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As filed with the Securities and Exchange Commission on June 25, 2002

Registration No. 333-85576

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Amendment No. 3
to
FORM S-1
REGISTRATION STATEMENT
UNDER THE SECURITIES ACT OF 1933

Southwall Technologies Inc.
(Exact name of registrant as specified in its charter)

Delaware
(State or other jurisdiction of
incorporation or organization) 3081
(Primary Standard Industrial
Classification Code Number) 94-2551470
(I.R.S. Employer
Identification Number)

Southwall Technologies Inc.
1029 Corporation Way, Palo Alto, California 94303 (650) 962-9111
(Address, including zip code, and telephone number, including
area code, of registrant's principal executive offices)

Thomas G. Hood
President and Chief Executive Officer
Southwall Technologies Inc.
1029 Corporation Way, Palo Alto, California 94303 (650) 962-9111
(Name, address, including zip code, and telephone number,
including area code, of agent for service)

Copies to:

Cameron Read
James W. Hackett, Jr.
Choate, Hall & Stewart
53 State Street
Boston, Massachusetts 02109
(617) 248-5000 Thomas P. Palmer
Jeffrey S. Cronn
Tonkon Torp LLP
888 SW Fifth Avenue
Portland, Oregon 97204
(503) 802-2018

Approximate date of commencement of proposed sale to the public:

As soon as practicable after this registration statement becomes effective.

        If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. o

        If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o

        If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o

        If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o

        If delivery of the prospectus is expected to be made pursuant to Rule 434, check the following box. o

The registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the registration statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

SUBJECT TO COMPLETION, DATED JUNE 25, 2002

PROSPECTUS

3,500,000 Shares

Common Stock

        We are offering 3,500,000 shares of our common stock. Our common stock is listed on the Nasdaq National Market under the symbol "SWTX." On June 21, 2002, the last reported sale price of our common stock on the Nasdaq National Market was $6.00 per share.

        Investing in our common stock involves certain risks. See "Risk Factors" beginning on page 7.

	Per Share	Total
Public Offering Price	$	$
Underwriting Discount	$	$
Proceeds, before expenses, to Southwall	$	$

        We have granted the underwriters the right to purchase up to an additional 500,000 shares and the selling stockholders have granted the underwriters the right to purchase up to an additional 25,000 shares of our common stock to cover over-allotments.

The Securities and Exchange Commission and state securities regulators have not approved or disapproved of these securities or determined if this prospectus is truthful or complete. It is illegal for any person to tell you otherwise.

Needham & Company, Inc.

Adams, Harkness & Hill, Inc.
	Wells Fargo Securities, LLC

The date of this prospectus is                            , 2002.

TABLE OF CONTENTS

	Page
Prospectus Summary	2
Risk Factors	7
Forward-looking Statements	16
Use of Proceeds	17
Dividend Policy	17
Capitalization	18
Price Range of Common Stock	19
Selected Consolidated Financial Data	20
Management's Discussion and Analysis of Financial Condition and Results of Operations	24
Business	39
Management	54
Related Party Transactions	61
Principal and Selling Stockholders	63
Description of Capital Stock	65
Underwriting	68
Legal Matters	70
Experts	70
Where You Can Find More Information	71

        XIR, XUV, Triangle Design, Superglass, Heat Mirror, California Series, Solis, ETCH-A-FLEX and Southwall are registered trademarks of Southwall. V-KOOL is a registered trademark of Globamatrix Holdings Pte. Ltd. All other trade names and trademarks referred to in this prospectus are the property of their respective owners.

        We have not authorized anyone to provide you with information different than that contained in this document. This document may only be used where it is legal to sell these securities. The information in this document is given as of the date of this document regardless of the time of delivery of this prospectus or of any sale of our common stock.

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PROSPECTUS SUMMARY

This summary highlights information contained elsewhere in this prospectus. This summary does not contain all of the information that you should consider before investing in our common stock. References in this prospectus to "Southwall Technologies," "Southwall," "we," "us," or "our" are to Southwall Technologies Inc. and its subsidiaries. You should read this entire prospectus carefully. Unless otherwise indicated, all information in this prospectus assumes that the underwriters have not exercised their option to purchase additional shares.

Southwall Technologies Inc.

        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 selectively absorb, reflect or transmit light and control the flow of energy. Our products consist of transparent insulation and solar-control films for automotive and architectural glass, and anti-reflective films for computer and television screens, including flat panel and plasma displays. They also include transparent conductive films for use in touch screen and liquid crystal displays. Based upon our production capacity, we believe we are one of the world's largest producers of rolls of clear plastic, or substrates, coated with thin films.

        Recent advances in manufacturing processes and techniques are reducing our production costs. These reductions allow our thin film coated substrates to more cost-effectively address the following markets:

        Automotive glass.    The thin film coated substrates we sell in this market reflect infrared heat and reduce the transmission of ultra-violet light. These coatings allow carmakers to use more glass and to increase the energy efficiency and comfort of their vehicles. We sell thin film coated substrates in this market primarily to original equipment manufacturers that produce glass for sale to European manufacturers of new cars. Our products are used in cars manufactured by Mercedes Benz, Renault, Audi, BMW, Volvo, Volkswagen and the PSA Group, among other companies. According to the Freedonia Group, the worldwide demand for new and replacement glass sold for the motor vehicle market is expected to increase from approximately 7.2 billion square feet in 1999 to approximately 8.7 billion square feet in 2009.

        Electronic displays.    The thin film coated substrates we sell in this market primarily reduce glare caused by reflection from glass surfaces, improve contrast and image quality, and reduce energy emission from and the build up of static charge on computer display screens. Our thin film coated substrates are used in computer display tubes, or CDTs, liquid crystal and plasma displays, and in applications such as touch screens, wireless telephones and automated teller machines. The combined worldwide market for 17 inch and 19 inch flat screen computer display tubes and active matrix liquid crystal displays used for computer and handheld applications is anticipated to grow from approximately 75 million units in 2000 to approximately 155 million units in 2005, according to a 2001 Stanford Resources, Inc. research study.

        Architectural.    The thin film coated substrates we sell in this market are primarily used to control the transmission of heat through window glass and to limit ultra-violet light damage. Glass windows are significantly responsible for heat build-up and loss in buildings. According to the Freedonia Group, the worldwide market for new and replacement glass sold for use in residential buildings is expected to increase from approximately 5.2 billion square feet in 1999 to approximately 8.0 billion square feet in 2009. Also according to Freedonia, the market for new and replacement glass for use in commercial buildings is expected to increase from approximately 16.2 billion square feet in 1999 to approximately 25.4 billion square feet in 2009.

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        To address market demands, we have expanded our operations. We began manufacturing in a new facility in Dresden, Germany in January 2001. The facility presently contains two production machines. We expect that our third production machine in Dresden will begin commercial production by the first quarter of 2003. In 2000, we also increased our commercial production capacity in Tempe, Arizona by adding a second production machine.

Our Competitive Advantages

        We believe we are well positioned for continued growth in sales of thin film coatings for the automotive glass, electronic display and architectural markets, and that our competitive advantages include:

•

Proprietary thin film manufacturing process knowledge and control systems;



•

Extensive thin film materials expertise and optical design capabilities;



•

Over twenty years' experience providing large quantities of sophisticated coatings on flexible film for demanding applications and customers;



•

The world's largest installed base of coating machinery for application of sputter coatings to flexible film; and



•

Substantial expertise and technical support in the areas of product testing, reliability and applications.

Our Strategy

        Our objective is to enhance our position as a global developer, manufacturer and marketer of thin film coatings on flexible substrates for the automotive glass, electronic display and architectural markets. The following are key elements of our strategy:

•

Increase penetration and expand customer base in the automotive glass market;



•

Increase production capacity in the automotive glass and architectural market;



•

Use expanded production capacity and new products to increase sales in the architectural markets;



•

Capitalize on expanding flat panel display markets; and



•

Continue to advance thin film production technology.

        We were incorporated in 1979 as a Delaware corporation. Our principal executive offices are located at 1029 Corporation Way, Palo Alto, California 94303, and our telephone number is (650) 962-9111. Our corporate web site is located at www.southwall.com. The information contained in our web site is not a part of this prospectus.

Recent Development

        On June 24, 2002, we disclosed preliminary estimates of our financial results for the quarter ended June 30, 2002, indicating that we expected revenues for the quarter to be between $19.5 million and $20.5 million and net income for the quarter to be between $1.2 million and $1.4 million. We also disclosed preliminary estimates of our financial results for the fiscal year ended December 31, 2002, indicating that we expected revenues for 2002 to be between $78.0 million and $82.0 million and net income for 2002 to be between $4.8 million and $5.2 million before including any adjustments from the sale of common stock that we are offering by means of this propectus. These estimates are, however, subject to certain assumptions, risks and uncertainties that could cause actual revenues or net income for our second quarter or 2002 to be different than the estimates presented.

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        We expect the remainder of 2002 to continue to be affected by a slowdown in sales by European automobile manufacturers. We do not anticipate a significant improvement, if any, over our first quarter sales to the automotive market for any of the remaining quarters of 2002. However, we recently announced a new ten-year distribution agreement with Globamatrix Holdings Pte. Ltd., or Globamatrix, which includes commitments by Globamatrix to purchase an annually increasing amount, subject to volume and quality standards, of our solar control products for retrofit applications to the automotive and residential and commercial architectural glass markets. As a result, we believe that we will have somewhat greater revenues from Globamatrix in 2002 than in 2001, and that this growth will continue through 2003.

        Our revenues from the CDT portion of our electronic display business have declined during 2002 as compared to 2001 primarily due to lower prices. During the same period, however, sales to the liquid crystal and plasma display portions of this market have increased. We recently started shipping production quantities and sizes of new films specifically designed for the liquid crystal display and plasma display panel markets that maintain optical clarity while reducing the reflection of ambient light to improve image quality. We expect the decline of the CDT portion of our electronic display business and the growth in sales of our new electronic display films to continue through 2003.

        Due to production capacity constraints, in the past we have not allocated resources to expanding revenues from our architectural products. Additional production capacity for architectural products has recently been created, in part, by the addition of our new Dresden facility. Our revenues from our architectural business have increased during 2002 as compared to 2001, and we expect that the availability of production capacity in 2003 will allow for continued growth in this business. However, we can give no assurances that availability of production capacity will increase our revenues from architectural products.

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The Offering

Common stock offered by us		3,500,000 shares
Common stock to be outstanding after this offering		12,086,278 shares
Over-allotment option:
	Common stock offered by us	500,000 shares
	Common stock offered by selling stockholders	25,000 shares
Use of proceeds		To pay down existing indebtedness, capital expenditures including purchasing a new production machine, replacing our enterprise resource planning system and updating our Palo Alto and Tempe facilities, and for working capital and general corporate purposes, including possible acquisitions.
Nasdaq National Market symbol		SWTX

        The number of shares of our common stock to be outstanding after this offering is based on our shares outstanding as of May 23, 2002 and excludes 2,096,204 shares which consist of:

•

1,401,859 shares subject to outstanding options under our 1997 stock incentive plan with a weighted average exercise price of $5.24 per share; and



•

694,345 shares subject to outstanding options under our 1998 stock option plan for employees and consultants with a weighted average exercise price of $6.61 per share.

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Summary Consolidated Financial Data

        The following tables summarize consolidated statements of operations and consolidated balance sheet data for our business. You should read this information together with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our consolidated financial statements and the related notes included elsewhere in this prospectus. The pro forma as adjusted consolidated balance sheet data reflects the sale of 3,500,000 shares of common stock offered by us at an assumed public offering price of $8.00, after deducting estimated underwriting discounts and commissions and estimated offering expenses.

        The consolidated statements of operations data for the five years ended December 31, 2001 are derived from our audited consolidated financial statements. The consolidated statements of operations data for the three months ended April 1, 2001 and March 31, 2002 and the consolidated balance sheet data as of March 31, 2002 have not been audited. In the opinion of management, such unaudited financial statements have been prepared on the same basis as the audited financial statements referred to above and include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of results of operations for the indicated periods when read in conjunction with our audited financial statements and notes. Results of operations for the three months ended March 31, 2002 are not necessarily indicative of the results that may be expected for the full year.

															Three Months Ended
		Year Ended December 31,
															April 1, 2001			March 31, 2002
		1997		1998			1999			2000			2001
		(In thousands, except per share data)
Consolidated Statements of Operations Data:
Net revenues by product:
Automotive glass		$	6,629	$	12,845		$	19,477		$	20,198		$	37,385	$	8,007		$	7,003
Electronic display			21,957		16,954			16,014			47,734			29,691		6,724			7,925
Architectural			21,503		20,234			19,107			17,416			15,900		2,982			4,341
Net revenues			50,089		50,033			54,598			85,348			82,976		17,713			19,269
Gross profit			14,779		5,780			13,892			16,288			22,828		2,864			6,844
Income (loss) from operations			2,446		(7,130	)		(527	)		(3,594	)		6,336		(1,217	)		1,322
Net income (loss)		$	2,281	$	(7,869	)	$	(1,865	)	$	(6,180	)	$	4,635	$	(1,131	)	$	1,181
Net income (loss) per share:
	Basic	$	0.32	$	(1.03	)	$	(0.25	)	$	(0.81	)	$	0.58	$	(0.15	)	$	0.14
	Diluted	$	0.29	$	(1.03	)	$	(0.25	)	$	(0.81	)	$	0.57	$	(0.15	)	$	0.13
Weighted average number of common stock and dilutive common stock equivalents:
	Basic		7,107		7,608			7,421			7,642			8,032		7,743			8,417
	Diluted		7,799		7,608			7,421			7,642			8,186		7,743			9,277

	March 31, 2002
	Actual			Pro Forma As Adjusted
	(In thousands)
Consolidated Balance Sheet Data:
Cash and cash equivalents	$	2,713		$	14,726
Working capital (deficit)		(4,987	)		11,632
Property, plant and equipment, net		47,326			53,326
Total assets		73,067			90,530
Term debt		13,800			9,800
Total liabilities		44,781			36,175
Total stockholders' equity		28,286			54,155

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RISK FACTORS

An investment in our common stock involves a high degree of risk. You should consider carefully the following risks, together with all other information included in this prospectus, before you decide to buy our common stock. If any of the following risks actually occur, our business, prospects, financial condition or results of operations would likely suffer materially. As a result, the trading price of our common stock may decline, and you could lose all or part of the money you paid to buy our common stock.

Financial Risks

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

        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 secure additional borrowings on favorable terms or at all. We intend to seek additional borrowings, and difficulties in borrowing money 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. Following the application of the proceeds from this offering, approximately $23.1 million of our assets will remain as collateral to secure loans under our credit facilities. 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 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. We are currently being sued under a master sale-leaseback agreement with respect to two of our production machines because we have withheld lease payments in

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connection with a dispute with the leasing company. The leasing company holds a security interest in the production machines and may be able to repossess those machines. If the leasing company were to repossess one or more of those machines, our ability to produce product would be materially impaired. Our revenues, gross margins and operating efficiency would also be materially adversely affected. 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. During the past three fiscal years, 21% of our sales have occurred during the first quarter with 25%, 29% and 25% 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. To a lesser extent, demand for our after-market automotive glass products generally increases when weather is warmer in northern climates and the replacement of glass windows in motor vehicles increases. Lower demand for our products during the first quarter generally results in lower sales, margins and operating results during that quarter. We believe this seasonality in the demand for our products will continue to affect our results 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:

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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;

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

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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;

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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.

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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 due to fluctuations of the euro against the dollar. In addition, other customers may also make payments in foreign currencies. Also, certain transactions with foreign suppliers are denominated in foreign currencies, primarily yen.

        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.

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 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 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:

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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;

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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.

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Our ability to successfully identify suitable target companies and integrate acquired companies or technologies may affect our future growth.

        A potential part of our continuing business strategy is to consider acquiring companies, products, and technologies that complement our current products, enhance our market coverage, technical capabilities or production capacity, or offer other growth opportunities. Our ability to successfully complete acquisitions requires that we identify suitable target companies, agree on acceptable terms, and obtain acquisition financing on acceptable terms. In connection with these acquisitions, we could incur debt, amortization expenses relating to identified intangibles, impairment charges relating to goodwill, or merger related charges, or could issue stock that would dilute our current shareholders' percentage of ownership. The success of any acquisitions will depend upon our ability to integrate acquired operations, retain and motivate acquired personnel, and increase the customer base of the combined businesses. We cannot assure you that we will be able to accomplish all of these goals. Any future acquisitions would involve certain additional risks, including:

•

difficulty integrating the purchased operations, technologies, or products;

•

unanticipated costs, which would reduce our profitability;

•

diversion of management's attention from our core business;

•

potential entrance into markets in which we have limited or no prior experience; and

•

potential loss of key employees, particularly those of the acquired business.

Failure to meet the volume requirements 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 product not delivered in a timely manner, either of which would reduce our gross margins.

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. 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

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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 for our products. 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 potential customers currently produce, or 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.

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 the materials we require 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

11

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 2000. 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.

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

12

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, Sales and Marketing, and 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 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.

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

13

new labor contract. Our customers in the automotive glass market sell glass incorporating our products to German automobile manufacturers including DaimlerChrysler. A prolonged strike by IG Metal or other workers or a significant delay in DaimlerChrysler's production schedule or the production schedules of others as a result of labor activity could disrupt the demand for our products, which would adversely affect our revenues.

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 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 experience unanticipated warranty or other claims with respect to our products which may lead to extensive litigation costs and expenses.

        In the ordinary course of business, we have periodically become engaged in litigation principally as a result of disputes with customers of our architectural products. We have settled some of these suits and others are pending. We may become engaged in similar or other lawsuits in the future. For example, we have recently received a letter that threatens litigation based upon the allegation that a sealant provided by a third party and used with our film was defective, and as a result the plaintiff has suffered elevated warranty replacement claims and costs. Some of our products that have been the basis for lawsuits against us could be the basis for future lawsuits. An adverse outcome in the defense of a warranty or other claim could subject us to significant liabilities to third parties. Any litigation, regardless of the outcome, could be costly and require significant time and attention of key members of our management and technical personnel.

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. Our insurance carriers in a case in which the plaintiff alleged we were responsible for defects in window products manufactured by others have advised us that they intend 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. Some of the proceeds of this offering could be used to defend or satisfy obligations arising from this potential litigation.

14

Offering Risks

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

        The market price of our common stock has been, and we expect will continue to be, subject to significant fluctuations. For example, over the past year the closing market price of our common stock has fluctuated between $2.60 on May 22, 2001 and $6.00 on June 21, 2002 while reaching a high of $15.45 on April 17, 2002. Factors affecting our market price include:

•

the limited number of shares of common stock available for purchase or sale in the public markets;


•

sales or purchases of large blocks of our shares;


•

quarterly variations in our results of operations;


•

failure to meet earnings estimates;


•

changes in earnings estimates or buy/sell recommendations by analysts;


•

the operating and stock price performance of comparable companies;


•

developments in the financial markets;


•

the announcement of new products or product enhancements or business results by us or our competitors; and


•

general market conditions or market conditions specific to the industries in which we operate.

        Recent events have caused stock prices for many companies, including our company, to fluctuate in ways unrelated or disproportionate to their operating performance. General economic and political events may affect market conditions generally, and, in particular, the market price of our common stock. These events and market trends are beyond our control. The market price of our common stock at any particular time may not remain the market price in the future.

Certain provisions of our charter, by-laws and Delaware law make a takeover difficult.

        Certain provisions of our corporate charter and by-laws and Delaware law, might discourage, delay or prevent a change of control or a change in our management, even if such changes would be beneficial to our stockholders. These provisions include the ability of our board of directors, without stockholder approval, to issue any class or series of preferred stock with dividend rights, dividend rates, conversion rights, redemption rights, preferences on liquidation or dissolution, voting rights and any other preferences, which could adversely affect the voting and other rights of the holders of common stock. These provisions could discourage proxy contests and make it more difficult for you and other stockholders to elect directors and take other corporate actions. We also have a severance policy that covers all of our officers and some of our key employees under which they may become entitled to special benefits in connection with certain changes in control of Southwall. The existence of all of these provisions and policies could limit the price that investors might be willing to pay for shares of our common stock and could deprive you of an opportunity to receive a premium for your common stock as part of a sale of Southwall. See "Description of Capital Stock."

The market price of our common stock may drop significantly when the restrictions on resale by our existing securityholders lapse.

        Following this offering, we will have approximately 12.1 million shares of common stock outstanding. Holders of                        shares have agreed not to sell these shares for at least 180 days following the date of this prospectus. As these restrictions on resale end, the market price of our common stock could drop significantly if holders of these shares sell them or if the market perceives they intend to sell them. We also currently have 1,401,859 shares subject to outstanding options under our 1997 stock incentive plan with a weighted average exercise price of $5.24 per share and 694,345

15

shares subject to outstanding options under our 1998 stock option plan with a weighted average purchase price of $6.61 per share, all of which may be exercised and sold by option holders in the future. These potential future exercises and sales also may make it difficult for us to sell equity securities in the future at a time and price that we deem appropriate.

FORWARD-LOOKING STATEMENTS

        This prospectus contains forward-looking statements, as that term is defined in the Private Securities Litigation Reform Act of 1995, that are subject to a number of risks and uncertainties. All statements other than statements of historical facts are forward-looking statements. These statements are identified by terminology such as "may," "will," "could," "should," "expects," "plans," "intends," "seeks," "anticipates," "believes," "estimates," "potential," or "continue," or the negative of such terms or other comparable terminology, although not all forward-looking statements contain these identifying words. Forward-looking statements are only predictions and include statements relating to:

•

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


•

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


•

our projected need for additional borrowings and our future liquidity;


•

our competition;


•

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


•

statements about the future size of markets;


•

pending and threatened litigation and its outcome;


•

our use of the proceeds of this offering; and


•

our projected capital expenditures.

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

16

USE OF PROCEEDS

        We estimate our net proceeds from the sale of 3,500,000 shares of common stock that we are offering by means of this prospectus will be approximately $25.9 million, at an assumed public offering price of $8.00 per share, after deducting estimated underwriting discounts and commissions, and offering expenses. If the underwriters' over-allotment option is exercised in full, we estimate our net proceeds will be approximately $29.6 million. We will not receive any proceeds from the sale of shares in the over-allotment option by the selling stockholders.

        We intend to use a portion of our net proceeds from this offering as follows:

•

to pay off the outstanding balance of our accounts receivable financing line of credit, which as of May 23, 2002 was approximately $5.6 million; this indebtedness bears interest at 0.88% per month of the average daily balance of accounts receivable against which we have borrowed and expires in June 2003;



•

approximately $2.5 million to pay down a note payable to a Japanese bank and guaranteed by Teijin Limited; this indebtedness bears interest per annum at a percentage rate of LIBOR plus 1.0% and we are required to make equal semi-annual principal repayments of $1.25 million each May and November until the note is fully repaid in November 2004; the $2.5 million we intend to repay in 2002 would be applied towards the last two required payments;



•

approximately $2.0 million to replace our enterprise resource planning system;



•

approximately $2.5 million towards the purchase of a new production machine (PM 10);



•

approximately $1.5 million to maintain and update our production facilities in Palo Alto and Tempe; and



•

approximately $0.75 million to partially repay a loan from a German bank; this loan bears interest at 5.8% per annum on the total committed amount under the loan of $1.5 million and is due in June 2009.

        The remaining net proceeds from this offering may be used as follows:

•

to make future acquisitions of product lines or technologies or other companies, although we currently have no acquisition agreements or understandings in place;



•

the potential resolution of disputes with insurers or settlement of litigation, including litigation with Matrix Funding Corporation arising out of sale-leaseback agreements for two of our production machines; and



•

the balance for funding of working capital and general corporate purposes.

        With respect to the balance of the net proceeds after the repayment of debt, replacement of our enterprise resource planning system, the purchase of PM 10 and the maintenance and updating of our production facilities in Palo Alto and Tempe, we have not determined the amount of net proceeds to be used for the other purposes indicated. Accordingly, our management will have flexibility in applying net proceeds of the offering. Pending any use, we intend to invest our net proceeds from this offering in short-term, interest-bearing, investment-grade securities, certificates of deposit or direct or guaranteed obligations of the United States.

DIVIDEND POLICY

        We have never declared or paid any cash dividends on our common stock, and we do not anticipate paying cash dividends in the foreseeable future. We currently intend to retain future earnings, if any, to fund the expansion and growth of our business. Payment of future cash dividends, if any, will be at the discretion of our board of directors after taking into account various factors, including our financial condition, operating results, current and anticipated cash needs and plans for expansion.

17

CAPITALIZATION

        The following table sets forth our capitalization as of March 31, 2002 on an actual basis and on a pro forma as adjusted basis to reflect the sale by us of 3,500,000 shares of common stock offered hereby at an assumed public offering price of $8.00 per share, after deducting the estimated underwriting discount and estimated offering expenses payable by us, and to reflect the net proceeds of the offering as applied.

        This information should be read in conjunction with our consolidated financial statements and notes thereto, appearing elsewhere in this prospectus.

				March 31, 2002
				Actual			Pro Forma as Adjusted
				(in thousands)
Line of credit				$	4,606		$	—
Current portion of long-term debt				$	7,579		$	7,579
Term debt, less current portion					13,800			9,800
	Total long-term debt			$	21,379		$	17,379
Stockholders' equity:
	Common Stock, $0.001 par value: 20,000 shares authorized; 8,562 shares issued and outstanding (actual); 12,062 shares issued and outstanding (pro forma as adjusted)				9			12
	Capital in excess of par value				53,467			79,333
	Notes receivable				(103	)		(103	)
	Translation loss on subsidiary				(356	)		(356	)
	Accumulated deficit				(24,731	)		(24,731	)
		Total stockholders' equity			28,286			54,155
			Total capitalization	$	49,665		$	71,534

        This information excludes 1,979,494 shares, which consist of:

•

1,450,653 shares subject to outstanding options as of March 31, 2002 under our 1997 stock incentive plan, with a weighted average exercise price of $5.24 per share; and



•

528,841 shares subject to outstanding options as of March 31, 2002 under our 1998 stock option plan for employees and consultants, with a weighted average exercise price of $5.20 per share.

18

PRICE RANGE OF COMMON STOCK

        Our common stock has been traded on the Nasdaq National Market System under the symbol "SWTX" since the completion of our initial public offering in June 1987. From August 2, 2000 through November 28, 2000, the trading of our common stock was suspended by Nasdaq in connection with the restatement of our financial statements. Prices in the following table represent the high and low closing sales prices per share for our common stock as reported by Nasdaq during the periods indicated.

		High		Low
2000
	First quarter	$	11.87	$	4.68
	Second quarter		11.25		7.37
	Third quarter		14.00		6.12
	Fourth quarter		4.17		2.62
2001
	First quarter		3.63		2.00
	Second quarter		3.47		2.03
	Third quarter		5.41		2.97
	Fourth quarter		7.26		4.55
2002
	First quarter		12.99		7.19
	Second quarter (through June 21, 2002)		15.45		6.00

        On June 21, 2002 the last reported sale price for our common stock as reported on Nasdaq was $6.00 per share. On such date, there were approximately 350 holders of record of our common stock, and we believe there were approximately 3,000 beneficial owners of our common stock.

19

SELECTED CONSOLIDATED FINANCIAL DATA
(in thousands, except per share data)

        The following selected consolidated financial data as of and for the five years ended December 31, 2001 are derived from our audited consolidated financial statements. The following selected consolidated financial data as of and for the three months ended April 1, 2001 and March 31, 2002 have been derived from our unaudited consolidated financial statements for the three months ended March 31, 2002. In the opinion of management, such unaudited financial statements have been prepared on the same basis as the audited financial statements referred to above and include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of results of operations for the indicated period when read in conjunction with our audited financial statements and related notes. Results of operations for the three months ended March 31, 2002 are not necessarily indicative of the results that may be expected for the full year. This information should be read together with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the consolidated financial statements and related notes included elsewhere in this prospectus.

																	Quarter Ended
		Year Ended December 31,
																	April 1, 2001			March 31, 2002
		1997			1998			1999			2000			2001
Consolidated Statements of Operations Data:
Net revenues by product:
	Automotive glass	$	6,629		$	12,845		$	19,477		$	20,198		$	37,385		$	8,007		$	7,003
	Electronic display		21,957			16,954			16,014			47,734			29,691			6,724			7,925
	Architectural		21,503			20,234			19,107			17,416			15,900			2,982			4,341
Total net revenues			50,089			50,033			54,598			85,348			82,976			17,713			19,269
Cost of sales			35,310			44,253			40,706			69,060			60,148			14,849			12,425
Gross profit			14,779			5,780			13,892			16,288			22,828			2,864			6,844
Operating expenses:
	Research and development		3,117			3,864			5,249			6,732			5,456			1,425			1,777
	Selling, general and administrative		9,216			9,046			8,670			12,614			11,036			2,656			3,745
	Legal settlement		—			—			500			536			—			—			—
Total operating expenses			12,333			12,910			14,419			19,882			16,492			4,081			5,522
Income (loss) from operations			2,446			(7,130	)		(527	)		(3,594	)		6,336			(1,217	)		1,322
Interest expense, net			(428	)		(1,150	)		(1,350	)		(2,808	)		(2,872	)		(757	)		(466	)
Other income, net			408			469			62			350			1,385			864			378
Income (loss) before provision for income taxes			2,426			(7,811	)		(1,815	)		(6,052	)		4,849			(1,110	)		1,234
Provision for income taxes			(145	)		(58	)		(50	)		(128	)		(214	)		21			53
Net income (loss)		$	2,281		$	(7,869	)	$	(1,865	)	$	(6,180	)	$	4,635		$	(1,131	)	$	1,181
Net income (loss) per share:
	Basic	$	0.32		$	(1.03	)	$	(0.25	)	$	(0.81	)	$	0.58		$	(0.15	)	$	0.14
	Diluted	$	0.29		$	(1.03	)	$	(0.25	)	$	(0.81	)	$	0.57		$	(0.15	)	$	0.13
Weighted average number of common stock and dilutive common stock equivalents:
	Basic		7,107			7,608			7,421			7,642			8,032			7,743			8,417
	Diluted		7,799			7,608			7,421			7,642			8,186			7,743			9,277

20

															As of
	As of December 31,
															April 1, 2001			March 31, 2002
	1997		1998			1999			2000			2001
Consolidated Balance Sheet Data:
Cash and cash equivalents	$	10,524	$	4,136		$	1,772		$	61		$	3,362		$	218		$	2,713
Working capital (deficit)		23,999		(4,256	)		(11,699	)		(32,148	)		(6,471	)		(32,593	)		(4,987	)
Property, plant and equipment, net		26,272		29,068			43,533			49,884			47,841			48,876			47,326
Total assets		61,469		54,019			70,142			80,462			73,158			74,049			73,067
Term debt		15,539		141			10,000			—			14,513			—			13,800
Total liabilities		25,729		28,202			45,562			60,324			46,706			55,347			44,781
Total stockholders' equity		35,740		25,817			24,580			20,138			26,452			18,702			28,286

																Quarter Ended
	Year Ended December 31,
																April 1, 2001			March 31, 2002
	1997			1998			1999			2000			2001
Selected Cash Flow Data:
Cash provided by (used in) operating activities	$	84		$	4,347		$	4,523		$	1,188		$	13,791		$	2,222		$	(947	)
Net cash provided by (used in) investing activities		(11,727	)		(7,190	)		(25,942	)		(12,855	)		(5,698	)		940			(367	)
Net cash provided by (used in) financing activities		14,748			(3,545	)		19,055			9,558			(4,793	)		(3,005	)		665
Net increase (decrease) in cash and cash equivalents		3,105			(6,388	)		(2,364	)		(1,711	)		3,301			157			(649	)

21

Quarterly Results of Operations:

        The following table sets forth statements of operations data for the nine fiscal quarters ended March 31, 2002. This information has been derived from our unaudited consolidated financial statements and has been prepared on the same basis as our audited consolidated financial statements contained in this prospectus. It includes all adjustments, consisting of normal recurring adjustments only, that we consider necessary for a fair presentation of such information when read in conjunction with our audited financial statements and related notes. Operating results for any quarter are not necessarily indicative of results for any future period. This information should be read together with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the consolidated financial statements and related notes included elsewhere in this prospectus.

Selected Quarterly Financial Information
(Unaudited)

		Quarters Ended
		April 2, 2000			July 2, 2000			Oct. 1, 2000			Dec. 31, 2000			April 1, 2001			July 1, 2001		Sep. 30, 2001		Dec. 31, 2001		March 31, 2002
Net revenues		$	17,109		$	20,928		$	26,361		$	20,950		$	17,713		$	21,946	$	22,777	$	20,540	$	19,269
Cost of sales			14,783			16,922			19,399			17,956			14,849			16,320		15,629		13,350		12,425
Gross profit			2,326			4,006			6,962			2,994			2,864			5,626		7,148		7,190		6,844
Income (loss) before provision for income taxes			(1,647	)		(1,606	)		(1,530	)		(1,269	)		(1,110	)		1,104		2,420		2,435		1,234
Net income (loss)			(1,683	)		(1,647	)		(1,548	)		(1,302	)		(1,131	)		1,184		2,409		2,172		1,181
Net income (loss) per share—
	Basic	$	(0.22	)	$	(0.22	)	$	(0.20	)	$	(0.17	)	$	(0.15	)	$	0.15	$	0.29	$	0.26	$	0.14
	Diluted	$	(0.22	)	$	(0.22	)	$	(0.20	)	$	(0.17	)	$	(0.15	)	$	0.15	$	0.28	$	0.25	$	0.13

        Our results of operations can vary significantly from quarter to quarter. As a result of our high fixed costs, if revenues fall significantly below our expectations, we will not be able to reduce our spending sufficiently to prevent a loss from operations. We anticipate that we will continue to have long sales cycles. Therefore, the timing of future customer contracts could be difficult to predict, making it very difficult to predict revenues in future quarters, and our operating results may vary significantly.

        Our revenue from the electronic display and architectural markets is affected by seasonality patterns with the highest sales occurring during the second, third and fourth fiscal quarters. During the past three fiscal years, 21% of our sales have occurred during the first quarter with 25%, 29% and 25% 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. In addition, our sales of electronic display products were adversely affected in 2001 by a worldwide decline in the personal computer industry.

        During 2001, our Dresden facility, at which PM 8 and PM 9 are located, commenced production of commercial product for the automotive market. This expansion in our overall manufacturing capacity allowed us to increase significantly our sales to the automotive market in 2001, compared with 2000.

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        Other factors that could affect our quarterly operating results include those described elsewhere in this prospectus and the following:

•

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;



•

The progress and outcome of litigation with which we are involved;



•

The announcement, consummation or integration by us of any acquired businesses, technologies or products;



•

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



•

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.

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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 "Selected Consolidated Financial Data" and our consolidated financial statements and notes thereto appearing elsewhere in this prospectus. This discussion and analysis contains forward-looking statements that involve risks and uncertainties. You should not place undue reliance on these forward-looking statements. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain important factors, including, but not limited to, those set forth under "Risk Factors" beginning on page 7 of this prospectus.

Overview

        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 1990s, we developed and produced thin film coated substances primarily for residential and commercial building applications, and for military applications. In the early 1990s, 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.

        In the second half of 2000, we restated our previously issued financial statements for the first quarter of 2000 and for the year 1999. The restatement was primarily related to an overstatement of licensing revenues and inventory and under-recognition of expenses. Following the restatement, we implemented additional processes and procedures as well as increased staffing to strengthen our internal accounting controls. In connection with the restatement, Nasdaq suspended trading in our common stock for over three months. In addition, following the announcement of the need to restate our financial statements, we and some of our officers were named as defendants in seven lawsuits, all alleging violations of the federal securities laws. We settled these lawsuits in 2001. The settlement required us and the other defendants to pay the plaintiff class $4.2 million, which was paid by our insurer.

Recent Development

        On June 24, 2002, we disclosed preliminary estimates of our financial results for the quarter ended June 30, 2002, indicating that we expected revenues for the quarter to be between $19.5 million and $20.5 million and net income for the quarter to be between $1.2 million and $1.4 million. We also disclosed preliminary estimates of our financial results for the fiscal year ended December 31, 2002, indicating that we expected revenues for 2002 to be between $78.0 million and $82.0 million and net income for 2002 to be between $4.8 million and $5.2 million before including any adjustments from the sale of common stock that we are offering by means of this prospectus. These estimates are, however, subject to certain assumptions, risks and uncertainties that could cause actual revenues or net income for our second quarter or 2002 to be different than the estimates presented.

        We expect the remainder of 2002 to continue to be affected by a slowdown in sales by European automobile manufacturers. We do not anticipate a significant improvement, if any, over our first

24

quarter sales to the automotive market for any of the remaining quarters of 2002. However, we recently announced a new ten-year distribution agreement with Globamatrix Holdings Pte. Ltd., or Globamatrix, which includes commitments by Globamatrix to purchase an annually increasing amount, subject to volume and quality standards, of our solar control products for retrofit applications to the automotive and residential and commercial architectural glass markets. As a result, we believe that we will have somewhat greater revenues from Globamatrix in 2002 than in 2001, and that this growth will continue through 2003.

        Our revenues from the CDT portion of our electronic display business have declined during 2002 as compared to 2001 primarily due to lower prices. During the same period, however, sales to the liquid crystal and plasma display portions of this market have increased. We recently started shipping production quantities and sizes of new films specifically designed for the liquid crystal display and plasma display panel markets that maintain optical clarity while reducing the reflection of ambient light to improve image quality. We expect the decline of the CDT portion of our electronic display business and the growth in sales of our new electronic display films to continue through 2003.

        Due to production capacity constraints, in the past we have not allocated resources to expanding revenues from our architectural products. Additional production capacity for architectural products has recently been created, in part, by the addition of our new Dresden facility. Our revenues from our architectural business have increased during 2002 as compared to 2001, and we expect that the availability of production capacity in 2003 will allow for continued growth in this business. However, we can give no assurances that availability of production capacity will increase our revenues from architectural products.

Historical Factors Affecting Our Financial Condition and Results of Operations

        As described in more detail below, our financial condition and results of operations are affected by a number of factors, including our financing arrangements, expansion of our manufacturing capacity, demand for our customers' products, our relationships with customers and suppliers, product warranty claims, fluctuations in our selling, general and administrative expenses, and the mix of products that we sell. Over the past several years, these factors have contributed to volatility in our results of operations and cash flows and have significantly affected our financial position.

        Our financing arrangements.    We incurred net losses from operating activities in 1998, 1999 and 2000. As a result of these net losses, together with the restatement in 2000 of our financial statements for prior periods and the suspension of trading of our common stock on Nasdaq in 2000, we were in default, as of December 31, 2000, under our German bank loans, our sale-leaseback agreement and our Japanese bank loan and the guarantee by Teijin of that loan. As a result, we reclassified all of the debt under those arrangements as current liabilities as of December 31, 2000. Accordingly, there was substantial doubt about our ability to continue as a going concern at December 31, 2000.

        At December 31, 2001 and March 31, 2002, we had made all payments required to be made through those dates under our German bank loans and our Japanese bank loan guaranteed by Teijin. We were in compliance with all of the covenants of the German bank loans. We have received waivers from Teijin and the Japanese bank of our defaults under the financial covenants of the Teijin guarantee. As a result, we have classified $9.2 million outstanding under the German bank loans and $5.0 million outstanding under the Japanese bank loan guaranteed by Teijin as long-term liabilities as of December 31, 2001 and March 31, 2002.

        During 1999, we entered into a sale-leaseback agreement for two of our production machines with an equipment leasing company. The leasing company has filed bankruptcy proceedings. Because we have an option to purchase the machines at the end of the lease periods, we treat these sale-leaseback arrangements as financings. During 2001, a dispute arose between us and an agent purporting to act on behalf of the leasing company. The agent has recently filed suit against us to recover the unpaid lease payments and alleged residual value of the machines. As a result, we have classified $3.3 million as

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short-term liabilities ($4.3 million outstanding under the sale-leaseback agreement, less $1.0 million of the amounts due from the leasing company that was not funded).

        Expansion of our manufacturing capacity.    The expansion of our manufacturing capacity has affected our results of operations, cash flows and financial position. We have invested $55.0 million in new production capacity in Tempe and Dresden since 1997. The expansion has been financed by a combination of term loans, investment incentive grants from the government of the State of Saxony, in Germany, short-term borrowings, and cash flows from operating activities. Our results of operations, profitability, cash flows, stockholders' equity and financial position were adversely affected by initial start up costs and the lower production yields we generally experience before our new production machines reach commercial production levels. As a result, our financial position has been weakened by reduced liquidity and higher leverage.

        Demand for our customers' products.    Volatility in our customers' markets affects our results of operations. Demand for our customers' products has changed rapidly from time to time in the past and may do so in the future. For example, partly as a result of changing demand in the personal computer industry from 1999 through 2001, our electronic display revenues rose from $16.0 million in 1999 to $47.7 million in 2000 then declined to $29.6 million in 2001. We can also be affected when the markets for the products in which our films are used evolve to new technologies, such as the evolution from cathode ray tubes, or CRTs, to flat panel displays. Additionally, our results of operations and cash flows can vary significantly from quarter to quarter as we experience seasonal fluctuations in revenue from our customers in the electronic display and architectural markets.

        Our customer and supplier relationships.    We derive significant benefits from our relationships with a few large customers and suppliers. Our revenues and gross profit can increase or decrease rapidly reflecting underlying demand for the products of one or a small number of our customers. In addition, a customer relationship may become unprofitable. For example, in the fourth quarter of 1998, we discovered quality issues with product that had been shipped to Sony, a significant customer at that time, and with other film that was still in our inventory. We recorded a $4.0 million provision in the fourth quarter of 1998 to account for product returned from Sony and the related write-off of inventory. We discontinued the manufacture and sale of film to Sony in 1999. Sony accounted for 33%, 7% and 0% of our total revenues in 1998, 1999 and 2000. We may also be unable to replace a customer when a relationship ends or demand for our product declines as a result of evolution of our customer's products. In 1999, we began our relationship with Mitsubishi Electric Company, or Mitsubishi, which accounted for 38% and 21% of our total revenues in 2000 and 2001, respectively. In 1999, we expanded our relationship with customers in the automotive glass market, including Pilkington PLC, Saint Gobain and Globamatrix Holdings Pte. Ltd., or Globamatrix, which collectively accounted for approximately 46% of our total revenues in 2001.

        In addition, Teijin, one of our suppliers, has guaranteed our loan from a Japanese bank in the original principal amount of $10.0 million, the proceeds of which we used to fund capital expenditures. Teijin and Globamatrix are investors in us, over time having purchased a total of 1.1 million shares of our common stock and, as of May 20, 2002, continue to hold 1.1 million shares, or approximately 13% of the outstanding stock. In addition, to assist us with our short-term liquidity needs, some of our key vendors, such as Teijin and Lintec Inc., have extended the amount of time in which we are required to repay amounts we owe to them.

        Product warranty claims.    Our gross margins and profitability have been adversely affected from time to time by product quality claims. From 1999 to 2001, our warranty provision has averaged 4.0% of net revenues. In 1998, our gross profit was reduced by $4.0 million related to product we produced for Sony.

        Fluctuations in our selling, general and administrative expenses.    Our selling, general and administrative expenses increased significantly in 2000 due to facility costs and expansion, and

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nonrecurring professional fees. Our Palo Alto facility rents increased by $1.7 million in 2000 pursuant to lease extensions entered into for all of our Palo Alto properties. Our nonrecurring legal and accounting expenses totaled $1.6 million in 2000 and were primarily related to the restatement of our previously issued first quarter 2000 and fiscal 1999 financial statements.

        Product mix.    Product mix affects our gross margins on the products we sell. Our product mix is determined by new products and applications that we have developed, end-customer market demand for products which use our applications, the availability of our production capacity and the allocation of our resources to meet demand for our products in markets we target. Generally, our gross margins on sales of electronic display film are lower than automotive and architectural products due to the additional costs for higher levels of outside processing required for electronic display film.

Application of Critical Accounting Policies and Estimates

        The preparation of our financial statements requires us to make estimates and assumptions that affect the amounts of assets and liabilities we report, our disclosure of contingencies, and the amounts of revenue and expenses we report in our financial statements. If we used different judgments or different estimates, there might be material differences in amount and timing of revenues and expenses we report. See Note 1 of our notes to consolidated financial statements for details of our accounting policies. The critical accounting policies, judgment and estimates, which we believe have the most significant effect on our financial statements, are set forth below:

•

Revenue recognition;


•

Allowances for doubtful accounts and warranties;


•

Valuation of inventories;


•

Assessment of the probability of the outcome of current litigation; and


•

Accounting for income taxes.

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

        Allowances for doubtful accounts and warranties.    We establish allowances for doubtful accounts and warranties for specifically identified, as well as anticipated, doubtful accounts and warranty claims based on credit profiles of our customers, current economic trends, contractual terms and conditions, and historical payment and warranty experience. As of December 31, 2001, our balance sheet included allowances for doubtful accounts of $0.4 million and $2.6 million for warranties. As of March 31, 2002, our balance sheet included allowances for doubtful accounts of $0.4 million and $3.0 million for warranties. During 1999, 2000, 2001 and the first quarter of 2002, we charged $1.9 million, $3.0 million, $3.9 million and $0.7 million, respectively, against revenue for warranty expense. Bad debt expenses were $0.3 million, $(0.1) million, $0.4 million and $0.1 million during 1999, 2000, 2001 and the first quarter of 2002, respectively. If we experience actual bad debt and warranty expense different from estimates or we adjust our estimates in future periods, our operating results, cash flows and financial position could be materially adversely affected.

        Valuation of inventories.    We state inventories at the lower of cost or market. We establish provisions for excess and obsolete inventories after periodic evaluation of historical sales, current economic trends, forecasted sales, predicted lifecycle and current inventory levels. During 1999, 2000,

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2001 and the first quarter of 2002, we charged $0.6 million, $0.5 million, $1.1 million and $0.1 million against cost of sales for excess and obsolete inventories. If we adjust our estimates, such forecasted sales and expected product lifecycle, our operating results, cash flows and financial position could be materially adversely affected.

        Assessment of the probability of the outcome of current litigation.    In the ordinary course of business, we have periodically become engaged in litigation principally as a result of disputes with customers of our architectural products. In addition, in 2000 seven lawsuits were filed against us, alleging violations of the federal securities laws, which were settled collectively in 2001. We have relied upon insurance coverage to fund the defense of these actions and significant portions of the settlements that were reached. Based on our review of pending litigation, we record accruals for loss contingencies when we believe it is probable that a liability has been incurred and we can reasonably estimate the amount of our share of the loss. In connection with recent settlements related to sales of architectural products, we have been advised by some of our insurers that they have reserved the right, and have expressed their intent, to proceed against us to recoup a portion or all of the settlements paid to plaintiffs.

        Accounting for income taxes.    In preparing our financial statements, we estimate our income taxes for each of the jurisdictions in which we operate, including Germany. We include differences between our deferred tax assets, such as net operating loss carry forwards, and tax liabilities in our consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income, and to the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase this allowance in any period, we must include an expense within the tax provision in our statement of operations. To date, we have recorded a full allowance against our deferred tax assets. The valuation allowance was $11.0 million as of December 31, 2001, which fully reserved our net deferred tax assets related to temporary differences, net operating loss carry forwards and other tax credit carry forwards. Future income tax liabilities will be reduced to the extent permitted under federal and applicable state income tax laws, when the future tax benefit can be utilized by applying it against future income.

        Significant management judgment is required in determining our provisions for income taxes, our deferred tax assets and liabilities and our future taxable income for purposes of assessing our ability to utilize any future tax benefit from our deferred tax assets. If actual results differ from these estimates or we adjust these estimates in future periods, our financial position, cash flows and results of operations could be materially affected.

