation, information of others that SOUTHWALL or LICENSEE, as the case may be, has agreed to keep confidential, in any case whether such information is provided in written, oral, graphic, pictorial or recorded form or stored on computer discs, hard drives, magnetic tape or digital or any other electronic medium (including, without limitation, the Proprietary Technical Materials). Notwithstanding the foregoing, Proprietary Information shall not include any information that (a) was in the public domain at the time it was disclosed or (b) enters the public domain other than by breach of this Agreement.



(g)

Proprietary Technical Materials. The term "Proprietary Technical Materials" shall mean all writings, documentation, manuals, instructions, correspondence, software or other data relating to the Proprietary Information (other than such that are prepared for internal purposes of SOUTHWALL or LICENSEE, as the case may be).



(h)

Purchase Order Confirmation. The term "Purchase Order Confirmation" shall mean the standard order acknowledgment form used by SOUTHWALL and set forth in Exhibit 3 hereto.



(i)

Territory. The term "Territory" shall mean worldwide.



(j)

Trademarks. The term "Trademarks" shall include those trademarks registered in the US Patent and Trademark Office and described in Exhibit 1 hereto and any renewals or replacements thereof.

2.

GRANT OF RIGHTS

(a)

Subject to the terms of this Agreement, SOUTHWALL hereby appoints LICENSEE as an exclusive distributor of the Product for the Territory and hereby grants to LICENSEE a nonexclusive license to use SOUTHWALL's Proprietary Technical Materials, Patents and Trademarks solely to distribute the Product as set forth herein. For such purpose, SOUTHWALL undertakes to use commercially reasonable efforts to furnish to LICENSEE available, up-to-date Proprietary Technical Materials related to the sales, promotion and installation of the Product.

2

(b)

LICENSEE agrees to consider granting SOUTHWALL rights to use LICENSEE's marketing material and know how (including, without limitation, trademarks, advertisements, techniques and the like). The parties will use reasonable efforts to agree in good faith as to fair consideration for any such rights at any time SOUTHWALL makes a request in writing therefor.



(c)

SOUTHWALL reserves the right to sell in the Territory all of its products, with the exception of Product, including, without limitation, directly to end user customers through other authorized manufacturers or distributors, original equipment manufacturers, representatives, or other distribution or licensing channels.



(d)

LICENSEE agrees that it will not sell in the Territory any products that exhibit similar light transmission to solar transmission ratios to Products which are directly competitive with Products during the term of this Agreement.

3.

EXCLUSIVITY OF RIGHTS

The right of exclusivity granted to LICENSEE by SOUTHWALL in Section 2 above shall not in any way impair the scope, validity or enforceability of the licenses for products other than Product previously granted by SOUTHWALL to its licensees listed in Exhibit 4 during the term of the license agreements with such licensees.

SOUTHWALL will not sell Product directly into the Territory for use in the Market. SOUTHWALL will not supply Film to any other Person that SOUTHWALL knows intends to use such Film for production of product directly competitive in the Market with Product.

4.

SUBCONTRACT RIGHTS

The parties hereto agree that LICENSEE may establish, at LICENSEE's sole cost and expense, as many distributors/dealers within the Territory as are reasonably necessary in the judgment of the LICENSEE to fully serve the Territory, subject to and in compliance with the terms of this Agreement. LICENSEE shall cause each such distributor and dealer to offer no guarantees or warranties with respect to any Product or Film beyond those made by SOUTHWALL hereunder.

5.

MARKETS FOR THE PRODUCT

Subject to the terms and conditions of this Agreement, the Product may be sold by LICENSEE to customers for use only in the Market. Notwithstanding anything to the contrary contained herein, LICENSEE shall not distribute or supply Film to any original equipment manufacturers without the prior written approval of SOUTHWALL.

6.

OBLIGATIONS OF LICENSEE

In order to develop the full sales potential of the Product, LICENSEE agrees that it will properly perform at its sole cost and expense the following duties:

(a)

Payment. LICENSEE will pay SOUTHWALL the purchase price for the Film and Product in accordance with this Agreement, without any deduction, claim, set off, counterclaim or reduction whatsoever. All payments made by LICENSEE to SOUTHWALL under this Agreement shall be in United States dollars. SOUTHWALL shall have no obligation to ship Film or Product to LICENSEE at any time when LICENSEE is delinquent in payment for Film or Product previously shipped.



(b)

Quality. LICENSEE's application of the Film and Product shall be at a minimum in strict accordance with industry standards and procedures set forth in Exhibit 5.



(c)

Inspection. SOUTHWALL shall have the right on reasonable prior written notice and during normal business hours to visit and inspect LICENSEE's places of business and any and all

3

places where the Film or Product is installed or stored to verify satisfaction by LICENSEE of its obligations under this Agreement, including, without limitation, the distribution and application of the Film and Product in accordance with industry standards and procedures.

(d)

Designation of Film and Product. LICENSEE will at all times designate Film and Product as a product of SOUTHWALL. LICENSEE shall mark the Film and Product with SOUTHWALL's Patent and Trademark markings in accordance with guidelines furnished by SOUTHWALL from time to time.



(e)

Marketing. LICENSEE agrees to:



1.

Use its best efforts as commercially reasonable to promote, distribute and market the Film and Product throughout the Territory, based on the Business Plan described below.



2.

Publish in sufficient quantities and update marketing and sales support materials as necessary from time to time during the term of this Agreement. LICENSEE shall promptly provide SOUTHWALL with copies of all marketing and sales support materials prepared for or by LICENSEE.



3.

Employ and train sales personnel with technical expertise and knowledge of the Film and Product to sell and install the Film and Product.