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Results of Operations

        The following table sets forth our results of operations expressed as a percentage of total revenues:

												Quarter Ended
		Year Ended December 31,
												April 1, 2001		March 31, 2002
		1997		1998		1999		2000		2001
Net Revenues
	Automotive glass	13.2	%	25.7	%	35.7	%	23.7	%	45.0	%	45.2	%	36.2	%
	Electronic display	43.9		33.9		29.3		55.9		35.8		38.0		41.4
	Architectural	42.9		40.4		35.0		20.4		19.2		16.8		22.4
Total net revenues		100.0		100.0		100.0		100.0		100.0		100.0		100.0
Cost of sales		70.5		88.4		74.6		80.9		72.5		83.8		64.2
Gross profit		29.5		11.6		25.4		19.1		27.5		16.2		35.8
Research and development		6.2		7.7		9.6		7.9		6.6		8.1		9.2
Selling, general and administrative		18.4		18.1		15.9		14.8		13.3		15.0		19.4
Legal settlement		—		—		0.9		0.6		—		—		—
Total operating expenses		24.6		25.8		26.4		23.3		19.9		23.1		28.6
Income (loss) from operations		4.9		(14.2	)	(1.0	)	(4.2	)	7.6		(6.9	)	7.2
Interest expense, net		(0.9	)	(2.3	)	(2.5	)	(3.3	)	(3.5	)	(4.3	)	(2.3	)
Other income, net		0.8		0.9		0.1		0.4		1.7		4.9		1.9
Income (loss) before provision for income taxes		4.8		(15.6	)	(3.3	)	(7.1	)	5.8		(6.3	)	6.8
Provision for income taxes		(0.3	)	(0.1	)	(0.1	)	(0.1	)	(0.3	)	(0.1	)	(0.3	)
Net income (loss)		4.6	%	(15.7	)%	(3.4	)%	(7.2	)%	5.6	%	(6.4	)%	6.5	%

First Quarter 2001 Compared to First Quarter 2002

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. We believe this slowdown in the European automobile market will continue throughout 2002. Therefore, we do not anticipate a significant improvement, if any, over our first quarter sales to the automotive market for any of the remaining quarters of 2002. 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 83.8% 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

29

significant volumes of commercial product during the first quarter of 2001, has lower manufacturing 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 8.1% of net revenues in the first quarter of 2001 to 9.2% 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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2000 Compared to 2001

        Net revenues.    Our net revenues decreased $2.3 million, or 2.7%, from $85.3 million in 2000 to $83.0 million in 2001. Our sales to the automotive market increased by $17.2 million, or 85.2%, from $20.2 million in 2000 to $37.4 million in 2001. In 2001, our Dresden operations began commercial production of film products for the automotive market. The additional production capacity from the Dresden plant was the primary factor in the increase of our sales to the automotive market during 2001. Our sales to the electronic display market decreased by $18.0 million, or 37.7%, from $47.7 million in 2000 to $29.7 million in 2001. The decline in sales was primarily the result of the worldwide slowdown in the sale and manufacture of personal computers and the adoption of lower cost manufacturing alternatives by one of our major customers. Our sales to the architectural market decreased $1.5 million, or 8.6%, from $17.4 million in 2000, to $15.9 million in 2001. The decrease was primarily the result of our using production machines previously used to produce products for the architectural market to manufacture products for the automotive market.

        Cost of sales.    Cost of sales decreased $9.0 million, or 13.0%, from $69.1 million in 2000 to $60.1 million in 2001. Cost of sales decreased from 80.9% of net revenues in 2000 to 72.5% of net revenues for 2001. The higher costs in 2000, as a percentage of revenues, were due to greater start-up costs in our Tempe and Dresden operations and higher electronic display revenues during 2000, which generally yield lower gross margins as a result of outside processing costs. Additionally, the reduction in the number of employees at our Tempe and Palo Alto facilities effected during the first quarter of 2001 resulted in cost savings. We also realized improved manufacturing yield in our Palo Alto and Tempe facilities during 2001, which further contributed to the improvement in margin from 2000 to 2001. We benefited in 2001 from producing a greater portion of our products at our Dresden plant, which has lower 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 $6.5 million, or 39.9%, from $16.3 million in 2000 to $22.8 million in 2001. Our gross margin improved from 19.1% in 2000 to 27.5% in 2001. The increase in gross profit and gross margin in 2001 was due to increased revenues from the Dresden plant with its lower cost base and cost savings and yield improvements in our Palo Alto and Tempe facilities.

Operating expenses

Research and development.    Research and development spending decreased $1.2 million, or 17.9%, from $6.7 million in 2000 to $5.5 million in 2001. Research and development expenses decreased from 7.9% of net revenues for 2000 to 6.6% of net revenues for 2001. The decrease in our research and development spending during 2001 was primarily attributable to reduced headcount and cost control measures.

Selling, general and administrative.    These expenses decreased $1.6 million, or 12.7%, from $12.6 million in 2000 to $11.0 million in 2001. Selling, general and administrative expenses, as a percentage of revenue, decreased from 14.8% in 2000 to 13.3% for 2001. The higher expenses in 2000 were mainly the result of accounting, legal and consulting costs incurred relating to our restatement in 2000 of financial statements for prior periods. In 2001, we incurred higher expenses in Dresden as the production machines located there were brought up to commercial production levels. Performance based compensation also increased in 2001 as a result of our improved profitability.

Legal settlement.    In 2000, we settled employee practices litigation relating to one individual for $0.5 million. Legal fees and expenses we incur are included in selling, general and administrative expenses, while actual settlements are reported as legal settlements. We incurred no settlement costs in 2001.

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        Income (loss) from operations.    Income (loss) from operations increased from an operating loss of $3.6 million in 2000 to an operating profit of $6.3 million for 2001. The improvement was due to reduced start-up costs and increased revenue from our Dresden operations, improved manufacturing yields, cost reduction programs put in place in the Palo Alto and Tempe facilities, and a reduction in professional fees during 2001 compared to 2000.

        Interest expense, net.    We incurred net interest expense of $2.8 million in 2000 and $2.9 million in 2001, and capitalized interest incurred in connection with construction in process of $1.8 million in 2000 and $0.1 million in 2001. The increase in net interest expense resulted principally from the completion of construction in process related to the Dresden and Tempe facilities in late 2000.

        Other income, net.    We recorded other income of $0.4 million in 2000, compared with $1.4 million for 2001. 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. We incurred a foreign currency loss in 2000 of $0.1 million and a foreign currency gain in 2001 of $0.7 million. We offset higher rent expense in Palo Alto by subleasing space in this facility to three different parties, resulting in rental income of $0.4 million in 2000 and $0.5 million in 2001. One of the subleases expired on February 28, 2001 while the underlying lease is scheduled to expire on December 31, 2002. This sublease generated $0.2 million and $0.03 million of rental income during 2000 and 2001, respectively, as compared to $0.6 million and $0.6 million in rental payments we owed in 2000 and 2001, respectively, pursuant to the underlying lease. We also sublet a portion of our Palo Alto facilities to two companies on a month-to-month basis during 2000 and 2001. Collectively, these arrangements generated $0.1 million and $0.4 million in rental income in 2000 and 2001, respectively, as compared to $0.8 million and $0.8 million in rental payments we owed in 2000 and 2001, respectively, pursuant to the underlying lease. The underlying lease covering these month-to-month arrangements is scheduled to expire on December 31, 2004.

        Income (loss) before provision for income taxes.    We recorded a pre-tax loss of $6.1 million in 2000, compared to a pre-tax profit of $4.8 million in 2001. Our improvement from a loss in 2000 to profitability in 2001 was due to higher revenues from the automotive market due to our Dresden operations, improved manufacturing yields and cost reduction programs put into place in our Palo Alto and Tempe facilities, a reduction in professional fees and an increase in other income, partially offset by a decrease in revenue from the electronic display market.

1999 Compared to 2000

        Net revenues.    Our net revenues increased $30.7 million, or 56.2%, from $54.6 million in 1999 to $85.3 million in 2000. In 2000, sales of our automotive glass film increased $2.5 million, or 14.1%, primarily due to a two-year supply agreement signed with Saint Gobain. Our sales of electronic display film increased $29.6 million, or 163.5%, principally as a result of revenue from Mitsubishi and other customers, partially offset by a loss of sales to a customer who adopted an alternative manufacturing solution. Our sales of architectural product decreased $1.4 million, or 7.3%, primarily due to the use of our production machines to produce product for automotive glass customers.

        Costs of sales.    Cost of sales increased $28.4 million, or 69.8%, from $40.7 million in 1999 to $69.1 million in 2000. Cost of sales for 1999 was 74.5% of net revenues compared to 81.0% of net revenues for 2000. The increase in the percentage of cost of sales to net revenues resulted from additional processing costs attributable to electronic display film production in 2000. It was also affected by the lower production yields on a new production machine in Tempe. Non-recurring start-up expenses in our Dresden facility for new plant and equipment and staffing also added $2.1 million to cost of sales in 2000.

        Gross profit and gross margin.    Gross profit increased $2.4 million, or 17.3%, from $13.9 million in 1999 to $16.3 million in 2000. Gross margin declined from 25.5% in 1999 to 19.1% in 2000. The

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increase in the percentage of cost of sales to net revenues resulted from additional processing costs attributable to electronic display film production in 2000. It was also affected by the lower production yields on a new production machine in Tempe. Non-recurring start-up expenses in our Dresden facility for new plant and equipment and staffing added $2.1 million to cost of sales.

Operating expenses

Research and development.    Total research and development expenses increased $1.5 million, or 28.8%, from $5.2 million in 1999 to $6.7 million in 2000. Research and development expenses, as a percentage of net revenues, decreased from 9.5% for 1999 to 7.9% for 2000. The percentage decrease in these expenses was the result of the increase in net revenues from 1999. The increase in research and development expense was primarily attributable to costs associated with an increase in research and development staff, and costs incurred in testing and preparing for commercial production a production machine (PM 6) located in our Tempe facility and another production machine (PM 8) located in our Dresden facility.

Selling, general and administrative.    Selling, general and administrative expenses increased $3.9 million, or 44.8%, from $8.7 million in 1999 to $12.6 million in 2000. Selling, general and administrative expenses, as a percentage of net revenues, decreased from 15.9% in 1999 to 14.8% in 2000. The primary reason for the decline in these costs as a percentage of sales was due to the increase in 2000 revenue of 56%. The increase in costs was the result of non-recurring legal, accounting and temporary labor costs incurred in the preparation of restated financial statements and other filings. We also incurred increased rents in Palo Alto and increased administrative expenses in Dresden. Travel and communication expenses also increased as additional sales personnel devoted increased time to international sales.

Legal settlement.    We incurred costs of $0.5 million in legal settlements related to a product liability claim in 1999 and $0.5 million in an employee practices claim in 2000.

        Income (loss) from operations.    Loss from operations increased $3.1 million from a loss of $0.5 million for 1999 to a loss of $3.6 million for 2000. Our larger loss in 2000 was primarily due to non-recurring costs to restate our financial statements, start-up costs for our Tempe and Dresden facilities, higher cost of sales, and increased rent expense.

        Interest expense, net.    We incurred net interest expense of $1.3 million in 1999 and $2.8 million in 2000, and capitalized interest of $1.2 million in 1999 and $1.8 million in 2000 incurred in connection with construction in process. This increase was primarily due to borrowings to finance construction of new production machines and facilities and working capital requirements.

        Other income, net.    We recorded other income of $0.1 million in 1999, compared with $0.3 million for 2000. We did not incur a foreign currency loss in 1999 and incurred a foreign currency loss of $0.1 million in 2000.

        Income (loss) before provision for income taxes.    We reported a pre-tax loss of $1.8 million for 1999 compared to a pre-tax loss of $6.1 million for 2000. Our higher loss in 2000 was primarily due to start-up costs in Tempe and Dresden, lower gross margins due to increased production costs, non-recurring expenses to restate our financial statements, increased rent at our Palo Alto facility, and higher interest expense due to increased debt.

Liquidity and Capital Resources

Liquidity

        Our cash and cash equivalents increased by $3.3 million from $0.1 million at December 31, 2000 to $3.4 million at December 31, 2001. At March 31, 2002, our cash and cash equivalents were $2.7 million. We increased cash from operating activities by $12.6 million from $1.2 million in 2000 to $13.8 million in 2001. We reduced cash used in investing activities by $7.2 million from $12.9 million in 2000 to

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$5.7 million in 2001. During the first quarter of 2002, we used $0.4 million of cash in investing activities as compared to $0.9 million of cash provided by investing activities during the first quarter of 2001, a difference of $1.3 million. We increased cash from financing activities by $10.0 million in 2000 and used cash to reduce debt by $5.6 million in 2001. During the first quarter of 2002, $1.0 million of cash was provided by financing activities as compared to $2.6 million of cash used in financing activities during the first quarter of 2001, an increase of $3.6 million. As a result of our compliance with various loan covenants and obtaining waivers from Teijin and the Japanese bank for the Japanese bank loan, $13.8 million and $14.5 million of long term debt was classified as noncurrent at March 31, 2002 and December 31, 2001, respectively. Accordingly, we reduced our working capital deficit from $32.1 million at December 31, 2000 to $6.5 million at December 31, 2001 and to $5.0 million at March 31, 2002. We reduced our total liabilities from $60.3 million at December 31, 2000 to $46.7 million at December 31, 2001 and to $44.8 million at March 31, 2002. Stockholders' equity increased from $20.1 million at December 31, 2000 to $26.5 million at December 31, 2001 and to $28.3 million at March 31, 2002.

        In 2001, we had net cash of $13.8 million provided by operating activities, which consisted primarily of depreciation of $6.0 million, net income of $4.6 million, a reduction of $4.3 million in accounts receivable and a reduction of $4.0 in inventory, partially offset by a reduction of $4.6 million in accounts payable. Cash provided by our operating activities was also increased as a result of average accounts receivable outstanding decreasing from 61 days in 2000 to 43 days in 2001, and inventory turns increasing from 6.6 in 2000 to 8.7 in 2001. While we generated significant cash in 2001 from a reduction in receivables and inventory, receivables and inventory increased during the first quarter of 2002. We do not expect to generate significant cash from a reduction in receivables or inventory in 2002 or in future years, especially if our sales volume increases. During the first quarter of 2002, we used $0.9 million of cash in operating activities as compared to $2.2 million of cash generated from operating activities during the first quarter of 2001, a decrease of $3.1 million. The decline in cash from operating activities during the first quarter of 2002 was primarily the result of an increase in accounts receivable and inventory and a reduction in accounts payable, partially offset by net income, compared to a loss in the first quarter of 2001.

        We entered into an agreement with the Saxony government in May 1999 under which we receive investment grants. As of 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 our fixed assets of our Dresden manufacturing facility. During 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 our fixed assets of our Dresden manufacturing facility. We received an additional $2.1 million in investment allowances from the Saxony government in 2001, and we 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 our fixed assets of our Dresden manufacturing facility. Additionally, we have received $0.9 million of Saxony government grants that have been recorded as an advance until we earn the grant through future 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 will 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			LIBOR+1.0	%(2)		7,500	$	2,500
	German bank loan dated May 12, 1999			6.13	%(3)		2,321		225
	German bank loan dated May 28, 1999			7.10	%(4)		2,196		—
	German bank loan dated May 28, 1999			3.75	%		1,129		188
	German bank loan dated July 25, 2000			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 19, 2000			7.50	%		190		52
	German bank loan dated December 18, 2000			7.50	%		208		57
	Note payable dated September 21, 2001			8.00	%		520		450
	Other equipment financings			—			207		68
		Total term debt					18,112		3,920
Capital leases:
		Sale-leaseback dated July 19, 1999		13.00	%		2,321		2,321
		Sale-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 equal to 0.88% per month 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 these accounts receivable.

(2)

As of March 31, 2001, the interest rate on this loan was 3.16%.

(3)

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

(4)

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

        At December 31, 2000, we were in default under our German bank loans, our sale-leaseback agreement and the guarantee by Teijin of the Japanese bank loan. Accordingly, all borrowings outstanding under the Japanese bank loan, the German bank loans, sale-leaseback agreement were classified as current liabilities on our balance sheet at December 31, 2000.

        At December 31, 2001 and March 31, 2002, we were not in compliance with certain of the covenants of the guarantee by Teijin of the Japanese bank loan. We have received waivers 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 waivers are conditioned on our agreement to prepay $2.5 million of the debt with the proceeds of this offering. Accordingly, the non-current portion of the amount outstanding under the loan of $5.0 million has been classified as a long-term liability on our balance sheet at December 31, 2001 and March 31, 2002.

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        As of March 31, 2002, we were in compliance with the covenants under our German bank loans. As a result, of the total $9.9 million outstanding under those loans as of March 31, 2002, we classified $8.7 million, which is the amount due after March 31, 2002, as a long-term liability.

        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. An agent purporting to act on behalf of the leasing company has recently filed suit against us to recover the unpaid lease payments and alleged residual value of the machines. The leasing company holds a security interest in the production machines and may be able to repossess those machines. As a result, we have classified all $3.3 million outstanding under those agreements net of $1.0 million of the amounts due from the leasing company that was not funded, as current portion of long-term debt 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 government allowances previously received by us. In February 2002, the Saxony government extended the date by which we must comply with these targets to June 2006.

Equity transactions

        In April 2001, we raised $1.0 million from the sale of 422,119 shares of common stock to Globamatrix. In addition, the exercise of stock options and employee purchases under our employee stock purchase plan generated cash proceeds to us of $0.7 million during 2001.

Capital expenditures

        We spent $12.9 million for capital expenditures in 2000, of which $9.8 million was invested in our Dresden facility and $3.1 million was invested in our Tempe and Palo Alto facilities for leasehold improvements, computer equipment and improvements to our production machines. Of the $9.8 million invested in our Dresden facility, $7.0 million represented progress payments on our two new production machines (PM 8 and PM 9). We financed our capital expenditures in Dresden primarily through $4.0 million of German bank loans, the release of $2.6 million of cash restricted by the Saxony government, and $1.0 million of subsidies from the Saxony government.

        During 2001, we spent $5.9 million for capital expenditures, primarily for production equipment and computer resources. In the fourth quarter of 2001, we placed an order to purchase PM 10 for our Dresden facility, to be paid for by progress payments beginning in 2001 through 2003, when the machine is expected to become operational. We do not currently have financing in place to purchase a new production machine and expect to fund this purchase through a combination of investment allowances from the Saxony government, cash from operating activities, borrowings from German banks, and a portion of the proceeds from this offering.

        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.

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        Our future payment obligations on our borrowings pursuant to our term debt, capital lease obligations, line of credit and noncancellable operating leases at December 31, 2001 were as follows (in thousands):

	Payments Due by Period
Contractual obligations	Total		Less than 1 year		1-3 years		4-5 years		After 5 years
Term debt	$	19,061	$	4,548	$	7,446	$	1,558	$	5,509
Financing lease obligations		3,767		3,767		—		—		—
Line of credit		2,974		2,974		—		—		—
Operating leases		10,229		3,601		5,678		950		—
Other long-term obligations		—		—		—		—		—
Total contractual cash obligations	$	36,031	$	14,890	$	13,124	$	2,508	$	5,509

        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 or in order for us to respond to unforseen technological, marketing or other problems, or to take advantage of unanticipated opportunities. To fully implement our business plan, we will need to raise additional capital from external sources.

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 continue to explore a number of alternative equity transaction proposals to meet or supplement our working capital and capital expenditure needs. 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.

Qualitative and Quantitative Disclosure about Market Risk

Financing risk

        Our exposure to market rate risk for changes in interest rates relates primarily to our term loan, specifically our loan from Sanwa Bank, which is tied to the London Interbank Offered Rate, 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. In addition, the interest rate on one of our German loans will be reset to the prevailing market rate in 2004 and on another of our German loans will be reset to the prevailing market rate in 2009. Fluctuations or changes in interest rates may adversely affect our expected interest expense. The effect of a 10% fluctuation in the interest rate on our loan from Sanwa Bank would have an effect of less than $25,000 and $10,000 on our interest expense for year ended December 31, 2001 and the quarter ended March 31, 2002, respectively. The effect of interest rate fluctuations during 2001 and 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 income than expected if interest rates fall. The effect of a 10% fluctuation in the interest rate of any floating

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rate securities would have had an adverse effect of less than $25,000 for the quarter ended March 31, 2002.

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% was 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 had an effect of approximately $0.1 million.

Recent Accounting Pronouncements

        In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations." SFAS No. 141 addresses financial accounting and reporting for business combinations and supersedes Accounting Principles Board ("APB") Opinion No. 16, "Business Combinations," and SFAS No. 38, "Accounting for Preacquisition Contingencies of Purchased Enterprises." SFAS No. 141 requires applicable business combinations to be accounted for using one method, the purchase method. The provisions of SFAS No. 141 apply to all business combinations initiated after June 30, 2001. We do not expect that the adoption of SFAS 141 will have a significant effect on our financial position or results of operations.

        In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets," which is effective for fiscal years beginning after March 15, 2001. SFAS No. 142 requires, among other things, the discontinuance of goodwill amortization. In addition, the standard includes provisions upon adoption for the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the testing for impairment of existing goodwill and other intangibles. We do not expect the adoption of SFAS 142 will have a significant effect on our financial position and results of operations.

        In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations," which addresses financial accounting and reporting for obligations related to the retirement of tangible long-lived assets and associated asset retirement costs. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. We do not expect that the adoption of SFAS 143 will have a significant effect on our financial position or results of operations.

        In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This Statement supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," and the accounting and reporting provisions of APB 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" for the disposal of a segment of a business. The provisions of SFAS No. 144 are required to be adopted during our fiscal year beginning January 1, 2002. We do not expect that the adoption of SFAS 144 will have a significant effect on our financial position or results of operations.

        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. We do not believe that the adoption of this statement will have a material effect on our consolidated financial statements.

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BUSINESS

        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 and plasma displays; transparent conductive films for use in touch screen and liquid crystal displays; energy control films for architectural glass; and various other coatings. Based upon our production capacity, we believe we are one of the world's largest producers of sputter-coated, flexible thin film products.

Industry Background

        Large area, single layer, thin film coatings were developed in the early 1960s using vacuum evaporation, a less precise precursor to sputter coating. As a result of technological developments in the early 1970s, multi-layer coatings for large substrates became possible. Sputtering based on these developments is used today in a large number of applications in which high quality, uniform coatings need to be deposited on large surfaces or on many smaller surfaces simultaneously. Examples of sputter coating include the deposition of various metal and metal oxide layers on wafers in the semiconductor and hard disk industries, and optical coatings on transparent surfaces in the automotive glass, electronic display, and architectural markets.

        Thin film coatings are used in a wide variety of surface applications to control the transmission and reflection of light and the flow of energy. Thin film coatings can modify the transmission and reflection of both visible and non-visible light, such as infrared and ultra-violet light, to enhance the performance and characteristics of the surface.

Thin film process technologies

        The three most common methods for commercially producing thin film coatings on glass and flexible substrates are:

•

Wet coating. The wet coating process generally involves depositing a thin layer of material onto glass by a spin coating technique or onto a flexible substrate, or film, by a number of different methods. In the case of spin coating, which is sometimes used for computer display tubes, or CDTs, a small amount of liquid is placed at the center of a spinning CDT, forcing the liquid from the center towards the outside edge. Once a uniform thin layer of liquid is thus applied, the layer is bake-dried at a moderate temperature. In the case of film coating, a thin layer of liquid material is applied to the surface of plastic film and then dried by means of thermal or direct radiation. This process is generally less expensive than sputter-coating, but generally yields coatings with lower quality, optical and mechanical characteristics.

•

Direct coating onto glass substrates. Direct coating onto glass can be accomplished by sputtering and by pyrolytic means. Direct-to-glass sputtering is a mature, well-known process for applying thin film coatings to glass. This technology is commonly used to manufacture products that conserve energy in buildings. Pyrolytic coatings are formed directly on the glass as it is produced on a float line. The process uses the heat of the molten glass to make a single layer, metal oxide coating from a solution sprayed onto the glass. Because this technique produces only single layer coatings, the solar performance is limited.

•

Sputter coating onto flexible film substrates. The sputter coating process, which is the process we primarily employ, deposits a thin layer of materials, generally metals and metal oxides, onto the surface of a flexible substrate, usually polyester. The substrate can then be either laminated in or applied to glass or suspended between panes of glass. The substrate can be applied to both flat glass and curved glass, such as is used in automotive applications.

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        The thin film coating process begins with a clear base substrate that is typically glass or a flexible polyester film. When using a flexible film, a hard coat is sometimes applied to prevent undesired interactions between the materials to be deposited and the base substrate, as well as improve the mechanical properties of the coating. Various materials are then deposited in very thin layers on the substrate. The process of building up the various layers results in a "stack." The stack consists of layers of materials that produce the desired optical and performance effects. In some applications, primarily with flexible films, adhesive or protective layers may be applied to the substrate to improve the subsequent application of the product onto a rigid substrate, such as glass.

Our Markets

        Primary markets for the thin film coated substrates that we manufacture are the automotive glass, electronic display and the architectural markets. Advances in manufacturing processes coupled with improved thin film deposition technologies in the automotive glass and electronic display markets are reducing production costs, allowing thin film coated substrates to more cost-effectively address these markets.

Automotive glass products

        Thin film coated substrates we sell in this market reflect infrared heat. These coatings allow carmakers to use more glass and increase energy efficiency by reducing the demand on a vehicle's air conditioning system, as well as improving thermal comfort in the vehicle. Thin film coated substrates in this market are sold primarily to original equipment manufacturers, or OEMs, that produce glass for sale to European manufacturers of new cars and trucks for worldwide distribution. These substrates are also sold to independent glass manufacturers as part of a large aftermarket for replacement automobile glass. In addition, thin film coated substrates for retrofit application to the inside surface of a vehicle window are sold through resellers who install the film.

        Nearly all automotive glass in the world uses some degree of tint or coloration to absorb light and solar energy, thus reducing solar transmission into the vehicle. This tint is usually created through the mixing of inorganic metals and metal oxides into the glass as the glass is produced. The cost of adding these materials is very low, but the solar control benefit is limited by the fact that solar energy is absorbed in the glass, causing the glass to heat up which eventually increases the temperature of the inside of the automobile.

        Based on the most recent report with respect to the worldwide production of flat glass by the Freedonia Group, an independent market research company, we believe approximately 7.2 billion square feet of glass were installed in motor vehicles in 1999. This amount consists of approximately 5.5 billion square feet of glass in new motor vehicles and 1.7 billion square feet of replacement glass.

        The use of thin films in the automotive glass market is being driven primarily by:

•

Incorporation of new features into conventional automotive glass based on newly-developed thin film products;

•

Growing demand for glass that rejects higher levels of solar heat, thereby improving occupant comfort and performance and extending lifetimes of leathers, fabrics and plastics used for automotive interiors;

•

Desire for smaller air conditioning systems that improve fuel efficiencies and reduce tailpipe emissions; and

•

Increasing adoption of laminated door glass for automobiles which offers security, safety, acoustic and ultra-violet protection benefits.

        We began volume production for this market in 1996, and we estimate that in 2001 our coated substrates were used in less than 1% of the total worldwide automotive OEM glass produced.

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Electronic display products

        Thin film coated substrates we sell in this market primarily reduce glare caused by reflection from glass surfaces, improve contrast and image quality, and reduce energy emission from and build up of static charge on the computer display screen. Our thin film coated substrates are used in cathode ray tubes, or CRTs, liquid crystal and plasma displays, and in applications such as touch screens, wireless telephones and automated teller machines. We recently started shipping production quantities and sizes of a new anti-reflective film specifically designed for the liquid crystal display and plasma display panel markets. The combined worldwide market for 17 inch and 19 inch flat screen computer display tubes and active matrix liquid crystal displays used for computer and handheld applications is anticipated to grow from approximately 75 million units in 2000 to 155 million units in 2005, according to a 2001 study by Stanford Resources, Inc., an independent market research firm. Considering the two categories separately, the market for 17 inch and 19 inch flat screen computer display tubes is expected to shrink from approximately 45 million units in 2000 to 37 million units in 2005, and the market for active matrix liquid crystal displays used for computer and handheld applications is expected to grow from approximately 30 million units in 2000 to 118 million units in 2005.

        The use of thin films in the electronic display market is increasing primarily due to:

•

Growing consumer demand for displayed information, driven largely by the availability of information and entertainment on the internet, as well as strong growth in the sales of wireless and portable communication devices; and

•

The introduction of new products incorporating thin film technology, including active matrix liquid crystal and plasma display screens used in industrial and consumer products.

        We began commercial production for the electronic display market in 1996. We estimate that in 2001, our coated substrates were applied to approximately 4% of the products in the 17 inch and 19 inch worldwide, flat screen CRT market, based on information from Stanford Resources, Inc.

Architectural products

        Thin film coated substrates we sell in this market are primarily used to control the transmission of heat through window glass, as well as to limit ultra-violet light damage. Window glass is a poor thermal barrier. The primary source of heat build-up and loss in buildings is through the glass windows.

        According to the Freedonia Group, the worldwide market for new and replacement glass sold for use in residential buildings is expected to increase from approximately 5.2 billion square feet in 1999 to approximately 8.0 billion square feet in 2009. Also, according to Freedonia, the market for new and replacement glass sold for use in commercial buildings is expected to increase from approximately 16.2 billion square feet in 1999 to approximately 25.4 billion square feet in 2009.

        The use of thin films in the architectural market is driven by:

•

Increasing energy conservation concerns;

•

Increasing amounts of new and replacement glass sold for use in residential buildings; and

•

Increasing amounts of new and replacement glass sold for use in commercial buildings.

        Our original business, in which we began volume production in 1979, focused on this market. In 2001, we estimate that our products were used in less than 1% of the glass used worldwide in residential and commercial buildings.

Market trends

        The needs of our customers and end-users are driving the evolution of the thin film coating industry. Our coated products enhance the performance of their finished products.

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        Trends in the automotive glass market include:

•

Advanced automotive designs. New automotive glass designs, such as larger and more steeply sloped windows, have resulted in increased heat build-up and ultraviolet damage in automobiles, which can be reduced by thin film coatings.

•

Expanded applications. Automobile manufacturers are looking for ways in which thin film coatings can support new windshield features such as electrical defrost and antenna functions, including receipt of radio, GPS satellite signals and wireless communications. The use of thin film coatings to electrically heat the glass is dependent on the development and adoption of new, more powerful, 42 volt electrical systems as compared to current 14 volt systems. According to a 2001 report by DRI-WEFA, an independent market research company, it is anticipated that 35% of the cars and light trucks produced in North America, Europe and Japan will have a 42 volt electrical system by 2010.

•

Door glass and rear glass. Most automobile manufacturers today use two separate pieces of glass laminated together to form "safety glass" only in the windshield. The door glass and the rear glass are typically made of a single piece of tempered, or heat treated, glass. Automobile manufacturers are presently adopting laminated door glass and rear glass because of the security, safety, acoustic, and ultra-violet protection benefits. We believe that this trend in the automotive glass business offers opportunities to introduce solar heat control as an additional option to these pieces of glass. We believe that the demand for laminated door glass in Europe is expected to grow from less than 2 million parts in 2001 to more than 5 million parts by 2006, of which approximately 50% is expected to contain a solar control coating.

        Trends in the electronic display market include:

•

Commercialization of flat panel technologies. The adoption of advanced display technologies such as liquid crystal and plasma displays, which require thin film coated substrates.

•

Preference for higher resolution displays. An increasing portion of the electronic products industry is moving to higher resolution displays, which are enhanced by advanced thin film technologies.

•

Reduction of harmful or undesirable emissions. Electronic product manufacturers are seeking ways to mitigate electromagnetic and infrared interference, driving the need for coatings that can reduce undesirable or potentially harmful radiation emissions by reflecting them back into the display without affecting functionality of the display.

        Trends in the architectural market include:

•

Enhanced efficiency. Demand for heating and cooling efficiency have driven the need for thin film coatings that provide energy savings. These concerns include controlling solar radiation, improving the efficiency of air conditioning, and offering insulating properties that reduce heat loss in cold climates and heat gain in hot climates while reducing ultra-violet damage.

•

Growth of remodeling market. Remodeling of existing structures has increased the use of more modern materials, including the use of glass that increases thermal and ultra-violet protection and provides insulation from noise.

Our Solution

        Our coated films solve our customers' need to improve the performance and competitiveness of their finished products. Our coated products offer a number of benefits to the end-use customers:

•

Improved thermal comfort in automobiles, homes, and office buildings;

•

Reduced eye-strain from prolonged use of electronic displays;

•

Blockage of potentially damaging solar and electromagnetic radiation from natural and electronic environments; and

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•

Improved energy efficiency for transportation vehicles and buildings, which reduces costs and consumption of fossil fuels.

        Our products are sold as large rolls, measuring up to approximately 7 feet wide by 20,000 feet long. The weight and extended shelf-life of these rolls allow for easy and inexpensive shipping and storage of product with our customers.

        We believe our competitive advantages include:

•

Proprietary thin film sputtering process knowledge and control systems;

•

Extensive thin film materials expertise and optical design capabilities;

•

Over twenty years' experience providing large quantities of sophisticated coatings on flexible film for demanding applications and customers;

•

The world's largest installed base of coating machinery for application of sputter coatings to flexible film;

•

Our new, state-of-the-art coating facility in a low-cost labor environment, with significant financial support from local and federal governments in Germany;

•

Substantial expertise and technical support in the areas of product testing, reliability, and applications;

•

Rapid product development capabilities on small, proprietary research systems prior to commercial production;

•

Key strategic relationship with a large Japanese chemical company for electronic materials supply in Asia;

•

Close working relationship with our key substrate supplier; and

•

International patent portfolio covering a broad range of products.

Our Strategy

        Our strategy is to enhance our position as a global developer, manufacturer and marketer of thin film coatings on flexible substrates for the automotive glass, electronic display, and architectural markets. The following are key elements of our strategy:

Increase penetration and expand customer base in the automotive glass market

        During 2000 and 2001, we expanded our production capacity primarily through the opening of our manufacturing facility in Dresden. As a result, we are working to expand the sale of our products to automotive glass suppliers for new cars. We are also introducing new products into the automotive glass markets. These products have better thermal performance characteristics than and have a different look from our existing products. We expect these products will position us to expand our business in Europe and attract new customers in the U.S. We also expect these products will be included in some vehicles beginning in 2003. Vehicles using our sputtered thin film coated products include models by European automakers Audi, BMW, Mercedes, Volvo, Peugeot-Citroen and Renault. Our thin film coated products are sold to these car makers through the two largest automotive glass suppliers operating in Europe, Saint Gobain and Pilkington PLC. We are also working with other glass manufacturers in Europe to expand our customer base. In addition, we intend to target other major OEMs in the automotive glass industry in Japan, North America and South America to similarly integrate our products into their glass components. We will also seek to develop relationships with companies that specialize in the replacement of automobile glass.

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Increase production capacity in the automotive glass and architectural markets

        Currently, two production machines (PM 8 and PM 9) in Dresden are commercially producing films and a third production machine (PM 10) is scheduled to be installed there and begin commercial production by the first quarter of 2003. These production machines will primarily produce films for the European automotive glass market but will be capable of manufacturing film for the architectural markets as well. In addition, this increase in our production capacity for automotive films in Europe has created additional capacity on our other production machines located in Palo Alto and Tempe.

Use expanded production capacity and new products to increase sales in the architectural market

        To take advantage of our expanded production capacity, we plan to increase our marketing and sales activities in 2002 to seek additional customers in the architectural market. We are also focused on the introduction of several new products to the architectural marketplace. New products for both suspended Heat Mirror films as well as laminated XIR® films are envisioned for release this year. These new products will increase the thermal insulation value of insulating glass made with our films and will improve the solar protection offered by laminated glass incorporating our films. As a result of enhanced sales activities and new products, we anticipate interest from a number of potential customers in North America and Europe. Significant orders, however, are not expected from these potential customers in 2002.

Capitalize on expanding flat panel display market

        We will endeavor to create and maintain a competitive position in the production of thin film coated substrates for the flat panel display market, which we expect will grow substantially over the next five years. We intend to increase our share of this market by:

•

Working closely with dominant manufacturers in the sector to successfully integrate our solutions into their products;

•

Continuing to invest to develop anti-reflective coatings on substrates used by liquid crystal display, or LCD, manufacturers; and

•

Pursuing the processing of our films to add certain properties internally, rather than through third party subcontractors.

        We seek to acquire a larger share of the growing LCD market by establishing relationships with LCD manufacturers and materials suppliers to provide thin film coatings for more of their products. Further, we will devote resources towards the development of additional coatings and processes to address the broader anti-reflective film market. For example, we recently started shipping production quantities and sizes of a new anti-reflective film specifically designed for the LCD and plasma display panel markets that maintains optical clarity while reducing the reflection of ambient light to improve image quality.

Continue to advance thin film production technology

        We are focusing on developing new technologies to enhance the capabilities of thin film products and enhance the efficiency of the production of thin film products. For example, we are commercializing a deposition technique for our optical coatings called plasma enhanced chemical vapor deposition, or PECVD. This is commonly used in the semiconductor and disk drive industries for deposition of active, interconnected elements or magnetic materials. The attractiveness of this technique is its high deposition rate and the potentially lower material cost for the coatings, as compared to sputtering. A production machine (PM 7) based on this technology is currently installed at our Tempe facility and is expected to begin commercial production in the second half of 2002. Coatings for the automotive and architectural product lines, may be produced by PECVD in the future.

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Technology

        In a sputtering process, a solid target and a substrate are placed in a vacuum chamber. By adding a small amount of process gas, typically argon, to the chamber and negatively charging the target, the process gas is ionized and a plasma discharge is formed. The positively charged gas ions strike the solid target with enough force to eject atoms from its surface. The ejected target atoms condense on the substrate and a thin film coating is constructed atom by atom. By placing a magnet behind the target, the electrons in the ionized plasma are confined to a specific region on the target enhancing the creation of ionized gas atoms and increasing the efficiency of the target atom ejection process. By using different targets as the substrate moves through the vacuum chamber, we can create a multi-layered coating, or stack.

        If the process gas is inert, such as argon, the coating will have the same composition as the target material. As an example, many of our coatings have a layer of silver in the stack. However, by adding a reactive gas such as oxygen or nitrogen to the process, it is possible to create metal oxide or metal nitride coatings from a metal target.

        The advantages of our sputtering process include the high density of the formed coatings and the high degree of uniformity control that we can achieve.

        While predominantly relying on sputter coating technology, we are actively developing new technologies and processes such as PECVD. The PECVD technique uses a gas rather than a solid target as the base material for the coating. The gas in the deposition chamber is excited into a very reactive plasma, using the energy from a microwave source mounted onto the chamber. A chemical reaction involving the excitement of gas molecules at the surface of the substrate then creates the thin film coating. In the past, this technique lacked the uniformity control necessary to make it useful for optical coatings, where uniformities of a few percent are required. New developments in this area have improved PECVD uniformity levels to the point that PECVD can now be explored for optical coatings. We plan to employ our new PECVD technology in one of our production machines (PM 7) in Tempe. However, since this system embodies a completely new technology, we expect and have budgeted for a much slower start-up of this system compared to our standard sputter coating systems. This system is also limited by its ability to process only rolls which are two feet wide or less.

        In addition to the vacuum-based deposition techniques described above, we have developed the ability to deposit wet chemistry based coatings under atmospheric conditions. In this technique, the active component of the thin film is in a solution and is applied to the substrate by rotating cylinder. After applying the wet film, the substrate is heated, evaporating the solvent and leaving a thin film of the active component behind. In Tempe, this technology is used to apply an anti-smudge coating on top of our sputtered anti-reflective films. The function of the anti-smudge coating is to make the final product more resistant to fingerprints and to make it easier to clean. Other coatings can be applied through this technique as well, and programs are in place to develop adhesive coatings and other coatings that enhance the mechanical durability of our products.

        We rely extensively upon trade secrets and know-how to develop and maintain our competitive position. We have 29 patents and seven patent applications pending in the United States and 39 patents and more than 50 patent applications pending outside the United States that cover materials, processes, products and production equipment. Of our existing patents, two U.S. patents and three international patents will expire in the next three years. We also seek to avoid disclosure of our know-how and trade secrets through a number of means, including requiring those persons with access to our proprietary information to execute nondisclosure agreements with us. We consider our proprietary technology, as well as its patent protection, to be an important factor in our business.

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Products

        The following table describes the markets into which we sell our products, the applications of our products, our product families, key features of our various products and representative customers.

MARKET	APPLICATION	FILM PRODUCTS	KEY FEATURES	REPRESENTATIVE CUSTOMERS
Automotive glass	Windscreens, side windows, and back windows	Infrared reflective (XIR 70 and XIR 75)	• Transmits 70% or 75% visible light • Reflects 85% of infrared heat energy	• Saint Gobain • Pilkington PLC
	After-market installation	Solis/V-KOOL	• Transmits 70% or 75% visible light • Reflects 85% of infrared heat energy	• Globamatrix
Electronic display	Flat screen monitors and TVs	Anti-reflective absorbing (ARA)	•Pigmented film • 8X reduction in light reflection • High picture quality	• Mitsubishi • Polar Vision
	Liquid crystal display (LCD) screens	Anti-reflective clear (ARC)	• Clear anti-reflective product	• Sumitomo Chemicals • Polar Vision
	LCD reflector for lighting sources	Silver reflecting	• 95% Reflecting • Light-weight mirror	• Mitsui Chemicals • Marubeni
	Plasma display panels (PDP)	Infrared reflective (XIR 70) Anti-reflective clear (ARC)	• Clear and Conductive • Clear infrared blocking	• Mitsui Chemicals
Architectural	New and retrofit residential and commercial windows and doors	Suspended Heat Mirror	• Cool in summer • Warm in winter • UV blocking • Noise reducing	• Kensington • Hankuk • Hurd • Edge Seal
	Commercial buildings	Laminated (XIR70 HT)	• Infrared reflecting • UV blocking • Cool in summer • Noise reducing	• Gulf Glass Industries • Cristales Curvados
	After-market installation	Solis/V-KOOL	• Infrared reflecting • UV blocking • Cool in summer • Noise reducing	• Globamatrix

Automotive glass products

        Direct-to-glass sputtering for automotive windshields is not well developed because of the need to bend the glass before it can be coated and then applied to an automobile. Coating flat glass and then bending it to match complex automobile designs is also difficult due, in part, to the stress on the coating during the bending, heating and cooling process. However, coating flat glass and then bending it is the method currently used by most glass producers. Sputter coated flexible substrates that we produce can be applied to windshields with different curvatures and incorporated into most in-line

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windshield production process used by glass companies today. Our net revenues from sales of automotive glass products were $19.5 million in 1999, $20.2 million in 2000, $37.4 million in 2001 and $7.0 million in the first quarter of 2002.

        Infrared reflective films.    Our XIR coated solar-control films are a transparent, sputter-coated, polyester films used in laminated glass for automobiles. The films have a patented, transparent solar-control coating on one side and a proprietary adhesion-promotion layer on the other.

        Applied solar-control films.    Our Solis/V-KOOL solar-control films for aftermarket installation for automotive glass utilizes our XIR technology. The product is applied to existing windows and has a protective hard coat over the patented, transparent solar-control coating on one side and the adhesion layer on the other. Solis/V-KOOL is sold through a worldwide distribution network of companies owned by or affiliated with Globamatrix.

Electronic display products

        Our sputter coated substrates offer the high optical quality necessary for higher resolution electronic displays. Our substrates can be easily cut into different shapes and sizes, providing increased flexibility for our customers. In addition, our products can effectively reduce undesirable or potentially harmful emissions without affecting the resolution of the display. Our net revenues from sales of electronic display products were $16.0 million in 1999, $47.7 million in 2000, $29.7 million in 2001 and $7.9 million in the first quarter of 2002.

        Anti-reflective films.    Our anti-reflective films minimize reflection of visible light and electromagnetic radiation while allowing high picture quality. Our anti-reflective absorbing, or ARA, films are pigmented and used in flat screen monitors. Our anti-reflective clear, or ARC, films are clear and used in LCD screens.

        Silver reflecting films.    Our light-weight silver reflecting film is a mirror-like product used as a reflector in LCD backlit screens.

        Transparent conductors.    XIR films are used in the plasma display panel markets to block near-infrared and electromagnetic radiation from the display. Our ALTAIR-M films are used in products such as touch panels, liquid crystal displays and electroluminescent displays where the circuit or conductive material must not obscure the screen. ALTAIR films are also used in electromagnetic interference shielding, infrared rejection and electrostatic discharge packaging applications.

Architectural products

        Windows containing our Heat Mirror product have approximately two to five times the insulating capacity of conventional double-pane windows. They also provide high levels of solar shading while transmitting a high percentage of visible light. In addition, our products also offer ultra-violet protection and reduce noise and condensation build-up. Architectural glass manufacturers are looking for ways to improve insulation without adding numerous panes of glass that are impractical to lift and cannot be supported by a structure's frame. This drives the need for thin film inside the glass that is a high performance insulator at a fraction of the weight of the glass. Our net revenues from sales of architectural products were $19.1 million in 1999, $17.4 million in 2000, $15.9 in 2001 and $4.3 million in the first quarter of 2002.

        Suspended Heat Mirror films.    Our Heat Mirror films provide a variety of shading and insulating properties as well as ultra-violet damage protection. Windows are the primary areas of heat loss in winter and a major source of heat gain in summer. Heat Mirror films, which are sold in rolls to window manufacturers, are suspended in the airspace between sealed double-pane residential and commercial windows. We have developed proprietary film-mounting technology, which we license to window fabricators. There are a total of 66 Heat Mirror licenses in approximately 20 countries. We currently offer 12 different Heat Mirror films for architectural applications.

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        Laminated films.    Our thin film coated flexible substrates are laminated between panes of glass and perform similarly to our XIR solar control films for automobiles. This film is currently sold primarily to fabricators of laminated window glass for large commercial building applications such as airports, office buildings, and museums. We have sold a total of 20 licenses for this architectural film product in approximately 15 countries.

        Applied solar-control films.    Our XIR coating for architectural applications is Solis/V-KOOL solar-control films for the architectural glass aftermarket. This product is applied to existing windows and has a protective hard coat over the patented, transparent solar-control coating on one side and an adhesion layer on the other. Solis/V-KOOL is sold through a worldwide distribution network of companies owned by or affiliated with Globamatrix.

Sales and Marketing

Distribution channels

        We sell our automobile and electronic display products primarily to OEMs in North America, Europe, the Middle East and Asia, principally through our own direct sales force and sales representatives. Mitsui Chemicals is our licensee and distributor for certain of our electronic products in Japan and Taiwan. Mitsui also has exclusive manufacturing rights for certain of our electronic products in Japan using our proprietary sputtering technology.

        We supply our Heat Mirror architectural products to approximately 66 insulated glass and window fabricators and distributors worldwide. Our proprietary mounting technology is licensed to our customers, who use special equipment for the manufacture of Heat Mirror-equipped windows. Our field services organization assists customers in the manufacture of Heat Mirror-equipped windows. In North America, we also promote our Heat Mirror product line through approximately 30 regionally based architectural glass sales representatives.

        We sell our Solis/V-KOOL aftermarket products for the automotive glass and architectural markets through a worldwide distribution network of companies owned by or affiliated with Globamatrix.

        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 principal foreign markets for our products in 2001 were Japan ($26.8 million), France ($19.8 million), Germany ($8.6 million) and Singapore ($6.4 million).

Warranties

        We offer warranties on our products which we believe are competitive for the markets in which those products are sold. The nature and extent of these warranties depend on the product, the market, and in some cases the customer being served. We carry liability insurance. However, our insurance does not cover warranty claims and there can be no assurance that our insurance will be sufficient to cover all product liability claims in the future or that the costs of this insurance or the related deductibles will not increase materially.

Customers

        Our customers include many of the world's leading OEMs in the automotive glass and electronic display markets. Our customers in the OEM automotive glass market include Saint Gobain and Pilkington PLC, which sell glass to automobile manufacturers including DaimlerChrysler, Renault, Audi, BMW, Volvo, Volkswagen and the PSA Group (which includes Peugot and Citroen). We currently have a supply agreement with Saint Gobain that runs throughs 2003 and may be renewed by mutual consent of the parties. Under the Agreement, Saint Gobain committed to purchase set amounts of product. Our failure to produce the required amounts of products under the agreement will result in price penalties on future sales under the agreement.

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        Our customers in the electronic display market include Mitsubishi Electric Corporation and Mitsui Chemicals. Our customers in 2001 in the architectural market included approximately 83 fabricators of insulated glass units and laminated glass for architectural applications.

        Our aftermarket applied film in the automotive and architectural glass markets is sold pursuant to an exclusive worldwide license in our distribution agreement with Globamatrix. Under the Agreement, which is scheduled to expire in 2011, Globamatrix agreed to purchase an aggregate of approximately $200.0 million of our products during the term of the agreement subject to volume and quality standards. Our failure to produce required amounts of product under the agreement will result in penalties under which we would be required to reimburse Globamatrix for the full cost of any product not timely delivered.

        A small number of customers have accounted for a substantial portion of our revenues. Our ten largest customers accounted for approximately 69%, 85%, 85% and 85% of our net sales in 1999, 2000, 2001 and the first quarter of 2002, respectively. During the first quarter of 2002, Pilkington, Mitsubishi, Mitsui and Saint Gobain accounted for 10.8%, 20.9%, 14.6% and 20.9%, respectively, of our net sales. During 2001, Pilkington, Mitsubishi and Saint Gobain accounted for 15.8%, 21.2% and 23.9%, respectively, of our net sales. During 2000, Saint Gobain, Mitsubishi and Samsung accounted for 14.1%, 37.3% and 12.2%, respectively, of our net sales; and during 1999, Saint Gobain and Pilkington accounted for 18.0% and 11.7%, respectively, of our net sales. Because of our fixed costs, the loss of, or substantial reduction in orders from, one or more of these customers would have a material adverse affect on our profitability and cash flow. The timing and amount of sales to these customers depends on sales levels and shipping schedules for the OEM products into which our products are incorporated. We have no control over the shipping dates or volume of products shipped by our OEM customers, and we cannot be certain that they will continue to ship products that incorporate our products at current levels or at all. In addition, we rely on our OEM customers to timely inform us of opportunities to develop new products that serve end-user demands.

Research and Development

        Our research and development activities are focused upon the development of new proprietary products, thin film materials science, and deposition process optimization and automation. Our research and development expenditures totaled $5.2 million, $6.7 million, $5.5 million and $1.8 million, or approximately 9.6%, 7.9%, 6.6% and 9.3% of total net revenues, during 1999, 2000, 2001 and the first quarter of 2002, respectively.

        Historically, our research and development efforts have been driven by customer requests for the development of new applications for thin film coated substrates. To meet the future needs of our customers, we continually seek to improve the quality and functionality of our current products and enhance our core technology. For example, we recently started shipping production quantities and sizes of a new anti-reflective film specifically designed for the liquid crystal display and plasma display panel markets that maintains optical clarity while reducing the reflection of ambient light to improve image quality. We are also working to develop a heatable automobile windshield using our XIR film capable of de-icing, defrosting and demisting the windshield, thus improving cold start visibility and reducing the need to scrape ice from the windshield. In addition, we are working with MegaWave Corporation to build a prototype antenna for integration into an automobile windshield which would be capable of receiving and transmitting radio, GPS and wireless telephone signals. However, we cannot guarantee that we will be successful in developing or marketing these applications.

        Although our production systems are built by outside vendors, we work closely with our vendors on the detailed implementation of the production machine designs. Our experience with designing production systems is critical for the proper construction of these machines. Once a new machine is installed and accepted by us, our engineers are responsible for transitioning the system into commercial production to help ensure stable manufacturing yields.

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Manufacturing

        The table below provides information about our current and proposed production machines and the class of products that each is currently tooled to produce.

Status	Machine Number	Location	Primary Markets For Current Production	Year Commercial Production Initiated/ Expected	Estimated Annual Capacity (Millions of Sq. Ft.)(1)
Existing	PM 1(2)	Palo Alto	Research and development	1980	—
	PM 2	Palo Alto	Architectural and electronic display	1982	6.0
	PM 3(3)
	PM 4A	Palo Alto	Automotive and architectural	1991	12.0
	PM 4B	Palo Alto	Automotive and architectural	1991	12.0
	PM 5	Tempe	Electronic display	1997	6.5
	PM 6	Tempe	Automotive and electronic display	2000	13.0
	PM 7(4)	Tempe	Electronic display	2002	3.0
	PM 8	Dresden	Automotive	2000	16.0
	PM 9	Dresden	Automotive	2001	16.0
Future	PM 10(5)	Dresden	Automotive	2003	16.0

⁽¹⁾

Estimated annual capacity represents our estimated yields based on our historical experience and anticipated product mix. The amount of product for which we receive orders and which we actually produce in any year may be materially less than these estimates.

⁽²⁾

Beginning in 2002, we intend to use PM 1 primarily for research and development rather than commercial production.

⁽³⁾

We sold PM 3 to an unrelated third party in 1995.

⁽⁴⁾

We expect this production machine, which uses PECVD-based technology, to be in commercial production by the third quarter of 2002. This machine will be used primarily to apply the final coating on electronic display products produced on our other machines.

⁽⁵⁾

We have ordered PM 10 and expect it to be installed and begin commercial production by the first quarter of 2003.

        We also have two small-scale sputtering machines in Palo Alto which are used for pre-production qualification and limited production, when they are not used for their primary research and development function. In Tempe, we also employ a wet coating and laminating machine, which is used to apply various topcoats and adhesives, and for lamination of liner films.

        We recently received ISO 9001/1994 certification of all of our U.S. production facilities. In addition, our Dresden facility has received ISO 9001/2000 certification.

Environmental Matters

        We use hazardous materials in our research and manufacturing operations and have air and water emissions that require controls. As a result, we are subject to stringent federal, state and local regulations governing the storage, use and disposal of wastes. We contract with outside vendors to collect and dispose of waste at all of our production facilities in compliance with applicable environmental laws. In addition, we have in place procedures that we believe enable us to deal properly with the gasses emitted in our production process, and we have implemented a program to monitor our past and present compliance with environmental laws and regulations. Although we believe we are currently in material compliance with such laws and regulations, current or future laws and regulations may require us to make substantial expenditures for compliance with chemical exposure, waste treatment or disposal regulations.

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Suppliers and Subcontractors

        We manufacture our products using materials procured from third-party suppliers. We obtain certain of these materials from limited sources. For example, we believe the substrates we use in the manufacture of the Heat Mirror product is currently available from one qualified source, Teijin Limited, holder of approximately 7.8% of our common stock as of May 23, 2002. The substrates used in the manufacture of our anti-reflective film are currently available from only two qualified sources, Teijin and Dai Nippon Printing. The loss of these current sources could adversely affect our ability to meet our scheduled product deliveries to customers. In each case, alternative sources of supply are being pursued; however, it takes approximately 18 to 24 months for us to qualify a new supplier and we may not be able to successfully develop alternative sources of supply.

        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. 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.

        Furthermore, our production machines are large, complex and difficult to design and assemble. 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 limited number of companies that are capable of manufacturing these machines to our specifications. Our inability in the future to have new production machines manufactured and prepared for commercial production in a timely manner would have a material adverse effect on our business.

Backlog

        Our backlog primarily consists of purchase orders for products to be delivered within 90 days. As of April 1, 2001 and March 31, 2002, we had a backlog of orders able to be shipped over the next 12 months of approximately $24.4 million and $15.8 million, respectively. None of these orders are firm orders and all are subject to cancellation. For these reasons, these orders may not be indicative of our future revenues.

Competition

        The thin film coatings industry and the markets in which our customers compete experience rapid technological change, especially the electronic display market. Adoption by our competitors of new equipment or process technologies could adversely affect us. We have a number of present and potential competitors, including our customers, many of which have greater financial resources and greater selling, marketing and technical resources than we possess.

        Automotive glass market.    Solar control products in the automotive OEM market are provided by large, worldwide glass laminators who typically have divisions also selling products to the commercial flat glass industry. Several of these companies, such as PPG, Pilkington PLC, Saint Gobain, Asahi, Guardian, and Glaverbel, have direct-to-glass sputtering capability. In the applied film segment of the automotive market, companies such as 3M, Bekeart, CP Films (a subdivision of Solutia), and Lintec Inc. produce competitive solar control products that are widely accepted in the market. In addition, during 2001, 3M entered the automotive solar control market with an all-polymer film. Although this non-metalic film has the advantage of being completely corrosion resistant, its many layers may delaminate. We may also be subject to future competition from companies that are able to infuse glass with solar control properties. We estimate that in 2001 our coated substrates were used in less than 1% of the total worldwide automotive OEM glass produced.

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        Electronic display market.    Competitors in the electronic display market include companies developing new coatings, such as wet coatings, for flat panel displays, as well as competitors who supply sputter coated films similar to those produced by us. Customers' selection of anti-reflective products is driven by quality, price and capacity. In addition, some of our current and potential customers are capable of creating products that compete with our products. We estimate that in 2001 our coated substrates were applied to approximately 4% of the products in the 17 inch and 19 inch worldwide, flat screen CRT market.

        Architectural market.    Products that provide solar control and energy conservation have been available to this market for almost 20 years. Since our introduction of our Heat Mirror suspended film product in 1979, large glass producers such as Guardian, PPG, Appogee, Glaverbel, and Asahi, have produced their own direct-to-glass sputtered products that provide solar control and energy conservation similar to our Heat Mirror product. We estimate that in 2001 our coated substrates were used in less than 1% of the glass used worldwide in residential and commercial buildings.

Basis of competition

        We believe we compete principally on the basis of:

•

Proprietary thin film sputtering process knowledge and control systems;


•

Our extensive thin film materials expertise and optical design capabilities;


•

The world's largest installed base of coating machinery for application of sputter coatings to flexible film;


•

Our new, state-of-the-art coating facility in a low-cost labor environment, with significant financial support from local and federal governments in Germany; and


•

Our ability to easily alter the format of our products, providing our customers with inventory versatility and higher production yields.

Employees

        As of May 15, 2002, we had 288 full-time employees, of whom 40 were engaged in engineering, 191 in manufacturing, and 57 in selling, general management, finance and administration. We are highly dependent upon the continuing services of certain technical and management personnel. None of our employees is represented by a labor union. We consider our employee relations to be good.

Properties

        Our administrative, marketing, engineering and manufacturing facilities are located in five buildings totaling approximately 119,000 square feet in Palo Alto, California, and one building of approximately 55,000 square feet in Tempe, Arizona. The buildings in Palo Alto are occupied under leases that expire from 2002 to 2005, with options to extend some of these leases for terms expiring through 2009. The lease for the building in Tempe expires in 2007, with options to extend through 2017. We own our new 60,000 square foot building in Dresden, which we took possession of in May 2000.

Legal Proceedings

        We are a defendant in an action entitled "Portfolio Financial Servicing Company v. Southwall Technologies Inc.," which was filed in state court in Utah on May 22, 2002. This action arises out of sale-leaseback agreements which we entered into with an entity formerly known as Matrix Funding Corporation, or Matrix, in 1999 in connection with the acquisition of two of our production machines. Matrix thereafter filed bankruptcy proceedings. In the action, the plaintiff claims to be an agent of the successor to Matrix. The plaintiff demands payment of $6,468,534, which it alleges constitutes unpaid

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lease payments, plus the alleged residual value of the equipment, less monies that Matrix owes to us. We intend to defend the action vigorously.

        We are a defendant in an action filed on April 5, 1996 entitled "Four Seasons Solar Products Corp. vs. Black & Decker Corp., 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. We filed a motion to dismiss. The Court has dismissed the unfair competition and fraudulent concealment claims against us. It has denied our motion to dismiss the breach of contract claim. We believe the claim to be without merit.

        In October 2000, we were served with a complaint entitled Hurd Millwork, Inc. v. Southwall Technologies Inc., et. al., United States District Court, Northern District of California, Case No. C00-3820 (CRB). Hurd is a manufacturer of insulated glass units which incorporate Heat Mirror film. Hurd alleged that various failures and deficiencies associated with the insulated glass units gave rise to warranty and other consumer claims. We have reached a settlement with the plaintiff, the terms of which are confidential. The cash portion of the settlement was paid by our insurance carriers. We have also provided a discount on the price of future film sales as part of the settlement.

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

        Our 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. We 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 we 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 judgment has been accrued at December 31, 2001 as additional construction costs.

        Our counsel has received a letter from a lawyer purporting to represent a manufacturer of skylights that allegedly incorporates our Heat Mirror film. The letter alleges that a sealant provided by a third party and used with our film was defective, and as a result the manufacturer and others similarly situated have suffered elevated warranty replacement claims and costs. The letter states that the manufacturer will bring legal action in the form of a class action lawsuit if the parties are unable to resolve the matter promptly. We believe the allegations to be without merit and intend to defend any subsequent action vigorously.

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

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MANAGEMENT

Executive Officers and Directors

        The names, ages and positions of our current directors and executive officers are as follows:

Name	Age	Position
Thomas G. Hood	46	President, Chief Executive Officer and Director
Robert R. Freeman	59	Senior Vice President, Chief Financial Officer and Secretary
Sicco W. T. Westra	51	Senior Vice President, Sales and Marketing
Wolfgang Heinze	52	Vice President, Dresden Operations
Nasser A. Lama	41	Vice President, U.S. Operations
Bruce M. Lairson	40	Vice President and Chief Technology Officer
John Lipscomb	52	Corporate Controller
Joseph B. Reagan(1)(2)	66	Chairman, Board of Directors
Bruce J. Alexander(2)	57	Director
Tadahiro Murakami(2)	60	Director
Robert C. Stempel(1)	68	Director
Walter C. Sedgwick(1)	54	Director

(1)

Member of the audit committee.

(2)

Member of the human resources committee.

Thomas G. Hood has served as Southwall's President and Chief Executive Officer since July 1998 and as a member of the board of directors of Southwall since March 1998. From March 1998 until July 1998, he served as Interim President and Chief Executive Officer. From July 1996 to March 1998, he served as Senior Vice President, General Manager, Energy Products Division. From January 1995 to July 1996, he was Vice President, General Manager, International Operations, and from October 1991 to January 1995, he was Vice President, Marketing and Sales. He is the inventor of record on ten of Southwall's patents. Mr. Hood has an MS degree in Mechanical Engineering from New Mexico State University.

Robert R. Freeman has been Senior Vice President, Chief Financial Officer and Secretary of Southwall since September 2000. From May 1999 to June 2000, he served as Senior Vice President and Chief Financial Officer of Rosendin Electric, Inc. From August 1993 to April 1999, he served as Senior Vice President and Chief Financial Officer of Helix Electric, Inc. Mr. Freeman has an MBA from the University of Southern California.

Sicco W. T. Westra has been Senior Vice President, Sales and Marketing of Southwall since May 2002. From August 1998 to May 2002, he served as our Senior Vice President, Engineering and Chief Technical Officer. From February 1998 until August 1998, he served as the Director of Global Production Management for Applied Materials, Inc. From March 1994 to August 1998, he served as a Manager of Business Development for BOC Coating Technology, Inc. Dr. Westra holds a PhD. from the University of Leiden in the Netherlands.

Wolfgang Heinze joined Southwall in January 1999 as Plant Manager of our Dresden factory. In December 2000, Mr. Heinze was promoted to the position of Vice President, Dresden Operations. Prior to joining Southwall, Mr. Heinze had been the Chief Executive Officer of FUBA Printed Circuits, GMBH from February 1991 to April 1998. Mr. Heinze has a MD of Commercial Science from the Technical University in Merseburg, Germany.

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Nasser A. Lama joined Southwall in September 1999 as Plant Manger of our Palo Alto factory. He was promoted to Vice President, U.S. Operations in March 2000. Prior to joining Southwall, Mr. Lama was Vice President of Operations of Ink Jet Technology, a subsidiary of FrancoTyp-Postalia, from March 1998 to March 2000. From August 1994 to March 1998, he was Director of Operations of Akashic Memories. Mr. Lama has an MS degree in Mechanical Engineering from Memphis State University.

Bruce M. Lairson joined Southwall in August 2001 as Director of New Products Engineering. In May 2002, he was promoted to the position of Vice President and Chief Technology Officer. Prior to joining Southwall, Mr. Lairson had been the Engineering Project Manager at Maxtor Inc. from June 2000 to July 2001. From March 1999 to June 2000, he served as a Director of Development at Komag Inc. and Ultracard Inc. From December 1997 to April 1999, he served as the Director of Advanced Technology at Western Digital Inc. Mr. Lairson holds a ME in Applied and Engineering Physics from Cornell University and a MS and PhD in Materials Science from Stanford University.

John Lipscomb has been Vice President, Corporate Controller since November 2000. From March 1996 to November 2000, he served as a Finance Director with Informix Software and with ABB LTD. From June 1988 to February 1996, he served in various senior level financial management positions with Apple Computer. Mr. Lipscomb has a B.A. degree in Accounting from the University of Massachusetts at Amherst.

Joseph B. Reagan has served as a member of our board of directors since June 1993 and as Chairman of the board of directors since May 2000. He previously served as a director from October 1987 through May 1992. Dr. Reagan is a technology and senior management consultant to industry and to the United States Government. He retired in 1996 after 37 years with the Lockheed Martin Corporation where he was a Corporate Vice President and General Manager of the Research and Development Division of the Missiles and Space Company. Dr. Reagan holds a PhD in Space Science from Stanford University.

Bruce J. Alexander has served as a member of our board of directors since May 1981. In April 1999, he joined Needham & Company, Inc., an investment bank, as a Managing Director. From June 1997 until April 1999, he served as President and Chief Executive Officer of Black & Company, an investment bank. From May 1994 to June 1997, he was with Needham & Company, Inc., serving as a Managing Director. From January 1992 to May 1994, he was a General Partner with Materia Ventures, L.P., a venture capital firm investing in advanced materials companies. From March 1987 to July 1991, he was President and Chief Executive Officer of Southwall. From February 1982 to March 1987, he held various positions with Southwall, including Executive Vice President, Vice Chairman of the Board, Chairman of the Board, acting Chief Executive Officer, and Chief Financial Officer.

Tadahiro Murakami has served as a member of the board of directors of Southwall since May 2000. He is the Assistant to the President of Teijin-Bayer Polytec Ltd., a subsidiary of Teijin Limited. From April 1999 until May 2000, he served as President of Teijin-Bayer Polytec Ltd. From February 1997 until April 1999, he served as Director of the Plastics Division for Teijin DuPont Films, a subsidiary of Teijin Limited, and was the General Manager of the Sales Department for Teijin DuPont Films from December 1994 until February 1997.

Robert C. Stempel has served as a member of our board of directors since May 2000. He is Chairman of Energy Conversion Devices, Inc. (ECD), an energy and information company headquartered in Troy, Michigan. Mr. Stempel retired as Chairman and Chief Executive Officer of General Motors Corporation in November 1992. He was named Chairman and Chief Executive Officer in August 1990. Prior to serving as Chairman, he had been President and Chief Operating Officer of General Motors since September 1987.

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Walter C. Sedgwick has served as a member of our board of directors since January 1979. Mr. Sedgwick has been a private investor since 1994.

Board of Directors

        Our board of directors is comprised of six directors. Each director serves for a one-year term. In connection with Teijin's guarantee of a loan to us in the original principal amount of $10.0 million, we have agreed to use our best efforts to elect a Teijin nominee to our board of directors.

        Our board of directors has an audit committee and a human resources committee. Messrs. Reagan, Alexander and Murakami are the members of the human resources committee. The human resources committee is authorized to make and review periodically recommendations regarding employee compensation, and to perform other duties regarding compensation for employees as the board of directors may direct. The human resources committee is also authorized to administer our stock option plans.

        Messrs. Reagan, Stempel and Sedgwick are the members of the audit committee. The audit committee is responsible for reviewing the results and scope of audits and other services provided by our independent public accountants, and reviewing our system of internal accounting and financial controls. The audit committee also reviews other matters with respect to our accounting, auditing and financial reporting practices and procedures as it deems necessary or desirable.

Director Compensation

        We pay each of our non-employee directors, other than the Chairman, an annual fee of $7,000 for their services as a director. We pay an annual fee of $30,000 to the Chairman. The directors' fees are payable in shares of our common stock at the director's option. In addition, each non-employee director receives $1,000 plus expenses for each board meeting attended. Non-employee directors also receive a fee of $500 for each board meeting held via teleconference. Non-employee directors who serve on committees of the board, other than committee chairmen, also receive $600 for each committee meeting attended. Committee chairmen receive $750 for each committee meeting attended.

        Directors may also receive options under our 1997 stock incentive plan. During 2001, we granted options to non-employee directors to purchase the following number of shares, all at an exercise price of $2.81 per share: Dr. Reagan, 24,000 shares; Mr. Alexander, 7,000 shares; Mr. Murakami, 7,000 shares; Mr. Sedgwick, 7,000 shares; and Mr. Stempel, 7,000 shares. For a summary of the option grants we made to Mr. Hood in 2001, please see "Executive Compensation-Option Grants in Last Fiscal Year" below.

        We pay no other compensation to our directors in respect of their services as directors.

Compensation Committee Interlocks and Insider Participation

        Our human resources (compensation) committee is composed of Joseph B. Reagan, Tadahiro Murakami and Bruce J. Alexander. Neither Dr. Reagan nor Mr. Murakami has at any time since our formation been an officer or employee of Southwall. From February 1982 to July 1991, Mr. Alexander held various positions with us, including Executive Vice President, Vice Chairman of the Board, Chairman of the Board, Chief Executive Officer and Chief Financial Officer. Mr. Alexander is a Managing Director of Needham & Company, Inc., a managing underwriter for this offering. In his capacity as a Managing Director of Needham & Company, Inc., Mr. Alexander may be deemed to benefit indirectly from the underwriting commission to be paid by us to the underwriters in connection with in this offering. None of our executive officers currently serves, or in the past has served as a member of the board of directors or compensation committee of any entity that has one or more executive officers serving on our board of directors or human resources committee.

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Executive Compensation

        The following summary compensation table sets forth the total compensation paid or accrued for services rendered in 2001, 2000 and 1999 by our chief executive officer and each of our four other most highly compensated executive officers (the "named executive officers"):

	Annual Compensation					Long-Term Compensation Awards
Name and Principal Position	Year	Salary(1)		Bonus(1)		Stock Underlying Options(#)	All Other Compensation(2)
Thomas G. Hood President and Chief Executive Officer	2001 2000 1999	$	270,000 265,192 257,288	$	123,571 19,120 —	50,000 28,550 125,000	$	1,000 1,000 1,000
Robert R. Freeman(3) Senior Vice President, Chief Financial Officer and Secretary	2001 2000 1999		200,000 58,462 —		62,071 — —	35,000 50,000 —		1,000 1,000 —
Sicco W. T. Westra Senior Vice President, Sales and Marketing	2001 2000 1999		195,000 176,144 177,817		50,821 12,620 —	30,000 17,300 12,000		1,000 1,000 1,000
Wolfgang Heinze(4) Vice President, Dresden Operations	2001 2000 1999		175,910 133,874 45,257		70,545 86,659 5,570	— 5,000 20,000		— — —
Ted L. Larsen(5) Vice President, Sales and Marketing Electronic Display Products	2001 2000 1999		176,110 174,446 138,280		41,474 920 296	20,000 6,500 5,000		1,000 1,000 1,000

(1)

The amounts listed under Salary and Bonus include amounts deferred pursuant to our 401(k) Plan.

(2)

The amounts listed under "All Other Compensation" for 1999, 2000 and 2001 consist of our matching contributions under our 401(k) Plan.

(3)

Mr. Freeman joined us in September 2000 as Senior Vice President, Chief Financial Officer and Secretary.

(4)

Mr. Heinze joined us in January 1999 and was promoted to the position of Vice President, Dresden Operations in December 2000.

(5)

Mr. Larsen retired in April 2002.

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Option Grants In Last Fiscal Year

        The following table shows information concerning each stock option we granted to the named executive officers during our fiscal year ended December 31, 2001.

							Potential Realizable Values at Assumed Annual Rate of Stock Price Appreciation for Option Term(3)
	Number of Shares Underlying Options Granted(1)	Percent of Total Options Granted to Employees in 2001
Name				Exercise Price Per Share(2)		Expiration Date
							5%		10%
Thomas G. Hood	50,000	9.2	%	$	3.71	1/24/2011	$	116,660	$	295,639
Robert R. Freeman	35,000	6.5			2.81	1/24/2011		61,907		156,884
Sicco W. T. Westra	30,000	5.5			2.81	1/24/2011		53,055		134,453
Wolfgang Heinze	—	—			—	—		—		—
Ted L. Larsen	20,000	3.7			2.81	1/24/2011		35,375		89,648

(1)

Option grants were made under our 1997 stock incentive plan. The options granted to Messrs. Freeman, Westra and Heinze vest in four equal annual installments, beginning one year after the grant date. The options granted to Mr. Hood vested in seven equal annual installments, beginning one year after the grant date and were subject to acceleration if we met certain earnings targets. We met these targets as of December 31, 2001, and Mr. Hood's options became fully vested. In the event of certain corporate transactions such as an acquisition or sale of our assets, the outstanding options of our named executive officers will become immediately exercisable for fully vested shares of common stock, unless the options are assumed or substituted with a comparable option by the acquiring company or its parent. In any event, our human resources committee may accelerate the vesting of outstanding options upon certain corporate transactions or involuntary terminations following a corporate transaction.

(2)

We granted all options at an exercise price per share equal to the fair market value of the common stock on the date of grant. The exercise price may be paid in cash or cash equivalents, in shares of the underlying common stock valued at fair market value on the exercise date or in a same-day sale program with the assistance of a designated brokerage firm.

(3)

The potential realizable values at assumed 5% and 10% annual rates of compounded stock price appreciation for the terms of the options are based on the fair market value or deemed fair market value of the common stock used by us for accounting purposes, as applicable, and do not represent our estimates or projections of our future stock prices. Actual gains, if any, on stock option exercises will be dependent on the future performance of our common stock.

Aggregated Option Exercises In Last Fiscal Year and Fiscal Year-End Option Values

        The following table sets forth information concerning option exercises and unexercised stock options for our fiscal year ended December 31, 2001 with respect to each named executive officer. We determined the value of unexercised in-the-money options by calculating the difference between the exercise price per share payable upon exercise of these options and the closing price of our common stock on the Nasdaq National Market at December 31, 2001, which was $7.15 per share. The value realized has been calculated by determining the difference between the exercise price per share paid

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upon exercise of the options and the closing price of our common stock on the Nasdaq National Market on the date of exercise of the options.

				Number of Securities Underlying Unexercised Options at December 31, 2001
						Value of Unexercised In-the-Money Options at December 31, 2001
Name	Shares Acquired On Exercise	Value Realized
				Exercisable	Unexercisable	Exercisable		Unexercisable
Thomas G. Hood	7,500	$	1,875	137,266	168,750	$	259,253	$	377,381
Robert R. Freeman	—		—	12,500	72,500		24,300		224,713
Sicco W. T. Westra	—		—	49,550	59,750		123,676		188,004
Wolfgang Heinze	—		—	11,250	13,750		36,430		41,290
Ted L. Larsen	5,625		1,406	47,150	28,750		107,480		102,358

1997 Stock Incentive Plan and 1998 Stock Option Plan for Employees and Consultants

        In May 1997, we adopted the 1997 stock incentive plan and reserved an aggregate of 400,000 shares of our common stock for issuance under the plan. The shares reserved for issuance under the plan automatically increase at the beginning of each year by 250,000. As of May 23, 2002, options to purchase a total of 1,401,859 shares of common stock were outstanding under the plan. The plan is administered by the human resources committee of the board of directors. The human resources committee has the authority to construe and interpret the plan and any agreement made under the plan, grant awards and make all other determinations necessary or advisable for administration of the plan.

        In August 1998, we adopted the 1998 stock option plan for employees and consultants and reserved an aggregate of 250,000 shares of our common stock for issuance under the plan. The shares reserved for issuance under the plan automatically increase at the beginning of each year by 150,000. As of May 23, 2002, options to purchase a total of 694,345 shares of common stock were outstanding under the plan. The plan is administered by the human resources committee. The human resources committee has the authority to construe and interpret the plan and any agreement made under the plan, grant awards and make all other determinations necessary or advisable for the administration of the plan.

1997 Employee Stock Purchase Plan

        In March 1997, our board of directors and stockholders adopted the 1997 employee stock purchase plan. We initially reserved 100,000 shares of our common stock for issuance under this plan. In May 2000, the board of directors and stockholders approved the reservation of an additional 29,904 shares for issuance under the plan. In May 2001 and April 2002, the board of directors approved the reservation of an additional 95,096 shares and 100,000 shares, respectively, for issuance under the plan. Our stockholders approved these increases at our 2002 annual stockholders meeting.

Severance Policy

        We have a severance policy that covers all of our officers, including the named executive officers other than Ted Larsen, who retired in April 2002, and some of our key employees, under which they may become entitled to special benefits in connection with certain changes in control of Southwall affected by merger, liquidation or tender offer.

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        Under the policy, each named executive officer will become entitled to a lump sum severance payment upon his involuntary termination within 24 months after a change in control. The cash payment will be equal to (i) in the case of our chief executive officer, two times the sum of the chief executive officer's annual rate of base salary in effect at the time of his or her involuntary termination plus the bonuses earned by him or her for the immediately preceding fiscal year or (ii) in the case of the other named executive officers, between one and one and one-half times, as determined by our board of directors, the sum of the officer's annual rate of base salary in effect at the time of his or her involuntary termination plus the bonuses earned by him or her for the immediately preceeding fiscal year.

        In the event benefits had become due as of May 22, 2002 under the severance policy currently in effect, the maximum cash amounts payable would be as follows: Mr. Hood, $540,000; Mr. Freeman, $300,000; Mr. Westra, $264,000; and Mr. Heinze, $232,500.

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RELATED PARTY TRANSACTIONS

Teijin

        On April 9, 1997, we signed a set of agreements with a major supplier of our raw materials, Teijin Limited. The agreements provided for, among other things, the purchase by Teijin of 667,000 shares of our common stock at a price of $7.50 per share; a guarantee by Teijin of a $10.0 million loan to us by a Japanese bank; and an agreement to collaborate on increasing marketing and product development ties between the two companies. We pay an annual loan guarantee fee to Teijin of 0.5625% of the outstanding principal balance of the loan guaranteed by Teijin. We paid a loan guarantee fee of approximately $57,344, $56,875 and $53,000 to Teijin during 1999, 2000 and 2001, respectively. As of March 31, 2002, $7.5 million was outstanding under the loan guaranteed by Teijin. Pursuant to letter agreements dated March 28, 2002 and May 9, 2002, between us and Teijin, we are obligated to repay $2.5 million of the loan guaranteed by Teijin with the proceeds of this offering. See "Use of Proceeds."

        Also, we have agreed to use our best efforts to elect a Teijin nominee to our board of directors. Mr. Hideo Nakamori, President and CEO of Metton America, Inc., a subsidiary of Teijin, was appointed to our board of directors in May 1999 and served as a member of the board until May 2000. Mr. Tadahiro Murakami, the Assistant to the President of Teijin-Bayer Polytec Ltd., a subsidiary of Teijin, was appointed to our board of directors in May 2000. During 2001, we paid Teijin approximately $9.0 million for purchases of raw material substrates.

Globamatrix

        We have a distribution agreement with Globamatrix under which we granted it an exclusive world-wide license to distribute our after-market applied film in the automotive and architectural glass markets. Under the agreement, which is scheduled to expire in 2011, Globamatrix agreed to purchase an annually increasing amount of our products subject to volume and quality standards. Our failure to produce required amounts of product under the agreement will result in penalties under which we would be required to reimburse Globamatrix for the full cost of any product not timely delivered. During 1999, 2000 and 2001, respectively, we had $2.0, $2.2 and $5.6 million in sales to Globamatrix under a prior distribution agreement.

        On April 20, 2001, Globamatrix purchased 422,119 shares of our common stock for $1.0 million (approximately $2.37 per share) pursuant to a stock purchase agreement. The closing price of our common stock on the Nasdaq National Market on April 19 and 20, 2001, was $2.10 and $2.19 per share, respectively. The shares were not registered under the Securities Act. Globamatrix holds registration rights with respect to the shares.

Transactions Involving Directors

        In April 1997, we entered into a development and technology agreement with Energy Conversion Devices, Inc., or ECD. Robert C. Stempel, a director of Southwall since May 2000, is the Chairman of ECD. This agreement provides that we will pursue with ECD the commercialization of the process of sputter coating on flexible substrates using PECVD techniques. The agreement further provides that we will pay ECD a royalty in an amount which is based upon the sales volume of product produced through PECVD techniques. We agree to pay to ECD 2.25% of net sales received by us in connection with PECVD technology for five years and 1.25% of net sales after that. To date, the process has not been commercialized and we have not paid ECD royalties under the agreement, but expect we will begin to pay royalties during 2002. In February 1999, we entered into an equipment purchase contract with ECD pursuant to which ECD agreed to modify one of our production machines (PM 7) so that the machine would produce our products by means of PECVD techniques. We paid ECD approximately $0.9 million in 1999, $0.01 million in 2000 and $0.3 million in 2001 in connection with its conversion of PM 7 to the use of PECVD technology. We owed ECD an additional $0.7 million at

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December 31, 2001 and $0.5 million at March 31, 2002 in connection with the conversion of PM 7, which is represented by a note payable. We have agreed under the note to pay ECD $0.05 million per month through December 2002, with a final payment of $0.07 million in January 2003. We have further agreed to attempt to procure for ECD a first priority security interest in PM 7.

        Bruce J. Alexander, one of our directors, is a Managing Director of Needham & Company, Inc., a managing underwriter for this offering. In this capacity, Mr. Alexander may be deemed to benefit indirectly from the underwriting commission to be paid by us to the underwriters in connection with this offering.

Loans to Officers and Directors

        During 1998, 1999, 2000 and 2001, we lent $43,875, $25,313, $0 and $18,750, respectively, to Thomas G. Hood, our President, Chief Executive Officer and a director, to permit him to exercise stock options that were about to expire at a time when he was not able to sell the shares issuable upon exercise to pay the exercise price. The indebtedness is represented by full recourse notes payable to us due on June 28, 2002 ($14,063), December 1, 2002 ($43,875), December 15, 2002 ($11,250) and February 13, 2003 ($18,750), each bearing interest at the rate of 7.0% per annum. The largest amount of indebtedness outstanding under these notes at any time during 2001 was $87,937. In addition, on March 8, 2002, we lent Mr. Hood an additional $14,700 to exercise additional options. This note is due March 8, 2003, and bears interest at 7.0% per annum. As of May 20, 2002, the aggregate amount of indebtedness under Mr. Hood's notes was $102,637.

        We believe that all transactions described above were made on terms no less favorable to us than would have obtained from unaffiliated third parties. Future transactions, if any, with our executive officers, directors and affiliates will be on terms no less favorable to us than could be obtained from unrelated third parties and will be approved by a majority of the board of directors and by a majority of our disinterested members of the board of directors.

62

PRINCIPAL AND SELLING STOCKHOLDERS

        The following table sets forth material information regarding beneficial ownership of our common stock as of May 23, 2002 by:

•

each person who we know to beneficially own more than 5% of our common stock;

•

each of our named executive officers;

•

each of our directors;

•

each selling stockholder; and

•

all executive officers and directors as a group.

        Except as noted below, the address of each person listed on the table is c/o Southwall Technologies Inc., 1029 Corporation Way, Palo Alto, California, 94303, and each person named has sole voting and investment power over the shares shown as beneficially owned, except to the extent authority is shared by spouses under applicable law.

		Percent of Common Stock Outstanding(1)
Name and Address of Beneficial Owner	Number of Shares(1)	Before Offering		After Offering(2)
Teijin Limited(3) 67, Minamihonmachi, 1-chome Chuoku, Osaka 541, Japan	667,000	7.8	%	5.5	%
Advisory Clients of Dimensional Fund Advisors, Inc. 1299 Ocean Avenue, 11th Floor Santa Monica, CA 90401	509,400	5.9		4.2
Globamatrix Holdings Pte. Ltd. 3 Science Park Drive 01-06 Singapore 118223	408,919	4.8		3.4
Joseph B. Reagan(4)	96,812	1.1		*
Bruce J. Alexander(5)	161,592	1.9		1.3
Tadahiro Murakami	11,750	*		*
Walter C. Sedgwick(6)	278,809	3.2		2.3
Robert C. Stempel(7)	11,750	*		*
Thomas G. Hood(8)	237,641	2.7		1.9
Robert R. Freeman(7)	21,250	*		*
Sicco W. T. Westra(7)	64,400	*		*
Wolfgang Heinze(7)	11,250	*		*
Ted L. Larsen(9)	58,975	*		*
All current executive officers and directors as a group (12 persons)(10)	1,057,369	11.5	%	8.3	%

*

Less than one percent.

(1)

The table is based upon information supplied by EquiServe and questionnaires received from the above directors and officers.

(2)

Does not assume the underwriters exercise the over-allotment option.

(3)

Tadahiro Murakami may be deemed a beneficial owner of the Teijin Limited shares under Rule 13d-3 of the Securities Exchange Act of 1934. Mr. Murakami disclaims beneficial ownership of such shares.

(4)

Includes options to purchase 64,496 shares that are exercisable within 60 days of May 23, 2002.

(5)

Includes options to purchase 26,420 shares that are exercisable within 60 days of May 23, 2002.

(6)

Includes options to purchase 55,744 shares that are exercisable within 60 days of May 23, 2002, 49,000 shares held in trust for Mr. Sedgwick's benefit, 17,272 shares held by Mr. Sedgwick's son and 3,000 shares held in trust for Mr. Sedgwick's children.

(7)

Consists of options that are exercisable within 60 days of May 23, 2002.

(8)

Includes options to purchase 198,516 shares that are exercisable within 60 days of May 23, 2002.

(9)

Includes options to purchase 44,650 shares that are exercisable within 60 days of May 23, 2002.

(10)

Includes options to purchase an aggregate of 613,415 shares that are exercisable within 60 days of May 23, 2002 and the shares held in trust described in note 6 above.

63

        If the underwriters' over-allotment option is exercised in full, we will sell an additional 500,000 shares of common stock and the selling stockholders identified below will sell an aggregate of 25,000 shares of common stock. The following table presents information regarding the selling stockholders' beneficial ownership of our common stock as of May 23, 2002 as adjusted to reflect the sale of common stock by us and each selling stockholder assuming the underwriters exercise the over-allotment option in full.

        Except as noted below, the address of each person listed on the table is c/o Southwall Technologies Inc., 1029 Corporation Way, Palo Alto, California, 94303, and each person named has sole voting and investment power over the shares shown as beneficially owned, except to the extent authority is shared by spouses under applicable law.

	Common Stock Beneficially Owned Prior to the Offering(1)				Common Stock Beneficially Owned After the Offering
				Common Stock to be Sold in the Offering
Name and Address of Selling Stockholders
	Number	Percent			Number	Percent
Sicco W. T. Westra(2)	64,400	*		25,000	39,400	*
All current executive officers and directors as a group (12 persons)(3)	1,057,369	11.5	%	25,000	1,032,369	8.2	%

*

Less than one percent.

(1)

The table is based upon information supplied by EquiServe and questionnaires received from the above officer.

(2)

Common stock beneficially owned prior to the offering consists of options that are exercisable within 60 days of May 23, 2002, 25,000 shares of which will be exercised and sold as part of this offering.

(3)

Common stock beneficially owned prior to the offering includes options to purchase an aggregate of 613,415 shares that are exercisable within 60 days of May 23, 2002, 25,000 of which will be sold as part of this offering.

64

DESCRIPTION OF CAPITAL STOCK

Authorized and Outstanding Capital Stock

        Upon the closing of this offering, our authorized capital stock will consist of 20,000,000 shares of common stock, par value $.001 per share and 5,000,000 shares of preferred stock, par value $.001 per share.

        The following summary description of the material provisions of our capital stock, as of the closing of this offering, is qualified by reference to the provisions of applicable law and to our restated certificate of incorporation filed as an exhibit to the registration statement of which this prospectus is a part.

Common Stock

        As of May 23, 2002, there were approximately 8,586,278 shares of our common stock outstanding and held of record by approximately 350 stockholders. Based upon the number of shares outstanding as of May 23, 2002 and giving effect to the issuance of the shares of common stock offered by Southwall hereby, but not the exercise of the underwriters' over-allotment option, there will be approximately 12,086,278 shares of common stock outstanding upon the closing of this offering. In addition, as of May 23, 2002, there were outstanding stock options to purchase a total of 1,929,004 shares of our common stock. Each share of common stock entitles its holder to one vote. The holders of common stock do not have cumulative voting rights in the election of directors and have no preemptive rights to subscribe for additional shares of our capital stock.

Preferred Stock

        As of May 23, 2002, there were no shares of our preferred stock outstanding. Our preferred stock may be issued in one or more series and our board of directors is authorized without stockholder approval to determine or alter the rights, preferences, privileges and restrictions to be granted or imposed on any series of our preferred stock.

Anti-Takeover Provisions of Our Organizational Documents and Delaware Law

        Our restated certificate of incorporation and by-laws and the Delaware General Corporation Law contain certain provisions that could discourage, delay or prevent a change in control of Southwall or our acquisition at a price which many stockholders may find attractive. The existence of these provisions could limit the price that investors might be willing to pay for our common stock.

Certificate of Incorporation and By-Laws

        Certain provisions of our restated certificate of incorporation and by-laws, which will be in effect after the closing of this offering, might discourage, delay or prevent a change of control or a change in our management, even if such changes would be beneficial to our stockholders. The most important provision is the ability of our board of directors, without stockholder approval, to issue any class or series of preferred stock with dividend rights, dividend rates, conversion rights, redemption rights, preferences on liquidation or dissolution, voting rights and any other preferences, which could adversely affect the voting power of the holders of common stock. The existence of this provision could limit the price that investors might be willing to pay for our common stock and could deprive you of an opportunity to receive a premium for your common stock as part of a sale.

Effect of Delaware Anti-Takeover Statute

        We are subject to Section 203 of the General Corporation Law of Delaware which, subject to some exceptions, prohibits a publicly held Delaware corporation from engaging in any business combination

65

with any interested stockholder for a period of three years following the date that the stockholder became an interested stockholder.

        Section 203 does not apply if:

•

prior to that date, the board of directors of the corporation approved either the business combination or the transaction which resulted in the stockholder becoming an interested stockholder;



•

upon consummation of the transaction which resulted in the stockholder becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced, excluding for purposes of determining the number of shares outstanding those shares owned by persons who are directors and also officers and by employee stock plans in which employee participants do not have the right to determine confidentially whether shares held subject to the plan will be tendered in a tender or exchange offer; or



•

on or subsequent to such date, the business combination is approved by the board of directors and authorized at an annual or special meeting of stockholders, and not by written consent, by the affirmative vote of at least two-thirds of the outstanding voting stock which is not owned by the interested stockholder.

        The application of Section 203 may limit the ability of stockholders to approve a transaction that they may deem to be in their best interests.

        Section 203 defines "business combination" to include:

•

any merger or consolidation involving the corporation and the interested stockholder;



•

any sale, transfer, pledge or other disposition of 10% or more of the assets of the corporation to or with the interested stockholder;



•

subject to some exceptions, any transaction which results in the issuance or transfer by the corporation of any stock of the corporation to the interested stockholder;



•

any transaction involving the corporation which has the effect of increasing the proportionate share of the stock of any class or series of the corporation beneficially owned by the interested stockholder; or



•

the receipt by the interested stockholder of the benefit of any loans, advances, guarantees, pledges or other financial benefits provided by or through the corporation.

        In general, Section 203 defines an "interested stockholder" as any entity or person beneficially owning 15% or more of the outstanding voting stock of the corporation or which is an affiliate or associate of the corporation and was the owner of 15% or more of the outstanding voting stock of the corporation at any time within the past three years, and any entity or person associated with, affiliated with or controlling or controlled by the entity or person.

Registration Rights

        One of our major customers, Globamatrix, has the right to demand registration of the shares of our common stock purchased pursuant to a Stock Purchase Agreement dated April 20, 2001. Globamatrix also has the right to include the unregistered shares of common stock owned by it in a public offering of our stock. Globamatrix has elected not to include any of our shares held by it in this offering. The agreement provided for the purchase by Globamatrix of 422,119 shares of our common stock for $1.0 million or a price of approximately $2.37 per share. The securities sold were not

66

registered under the Securities Act in reliance upon an exemption from the registration provisions of the Securities Act set forth in Section 4(2) thereof.

Limitation of Liability

        Our restated certificate of incorporation provides that none of our directors shall be personally liable to us or to our stockholders for monetary damages for breach of fiduciary duty as a director, except that the limitation shall not eliminate or limit liability to the extent that the elimination or limitation of the liability is not permitted by the Delaware General Corporation Law.

        Our by-laws provide for the indemnification of our directors and permit us to indemnify our officers to the fullest extent permitted by the Delaware General Corporation Law. A principal effect of these provisions is to limit or eliminate the potential liability of our directors and officers for monetary damages arising from breaches of their duty of care, subject to certain exceptions. These provisions may also shield directors and officers from liability under federal and state securities laws.

Stock Transfer Agent

        The transfer agent and registrar for our common stock is EquiServe, Canton, Massachusetts.

67

UNDERWRITING

        We and the selling stockholders have entered into an underwriting agreement with the underwriters named below. The underwriters' obligations are several, which means that each underwriter is required to purchase a specific number of shares, but is not responsible for the commitment of any other underwriter to purchase shares. Subject to the terms and conditions of the underwriting agreement, each underwriter has severally agreed to purchase from us the number of shares of common stock set forth opposite its name below:

Underwriter		Number of Shares
Needham & Company, Inc.
Adams, Harkness & Hill, Inc.
Wells Fargo Securities, LLC
	Total

        The underwriters have advised us and the selling stockholders that the underwriters propose to offer the shares of common stock to the public at the public offering price per share set forth on the cover page of this prospectus. The underwriters may offer shares to securities dealers, who may include the underwriters, at that public offering price less a concession of up to $            per share. The underwriters may allow, and these dealers may re-allow, a concession to other securities dealers of up to $                        per share. After the offering to the public, the offering price and other selling terms may be changed by the underwriters.

        We and the selling stockholders have granted to the underwriters an option to purchase up to 525,000 additional shares of common stock at the public offering price per share, less the underwriting discount, set forth on the cover page of this prospectus. This option is exercisable during the 30-day period after the date of this prospectus. The underwriters may exercise this option only to cover over-allotments, which are discussed below, made in connection with this offering. If this option is exercised, each of the underwriters will be obligated to purchase approximately the same percentage of the additional shares as the number of shares of common stock to be purchased by that underwriter, as shown in the table above, bears to the total number of shares shown.

        The underwriting discount is equal to the public offering price per share of common stock less the amount paid by the underwriters to us and the selling stockholders per share of common stock. The underwriting discount is currently expected to be approximately            % of the public offering price. The following table shows the per share and total underwriting discount to be paid to the underwriters by us and the selling stockholders. These amounts are shown assuming both no exercise and full exercise of the underwriters' option to purchase additional shares.

	Total
	Per Share	No Exercise	Full Exercise
Paid by Southwall	$	$	$
Paid by the selling stockholders

        The underwriting agreement provides that the obligations of the several underwriters to purchase the shares of common stock offered hereby are subject to certain conditions precedent and that the underwriters will purchase all shares of the common stock offered hereby, other than those covered by the over-allotment option described above, if any of these shares are purchased.

        The underwriting agreement also provides that we and the selling stockholders will indemnify the underwriters against certain liabilities that may be incurred in connection with this offering, including

68

liabilities under the Securities Act, or to contribute to payments that the underwriters may be required to make in respect thereof.