4.

Participate in all reasonable exhibitions and promotion opportunities in the Territory.




(f)

Business Plan. LICENSEE will present a business plan which addresses the Territory, including all serviced and certain non-serviced countries agreed upon by the parties, to SOUTHWALL by February 15^th of each year. Representatives of SOUTHWALL and LICENSEE shall hold a meeting at a mutually agreed upon location by March 15^th of each year to discuss the business plan.



(g)

Representation and Warranties. LICENSEE will not (orally or in writing) extend or offer any warranty nor make any representations concerning the Film or Product to any Person except for the warranty described in Section 11 hereto.



(h)

Recalls. LICENSEE will maintain for the purpose of potential recall procedures, accurate and detailed records of all sales of Film and Product, and provide copies of all such records promptly following a written request therefor by SOUTHWALL. Such records will include at least: (i) the date of sale, (ii) customer name, address, telephone and fax numbers, and purchase order number, (iii) lot number, (iv) LICENSEE product number, and (v) quantities sold.

In the event that SOUTHWALL recalls any or all of the Film or Product due to defects, revisions, upgrades or other reason, LICENSEE shall provide reasonable assistance in such recall if requested by SOUTHWALL.

(i)

Inventory. LICENSEE will at all times maintain an inventory of the Product sufficient to meet commercially reasonable anticipated orders. LICENSEE shall provide adequate storage facilities for Film and Product conforming to SOUTHWALL's commercially reasonable requirements.



(j)

General Conduct. LICENSEE shall at all times conduct its business in a businesslike manner and shall not engage in any deceptive, misleading, illegal or unethical business practice or any practice that will reflect unfavorably on SOUTHWALL, the Product, or the Film.



(k)

Collection of Fees. LICENSEE shall have full responsibility for the invoicing and collection of fees from its customers, and shall bear all expenses incurred in connection therewith. The

4

inability, delay or difficulty in LICENSEE's collecting of fees from its customers shall have no effect on its payment obligations to SOUTHWALL hereunder.

(l)

Credit Restrictions. LICENSEE may in its sole discretion provide SOUTHWALL with adequate information to provide SOUTHWALL with reasonable assurance of payment, which may include audited financial statements of LICENSEE, bank references, trade references and other similar information.

7.

OBLIGATIONS OF SOUTHWALL

To assist LICENSEE in the rapid and successful commercialization of the Product, SOUTHWALL agrees to provide the following support and assistance to LICENSEE at SOUTHWALL's expense except where noted below. All communications and materials described in this Section 7 will be in English.

(a)

Licensee Assistance. SOUTHWALL shall provide reasonable marketing and product management assistance, including making available a SOUTHWALL employee (the "Product Manager/Engineer") knowledgeable in the performance and applications of the Product. The Product Manager/Engineer will be 100% dedicated to the business activities of the LICENSEE. The Product Manager/Engineer will be located in Tempe, Arizona (or other suitable location mutually agreed to by SOUTHWALL and LICENSEE). If the Product Manager/Engineer's employment with SOUTHWALL terminates or is terminated (for any reason), SOUTHWALL shall use commercially reasonable efforts to replace the Product Manager/Engineer promptly with a person of reasonably equivalent or superior abilities and credentials.



(b)

General Conduct. SOUTHWALL shall at all times conduct its business in a businesslike manner and shall not engage in any deceptive, misleading, illegal or unethical business practice or any practice that will reflect unfavorably on LICENSEE, the Product, or the Film.



(c)

Quality Control. SOUTHWALL shall use commercially reasonable efforts to supply the Film and Product in accordance with specifications in Exhibit 5 attached hereto. In case of disagreement on the level of quality of the Film or Product supplied by SOUTHWALL, LICENSEE will make sample laminates containing the questionable film after which both parties will review the samples to determine the Film or Product status. In cases where it is agreed by the parties that the Film or Product does not comply with agreed upon specifications, SOUTHWALL agrees to replace all unacceptable Film or Product at no additional cost inclusive of freight to LICENSEE. If the parties fail to agree on the Film or Product status, SOUTHWALL shall continue to supply LICENSEE with Film and/or Product, while Section 17(i) of this Agreement shall govern the resolution of the disputed quantities of Film and/or Product. A good faith disagreement between the parties pursuant to the immediately preceding sentence shall not be deemed a default under this Agreement or give rise to any right by either party to terminate, or suspend performance, under this Agreement.



(d)

Patent Infringement Indemnity. SOUTHWALL shall hold LICENSEE harmless from damages, settlements, attorneys' fees and expenses resulting from infringement by the Film or Product of any patent issued as of the date of this Agreement, or subsequent replacement Film and Product under Section 1(a) and 1(e) respectively, provided LICENSEE promptly notifies SOUTHWALL of any and all threats, claims and proceedings related thereto and SOUTHWALL is given reasonable assistance by LICENSEE and the opportunity to assume sole control over the defense and all negotiations for a settlement or compromise. SOUTHWALL will not be responsible for any settlement it does not approve in writing. THE FOREGOING IS SUBJECT TO SECTION 16 AND IN LIEU OF ANY WARRANTIES OF NONINFRINGEMENT, WHICH ARE HEREBY DISCLAIMED. The foregoing obligation

5

of SOUTHWALL does not apply with respect to Film or Product (i) not supplied by SOUTHWALL, (ii) modified after shipment by SOUTHWALL, if the alleged infringement relates to such modification, (iii) combined with other products, processes or materials where the alleged infringement relates to such combination or (iv) if LICENSEE continues allegedly infringing activity after becoming aware of such alleged infringement. LICENSEE will indemnify and hold harmless SOUTHWALL and its officers, directors, agents and employees from all damages, settlements, attorneys' fees and expenses related to a claim of infringement or misappropriation excluded from SOUTHWALL's indemnity obligation by this section.

(e)

Returns. SOUTHWALL shall use commercially reasonable efforts to process any return materials from LICENSEE as promptly as reasonably practicable and in accordance with established claim procedures for Film and Product as described in Exhibit 6.

8.

MINIMUM PURCHASE OF PRODUCT

(a)

LICENSEE shall purchase Product and SOUTHWALL shall supply Product, in each case subject to the terms and conditions of this Agreement. LICENSEE shall purchase, and SOUTHWALL shall supply (to the extent it receives purchase orders in accordance herewith), at least US $11.50 million of Product in calendar year 2002, at least US $13.25 million of Product in calendar year 2003, and at least US $15.25 million of Product in calendar year 2004. The minimum amount of Product that LICENSEE is obligated to purchase and SOUTHWALL is obligated to supply (to the extent it receives purchase orders in accordance herewith) in each year under this Agreement shall be referred to herein as the "Annual Amount." For each of the calendar years 2005 through 2011, inclusive, the Annual Amount shall be 110% of the Annual Amount for the immediately preceding year.

(b)

On or before February 28, 2002, LICENSEE will deliver to SOUTHWALL a blanket purchase order for Product that will cover the six (6) quarter period, beginning with the quarter ended March 31, 2002. The orders reflected in such blanket purchase order and each other purchase order delivered hereunder shall be consistent with the applicable Annual Amount, Maximum Amount (as defined below) and other requirements of this Section 8. The blanket purchase order will (i) give specific quantities of Product to be shipped to LICENSEE for each quarter during such period and (ii) with respect to the first quarter of such period, stipulate monthly quantities, product types and specifications of Product to be produced. Not later than 60 days prior to the end of each quarter, LICENSEE shall provide SOUTHWALL with (i) instructions as to the monthly quantities, product types and specifications of Product to be produced for the immediately following quarter and (ii) a blanket purchase order for the quarter immediately following the last quarter then covered by a purchase order. In no event shall the quantity of Product ordered by LICENSEE for any month exceed 12% of the blanket purchase order for the rolling 12-month period immediately following such month. Within 10 business days of receipt of each purchase order, SOUTHWALL will deliver to LICENSEE a Purchase Order Confirmation. Each purchase order shall represent a binding minimum order for the LICENSEE and SOUTHWALL following the delivery of the applicable Purchase Order Confirmation. As an alternative method of performing its obligations hereunder, LICENSEE may order and accept less than the Annual Amount for calendar year 2002, 2003 or 2004, provided that LICENSEE shall reimburse SOUTHWALL within 30 days of year end (not as a penalty, liquidated damages or the like but as compensation to SOUTHWALL for the costs associated with production of Product and to ensure SOUTHWALL a steady source of income so that it might continue such production) for the difference in the purchase price of all Product ordered and accepted for such calendar year and the Annual Amount. If LICENSEE orders at least the Annual Amount for any of calendar year 2002, 2003 or 2004 and SOUTHWALL fails to deliver the Annual Amount for such year, then SOUTHWALL shall reimburse LICENSEE within 30 days of the applicable year end (not as a penalty,

6

liquidated damages or the like but as compensation to LICENSEE for the costs associated with marketing Product) for the difference between the Annual Amount for such calendar year and the total purchase price of all Product delivered for such calendar year, provided that SOUTHWALL shall not be required to make delivery of any Product for which it pays such reimbursement.

Any increase in quantities of Product or a change in specifications requires a 90 day lead time and shall be consistent with all of the terms and conditions of this Agreement, including, without limitation, this Section 8, and no such changes shall be binding on SOUTHWALL unless SOUTHWALL accepts in writing such changes.

(c)

In addition to the Product, LICENSEE may also purchase Film from SOUTHWALL pursuant to the terms of this Agreement. Subject to Section 8(d), for each dollar of Film that LICENSEE orders each year, an equivalent dollar amount of Product shall be purchased over and above the Annual Amount for such year.



(d)

LICENSEE may order an additional quantity of Product and Film (including Film ordered pursuant to Section 8(c)) in excess of the applicable Annual Amount for any year, provided that such additional quantity for any year plus the applicable Annual Amount shall not exceed the "Maximum Amount." The Maximum Amount shall be US $12.65 million for calendar 2002, US $15.23 million for calendar 2003, and US $18.25 million for calendar 2004. The Maximum Amount for each calendar year 2005 through 2011, inclusive, shall be 120% of the Annual Amount for that year. If LICENSEE wishes to purchase an amount for any year after 2003 that is more than the Annual Amount, LICENSEE shall so notify SOUTHWALL in writing during the first fiscal quarter of the year prior to the year such additional purchases are to take effect.