        The underwriters are offering the shares of our common stock, subject to prior sale, when, as and if issued to and accepted by them, subject to approval of legal matters by their counsel, including the validity of the shares, and other conditions contained in the underwriting agreement, such as the receipt by the underwriters of officers' certificates and legal opinions. The underwriters reserve the right to withdraw, cancel or modify offers to the public and to reject orders in whole or in part.

        We have agreed not to offer, sell, contract to sell, grant options to purchase, or otherwise dispose of any shares of our common stock or securities exchangeable for or convertible into our common stock for a period of 180 days after the date of this prospectus without the prior written consent of Needham & Company, Inc. This agreement does not apply to options outstanding under any existing employee benefit plans. Our directors, officers and the selling stockholders have agreed, subject to certain exceptions, not to, directly or indirectly, sell, hedge, or otherwise dispose of any shares of common stock, options to acquire shares of common stock or securities exchangeable for or convertible into shares of common stock, for a period of 180 days after the date of this prospectus without the prior written consent of Needham & Company, Inc. Needham & Company, Inc. may, in its sole discretion and at any time without notice, release all or any portion of the securities subject to these lock-up agreements.

        In connection with this offering, the underwriters may engage in transactions that stabilize, maintain or otherwise affect the price of our common stock. Specifically, the underwriters may over-allot shares of our common stock in connection with this offering by selling more shares than are set forth on the cover page of this prospectus. This creates a short position in our common stock for their own account. The short position may be either a covered short position or a naked short position. In a covered short position, the number of shares over-allotted by the underwriters is not greater than the number of shares that they may purchase under the over-allotment option. To close out a short position, the underwriters may bid for, and purchase, common stock in the open market. The underwriters may also elect to reduce any short position by exercising all or part of the over-allotment option. In determining the source of shares to close out the covered short position, the underwriters will consider, among other things, the price of shares available for purchase in the open market as compared to the price at which they may purchase shares through the over-allotment option. If the underwriters sell more shares than could be covered by the over-allotment option, a naked short position, the position can only be entirely closed out by buying shares in the open market. A naked short position is more likely to be created if the underwriter is concerned that there may be downward pressure on the price of the shares in the open market after pricing that could adversely affect investors who purchase shares in the offering.

        The underwriters may also impose a penalty bid. This occurs when a particular underwriter or dealer repays selling concessions allowed to it for distributing our common stock in this offering because the underwriters repurchase that stock in stabilizing or short covering transactions.

        Finally, the underwriters and selling group members, if any, or their affiliates may engage in passive market making transactions in our common stock on the Nasdaq National Market immediately prior to the commencement of sales in this offering, in accordance with Rule 103 of Regulation M under the Securities Exchange Act of 1934. Rule 103 generally provides that:

•

a passive market maker may not effect transactions or display bids for our common stock in excess of the highest independent bid price by persons who are not passive market makers;



•

net purchases by a passive market maker on each day are generally limited to 30% of the passive market maker's average daily trading volume in our common stock during a specified

69

two-month prior period or 200 shares, whichever is greater, and must be discontinued when that limit is reached; and

•

passive market making bids must be identified as such.

        Any of these activities may stabilize or maintain the market price of our common stock at a price that is higher than the price that might otherwise exist in the absence of these activities or may prevent or retard a decline in the market price of our stock. The underwriters are not required to engage in these activities, and may discontinue any of these activities at any time without notice. These transactions may be effected on the Nasdaq National Market or otherwise.

        Neither we nor any of the underwriters make any representation or prediction as to the direction or magnitude of any effect that the transactions described above may have on the price of the common stock. In addition, neither we nor any of the underwriters make any representation that the underwriters will engage in these transactions or that these transactions, once commenced, will not be discontinued without notice.

        Bruce J. Alexander, a member of our board of directors since May 1981, presently serves as a Managing Director of Needham & Company, Inc. From March 1987 to July 1991, he was President and Chief Executive Officer of Southwall, and from February 1982 to March 1987, he held various offices with us, including Executive Vice President, Vice Chairman of the Board, Chairman and acting Chief Executive Officer, and Chief Financial Officer.

        Some of the underwriters and their affiliates have engaged in, and may in the future engage in, investment banking and other commercial dealings in the ordinary course of business with us. They have received customary fees and commissions for these transactions.

LEGAL MATTERS

        The validity of the shares of common stock offered hereby will be passed upon for us by Choate, Hall & Stewart, Boston, Massachusetts. Certain legal matters will be passed upon for the underwriters by Tonkon Torp LLP, Portland, Oregon.

EXPERTS

        The financial statements as of December 31, 2001 and December 31, 2000 and for each of the three years in the period ended December 31, 2001 included in this prospectus have been so included in reliance on the report (which contains an explanatory paragraph relating to Southwall's non-compliance with covenants of a guarantee agreement which have been waived through and including September 30, 2003, as described in Note 4 to the financial statements) of PricewaterhouseCoopers LLP, independent accountants, given on the authority of said firm as experts in auditing and accounting.

70

WHERE YOU CAN FIND MORE INFORMATION

        We file annual, quarterly and current reports, proxy statements and other information with the SEC. You may read and copy any reports, statements and other information we file with the SEC at the SEC's Public Reference Room at 450 Fifth Street, N.W., Washington, D.C., 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Our SEC filings are also available on the SEC's Internet site as part of the EDGAR database (http://www.sec.gov).

        We have filed with the SEC a registration statement on Form S-1 (including the exhibits and schedules thereto) under the Securities Act and the rules and regulations thereunder, for the registration of the common stock offered in this prospectus. This prospectus is part of the registration statement. This prospectus does not contain all the information included in the registration statement because we have omitted certain parts of the registration statement as permitted by the SEC rules and regulations. For further information about us and our common stock, you should refer to the registration statement. Statements contained in this prospectus as to any contract, agreement or other document referred to are not necessarily complete. Where the contract or other document is an exhibit to the registration statement, each statement is qualified by the provisions of that exhibit.

71

SOUTHWALL TECHNOLOGIES INC.

Index to Consolidated Financial Statements

Report of Independent Accountants	F-2
Consolidated Balance Sheets as of December 31, 2000, 2001 and March 31, 2002 (unaudited)	F-3
Consolidated Statements of Operations for the Years Ended December 31, 1999, 2000, 2001 and the three months ended April 1, 2001 (unaudited) and March 31, 2002 (unaudited)	F-4
Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 1999, 2000, 2001 and the three months ended March 31, 2002 (unaudited)	F-5
Consolidated Statements of Cash Flows for the Years Ended December 31, 1999, 2000, 2001 and the three months ended April 1, 2001 (unaudited) and March 31, 2002 (unaudited)	F-6
Notes to Consolidated Financial Statements	F-7
Report of Independent Accountants on Financial Statement Schedule	F-29
Financial Statement Schedule—Valuation and Qualifying Accounts and Reserves	F-30

F-1

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders of
Southwall Technologies Inc.

        In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of stockholders' equity and of cash flows present fairly, in all material respects, the financial position of Southwall Technologies Inc. (the "Company") and its subsidiaries at December 31, 2000 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America. These consolidated financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits of these consolidated financial statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether these consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in these consolidated financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.

        As discussed in Note 4, the Company was not in compliance with certain of the financial covenants of a loan guarantee agreement with Teijin Limited, a stockholder and supplier of the Company. Compliance with these covenants has been waived through and including September 30, 2003.

PricewaterhouseCoopers LLP

San Jose, California
March 4, 2002, except as to Note 4, which is dated as of May 17, 2002,
and Note 9, which is dated as of May 22, 2002.

F-2

SOUTHWALL TECHNOLOGIES INC.

CONSOLIDATED BALANCE SHEETS

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

				December 31,
										March 31, 2002
				2000			2001
										(unaudited)
ASSETS
Current assets
	Cash and cash equivalents			$	61		$	3,362		$	2,713
	Restricted cash				1,849			1,602			1,120
	Accounts receivable, net				13,317			9,020			10,239
	Inventories, net				10,174			6,151			7,053
	Other current assets				2,008			3,471			2,932
		Total current assets			27,409			23,606		$	24,057
Property, plant and equipment, net					49,884			47,841			47,326
Restricted loan proceeds					794			738			741
Other assets					2,375			973			943
Total assets				$	80,462		$	73,158		$	73,067
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
	Current portion term debt (Note 4)			$	5,806		$	8,315		$	7,579
	Line of credit (Note 3)				8,719			2,974			4,606
	Accounts payable				16,857			10,338			8,757
	Accrued compensation				1,915			2,794			2,535
	Other accrued liabilities				4,551			5,656			5,567
	Government grants advanced (Note 5)				1,085			—			—
	Term debt reclassified to current (Note 4)				20,624			—			—
		Total current liabilities			59,557			30,077			29,044
Term debt (Note 4)					—			14,513			13,800
Government grants advanced (Note 5)					—			941			771
Other					767			1,175			1,166
		Total liabilities			60,324			46,706			44,781
Commitment and contingencies (Note 9)
Stockholders' equity
	Common stock, $0.001 par value per share, 20,000 shares authorized; issued and outstanding 7,889, 8,332 and 8,563 (unaudited) at December 31, 2000, 2001 and March 31, 2002, respectively				8			8			9
	Capital in excess of par value				51,764			52,614			53,467
	Less cost of treasury stock 166 and 0 shares outstanding				(839	)		—			—
	Notes receivable				(99	)		(88	)		(103	)
	Accumulated other comprehensive income (loss)
		Cumulative translation loss			(151	)		(172	)		(356	)
	Accumulated deficit				(30,545	)		(25,910	)		(24,731	)
		Total stockholders' equity			20,138			26,452			28,286
			Total liabilities and stockholders' equity	$	80,462		$	73,158		$	73,067

The accompanying notes are an integral part of these consolidated financial statements.

F-3

SOUTHWALL TECHNOLOGIES INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

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

											Three Months Ended
		Year Ended December 31,
											April 1, 2001			March 31, 2002
		1999			2000			2001
											(unaudited)			(unaudited)
Net revenues		$	54,598		$	85,348		$	82,976		$	17,713		$	19,269
Cost of sales			40,706			69,060			60,148			14,849			12,425
Gross profit			13,892			16,288			22,828			2,864			6,844
Operating expenses
	Research and development		5,249			6,732			5,456			1,425			1,777
	Selling, general and administrative		8,670			12,614			11,036			2,656			3,745
	Legal settlements		500			536			—			—			—
Total operating expenses			14,419			19,882			16,492			4,081			5,522
Income (loss) from operations			(527	)		(3,594	)		6,336			(1,217	)		1,322
Interest expense, net			(1,350	)		(2,808	)		(2,872	)		(757	)		(466	)
Other income, net			62			350			1,385			864			378
Income (loss) before provision for income taxes			(1,815	)		(6,052	)		4,849			(1,110	)		1,234
Provision for income taxes			(50	)		(128	)		(214	)		(21	)		(53	)
Net income (loss)		$	(1,865	)	$	(6,180	)	$	4,635		$	(1,131	)	$	1,181
Net income (loss) per share:
	Basic	$	(0.25	)	$	(0.81	)	$	0.58		$	(0.15	)	$	0.14
	Diluted	$	(0.25	)	$	(0.81	)	$	0.57		$	(0.15	)	$	0.13
Weighted average shares of common stock and dilutive common stock equivalents:
	Basic		7,421			7,642			8,032			7,743			8,417
	Diluted		7,421			7,642			8,186			7,743			9,277

The accompanying notes are an integral part of these consolidated financial statements.

F-4

SOUTHWALL TECHNOLOGIES INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

(in thousands)

		Common Stock																					Accumulated Comprehensive Income (Loss)
					Capital in Excess of Par Value			Treasury Stock			Notes Receivable			Other Comprehensive Loss			Accumulated Deficit			Total Stockholders' Equity
		Shares	Amount
Balance at December 31, 1998		7,889	$	8	$	52,181		$	(2,852	)	$	(1,020	)	$	0		$	(22,500	)	$	25,817		$	(7,869	)
	Interest paid with stock					(55	)		148												93
	Exercise of options					(264	)		607												343
	Sales to employees under stock purchase plan					(81	)		181												100
	Issuance of stock for bonuses					(10	)		28												18
	Stock option loans, net											114									114
	Translation loss on foreign subsidiary														(40	)					(40	)		(40	)
	Net loss																	(1,865	)		(1,865	)		(1,865	)
Balance at December 31, 1999		7,889		8		51,771			(1,888	)		(906	)		(40	)		(24,365	)		24,580			(1,905	)
	Exercise of options					(175	)		640												465
	Sales to employees under stock purchase plan					(69	)		209												140
	Issuance of stock for bonuses					(23	)		149												126
	Repayments of notes receivable											807									807
	Translation loss on foreign subsidiary														(111	)					(111	)		(111	)
	Issuance of stock for legal settlement					260			51												311
	Net loss																	(6,180	)		(6,180	)		(6,180	)
Balance at December 31, 2000		7,889		8		51,764			(839	)		(99	)		(151	)		(30,545	)		20,138			(6,291	)
	Exercise of options	22				(107	)		644												537
	Sale of stock, net	422				970															970
	Sales to employees under stock purchase plan					(107	)		192												85
	Issuance of stock for bonuses					(1	)		3												2
	Accelerated vesting on exercise of stock option					94															94
	Repayments of notes receivable											11									11
	Translation loss on foreign subsidiary														(21	)					(21	)		(21	)
	Net income																	4,635			4,635			4,635
Balance at December 31, 2001		8,333		8		52,614			0			(88	)		(172	)		(25,910	)		26,452			4,614
	Exercise of options	230		1		853			—			—			—			—			854
	Stock option loans											(15	)								(15	)
	Translation loss on foreign subsidiary														(184	)					(184	)		(184	)
	Net income																	1,179			1,179			1,179
Balance at March 31, 2002		8,563	$	9	$	53,467		$	—		$	(103	)	$	(356	)	$	(24,731	)	$	28,286		$	5,610

The accompanying notes are an integral part of these consolidated financial statements.

F-5

SOUTHWALL TECHNOLOGIES INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

											Three Months Ended
		Year Ended December 31,
											April 1, 2001 (unaudited)			March 31, 2002 (unaudited)
		1999			2000			2001
Cash flows (used in) or provided by operating activities:
	Net income (loss)	$	(1,865	)	$	(6,180	)	$	4,635		$	(1,131	)	$	1,181
	Adjustments to reconcile net income (loss) to net cash provided by operating activities:
	Depreciation and amortization		4,946			5,662			5,982			1,382			1,375
Change in assets and liabilities:
	Accounts receivable, net		1,290			(2,188	)		4,297			3,678			(1,219	)
	Inventories, net		(1,164	)		(2,953	)		4,023			897			(902	)
	Other current and non-current assets		(2,442	)		(573	)		(610	)		(329	)		556
	Accounts payable, and accrued liabilities		3,758			7,420			(4,535	)		(2,275	)		(1,938	)
Cash provided by (used in) operating activities			4,523			1,188			13,791			2,222			(947	)
Cash flows from investing activities:
	Short-term investments		7			—			—			—			—
	Restricted cash		(1,883	)		34			247			1,300			482
	Expenditures for property, plant and equipment and other assets		(24,066	)		(12,889	)		(5,945	)		(360	)		(849	)
Net cash provided by (used in) investing activities			(25,942	)		(12,855	)		(5,698	)		940			(367	)
Cash flows from financing activities:
	Proceeds from foreign government grants		4,943			1,007			—			—			—
	Proceeds from investment allowances		—			1,085			2,050			—			—
	Proceeds from borrowings		9,859			5,151			1,710			—			—
	Principal payments on borrowings		(1,224	)		(2,896	)		(4,311	)		(1,211	)		(1,449	)
	Borrowings (payments) on line of credit		4,920			3,799			(5,745	)		(1,413	)		1,632
	Proceeds from sale of stock		—			—			970			—			—
	Repayment of stockholder's note receivable		298			807			11			—			—
	Stock issued under stock options and purchase plans		259			1,041			687			65			838
Net cash provided by (used in) financing activities			19,055			9,994			(4,628	)		(2,559	)		1,021
	Effect of foreign exchange rate changes on cash and cash equivalents		—			(38	)		(165	)		(446	)		(356	)
Net increase (decrease) in cash and cash equivalents			(2,364	)		(1,711	)		3,301			157			(649	)
Cash and cash equivalents, beginning of year			4,136			1,772			61			61			3,362
Cash and cash equivalents, end of year		$	1,772		$	61		$	3,362		$	218		$	2,713
Supplemental cash flow disclosures:
	Interest paid	$	1,408		$	4,598		$	2,971		$	501		$	233
	Income taxes paid	$	50		$	156		$	111		$	22		$	21
Supplemental schedule of non-cash investing and financing activities:
	Treasury stock used for payment of interest	$	93			—			—			—			—
	Treasury stock used for payment of bonuses and legal settlements	$	18		$	436			—			—			—
	Exercise of stock options with issuance of stockholders notes receivable	$	184			—		$	19		$	19		$	15
	Offset deposit to reduce sale-leaseback obligations		—			—		$	1,000			—			—

The accompanying notes are an integral part of these consolidated financial statements.

F-6

SOUTHWALL TECHNOLOGIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

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

The Company

        Southwall Technologies Inc. is a global developer, manufacturer and marketer of thin film coatings for the automotive glass, electronic display and architectural markets. The Company has 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. The Company's products consist of transparent solar-control films for automotive glass, anti-reflective films for computer screens, including flat panel and plasma displays, transparent conductive films for use in touch screen and liquid crystal displays, energy control films for architectural glass, and various other coatings.

Principles of consolidation

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

        Certain amounts in prior years have been reclassified to conform to the current year's presentation.

Foreign currency translation

        The Company's German subsidiary used its local currency as its functional currency in 2001. Accordingly, the financial statements of this subsidiary are translated into U.S. dollars in accordance with SFAS No. 52, "Foreign Currency Translation." Assets and liabilities are translated at exchange rates in effect at the balance sheet date and revenue and expense accounts at average exchange rates during the quarter. Exchange gains or losses from the translation of monetary assets and liabilities that are not denominated in U.S. dollars are recorded directly to a separate component of stockholders equity. Where the functional currency is U.S. dollars, gains and losses for remeasuring foreign currency denominated balances into U.S. dollars are included in other income.

Management estimates

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

Interim financial information

        The interim consolidated statements of operations and cashflows for the three-month period ended March 31, 2002 and April 1, 2001, together with the financial data and other information for this period disclosed in these notes to the financial statements, are unaudited. In the opinion of management, the interim financial statements have been prepared on the same basis as the audited financial statements and reflect all adjustments (consisting only of normal recurring adjustments) necessary for the fair presentation of the interim results. The results of operations for the interim periods are not necessarily indicative of the results to be expected for any future periods.

F-7

Cash and cash equivalents

        The Company deposits its cash in an interest bearing bank account. The Company did not have any cash equivalents at December 31, 2000 or 2001.

Restricted cash

        Restricted cash consists of the unapplied portion of grants received from the Saxony government to co-finance the costs of the construction of the Company's Dresden facility. In the event the Company fails to meet certain conditions related to the grants, the Saxony government has the right to reclaim the grants. (See Note 5). In addition, restricted cash includes a $0.5 million irrevocable standby letter of credit secured by a certificate of deposit. As of January 2, 2002, the holder drew on the letter of credit to reduce outstanding amounts related to leases of production machines.

Revenue recognition

        Revenues from product sales are recognized upon product shipment when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable, collection of resulting receivables is reasonably assured and product returns are reasonably estimable. Provisions for estimated cost of warranty repairs and returns and allowances are recorded at the time products are shipped and are adjusted periodically to reflect historical and anticipated experience.

        The Company has agreements under which it receives fees for certain licensing rights to technology and products. The Company does not allocate cost of sales to license revenues because such costs are insignificant. License revenues associated with these agreements are recognized ratably over the period of the contract when collection of the resulting receivable is probable. License revenues were $515, $503 and $211 for the years 1999, 2000 and 2001, respectively.

Certain risks and concentrations

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

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

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

        The Company's ten largest customers accounted for approximately 69%, 85% and 85% of net sales in 1999, 2000 and 2001, respectively. During 2001, three customers each accounted for more than 10% of its net revenues. The Company expects to continue to derive a significant portion of its net product sales from a relatively small number of customers. Accordingly, the loss of a large customer could materially hurt the Company's business, and the deferral or loss of anticipated orders from a small

F-8

number of customers could materially reduce its revenue, operating results and cash flows in any period. At December 31, 2000, accounts receivables from two customers represented 19% and 13% of the Company's accounts receivables, respectively. At December 31, 2001, accounts receivable from two customers represented 16% and 16% of the Company's accounts receivable, respectively.

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

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

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

Inventories

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

Property and equipment

        Property and equipment are stated at cost. The Company uses the units-of-production method for calculating depreciation on certain of its production machines and the straight-line method for all other property and equipment. Estimated useful lives of the assets range from five to ten years. On its large-scale production machines for which the units-of-production depreciation method is used, the Company records minimum annual depreciation of at least one-half of the depreciation that would have been

F-9

recorded utilizing the straight-line depreciation method over a ten-year life. Leasehold improvements are amortized using the term of the related lease or the economic life of the improvements, if shorter.

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

Interest capitalized

        Interest incurred during the construction of long-lived assets is capitalized as part of the cost of acquiring property and equipment, in accordance with SFAS No. 34, "Capitalization of Interest Cost". Capitalization of interest is discontinued when the assets are ready for their intended use, which is generally upon completion of construction.

Intangible assets

        Patents, licenses and trademarks relating to the Company's commercial products are stated at cost less accumulated amortization. Amortization is computed on the straight-line basis over terms of up to 17 years. At December 31, 2000 and 2001, patents, licenses and trademarks are included in other assets in the amount of $0.6 million and $0.7 million respectively, net of accumulated amortization of $1.3 million and $1.3 million, respectively. Amortization expense for 1999, 2000 and 2001 was $0.2 million, $0.2 million, and $0.1 million, respectively.

Impairment of long-lived assets

        The Company evaluates the recoverability of its long-lived assets in accordance with SFAS No. 121, "Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to be disposed of." SFAS No. 121 requires recognition of impairment of long-lived assets in the event the net book value of such assets exceeds the future undiscounted cash flows attributable to such assets. No such losses have been recognizable through December 31, 2001. In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This Statement supersedes SFAS 121 and the accounting and reporting provisions of Accounting Principles Board, or APB, Opinion 30, "Reporting the Results of Operations—Reporting the effects of Disposal of Segment of a Business, and Extraordinary, Unusual and infrequently Occurring events and Transactions." The provisions of SFAS 144 are required to be adopted during Southwall's fiscal year beginning January 1, 2002. The Company does not expect that the adoption of SFAS 144 will have a significant effect on its financial position or results of operations.

Fair value disclosures of financial instruments

        The Company has estimated the fair value amounts of its financial instruments, including cash and cash equivalents, accounts receivable, accounts payable, debt and accrued liabilities using available market information and valuation methodologies considered to be appropriate and have determined that the book value of those instruments at December 31, 2000 and 2001 approximates fair value.

F-10

Stock-based compensation

        The Company accounts for stock based compensation to employees using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, ("APB 25"), "Accounting for Stock Issued to Employees," as permitted under the provisions of SFAS 123, "Accounting for Stock-Based Compensation." The Company also provides additional pro forma disclosures as required under SFAS 123. If equity instruments such as stock, options or warrants are granted to non-employees, such instruments are accounted for at fair value in accordance with SFAS 123 and related interpretations.

Research and development expense

        Research and development costs are expensed as incurred.

Comprehensive income (loss)

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

Income taxes

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

Net income (loss) per share

        Basic net income (loss) per share is computed by dividing income available to common shareholders (numerator) by the weighted average number of common shares outstanding (denominator) for the period. Diluted net income (loss) per share gives effect to all dilutive potential common shares outstanding during the period. The computation of diluted earnings per share uses the average market prices during the period. During 2000, there was no difference between the denominators used for calculation of basic and diluted net income (loss) per share. At December 31, 2001, the dilutive stock options were 8,186 shares for dilutive earnings per share, and 8,032 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 where 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.

F-11

Recent accounting pronouncements

        In July 2001, the Financial Accounting Standards Board issued SFAS No. 141, "Business Combinations." SFAS No. 141 addresses financial accounting and reporting for business combinations and supersedes APB Opinion No. 16, "Business Combinations," and SFAS No. 38, "Accounting for Preacquisition Contingencies of Purchased Enterprises." SFAS No. 141 requires applicable business combinations to be accounted for using one method, the purchase method. The provisions of SFAS No. 141 apply to all business combinations initiated after June 30, 2001. The Company does not expect that the adoption of SFAS 141 will have a significant effect on its financial position or results of operations.

        In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets," which is effective for fiscal years beginning after March 15, 2001. SFAS No. 142 requires, among other things, the discontinuance of goodwill amortization. In addition, the standard includes provisions upon adoption for the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the testing for impairment of existing goodwill and other intangibles. The Company does not expect the adoption of SFAS 142 will have a significant effect on its financial position or results of operations.

        In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations," which addresses financial accounting and reporting for obligations related to the retirement of tangible long-lived assets and associated asset retirement costs. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. The Company does not expect that the adoption of SFAS 143 will have a significant effect on its financial position or results of operations.

        In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This Statement supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," and the accounting and reporting provisions of APB 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" for the disposal of a segment of a business. The provisions of SFAS No. 144 are required to be adopted during the Company's fiscal year beginning January 1, 2002. The Company does not expect that the adoption of SFAS 144 will have a significant effect on its financial position or results of operations.

F-12

        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 the Company's consolidated financial statements.

NOTE 2—LIQUIDITY

        The Company' current liabilities of $30.1 million at December 31, 2001, exceeded current assets of $23.6 million (a working capital deficit) and the Company must meet commitments for debt service payments of $8.3 million. Management believes that existing liquidity sources, including expected cash flows from operations, existing cash reserves and existing credit facilities, will satisfy its cash requirements for the next twelve months. To fully achieve its business objective for 2003 and beyond, Southwall will need to raise additional capital from external sources.

        The Company is addressing its liquidity needs through a combination of achieving profitable operations, improving cash flow from operations, obtaining waivers from lenders for events of default, renegotiating provisions of key financing agreements and obtaining additional sources of financing. The Company is in discussions with lenders regarding establishing new credit facilities to meet projected working capital and capital expenditure needs in 2002. Additionally, the Company continues to explore a number of alternative equity transaction proposals to meet or supplement working capital and capital expenditure needs. While the company has received proposals, no assurances can be made that alternative sources of financing will be available, if at all, or on terms acceptable to the Company.

NOTE 3—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 of 0.88% per month of the average daily accounts receivable against which the Company is borrowing during the settlement period. In connection with the line of credit, the Company granted to the financial institution 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 December 31, 2001, the Company had approximately $7.0 million of availability under the line of credit of which it had borrowed $3.0 million, which is classified as current on the accompanying balance sheet.

F-13

NOTE 4—TERM DEBT

        The Company's indebtedness consisted of the following at December 31, 2001:

Description			Rate	Balance at December 31, 2001		Due in 2002
Line of credit			(1)	$	2,974		(1	)
Term debt:
	Japanese bank loan, guaranteed by Teijin		LIBOR + 1.0%		7,500	$	2,500
	German bank loan dated May 12, 1999		6.13%(2)		2,465		308
	German bank loan dated May 28, 1999		7.10%(3)		2,259		—
	German bank loan dated May 28, 1999		3.75%		1,290		258
	German bank loan dated July 25, 2000		7.15%		1,918		266
	German bank loan due June 30, 2009		5.75%		1,525		—
	German bank loan dated June 29, 2000		5.75%		347		154
	German bank loan dated July 10, 2000		7.10%		385		193
	German bank loan dated December 19, 2000		7.50%		162		90
	German bank loan dated December 18, 2000		7.50%		234		78
	Note Payable dated September 21, 2001		8.00%		720		600
	Other equipment financings		—		256		101
		Total term debt			19,061		4,548
Capital leases:
	Sale-leaseback dated July 19, 1999		13.00%		2,321		2,321
	Sale-leaseback dated October 19, 1999		13.00%		1,446		1,446
		Total capital leases			3,767		3,767
Total term debt and capital leases					22,828	$	8,315
		Less current portion			8,315
		Term debt, non-current		$	14,513

(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 equal to 0.88% per month 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, dated May 6, 1997, 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%, (7.70% and 3.16% at December 31, 2000 and 2001, respectively). 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

F-14

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 December 31, 2001 and 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. 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 December 31, 2001 and March 31, 2002. The Company is current in all principal and interest payments due under the loan. As a result of the waiver, the next covenant measurement date would be December 31, 2003; if the Company were not in compliance at that date, the loan could be called. If all scheduled interest and principal payments were made through December 31, 2003, the remaining balance outstanding would be $2.5 million, assuming no prepayments were made under the conditions of the waiver.

        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 December 31, 2001, the Company had a total of $3.8 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 has provided the lessor an irrevocable standby letter of credit in the amount of $0.5 million to collateralize all of its obligations under these agreements. In addition, $1 million of the amounts due from the Lessor was not funded, but will be released upon the Company satisfying certain financial conditions. 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 has drawn down on the letter of credit in the amount of $0.5 million in January 2002; in May, 2002 a suit was filed against the Company demanding payment of unpaid lease payments and alleged residual values (Note 9). The Company is in negotiations with the lessor to buy out the lease at amounts which approximate the unpaid obligations, to be reduced by the $1.0 million holdback not funded by the lessor and the $0.5 million payment under the letter of credit. The Company has classified $3.8 million due under the leases as a current liability in the accompanying balance sheet at December 31, 2001, including $0.2 million that would otherwise be classified as a long-term liability.

        On May 12, 1999, the Company entered into a loan agreement with a German bank that provides for borrowings up to euros 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

F-15

Company was in compliance at December 31, 2001. Of the borrowings outstanding of $2.5 million under this bank loan at December 31, 2001, $2.2 million was classified as noncurrent in the accompanying balance sheet.

        On May 28, 1999, the Company entered into a general loan agreement with a German bank. Under the terms of the loan agreement, funds 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 December 31, 2001; 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 deutschemarks 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 December 31, 2001, $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 December 31, 2001, the amount due was $1.3 million, and $1.0 million is classified as a noncurrent liability. The third tranche, dated July 25, 2000, 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 first five years. At December 31, 2001, the amount due was $1.9 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 euros 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 December 31, 2001. The amount due under this bank loan at December 31, 2001 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 euros 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 December 31, 2001. The amount due under this bank loan was $0.3 million at December 31, 2001; 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 December 31, 2001. The amount due under

F-16

this bank loan was $0.4 million; of this amount, $0.2 million was classified as noncurrent at December 31, 2001.

        On December 18, 2000, the Company entered into a loan agreement with a German bank that provides for borrowings up to DM 0.5 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 December 31, 2001, the amount outstanding under this bank loan was $0.2 million; of this amount, $0.1 million was classified as noncurrent at December 31, 2001.

        On December 19, 2000, the Company entered into a loan agreement with a German bank that provides for borrowings up to euros 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 December 31, 2001, the amount outstanding under this bank loan was $0.2 million; all of this amount was classified as noncurrent at December 31, 2001.

        The preceding German bank loans are collateralized by the production equipment, building and land owned by the Company's German subsidiary. In addition, effective January 1, 2002, all of these banks loans were denominated in euros.

        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 $0.96 million owed on the machine. The first installment on the note was paid on September 26, 2001 in the amount of $0.14 million. The remaining balance of the note is payable in 16 monthly installments. The note bears interest at 8.0% per annum. At December 31, 2001, the amount outstanding under this bank loan was $0.7 million; of this amount, $0.1 million was classified as noncurrent at December 31, 2001. Other term debt consists of capitalized leases related primarily to certain computer equipment used by the Company.

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

Year	Amount
2002	$	8,315
2003		3,949
2004		3,497
2005		779
2006		779
Thereafter		5,509
Total	$	22,828

F-17

        The Company incurred total interest on indebtedness of $2.6 million, $4.6 million and $2.9 million in 1999, 2000 and 2001, respectively. Of these amounts, Southwall capitalized $1.2 million in 1999, $1.8 million in 2000 and $0.1 million in 2001 as part of the costs related to the construction of new production machines and facilities.

NOTE 5—GOVERNMENT GRANTS 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 December 31, 2001, 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 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.

        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 is further eligible for investment allowances calculated based on the capital investment of euros 47.0 million ($39.2 million), subject to European Union regulatory approval. During 2000, the Company received euros 1.2 million ($1.0 million) in investment allowances from the Saxony government and those proceeds were applied to reduce the capitalized construction cost of the Dresden facility. The Company received an additional euros 2.5 million ($2.1 million) in investment allowances from the Saxony government in 2001, and those proceeds were also applied to reduce the capitalized construction cost of the Dresden facility. The Company has also applied for approximately euros 1.2 million ($1.0 million) in investment allowances in 2002. The investment allowance is 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.

F-18

        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 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 in the future.

NOTE 6—INCOME TAXES

        The income tax provision in 2000 and 2001 relates primarily to foreign withholding taxes on royalty payments and federal statutory and state alternative minimum tax obligations. The effective income tax rate differs from the federal statutory rate as a result of valuation allowances established for deferred tax assets. The Company believes that sufficient uncertainty exists with regard to the realization of these tax assets; accordingly, a full valuation allowance is necessary. These factors include the lack of a significant history of consistent profits and the lack of carryback capacity to realize these assets. Based on this absence of objective evidence, the Company is unable to assert that it will generate sufficient taxable income to realize the deferred tax assets.

        Deferred tax (liabilities) assets are comprised of the following:

	December 31,
	2000			2001
Depreciation	$	(3,679	)	$	(4,388	)
Other		(44	)		(277	)
Gross deferred tax liabilities		(3,723	)		(4,665	)
Inventory reserves		552			540
Other		2,952			4,354
Loss carryforwards		12,396			9,377
Credit carryforwards		952			1,364
Gross deferred tax assets		16,852			15,635
Deferred tax assets valuation allowance		(13,129	)		(10,970	)
Net deferred taxes	$	—		$	—

        At December 31, 2001, the Company had net federal operating loss carryforwards of approximately $26.1 million that expire at various dates from 2002 through 2019. The net operating loss carryforwards include approximately $3.9 million resulting from employee exercises of non-incentive stock options or disqualifying dispositions, the tax benefit of which, when realized, will be accounted for as an addition to capital in excess of par value, rather than as a reduction of the provision for income taxes. The Company has state and German net operating loss carryforwards that expire at various future dates. Research and development, investment and foreign tax credit carryovers of approximately $1.3 million are also available to reduce future federal and state income taxes and expire at various dates through 2004. If certain substantial changes in ownership of the Company occur, there would be an annual limitation on the amount of the carryforwards that can be utilized.

F-19

NOTE 7—BENEFIT PLANS

Stock Option Plans

        The Company has granted stock options under various option plans and agreements in the past and currently grants stock options under the 1997 Stock Incentive Plan and the 1998 Stock Option Plan for Employees and Consultants. The board of directors adopted the 1998 Stock Option Plan for Employees and Consultants on August 6, 1998. The human resources committee of the board of directors administers the plans and agreements. The exercise price of options granted under the 1997 and 1998 plans must be at least 85% of the fair market value of the stock at the date of grant.

        Generally, options granted under the plans vest at a rate of 25% per year, are non-transferable and expire over terms not exceeding ten years from the date of grant or three months after the optionee terminates his relationship with the Company.

        During 1998 and 1999, certain employees, officers and directors of Southwall exercised stock options under the plans by issuing full recourse notes with an annual rate of interest of generally 7%. During 1998 and 1999, outstanding notes from certain of those employees, officers and directors were extended from terms of one year to terms of two years. Both the principal and the interest accrued on the notes are due at the end of the term of each note. These notes aggregate $0.1 million and $0.1 million at December 31, 2000 and 2001 respectively.

        As of December 31, 2001, there were 314,675 shares of Common Stock available for grant under the two stock option plans.

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

	Options		Range of Exercise Price	Weighted Average Exercise Price
Options outstanding at January 1, 1999	1,413		—		—
Granted	637		$2.75 - $4.50		3.77
Exercised	(127	)	$2.50 - $4.38		2.89
Cancelled or expired	(262	)	$2.50 - $8.63		5.15
December 31, 1999	1,661		$2.50 - $8.63	$	4.59
Granted	752		$1.56 - $11.50		5.35
Exercised	(128	)	$2.50 - $9.87		3.82
Cancelled or expired	(317	)	$1.56 - $11.50		4.66
December 31, 2000	1,968		$1.56 - $11.50	$	4.92
Granted	541		$2.13 - $6.06		3.19
Exercised	(150	)	$1.56 - $6.88		3.59
Cancelled or expired	(448	)	$2.13 - $11.50		4.80
December 31, 2001	1,911		$1.56 - $11.50	$	4.81
Granted (unaudited)	320		2.67 - 8.00		7.93
Exercised (unaudited)	(230	)	2.13 - 11.50		5.20
Cancelled or expired (unaudited)	(22	)	2.13 - 11.50		5.82
March 31, 2002	1,979		$2.13 - $11.50	$	6.75

F-20

Employee Stock Purchase Plan

        In March 1997, the Company adopted the 1997 Employee Stock Purchase Plan ("the 1997 Plan") and reserved 100 shares of Common Stock for issuance thereunder. Employees, subject to certain limitations, may purchase shares at 85% of the lower of the fair market value of the Common Stock at the beginning of the six-month offering period, or the last day of the purchase period. During 1999, 2000 and 2001, 36, 41 and 38 shares, respectively, were sold under the 1997 Plan. At December 31, 2001, there were 58 shares available for issuance under the 1997 Plan.

Stock-Based Compensation

        Southwall has stock option plans that reserve shares of Common Stock for issuance to employees, officers, directors and consultants. The Company applies APB Opinion 25 and related interpretations in accounting for its plans. Accordingly, no compensation cost is recognized for grants at fair market value. Southwall adopted the disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based Compensation. Had compensation cost for our stock option plans and stock purchase plans been determined based on the fair value at the grant date for awards granted in 1999, 2000 and 2001 consistent with the provisions of SFAS No. 123, net income (loss) and net income (loss) per share would have been reduced to the pro forma amounts indicated below:

		1999			2000			2001
Net income (loss)—as reported		$	(1,865	)	$	(6,180	)	$	4,635
Net income (loss)—pro forma		$	(2,659	)	$	(7,830	)	$	3,833
Net income (loss) per share—as reported
	Basic	$	(0.25	)	$	(0.81	)	$	0.58
	Diluted	$	(0.25	)	$	(0.81	)	$	0.57
Net income (loss) per share—pro forma
	Basic	$	(0.36	)	$	(1.02	)	$	0.48
	Diluted	$	(0.36	)	$	(1.02	)	$	0.47

        For the stock option plans, the fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model for the multiple option approach with the following weighted average assumptions used for grants in 1999, 2000 and 2001, respectively. Expected volatility of 110% in 1999, 134% in 2000, and 89% in 2001; risk-free interest rate of 5.4%, 6.2% and 4.6%; and expected lives from vesting date of 3.23, 2.54 and 3.26 years. Southwall has not paid dividends and assumed no dividend yield. The weighted average fair value of stock options granted in 1999, 2000 and 2001 was $2.60, $3.74 and $1.89 per share, respectively.

        For the employee stock purchase plans, the fair value of each purchase right is estimated at the beginning of the offering period using the Black-Scholes option-pricing model with the following weighted-average assumptions used in 1999, 2000, and 2001 respectively. Expected volatility of 139%, 134% and 89%; risk-free interest rate of 5.8%, 6.32% and 4.19%; and expected lives of 0.5 years in each year. The Company has not paid dividends and assumed no dividend yield. The weighted-average fair value of those purchase rights granted in 1999, 2000 and 2001 was $1.98, $2.19 and $1.21 per right, respectively.

F-21

NOTE 7—BENEFIT PLANS (Continued)

        The following table summarizes information about stock options outstanding at December 31, 2001:

	Options Outstanding				Options Exercisable
Range of Exercise Price	Number Outstanding at 12/31/01	Weighted Average Remaining Contractual Life	Weighted Average Exercise Price		Number Exercisable at 12/31/01	Weighted Average Exercise Price
$1.56 - $2.75	137	5.96	$	2.39	12	$	2.20
$2.81 - $2.81	230	6.07		2.81	—		0.00
$2.94 - $3.71	221	4.44		3.38	106		3.14
$3.75 - $4.50	275	4.65		4.16	161		4.18
$4.63 - $5.00	307	2.81		4.91	239		4.89
$5.07 - $5.07	70	6.72		5.07	—		0.00
$5.20 - $5.20	209	5.74		5.20	53		5.21
$5.75 - $6.88	216	3.51		6.59	175		6.58
$7.00 - $8.13	193	4.87		7.30	79		7.23
$8.25 - $11.50	53	5.60		10.24	25		9.82
$1.56 - $11.50	1,911	4.71	$	4.81	850	$	5.23

401(k) Plan

        In 1998, the Company sponsored a 401(k) defined contribution plan covering eligible employees who elect to participate. Southwall is allowed to make discretionary profit sharing and 401(k) matching contributions as defined in the plan and as approved by the board of directors. The Company matches 25% of each eligible participant's 401(k) contribution up to a maximum of 20% of the participant's compensation, not to exceed one thousand dollars per year. Southwall's actual contribution may be reduced by certain available forfeitures, if any, during the plan year. No discretionary or profit sharing contributions were made for the years ending December 31, 1999, 2000 and 2001. Matching contributions for the years ended December 31, 1999, 2000 and 2001 were $0.1 million, $0.2 million, and $0.1 million respectively.

NOTE 8—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 has one segment and is organized on the basis of products and services. The

F-22

total net revenues for the automotive glass, electronic display, and architectural product lines were as follows:

								Quarter ended
		Year
								April 1, 2001 (unaudited)		March 31, 2002 (unaudited)
		1999		2000		2001
Automotive glass		$	19,477	$	20,198	$	37,385	$	8,007	$	7,003
Electronic display			16,014		47,734		29,691		6,724		7,925
Architectural			19,107		17,416		15,900		2,982		4,341
	Total net revenues	$	54,598	$	85,348	$	82,976	$	17,713	$	19,269

        The following is a summary of net revenue by geographic area for 1999, 2000 and 2001.

								Quarter ended
		Year
								April 1, 2001 (unaudited)		March 31, 2002 (unaudited)
		1999		2000		2001
United States		$	12,550	$	12,750	$	10,881	$	3,211	$	2,710
Japan			12,948		34,956		26,755		4,989		7,600
France			9,508		12,030		19,842		3,763		4,034
Pacific Rim			8,088		14,681		9,113		1,972		1,856
Rest of world			5,735		6,763		7,830		1,421		1,549
Germany			5,769		4,168		8,555		2,357		1,520
	Total net revenues	$	54,598	$	85,348	$	82,976	$	17,713	$	19,269

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

		As of December 31,
		2000		2001
United States		$	64,145	$	54,813
Germany			16,317		18,345
	Consolidated	$	80,462	$	73,158

        Four customers accounted for net sales in 1999, 2000, 2001, and the quarters ended:

								Quarter ended
		Year
Customer								April 1, 2001 (unaudited)		March 31, 2002 (unaudited)
		1999		2000		2001
A		18.0	%	14.5	%	24.0	%	20.9	%	20.9	%
B		9.4	%	39.5	%	20.5	%	26.0	%	20.9	%
C		0.0	%	0.0	%	7.7	%	4.9	%	14.6	%
D		11.7	%	6.7	%	15.3	%	18.5	%	10.8	%
	Total	39.1	%	60.7	%	67.5	%	70.3	%	67.2	%

F-23

NOTE 9—COMMITMENTS and CONTINGENCIES

Commitments

        The Company leases certain property and equipment as well as its facilities under noncancellable operating leases. These leases expire at various dates through 2009. As of December 31, 2001, the future minimum payments under these leases are as follows:

	Operating Leases
2002	$	3,601
2003		2,832
2004		2,846
2005		475
2006		475
Thereafter		—
Future minimum lease payments	$	10,229

        Rent expense under operating leases was approximately $1.5 million, $3.2 million and $3.7 million in 1999, 2000, and 2001 respectively.

Contingencies

        The Company is a defendant in an action entitled "Portfolio Financial Servicing Company v. Southwall Technologies Inc.," which was filed in state court in Utah on May 22, 2002. This action arises out of sale-leaseback agreements which the Company entered into with an entity formerly known as Matrix Funding Corporation, or Matrix, in 1999 in connection with the acquisition of two of our production machines, as described in Note 4 to these financial statements. Matrix thereafter filed bankruptcy. In the action, the plaintiff purports to be an agent of the successor to Matrix. The plaintiff demands payment of $6,468,534, which it alleges constitutes unpaid lease payments, plus the alleged residual value of the equipment, less monies that Matrix owes to the Company. The Company intends to defend the action vigorously.

        The Company is a defendant in an action filed on April 5, 1996 entitled "Four Seasons Solar Products Corp. vs. Black & Decker Corp., 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 filed a motion to dismiss. The Court has dismissed the unfair competition and fraudulent concealment claims against the Company. It has denied the Company's motion to dismiss the breach of contract claim. The Company believes the claim to be without merit. Defense of this action is covered by the Company's insurance carrier and the Company expects that settlements, if any, will be substantially covered by its insurance policy. The action is in the early stages, thus an estimate of the Company's loss exposure cannot be made. Management plans to vigorously contest the claim.

F-24

        In October 2000, the Company was served with a complaint entitled Hurd Millwork, Inc. v. Southwall Technologies Inc., et. al., United States District Court, Northern District of California, Case No. C00-3820 (CRB). Hurd is a manufacturer of installed glass units which incorporated Heat Mirror film. Hurd alleged that various failures and deficiencies associated with the installed glass units gave rise to warranty and other consumer claims. The Company reached a settlement with plaintiffs, the terms of which are confidential. The cash portion of the settlement was paid by the Company's insurance carrier. The Company also agreed to provide a discount on the price of future film sales as part of the settlement. The Company did not commit to or guarantee an aggregate dollar amount that Hurd would be entitled to receive as a discount; the discount is entirely contingent on future purchases of architectural glass product by Hurd from the Company during a four-year period ending February 2006. Due to the contingent nature of the discount to be granted in the future, no amount has been recorded by the Company as a sales discount liability for the settlement at December 31, 2001 or March 31, 2002.

        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 accrued at December 31, 2001 as additional construction costs.

        The insurance carriers in some of the litigation related to alleged product failures and defects in window products manufactured by third parties in which the Company was a defendant paid the defense and settlement costs related to such litigation. Those insurance carriers reserved their rights and have expressed their intent to proceed against the Company to recover a portion or all of such payments. As a result, those insurance carriers could seek from the Company up to an aggregate of $12.9 million plus defense costs, although any such recovery would be restricted to claims that were not covered by the Company's insurance policies. The Company intends to vigorously defend any attempts by these insurance carriers to seek reimbursement. The Company is not able to estimate the likelihood that these insurance carriers will seek to recover any such payments, the amount, if any, they might seek, or the outcome of such attempts. As a result, no adjustment has been recorded due to the uncertainty surrounding the potential exposure. Management can give no assurance that a material claim will not be asserted at some future date by the insurers.

        The Company's counsel has received a letter from a lawyer purporting to represent a manufacturer of skylights that allegedly incorporates the Company's Heat Mirror film. The letter alleges that a sealant provided by a third party and used with the Company's film was defective, and as a result the manufacturer and others similarly situated have suffered elevated warranty replacement claims and costs. The letter states that the manufacturer will bring legal action in the form of a class action lawsuit

F-25

if the parties are unable to resolve the matter quickly. The Company believes the allegations to be without merit and intends to defend any related action vigorously.