(e)

Beginning on April 1, 2002, if SOUTHWALL fails to provide the quantity of Product ordered by LICENSEE to be delivered in any given month pursuant to this Section 8 within seven (7) days after the end of such month, SOUTHWALL will issue a credit memo (in the form attached hereto as Exhibit 7) in an amount calculated as described herein and based on the difference in total square footage of each product type (as listed in Exhibit 2) ordered pursuant to the applicable purchase order for such month and the total square footage of each product type actually shipped to LICENSEE within one week of the end of the month (the "Deficiency"). If the Deficiency for each product type for any month is (i) less than or equal to 5% of the total square footage ordered with respect to such month, LICENSEE shall not be entitled to any credit memo for any discount on the purchase price or other adjustment; (ii) greater than 5% but less than 15% of the total square footage ordered with respect to such month, LICENSEE shall receive a credit memo for a discount calculated based on the following formula:

Credit note = 0.15 × P × (.95A-B)

Wherein:	A = Amount ordered (square feet)
	B = Amount shipped (square feet)
	P = Price of product type

7

For example, if amount ordered for a product type is 100,000 square feet and the amount shipped is 90,000 square feet for that product type, and the price of the product type is $2.05, then the credit note to be issued shall be $1,537.50; or (iii) greater than or equal to 15% of the total square footage ordered with respect to such month, LICENSEE shall receive a credit memo for a discount calculated based on the following formula:

Credit note = (0.15 x P x 0.1A) + (0.25 x P x (0.85A-B))

For example, if the amount ordered for a product type is 100,000 square feet and the amount shipped is 75,000 square feet for that product type, and the price of the product type is $2.05, then the credit note to be issued shall be $6,662.50.

LICENSEE shall not be entitled to any discount or credit memo with respect to Product not ordered in accordance with the terms of this Section 8.

9.

PRICE

From the date hereof through December 31, 2004, the purchase price for Film and Product sold hereunder shall be as set forth on SOUTHWALL's Price Schedule attached hereto as Exhibit 8, provided, that, after December 31, 2004, SOUTHWALL may change the prices to be charged for Film and Product sold hereunder at any time, subject to the other provisions of this Section 9, by amending its published Price Schedule and giving LICENSEE sixty (60) days' prior written notice thereof (which notice may be given prior to December 31, 2004). The maximum allowable price increase per year will be based only on actual increases in SOUTHWALL's cost to manufacture Film or Product, which will include the costs of: raw materials (polyester film and metal targets); electricity, gases and other consumables; packaging materials; labor rates; converting costs charged directly to SOUTHWALL by outside vendor(s); and any or all increases allowed by inflation as measured by the Consumer's Price Index (CPI). Increases in the foregoing costs may be used singularly or in any combination to justify new prices, but in no event will the total annual increase exceed the lower of the total of all such factors and 8% of the applicable purchase price from the previous year. Both SOUTHWALL and LICENSEE agree to negotiate in good faith, in the event of circumstances beyond the control of SOUTHWALL, a mutually satisfactory price adjustment notwithstanding the restrictions set forth in this Section 9. If the parties cannot in good faith agree upon such a price adjustment in the event of circumstances beyond SOUTHWALL's control, the chief executive officers of each of the parties shall meet promptly and in person to attempt to resolve the matter; if they are unable to agree upon an appropriate price adjustment within twenty (20) days of the commencement of such discussions, the matter shall be governed by section 17(i).

10.

TERMS AND CONDITIONS OF SALE

This Agreement and all sales of Film or Product hereunder by SOUTHWALL to LICENSEE shall be subject to SOUTHWALL's Terms and Conditions, a copy of which is attached hereto as Exhibit 9 except in the case of payment terms wherein SOUTHWALL hereby agrees that it shall not be changed for the duration of this Agreement. For the avoidance of doubt, payment terms are open account terms (subject to the Maximum Amount), net sixty (60) days from date of shipment. Such Terms and Conditions shall govern in the event of any inconsistencies with any other document (except the body of this Agreement which shall govern in the event of any inconsistencies) received by LICENSEE or SOUTHWALL prior or after receipt of the Purchase Order Confirmation.

11.

PRODUCT WARRANTY

The sole warranty provided by SOUTHWALL to LICENSEE with respect to the Product, Film, Patents, Trademarks, SOUTHWALL technology and intellectual property, or otherwise is contained in the Limited Warranty attached hereto as Exhibit 10. The disclaimers and limitations

8

set forth in SOUTHWALL's Terms and Conditions attached hereto as Exhibit 9 and the Limited Warranty attached hereto as Exhibit 10 are incorporated herein by reference. If laws from time to time in effect in the Territory imply warranties which cannot be excluded or can only be excluded to a limited extent, this Agreement shall be construed to incorporate such exclusions or limitations.

THE WARRANTIES IN THIS SECTION 11 ARE IN LIEU OF ALL OTHER WARRANTIES, EXPRESS OR IMPLIED, INCLUDING, WITHOUT LIMITATION, ANY WARRANTY OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE.

12.

TERM AND TERMINATION

(a)

Term. The Term of this Agreement shall commence on January 1, 2002 and expire on December 31, 2011. Following the termination of this Agreement, the parties shall negotiate in good faith to renew this Agreement, subject to such reasonable changes in the pricing and minimum purchase requirements as the parties shall mutually agree to.

(b)

Termination by LICENSEE. LICENSEE may terminate this Agreement by giving not less than thirty (30) days' prior written notice to SOUTHWALL solely upon occurrence of any of the following events:

i.

SOUTHWALL ceases to function as a going concern;

ii.

SOUTHWALL (a) makes a general assignment for the benefit of creditors or transfers all or a substantial portion of its assets to a receiver, (b) has become insolvent, (c) commences a voluntarily case under the bankruptcy laws of any jurisdiction or (d) a proceeding or case shall be commenced without the application or consent of SOUTHWALL and such proceeding shall continue undismissed for a period of 45 days;

iii.

SOUTHWALL fails to manufacture Product substantially in accordance with the prescribed specifications set forth in Exhibit 5 attached hereto, provided that such failure continues for one hundred twenty (120) days after the earlier of (A) SOUTHWALL receives written notice from LICENSEE of such failure and (B) SOUTHWALL becomes aware of such failure (in which event, SOUTHWALL shall promptly notify LICENSEE in writing of such failure); or

iv.

SOUTHWALL fails to observe, keep or perform any material covenant, term or condition herein, provided that such failure continues for one hundred twenty (120) days after SOUTHWALL receives written notice from LICENSEE of such failure.

(c)

Termination by SOUTHWALL. SOUTHWALL may terminate this Agreement, by giving not less than thirty (30) days' prior written notice to LICENSEE, upon occurrence of any of the following events:

i.

LICENSEE ceases to function as a going concern;

ii.

LICENSEE (a) makes a general assignment for the benefit of creditors or transfers all or a substantial portion of its assets to a receiver, (b) has become insolvent, or (c) goes into bankruptcy (whether voluntarily or involuntarily);

iii.

LICENSEE fails to apply and sell Film or Product substantially in accordance with the industry standards, provided that such failure continues for one hundred twenty (120) days after the earlier of (A) LICENSEE receiving written notice from SOUTHWALL of such failure and (B) LICENSEE becoming aware of such failure (in which event, LICENSEE shall promptly notify SOUTHWALL in writing);

iv.

LICENSEE fails to observe, keep or perform any material covenant, term or condition herein, provided that such failure continues for one hundred twenty (120) days after LICENSEE receives written notice from SOUTHWALL of such failure.

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13.

EFFECT OF TERMINATION OR EXPIRATION

(a)

Upon any termination or expiration of this Agreement: (i) each party shall promptly return to the other all Proprietary Technical Materials and technical data previously provided to it and shall certify that all copies thereof have been destroyed, (ii) LICENSEE shall immediately cease further marketing and distribution of the Film or Product, except to fulfill sales for which it was contractually committed prior to such termination, (iii) each party shall immediately pay to the other all sums which remain due and owing under this Agreement, (iv) all licenses and rights of each party hereunder shall terminate and each party shall immediately cease using the other's name, trademarks and trade names, (v) all obligations as to confidentiality and all restrictions imposed on either party by any warranty, remedy, liability limits or disclaimers in this Agreement, along with the Terms and Conditions shall survive the termination or expiration of this Agreement, in accordance with their terms, and (vi) each party shall provide to the other a certificate of an executive officer of it certifying that it has complied with all of the requirements of this Section 13(a).

(b)

Upon termination of this Agreement by SOUTHWALL, LICENSEE must, if so instructed by SOUTHWALL, promptly return all unsold Film and Product to SOUTHWALL for credit, provided such unsold Film and Product is returned within thirty (30) days of receipt of written notice from SOUTHWALL and is in the same condition as that in which it was delivered to LICENSEE, as determined in the sole, commercially reasonable judgment of SOUTHWALL's quality assurance department. LICENSEE shall return such unsold Film and Product freight prepaid. If SOUTHWALL does not request LICENSEE to return Film or Product, all payments for such unreturned Film or Product shall become immediately due and payable to SOUTHWALL.

(c)

Upon termination of this Agreement by LICENSEE, LICENSEE may at LICENSEE's option return all unsold Film and Product to SOUTHWALL for credit, provided such unsold Film and Product is returned within thirty (30) days of termination and is in the same condition as that in which it was delivered to LICENSEE, as determined in the sole, commercially reasonable judgment of SOUTHWALL's quality assurance department. LICENSEE shall return such unsold Film and Product freight prepaid. In case LICENSEE does not choose to return the unsold Film and Product within such 30 day period, all payments for such unreturned Film and Product shall become immediately due and payable to SOUTHWALL.

(d)

The following provisions shall survive termination of this Agreement: 1, 6(a), 10, 11, 12, 13, 14, 15, 16 and 17.

14.

TRADEMARKS; MARKINGS

(a)

Ownership Rights. LICENSEE hereby admits and recognizes SOUTHWALL's exclusive ownership of its Trademarks, Patents, trade names, trade secrets, service marks, business names, product names, logos, know how and copyrights applicable thereto (in each case, whether or not registered in the Territory) and the value of such marks and names worldwide, and LICENSEE acknowledges that it has no right, title or interest in any of the foregoing. LICENSEE shall have the right to indicate that it is an authorized distributor of SOUTHWALL, but SOUTHWALL does not grant to the LICENSEE any right, title or interest in SOUTHWALL'S Trademarks or trade names or any other property except for the right to use such Trademarks and trade names as described Section 2. LICENSEE will not alter, deface, remove, cover-up or mutilate in any manner whatsoever the label, Trademark, serial or model number, brand or name affixed to the Film or Product except with SOUTHWALL's prior written approval.

10

(b)

Use of Trademarks. The license granted in Section 2 with respect to the Trademarks, Patents and Proprietary Technical Materials is limited to the period in which SOUTHWALL uses such materials. LICENSEE shall be entitled to use, under the same terms and conditions as provided for under this Agreement, any and all such Trademarks and trade names which shall be used in the future by SOUTHWALL which replace the Trademarks and trade names. LICENSEE shall cease the use of any SOUTHWALL Trademark or trade name within ninety (90) days of written notice that SOUTHWALL has in good faith discontinued use of such Trademark or trade name. LICENSEE shall not adopt, use or register any of SOUTHWALL's trade names, Trademarks, service marks, business names, product names or logos, nor use any word or symbol or combination that is identical or similar to any such marks during the term of this Agreement or thereafter without SOUTHWALL's prior written consent.



(c)

No Additional Rights. Except as expressly set forth in Section 2, no licenses are granted or implied by this Agreement with respect to any Trademarks, Patents, trade names, trade secrets, service marks, business names, product names, logos, know how and copyrights applicable thereto or other property rights owned or controlled by SOUTHWALL or under which SOUTHWALL has rights.