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

NOTE 10—RELATED PARTY TRANSACTIONS

Teijin

        On April 9, 1997, Southwall signed a comprehensive set of collaborative agreements with a major supplier of the Company's raw materials, Teijin Limited. The agreements provided for, among other things, the purchase by Teijin of 667,000 shares of the Company's common stock at a price of $7.50 per share; a guarantee by Teijin of a $10.0 million loan to the Company; and an agreement to collaborate to achieve closer marketing and product development ties between the two companies. The Company pays an annual loan guarantee fee to Teijin of 0.5625% of the outstanding principal balance of the loan guaranteed by Teijin. The Company paid a loan guarantee fee of approximately $53,000 to Teijin during 2001. As of December 31, 2001, $7.5 million was outstanding under the loan guaranteed by Teijin. Pursuant to a letter agreement dated March 28, 2002, the Company is obligated to repay $2.5 million of the loan guaranteed by Teijin with the proceeds from common stock sold in a public offering or an amount equal to 10% of the proceeds from a sale of stock other than in a public offering.

        Also under these agreements, Teijin has the right to nominate a representative to the Company's board of directors. During 1999, 2000 and 2001, the Company paid Teijin approximately $3.2 million, $10.3 million and $9.0 million for purchases of raw material substrates. At December 31, 2000 and 2001, accounts payable to Teijin were $2.8 million and $1.8 million.

Globamatrix

        The Company has two distribution agreements with Globamatrix under which the Company granted it exclusive licenses in North America to distribute the Company's after-market applied film in the automotive and architectural glass markets. Under the agreements, which are scheduled to expire in 2007 and 2008, Globamatrix agreed to purchase an annually increasing amount of our products. During 1999, 2000 and 2001, sales to Globamatrix were $2.1 million, $2.2 million and $5.6 million. At December 31, 2000 and 2001, accounts receivable from Globamatrix were $0.6 million and $1.5 million.

        On April 20, 2001, Globamatrix purchased 422,119 shares of the Company's common stock for $1.0 million (approximately $2.37 per share) pursuant to a stock purchase agreement. The closing price of the Company's common stock on the Nasdaq National Market was $2.10 per share on April 19, 2001, and $2.19 per share on April 20, 2001. The shares were not registered under the Securities Act. Globamatrix holds registration rights with respect to the shares.

F-26

Transactions Involving Directors

        In April 1997, the Company entered into a development and technology agreement with Energy Conversion Devices, Inc., or ECD. This agreement provides that the Company will pursue with ECD the commercialization of the process of sputter coating on flexible substrates using PECVD processes. The agreement further provides that the Company will pay ECD a royalty in an amount based upon the sales volume of product produced through the PECVD process. Southwall agreed to pay to ECD 2.25% of its net sales in connection with PECVD technology for five years and 1.25% of net sales after that. Through March 1, 2002, the process had not been commercialized and the Company had not paid ECD royalties under the agreement but expected to begin to pay royalties in 2002. In February 1999, the Company entered into an equipment purchase contract with ECD pursuant to which ECD agreed to modify one of the Company's production machines (PM 7) so that the machine would produce products by means of the PECVD process. The Company paid ECD approximately $0.9 million in 1999, $0.01 million in 2000 and $0.29 million in 2001 in connection with its conversion of PM 7 to the use of PECVD technology. A director of Southwall is the Chairman of ECD. The Company presently owes ECD approximately $0.57 million in connection with the conversion of PM 7, which is represented by a note payable. As of December 31, 2001, the Company owed ECD approximately $0.72 million. The Company has agreed under the note to pay ECD $0.05 million per month through December 2002, with a final payment of $0.07 million in January 2003. The Company has further agreed to attempt to procure for ECD a first priority security interest in PM 7.

F-27

NOTE 11—BALANCE SHEET DETAIL

	December 31,
Accounts receivable, net:
	2000			2001
Accounts receivable	$	13,957		$	9,409
Allowance for doubtful accounts		(640	)		(389	)
Accounts receivable, net	$	13,317		$	9,020

		December 31,
Inventories, net:						March 31, 2002
		2000		2001
						(unaudited)
Raw materials		$	4,394	$	3,545	$	3,033
Work-in-process			4,799		2,430		3,279
Finished goods			981		176		741
	Total Inventories	$	10,174	$	6,151	$	7,053

		December 31,
Property, plant and equipment, net:
		2000			2001
Land, buildings and leasehold improvements		$	11,179		$	8,968
Machinery and equipment			63,717			70,986
Furniture and fixtures			4,075			4,730
Construction-in-process			6,999			5,179
		$	85,970		$	89,863
Less—Accumulated depreciation			(36,086	)		(42,022	)
	Total property, plant and equipment	$	49,884		$	47,841

        Depreciation and amortization expense for the years ended December 31, 1999, 2000 and 2001 was $4.9 million, $5.7 million, and $6.0 million respectively. See Note 5 to the financial statements with respect to a government grant received to offset construction and equipment costs for the German subsidiary.

		December 31,
Other accrued liabilities:
		2000		2001
Reserve for warranties and sales returns		$	1,903	$	2,642
Legal settlement			550		475
Accrued sales commission			441		405
Insurance premium financing			314		967
Accrued taxes			120		383
Accrued professional fees			393		187
Other			830		597
	Total other accrued liabilities	$	4,551	$	5,656

F-28

REPORT OF INDEPENDENT ACCOUNTANTS ON
FINANCIAL STATEMENT SCHEDULE

To the Board of Directors and Stockholders of
Southwall Technologies Inc.

        Our audits of the consolidated financial statements referred to in our report dated March 4, 2002, except as to Note 4, which is dated as of May 17, 2002, and Note 9, which is dated as of May 22, 2002, appearing in Item 14(a)(1) of the Annual Report on Form 10-K of Southwall Technologies Inc. included an audit of the financial statement schedule listed in Item 14(a)(2) of the Form 10-K. In our opinion, this financial statement schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.

PricewaterhouseCoopers LLP

San Jose, California
March 4, 2002

F-29

FINANCIAL STATEMENT SCHEDULE
Valuation and qualifying accounts and reserves

Description		Balance at Beginning of Year		Additions			Deductions			Balance at End of Year
		(in thousands)
December 31, 2001
	Inventory reserves	$	1,418	$	876		$	1,293	(2)	$	1,001
	Allowance for doubtful accounts		640		460			712	(2)		388
	Reserve for warranty and sales returns		1,903		3,945	(1)		3,206	(2)		2,642
December 31, 2000
	Inventory reserves		1,182		2,098			1,862	(2)		1,418
	Allowance for doubtful accounts		875		737			972	(2)		640
	Reserve for warranty and sales returns		1,174		3,008	(1)		2,279	(2)		1,903

(1)

Charged against revenue.

(2)

Reserves utilized during the year.

F-30

PART II

INFORMATION NOT REQUIRED IN THE PROSPECTUS

Item 13. Other Expenses of Issuance and Distribution.

        Estimated expenses (other than underwriting discounts and commissions) payable in connection with the sale of the common stock offered hereby are as follows:

SEC registration fee		$	5,000
NASD filing fee			5,000
Printing and engraving expenses			100,000
Legal fees and expenses			250,000
Accounting fees and expenses			275,000
Blue Sky fees and expenses (including legal fees)			15,000
Transfer agent and registrar fees and expenses			1,000
Miscellaneous			10,000
	Total	$	661,000

Item 14. Indemnification of Directors and Officers.

        Section 145(a) of the General Corporation Law of the State of Delaware provides that a Delaware corporation may indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the corporation) by reason of the fact that the person is or was a director, officer, employee or agent of the corporation or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation or enterprise, against expenses, judgments, fines and amounts paid in settlement actually and reasonably incurred by the person in connection with such action, suit or proceeding if the person acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had no cause to believe the person's conduct was unlawful.

        Section 145(b) provides that a Delaware corporation may indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the corporation to procure a judgment in its favor by reason of the fact that such person acted in any of the capacities set forth above, against expenses actually and reasonably incurred by the person in connection with the defense or settlement of such action or suit if the person acted under similar standards, except that no indemnification may be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable to the corporation unless and only to the extent that the court in which such action or suit was brought shall determine that despite the adjudication of liability, such person is fairly and reasonably entitled to be indemnified for such expenses which the court shall deem proper.

        Section 145 further provides that to the extent a director or officer of a corporation has been successful in the defense of any action, suit or proceeding referred to in subsections (a) and (b) or in the defense of any claim, issue or matter therein, such person shall be indemnified against expenses actually and reasonably incurred by such person in connection therewith; that indemnification provided for by Section 145 shall not be deemed exclusive of any other rights to which the indemnified party may be entitled; and that the corporation may purchase and maintain insurance on behalf of a director, employee or officer of the corporation against any liability asserted against such person or incurred by such person in any such capacity or arising out of such person's status as such whether or not the

II-1

corporation would have the power to indemnify such person against such liabilities under such Section 145.

        The Company's charter and by-laws provide for indemnification of the Company's directors to the fullest extent permitted by law. The Company's by-laws permit the Company to indemnify the Company's officers to the extent permitted by law. The by-laws also permit the Board of Directors to authorize the Company to purchase and maintain insurance against any liabilities asserted against any director, officer, employee or agent of the Company arising out of his capacity as such. The Company has a directors and officers liability insurance policy.

        The underwriting agreement provides that the underwriters are obligated, under certain circumstances, to indemnify directors, officers and controlling persons of the company against certain liabilities, including liabilities under the Securities Act of 1933, as amended (the "Securities Act"). Reference is made to the form of underwriting agreement filed as Exhibit 1.1 hereto.

        In addition, Southwall has a directors and officers liability insurance policy.

Item 15. Recent Sales of Unregistered Securities.

        On April 20, 2001, Southwall entered into a Stock Purchase Agreement with one of its major customers, Globamatrix Holdings Pte. Ltd. The agreement provided for the purchase by Globamatrix of 422,119 shares of Southwall's common stock for $1.0 million or a price of approximately $2.37 per share. The securities sold were not registered under the Securities Act. No underwriters were involved in the sale of securities. The sale was made in reliance upon an exemption from the registration provisions of the Securities Act set forth in Section 4(2) thereof relative to sales by an issuer not involving any public offering. All of the securities are deemed restricted securities for purposes of the Securities Act.

II-2

Item 16. Exhibits and Financial Statement Schedules.

(a)

Exhibits

Exhibit No.	Exhibit
1.1*	Form of Underwriting Agreement
3.1(1)	Restated Certificate of Incorporation of the Company.
3.2(1)	By-laws of the Company.
5.1*	Opinion of Choate, Hall & Stewart.
10.35.1(11)	Lease Agreement for the facilities at 3941 East Bayshore Road, dated October 7, 1999, between the Company and Straube Associates, Inc.
10.36(1)	Lease Agreement for the facilities at 3961 East Bayshore Road, dated March 20, 1979, between the Company and Allan F. Brown and Robert V. Brown.
10.36.1(11)	Amendment, dated October 12, 1999, between the Company and Brown Investment Company to the Lease Agreement for the facilities at 3961 East Bayshore Road, dated March 20, 1979, between the Company and Allan F. Brown and Robert V. Brown.
10.52(2)	Marketing and Distribution Agreement dated as of May 20, 1988, among Mitsui, Marubeni Corporation and the Company, as amended.
10.52.1	Amendment to the Marketing and Distribution Agreement dated as of May 20, 1988, among Mitsui, Marubeni Corporation and the Company, dated December 28, 1990.
10.59(3)	Lease Agreement for the facilities at 3969-3975 East Bayshore Road Palo Alto, California, dated January 1, 1989, between the Company and Bay Laurel Investment Company.
10.59.1(11)	Amendment, effective January 1, 2000, between the Company and Judd Properties, LLC to the Lease Agreement for the facilities at 3969-3975 East Bayshore Road Palo Alto, California, dated January 1, 1989, between the Company and Bay Laurel Investment Company.
10.60(3)	Lease Agreements for the facilities at 3977-3995 East Bayshore Road Palo Alto, California, dated January 1, 1989, between the Company and Bay Laurel Investment Company.
10.60.1(11)	Amendment, effective January 1, 2000, between the Company and Judd Properties, LLC to the Lease Agreements for the facilities at 3977-3995 East Bayshore Road Palo Alto, California, dated January 1, 1989, between the Company and Bay Laurel Investment Company.
10.71(4)	Lease Agreement for the facilities at 3780 Fabian Way, Palo Alto, California, dated June 11, 1990, between the Company and The Fabian Building.
10.72(4)	License Agreement between Mitsui and the Company, dated December 28, 1990.
10.72.1	Amendment to the License Agreement dated as of December 28, 1990 between Mitsui and the Company, dated August 2000.
10.78(5)	Amendment to property lease dated February 2, 1994 to extend lease period on building at 3961 E. Bayshore Road, Palo Alto, California. Original lease filed as Exhibit No. 10.36 above.
10.80(6)	Lease Agreement between Frank Gant, as Lessor, and the Company, as Lessee, effective September 1, 1994.
10.84(7)	Lease Agreement between Chamberlain Development, L.L.C., as Lessor and the Company, as Lessee, effective August 22, 1996.
10.88(8)	Basic Agreement dated April 9, 1997, for the sale of 667,000 shares of the Company's common stock to Teijin Limited, a Japanese corporation, and for mutually beneficial cooperation and collaboration between Teijin and the Company.
10.89(8)	Credit Agreement dated May 6, 1997, between Sanwa Bank, Limited and the Company.

II-3

10.89.1*	First Amendment to Credit Agreement dated November 8, 1999 between Sanwa Bank, Limited and the Company.
10.90(8)	Reimbursement and Security Agreement dated May 6, 1997, between Teijin Limited, a Japanese corporation, and the Company.
10.91(8)	Promissory Note, dated May 6, 1997, obligating the Company to Sanwa Bank, Limited, in the amount of $10 million.
10.92(9)	The Company's 1997 Stock Incentive Plan.
10.93(10)	The Company's 1997 Employee Stock Purchase Plan, as amended.
10.94(12)	The Company's October 22, 1999 Severance Policy in the Event of a Merger.
10.95(12)	Amendment to property lease dated August 22, 1996, to increase rent on building located at 8175 South Hardy Drive, Tempe, Arizona effective December 1, 2000. Original lease was filed as Exhibit 10.84 above.
10.96(13)	Digeo, Inc. sublease agreement.
10.97(13)	Energy Conversion Devices note payable.
10.98(14)	Globamatrix Purchase Agreement.
10.99(15)	1998 Stock Plan for Employees and Consultants.
10.100(15)	Receivables Financing Agreement between Pacific Business Funding and the Company, dated June 30, 1999.
10.101(16)	Supply Agreement between Saint Gobain Sekurit France and the Company, dated December 19, 2001 (portions of this exhibit have been omitted based on a request for confidential treatment; the non-public information has been filed with the Commission).
10.103(15)	German bank loan dated May 12, 1999.
10.104(15)	German bank loan dated May 28, 1999.
10.105(15)	German bank loans dated May 28, 1999 and December 1, 1999.
10.106(15)	German bank loan due June 30, 2009.
10.107(15)	German bank loan dated June 29, 2000.
10.108(15)	German bank loan dated July 10, 2000.
10.109(15)	German bank loans dated December 18, 2000 and December 19, 2000.
10.111	Master Lease Agreement between Matrix Funding Corporation and the Company, dated July 19, 1999.
10.112(15)	Development and Technology Agreement between Energy Conversion Devices, Inc. dated April 11, 1997.
10.114*	Promissory Notes issued by Thomas G. Hood to the Company.
10.115*	Teijin Waiver Letter dated March 28, 2002.
10.116(18)	Distribution Agreement between Globamatrix Holdings Pte. Ltd. and the Company, dated as of January 1, 2002 (portions of this exhibit have been omitted based on a request for confidential treatment; the non-public information has been filed with the Commission).
10.117(17)	Teijin Waiver Letter dated May 9, 2002.
10.118(17)	Sanwa Bank Waiver Letter dated May 15, 2002.
10.119	Standard Industrial Lease dated October 1999 for the facilities at 1029 Corporation Way, Palo Alto, California between the Company and C&J Development.
10.120	Guarantee Agreement Regarding 10 million US$ Credit Facility between Teijin Limited and the Company, dated May 6, 1997.
10.120.1*	Memorandum Amendment to the Guarantee Agreement between Teijin Limited and the Company, dated August 1999.
21(15)	List of Subsidiaries of the Company.
23.1	Consent of Independent Accountants.
23.2*	Opinion of Choate, Hall & Stewart (See Exhibit No. 5.1 above).

II-4

24.1* Power of Attorney.

*

Previously filed

⁽¹⁾

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

⁽²⁾

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

⁽³⁾

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

⁽⁴⁾

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

⁽⁵⁾

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

⁽⁶⁾

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

⁽⁷⁾

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

⁽⁸⁾

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

⁽⁹⁾

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

⁽¹⁰⁾

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

⁽¹¹⁾

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

⁽¹²⁾

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

⁽¹³⁾

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

⁽¹⁴⁾

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

⁽¹⁵⁾

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

⁽¹⁶⁾

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

⁽¹⁷⁾

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

⁽¹⁸⁾

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

(b)

Financial Statement Schedules.

        All schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.

Item 17. Undertakings.

        Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the provisions described in

II-5

Item 14 above, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission this indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against these liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by a director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether this indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of the issue.

        The undersigned registrant hereby undertakes (1) to provide to the underwriters at the closing specified in the underwriting agreement, certificates in the denominations and registered in the names as required by the underwriters to permit prompt delivery to each purchaser; (2) that for purposes of determining any liability under the Securities Act, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this registration statement as of the time it was declared effective; and (3) that for the purpose of determining any liability under the Securities Act, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of the securities at that time shall be deemed to be the initial bona fide offering thereof.

II-6

SIGNATURES AND POWER OF ATTORNEY

        Pursuant to the requirements of the Securities Act of 1933, as amended, the registrant has duly caused this amendment to the registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in Palo Alto, California on June 25, 2002.

SOUTHWALL TECHNOLOGIES INC.
By:	/s/  THOMAS G. HOOD Thomas G. Hood President and Chief Executive Officer

        Pursuant to the requirements of the Securities Act of 1933, this amendment to the registration statement has been signed by the following persons in the capacities and on the dates indicated.

Signature	Title(s)	Date
* Joseph B. Reagan	Chairman, Board of Directors	June 25, 2002
/s/  THOMAS G. HOOD Thomas G. Hood	President, Chief Executive Officer and Director (Principal Executive Officer)	June 25, 2002
/s/  ROBERT R. FREEMAN Robert R. Freeman	Chief Financial Officer, Vice President and Secretary (Principal Financial and Accounting Officer)	June 25, 2002
* Robert C. Stempel	Director	June 25, 2002
* Bruce J. Alexander	Director	June 25, 2002
Walter C. Sedgwick	Director
* Tadahiro Murakami	Director	June 25, 2002

*By: /s/  THOMAS G. HOOD Thomas G. Hood
as Attorney-in-fact June 25, 2002

II-7

Exhibit Index

Exhibit No.	Exhibit
1.1*	Form of Underwriting Agreement
3.1(1)	Restated Certificate of Incorporation of the Company.
3.2(1)	By-laws of the Company.
5.1*	Opinion of Choate, Hall & Stewart.
10.35.1(11)	Lease Agreement for the facilities at 3941 East Bayshore Road, dated October 7, 1999, between the Company and Straube Associates, Inc.
10.36(1)	Lease Agreement for the facilities at 3961 East Bayshore Road, dated March 20, 1979, between the Company and Allan F. Brown and Robert V. Brown.
10.36.1(11)	Amendment, dated October 12, 1999, between the Company and Brown Investment Company to the Lease Agreement for the facilities at 3961 East Bayshore Road, dated March 20, 1979, between the Company and Allan F. Brown and Robert V. Brown.
10.52(2)	Marketing and Distribution Agreement dated as of May 20, 1988, among Mitsui, Marubeni Corporation and the Company, as amended.
10.52.1	Amendment to the Marketing and Distribution Agreement dated as of May 20, 1988, among Mitsui, Marubeni Corporation and the Company, dated December 28, 1990.
10.59(3)	Lease Agreement for the facilities at 3969-3975 East Bayshore Road Palo Alto, California, dated January 1, 1989, between the Company and Bay Laurel Investment Company.
10.59.1(11)	Amendment, effective January 1, 2000, between the Company and Judd Properties, LLC to the Lease Agreement for the facilities at 3969-3975 East Bayshore Road Palo Alto, California, dated January 1, 1989, between the Company and Bay Laurel Investment Company.
10.60(3)	Lease Agreements for the facilities at 3977-3995 East Bayshore Road Palo Alto, California, dated January 1, 1989, between the Company and Bay Laurel Investment Company.
10.60.1(11)	Amendment, effective January 1, 2000, between the Company and Judd Properties, LLC to the Lease Agreements for the facilities at 3977-3995 East Bayshore Road Palo Alto, California, dated January 1, 1989, between the Company and Bay Laurel Investment Company.
10.71(4)	Lease Agreement for the facilities at 3780 Fabian Way, Palo Alto, California, dated June 11, 1990, between the Company and The Fabian Building.
10.72(4)	License Agreement between Mitsui and the Company, dated December 28, 1990.
10.72.1	Amendment to the License Agreement dated as of December 28, 1990 between Mitsui and the Company, dated August 2000.
10.78(5)	Amendment to property lease dated February 2, 1994 to extend lease period on building at 3961 E. Bayshore Road, Palo Alto, California. Original lease filed as Exhibit No. 10.36 above.
10.80(6)	Lease Agreement between Frank Gant, as Lessor, and the Company, as Lessee, effective September 1, 1994.
10.84(7)	Lease Agreement between Chamberlain Development, L.L.C., as Lessor and the Company, as Lessee, effective August 22, 1996.
10.88(8)	Basic Agreement dated April 9, 1997, for the sale of 667,000 shares of the Company's common stock to Teijin Limited, a Japanese corporation, and for mutually beneficial cooperation and collaboration between Teijin and the Company.
10.89(8)	Credit Agreement dated May 6, 1997, between Sanwa Bank, Limited and the Company.
10.89.1*	First Amendment to Credit Agreement dated November 8, 1999 between Sanwa Bank, Limited and the Company.
10.90(8)	Reimbursement and Security Agreement dated May 6, 1997, between Teijin Limited, a Japanese corporation, and the Company.
10.91(8)	Promissory Note, dated May 6, 1997, obligating the Company to Sanwa Bank, Limited, in the amount of $10 million.
10.92(9)	The Company's 1997 Stock Incentive Plan.
10.93(10)	The Company's 1997 Employee Stock Purchase Plan, as amended.
10.94(12)	The Company's October 22, 1999 Severance Policy in the Event of a Merger.

10.95(12)	Amendment to property lease dated August 22, 1996, to increase rent on building located at 8175 South Hardy Drive, Tempe, Arizona effective December 1, 2000. Original lease was filed as Exhibit 10.84 above.
10.96(13)	Digeo, Inc. sublease agreement.
10.97(13)	Energy Conversion Devices note payable.
10.98(14)	Globamatrix Purchase Agreement.
10.99(15)	1998 Stock Plan for Employees and Consultants.
10.100(15)	Receivables Financing Agreement between Pacific Business Funding and the Company, dated June 30, 1999.
10.101(16)	Supply Agreement between Saint Gobain Sekurit France and the Company, dated December 19, 2001 (portions of this exhibit have been omitted based on a request for confidential treatment; the non-public information has been filed with the Commission).
10.103(15)	German bank loan dated May 12, 1999.
10.104(15)	German bank loan dated May 28, 1999.
10.105(15)	German bank loans dated May 28, 1999 and December 1, 1999.
10.106(15)	German bank loan due June 30, 2009.
10.107(15)	German bank loan dated June 29, 2000.
10.108(15)	German bank loan dated July 10, 2000.
10.109(15)	German bank loans dated December 18, 2000 and December 19, 2000.
10.111	Master Lease Agreement between Matrix Funding Corporation and the Company, dated July 19, 1999.
10.112(15)	Development and Technology Agreement between Energy Conversion Devices, Inc. dated April 11, 1997.
10.114*	Promissory Notes issued by Thomas G. Hood to the Company.
10.115*	Teijin Waiver Letter dated March 28, 2002.
10.116(18)	Distribution Agreement between Globamatrix Holdings Pte. Ltd. and the Company, dated as of January 1, 2002 (portions of this exhibit have been omitted based on a request for confidential treatment; the non-public information has been filed with the Commission).
10.117(17)	Teijin Waiver Letter dated May 9, 2002.
10.118(17)	Sanwa Bank Waiver Letter dated May 15, 2002.
10.119	Standard Industrial Lease dated October 1999 for the facilities at 1029 Corporation Way, Palo Alto, California between the Company and C&J Development.
10.120	Guarantee Agreement Regarding 10 million US$ Credit Facility between Teijin Limited and the Company, dated May 6, 1997.
10.120.1*	Memorandum Amendment to the Guarantee Agreement between Teijin Limited and the Company, dated August 1999.
21(15)	List of Subsidiaries of the Company.
23.1	Consent of Independent Accountants.
23.2*	Opinion of Choate, Hall & Stewart (See Exhibit No. 5.1 above).
24.1*	Power of Attorney.

*

Previously filed

⁽¹⁾

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

⁽²⁾

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

⁽³⁾

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

⁽⁴⁾

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

⁽⁵⁾

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

⁽⁶⁾

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

⁽⁷⁾

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

⁽⁸⁾

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

⁽⁹⁾

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

⁽¹⁰⁾

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

⁽¹¹⁾

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

⁽¹²⁾

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

⁽¹³⁾

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

⁽¹⁴⁾

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

⁽¹⁵⁾

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

⁽¹⁶⁾

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

⁽¹⁷⁾

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

⁽¹⁸⁾

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

QuickLinks

TABLE OF CONTENTS
PROSPECTUS SUMMARY
Southwall Technologies Inc.
The Offering
Summary Consolidated Financial Data
RISK FACTORS
FORWARD-LOOKING STATEMENTS
USE OF PROCEEDS
DIVIDEND POLICY
CAPITALIZATION
PRICE RANGE OF COMMON STOCK
SELECTED CONSOLIDATED FINANCIAL DATA (in thousands, except per share data)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
BUSINESS
MANAGEMENT
RELATED PARTY TRANSACTIONS
PRINCIPAL AND SELLING STOCKHOLDERS
DESCRIPTION OF CAPITAL STOCK
UNDERWRITING
LEGAL MATTERS
EXPERTS
WHERE YOU CAN FIND MORE INFORMATION
SOUTHWALL TECHNOLOGIES INC. Index to Consolidated Financial Statements
REPORT OF INDEPENDENT ACCOUNTANTS
SOUTHWALL TECHNOLOGIES INC. CONSOLIDATED BALANCE SHEETS (dollars and shares in thousands, except for per share data)
SOUTHWALL TECHNOLOGIES INC. CONSOLIDATED STATEMENTS OF OPERATIONS (dollars and shares in thousands, except per share data)
SOUTHWALL TECHNOLOGIES INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (in thousands)
SOUTHWALL TECHNOLOGIES INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
SOUTHWALL TECHNOLOGIES INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars and shares in thousands, except per share data)
REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE
FINANCIAL STATEMENT SCHEDULE Valuation and qualifying accounts and reserves
PART II
INFORMATION NOT REQUIRED IN THE PROSPECTUS

Item 13. Other Expenses of Issuance and Distribution.
Item 14. Indemnification of Directors and Officers.
Item 15. Recent Sales of Unregistered Securities.
Item 16. Exhibits and Financial Statement Schedules.
Item 17. Undertakings.

SIGNATURES AND POWER OF ATTORNEY
Exhibit Index

EX-10.52-1

Exhibit 10.52.1

AMENDMENT AGREEMENT

THIS AMENDMENT AGREEMENT made and entered into this 28th day of December, 1990 by and among MITSUI TOATSU CHEMICALS, INC., a corporation duly organized and existing under the laws of Japan, with its principal office at 2-5 Kasumigaseki 3-chome, Chiyoda-ku, Tokyo, Japan (hereinafter called “Mitsui”), MARUBENI CORPORATION, a corporation duly organized and existing under the laws of Japan, with its principal office at 4-2, Ohtemachi 1-chome, Chiyoda-ku, Tokyo, Japan (hereinafter called “Marubeni”), (collectively “Buyers”) and SOUTHWALL TECHNOLOGIES INC., a corporation duly organized and existing under the laws of the State of Delaware, with its principal office at 1029 Corporation Way, Palo Alto, California 94303, U.S.A. (hereinafter called “Southwall”).

WITNESSETH:

WHEREAS, the parties hereto entered into a certain MARKETING AND DISTRIBUTION AGREEMENT dated May 20, 1988 (hereinafter called the “ORIGINAL AGREEMENT”) relating to the distribution by Mitsui and Marubeni of the Southwall Products (as defined in the ORIGINAL AGREEMENT) in the Territory (as defined in the ORIGINAL AGREEMENT);

WHEREAS, Mitsui and Southwall entered into a license agreement dated December 28, 1990 (hereinafter called the “License Agreement”) pursuant to which Southwall granted to Mitsui a license to produce certain of the Southwall Products; and

WHEREAS, in connection with conclusion of the License Agreement by Mitsui and Southwall, the parties hereto desire to amend certain portions of the ORIGINAL AGREEMENT.

NOW, THEREFORE, in consideration of the premises and mutual covenants contained herein, the parties hereto agree as follows:

Article 1

Section 1.1 of the ORIGINAL AGREEMENT shall be deleted in its entirety and replaced with the following:

“1.1.1 “Southwall Products” shall refer to the standard products listed on Exhibit A-1. Southwall’s Heat Mirror™ products, which are the subject of a pre-existing agreement between Southwall and Mitsui) the “Hear Mirror Agreement”), shall also be considered Southwall Products, and have been listed on Exhibit A-1. The Heat Mirror Agreement shall remain in effect to the extent it is not

contradicted by the terms and conditions of this Agreement. Furthermore, Southwall and Mitsui hereby agree that Marubeni shall become a party to the Heat Mirror Agreement, as of the date hereof, having the same rights and obligations as Mitsui hereunder. To the extent that the terms of this Agreement are in conflict with the terms of the Heat Mirror Agreement, the terms of this Agreement shall govern.

1.1.2 “Licensed Products” shall refer to the products listed on Exhibit A-2, which are produced by Mitsui under a license from Southwall (the “Licensed Products”).

1.1.3 As and when any other products manufactured and sold by Southwall which are not, currently, standard products listed on Exhibit A-1 as Southwall Products become commercially available to end-user customers, Southwall shall notify the Buyers of such fact and provide necessary particulars and the Buyers shall have a right to request that such products be characterized as Southwall Products.” Southwall shall honor any such request by the Buyers unless Southwall has a reasonable basis for not doing so. Southwall shall not be obligated under this Agreement to make such characterization.

Article 2

Section 1.8 of the ORIGINAL AGREEMENT shall be deleted in its entirety and replaced with the following:

“1.8 “Territory” shall, subject to the provisions of Section 4.1, refer to Japan, Taiwan, South Korea, Hong Kong, Thailand, Philippines, Malaysia, Singapore, Brunei and Indonesia”.

Article 3

Section 4.1 of the ORIGINAL AGREEMENT shall be amended by replacing the period after “Korea” in line six thereof with a comma and adding the words “Hong Kong, Thailand, Philippines, Malaysia, Singapore, Brunei and Indonesia” thereafter.

Article 4

The first paragraph of Section 4.3 of the ORIGINAL AGREEMENT shall be amended by inserting the word “exclusive” between the words “its” and “distributors” in line six thereof. The second paragraph of Section 4.3 shall be deleted in its entirety and replaced with the following:

“In addition, except for Southwall’s current customers in Korea and Thailand, Southwall will not sign up any other customers in the Territory without first giving Buyers 30 days notice of such intention. Southwall and Buyers

shall then meet and Southwall shall give due consideration to any business plan the Buyers may present to Southwall for that country for the purpose of appointing the Buyers as exclusive distributor in said country. Southwall shall honor Buyers’ requests unless it has a reasonable basis for not doing so.”

Article 5

Section 4.5 of the ORIGINAL AGREEMENT shall be amended by inserting the words “and Licensed Products” between the words “Products” and “it” in line three thereof.

Article 6

A new Section 4.10 shall be added to the ORIGINAL AGREEMENTas follows:

“4.10 Purchase of Licensed Products. If, for any reason, Mitsui is not able to produce the Licensed Products at all, or in sufficient quantity to meet the demand therefore in the Territory, the buyers shall have the rights to purchase from Southwall, subject to availability, such further quantity of the Licensed Products as will be necessary to make up said shortage of the Licensed Products. Southwall will give due consideration to the Buyers’ request consistent with Southwall’s other obligations and customer requirements or commitments. However, Southwall has no obligation to supply products that it does not make generally available to others or to provide special priority to Buyer’s orders. Section 7.5 will apply to any such purchases.”

Article 7

The table in Section 5.2 of the ORIGINAL AGREEMENT shall be amended to reflect Buyers current minimum forecast of sales, as follows:

	ANNUAL MINIMUM PURCHASE
	QUANTITY IN U.S. DOLLARS
CALENDAR YEAR	FOR CALENDAR YEAR
1991	$234,000
1992	$335,000
1993	$435,000

Article 8

Section 5.3 of the ORIGINAL AGREEMENT shall be deleted in its entirety and replaced with the following:

“5.3 Loss of Exclusivity. If on December 31, 1993 the Buyers have failed to purchase the cumulative annual minimum purchase quantities for the three years commencing January 1, 1991, then the parties shall meet to review the market situation as of that time. If, after such meeting, Southwall so elects, Southwall may, by providing written notice thereof, cause the rights of the Buyers under this Agreement to become non-exclusive in the Territory.”

Article 9

Section 6.1 of the ORIGINAL AGREEMENT shall be amended by deleting the words “at or around the Three-Year Checkpoint” in lines seven and eight thereof and inserting a period after the words “Joint Venture” in line seven.

Article 10

Section 8.1 of the ORIGINAL AGREEMENT shall be amended by inserting the words “and Licensed Products” after the word “Products” in lines two, seven, eleven and fourteen thereof.

Article 11

Section 10.1 of the ORIGINAL AGREEMENT shall be amended by inserting a comma and the words “Hong Kong, Thailand, Philippines, Malaysia, Singapore, Brunei and Indonesia” after the word “Korea” in line seven thereof.

Article 12

The words “after the Three-Year Checkpoint,” in lines one and two and “thereafter” in line three of Section 10.3 of the ORIGINAL AGREEMENT shall be deleted.

Article 13

Section 10.4 of the ORIGINAL AGREEMENT shall be amended by replacing the period after the last sentence thereof with a semicolon and adding the words “provided, however, that if this Agreement is terminated by Southwall for a reason not attributable to the Buyers, this Section shall not apply to the extent necessary for the Buyers to exercise their rights under Section 16.2 (b).

Article 14

Section 11.1 of the ORIGINAL AGREEMENT shall be deleted in its entirety and replaced with the following:

“11.1 Southwall Developments.” Any developments (whether or not patentable or copyrightable) that are developed independently by Southwall, by Southwall jointly with a

third party or by a third party licensee or distributor of Southwall (the “Southwall Developments”) shall, for purposes of this Agreement, be deemed to be owned solely by Southwall. Subject to the payment of the consideration set forth in Section 3.1 and, where applicable, to any agreement between Southwall and a given third party, Southwall hereby grants to the Buyers an exclusive, non transferable right and license under the Southwall Development to the same extent as the right and license granted pursuant to ARTICLE X. Southwall shall promptly disclose in writing to the Buyers any Southwall Developments which Southwall is not prohibited from disclosing pursuant to any agreement with a third party.”

Article 15

The Buyers have expressed their desire to distribute Southwall’s Heat Mirror XIR products in the Territories. All parties recognize that Southwall has an agreement with Monsanto Company (“Monsanto”) that provides Monsanto with non-exclusive distribution rights for Heat Mirror XIR in the Territories. From the date of this amendment, Southwall grants to the Buyer:

A)Non exclusive distribution rights for Heat Mirror XIR solely for use in architectural window applications in the Territory, including:

-laminated safety glass

-factory applied films

-retrofit applied films

B)The nonexclusive right in the Territory to continue their efforts with Honda for the purpose of obtaining Honda as a customer/user of Heat Mirror XIR in automobile window applications. In addition, Southwall and Buyers shall meet from time to time to review progress in the marketing of Heat Mirror XIR products in the Territory. Based on such progress, the parties shall discuss the possible expansion of Buyers’ marketing right to include other Japanese car manufacturers. Southwall shall give due consideration to any such expansion, but shall have no obligation to make any such expansion.

C)Solely to support their rights under A and B above and consistent with Southwall’s obligations to others, the Buyers may purchase Heat Mirror XIR from Southwall and the relationship of the parties with respect to Heat Mirror XIR shall be governed by the terms of the Original Agreement as if Heat Mirror XIR was a Southwall Product thereunder, except that (1) Buyers will not have any of exclusivity with respect to Heat Mirror XIR; (2) purchases of Heat Mirror XIR will not apply to minimums under the Original Agreement, as amended; (3) the price

and specifications of Heat Mirror XIR shall be the same as for Monsanto; and (4) Southwall makes no representation as to sufficiency of its capacity to make Heat Mirror XIR.

On or before June 30, 1992, the parties will meet to review and discuss the Buyers’ progress in marketing and selling Heat Mirror XIR in the Territory. At such time, Southwall and Buyers shall discuss the expansion of Buyers’ marketing rights and Southwall shall consider various further commitments regarding Heat Mirror XIR, including maintaining status quo, expansion of non-exclusive rights or exclusivity within the Territory.

Article 16

EXHIBIT A to the ORIGINAL AGREEMENT shall be replaced with two new EXHIBITS, namely EXHIBIT A-1 and EXHIBIT A-2, in the forms attached hereto as Appendix 1.

Article 17

All other terms and conditions of the ORIGINAL AGREEMENT shall remain unchanged and continue in full force and effect.

IN WITNESS WHEREOF, the parties hereto have caused this AMENDMENT AGREEMENT to be executed by their respective, duly authorized representatives on the day and year first above written.

MITSUI TOATSU CHEMICAL, INC.
By:	/s/ Yoshihiro Nabeta
	Yoshihiro Nabeta
	Director of Performance Polymers
MARUBENI CORPORATION
By:	/s/ Kazuyoshi Orihashi
	Kazuyoshi Orihashi
	General Manager of Chemicals
	Project Department
SOUTHWALL TECHNOLOGIES INC.
By:	/s/ Bruce J. Alexander
	Bruce J. Alexander
	President & Chief Executive Officer

APPENDIX 1

EXHIBIT A-1

SOUTHWALL PRODUCTS

STANDARD PRODUCTS

Applied Films for Retrofit Architectural Applications

Heat Mirror 88 on 1mil PET (no topcoat, no adhesive)

Heat Mirror 77 on 1mil PET (no topcoat, no adhesive)

Heat Mirror 66 on 1mil PET (no topcoat, no adhesive)

Heat Mirror 55 on 1mil PET (no topcoat, no adhesive)

Heat Mirror 44 on 1mil PET (no topcoat, no adhesive)

Heat Mirror 33 on 1mil PET (no topcoat, no adhesive)

Heat Mirror 22 on 1mil PET (no topcoat, no adhesive)

BRG on 1mil PET (no topcoat, no adhesive)

Suspended Films for Architectural Applications

Heat Mirror 88 on 2mil High-shrink PET

Heat Mirror 77 on 2mil High-shrink PET

Heat Mirror 66 on 2mil High-shrink PET

Heat Mirror 55 on 2mil High-shrink PET

Heat Mirror 44 on 2mil High-shrink PET

Heat Mirror 33 on 2mil High-shrink PET

Heat Mirror 22 on 2mil High-shrink PET

Heat Mirror XUV 88 on 3mil High-shrink PET

Heat Mirror XUV 77 on 3mil High-shrink PET

Heat Mirror XUV 66 on 3mil High-shrink PET

Heat Mirror XUV 55 on 3mil High-shrink PET

Heat Mirror XUV 44 on 3mil High-shrink PET

Heat Mirror XUV 33 on 3mil High-shrink PET

Heat Mirror XUV 22 on 3mil High-shrink PET

Silver Reflector Films

dBar 40 Architectural EMI/RFI Shielding Windows

dBar 60 Architectural EMI/RFI Shielding Windows

DEVELOPMENT PRODUCTS

Heat Mirror on PMMA

Silver Reflector Film on PMMA

Tempest Filters

Titanium on PET - STI UT18 (copy belts)

EXHIBIT A-2

LICENSED PRODUCTS

ALTAIR-O films

ALTAIR-M films

ETCH-A-FLEX on Polyimide films

ETCH-A-FLEX-C on Polyimide films

DEVELOPMENT PRODUCTS

ALTAIR-O on PES

ALTAIR-O on PEEK

ALTAIR-O on PTFE

ALTAIR-O on PMMA

ALTAIR-M on PES

ALTAIR-M on PEEK

ALTAIR-M on PMMA

ETCH-A-FLEX on PES

ETCH-A-FLEX on PEEK

ETCH-A-FLEX-C on PES

ETCH-A-FLEX-C on PEEK

ETCH-A-FLEX on Plating Stock on 1 mil Polyimide

AuNi Transparent Conductor Films

EX-10.72-1

Exhibit 10.72.1

MEMORANDUM

Mitsui Chemicals, Inc. (“Mitsui”) and Southwall Technologies, Inc. (“Southwall”) hereby confirm certain issues, which were agreed upon during the July 14, 2000 meeting at Palo Alto by representatives from Mitsui and Southwall in connection with the License Agreement dated December 28, 1990 (“License Agreement”).

1.             license Agreement

A.Definition

(i)The parties shall confirm the definition of “Products” (i.e. transparent conductive sputter coated thin films including Altair films and sputtercoated flexible circuit base materials including Etch-A-Flex) by specifically mentioning XIR films and AR films.

(ii)The parties shall confirm the definition of “Device” by specifically mentioning certain applications such as, but without limitation to, the following: Cathode Ray Tube (CRT), Liquid Crystal Display (LCD), Plasma Display Panel (PDP), Electroluminescence Display (ELD), Field Emission Display (FED).

B.XIR

(i)Mitsui shall have exclusive rights to XIR for Device in Japan and Taiwan.

(ii)Notwithstanding the foregoing, Southwall may sell XIR under existing agreements to Teijin and/or Bridgestone until February 9, 2001. Thereafter, Mitsui shall in principal succeed sales of XIR for Device to Teijin and/or Bridgestone, but continuation of such sales shall be ultimately decided by Mitsui in good faith.

C.New AR

(i)The parties shall confirm the new AR film manufactured by Southwall using AC Mid-frequency Dual Planar Magnetron Technology (“New AR”), in order to distinguish from the AR to which Mitsui has exclusive rights to in Japan and Taiwan under the License Agreement.

(ii)Southwall may sell New AR film for Device applications to any companies in Japan and Taiwan.

1

2.Toll Manufacture

A.Mitsui will ask Southwall to toll manufacture XIR and related products in quantities to be separately agreed by the parties and at most favored customer prices.

B.For such XIR and related products, which are toll manufactured by Southwall for Mitsui, the minimum royalty which Mitsui must pay Southwall under the License Agreement shall be reduced in accordance with the following formula:

Adjusted Minimum Royalty = A–(BxC)

Where:
A	=	Minimum annual royalty payable by Mitsui under the License Agreement to maintain exclusivity.
B	=	Percentage credit of 5% effective until March 31, 2001, and 3% from April 1, 2001.
C	=	Mitsui purchase amount of toll manufactured products from Southwall in a given calendar year.

3.Mitsui and Southwall shall effectuate their understanding outlined in this Memorandum through a new license agreement and a toll manufacture agreement (collectively “New Agreements”) to be executed as soon as possible.

4.The parties agree to be bound by the terms of this Memorandum until such time as the New Agreements have been executed.

5.This Memorandum and its contents are subject to the confidentiality restrictions set forth in the parties' jointly executed letter dated March 2, 1999.

Subject to final execution of the New Agreements, the parties hereby acknowledge that this Memorandum fairly represents their understanding and to evidence such, shall enter their respective signatures below.

Mitsui Chemicals, Inc.	Southwall Technologies, Inc.
/s/ Razuyoshi Isogaya	/s/ Thomas G. Hood
Razuyoshi Isogaya Managing Director Group Executive Engineered Materials Group	Thomas G. Hood President and CEO
Date: August 2, 2000	Date: August 10, 2000

2

EX-10.111

Exhibit 10.111

M A T R I X
F U N D I N G  C O R P O R A T I O N

6975 Union Park Center, Second Floor
Midvale, Utah 84047

MASTER LEASE AGREEMENT NO. R0825

This Master Lease Agreement is made this 19th day of July, 1999 between MATRIX FUNDING CORPORATION, with its principal office at 6975 Union Park Center, Second Floor, Midvale, UT 84047 (the “Lessor”), and SOUTHWALL TECHNOLOGIES, INC., with its principal office at 1029 Corporation Way, Palo Alto, CA 94303 (the “Lessee”).

1.             LEASE:

Lessor agrees to lease to Lessee, and Lessee agrees to lease from Lessor, the property (together with all attachments, replacements, parts, substitutions, additions, repairs, accessions and accessories, incorporated therein and/or affixed thereto) (collectively, the “Property”) described in any Lease Schedule (“Schedule”) executed and delivered by Lessor and Lessee in connection with this Master Lease Agreement.  Each Schedule shall incorporate by reference the terms and conditions of this Master Lease Agreement, and together with the Acceptance Certificate (as defined herein) and Master Progress Funding Agreement, if applicable, shall constitute a separate “Lease”.  In the event of conflict between the provisions of this Master Lease Agreement and any Schedule, the provisions of the Schedule shall govern.

2.             ADDITIONAL DEFINITIONS:

(a)           Except as otherwise provided in Section 6(a) hereof, “Acceptance Date” means, as to the Property designated on any Schedule, the date Lessee accepts the Property as set forth in any acceptance certificate signed by the Lessee which is acceptable to Lessor (the “Acceptance Certificate”).  If Lessee fails to sign and deliver an Acceptance Certificate, then except as otherwise provided in Section 6(a) hereof, the Acceptance Date shall be a date determined by Lessor which shall be no sooner than the date Lessee receives substantially all of the Property.

(b)           “Commencement Date” means, as to the Property designated on any Schedule, where the Acceptance Date for such Schedule falls on the first day of a calendar quarter, that date, and, in any other case, the first day of the calendar quarter following the calendar quarter in which such Acceptance Date falls.

3.             TERM OF LEASE:

The term of any Lease, as to all Property designated on the applicable Schedule, shall commence on the Acceptance Date for such Property, and shall continue for an “Initial Period” ending that number of months from the Commencement Date as specified in the Schedule.  Thereafter, Lessee shall have options to purchase or return the Property or to extend the Lease, all as provided in Section 18(m) of this Agreement.

4.             RENT AND PAYMENT:

Lessee shall pay as rent for use of the Property, aggregate rentals equal to the sum of all the Monthly Rentals (defined in the Schedule) and other payments due under the Lease for the entire Initial Period.  The Monthly Rental shall begin on the Acceptance Date and shall be due and payable by Lessee in advance on the first day of each month throughout the Initial Period.  If the Acceptance Date does not fall on the first day of a calendar quarter, then the first rental payment shall be calculated by multiplying the number of days from and including the Acceptance Date to the Commencement Date by a daily rental equal to one thirtieth (1/30) of the Monthly Rental, and shall be due and payable on the Acceptance Date.  Lessee shall pay all rentals to Lessor, or its assigns, at Lessor’s address set forth above (or as otherwise directed in writing by Lessor, or its assigns), without notice or demand.  LESSEE SHALL NOT ABATE, SET OFF OR DEDUCT ANY AMOUNT OR DAMAGES FROM OR REDUCE ANY MONTHLY RENTAL OR OTHER PAYMENT DUE FOR ANY REASON.  THIS

LEASE IS NON-CANCELABLE FOR THE ENTIRE TERM OF THE INITIAL PERIOD AND ANY EXTENSION PERIODS.