15.

PROPRIETARY INFORMATION; PROPRIETARY TECHNICAL MATERIALS

All Proprietary Information and Proprietary Technical Materials provided by or attributable to SOUTHWALL are the property of and are proprietary to SOUTHWALL. All Proprietary Information and Proprietary Technical Materials provided by or attributable to LICENSEE are the property of and are proprietary to LICENSEE. Each party shall use the Proprietary Information and Proprietary Technical Materials of the other party only as expressly allowed in this Agreement. Each party shall maintain and protect the confidentiality of the Proprietary Information and Proprietary Technical Materials of the other party and keep such Proprietary Information and Proprietary Technical Materials within its possession or under its control sufficient to prevent any activity with respect thereto that is not specifically authorized by this Agreement. Except as set forth herein, neither party shall copy or reproduce, or transfer, assign, sublicense, loan, disclose or otherwise make available any or all Proprietary Information or Proprietary Technical Materials of the other party to any Person without the prior written consent of owner party to the specific action to be taken. Any and all Proprietary Technical Materials which SOUTHWALL may furnish shall be in LICENSEE's possession pursuant only to the license granted LICENSEE under Section 2 of this Agreement.

16.

LIMITATION OF REMEDIES AND DAMAGES

WITH RESPECT TO ANY SUBJECT MATTER OF THIS AGREEMENT OR ANY ATTACHMENT, PRODUCT ORDER, SCHEDULE OR ANY TERMS AND CONDITIONS RELATED THERETO, IN NO EVENT SHALL SOUTHWALL BE LIABLE TO LICENSEE OR ANY OTHER PARTY FOR ANY TERMINATION DAMAGES (INCLUDING, WITHOUT LIMITATION, LABOR CLAIMS AND LOSS OF PROFITS, INVESTMENTS OR GOOD WILL), INDEMNITY FOR CLIENTELE OR ANY OTHER DAMAGES OF ANY KIND, INCLUDING BUT NOT LIMITED TO ANY INDIRECT, INCIDENTAL, CONSEQUENTIAL OR SPECIAL DAMAGES, EVEN IF SOUTHWALL HAS BEEN ADVISED OF THE POSSIBILITY OF SUCH DAMAGES, AND LICENSEE HEREBY WAIVES ALL SUCH CLAIMS.

17.

GENERAL

(a)

Independent Contractor. Each party will act as an independent contractor under the terms of this Agreement and not as an agent or legal representative of the other party for any purpose. Neither party will in any way represent or imply that it is acting on behalf of the other party.

11

Neither party nor any subcontractors of such party shall have the right or authority to assume or create any obligation of any kind, express or implied, on behalf of one party to the other party's customers or to any other Person.

(b)

Product Changes. SOUTHWALL reserves the right, subject to prior consultation and discussion with LICENSEE, to make design modifications in the Product and Film at any time but shall not be obligated to implement such modifications in Product or Film that has previously been delivered. SOUTHWALL undertakes to give reasonable notice to LICENSEE of such design modifications, their characteristics and positive and negative consequences.



(c)

Notices. All notices, requests, consents and other communications required or permitted under this Agreement shall be in writing and shall be mailed by registered or certified mail, return receipts requested, postage prepaid, or transmitted by telegram, telex or facsimile transmission if confirmed by such mailing, to LICENSEE and SOUTHWALL at their respective addresses set forth on the signature page hereto. All notices, consents and other communications will be deemed effective when actually received. Either party may change its address by written notice to the other.



(d)

Assignment. Neither party shall have authority to and shall not assign, transfer or sublicense this Agreement or any license, right or obligation hereunder without the prior written consent of the other, except for an assignment or transfer in connection merger, consolidation or other acquisition of such assigning or transferring party.



(e)

No Waiver. The failure by either party to enforce at any time any of the provisions of this Agreement, or to exercise any election or option provided herein, shall in no way be construed as a waiver of such provisions or option, nor in any way be construed to affect the validity of this Agreement or any part thereof, or the right of either party thereafter to enforce each and every such provision on a future occasion.



(f)

No Other Warranty or Representation. Both parties hereby acknowledge that they have not entered into this Agreement in reliance upon any warranty or representation by any Person except for the warranties or representations specifically set forth herein.



(g)

Compliance with Laws. Each party hereby agrees and represents that it will, at all times during the term of this Agreement, comply in all material respects with all applicable laws, statutes, treaties and regulations of the United States (including, but not limited to, the Foreign Corrupt Practices Act and antiboycott regulations) and any other country or jurisdiction with respect to the subject matter of this Agreement.

Notwithstanding anything in this Agreement to the contrary, if at any time either party determines that the continuation of this Agreement shall constitute a violation of any statute, treaty, or regulation of the United States of America or of any other country or jurisdiction and such violation would reasonably be expected to have an adverse effect on the party seeking to terminate, this Agreement shall terminate immediately upon written notice by the party seeking to terminate to the other party setting forth such violation, unless the party receiving such notice is able to cure such violation promptly. If the sale, delivery or export of the Film or Products under this Agreement shall constitute a violation of any statute, treaty, or regulation of the United States of America or of any other country or jurisdiction, than the sale, delivery and export of such item shall terminate immediately.

(h)

Export Control. LICENSEE at its sole expense shall obtain any necessary licenses, customs clearances, and/or exemptions with respect to the export from the United States of the Film and Product, shall deal with all other formalities and documentation requirements and shall keep SOUTHWALL informed of all local requirements relating to the Film and Product. In the event this Agreement is terminated for any reason or there is a failure to renew the

12

Agreement, LICENSEE agrees to transfer to SOUTHWALL, or any Person designated by SOUTHWALL, all licenses, clearances or certificates necessary to export the Film or Product.

(i)

Governing Law and Arbitration. This Agreement shall be governed by and construed under the laws of the State of California (U.S.A.).

Disputes arising out of, in connection with, or relating to this Agreement that are not settled by mutual agreement shall be resolved as follows. The complaining party shall give the other party a written notice containing a concise description of the dispute to be resolved and the terms of the complaining party's proposal for a reasonable settlement thereof. Within thirty (30) days after receipt of such notice and proposed settlement from the complaining party, the other party shall send to the complaining party a notice proposing a settlement which such other party considers more reasonable, or else shall be deemed to have accepted the complaining party's settlement proposal. Within forty-five (45) days after receipt of such response the complaining party shall either accept the settlement proposal of the other party or shall refer the matter to arbitration. The arbitration shall be conducted in Palo Alto, California in accordance with the International Arbitration Rules of the American Arbitration Association. The parties agree that given the scope of the Territory, it is appropriate for each party to have the right to take depositions (including video depositions) and such deposition testimonies shall be admissible in any arbitration. Further, the parties agree to co-operate with the scheduling and any proceeding related to obtaining orders authorizing the depositions and the appointment of appropriate court reporters. Judgment upon the award so rendered by any arbitration in accordance herewith may be entered in courts of the County of Santa Clara (California, U.S.A.). Each party expressly waives the right to submitting any such claim to any other court to which it might be entitled.

(j)

Taxes. The fees and payments listed in this Agreement are exclusive of taxes, and if SOUTHWALL is required to pay any export or import duties or sales, use, value-added, privilege, excise, property or other taxes based on the transactions contemplated by this Agreement or the LICENSEE's or a customer's use of the Film or Product (whether United States or foreign, federal, state or local), then such duties or taxes shall be billed to and paid by the LICENSEE, except for taxes based on the net income of SOUTHWALL, which shall be the responsibility of SOUTHWALL. The LICENSEE shall indemnify and hold SOUTHWALL harmless from any and all encumbrance, fine, penalty, interest or other expense which SOUTHWALL may incur as a result of the failure of the LICENSEE to pay amounts in respect of taxes which the LICENSEE is required to pay under this Agreement.



(k)

International Conventions on the Sale of Goods. Except as otherwise set forth in this Agreement, the parties agree and acknowledge that international conventions, treaties or agreements on terms and conditions relating to the sale of goods, such as, but not limited to, the "United Nations Convention on Contracts for the International Sales of Goods" and the "Uniform Law of the International Sales of Goods" shall not apply to this Agreement or the transactions under this Agreement.



(l)

Headings. The section headings to this Agreement do not form a part of it, but are for convenience only and shall not limit or affect the meaning of the paragraphs.



(m)

Language. This Agreement has been entered into in the English language, which shall be the controlling language hereof for all purposes, and all documents exchanged hereunder shall be provided in English. All references to dollars or prices herein shall be deemed to refer to United States dollars.



(n)

Force Majeure. The parties hereto shall be excused from the performance of their obligations hereunder if such performance is delayed by causes beyond their reasonable control, including,

13

but not limited to acts of God, war, riot, epidemics, fire, flood, insurrection, acts of civil or military authorities, failure of transportation or communications, failure of equipment, interruptions in deliveries of raw materials, or acts and/or failures to act of third parties who have contractual or other business relationships with the parties hereto or whose acts and failures to act may affect the ability of the parties to perform their respective obligations hereunder. Such performance shall only be excused for a period equal to the duration of the cause of the delay in performance, and if such delay shall exceed sixty (60) days, the non-delaying party shall have the right to terminate this Agreement forthwith, with neither party being liable therefor. Notwithstanding the foregoing, the parties shall remain liable for all obligations accrued by them prior to such termination. Nothing contained in this Section shall excuse the LICENSEE from paying SOUTHWALL all amounts due to SOUTHWALL when due. If foreign exchange controls prevent payment to SOUTHWALL, the LICENSEE at the request of SOUTHWALL shall open a separate bank account in the Territory and shall make payments to such account; provided, however, the making of such payments shall not require SOUTHWALL to continue to make shipments pursuant to this Agreement.

(o)

Severability. In the event that any provision of this Agreement (other than a provision which goes to the essence of the consideration for this Agreement) is declared invalid, unenforceable or void to any extent by a court of competent jurisdiction, such provision shall be modified, if possible, by reducing its duration and scope to allow enforcement of the maximum permissible duration and scope. In any event, such declaration shall not affect the remaining provisions and this Agreement shall be enforced as modified, or if no modification is enforceable, as if such invalid clause had not been included, provided that, the economic benefits conferred by this Agreement to both parties remains substantially unimpaired.



(p)

Successors. This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and permitted assigns.



(q)

Entire Agreement. This Agreement, including all exhibits and schedules hereto, constitutes the entire agreement and understanding between the parties concerning the subject matter hereof and supersedes all prior agreements, negotiations and understandings of the parties with respect hereto (whether written or oral), including, without limitation, that certain Solar Control Film Distribution Agreement between the parties dated March 14, 1997 (the "Solar Control Agreement"), that certain XIR Laminated Film Manufacturing and Distribution Agreement between the parties dated November 17, 1997, as amended (the "XIR Agreement"), and the Letter of Agreement between the parties dated January 15, 2002 (the "LOA"). The Solar Control Agreement, the XIR Agreement and the LOA are hereby terminated in full and of no further force or effect. No representation, promise, modification or amendment shall be binding upon either party unless in writing and signed on behalf of such party by a duly authorized representative. Although LICENSEE may use its standard purchase order form to give any other notice provided for hereunder, said order or notice will be governed by the terms and conditions of this Agreement, and any term or condition set forth in any such standard form which is inconsistent with or in addition to the terms and conditions of this Agreement shall have no force or effect.