If any rental or other payment due under any Lease shall be unpaid after its due date, Lessee will pay on demand, as a late charge, but not as interest, the greater of twenty–five dollars ($25) or five percent (5%) of any such unpaid amount but in no event to exceed maximum lawful charges.  If late charges are assessed by a lending institution due to any late payment by Lessee, Lessee agrees to pay such late charges or to reimburse Lessor for their payment.

5.             TAXES:

Lessee shall pay to Lessor when due all taxes, fees, assessments and charges paid, payable or required to be collected by Lessor, however designated, which are levied or based on the Monthly Rental or other payment due under the Lease, or on the possession, use, operation, lease, rental, sale, purchase, control or value of the Property, including without limitation, registration and license fees and assessments, state and local privilege or excise taxes, documentary stamp taxes or assessments, sales and use taxes, personal and other property taxes, and taxes or charges based on gross revenue, but excluding taxes based on Lessor’s net income (collectively, “taxes”).  Lessor shall invoice Lessee for all taxes in advance of their payment due date, and Lessee shall promptly remit to Lessor all taxes upon receipt of an invoice from Lessor.  Lessee shall pay all penalties and interest resulting from its failure to timely remit all taxes to Lessor when invoiced by Lessor.  Lessor shall file all required sales and use tax and personal property tax returns and reports concerning the Property with all applicable governmental agencies.

6.             USE; ALTERATIONS AND ATTACHMENTS:

(a)           After Lessee receives and inspects any Property and is satisfied that the Property is satisfactory, Lessee shall execute and deliver to Lessor an Acceptance Certificate in form provided by Lessor; provided, however, that Lessee’s failure to execute and deliver an Acceptance Certificate for any Property shall not affect the validity and enforceability of the Lease with respect to the Property.  If Lessee has signed and delivered a Master Progress Funding Agreement, Lessor may, in its sole discretion, at any time by written notice to Lessee, declare all prior Authorizations signed in connection with the Master Progress Funding Agreement to be and constitute the “Acceptance Certificate” for all purposes under the Lease, and the Acceptance Date of the Lease shall be the date determined by Lessor in its sole discretion which shall not be earlier than the date of the last Authorization.

(b)           Lessee shall at all times keep the Property in its sole possession and control.  The Property shall not be moved from the location stated in the Schedule without the prior written consent of Lessor.

(c)           Lessee shall cause the Property to be installed, used, operated and, at the termination of the Lease, removed (i) in accordance with any applicable manufacturer’s manuals or instructions; (ii) by competent and duly qualified personnel only; and
(iii) in accordance with applicable governmental regulations.

(d)           Lessee may not make alterations or attachments to the Property without first obtaining the written consent of Lessor.  Any such alterations or attachments shall be made at Lessee’s expense and shall not interfere with the normal and satisfactory operation or maintenance of the Property.  The manufacturer may incorporate engineering changes or make temporary alterations to the Property upon request of Lessee.  Unless Lessor shall otherwise agree in writing, all such alterations and attachments shall be and become the property of Lessor upon their attachment to the Property or, at the option of Lessor, shall be removed by Lessee at the termination of the Lease as to such Property and the Property restored at Lessee’s expense to its original condition, reasonable wear and tear only excepted.

(e)           The Property is and shall remain personal property during the term of the Lease notwithstanding that any portion thereof may in any manner become affixed, attached to or located on real property or any building or improvement thereon.  Lessee shall not permit the Property to become an accession to other goods or a fixture to or part of any real property.  Lessee will obtain and deliver to Lessor a waiver of liens, in form satisfactory to Lessor, from all persons not a party hereto who might secure an interest, lien or other claim in the Property.

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(f)            In the event the Property includes software (which Lessee agrees shall include all documentation, later versions, updates, upgrades, and modifications) (herein “Software”), the following shall apply: (i) Lessee shall possess and use the Software in accordance with the terms and conditions of any license agreement (“License”) entered into with the owner/vendor of such Software and shall not breach the License (at Lessor’s request, Lessee shall provide a complete copy of the License to Lessor); (ii) Lessee agrees that Lessor has an interest in the License and Software due to its payment of the price thereof and is an assignee or third–party beneficiary of the License; (iii) as due consideration for Lessor’s payment of the price of the License and Software and for providing the Software to Lessee at a lease rate (as opposed to a debt rate), Lessee agrees that Lessor is leasing (and not financing) the Software to Lessee; (iv) except for the original price paid by Lessor, Lessee shall, at its own expense, pay promptly when due all servicing fees, maintenance fees, update and upgrade costs, modification costs, and all other costs and expenses relating to the License and Software and to maintain the License in effect during the term of the Lease; and (v) the Software shall be deemed Property for all purposes under the Lease.

(g)           Lessee shall comply with all applicable laws, regulations, requirements, rules and orders, all manufacturer’s instructions and warranty requirements, and with the conditions and requirements of all policies of insurance with respect to the Property and the Lease.

(h)           The Property is leased solely for commercial or business purposes.

7.             MAINTENANCE AND REPAIRS; RETURN OF PROPERTY:

(a)           During the continuance of each Lease, Lessee shall, at its expense, and in accordance with all manufacturer maintenance specifications, (i) keep the Property in good repair, condition and working order; (ii) make all necessary adjustments, repairs and replacements; (iii) furnish all required parts, mechanisms, devices and servicing; and (iv) not use or permit the Property to be used for any purpose for which, in the opinion of the manufacturer, the Property is not designed or reasonably suitable.  Such parts, mechanisms and devices shall immediately become a part of the Property for all purposes hereunder and title thereto shall vest in Lessor.  If the manufacturer does not provide maintenance specifications, Lessee shall perform all maintenance in accordance with industry standards for like Property.

(b)           During the continuance of each Lease, Lessee shall, at its own expense, enter into and maintain in force a contract with the manufacturer or other qualified maintenance organization satisfactory to Lessor for maintenance of each item of Property.  Such contract as to each item shall commence upon the Acceptance Date.  Lessee shall furnish Lessor with a copy of such contract upon demand.

(c)           Lessee shall pay all shipping and delivery charges and other expenses incurred in connection with the Property.  Upon default, or at the expiration or earlier termination of any Lease, Lessee shall, at its own expense, assemble, prepare for shipment and promptly return the Property to Lessor at the location within the Continental United States designated by Lessor.  Upon such return, the Property shall be in the same operating order, repair, condition and appearance as on the Acceptance Date, except for reasonable wear and tear from proper use thereof, and shall include all engineering changes theretofore prescribed by the manufacturer.  Lessee shall provide maintenance certificates or qualification letters and/or arrange for and pay all costs which are necessary for the manufacturer to accept the Property under contract maintenance at its then standard rates (“recertification”).  The term of the Lease shall continue upon the same terms and conditions until such recertification has been obtained.  With regard to Software, at the expiration or earlier termination of any Lease, or upon demand by Lessor upon the occurrence of an Event of Default under the Lease, Lessee shall (i) delete from its systems all Software then installed, (ii) destroy all copies or duplicates of the Software which were not returned to Lessor, and (iii) cease using the Software altogether.  Upon its receipt from Lessee, Lessor shall be responsible to return the Software to the owner/vendor/licensor so that Lessee shall not be in breach of any software license.

8.             OWNERSHIP AND INSPECTION:

(a)           The Property shall at all times be the property of Lessor or its assigns, and Lessee shall have no right, title or interest therein except as to the use thereof subject to the terms and conditions of the Lease.  For purposes of the foregoing, Lessee transfers to Lessor all right, title and interest (including all ownership interest) which Lessee may have in and to the Property.  Lessor may affix (or require Lessee to affix) tags, decals or plates to

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the Property indicating Lessor’s ownership, and Lessee shall not permit their removal or concealment.  Lessee shall not permit the name of any person or entity other than Lessor or its assigns to be placed on the Property as a designation that might be interpreted as a claim of ownership or security interest.

(b)           LESSEE SHALL KEEP THE PROPERTY AND LESSEE’S INTEREST UNDER ANY LEASE FREE AND CLEAR OF ALL LIENS AND ENCUMBRANCES, EXCEPT THOSE PERMITTED IN WRITING BY LESSOR OR ITS ASSIGNS.

(c)           Lessor, its assigns and their agents shall have free access to the Property at all reasonable times during normal business hours for the purpose of inspecting the Property and for any other purpose contemplated in the Lease.

(d)           Lessee shall immediately notify Lessor in writing of all details concerning any damage or loss to the Property, including without limitation, any damage or loss arising from the alleged or apparent improper manufacture, functioning or operation of the Property.

9.             WARRANTIES:

(a)           Lessee acknowledges that Lessor is not the manufacturer of the Property nor the manufacturer’s agent nor a dealer therein.  The Property is of a size, design, capacity, description and manufacture selected by the Lessee.  Lessee is satisfied that the Property is suitable and fit for its purposes.  LESSEE AGREES THAT LESSOR HAS NOT MADE AND DOES NOT MAKE ANY WARRANTY OR REPRESENTATION WHATSOEVER, EXPRESS OR IMPLIED, AS TO THE PROPERTY, INCLUDING, WITHOUT LIMITATION, ANY WARRANTY OR REPRESENTATION AS TO: (i) THE DESCRIPTION, CONDITION, DESIGN, QUALITY OR PERFORMANCE OF THE PROPERTY OR QUALITY OR CAPACITY OF MATERIALS OR WORKMANSHIP IN THE PROPERTY; (ii) ITS MERCHANTABILITY OR FITNESS OR SUITABILITY FOR A PARTICULAR PURPOSE WHETHER OR NOT DISCLOSED TO LESSOR; AND (iii) DELIVERY OF THE PROPERTY FREE OF THE RIGHTFUL CLAIM OF ANY PERSON BY WAY OF INFRINGEMENT OR THE LIKE.  LESSOR EXPRESSLY DISCLAIMS ALL SUCH WARRANTIES.  If the Software is not properly installed, does not function as represented or warranted by original licensor, or is unsatisfactory for any reason, Lessee shall make any claim on account thereof solely against original licensor and shall nevertheless pay all sums payable under the Lease, Lessee hereby waiving the right to make any such claims, against Lessor.  Lessor shall not be liable to Lessee for any loss, damage or expense of any kind or nature caused, directly or indirectly, by the Property or the use, possession or maintenance thereof, or the repair, service or adjustment thereof, or by any delay or failure to provide any such maintenance, repair, service or adjustment, or by any interruption of service or loss of use thereof (including without limitation, Lessee’s use of or right to use any Software) or for any loss of business howsoever caused.

(b)           NOTWITHSTANDING ANYTHING TO THE CONTRARY CONTAINED IN THE LEASE, LESSOR SHALL NOT, UNDER ANY CIRCUMSTANCES, BE LIABLE TO LESSEE OR ANY THIRD PARTY, FOR CONSEQUENTIAL, INCIDENTAL, SPECIAL OR EXEMPLARY DAMAGES ARISING OUT OF OR RELATED TO THE TRANSACTION CONTEMPLATED HEREUNDER, WHETHER IN AN ACTION BASED ON CONTRACT, TORT (INCLUDING NEGLIGENCE OR STRICT LIABILITY) OR ANY OTHER LEGAL THEORY, INCLUDING WITHOUT LIMITATION, LOSS OF ANTICIPATED PROFITS, OR BENEFITS OF USE OR LOSS OF BUSINESS, EVEN IF LESSOR IS APPRISED OF THE LIKELIHOOD OF SUCH DAMAGES OCCURRING.

IT IS EXPRESSLY UNDERSTOOD AND AGREED THAT EACH AND EVERY PROVISION OF ANY LEASE WHICH PROVIDES FOR A LIMITATION OF LIABILITY, DISCLAIMER OF WARRANTIES OR EXCLUSION OF DAMAGES, IS INTENDED BY THE PARTIES TO BE SEVERABLE FROM ANY OTHER PROVISION AND IS A SEPARABLE AND INDEPENDENT ELEMENT OF RISK ALLOCATION AND IS INTENDED TO BE ENFORCED AS SUCH.

(c)           Lessor assigns to Lessee all assignable warranties on the Property, including without limitation any warranties described in Lessor’s purchase contract, which assignment shall be effective only (i) during the Initial Period and any extensions thereof, and (ii) so long as no Event of Default exists.

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10.           NET LEASE; LESSEE’S OBLIGATIONS ABSOLUTE AND UNCONDITIONAL:

This Agreement is a “net lease” and, as between Lessor and Lessee, Lessee shall be responsible for and shall indemnify Lessor against, all costs, expenses and claims of every nature whatsoever arising out of or in connection with or related to the Lease or the Property.

Lessee agrees that its obligation to pay Monthly Rental and other obligations under the Lease shall be irrevocable, independent, absolute and unconditional and shall not be subject to any abatement, reduction, recoupment, defense, offset or counterclaim otherwise available to Lessee; nor, except as otherwise expressly provided herein or as agreed to by Lessor in writing, shall this Agreement terminate for any reason whatsoever prior to the end of the Initial Period.

11.           ASSIGNMENT BY LESSOR:

Lessor may assign or transfer its rights and interests in the Lease and Property to another party (“Lessor’s Assignee”) either outright or as security for loans.  Upon notice of any such assignment and instructions from Lessor, Lessee shall pay its Monthly Rental and other payments and perform its other obligations under the Lease to the Lessor’s Assignee (or to another party designated by Lessor’s Assignee).  Upon any such sale or assignment, LESSEE’S OBLIGATIONS TO LESSOR’S ASSIGNEE UNDER THE ASSIGNED SCHEDULE SHALL BE ABSOLUTE AND UNCONDITIONAL AND LESSEE WILL NOT ASSERT AGAINST LESSOR’S ASSIGNEE ANY CLAIM, DEFENSE, OFFSET OR COUNTERCLAIM WHICH LESSEE MIGHT HAVE AGAINST LESSOR.  Lessor’s Assignee shall have all of the rights but none of the obligations of Lessor under the assigned Lease, and after such assignment Lessor shall continue to be responsible for all of Lessor’s obligations under the Lease.

Upon any such assignment, Lessee agrees to execute and deliver to Lessor: (i) estoppel certificates, acknowledgments of assignment and other documents requested by Lessor which acknowledge the assignment and affirm provisions of the Lease, and (ii) UCC–1 financing statements or precautionary filings as requested.

Only one executed counterpart of any Schedule shall be marked “Original”; any other executed counterparts shall be marked “Duplicate Original” or “Counterpart”.  No security interest in any Schedule may be created through the transfer and possession of any counterpart other than the “Original”.

12.           RISK OF LOSS ON LESSEE:

From the earlier of the date the supplier ships the Property to Lessee or the date Lessor confirms Lessee’s purchase order or contract to supplier until the date the Property is returned to Lessor as provided in the Lease, Lessee hereby assumes and shall bear all risk of loss for theft, damage or destruction to the Property, howsoever caused.  NO SUCH LOSS OR DAMAGE SHALL IMPAIR ANY OBLIGATION OF LESSEE UNDER THIS LEASE WHICH SHALL CONTINUE IN FULL FORCE AND EFFECT.

In the event of damage or loss to the Property (or any part thereof) and irrespective of payment from any insurance coverage maintained by Lessee, but applying full credit therefore, Lessee shall at the option of Lessor, (a) place the Property in good repair, condition and working order; or (b) replace the Property (or any part thereof) with like property of equal or greater value, in good repair, condition and working order and transfer clear title to such replacement property to Lessor whereupon such replacement property shall be deemed the Property for all purposes under the Lease; or (c) pay to Lessor the total rent due and owing at the time of such payment plus an amount calculated by Lessor which is equal to the Casualty Loss Value specified in the Casualty Loss Schedule attached to the applicable Schedule.

13.           INSURANCE:

Lessee shall obtain and maintain for the entire term of this Lease, at its own expense (as primary insurance for Lessor and Lessee), property damage and liability insurance and insurance against loss or damage to the Property including without limitation loss by fire (including so–called extended coverage), theft, collision and such other risks

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of loss as are customarily insured against on the type of Property leased under any Lease and by businesses in which Lessee is engaged, in such amounts, in such form and with such insurers as shall be satisfactory to Lessor; provided, however, that the amount of insurance against loss or damage to the Property shall be equal to or greater than the Casualty Loss Value of such items of Property as specified in the Casualty Loss Schedule attached to the Schedule.  Each insurance policy will name Lessee as insured and Lessor and its assignees as additional insureds and loss payees thereof as their interests may appear, shall contain cross–liability endorsements and shall contain a clause requiring the insurer to give Lessor and its assignees at least 30 days prior written notice of any material alteration in the terms of such policy or of the cancellation thereof.  Lessee shall furnish to Lessor a certificate of insurance or other evidence satisfactory to Lessor that such insurance coverage is in effect; provided, however, that Lessor shall be under no duty either to ascertain the existence of or to examine such insurance policy or to advise Lessee in the event such insurance coverage shall not comply with the requirements hereof.  All insurance covering loss or damage to the Property shall contain a breach of warranty clause satisfactory to Lessor.

14.           INDEMNIFICATION:

Except for the gross negligence or willful misconduct of Lessor, Lessee shall indemnify and hold Lessor harmless from and against any and all claims, (including without limitation negligence, tort and strict liability), damages, judgments, suits and legal proceedings, and any and all costs and expenses in connection therewith (including attorney’s fees incurred by Lessor either in enforcing this indemnity or in defending against such claims), arising out of or in any manner connected with or resulting from the Lease or the Property, including, without limitation the manufacture, purchase, financing, ownership, rejection, non–delivery, transportation, delivery, possession, use, operation, maintenance, condition, lease, return, storage or disposition thereof; including without limitation (a) claims for injury to or death of persons and for damage to property; (b) claims relating to patent, copyright, or trademark infringement, (c) claims relating to latent or other defects in the Property whether or not discoverable by Lessor and (d) claims for wrongful, negligent or improper act or misuse by Lessor.  Lessee agrees to give Lessor prompt notice of any such claim or liability.  For purposes of this paragraph and any Lease, the term “Lessor” shall include Lessor, its successors and assigns, shareholders, directors, officers, representatives and agents, and the provisions of this paragraph shall survive expiration of any Lease with respect to events occurring prior thereto.

Upon request of Lessor, Lessee shall assume the defense of all demands, claims, or actions, suits and all proceedings against Lessor for which indemnity is provided and shall allow Lessor to participate in the defense thereof.  Lessor shall be subrogated to all rights of Lessee for any matter which Lessor has assumed obligation hereunder, and may settle any such demand, claim, or action without Lessee’s prior consent, and without prejudice to Lessor’s right to indemnification hereunder.

15.           EVENTS OF DEFAULT:

An “Event of Default” shall occur under any Lease if Lessee:

(a)           fails to pay any Monthly Rental or other payment required under the Lease when the same becomes due and payable and such failure continues for ten (10) days after its due date;

(b)           attempts to or does, remove, sell, assign, transfer, encumber, sublet or part with possession of any one or more items of the Property or any interest under any Lease, except as expressly permitted herein, or permits a judgment or other claim to become a lien upon any or all of Lessee’s assets or upon the Property;

(c)           permits any item of Property to become subject to any levy, seizure, attachment, assignment or execution; or Lessee abandons any item of Property;

(d)           or any guarantor, fails to observe or perform any of its covenants and obligations required to be observed or performed under the Lease and such failure continues uncured for ten (10) days after occurrence thereof, except that the ten (10) day cure period shall not apply and an Event of Default shall occur immediately upon Lessee’s failure to maintain insurance;

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(e)           or any guarantor, breaches any of its representations and warranties made under any Lease, or if any such representations or warranties shall be false or misleading in any material respect;

(f)            or any guarantor, shall (i) be adjudicated insolvent or a bankrupt, or cease, be unable, or admit in writing its inability, to pay its debts as they mature, or make a general assignment for the benefit of creditors or enter into any composition or arrangement with creditors; (ii) apply for or consent to the appointment of a receiver, trustee or liquidator of it or of a substantial part of its property, or authorize such application or consent, or proceedings seeking such appointment shall be instituted against it without such authorization, consent or application and shall continue undismissed for a period of 60 days; (iii) authorize or file a voluntary petition in bankruptcy or apply for or consent to the application of any bankruptcy, reorganization in bankruptcy, arrangement, readjustment of debt, insolvency, dissolution, moratorium or other similar law of any jurisdiction, or authorize such application or consent; or proceedings to such end shall be instituted against it without such authorization, application or consent and such proceeding instituted against it shall continue undismissed for a period of 60 days;

(g)           or any guarantor, shall suffer an adverse change in its financial condition after the date hereof as determined by Lessor in its sole discretion, or there shall occur a substantial change in ownership of the outstanding stock of Lessee or a substantial change in control of its board of directors;

(h)           shall be in default under any other Schedule or agreement executed with Lessor; or shall fail to sign and deliver to Lessor any document requested by Lessor in connection with any Lease or shall fail to do any thing determined by Lessor to be necessary or desirable to effectuate the transaction contemplated by the Lease or to protect Lessor’s rights and interests in the Lease and Property; or shall fail to provide financial statements to Lessor as provided in Section 18(g) hereof.

(i)            breach by Lessee of any license or other agreement for Software.

16.           REMEDIES:

Upon the occurrence of any Event of Default and at any time thereafter, Lessor may, with or without giving notice to Lessee and with or without canceling the Lease, do any one or more of the following:

(a)           enforce this Agreement according to its terms;

(b)           advance funds on Lessee’s behalf to cure the Event of Default, whereupon Lessee shall immediately reimburse Lessor therefor, together with late charges accrued thereon;

(c)           refuse to deliver the Property to Lessee;

(d)           upon notice to Lessee, cancel this Master Lease Agreement and any or all Schedules executed pursuant thereto;

(e)           if Lessor determines, in its sole discretion, not to take possession of the Property, Lessor shall continue to be the owner of the Property and may, but is not obligated to, dispose of the Property by sale or otherwise, all of which determinations may be made by Lessor in its sole discretion and for its own account;

(f)            declare immediately due and payable all amounts due or to become due hereunder for the full term of the Lease (including any renewal or purchase options which Lessee has contracted to pay);

(g)           with or without terminating the Lease, recover the Casualty Loss Value of the Property as of the rent payment date immediately preceding the date of default together with all costs and expenses incurred by Lessor in the repossession, recovery, storage, repair, sale, re–lease or other disposition of the Property, including without limitation, reasonable attorneys’ fees and costs incurred in connection therewith or otherwise resulting or arising from Lessee’s default, and any indemnity if then determinable, plus interest on all of the above until paid (before and after judgment) at the lesser of the rate of eighteen percent (18%) per annum or the highest rate permitted by law (collectively, “Lessor’s Damages”);

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(h)           without notice to Lessee, repossess the Property wherever found, with or without legal process, and for this purpose Lessor and/or its agents or assigns may enter upon any premises of or under the control or jurisdiction of Lessee or any agent of Lessee, without liability for suit, action or other proceeding by Lessee (any damages occasioned by such repossession being hereby expressly waived by Lessee) and remove the Property therefrom; Lessee further agrees on demand, to assemble the Property and make it available to Lessor at a place to be designated by Lessor;

(i)            in its sole discretion, re–lease or sell any or all of the Property at a public or private sale on such terms and notice as Lessor shall deem reasonable (such sale may, at Lessor’s sole option, be conducted at Lessee’s premises), and recover from Lessee liquidated damages for the loss of a bargain and not as a penalty an amount equal to the Lessor’s Damages;

(j)            if Lessee breaches any of its obligations under Section 7(c) of this Agreement with regard to Software, Lessee shall be liable to Lessor for additional damages in an amount equal to the original price paid by Lessor for the Software, and in addition, at Lessor’s option, Lessor shall be entitled to injunctive relief;

(k)           exercise any other right or remedy which may be available to it under the Uniform Commercial Code or any other applicable law;

(l)            a cancellation hereunder shall occur only upon notice by Lessor and only as to such items of Property as Lessor specifically elects to cancel and this Lease shall continue in full force and effect as to the remaining items, if any.

(m)          by notice to Lessee, declare any license agreement with respect to Software terminated, in which event the right and license of Lessee to use the Software shall immediately terminate, and Lessee shall thereupon cease all use of the Software and return all copies thereof to Lessor or original licensor; (ii) have access to and disable the Software by any means deemed necessary by Lessor, for which purposes Lessee hereby expressly consents to such access and disablement, promises to take no action that would prevent or interfere with Lessor’s ability to perform such access and disablement, and waives and releases any and all claims that it has or might otherwise have for any and all losses, damages, expenses, or other detriment that it might suffer as a result of such access and disablement; and (iii) Lessee agrees that the detriment which Lessor will suffer as a result of a breach by Lessee of the obligations contained in the Lease cannot be adequately compensated by monetary damages, and therefore Lessor shall be entitled to injunctive and other equitable relief to enforce the provisions of this paragraph 16(m).  LESSEE AGREES THAT LESSOR SHALL HAVE NO DUTY TO MITIGATE LESSOR’S DAMAGES UNDER ANY LEASE BY TAKING LEGAL ACTION TO RECOVER THE SOFTWARE FROM LESSEE OR ANY THIRD PARTY, OR TO DISPOSE OF THE SOFTWARE BY SALE, RE–LEASE OR OTHERWISE.

In the event Lessor in good faith believes the Property to be in danger of misuse, abuse or confiscation or to be in any other way threatened; or believes in good faith that the Property is no longer sufficient or has declined or may decline in value; or believes in good faith for any other reason that the prospect of payment or performance has become impaired, Lessor shall have the right, in its sole discretion, to either require additional collateral or declare the entire indebtedness under any Lease immediately due and payable.

Lessor may exercise any and all rights and remedies available at law or in equity, including those available under the Uniform Commercial Code.  The rights and remedies afforded Lessor hereunder shall not be deemed to be exclusive, but shall be in addition to any rights or remedies provided by law.  Lessor’s failure promptly to enforce any right or remedy hereunder shall not operate as a waiver of such right or remedy, and Lessor’s waiver of any default shall not constitute a waiver of any subsequent or other default.  Lessor may accept late payments or partial payments of amounts due under the Lease and may delay enforcing any of Lessor’s rights or remedies hereunder without losing or waiving any of Lessor’s rights or remedies under the Lease.

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17.           LESSEE’S REPRESENTATIONS AND WARRANTIES:

Lessee represents and warrants as follows:

(a)           If Lessee is a corporation, duly organized and validly existing in good standing under the laws of the jurisdiction of its incorporation, duly qualified to do business in each jurisdiction where any Property is, or is to be located, and has full corporate power and authority to hold property under lease and to enter into and perform its obligations under any Lease; the execution, delivery and performance by Lessee of any Lease has been duly authorized by all necessary corporate action on the part of Lessee, and is not inconsistent with its Articles of Incorporation or By–Laws or other governing instruments;

(b)           If Lessee is a partnership, duly organized by written partnership agreement and validly existing in accordance with the laws of the jurisdiction of its organization, duly qualified to do business in each jurisdiction where the Property is, or is to be located, and has full power and authority to hold property under lease and to enter into and perform its obligations under any Lease; the execution, delivery and performance by Lessee of any Lease has been duly authorized by all necessary action on the part of the Lessee, and is not inconsistent with its partnership agreement or other governing instruments.  Upon request, Lessee will deliver to Lessor certified copies of its partnership agreement and other governing instruments and original certificate of partners and other instruments deemed necessary or desirable by Lessor.  To the extent required by applicable law, Lessee has filed and published its fictitious business name certificate;

(c)           The execution, delivery and performance by Lessee of any Lease does not violate any law or governmental rule, regulation, or order applicable to Lessee, does not and will not contravene any provision, or constitute a default under any indenture, mortgage, contract, or other instrument to which it is bound and, upon execution and delivery of each Lease, will constitute a legal, valid and binding agreement of Lessee, enforceable in accordance with its terms;

(d)           No action, including any permits or consents, in respect of or by any state, federal or other governmental authority or agency is required with respect to the execution, delivery and performance by Lessee of any Lease;

(e)           All computer hardware and software that is utilized by Lessee in the operation of its businesses is and will be
“Year 2000 Compliant” in that it is and will be capable of accepting, processing and printing date data between and within the twentieth and twenty-first centuries, and neither the performance nor functionality of any computer hardware or software is affected by dates prior to, during, or after the Year 2000.  Upon request, Lessee shall provide written assurances to Lessor that its hardware and software are “Year 2000 Compliant”.

18.           GENERAL:

(a)           Entire Agreement. Each Schedule shall incorporate the terms and conditions of this Master Lease Agreement and, together with the Acceptance Certificate (as defined herein) and Master Progress Funding Agreement (and Authorizations thereunder), if applicable, and any amendments to any of the foregoing documents, shall supersede all prior agreements and constitute the entire understanding and agreement between the Lessor and Lessee with regard to the subject matter hereof and thereof, and there is no understanding or agreement, oral or written, which is not set forth herein or therein.

(b)           Time Is of the Essence; Provisions Severable. Time is of the essence with respect to any Lease.  The provisions contained in any agreement shall be deemed to be independent and severable.  The invalidity or partial invalidity of any one provision or portion of the Lease under the laws of any jurisdiction shall not affect the validity or enforceability of any other provisions of the Lease.  The captions and headings set forth herein are for convenience of reference only and shall not define or limit any of the terms hereof.

(c)           Notices. Notices or demands required to be given hereunder shall be in writing and addressed to the other party at the address herein or such other address provided by written notice hereunder and shall be effective (i) upon the next business day if sent by guaranteed overnight express service (such as Federal Express);

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(ii) on the same day if personally delivered; or (iii) three days after mailing if sent by certified or registered U.S. mail, postage prepaid.

(d)           Governing Law; Waiver of Trial by Jury. THIS LEASE SHALL IN ALL RESPECTS BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF UTAH, INCLUDING ALL MATTERS OF CONSTRUCTION, VALIDITY AND PERFORMANCE.  LESSEE AGREES TO SUBMIT TO THE JURISDICTION OF THE STATE AND/OR FEDERAL COURTS IN THE STATE OF UTAH IN ALL MATTERS RELATING TO THE LEASE, THE PROPERTY AND THE CONDUCT OF THE RELATIONSHIP BETWEEN LESSOR AND LESSEE.  THIS LEASE WAS EXECUTED IN THE STATE OF UTAH (BY THE LESSOR HAVING COUNTERSIGNED IT IN UTAH) AND IS TO BE PERFORMED IN THE STATE OF UTAH (BY REASON OF ONE OR MORE PAYMENTS REQUIRED TO BE MADE TO LESSOR IN UTAH).  LESSOR AND LESSEE HEREBY WAIVE THE RIGHT TO TRIAL BY JURY OF ANY MATTERS ARISING OUT OF THE LEASE OR PROPERTY OR THE CONDUCT OF THE RELATIONSHIP BETWEEN LESSOR AND LESSEE.

(e)           Binding Effect; Survivability. The provisions of each Lease shall inure to the benefit of and shall bind Lessor and Lessee and their respective permitted successors and assigns.  All representations, warranties, covenants and indemnities of Lessee made or agreed to in the Lease or in any certificates delivered in connection therewith shall survive the expiration, termination or cancellation of the Lease for any reason.

(f)            Further Assurances; Financing Statements. Lessee will cooperate with Lessor in protecting Lessor’s interests in the Property, the Lease and the amounts due under the Lease, including, without limitation, the execution and delivery of Uniform Commercial Code statements and filings, patent and copyright registration documents with respect to proprietary Software (if applicable), and other documents requested by Lessor.  Lessee shall pay all costs of filing any financing, continuation or termination statements with respect to the Property and Lease, including without limitation, any intangibles tax, documentary stamp tax or other similar tax or charge relating thereto and of all UCC or other lien searches deemed necessary or advisable by Lessor.  Lessee will do whatever may be necessary or advisable to have a statement of the interest of Lessor in the Property noted on any certificate of title relating to the Property and will deposit said certificate with Lessor.  Lessee will execute and deliver to Lessor such other documents and written assurances and take such further action as Lessor may request to more fully carry out the implementation, effectuation, confirmation and perfection of the Lease and any rights of Lessor thereunder.  Lessee grants to Lessor a security interest in all deposits and other property transferred or pledged to Lessor to secure the payment and performance of all of Lessee’s obligations under the Lease.

(g)           Financial Statements. Lessee shall provide to Lessor a copy of its annual audited financial statements within 90 days after its fiscal year end, and a copy of its quarterly unaudited financial statements within 45 days after the end of each fiscal quarter.

(h)           Security Interest. In the event a court of competent jurisdiction or other governing authority shall determine that the Lease is not a “true lease” or is a lease intended as security or that Lessor (or its assigns) does not hold legal title to or is not the owner of the Property, then the Lease shall be deemed to be a security agreement with Lessee, as debtor, having granted to Lessor, as secured party, a security interest in the Property effective the date of the Lease, and the Property shall secure all duties and obligations of Lessee under any Lease or other agreement with Lessor.  As security for the performance by Lessee of its duties and obligations under any Lease, Lessee hereby grants to Lessor a security interest in all of Lessee’s rights under any license agreement related to any Software, including, without limitation, all of its rights with respect to the Software.  With regard to any security interest created hereunder in any of the Property, Lessee consents and agrees that Lessor shall have all of the rights, privileges and remedies of a secured party under the Utah Uniform Commercial Code.

(i)            Change in Lessee’s Name or Address. Lessee shall not change its name or address from that set forth above, unless it shall have given Lessor or its assigns no less than 30 days’ prior written notice.

(j)            Covenant of Quiet Possession. Lessor agrees that so long as no Event of Default has occurred and is continuing, Lessee shall be entitled to quietly possess the Property subject to and in accordance with the terms and conditions of this Agreement.

10

(k)           Lessor’s Right to Perform for Lessee. If Lessee fails to perform or comply with any of its agreements contained herein, Lessor may perform or comply with such agreements and the amount of any payments and expenses of Lessor incurred in connection with such performance or compliance (including attorneys’ fees), together with interest thereon at the lesser of the rate of eighteen percent (18%) per annum, or the highest rate permitted by law shall be deemed additional rent payable by Lessee upon demand.

(l)            Attorneys’ Fees. Lessee shall reimburse Lessor for all charges, costs, expenses and attorneys’ fees incurred by Lessor (a) in defending or protecting its interest in the Property; (b) in the execution, delivery, administration, amendment and enforcement of the Lease or the collection of any rent or other payments due under the Lease; and (c) in any lawsuit or other legal or arbitration/mediation proceeding to which the Lease gives rise, including without limitation, actions in tort.

(m)          Lessee’s Options at End of Initial Period. At the end of the Initial Period of any Lease, or upon any expiration of any renewal or extension thereof as provided for in option (2) herein or otherwise, Lessee shall, provided at least one hundred eighty (180) days prior written notice is received by Lessor from Lessee via certified mail, do one of the following: (1) purchase the Property for a price to be determined by Lessor and Lessee, (2) extend the Lease for twelve (12) additional months at the rate specified on the respective Schedule, or (3) return the Property to Lessor at Lessee’s expense to a destination within the continental United States specified by Lessor and terminate the Schedule; provided, however, that for option (3) to apply, all accrued but unpaid late charges, interest, taxes, penalties, and any and all other sums due and owing under the Schedule must first be paid in full, the provisions of Sections 6(c) and (d) and 7(c) hereof must be specifically complied with, and Lessee must enter into a new Schedule with Lessor to lease Property which replaces the Property listed on the old Schedule.  With respect to options (1) and (3), each party shall have the right in its absolute and sole discretion to accept or reject any terms of purchase or of any new Schedule, as applicable.  In the event Lessor and Lessee have not agreed to either option (1) or (3) by the end of the Initial Period or any renewal or extension period then in effect, or if Lessee fails to give written notice of its option via certified mail at least one hundred eighty (180) days prior to the termination of the Initial Period or any renewal or extension period then in effect, then option (2) shall apply at the end of the Initial Period or any renewal or extension period then in effect.

(n)           Amendment and Modification. The Lease may not be amended or modified except by a writing signed by a duly authorized representative of each party, but no such amendment or modification needs further consideration to be binding.  Notwithstanding the foregoing, Lessee authorizes Lessor to amend any Schedule to identify more accurately the Property (including, without limitation, supplying serial numbers or other identifying data), and such amendment shall be binding on Lessor and Lessee unless Lessee objects thereto within 10 days after receiving notice of the amendment from Lessor.

(o)           Joint and Several Liability. In the event two or more parties sign the Agreement as Lessee, each party shall be jointly and severally liable for all Lessee representations, warranties, and obligations (including without limitation, payment obligations) under this Agreement or under any Schedule or other document executed in connection herewith.

19.           WAIVERS:

To the extent permitted by applicable law, Lessee hereby waives any and all rights and remedies conferred upon a Lessee by Sections 2A–508 through 2A–522 of the Uniform Commercial Code, including but not limited to Lessee’s rights to: (i) cancel the Lease; (ii) repudiate the Lease; (iii) reject the Property; (iv) revoke acceptance of the Property; (v) recover damages from Lessor for any breaches or warranty or for any other reason; (vi) claim, grant or permit a security interest in the Property in Lessee’s possession or control for any reason; (vii) deduct all or any part of any claimed damages resulting from Lessor’s default, if any, under the Lease; (viii) “cover” by making any purchase or lease of or contract to purchase or lease Property in substitution for those due from Lessor; (ix) recover any general, special, incidental or consequential damages, for any reason whatsoever; and (x) commence legal action against Lessor for specific performance, replevin, detinue, sequestration, claim and deliver or the like for any Property identified to the Lease.  To the extent permitted by applicable law, Lessee also hereby waives any rights now or hereafter conferred by statute or otherwise which may require Lessor to sell, lease or otherwise use any Property in mitigation of Lessor’s damages as set forth in Section 16 hereof or which may otherwise limit or modify any of Lessor’s rights or remedies in that section.

11

No waiver or modification by Lessor of any of the terms and conditions hereof shall be effective unless in writing signed by an officer of Lessor.

20.           ASSIGNMENT BY LESSEE:

LESSEE MAY NOT ASSIGN THIS AGREEMENT OR ANY OF ITS RIGHTS HEREUNDER OR SUBLEASE THE PROPERTY WITHOUT THE PRIOR WRITTEN CONSENT OF LESSOR WHICH WILL NOT BE UNREASONABLY WITHHELD.  NO PERMITTED ASSIGNMENT OR SUBLEASE SHALL RELIEVE LESSEE OF ANY OF ITS OBLIGATIONS HEREUNDER.

BY INITIALING THIS SECTION, LESSEE ACKNOWLEDGES THAT IT HAS READ THE ABOVE PARAGRAPHS UNDER SECTIONS 18, 19 AND 20, AND FULLY UNDERSTANDS THEIR CONTENT AND AGREES TO THEIR PROVISIONS.

Initialed /s/ Finley

21.           POWER OF ATTORNEY.  LESSEE HEREBY AUTHORIZES AND APPOINTS LESSOR AND LESSOR’S AGENTS AND ASSIGNS AS LESSEE’S ATTORNEY–IN–FACT TO COMPLETE, EXECUTE, FILE AND AMEND ON LESSEE’S BEHALF UCC FINANCING STATEMENTS, PRECAUTIONARY OR OTHERWISE, IN CONNECTION WITH THE PROPERTY AND LEASE AND TO CONFORM THE DESCRIPTION OF THE PROPERTY (INCLUDING SERIAL NUMBERS) IN ANY SUCH FINANCING STATEMENTS OR OTHER DOCUMENTATION.

IN WITNESS WHEREOF, Lessor and Lessee have executed this Agreement on the day and year first above written.

LESSOR:			LESSEE:
MATRIX FUNDING CORPORATION			SOUTHWALL TECHNOLOGIES, INC.
BY:	/s/ Kay Paul		BY:	/s/  Bill R. Finley
TITLE:		Assistant Vice President	TITLE:		Vice President and CFO
					Bill R. Finley

12

LEASE SCHEDULE NO. 1

dated July 19, 1999 (the “Schedule”)

to MASTER LEASE AGREEMENT NO. R0825 dated July 19, 1999 (the “Master Lease”) between MATRIX FUNDING CORPORATION as Lessor and SOUTHWALL TECHNOLOGIES, INC. as Lessee.

This Schedule incorporates by reference the terms and conditions of the Master Lease, Exhibit A (the “Property Description”) and Exhibit B (the “Casualty Loss Schedule”), and constitutes a separate “Lease” between Lessor and Lessee. All capitalized terms used herein but not defined herein shall have the same meanings ascribed to them in the Master Lease.

1.Property:  (1) PM7 Microwave Plasma Enhanced Chemical Vapor Deposited Optical Coating System and (1) Telephone System to be more fully described on an Exhibit A, together with all other property hereafter purchased or paid for by Lessor pursuant to that Master Progress Funding Agreement dated July 19, 1999, between Lessor and Lessee, which relates to the Schedule between Lessor and Lessee, (including without limitation, all authorizations signed in connection with said Master Progress Funding Agreement which relate to the Schedule), and any and all additions, enhancements and replacements thereto.

The Property subject to this Schedule shall be more fully and completely described in an Acceptance Certificate which shall later be executed by Lessee in connection with this Schedule. Upon Lessee’s execution thereof, this Schedule shall be automatically amended to include herein as property leased hereunder all Property described in said Acceptance Certificate.

2.Property Location:  8175 S. Hardy, Tempe, AZ 85284 and 3961 East Bayshore, Palo Alto, CA 94303.  Upon Lessee’s later execution of an Acceptance Certificate in connection with this Schedule, this Schedule shall be automatically amended to include the additional locations, if any, specified in said Acceptance Certificate.

3.             Acceptance Date: As specified in the Acceptance Certificate

4.             Initial Period:  Thirty-six (36) months from Commencement Date

5.             Monthly Rental: $89,670,00, plus applicable sales tax

6.             Deposit: $89,670.00 applied to the last Monthly Rental, plus applicable sales tax

7.             Total Cost Not To Exceed: $3,000,000.00

8.             Lease Rate Factor: .02989

9.Floating LeaseRate Factor:  The Lease Rate Factor of .02989 shall increase .00005992 for every five (05) basis point increase in Forty-eight (36) month U.S. Treasury Notes as

of the Acceptance Date of the Property (the “Revised Lease Rate Factor”), at which time the final Monthly Rental under this Schedule shall be adjusted by multiplying the Total Cost, indicated in Section 7, by the Revised Lease Rate Factor.  The Forty-eight (36) month U.S. Treasury Note yield used as the basis for the derivation of the Revised Lease Rate Factor herein is 5.5%.

10.Additional Event of Default: Lessor as Secured Party, and Lessee, as Debtor, have entered into a Security Agreement dated July 19, 1999, pursuant to which Lessee has granted to Lessor a security interest in personal property (“Collateral” as described in the Security Agreement) to secure Lessee’s obligations under this Schedule. Lessee’s breach of any of its representatives, warranties, covenants and agreements under the Security Agreement shall constitute an additional Event of Default under Section 16 of the Master Lease.  Upon the occurrence of an Event of Default specified above, Lessor shall be entitled to exercise all of its rights and remedies under Section 16 of the Master Lease and under the Security Agreement, including without limitation as an additional remedy, foreclosure of Lessor’s security interest in the Collateral as provided under the Security Agreement.

11.Representation of Lessee: Lessor and Lessee agree that this Schedule constitutes a “finance lease” under the Uniform Commercial Code - Article 2A, in that (a) Lessee has selected the Property in its sole discretion, (b) Lessor has acquired the Property solely for purposes of leasing such Property under this Schedule, and (c) Lessee has received a copy of the contract evidencing Lessor’s purchase of the Property.

12.Financial Covenants; Holdback of Portion of the Cost of the Property: Lessee represents, warrants and covenants with Lessor that based upon Lessee’s audited financial statements for the period ended December 31, 1999, Lessee shall be in compliance with the following “Financial Covenants:” (1) the Quick Ratio shall not be less than .70:1; (2) Tangible Net Worth shall not be less than $23,000,000.00; (3) the Long-Term Debt to Tangible Net Worth ratio shall not be greater than 1.35:1; the Net Income for the fiscal year ended December 31, 1999 shall not be less than $500,000.00; and the Debt Service Coverage ratio (defined as total Earnings Before Interest, Taxes, Depreciation and Amortization divided by the sum of (i) the Current Portion of Long Term Debt, (ii) Interest Expense, and (iii) Projected Debt Service to Lessor (defined as the sum of one year’s Monthly Rental Payments owed to Lessor)) shall not be less than 125%.

Notwithstanding any agreement or obligation of Lessor to pay the full cost of the Property to the contrary, Lessor shall be entitled to holdback $1,000,000.00 (the “Retention Amount”) from the $3,000,000.00 total Property cost until Lessor shall receive the audited financial statements of Lessee for the period ended December 31, 1999, and shall determine, in Lessor’s reasonable discretion, that based upon such financial statements, the Financial Covenants have been met; whereupon, provided no Event of Default has occurred and is continuing under the Lease, Lessor shall disburse to Lessee the Retention Amount. In the event that Lessor shall determine, in its reasonable discretion, that based upon Lessee’s audited financial statements for the period ended December 31, 1999, any one or more of the Financial Covenants have not been met,

Lessor shall not be obligated to disburse the Retention Amount. If Lessee fails to meet the Financial Covenants based upon its audited financial statements for the period ended December 31, 1999, Lessor agrees to review Lessee’s financial statements for each subsequent quarter after December 31, 1999.  If Lessor determines, in its reasonable discretion, that based upon Lessee’s financial statements for any subsequent quarter (annualized, as necessary, for comparative purposes), Lessee has met the Financial Covenants, then, provided no Event of Default has occurred and is continuing under the Lease, Lessor shall disburse to Lessee the Retention Amount.  The Retention Amount shall bear interest at 4%, which, provided no Event of Default has occurred and is continuing under the Lease, shall be paid quarterly to Lessee.

Lessee agrees and covenants with Lessor that (a) Lessee shall pay to each vendor, on its due date, the purchase price of all Property not paid by Lessor from the initial funding (exclusive of the Retention Amount), and (b) notwithstanding Lessor’s holdback of the Retention Amount upon the terms and conditions specified herein, Lessee shall remit to Lessor on its due date, each Monthly Rental Payment required under this Schedule.

LESSOR:		LESSEE:
MATRIX FUNDING CORPORATION		SOUTHWALL TECHNOLOGIES, INC.
BY:		BY:
TITLE:	Assistant Vice Present	TITLE:

EXHIBIT B

CASUALTY LOSS SCHEDULE

DATED JULY 19, 1999

TO

LEASE SCHEDULE NO. 1

DATED JULY 19, 1999

TO

MASTER LEASE AGREEMENT NO. R0825

The Casualty Loss Value for eachitem of Property shall be determined by multiplying the original cost of such item to Lessor by the stipulated loss percentage indicated below which corresponds to themonth of the Lease after commencement in which the lastMonthly Rental payment was made.  The dollar amount shown below represents the Casualty Loss Value which would apply if all of the Property were lost or destroyed.

AFTER PAYMENT NUMBER	TOTAL CASUALTY LOSS VALUE	CASUALTY LOSS PERCENTAGE		AFTER PAYMENT NUMBER	TOTAL CASUALTY LOSS VALUE	CASUALTY LOSS PERCENTAGE
0	$3,900,000	130.00	%	19	$2,379,942	79.33	%
1	$3,835,727	127.86	%	20	$2,293,961	76.47	%
2	$3,755,199	125.17	%	21	$2,217,769	73.93	%
3	$3,674,479	122.48	%	22	$2,130,612	71.02	%
4	$3,593,567	119.79	%	23	$2,043,357	68.11	%
5	$3,512,462	117.08	%	24	$1,956,003	65.20	%
6	$3,458,270	115.28	%	25	$1,868,550	62.29	%
7	$3,375,401	112.51	%	26	$1,780,998	59.37	%
8	$3,292,370	109.75	%	27	$1,693,347	56.44	%
9	$3,209,175	106.97	%	28	$1,605,596	53.52	%
10	$3,125,817	104.19	%	29	$1,521,392	50.71	%
11	$3,042,294	101.41	%	30	$1,432,812	47.76	%
12	$2,958,608	98.62	%	31	$1,344,169	44.81	%
13	$2,874,756	95.83	%	32	$1,255,463	41.83	%
14	$2,807,855	93.60	%	33	$1,166,692	38.89	%
15	$2,722,537	90.75	%	34	$1,077,859	35.93	%
16	$2,637,087	87.90	%	35	$988,961	32.97	%
17	$2,551,505	85.05	%	36	$900,000	30.00	%
18	$2,465,790	82.19	%

LESSOR:		LESSEE:
MATRIX FUNDING CORPORATION		SOUTHWALL TECHNOLOGIES, INC.
BY:		BY:
ITS:	Assistant Vice President	ITS:	Assistant Vice President

SECURITY AGREEMENT

(Personal Property)

THIS SECURITY AGREEMENT is made this 19th day of July, 1999, between Southwall Technologies, Inc., having its principal place of business at 1029 Corporation Way, Palo Alto, CA 94303 (“Debtor”) and Matrix Funding Corporation, having its principal place of business at 6975 Union Park Center Second Floor, Midvale, UT 84047 (“Secured Party”).