[The remainder of this page is left blank intentionally.]

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        IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first set forth above.

SOUTHWALL TECHNOLOGIES INC. 1029 Corporation Way Palo Alto, CA 94303 U.S.A. Facsimile No.: 650-962-0182		GLOBAMATRIX HOLDINGS PTE. LTD. 3 Science Park Drive 02-16, Singapore 118223 Facsimile No.: 65-67747377
By:		By:
	Name: Thomas G. Hood Title: President and CEO		Name: Andrew Kwan Title: Director

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Exhibit 10.116

SOUTHWALL TECHNOLOGIES INC. DISTRIBUTION AGREEMENT

EX-10.117

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EXHIBIT 10.117

[ COMPANY LETTERHEAD ]

May 9, 2002

Southwall Technologies Inc.
1029 Corporation Way
Palo Alto, CA 94303

ATTN: Thomas G. Hood
President and Chief Executive Officer

Dear Mr. Hood:

This letter is written with references to the Guarantee Agreement dated as of May 6, 1997, between Southwall Technologies, Inc. ("STI") and Teijin Limited ("Teijin") as amended in August 1999 by Memorandum between STI and Teijin (such Guarantee, as amended, the "Guarantee Agreement").

STI has advised Teijin that, as of December 31, 2001 and March 31, 2002, it was not in compliance with the Minimum Quick Ratio, Tangible Net Worth Amount and Maximum Debt/Tangible Net Worth of the financial covenants in Article 4-1(1) of the Guarantee Agreement. STI has requested that Teijin waive STI's non-compliance through September 30, 2003, including, without limitation, the measurement periods ending on December 31, 2001 and March 31, 2002.

Subject to the conditions set forth below, this will confirm that Teijin hereby waives any defaults under Article 5.1 of the Guarantee Agreement that may exist through and including September 30, 2003, arising out of STI's failure to comply with the financial covenants of the Minimum Quick Ratio, Tangible Net Worth Amount and Maximum Debt Tangible Net Worth in Article 4-(1) of the Guarantee Agreement.

This waiver does not apply to any period after September 30, 2003, after which Teijin shall be entitled to enforce its rights under the Guarantee Agreement with respect to STI's non-compliance with one or more of such covenants for the any measurement period starting after September 30, 2003. This waiver is solely and exclusively for the purpose of the Guarantee Agreement and without prejudice to any other rights that Teijin has or may have against STI.

In addition, this waiver is conditioned on STI's agreement that, 1) in the event that is issues new capital to third parties in a public offering of its equity securities at any time prior to September 30, 2003, STI shall apply $2.5 million of the proceeds of the offering to the prepayment of the 2004 installments of the Sanwa loan and 2) in the event that it issues new capital to third parties in one or more transactions other than a public offering of its equity securities at any time prior to September 30, 2003, STI shall apply 10% of the aggregate proceeds of such offerings to the prepayment of the 2004 installments of the Sanwa loan. STI hereby confirms its obligation to make scheduled payments in accordance with the terms of the Sanwa loan.

   
Very truly yours,

Teijin Limited

/s/ Y. Kobayashi

By Yakio Kobayashi
    Assistant to General Manager

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EXHIBIT 10.117

EX-10.118

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EXHIBIT 10.118

[SOUTHWALL TECHNOLOGIES LETTERHEAD]

Via:

E-mail Shunji_Endo@ufjbank.co.jp
Facsimile (415) 788-5459

May 15, 2002

Mr. Naoto Shiraiwa
Vice President & Manager
UFJ Bank
One Front Street, Suite 1800
San Francisco, California 94111
U.S.A.

Re: Credit Agreement dated as of May 6, 1997 between Southwall Technologies Inc. ("STI") and the Sanwa Bank Limited ("Credit Agreement"), and to the First Amendment to the Credit Agreement dated November 8, 1999 between Southwall Technologies Inc. and the Sanwa Bank Limited.

Dear Mr. Shiraiwa,

On May 9, 2002, Teijin waived any defaults under Article 5.1 of the Guarantee Agreement that may exist through and including September 30, 2003 arising out of STI's failure to comply with the financial covenants of the Minimum Quick Ratio, Tangible Net Worth Amount and Maximum Debt/Tangible Net Worth in article 4-(1) of the Guarantee Agreement. A copy of that waiver is attached as Exhibit A of this letter.

Southwall Technologies respectively requests the UFJ Bank Limited (formerly Sanwa Bank Limited) waive any Default or Event of Default pursuant to Section 7.01(h) of the above referenced Credit Agreement for STI's failure to comply with the above terms of the Teijin Guaranty Agreement.

Your agreement to acknowledge that Teijin's waiver is sufficient to remedy the default in the above referenced Credit Agreement will allow Southwall to classify a portion of its debt to UFJ Bank as long term debt in its 10-Q filing. This 10-Q will be added to the amended S-1 filed with the SEC for the sale of additional shares of its Common Stock.

Thank you for your consideration of this request.

Sincerely,

/s/  THOMAS G. HOOD

Thomas G. Hood
President and Chief Executive Officer

Enclosure

Acknowledged:

/s/  NAOTO SHIRAIWA Signed
UFJ Bank Ltd. May 16, 2002 Date

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EXHIBIT 10.118