1.             Background.  Secured Party, as lessor, and Debtor, as lessee, have entered into Lease Schedule No. 1 dated July 19, 1999 (“Schedule”) to Master Lease Agreement No. R0825, dated July 19, 1999 (“Master Lease”).  Debtor will execute and deliver to Secured Party an “Acceptance Certificate” certifying it has accepted the leased property for all purposes under the Schedule.  The Master Lease, the Schedule and the Acceptance Certificate, together with all amendments, riders and supplements thereto, are referred to herein collectively as the “Lease”.

As a condition to its execution and performance of the Lease, Secured Party requires Debtor to grant a security interest in the “Collateral” described herein to secure Debtor’s payment and performance of all of its obligations under the Lease.

2.             Grant of Security Interest.  For valuable consideration, the receipt and sufficiency of which is hereby acknowledged, Debtor hereby grants to the Secured Party a security interest in the “Collateral” described in Section 3 to secure all of Debtor’s obligations (including without limitation all payment obligations) under the Lease and all other obligations and liabilities of Debtor to the Secured Party for which the Debtor is now or may become liable in any manner, whether such obligations arise under the Lease or otherwise, and whether primary or secondary, direct or indirect, contingent or absolute, and howsoever arising, including without limitation, all costs and expenses incurred in connection with the Lease or in the protection or maintenance of the Collateral or in the enforcement of this Security Agreement, including without limitation, court costs and attorneys’ fees.

3.             Collateral.  The property serving as “Collateral” and subject to the above security interest is as follows:

                All property described in Exhibit A attached hereto, together with all attachments, replacements, parts, substitutions, additions, repairs, accessions and accessories incorporated therein or affixed thereto, and all proceeds (including insurance proceeds) of the foregoing.

4.             Representations Warranties and Covenants.  Debtor represents, warrants and covenants with Secured Party as follows:

                a.             Title.  Debtor is the absolute owner of the Collateral with full right and interest therein, all of which is free and clear of any and all liens, claims and encumbrances.  Debtor has full power and authority to grant a security interest in the Collateral and agrees to defend its title and ownership of the Collateral against all other persons who may claim an interest in it.

                b.             No Other Security Interests.  Debtor warrants that there are no security interests (including filed financing statements), liens, claims or other encumbrances against the Collateral other than as specified herein or created hereby. Debtor agrees that during the course of this Agreement and as long as any Debtor obligations under the Lease remain outstanding, (i) Debtor will not grant or permit a security interest in the Collateral other than the security interest created hereunder, and (ii) Debtor will keep the Collateral free from any and all liens, claims and encumbrances.

                c.No Sale or Disposition of Collateral.  Debtor will not assign, transfer, discount, sell, offer for sale, or otherwise dispose of the Collateral or any interest therein without the prior written consent of the Secured Party.

                d.             Unlawful Uses of Collateral.  Debtor will not use or permit any person to use the Collateral in a manner prohibited by law, or in violation of any policy of insurance, or in any manner inconsistent with the interest of the Secured Party.

                e.             Care of Collateral.  Debtor agrees to maintain the Collateral in at least as good order and condition as it is at the time of execution and delivery of this Security Agreement, and Debtor agrees to take all steps necessary or advisable to preserve the Collateral and to prevent the Collateral from being misused, wasted or destroyed.

                f.              Taxes.  Debtor agrees to pay promptly when due all taxes and assessments on or with respect to the Collateral. Should Debtor fail to do so, the Secured Party may at its option (although it is not required to do so) pay or discharge the same.  Any such payment shall become an obligation of Debtor secured by the Collateral.

                g.             Insurance.  Debtor agrees to maintain in force casualty andliability insurance with regard to the Collateral in amounts and with insurers acceptable to Secured Party. Debtor will cause Secured Party to be shown as co-insured and loss payee on all such policies of insurance.  Should Debtor fail to maintain insurance as required above, the Secured Party may at its option (although it is not required to do so) obtain and pay such insurance.  Any such payment shall become an obligation of Debtor secured by the Collateral.

                h.             Lease.  Debtor shall be liable under this Security Agreement for all of its obligations under the Lease, and the terms and conditions of the Lease are incorporated by reference into this Agreement.  Breach of any of Debtor’s obligations under the Lease shall constitute a breach of this Agreement.

                i.              Corporate Authority.  Debtor warrants that it is duly organized and validly existing under the laws of the state of its incorporation; it is qualified and in good standing in all jurisdictions in which it is doing business; and that the execution and performance of this Security Agreement is within the Debtor’s corporate powers, has been duly authorized, and is not in contravention of any law or regulation or the Debtor’s articles of incorporation, bylaws or other governing instruments, or any agreement or undertaking of which Debtor is a party or by which it is bound.

                5.             Financing, Statements and Other Documents.  Debtor agrees to execute one or more financing statements with regard to the Collateral in form acceptable to the Secured Party who is authorized to file the financing statement(s) in any jurisdiction deemed necessary or advisable to perfect the Secured Party’s security interest in the Collateral. Debtor expressly agrees to sign such financing statements on request of the Secured Party, and Debtor authorizes and appoints the Secured Party as its attorney in fact to sign any such statements in its stead with full power of substitution.

                Debtor agrees to cooperate fully with the Secured Party in executing additional instruments, documents, financing statements, amendments to financing statements, and the like as may be deemed necessary or advisable by the Secured Party in order to maintain and continue the security interest and lien created or permitted by this Security Agreement.

                Debtor agrees that a copy or other reproduction of this Security Agreement or financing statement is sufficient as a financing statement under this Security Agreement.

6.             Inspection of the Property.

                Upon receipt of written notice, Debtor agrees to the inspection of the Collateral from time to time by the Secured Party, its agents and assigns, as the Secured Party may deem necessary or advisable in the protection of its interests under this Security Agreement.

7.             Default.  Each of the following shall constitute an “Event of Default” under this Security Agreement:

                a.             Nonpayment.  Any failure of the Debtor to pay Lessor or its assigns when due any obligation under the Lease or other instrument and such failure shall continue uncured for ten (10) days after written notice is given to Debtor.

                b.             Nonperformance.  Any failure of the Debtor to perform or observe fully and in a timely and satisfactory manner any obligation under the Lease or this Security Agreement.

                c.             Representations and Warranties That Prove False.  Any representation or warranty made by Debtor under the Lease or this Security Agreement is false or materially misleading.

                d.             Bankruptcy and Insolvency.  Debtor becomes insolvent or is subject to any proceeding under applicable bankruptcy or insolvency laws (whether voluntary or involuntary), including without limitation, an assignment for the benefit of creditors; or Debtor has its property (or part of it) placed under the custody of a receiver or trustee.

                e.             Unauthorized Use of Collateral or Proceeds.  Any assignment, sale, discount, transfer, creation of an encumbrance against or use of the Collateral or its proceeds except as authorized in this Security Agreement,

                f.              Breach of Security Agreement.  Debtor’s breach of any representation, warranty, covenant or agreement contained in this Security Agreement.

8.             Remedies.              Upon the occurrence of an Event of Default under this Security Agreement, the Secured Party shall have the following rights and remedies, which are immediately available to the Secured Party:

                a.             All of Secured Party’s rights and remedies under the Lease;

                b.             All rights and remedies provided in this Security Agreement;

                c.             All rights and remedies provided at law or in equity, including without limitation those provided to secured parties under Article 9 of the Uniform Commercial Code (“UCC”);

                Among the rights and remedies mentioned above are specifically included:

                x.             Right to Take Possession of the Collateral.  The Secured Party shall have the right to take possession of the Collateral. Debtor will cooperate fully with the Secured Party, including without limitation assembling and delivering the Collateral to the Secured Party at a location designated by the Secured Party.

                y.             Right to Dispose of Collateral.  The Secured Party shall have the right to dispose of the Collateral by public or private proceeding and may do so by way of one or more contracts. Such sale or other disposition of the Collateral may be made as a unit or in parcels and at any time and place and on any terms provided only that the disposition effected is commercially reasonable. Any actions so taken shall be considered commercially reasonable if made in the good faith exercise of the Secured Party’s reasonable business judgment in the matter.

                z.             Enforcement Costs and Attorneys’ Fees.  Debtor shall be liable for and shall pay to Secured Party all of Secured Party’s costs and expenses incurred in enforcing its rights and remedies under this Security Agreement in effect with regard to the Collateral, including without limitation its court costs and attorney’s fees.

                Secured Party’s remedies under this Security Agreement shall be cumulative, and Secured Party shall not be obligated to exercise any remedy before any other remedy, nor shall Secured Party be precluded from exercising any remedy because it has not first exercised any other remedy.

9.             Assignment.  Secured Party may assign or transfer the whole or any part of its security interest in the Collateral created hereunder. Any transferee shall be vested with all of the rights, remedies and powers of the Secured Party under this Security Agreement.

l0.            Term.  This Security Agreement is a continuing agreement, and all rights, remedies and powers of the Secured Party hereunder shall apply to all past, present, and future obligations of Debtor under the Lease, notwithstanding the bankruptcy, dissolution or insolvency of Debtor, and shall continue in full force and effect until all obligations of Debtor under the Lease have

been paid, performed and satisfied in full,notwithstanding any termination of the Lease.  The power of sale and other rights and remedies granted to the Secured Party hereunder may be exercised even though any remedies of the Secured Party under the Lease may be barred for whatever reason.

11.           Choice of Law: Jurisdiction; Waiver of Jury Trial.  This Agreement shall be governed by and construed in accordance with the laws of the State of Utah in all save perfection of the security interest as required by the Uniform Commercial Code, and at Secured Party’s option, jurisdiction of any dispute shall be in the Utah state or federal courts.  Debtor consents to such jurisdiction.  BOTH PARTIES HERETO WAIVE THE RIGHT TO JURY TRIAL.

12.           Severability.  In the event that any provision of this Security Agreement is found to be unenforceable in any legal proceeding, the remaining provisions shall remain in full force and effect.

                IN WITNESS WHEREOF, the parties have entered into this Agreement as of the day and year first above written.

DEBTOR:	SECURED PARTY:
SOUTHWALL TECHNOLOGIES, INC.	MATRIX FUNDING CORPORATION
By:	By:
Title:	Title:

Exhibit A

Personal Property

Southwall Technologies, Inc.

Master Lease Agreement No. R0825

Lease Schedule No. 1

QTY	DESCRIPTION	SERIAL NO.
	PM1 Sputter Web Coater System located at 3961 E. Bayshore, Palo Alto, CA 94303
	TF Depo Mach #1-HMA
	PM-1 Mox Proc Automation
	Polychromr Hexatrom PM1
	PM 1 gas plumbing
	Standard Minichambers PM-1 upgrade
	Hexatrom Installation PM1
	Poly Hex Development PM 1
	PM-1 Chill upgrade
	Std source feedthrus (3), Utilities feedthru (1)
	.M 1 power supply & dr sys and Replacement of PM-1 water manifolds
	Vacuum air cleaning System for PM-1
	Cathode Loader attached to forklift
	Standard Cathode source (assembly 1 of 3)
	Standard Cathode source (assembly 2 of 3
	Standard Cathode source (assembly 3 of 3)
	Conductivity Measure System
	Viewport & decking addition
	Optical fibers on PM-1
	PM-1 Cathode cart mod
	PM1 Chiller upgrade
	Computer Console
	PM-1 Steel Gas Manifolds
	PM1 Marker Cathode
	Diffusion pump halo baffles PM-1 upgrade
	Strip chart recorders
	In-vessell door roller guidance system
	Computer console installation
	PM #1 window
	PMI Hollow mandrels with square ends
	Shields PM-1 upgrade
	Vac exhaust precipitator
	Reactive oxide hardware

PM1 cover for mechanical pump

PM 1 crane hoist

Contour drum map document

Retro-fit

Preliminary engineering

AC Cathodes

Cathode Mounting Hardware

Minichamber/shielding

Power supplies

Electromechanical Web Drive Upgrade

PLC Process Control Upgrade

Hexatrom relocation/Delcom install

System Utility Upgrades

Outside Contractor Installations

Project Management

Contingency

AMENDMENT NO. 1

to

LEASE SCHEDULE NO. 1

to

MASTER LEASE AGREEMENT NO. R0825

                Reference is made to Lease Schedule No. 1 (the “Schedule”) to Master Lease Agreement No. R0825 dated July 19, 1999 (the “Master Lease”), by and between MATRIX FUNDING CORPORATION (the “Lessor”) and SOUTHWALL TECHNOLOGIES, INC. (the “Lessee”).  The Schedule as it incorporates the terms and conditions of the Master Lease is referred to herein as the “Lease”.  Pursuant to the Lease, Lessor has agreed to purchase and lease to Lessee property specified in the Lease.  All capitalized terms used herein but not defined herein shall have the same meanings ascribed to them in the Lease.

                The Schedule as originally signed was based upon a Total Cost Not to Exceed $3,000,000.00.  The revised Total Cost as of the date hereof for the items of Property listed on the attached Exhibit A is $2,990,236.62.  Based upon the decreased Property cost and a more specific description and location of the Property, the Schedule is hereby amended retroactive to July 19, 1999 by deleting Sections 1, 2, 5, 6, 7, 8 and 10 of the Schedule and replacing them with the following:

Section 1.             Property:         (1) PM7 and (1) Telephone System as more fully described on the

attached Exhibit A of one (1) page, which by reference becomes a part hereof.

Section 2.Property Location: 8175 S. Hardy, Tempe, AZ 85284 (PM7)

                                              1029 Corporation Way, Palo Alto, CA 94303 (Telephone System)

Section 5.             Monthly Rental: $93,391.07, plus applicable sales tax

Section 6.             Deposit: $93,391.07, plus applicable sales tax

Section 7.             Total Cost: $2,990,236.62

Section 8.             Lease Rate Factor: .031232

Section 10.Additional Event of Default Lessor as Secured Party, and Lessee, as Debtor, have entered into a Security Agreement dated July 19, 1999, pursuant to which Lessee has granted to Lessor a security interest in personal property (“Collateral” as described in the Security Agreement) to secure Lessee’s obligations under this Schedule. Lessee’s breach of any of its representatives, warranties, covenants and agreements under the Security Agreement shall constitute an additional Event of Default under Section 15 of the Master Lease.  Upon the occurrence of an Event of Default specified above, Lessor shall be entitled to exercise all of its rights and remedies under Section 15 of the Master Lease and under the Security Agreement,

including without limitation as an additional remedy, foreclosure of Lessor’s security interest in the Collateral as provided under the Security Agreement.

The following shall be added as Section 1-3 of the Schedule:

Section 13. For purposes of this Lease Schedule No. 1 only, in paragraph 2(b) of the Master Lease, The phrase “calendar quarter” shall be deleted wherever it appears and replaced with the word “month”. In line 4 of Section 4 the phrase “calendar quarter” shall be deleted and replaced with the phrase “the month”. In lines 5, 6 and 7 of Section 4 the phrase “calculated by multiplying the number of days from and including the Acceptance Date to the Commencement Date by daily rental equal to one thirtieth (1/30) of the Monthly Rental” shall be deleted and replaced with “a pro rata portion of the Monthly Rental, calculated on a 30-day basis for the period between the Acceptance Date and the Commencement Date.”

All other terms and conditions of the Lease shall continue in full force and effect without change.

Dated: May 1, 2000

Lessor:		Lessee:
MATRIX FUNDING CORPORATION		SOUTHWALL TECHNOLOGIES, INC.
By:		By:
Its:	Assistant Vice President	Its:

CASUALTY LOSS SCHEDULE

DATED MAY 1, 2000

TO

LEASE SCHEDULE N0. 1

DATED JULY 19, 1999, AS AMENDED

TO

MASTER LEASE AGREEMENT NO. R0825

Upon execution below by the Lessee and Lessor, this Casualty Loss Schedule shall replace and supercede the original Casualty Loss Schedule previously executed, which shall from and after the date hereof become null and void.

The Casualty Loss Value for each item of Property shall be determined by multiplying the original cost of such item to Lessor by the stipulated loss percentage indicated below which corresponds to the month of the Lease after commencement in which the last Monthly Rental payment was made. The dollar amount shown below represents the Casualty Loss Value which would apply if all of the Property were lost or destroyed.

AFTER PAYMENT NUMBER	TOTAL CASUALTY LOSS VALUE	CASUALTY LOSS PERCENTAGE		AFTER PAYMENT NUMBER	TOTAL CASUALTY LOSS VALUE	CASUALTY LOSS PERCENTAGE
0	$3,887,308	130,00	%	19	$2,393,635	80.05	%
1	$3,825,230	127.92	%	20	$2,307,806	77.18	%
2	$3,747,111	125.31	%	21	$2,231,570	74.63	%
3	$3,668,680	122.69	%	22	$2,144,299	71.71	%
4	$3,589,936	120.06	%	23	$2,056,788	68.78	%
5	$3,510,877	117.41	%	24	$1,969,038	65.85	%
6	$3,458,177	115.65	%	25	$1,881,047	62.91	%
7	$3,377,152	112.94	%	26	$1,792,814	59.96	%
8	$3,295,837	110.22	%	27	$1,704,340	57.00	%
9	$3,214,231	107.49	%	28	$1,615,623	54.03	%
10	$3,132,333	104.75	%	29	$1,530,299	51.18	%
11	$3,050,142	102.00	%	30	$1,440,467	48.17	%
12	$2,967,658	99.24	%	31	$1,350,427	45.16	%
13	$2,884,878	96.48	%	32	$1,260,176	42.14	%
14	$2,818,745	94.26	%	33	$1,169,716	39.12	%
15	$2,734,258	91.44	%	34	$1,079,045	36.09	%
16	$2,649,505	88.61	%	35	$988,164	33.05	%
17	$2,564,484	85.76	%	36	$897,071	30.00	%
18	$2,479,194	82.91	%	and thereafter

LESSOR:		LESSEE:
MATRIX FUNDING CORPORATION		Southwall Technologies, Inc.
BY:		BY:
ITS:	Assistant Vice President	ITS:

ACCEPTANCE CERTIFICATE

TO

LEASE SCHEDULE NO. 1,

as amended by Amendment No. 1 thereto,

to

Master Lease Agreement No. R0825 dated July 19, 1999, (the “Lease”) between MATRIX FUNDING CORPORATION, (the “Lessor”), and SOUTHWALL TECANOLOGIES, INC., (the “Lessee”).

1.             Condition of the Property:

The Lessee certifies that all items of Property described in Paragraph 4 have been delivered to the location indicated in Paragraph 2, have been examined, tested, and determined by Lessee to be ready for use, and are hereby accepted as items of Property for all purposes under the Lease, all on the date indicated in Paragraph 3.

2.             Location of Property:                  8175 S. Hardy, Tempe, AZ 85284 (PM7)

                                                                        1029 Corporation Way, Palo Alto, 94303 (Telephone System)

3.             Acceptance Date: May 1, 2000

4. Description of Property: PM7 Microwave Plasma Enhanced Chemical Vapor Deposited Optical Coating System and Telephone System more fully described on the attached Exhibit A, which by reference becomes a part hereof.

LESSEE:

SOUTHWALL TECHNOLOGIES, INC.

BY:

TITLE:

Exhibit A

QTY		DESCRIPTION	SERIAL #	PER UNIT COST	INVOICE TOTAL
	Location: 8175 S. Hardy, Tempe, A2 85284
1		PM7 Microwave Plasma Enhanced Chemical Vapor Deposit Optical Coating System
		Purchase of Sputter Web Coater Type A 500 B4 Z6			$673,750.00
		Refurbishing of the above			$2,116,300.00
		Shipping Charges			$65,036.67
	Location: 1029 Corporation Way, Palo Alto, CA 94303
	Pac West Telecomm Inc.
	Invoice No. 70324
		System 2000 Telephone System			$135,149.95
12		Superset 4016 Dark Grey
12		Superset 4025 Dark Grey
7		Superset 4150 Dark Grey
2		Dataset 2103
3		Peripheral Node (AC)
		Total			$2,990,236.82

LEASE SCHEDULE NO. 2

dated October 14, 1999 (the “Schedule”)

to MASTER LEASE AGREEMENT N0. R0825 dated July 19, 1999 (the “Master Lease”) between MATRIX FUNDING CORPORATION as Lessor and SOUTHWALL TECHNOLOGIES, INC. as Lessee.

This Schedule incorporates by reference the terms and conditions of the Master Lease, Exhibit A (the “Property Description”) and Exhibit B (the “Casualty Loss Schedule”), and constitutes a separate “Lease” between Lessor and Lessee. All capitalized terms used herein but not defined herein shall have the same meanings ascribed to them in the Master Lease.

1.Property: (1) PM6 Multi Layer Vacuum Metalizer Sputter Web Coating System, together with all other property hereafter purchased or paid for by Lessor pursuant to that Master Progress Funding Agreement dated July 19, 1999, between Lessor and Lessee, which relates to the Schedule between Lessor and Lessee, (including without limitation, all authorizations signed in connection with said Master Progress Funding Agreement which relate to the Schedule), and any and all additions, enhancements and replacements thereto.

2.Property Location: 8175 S. Hardy, Tempe, AZ 85284

3.Acceptance Date: As specified in the Acceptance Certificate (estimated to be October 22, 1999)

4.             Commencement Date: January 1, 2000

5.             Initial Period: Twenty-four (24) months from Commencement Date

6.             Monthly Rental: $145,000.00, plus applicable sales tax

7.             Deposit: $145,000.00 applied to the last Monthly Rental, plus applicable sales tax

8.             Total Cost To Be Funded by Lessor: $3,600,000.00

9.             Lease Rate Factor: .040278

10.Interim Service Charges: Notwithstanding anything to the contrary contained in the Master Lease, for purposes of this Schedule only, Lessee shall irrevocably pay to Lessor a per diem charge equal to $10,400.00, plus applicable sales tax, for the period beginning with Lessor’s initial funding (herein estimated to be October 22, 1999) through and including December 31, 1999.

11.Additional Event of Default: Lessor as Secured Party, and Lessee as Debtor, have entered into a Security Agreement dated October 14, 1999, pursuant to which Lessee has granted to Lessor a security interest in personal property as described in the Security Agreement

(“Collateral”) to secure Lessee’s obligations under this Schedule. Lessee’s breach of any of its representations, warranties, covenants and agreements under the Security Agreement shall constitute an additional Event of Default under Section 15 of the Master Lease. Upon the occurrence of an Event of Default under the Lease, which may include the Event of Default specified above, Lessor shall be entitled to exercise all of its rights and remedies under the Master Lease and under the Security Agreement, including without limitation as an additional remedy, foreclosure of Lessor’s security interest in the Collateral as provided under the Security Agreement.

12.Letter of Credit; Additional Event of Default: Lessee shall cause a commercial bank acceptable to Lessor to issue to Lessor an irrevocable standby letter of credit (“credit”) in the amount of $500,000.00 in form acceptable to Lessor. The credit shall not expire before January 1, 2002. The credit is given to secure all of Lessee’s obligations and agreements under the Lease.

In addition to the Events of Default set forth in Section 15 of the Master Lease, each of the following shall constitute an additional Event of Default under the Lease: (i) failure of Lessee to provide the credit as specified above or (ii) Lessor’s knowledge or receipt of notification that the credit will not continue in effect according to its terms for the entire Initial Period of the Lease, and extended period, if applicable. Upon the occurrence of an Event of Default under the Lease, which may include without limitation, an additional Event of Default specified above, Lessor shall be entitled to exercise any of its rights or remedies under the Lease, including without limitation as an additional remedy, the right to draw down the credit and use the proceeds therefrom to satisfy Lessor’s remedies under the Lease.

Lessee shall be responsible for the payment of all fees associated with said credit.

13.Representation of Lessee: Lessor and Lessee agree that this Schedule constitutes a “finance lease” under the Uniform Commercial Code - Article 2A, in that (a) Lessee has selected the Property in its sole discretion, (b) Lessor has acquired the Property solely for purposes of leasing such property under this Schedule, and (c) Lessee has received a copy of the contract evidencing Lessor’s purchase of the Property.

LESSOR:	LESSEE:
MATRIX FUNDING CORPORATION	SOUTHWALL TECHNOLOGIES, INC.
BY:	BY:
TITLE:	TITLE:

EXHIBIT B

CASUALTY LOSS SCHEDULE

DATED OCTOBER 14,1999

TO

LEASE SCHEDULE NO. 2

DATED OCTOBER 14,1999

TO

MASTER LEASE AGREEMENT NO. R0825

The Casualty Loss Value for each item of Property shall be determined by multiplying the original cost of such item to Lessor by the stipulated loss percentage indicated below which corresponds to the month of the Lease after commencement in which the last Monthly Rental payment was made. The dollar amount shown below represents the Casualty Loss Value which would apply if all of the Property were lost or destroyed.

AFTER PAYMENT NUMBER	TOTAL CASUALTY LOSS VALUE	CASUALTY LOSS PERCENTAGE	AFTER PAYMENT NUMBER	TOTAL CASUALTY LOSS VALUE	CASUALTY LOSS PERCENTAGE
0	$4,680,000	130.00%	13	$2,725,008	75.69%
1	$4,539,643	126.10%	14	$2,581,749	71.72%
2	$4,386,078	121.84%	15	$2,429,727	67.49%
3	54,232,804	117.58%	16	$2,278,118	63.28%
4	$4,079,818	113.33%	17	$2,126,922	59.08%
5	$3,927,121	109.09%	18	$1,976,137	54.89%
6	$3,793,766	105.38%	19	$1,825,762	50.72%
7	$3,640,028	101.11%	20	$1,675,796	46.55%
8	$3,486,645	96.85%	21	$1,527,970	42.44%
9	$3,333,614	92.60%	22	$1,378,177	38.28%
10	$3,180,936	88.36%	23	$1,228,854	34.13%
11	$3,028,609	84.13%	24	$1,080,000	30.00%
12	$2,876,634	79.91%

LESSOR:		LESSEE:
MATRIX FUNDING CORPORATION			SOUTHWALL TECHNOLOGIES, INC.
BY:		BY:
TITLE:	Assistant Vice Present	TITLE:

SECURITY AGREEMENT

(Personal Property)

THIS SECURITY AGREEMENT is made this 14th day of October, 1999, between Southwall Technologies, Inc., having its principal place of business at 1029 Corporation Way, Palo Alto, CA 94303 (“Debtor”) and Matrix Funding Corporation, having its principal place of business at 5975 Union Park Center Second Floor, Midvale, UT 84047 (“Secured Party”).

1.             Background. Secured Party, as lessor, and Debtor, as lessee, have entered into Lease Schedule No. 2 dated October 14, 1999 (‘‘Schedule”) to Master Lease Agreement No. R0825, dated July 19, 1999 (“Master Lease”). Debtor will execute and deliver to Secured Party an “Acceptance Certificate” certifying it has accepted the leased property for all purposes under the Schedule. The Master Lease, the Schedule and the Acceptance Certificate, together with all amendments, riders and supplements thereto, are referred to herein collectively as the “Lease”.

As a condition to its execution and performance of the Lease, Secured Party requires Debtor to grant a security interest in the “Collateral” described herein to secure Debtor’s payment and performance of all of its obligations under the Lease.

2.             Grant of Security Interest. For valuable consideration, the receipt and sufficiency of which is hereby acknowledged, Debtor hereby grants to the Secured Party a security interest in the “Collateral” described in Section 3 to secure all of Debtor’s obligations (including without limitation all payment obligations) under the Lease and all other obligations and liabilities of Debtor to the Secured Party for which the Debtor is now or may become liable in any manner, whether such obligations arise under the Lease or otherwise, and whether primary or secondary, direct or indirect, contingent or absolute, and howsoever arising, including without limitation, all costs and expenses incurred in connection with the Lease or in the protection or maintenance of the Collateral or in the enforcement of this Security Agreement, including without limitation, court costs and attorneys’ fees.

3.             Collateral. The property serving as “Collateral” and subject to the above security interest is as follows:

                All property described in Exhibit A attached hereto, together with all attachments, replacements, parts, substitutions, additions, repairs, accessions and accessories incorporated therein or affixed thereto, and all proceeds (including insurance proceeds) of the foregoing.

4.             Representations. Warranties and Covenants. Debtor represents, warrants and covenants with Secured Party as follows:

                a.             Title. Debtor is the absolute owner of the Collateral with full right and interest therein, all of which is free and clear of any and all liens, claims and encumbrances. Debtor has full power and authority to grant a security interest in the Collateral and agrees to defend its title and ownership of the Collateral against all other persons who may claim an interest in it.

                b.             No Other Security Interests. Debtor warrants that there are no security interests (including filed financing statements), liens, claims or other encumbrances against the Collateral other than as specified herein or created hereby. Debtor agrees that during the course of this Agreement and as long as any Debtor obligations under the Lease remain outstanding, (i) Debtor will not grant or permit a security interest in the Collateral other than the security interest created hereunder, and (ii) Debtor will keep the Collateral free from any and all liens, claims and encumbrances.

                c.             No Sale or Disposition of Collateral. Debtor will not assign, transfer, discount, sell, offer for sale, or otherwise dispose of the Collateral or any interest therein without the prior written consent of the Secured Party.

                d.             Unlawful Uses of Collateral. Debtor will not use or permit any person to use the Collateral in a manner prohibited by law, or in violation of any policy of insurance, or in any manner inconsistent with the interest of the Secured Party.

                e.             Care of Collateral. Debtor agrees to maintain the Collateral in at least as good order and condition as it is at the time of execution and delivery of this Security Agreement, and Debtor agrees to take all steps necessary or advisable to preserve the Collateral and to prevent the Collateral from being misused, wasted or destroyed.

                f.              Taxes. Debtor agrees to pay promptly when due all taxes and assessments on or with respect to the Collateral. Should Debtor fail to do so, the Secured Party may at its option (although it is not required to do so) pay or discharge the same. Any such payment shall become an obligation of Debtor secured by the Collateral.

                g.             Insurance. Debtor agrees to maintain in force casualty and liability insurance with regard to the Collateral in amounts and with insurers acceptable to Secured Party. Debtor will cause Secured Party to be shown as co-insured and loss payee on all such policies of insurance. Should Debtor fail to maintain insurance as required above, the Secured Party may at its option (although it is not required to do so) obtain and pay such insurance. Any such payment shall become an obligation of Debtor secured by the Collateral.

                h.             Lease. Debtor shall be liable under this Security Agreement for all of its obligations under the Lease, and the terms and conditions of the Lease are incorporated by reference into this Agreement. Breach of any of Debtor’s obligations under the Lease shall constitute a breach of this Agreement.

                i.              Corporate Authority. Debtor warrants that it is duly organized and validly existing under the laws of the state of its incorporation; it is qualified and in good standing in all jurisdictions in which it is doing business; and that the execution and performance of this Security Agreement is within the Debtor’s corporate powers, has been duly authorized, and is not in contravention of any law or regulation or the Debtor’s articles of incorporation, bylaws or other governing instruments, or any agreement or undertaking of which Debtor is a party or by which it is bound.

5.             Financing Statements and Other Documents. Debtor agrees to execute one or more financing statements with regard to the Collateral in form acceptable to the Secured Party who is authorized to file the financing statement(s) in any jurisdiction deemed necessary or advisable to perfect the Secured Party’s security interest in the Collateral. Debtor expressly agrees to sign such financing statements on request of the Secured Party, and Debtor authorizes and appoints the Secured Party as its attorney in fact to sign any such statements in its stead with full power of substitution.

                Debtor agrees to cooperate fully with the Secured Party in executing additional instruments, documents, financing statements, amendments to financing statements, and the like as may be deemed necessary or advisable by the Secured Party in order to maintain and continue the security interest and lien created or permitted by this Security Agreement.

                Debtor agrees that a copy or other reproduction of this Security Agreement or financing statement is sufficient as a financing statement under this Security Agreement.

6.            Inspection of the Property.

                Upon receipt of written notice, Debtor agrees to the inspection of the Collateral from time to time by the Secured Party, its agents and assigns; as the Secured Party may deem necessary or advisable in the protection of its interests under this Security Agreement.

7.             Default. Each of the following shall constitute an “Event of Default” under this Security

Agreement:

                a. Nonpayment. Any failure of the Debtor to pay Lessor or its assigns when due any obligation under the Lease or other instrument and such failure shall continue uncured for ten (10) days after written notice is given to Debtor.

                b.             Nonperformance. Any failure of the Debtor to perform or observe fully and in a timely and satisfactory manner any obligation under the Lease or this Security Agreement.

                c.             Representations and Warranties That Prove False. Any representation or warranty made by Debtor under the Lease or this Security Agreement is false or materially misleading.

                d.             Bankruptcy and Insolvency. Debtor becomes insolvent or is subject to any proceeding under applicable bankruptcy or insolvency laws (whether voluntary or involuntary), including without limitation, an assignment for the benefit of creditors; or Debtor has its property (or part of it) placed under the custody of a receiver or trustee.

                e.             Unauthorized Use of Collateral or Proceeds. Any assignment, sale, discount, transfer, creation of an encumbrance against or use of the Collateral or its proceeds except as authorized in this Security Agreement.

                f.              Breach of Security Agreement. Debtor’s breach of any representation, warranty, covenant or agreement contained in this Security Agreement.

8.             Remedies. Upon the occurrence of an Event of Default under this Security Agreement, the Secured Party shall have the following rights and remedies, which are immediately available to the Secured Party: .

                a.             All of Secured Party’s rights and remedies under the Lease;

                b.             All rights and remedies provided in this Security Agreement;

                c.             All rights and remedies provided at law or in equity, including without limitation those provided to secured parties under Article 9 of the Uniform Commercial Code (“UCC”);

                Among the rights and remedies mentioned above are specifically included:

                x.             Right to Take Possession of the Collateral. The Secured Party shall have the right to take possession of the Collateral. Debtor will cooperate fully with the Secured Party, including without limitation assembling and delivering the Collateral to the Secured Party at a location designated by the Secured Party.

                y.             Right to Dispose of Collateral. The Secured Party shall have the right to dispose of the Collateral by public or private proceeding and may do so by way of one or more contracts. Such sale or other disposition of the Collateral may be made as a unit or in parcels and at any time and place and on any terms provided only that the disposition effected is commercially reasonable. Any actions so taken shall be considered commercially reasonable if made in the good faith exercise of the Secured Party’s reasonable business judgment in the matter.

                z.             Enforcement Costs and Attorneys’ Fees. Debtor shall be liable for and shall pay to Secured Party all of Secured Party’s costs and expenses incurred in enforcing its rights and remedies under this Security Agreement in effect with regard to the Collateral, including without limitation its court costs and attorney’s fees.

                Secured Party’s remedies under this Security Agreement shall be cumulative, and Secured Party shall not be obligated to exercise any remedy before any other remedy, nor shall Secured Party be precluded from exercising any remedy because it has not first exercised any other remedy.

9.             Assignment. Secured Party may assign or transfer the whole or any part of its security interest in the Collateral created hereunder. Any transferee shall be vested with all of the rights, remedies and powers of the Secured Party under this Security Agreement.

10.           Term. This Security Agreement is a continuing agreement, and all rights, remedies and powers of the Secured Party hereunder shall apply to all past, present, and future obligations of Debtor under the Lease, notwithstanding the bankruptcy, dissolution or insolvency of Debtor, and shall continue in full force and effect until all obligations of Debtor under the Lease have been paid, performed and satisfied in fill, notwithstanding any termination of the Lease. The power of sale and other rights and remedies granted to the Secured Party hereunder may be

exercised even though any remedies of the Secured Party under the Lease may be barred for whatever reason.

11.           Choice of Law: Jurisdiction: Waiver of Jury Trial. This Agreement shall be governed by and construed in accordance with the laws of the State of Utah in all save perfection of the security interest as required by the Uniform Commercial Code, and at Secured Party’s option, jurisdiction of any dispute shall be in the Utah state or federal courts. Debtor consents to such jurisdiction. BOTH PARTIES HERETO WAIVE THE RIGHT TO JURY TRIAL.

12.          Severability. In the event that any provision of this Security Agreement is found to be

unenforceable in any legal proceeding, the remaining provisions shall remain in full force and effect.

                IN WITNESS WHEREOF, the parties have entered into this Agreement as of the day and year first above written.

DEBTOR:	SECURED PARTY:
SOUTHWALL TECHNOLOGIES, INC.	MATRIX FUNDING CORPORATION
By:	By:
Title:	Title:

Exhibit A

Personal Property

Qty	Description	Serial No.
(1)	PM2 Sputter Web Coater System (no serial number) located at 3961 E. Bayshore, Palo Alto, CA 94303

EX-10.119

EXHIBIT 10.119

STANDARD INDUSTRIAL LEASE

BY AND BETWEEN

C & J DEVELOPMENT CO.,

AS LANDLORD

AND

SOUTHWALL TECHNOLOGIES, INC.

AS TENANT

TABLE OF CONTENTS

ITEM
1.	USE
2.	TERM
3.	POSSESSION
4.	MONTHLY RENT
5.	ADJUSTMENT OF BASIC RENT
6.	RESTRICTION ON USE
7.	COMPLIANCE WITH LAWS
8.	ALTERATIONS
9.	REPAIR AND MAINTENANCE
10.	LIENS
11.	INSURANCE
12.	UTILITIES AND SERVICE
13.	TAXES AND OTHER CHARGES
14.	ENTRY BY LANDLORD
15.	COMMON AREA; PARKING
16.	COMMON AREA CHARGES
17.	DAMAGE BY FIRE; CASUALTY
18.	INDEMNIFICATION
19.	ASSIGNMENT AND SUBLETTING
20.	DEFAULT
21.	LANDLORD’S RIGHT TO CURE TENANT’S DEFAULT
22.	EMINENT DOMAIN
23.	NOTICE AND COVENANT TO SURRENDER
24.	TENANT’S QUITCLAIM
25.	HOLDING OVER
26.	SUBORDINATION
27.	CERTIFICATE OF ESTOPPEL
28.	SALE BY LANDLORD
29.	ATTORNMENT TO LENDER OR THIRD PARTY
30.	DEFAULT BY LANDLORD
31.	CONSTRUCTION CHANGES
32.	MEASUREMENT OF PREMISES
33.	ATTORNEY FEES
34.	SURRENDER
35.	WAIVER
36.	EASEMENTS; AIRSPACE RIGHTS
37.	RULES AND REGULATIONS
38.	NOTICES
39.	NAME
40.	GOVERNING LAW; SEVERABILITY
41.	DEFINITIONS
42.	TIME
43.	EXAMINATION OF LEASE
44.	INTEREST ON PAST DUE OBLIGATIONS; LATE CHARGE
45.	ENTIRE AGREEMENT
46.	CORPORATE AUTHORITY
47.	RECORDING
48.	REAL ESTATE BROKERS
49.	EXHIBITS AND ATTACHMENTS
50.	ENVIRONMENTAL MATTERS
51.	SIGNAGE
52.	SUBMISSION OF LEASE
53.	ADDITIONAL RENT
54.	PREMISES TAKEN “AS IS”
55.	CAPITAL EXPENDITURES

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LEASE

        THIS LEASE is made this ____ day of October, 1999, by and between C&J Development Co., a California limited partnership, (“Landlord”) and Southwall Technologies, Inc. (formerly The Southwall Corporation), a Delaware corporation (“Tenant”).

W I T N E S S E T H:

        Landlord leases to Tenant and Tenant leases from Landlord those certain premises outlined in red on Exhibit A (the “Premises”) commonly known as 1029 Corporation Way, Palo Alto, California, which Landlord and Tenant hereby agree consists of approximately nineteen thousand seven hundred and eighty-two (19,782) square feet in 1029 Corporation Way, Palo Alto, California (the “Project”). As used herein the term Project shall mean and include all of the land described in Exhibit B and all the buildings, improvements, fixtures and equipment new or hereafter situated on said land.

        Tenant covenants, as a material part of the consideration of this lease, to perform and observe each and all of the terms, covenants and conditions set forth below, and this lease is made upon the condition of such performance and observance.

        1.     USE

                Subject to the restrictions contained in paragraph 6 hereof, Tenant shall use the Premises for marketing, sales, research and development, general office and administrative uses and shall not use or permit the Premises to be used for any other purpose.

        2.     TERM

(a) The term shall be for three (3) years (unless sooner terminated or hereinafter provided) and, subject to paragraph 3, shall commence on January 1, 2000 and end on December 31, 2002.

        3.     POSSESSION

(a) If Landlord for any reason cannot deliver possession of the Premises to Tenant by the date of commencement set forth in paragraph 2, this lease shall not be void or voidable, Landlord shall not be liable to Tenant for any loss or damage on account thereof and Tenant shall not be liable for rent until Landlord delivers possession of the Premises. If the term commences on a date other than the date specified in paragraph 2 above, then the parties shall immediately execute an amendment to this lease stating the actual date of commencement and the revised expiration date. The expiration date of the term shall be extended by the same number of days that Tenant’s possession of the Premises was delayed from that set forth in paragraph 2.

                (b) Tenant’s inability or failure to take possession of the Premises when delivery is tendered by Landlord shall not delay the commencement of the term of this lease or Tenant’s obligation to pay rent. Tenant acknowledges that Landlord shall incur significant expenses upon the execution of this lease, even if Tenant never takes possession of the Premises, including without limitation brokerage commissions and fees and legal and other professional fees. Tenant acknowledges that all of said expenses shall be included in measuring Landlord’s damages should Tenant breach the terms of this lease.

        4.     MONTHLY RENT

                (a) Basic Rent. Tenant shall pay to Landlord as basic rent for the Premises, in advance and subject to adjustment as provided in paragraph b, the sum of Fifty Thousand and Four Hundred and Forty-Five and 10/100 Dollars ($50,444.10) on or before the first day of the first full calendar month of the term and on or before the first day of each and every successive calendar month. Basic rent for any partial month shall be payable in advance and shall be prorated at the rate of 1/30th of the monthly basic rent per day.

                (b) Common Area Charges. In addition to the above basic rent, and as additional rent, Tenant shall pay to Landlord, subject to adjustments and reconciliation as provided in paragraph 16 of this lease, the sum of Three Thousand Seven Hundred and Five and 00/100 Dollars ($3,705.00) on or before the first day of the first full calendar month of the term and on the first day of each and every succeeding calendar month, said sum representing Tenant’s estimated payment of its percentage share of common area charges as provided for in paragraph 16 of this lease. Payment of common area charges for any partial month shall be payable in advance and shall be prorated at the rate of 1/30th of the monthly payment of common area charges per day.

                (c) Manner and Place of Payment. All payments of basic rent and common area charges shall be paid to Landlord, without deduction or offset, in lawful money of the United States of

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America, at the office of Landlord at 360 S. San Antonio Road, Suite 14, Los Altos, California, 94022 or to such other person or place as Landlord may from time to time designate in writing.

                (d) Last Month’s Rent. Concurrently with Tenant’s execution of this lease, Tenant shall deposit with Landlord, the sum of Twenty-Two Thousand Seven Hundred and Forty-Nine and 30/100 Dollars ($22,749.30), to be applied against the basic rent and common area charges for the last lease month of the term.

                (e) Security Deposit. Concurrently with Tenant’s execution of this lease, Tenant shall deposit with Landlord the sum of Twenty-Two Thousand Seven Hundred and Forty-Nine and 30/100 Dollars ($22,749.30), which sum shall be held by Landlord as a security deposit for the faithful performance by Tenant of all of the terms, covenants and conditions of this lease to be kept and performed by Tenant. If Tenant defaults with respect to any provision of this lease, including but not limited to, the provisions relating to the payment of basic rent and common area charges, Landlord may (but shall not required to) use, apply, or retain all or any part of this security deposit for the payment of any amount which Landlord may spend by reason of Tenant’s default or to compensate Landlord for any other loss or damage which Landlord may suffer by reason of default. If any portion of said deposit is so used, Tenant shall, within ten (10) days after written demand therefor, deposit cash with Landlord in the amount sufficient to restore the security deposit to its original amount; Tenant’s failure to do so shall be a material breach of this lease. Landlord shall not be required to keep this security deposit separate from its general funds and Tenant shall not be entitled to interest on such deposit. If Tenant is not in default at the expiration or termination of this lease, the security deposit or any balance thereof shall be returned to Tenant after Tenant has vacated the Premises. In the event of termination of Landlord’s interest in this lease, Landlord shall transfer said deposit to Landlord’s successor in interest, and Tenant agrees that Landlord shall thereupon be released from liability for the return of such deposit or any accounting therefor.

        5.     ADJUSTMENT OF BASIC RENT

                The basic rent provided for in paragraph 4(a) shall be adjusted periodically and the monthly basic rent for each period shall be as set forth below:

Lease Months  1-12	(1/1/00-12/31/00)	$	50,444.10 per month
Lease Months  1-12	(1/1/01-12/31/01)	$	51,957.42 per month
Lease Months  1-12	(1/1/02-12/31/02)	$	53,516.15 per month

                6.     RESTRICTION ON USE

                Tenant shall not do or permit to be done in or about the Premises or the Project, nor bring or keep or permit to be brought or kept in or about the Premises or Project, anything which is prohibited by or will in any way increase the existing rate of, otherwise affect, fire or any other insurance covering the Project or any part thereof, or any of its contents, or will cause a cancellation of any insurance covering the Project or any part thereof, or any of its contents. Tenant shall not do or permit to be done anything in or about the Premises or the Project which will constitute waste or which will in any way obstruct or interfere with the rights of other tenants, business invitees or occupants of the Project or injure or annoy them, or use or allow the Premises to be used  for any unlawful purpose, nor shall Tenant cause, maintain or permit any nuisance in or about the Premises or the Project. No loudspeaker or other device, system or apparatus which can be heard outside the Premises shall be used in or at the Premises without the prior written consent of Landlord. Tenant shall not use the Premises for the preparation, or mixing of anything that might emit any objectionable odor, noise or light into the adjoining premises or Common Area. Tenant shall not do anything on the Premises that will cause damage to the Project and Tenant shall not overload the floor capacity of the Premises or the Project. No machinery, apparatus or other appliance shall be used or operated in or on the Premises that will in any manner injure, vibrate or shake the Premises. Landlord shall be the sole judge, of whether such odor, noise, light or vibration is such as to violate the provisions of this paragraph. No waste materials or refuse shall be dumped upon or permitted to remain upon any part of the Premises or the Project except in trash containers placed inside exterior enclosures designated for that purpose by Landlord, or where otherwise designated by Landlord; and no toxic or hazardous materials shall be disposed of through the plumbing or sewage system. No materials, supplies, equipment, finished products or semi finished products, raw materials or articles of any nature shall be stored or permitted to remain outside of the building proper. No retail sales shall be made on the Premises

        7.     COMPLIANCE WITH LAWS

                Tenant shall, in connection with its use and occupation of the Premises, at its sole cost and expense, promptly observe and comply with (i) all laws, statutes, ordinances and governmental rules, regulations and requirements now or hereafter in effect, (ii) with the requirements of any board of fire underwriters or other similar body now or hereafter constituted and (iii) with any direction or occupancy certificate issued pursuant to law by any public authority; provided, however, that no such failure shall be deemed a breach of these provisions if Tenant, immediately upon notification,

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commences to remedy or rectify said failure. The judgment of any court of competent jurisdiction or the admission of Tenant in any action against Tenant (whether or not Landlord is a party thereto) that Tenant has violated any such law, statute, ordinance or governmental rule, regulation, requirement, direction or provision, shall be conclusive of that fact as between Landlord and Tenant. This lease shall remain in full force and effect notwithstanding any loss of use or other effect on Tenant’s enjoyment of the Premises by reason of any governmental laws, statutes, ordinances, rules, regulations and requirements now or hereafter in effect.

                Landlord represents that the project was constructed in accordance with applicable laws, statutes, ordinances and/or governmental rules, regulations or requirements in effect as of the date of construction of the Project, and that the improvements to be constructed in accordance with Exhibit C of the original lease between Landlord and Tenant dated October 21, 1983 were constructed in accordance with applicable laws, statutes, ordinances and/or governmental rules, regulations or requirements in effect as of the date of construction of such improvements.

                Landlord and Tenant hereby acknowledge that the Americans with Disabilities Act and Title 24 of the Code of California Regulations may affect Tenant’s use and occupancy of the Premises and require Tenant to modify or alter the design, layout or other physical elements of the interior of the Premises or provide auxiliary aids and services in connection with its business operations. Tenant shall, at Tenant’s sole cost and expense, comply in all respects with the requirements of the Americans with Disabilities Act and Title 24 of the Code of California Regulations as it affects Tenant’s use and occupancy of the Premises throughout the term of the lease, as may be extended, and Tenant acknowledges and agrees that, notwithstanding any modifications to the Common Area which may be made by Landlord in order to conform such areas with the requirements of the Americans with Disabilities Act and Title 24 of the Code of California Regulations, Landlord makes no representations or warranties regarding the compliance of the Premises or the Project with the Americans with Disabilities Act and Title 24 of the Code of California Regulations, nor shall Landlord have any obligations or liabilities to Tenant to construct any modifications or alterations to the interior of the Premises in order to comply with the Americans with Disabilities Act and Title 24 of the Code of California Regulations.

        8.     ALTERATIONS

                Tenant shall not make or suffer to be made any alteration, addition or improvement to or of the Premises or any part thereof (collectively referred to herein as “alterations”) without (i) the prior written consent of Landlord (which consent shall not be unreasonably withheld and Landlord further agrees that Landlord shall not raise the basic rent as of condition of such consent), (ii) a valid building permit issued by the appropriate governmental authority and (iii) otherwise complying with all applicable laws, regulations and requirements of governmental agencies having jurisdiction and with the rules, regulations and requirements of any board of fire underwriters or similar body. Any alteration made by Tenant (excluding moveable furniture and trade fixtures not attached to the Premises) shall at once become a part of the Premises and belong to Landlord. Without limiting the foregoing, all heating, lighting, electrical (including all wiring, conduit, outlets, drops, buss ducts, main and subpanels), air conditioning, partitioning, drapery and carpet installations made by Tenant, regardless of how attached to the Premises, together with all other alterations that have become an integral part of the Project in which the Premises are a part, shall be and become part of the Premises and belong to Landlord upon installation and shall not be deemed trade fixtures, and shall remain upon and be surrendered with the Premises at the termination of the lease.

                If Landlord consents to the making of any alteration by Tenant, the same shall be made by Tenant at its sole risk, cost and expense and only after Landlord’s written approval of any contractor or person selected by Tenant for that purpose (provided that Landlord waives the right to approve such contractor or person if the same is a duly licensed contractor and a valid building permit is issued by the appropriate governmental authority), and the same shall be made at such time and in such manner as Landlord may from time to time designate. Tenant shall, if required by Landlord, secure at Tenant’s cost a completion and lien indemnity bond for such work. Upon the expiration or sooner termination of the term, Landlord may, at is sole option, require Tenant, at Tenant’s sole cost and expense, to promptly both remove any such alteration made by Tenant and designated by Landlord to be removed and repair any damage to the Premises caused by such removal. Any moveable furniture and equipment or trade fixtures remaining on the Premises at the expiration or other termination of the term shall become the property of the Landlord unless promptly removed by Tenant.

                If during the term, and subject to paragraph 7 above, any alteration, addition or change of the Premises or the Project is required by law, regulation, ordinance or order of any public or quasi-public authority, Tenant, at its sole cost and expense, shall promptly make the same. If during the term any alterations, additions or changes to the Common Area or to the Project in which the Premises is located is required by law, regulation, ordinance or order of any public or quasi-public authority, and it is impractical in the Landlord’s judgment for the affected tenants to individually make such alterations, additions or changes, Landlord shall make such alterations, additions or changes and the cost thereof shall be a common area charge and Tenant shall pay its percentage share of such cost to Landlord as provided in paragraph 16.

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        9.     REPAIR AND MAINTENANCE

                By entry hereunder, Tenant accepts the Premises as being in good and sanitary order, condition and repair (excepting only “punchlist items”). Except as expressly provided below, Tenant shall at its sole cost keep and maintain the entire Premises and every part thereof including, without limitation, the windows, window frames, plate glass, glazing, elevators within the Premises, truck doors, doors and all door hardware, the interior walls and partitions, lighting and the electrical, mechanical, and plumbing systems. Tenant shall also repair and maintain the heating and air conditioning systems (unless Landlord has elected to keep and maintain the heating and air conditioning systems as provided below) which shall include, without limitation, a periodic maintenance agreement with a reputable and licensed heating and air conditioning service company. If Tenant’s use of the heating and air conditioning systems is limited to normal business hours (8:00 a.m. to 6:00 p.m.), such agreement shall provide for service at least as often as every 60 days, if Tenant’s use of the heating and air conditioning systems extends beyond such normal business hours this service shall be as often as may be required by landlord and in any event such service shall meet all warranty enforcement requirements of such equipment and comply with all manufacturer recommended maintenance. Landlord may elect, at its option, to keep and maintain the heating and air conditioning systems of the premises and in such event, Tenant shall pay to Landlord upon demand the full cost of such maintenance.

                Subject to the provisions of paragraph 17, Landlord shall keep and reasonably maintain the roof, structural elements, and exterior walls of the buildings constituting the Project and Common Area in reasonably good order and repair. Tenant waives all rights under and benefits of California Civil Code Sections 1932(1), 1941, and 1942 and under any similar law, statute or ordinance now or hereafter in effect. The cost of the repairs and maintenance which are the obligation of Landlord hereunder, including without limitation, maintenance contracts and supplies, materials, equipment and tools used in such repairs and maintenance shall be obtained at competitive prices for major repairs and shall be a common area charge and Tenant shall pay its percentage of such costs to Landlord as provided in paragraph 16; provided, however, that if any repairs or maintenance is required because of an act or omission of Tenant, or its agents, employees or invitees, Tenant shall pay to Landlord upon demand the full cost of such repairs or maintenance.

                As used herein, “punchlist items” shall mean minor repairs to painting, carpets, walls and other interior improvements to the Premises as reasonably determined by Tenant and disclosed to Landlord within thirty (30) days of the date Tenant takes possession of the Premises. Landlord shall repair all punchlist items subject to the terms of paragraph 16, below. Landlord shall have no obligation to repair items that are not disclosed to Landlord by Tenant in writing within thirty (30) days of the date possession of the Premises is delivered to Tenant.

        10.  LIENS

                Tenant shall keep the Premises and the Project free from any liens arising out of any work performed, materials furnished or obligations incurred by Tenant, its agents, employees or contractors. Upon Tenant’s receipt of a preliminary twenty (20) day notice filed by a claimant pursuant to California Civil Code Section 3097, Tenant shall immediately provide Landlord with a copy of such notice. Should any such lien be filed against the Project, Tenant shall give immediate notice of such lien to Landlord. In the event that Tenant shall not, within ten (10) days following the imposition of such lien, cause the same to be released of record, Landlord shall have, in addition to all other remedies provided herein and by law, the right, but no obligation, to cause the same to be released by such means as it shall deem proper, including payment of the claim giving rise to such lien. All sums paid by Landlord for such purpose, and all expenses (including attorneys’ fees) incurred by it in connection therewith, shall be payable to Landlord by Tenant on demand with interest at the rate of ten percent (10%) per annum or the maximum rate permitted by law, whichever is less. Landlord shall have the right at all times to post and, keep posted on the Premises any notices permitted or required by law, or which Landlord shall deem proper for the protection of Landlord, the Premises and the Project and any other party having an interest therein, from mechanics’ and material men’s liens and like liens. Tenant shall give Landlord at least fifteen (15) days prior notice of the date of the commencement of any construction on the Premises in order to permit the posting of such notices. In the event Tenant is required to post an improvement bond with a public agency in connection with any work performed by Tenant on or to the Premises, Tenant shall include Landlord as an additional obligee.

        11.  INSURANCE

                Tenant, at its sole cost and expense, shall keep in force during the term (i) commercial general liability and property damage insurance with a combined single limit of at least $5,000,000 per occurrence insuring against personal or bodily injury to or death of persons occurring in, on or about the Premises or Project and any and all liability of the insured with respect to, the Premises or arising out of Tenant’s maintenance, use or occupancy of the Premises and all areas appurtenant thereto, (ii) direct physical loss special insurance covering the leasehold improvements in the Premises and all of Tenant’s equipment, trade fixtures, appliances, furniture, furnishings, and personal property from time to time located in, on or about the Premises, with coverage in the amount of the full replacement cost thereof, (iii) Worker’s Compensation Insurance as required by law, together with employer’s liability coverage with a limit of not less than $1,000,000 for bodily injury for each accident and for bodily injury by disease for each employee. Tenant’s commercial general liability and property damage insurance

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and Tenant’s Workers Compensation Insurance shall be endorsed to provide that said insurance shall not be canceled or reduced except upon at least thirty (30) days prior written notice to Landlord and (iv) full replacement cost plate glass insurance. Further, Tenant’s commercial general liability and property damage insurance shall be primary and shall name Landlord and McCandless Simons Company, Inc., and their respective partners, officers, directors and employees and such other persons or entities as directed from time to time by Landlord as additional insured for all liability using ISO Bureau Form CG20111185 (or a successor form); shall contain a severability of interest clause and cross-liability endorsement; shall be endorsed to provide that the limits and aggregates apply per location using ISO Bureau Form CG25041185; and shall be issued by an insurance company admitted to transact business in the State of California and rated A+VIII or better in Best’s Insurance Reports (or successor report). The deductibles for all insurance required to be maintained by Tenant hereunder shall be no more than $5,000 per occurrence. The commercial general liability insurance carried by Tenant shall specifically insure the performance by Tenant of the indemnification provisions set forth in paragraph 18 of this lease provided, however, nothing contained in this paragraph 11 shall be construed to limit the liability of Tenant under the indemnification provisions set forth in said paragraph 18. If Landlord or any of the additional insured named on any of Tenant’s insurance have other insurance which is applicable to the covered loss on a contributing, excess or contingent basis, the amount of the Tenant’s insurance company’s liability under the policy of insurance maintained by Tenant shall not be reduced by the existence of such other insurance. Any insurance carried by Landlord or any of the additional insured named on Tenant’s insurance policies shall be excess and non-contributing with the insurance so provided by Tenant.

                Tenant shall, prior to the commencement of the term, provide Landlord with a completed Certificate of Insurance using a form acceptable in Landlord’s reasonable judgment, attaching thereto copies of all endorsements required to be provided by Tenant under this lease. Tenant agrees to increase the coverage or otherwise comply with changes in connection with said commercial general liability, property damage, direct physical loss and Worker’s Compensation Insurance as Landlord or Landlord’s lender may from time to time require.

                Landlord shall obtain and keep in force a policy or policies of insurance covering loss or damage to the Premises and Project in the amount of the full replacement value thereof, providing protection against those perils included within the classification of  “all risk” insurance, with increased cost of reconstruction and contingent liability (including demolition), plus a policy of rental income insurance in the amount of one hundred percent (100%) of twelve (12) months’ rent (including sums paid as additional rent) and such other insurance as Landlord or Landlord’s lender may from time to time require. Landlord may, but shall not be obligated to, also obtain flood and/or earthquake insurance. Landlord shall have no liability to Tenant if Landlord elects not to obtain flood and/or earthquake insurance. The cost of all such insurance purchased by Landlord, plus any charges for deferred payment of premiums and the amount of any deductible incurred upon any covered loss within the Project, shall be common area charges and Tenant shall pay to Landlord its percentage share of such costs as provided in paragraph 16.

                Landlord and Tenant hereby mutually waive any and all rights of recovery against one another for real or personal property loss or damage occurring to the Premises or the Project, or any part thereof, or to any personal property therein, from perils insured against under fire and extended insurance and any other property insurance policies existing for the benefit of the respective parties so long as such insurance permits waiver of liability and contains a waiver of subrogation without additional premiums.

                If Tenant does not take out and maintain insurance as required pursuant to this paragraph 11, Landlord may, but shall not be obligated to, take out the necessary insurance and pay the premium therefore, and Tenant shall repay to Landlord promptly on demand, as additional rent, the amount so paid. In addition, Landlord may recover from Tenant and Tenant agrees to pay, as additional rent, any and all reasonable expenses (including attorney fees) and damages which Landlord may sustain by reason of the failure of Tenant to obtain and maintain such insurance, it being expressly declared that the expenses and damages of Landlord shall not be limited to the amount of the premiums thereon.

12.  UTILITIES AND SERVICE

                Tenant shall pay for all water, gas, light, heat power, electricity, telephone, trash pickup, sewer charges and all other services supplied to or consumed on the Premises. In the event that any service is not separately metered or billed to the Premises, the cost of such utility service or other service shall be a common area charge and Tenant shall pay its percentage share of such cost to Landlord as provided in paragraph 16. In addition, the cost of all utilities and services furnished by Landlord to the Common Area shall be a common area charge and Tenant shall pay its percentage share of such cost to Landlord as provided in paragraph 16.

                If Tenant’s use of any such utility or service is materially in excess of the average furnished to the other tenants of the Project, and such utility or service is not separately metered, then Tenant shall pay to Landlord upon demand, as additional rent, the full cost of such excess use, or Landlord may cause such utility or service to be separately metered, in which case Tenant shall pay the full cost of such utility or service and reimburse Landlord upon demand for the cost of installing the separate meter.

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                Landlord shall not be liable for, and Tenant shall not be entitled to any abatement or reduction of rent by reason of, the failure of any person or entity to furnish any of the foregoing services when such failure is caused by accident, breakage, repairs, strikes, lockouts or other labor disturbances or labor disputes of any character, governmental moratoriums, regulations or other governmental actions, or by any other cause, similar to dissimilar, beyond the reasonable control of Landlord. In addition, Tenant shall not be relieved from the performance of any covenant or agreement in this lease because of any such failure, and no eviction of Tenant shall result from such failure.

13.  TAXES AND OTHER CHARGES

                All real estate taxes and assessments and other taxes, fees and charges of every kind or nature, foreseen or unforeseen, which are levied, assessed or imposed upon Landlord and/or against the Premises, building, Common Area or Project, or any part thereof by any federal, state, county, regional, municipal or other governmental or quasi-public authority, together with any increase therein for any reason, shall be a common area charge and Tenant shall pay its percentage share of such costs to Landlord as provided in paragraph 16. By way of illustration and not limitation, “other taxes, fees and charges” as used herein include any and all taxes payable by Landlord (other than state and federal personal or corporate income taxes measured by the net income of Landlord from all sources, and premium taxes), whether or not now customary or within the contemplation of the parties hereto, (i) upon, allocable to, or measured by the rent payable hereunder, including, without limitation, any gross income or excise tax levied by the local, state or federal government with respect to the receipt of such rent, (ii) upon or with respect to the possession, leasing, operation, management, maintenance, alteration, repair, use or occupancy by tenant of the Premises or any part thereof, (iii) upon or measured by the value of Tenant’s personal property or leasehold improvements located in the Premises, (iv) upon this transaction or any document to which Tenant is a party creating or transferring an interest or estate in the Premises, (v) upon or with respect to vehicles, parking or the number of persons employed in or about the Project, and (vi) and tax, license, franchise fee or other imposition upon Landlord which is otherwise measured by or based in whole or in part upon the Project or any portion thereof. If Landlord contests any such tax, fee or charge, the cost and expense incurred by Landlord thereby (including, but not limited to, costs of attorneys and experts) shall also be common area charges and Tenant shall pay its percentage share of such costs to Landlord as provided in paragraph 16. In the event the Premises and any improvements installed therein by Tenant or Landlord are valued by the assessor disproportionately higher than those of other tenants on the building or Project or in the event alterations or improvements are made to the Premises, Tenant’s percentage share of such taxes, assessments, fees and/or charges shall be readjusted upward accordingly and Tenant agrees to pay such readjusted share. Such determination shall be made by Landlord from the respective valuations assigned in the assessor’s work sheet or such other information as may be reasonably available and Landlord’s determination thereof shall be conclusive.

                Tenant agrees to pay, before delinquency, any and all taxes levied or assessed during the term hereof upon Tenant’s equipment, furniture, fixtures and other personal property located in the Premises, including carpeting and other property installed by Tenant notwithstanding that such carpeting or other property has become a part of the Premises. If any of Tenant’s personal property shall be assessed with the Project, Tenant shall pay to Landlord, as additional rent, the amount attributable to Tenant’s personal property within ten (10) days after receipt of a written statement from Landlord setting forth the amount of such taxes, assessments and public charges attributable to Tennant’s personal property.

14.  ENTRY BY LANDLORD

                Landlord reserves, and shall at all reasonable times have, the right to enter the Premise (i) to inspect the Premises, (ii) to supply services to be provided by Landlord hereunder, (iii) to show the Premises to prospective purchasers, lenders or tenants and to put ‘for sale’ or ‘for lease’ signs thereon, (iv) to post notices required or allowed by this lease or by law, (v) to alter, improve or repair the Premises and any portion of the Project, and (vi) to erect scaffolding and other necessary structures in or through the Premises or the Project where reasonably required by the character of the work to be performed. Landlord shall not be liable in any manner for any inconvenience, disturbance, loss of business, nuisance or other damage arising from Landlord’s entry and acts pursuant to this paragraph and Tenant shall not be entitled to an abatement or reduction of rent if Landlord exercises any rights presented in this paragraph. For each of the foregoing purposes, Landlord shall at all times have and retain a key with which to unlock all of the doors in, on and about the Premises (excluding Tenant’s vaults, safes and similar areas designated in writing by Tenant in advance), and Landlord shall have the right to use any and all means which Landlord may deem proper to open said doors in an emergency in order to obtain entry to the Premises. Any entry by Landlord to the Premises pursuant to this paragraph shall not under any circumstances by construed or deemed to be a forcible or unlawful entry into or a detainer of the Premises or an eviction, actual or constructive, of Tenant from the premises or any portion thereof. Notwithstanding the foregoing, and except in the case of emergency, Landlord shall give Tenant at least twenty-four (24) hours prior notice of its intent to enter the Premises.

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15.  COMMON AREA PARKING

                Subject to the terms and conditions of this lease and such rules and regulations as Landlord may from time to time prescribe and so long as such rules and regulations do not conflict with the terms and conditions of this lease, Tenant and Tenant’s employees and invitees shall, in common with other occupants of the Project, and their respective employees and invitees shall, in common with other occupants of the Project, and their respective employees and invitees and others entitled to the use thereof, have the non-exclusive right to use the access roads, parking areas and facilities within the Project provided and designated by Landlord for the general use and convenience of the occupants of the Project which areas and facilities shall include, but not be limited to, sidewalks, parking, refuse, landscape and plaza areas, roofs and building exteriors, which areas and facilities are referred to herein as “Common area”. This right shall terminate upon the termination of this lease.

                Landlord reserves the right from time to time to make changes in the shape, size, location, amount and extent of the Common Area. Landlord shall also have the right at any time to change the name, number or designation by which the Project is commonly known. Landlord further reserves the right to promulgate such rules and regulations relating to the use of the Common Area, and any part thereof, as Landlord may deem appropriate for the best interests of the occupants of the Project. The rules and regulations shall be binding upon Tenant upon delivery of a copy of them to Tenant and Tenant shall abide by them and cooperate in their observance. Such rules and regulations may be amended by Landlord from time to time, with or without advance notice.

                Tenant shall have the non-exclusive use of seventy five (75) parking spaces in the Common Area as designated from time to time by Landlord. Landlord reserves the right at its sole option to assign and label parking spaces, but it is specifically agreed that Landlord is not responsible for policing any such parking spaces. Tenant shall not at any time park or permit the parking of Tenant’s trucks or other vehicles, or the trucks or other vehicles of others; adjacent to loading areas so as to interfere in any way with the use of such areas; nor shall Tenant at any time park or permit the parking of Tenant’s vehicles or trucks, or other vehicles or trucks of Tenant’s suppliers or others, in any portion of the Common Area not designated by Landlord for such use by Tenant. Tenant shall not park or permit any inoperative vehicle or equipment to be parked on any portion of the Common Area. Tenant shall not permit, allow or place any type of circulars or advertisements on vehicles parking in the Common Area. Tenant shall not use any Common Area, including the space directly adjacent to the Premises for sales or displays.

                Landlord shall operate, manage and maintain the Common Area. The manner in which the Common Area shall be operated, managed and maintained and the expenditures for such operation, management and maintenance shall be at the sole discretion of Landlord. The cost of such maintenance, operation and management of the Common Area, including, but not limited to landscaping, repair of paving, parking lots and sidewalks, repaving, resurfacing, repairs, replacements, painting, lighting, cleaning, trash removal, roof replacement and repair, heating, ventilating and air-conditioning repair and replacement, fire protection and similar items; non-refundable contributions toward one or more reserves for replacements other than equipment; rental on equipment; security and exterminator services and salaries and employee benefits (including union benefits) of on-site and accounting personnel engaged in such maintenance and operations management, shall be a common area change and Tenant shall pay to Landlord its percentage share of such costs as provided in paragraph 16.

16.  COMMON AREA CHARGES

                Tenant shall pay to Landlord, as additional rent, an amount equal to One Hundred percent (100.00%) of the total common area charges as defined below. Tenant’s percentage share of common area charges shall be paid as follows.

                Tenant’s estimated monthly payment of common area charges payable by Tenant during the calendar year in which the term commences is set forth in paragraph 4(b) of this lease. Prior to the commencement of each succeeding calendar year of the term (or as soon as practicable thereafter, Landlord shall deliver to Tenant a written estimate of Tenant’s monthly payment of common area charges. Tenant shall pay, as additional rent, on the first day of each month during the term in accordance with paragraph 4(b) of the lease, its monthly share of common area charges as estimated by Landlord. Within one hundred twenty (120) days of the end of each calendar year and of the termination of this lease (or as soon as practicable thereafter), Landlord shall deliver to Tenant a statement of actual common area charges incurred for the preceding year. If such statement shows that Tenant has paid for less than its actual percentage, then Tenant shall on demand pay to Landlord the amount of such deficiency. If Tenant fails to pay such deficiency due within ten (10) days after demand, Tenant shall pay an additional ten percent (10%) of the amount due as a penalty. If such statement shows that Tenant has paid more than its actual percentage share then Landlord shall, at its option, promptly refund such excess to Tenant or credit the amount thereof to the common area charge next becoming due from Tenant. Landlord reserves the right to revise any estimate of common area charges if actual or projected common area charges show an increase or decrease in excess of 10% from any earlier estimate for the same period. In such event, Landlord shall deliver the revised estimate to Tenant, together with an explanation of the reasons therefore, and Tenant shall revise its payments accordingly. Landlord’s and Tenant’s obligation with respect to adjustments at the end of the term or earlier expiration of this lease shall survive such termination or expiration.

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                “Common area charges,” as used in this lease, shall include, but not be limited to, (i) all items identified in paragraphs 8, 9, 11, 12, 13 and 16 as being common area charges; (ii) amortization of such capital improvements having a useful life greater than one year as Landlord may have installed for the purpose of reducing operating costs and/or to comply with governmental rules and regulations promulgated after completion of the building (Tenant’s share of any such capital improvement shall equal Tenant’s proportionate share of the fraction of the cost of such capital improvement equal to the remaining term of the lease over the useful life of such capital improvement); (iii) salaries and employee benefits (including union benefits) of personnel engaged in the operation and maintenance of the Project (or the building in which the Premises are located) and payroll taxes applicable thereto; (iv) supplies, materials, equipment and tools used or required in connection with the operation and maintenance of the Project; (v) licenses, permits and inspection fees; (vi) a reasonable reserve for repairs and replacement of equipment used in the maintenance and operation of the Project; (vii) all other operating costs incurred by Landlord in maintaining and operating the Project; and (viii) an amount equal to five percent (5%) of the actual expenditures for the aggregate of all other common area charges as compensation for Landlord’s accounting and processing services.

        17.  DAMAGE BY FIRE; CASUALTY

                In the event the Premises are damaged by any casualty which is fully covered under an insurance policy required to be maintained by Landlord pursuant to paragraph 11, Landlord shall be entitled to the use of all insurance proceeds and shall repair such damage as soon as reasonably possible and this lease shall continue in full force and effect.

                In the event the Premises are damaged by any casualty not fully covered under an insurance policy required to be maintained pursuant to paragraph 11, Landlord may, at Landlord’s option, either (i) repair such damage, at Landlord’s expense, as soon as reasonably possible, in which event this lease shall continue in full force and effect, or (ii) give written notice to Tenant within thirty (30) days after the date of the occurrence of such damages of Landlord’s intention to cancel and terminate this lease as of the date of the occurrence of the damages; provided, however, that if such damage is caused by an act or omission of Tenant or its agent, servants or employees, then Tenant shall repair such damage promptly at its sole cost and expense. In the event Landlord elects to terminate this lease pursuant hereto, Tenant shall have the right within ten (10) days after receipt of the required notice to notify Landlord in writing of Tenant’s intention to repair such damage at Tenant’s expense, without reimbursement from Landlord, in which event this lease shall continue in full force and effect and Tenant shall proceed to make such repairs as soon as reasonably possible. If Tenant does not give such notice within the ten (10) day period, this lease shall be canceled and terminated as of the date of the occurrence of such damage. Under no circumstances shall Landlord be required to repair any injury or damage to (by fire or other cause), or to make any restoration or replacement of, any of Tenant’s personal property, trade fixtures or property leased from third parties, whether or not the same is attached to the Premises.

                If the Premises are totally destroyed during the term from any cause (including any destruction required by any authorized public authority), whether or not covered by the insurance required under paragraph 11, this lease shall automatically terminate as of the date of such total destruction; provided, however, that if the Premises can reasonably and lawfully be repaired or restored within twelve (12) months of the date of destruction to substantially the condition existing prior to such destruction and if the proceeds of the insurance payable to the Landlord by reason of such destruction are sufficient to pay the cost of such repair or restoration, then the insurance proceeds shall be so applied, Landlord shall promptly repair and restore the Premises and this lease shall continue, without interruption, in full force and effect. If the Premises are totally destroyed during the last twelve (12) months of the term, either Landlord or Tenant may at either parties’ option cancel and terminate this lease as of the date of occurrence of such damage by giving written notice to the other of its’ election to do so within thirty (30) days after the occurrence of such damage.

                If the Premises are partially or totally destroyed or damaged and Landlord or Tenant repair them pursuant to this lease, the rent payable hereunder for the period during which such damage and repair continues shall be abated only in proportion to the square footage of the Premises rendered untenantable to Tenant by such damage or destruction. Tenant shall have no claim against Landlord for any damage, loss or expense suffered by reason of any such damage, destruction, repair or restoration or Landlord’s election under this paragraph 17 not to repair or restore such damage or destruction. The parties waive the provisions of California Civil Code sections 1932(2) and 1933(4) (which provisions permit the termination of a lease upon destruction of the leased premises), and hereby agree that the provisions of this paragraph 17 shall govern in the event of such destruction.

        18.  INDEMNIFICATION

                Landlord shall not be liable to Tenant and Tenant hereby waives all claims against Landlord for any injury to or death of any person or damage to or destruction of property in or about the Premises or the Project (including but not limited to damage to person or property caused by water leakage of any character from the roof, walls, ceiling, basement or other portions of the Project or caused by gas, fire, oil, fumes, electricity, steam or land or structural movement) by or from any cause whatsoever except the material failure of Landlord to perform its obligations under this lease where such failure has persisted for an unreasonable period of time after written notice of such failure.

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Without limiting the foregoing, Landlord shall not be liable to Tenant for any injury to or death of any person or damages to or destruction of property by reason of, or arising from, any latent defect in the Premises or Project or the act or negligence of any other tenant of the Project. Tenant shall immediately notify Landlord of any defect in the Premises or Project.

                Except as to injury to persons or damage to property the principal cause of which is the material failure by Landlord to observe any of the terms and conditions of this lease where such failure has persisted for an unreasonable period of time after written notice of such failure, Tenant shall hold Landlord harmless from and defend Landlord against any claim, liability, loss, damage or expense (including attorney fees) arising out of any injury to or death of any person or damage to or destruction of property occurring in, on or about the Premises from any cause whatsoever or on account of the use, condition, occupational safety or occupancy of the Premises. Tenant shall further hold Landlord harmless from and defend Landlord against any claim, liability, loss, damage or expense (including reasonable attorney fees) arising (i) from Tenant’s use of the Premises or from the conduct of its business or from any activity or work done, permitted or suffered by Tenant or its agents or employees in or about the Premises or Project, (ii) out of the failure of Tenant to observe or comply with Tenant’s obligation to observe and comply with laws or other requirements as set forth in paragraph 7, (iii) by reason of Tenant’s use, handling, storage, or disposal of toxic or hazardous materials or waste, (iv) by reason of any labor or service performed for, or materials used by or furnished to, Tenant or any contractor engaged by Tenant with respect to the Premises, or (v) from any other act, neglect, fault or omission of Tenant or its agents, employees or invitees. The provisions of this paragraph 18 shall survive the expiration or earlier termination of this lease.

        19.  ASSIGNMENT AND SUBLETTING

                Tenant shall not voluntarily assign, encumber or otherwise transfer its interest in this lease or in the Premises, or sublease all of any part of the Premises, or allow any other person, concessionaire or entity to occupy or use all or any part of the Premises, without first obtaining Landlord’s written consent (which consent shall not be unreasonably withheld) and otherwise complying with the requirements of this paragraph 19. Any assignment, encumbrance or sublease without Landlord’s consent, shall constitute a default.

                If Tenant desires to sublet or assign all or any portion of the Premises, Tenant shall give Landlord written notice thereof, specifying the projected commencement date of the proposed sublet or assignment (which date shall be not less than thirty (30) days or more than ninety (90) days after the date of such notice), the portions of the Premises proposed to be sublet or assigned, and the identity of the proposed assignee or subtenant. Tenant shall further provide Landlord with such other information concerning the proposed assignee or subtenant as requested by Landlord. Any proposed assignee or sublessee must agree to assume and agree to perform all the covenants and conditions of Tenant under this lease. In the case of any proposed assignment, or in the case of a proposed sublet of fifty percent (50%) or more of the Premises at a time when Tenant has not occupied the Premises, or if the proposed sublet is for fifty percent (50%) or more of the Premises for a sublet term ending within the last twelve (12) months of the term of this lease, Landlord shall have the right, exercisable by written notice to be delivered to Tenant within thirty (30) days of receipt of Tenant’s notice, to terminate this lease effective as of the date specified in Tenant’s notice as the proposed commencement date of the assignment or sublease. If Landlord does not elect to terminate this lease and if Landlord consents in writing to the proposed assignment or sublet (regardless of whether Landlord had a termination right), Tenant shall be free to assign or sublet all or a portion of the Premises subject to the following conditions: (i) any sublease shall be on the same terms set forth in the notice given to Landlord; (ii) no sublease shall be valid and no subtenant shall take possession of the sublet premises until an executed counterpart of such sublease has been delivered to Landlord; (iii) no subtenant shall have a further right to sublet; (iv) any sums or other economic consideration received by Tenant as a result of such assignment or sublet (except rental or other payments received which are attributable to the amortization over the term of this lease of the cost of leasehold improvements constructed for such assignees or subtenant, and brokerage fees) whether denominated rentals or otherwise, which exceed, in the aggregate, the total sums which Tenant is obligated to pay Landlord under this lease (prorated to reflect obligations allocable to that portion of the Premises subject to such sublease), shall be shared equally between Landlord and Tenant (50%/50%); and (v) no sublet or assignment shall release Tenant  of Tenant’s obligation or alter the primary liability of Tenant to pay the rent and to perform all other obligations to be performed by Tenant hereunder. Tenant shall pay to Landlord promptly upon demand as additional rent, Landlord’s actual attorneys’ fees and other costs incurred for reviewing, processing or documenting any requested assignment or sublease, whether or not Landlord’s consent is granted.

                If Tenant is a partnership, a withdrawal or change, voluntary or involuntary or by operation of law, of any general partner or the dissolution of the partnership shall be deemed an assignment of this lease subject to all conditions of this paragraph 19. If Tenant is a corporation any dissolution, merger, consolidation or other reorganization of Tenant or the sale or other transfer of a controlling percentage of the capital stock of Tenant or the sale of more than fifty percent (50%) of the value of Tenant’s assets shall be an assignment of this lease subject to all the conditions of this paragraph 19. The term “controlling percentage” means the ownership of, and the right to vote, stock possessing more than 50% of the total combined voting power of all classes of Tenant’s capital stock issued, outstanding and entitled to vote. This paragraph shall not apply if Tenant is a corporation the

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stock of which is traded through an exchange.

                The acceptance of rent by Landlord from any other person shall not be deemed to be a waiver by Landlord of any provision hereof. Consent to one assignment or sublet shall not be deemed consent to any subsequent assignment or sublet. In the event of default by any assignee of Tenant or any successor of Tenant in the performance of any of the terms hereof, Landlord may proceed directly against Tenant without the necessity of exhausting remedies against such assignee or successor. Landlord may consent to subsequent assignments or sublets of this lease or amendments or modifications to this lease with assignees of Tenant, without notifying Tenant, or any successor of Tenant, and without obtaining its or their consent thereto and such action shall not relieve Tenant of liability under this lease.

                No interest of Tenant in this lease shall be assignable by operation of law (including, without limitation, the transfer of this lease by testacy or intestacy). Each of the following acts shall be considered an involuntary assignment: (i) if Tenant is or becomes bankrupt or insolvent, makes an assignment for the benefit of creditors or institutes a proceeding under the Bankruptcy Act in which Tenant is the bankrupt; or, if Tenant is a partnership or consists of more than one person or entity, if any partner of the partnership or other person or entity is or becomes bankrupt or insolvent, or makes an assignment for the benefit of creditors; (ii) if a writ of attachment or execution is levied on this lease; or (iii) if, in any proceeding or action in which Tenant is a party, a receiver is appointed with authority to take possession of the Premises. An involuntary assignment shall constitute a default by Tenant and Landlord shall have the right to elect to terminate this lease, in which case this lease shall not be treated as an asset of Tenant.

                Tenant immediately and irrevocably assigns to Landlord, as security for Tenant’s obligations under this lease, all rent from any subletting of all or a part of the Premises as permitted by this lease, and Landlord, as assignee and as attorney-in-fact for Tenant, or a receiver of Tenant appointed on Landlord’s application, may collect such rent and apply it toward Tenant’s obligations under this lease; except that, until the occurrence of an act or default by Tenant, Tenant shall have the right to collect such rent, subject to promptly forwarding to Landlord any portion thereof to which Landlord is entitled pursuant to this paragraph 19.

                Notwithstanding the above requirement that Tenant obtain the consent of Landlord prior to any assignment or sublet, Tenant may, without obtaining the prior consent of Landlord, assign or sublease the whole or any part of the Premises to any corporation or other entity which is wholly owned by Tenant or of which Tenant is a wholly owned subsidiary, or which is wholly owned by either of the foregoing or which merges with Tenant provided that (i) Tenant shall give written notice thereof to Landlord in the manner required for other assignments or subleases by this paragraph 19; (ii) Tenant shall continue to be fully obligated under this lease; (iii) any such assignee or sublessee shall expressly assume and agree to perform all of the terms and conditions of this lease to be performed by Tenant; and (iv) any such assignment of sublet shall be subject to all other terms and conditions of this paragraph 19 pertaining to assignments and/or sublets (excepting only the requirement concerning prior written consent of Landlord).

20.  DEFAULT

                The occurrence of any of the following shall constitute a default by Tenant: (i) failure of Tenant to pay any rent or other sum payable hereunder within five (5) days of when due; (ii) abandonment of the Premises (Tenant’s failure to occupy and conduct business in the Premises for fourteen (14) consecutive days shall be deemed an abandonment); or (iii) failure of Tenant to perform any other term, covenant or condition of this lease if the failure to perform is not cured within thirty (30) days after notice thereof has been given to Tenant (provided that if such default cannot reasonably be cured within thirty (30) days, Tenant shall not be in default if Tenant commences to cure such failure to perform within the thirty (30) days, period and diligently and in good faith continues to cure the failure to perform).  The notice referred to in clause (iii) above shall specify the failure to perform and the applicable lease provision and shall demand that Tenant perform the provisions of this lease within the applicable period of time. No notice shall be deemed a forfeiture or termination of this lease unless Landlord so elects in the notice. No notice shall be required in the event of abandonment or vacation of the Premises.

                In addition to the above, the occurrence of any of the following events shall also constitute a default by Tenant: (i) Tenant fails to pay its debts as they become due or admits in writing its inability to pay its debts, or makes a general assignment for the benefit of creditors (for purposes of determining whether Tenant is not paying its debts as they become due, a debt shall be deemed overdue upon the earliest to occur of the following: thirty (30) days from the date a statement therefor has been rendered; the date on which any action or proceeding therefor is commenced; or the date on which a formal notice of default or demand has been sent); (ii) Tenant fails to furnish Landlord a schedule of Tenant’s aged accounts payable within ten (10) days after Landlord’s written request, (iii) any financial statements given to Landlord by Tenant, any assignee of Tenant, subtenant of Tenant, any guarantor of Tenant, or successor in interest of Tenant (including, without limitation, any schedule of Tenant’s aged accounts payable) are materially false. At any time during the term of this lease Landlord, at Landlord’s option, shall have the right to receive from Tenant upon Landlord’s request, a current annual balance sheet for Landlord’s review. If the balance sheet shows a negative net worth,

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Landlord may terminate this lease by giving Tenant sixty (60) days prior notice.

                In the event of a default by Tenant, then Landlord, in addition to any other rights and remedies of Landlord at law or in equity, shall have the right either to terminate Tenant’s right to possession of the Premises (and thereby terminate this lease) or, from time to time and without termination of this lease, to relet the premises or any part thereof for the account and in the name of Tenant for such term and on such terms and conditions as Landlord in its sole discretion may deem advisable, with the right to make alterations and repairs to the Premises.

                Should Landlord elect to keep this lease in full force and effect, Landlord shall have the right to enforce all of Landlord’s rights and remedies under this lease, including but not limited to the right to recover and to relet the Premises. If Landlord relets the Premises, then Tenant shall pay to Landlord, as soon as ascertained, the costs and expenses incurred by Landlord in such reletting and in making alterations and repairs. Rentals received by Landlord from such reletting shall be applied (i) to the payment of any indebtedness due hereunder, other than basic rent and common area charges, from Tenant to Landlord; (ii) to the payment of the cost of any repairs necessary to return the Premises to good condition normal wear and tear excepted, including the cost of alterations and the cost of storing any of Tenant’s property left on the Premises at the time of reletting; and (iii) to the payment of basic rent or common area charges due and unpaid hereunder. The residue, if any, shall be held by Landlord and applied in payment of future rent or damages in the event of termination as the same may become due and payable hereunder and the balance, if any at the end of the term of this lease, shall be paid to Tenant. Should the basic rent and common area charges received from time to time from such reletting during any month be less than that agreed to be paid during that month by Tenant hereunder, Tenant shall pay such deficiency to Landlord. Such deficiency shall be calculated and paid monthly. No such reletting of the Premises by Landlord shall be construed as an election on its part to terminate this lease unless a notice of such intention is given to Tenant or unless the termination hereof is decreed by a court of competent jurisdiction. Notwithstanding any such reletting without termination, Landlord may at any time thereafter elect to terminate this lease for such previous breach, provided it has not been cured. Landlord shall have the remedy described in California Civil Code section 1951.4 (Landlord may continue the lease in effect after Tenant’s breach and abandonment and recover as rent as it becomes due, if Tenant has the right to sublet or assign, subject only to reasonable limitations).

                Should Landlord at any time terminate this lease for any breach, in addition to any other remedy it may have, it shall have the immediate right of entry and may remove all persons and property from the Premises and shall have all the rights and remedies of a landlord provided by California Civil Code Section 1951.2 or any successor code section. Upon such termination, in addition to all its other rights and remedies, Landlord shall be entitled to recover from Tenant all damages it may incur by reason of such breach, including the cost of recovering the Premises and including (i) the worth at the time of award of the unpaid rent which had been earned by the time of termination; (ii) the worth at the time of award of the amount by which the unpaid rent which would have been earned after termination until the time of award exceeds the amount of such rental loss that Tenant proves could have been reasonably avoided; (iii) the worth at the time of the award of the amount by which the unpaid rent for the balance of the term after the time of award exceeds the amount of such rental loss that Tenant proves could be reasonably avoided; and (iv) any other amount necessary to compensate Landlord for all the detriment proximately caused by Tenant’s failure to perform its obligations under this lease or which in the ordinary course of events would be likely to result therefrom. The “worth at the time of award of the amounts referred to in (i) and (ii) above is computed by allowing interest at the rate of twelve percent (12%) per annum or the maximum rate permitted by law, whichever is less. The “worth at the time of award of the amount referred to in (iii) above shall be computed by discounting such amount at the discount rate of the federal reserve bank of San Francisco at the time of award plus one percent (1%). Property removed from the Premises may be stored in a public or private warehouse or elsewhere at the sole cost and expense of Tenant. In the event that Tenant shall not immediately pay the cost of storage of such property after the same has been stored for a period of thirty (30) days or more, Landlord may sell any or all thereof at a public or private sale in such manner and at such times and places that Landlord, in its sole discretion, may deem proper, without notice to or demand upon Tenant.

        21.  LANDLORD’S RIGHT TO CURE TENANT’S DEFAULT

                Landlord, at any time after Tenant commits a default, may, but shall not be obligated to, cure the default at Tenant’s cost. If Landlord at any time, by reason of Tenant’s default, pays any sum or does any act that requires the payment of any sum, the sum paid by Landlord shall be due immediately from Tenant to Landlord and shall bear interest at the rate of twelve percent (12%) per annum or the maximum rate permitted by law, whichever is less, from the date the sum is paid by Landlord until Landlord is reimbursed by Tenant. Amounts due Landlord hereunder shall be additional rent.

        22.  EMINENT DOMAIN

                If all or any part of the Premises shall be taken by any public or quasi-public authority under the power of eminent domain or conveyance in lieu thereof, this lease shall terminate as to any portion of the Premises so taken or conveyed on the date when title vests in the condemner, and Landlord shall be entitled to any and all payments, income, rent, award or any interest therein whatsoever which may be paid or made in connection with such taking or conveyance Tenant shall

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have no claim against Landlord or otherwise for the value of any unexpired term of this lease. Notwithstanding the foregoing, Tenant shall be entitled to any compensation for depreciation to and cost of removal of Tenant’s equipment and fixtures and any compensation for its relocation expenses necessitated by such taking, but in each case only to the extent the condemning authority makes a separate award therefor or specifically identifies a portion of the award as being therefor. Each party waives the provisions of Section 1265.130 of the California Code of Civil Procedure (which section allows either party to petition the Superior Court to terminate this lease in the event of a partial taking of the Premises).

                If any action or proceeding is commenced for such taking of the Premises or any portion thereof or of any other space in the Project, or if Landlord is advised in writing by any entity or body having the right or power of condemnation of its intention to condemn the Premises or any portion thereof or of any other space in the Project, and Landlord shall decide to discontinue the use and operation of the Project or decide to demolish, alter or rebuild the Project, then Landlord shall have the right to terminate this lease by giving Tenant written notice thereof within sixty (60) days of the earlier of the date of Landlord’s receipt of such notice of intention to condemn or the commencement of said action or proceeding. Such termination shall be effective as of the last day of the calendar month next following the month in which such notice is given or the date on which title shall vest in the condemnor, whichever occurs first. In the event of a partial taking, or conveyance in lieu thereof, of the Premises and fifty percent (50%) or more of the number of square feet in the Premises are taken then Tenant may terminate this lease. Any election by Tenant to so terminate shall be by written notice given to Landlord within sixty (60) days from the date of such taking or conveyance and shall be effective on the last day of the calendar month next following the month in which such notice is given or the date on which title shall vest in the condemnor, whichever occurs first.

                If a portion of the Premises is taken by power of eminent domain or conveyance in lieu thereof and neither Landlord nor Tenant terminates this lease as provided above, then this lease shall continue in full force and effect as to the part of the Premises not so taken or conveyed and all payments of rent shall be apportioned as of the date of such taking or conveyance so that thereafter the amounts to be paid by Tenant shall be in the ratio that the area of the portion of the Premises not so taken bears to the total area of the Premises prior to such taking.

        23.  NOTICE AND COVENANT TO SURRENDER

                On the last day of the term or on the effective date of any earlier termination, Tenant shall surrender to Landlord the Premises and all of Tenant’s improvements and alterations in their condition existing as of the commencement of the term (normal wear and tear excepted), with all originally painted interior walls washed or repainted if marked or damaged, interior vinyl covered walls cleaned and repaired or replaced if marked or damaged, all carpets shampooed and cleaned, the air conditioning and heating system serviced and repaired by a reputable and licensed service firm (unless Landlord has elected to maintain such system pursuant to paragraph 8; and all floors cleaned and waxed; all to the reasonable satisfaction of Landlord, Tenant shall remove all of Tenant’s personal property and trade fixtures, together with improvements or alterations that Tenant is obligated to remove pursuant to the provisions of  paragraph 8, from the Premises, and all such property not removed shall be deemed abandoned.

                If the Premises are not surrendered as required in this paragraph, Tenant shall indemnify Landlord against all loss, liability and expense (including but not limited to, attorney fees) resulting from the failure by Tenant in so surrendering the Premises, including, without limitation, any claims made by any succeeding tenants. It is agreed between Landlord and Tenant that the provisions of this paragraph shall survive termination of this lease.

        24.  TENANT’S QUITCLAIM

                At the expiration or earlier termination of this lease, Tenant shall execute, acknowledge and deliver to Landlord, within ten (10) days after written demand from Landlord to Tenant, any quitclaim deed or other document required to remove the cloud or encumbrance created by this lease from the real property of which the Premises are a part. This obligation shall survive said expiration or termination.

        25.  HOLDING OVER

                Any holding over after the expiration or termination of this lease with the written consent of Landlord shall be construed to be a tenancy from month to month at double the monthly rent as adjusted, in effect on the date of such expiration or termination. All provisions of this lease, except those pertaining to the term and any option to extend, shall apply to the month to month tenancy. The provisions of this paragraph are in addition to, and do not affect, Landlord’s right of reentry or other rights hereunder or provided by law.

                If Tenant shall retain possession of the Premises or any part thereof without Landlord’s consent following the expiration or sooner termination of this lease for any reason, then Tenant shall pay to Landlord for each day of such retention double the amount of the daily rental an effect during the last month prior to the date of such expiration or termination. Tenant shall also indemnify and hold

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Landlord harmless from any loss, liability and expense (including, but not limited to, attorneys fees) resulting from delay by Tenant in surrendering the Premises, including without limitation any claims made by any succeeding tenant founded on such delay. Acceptance of rent by Landlord following expiration or termination shall not constitute a renewal of this lease, and nothing contained in this paragraph shall waive Landlord’s right to re entry or any other right. Tenant shall be only a Tenant at sufferance, whether or not Landlord accepts any rent from Tenant, while Tenant is holding over without Landlord’s written consent.

        26.  SUBORDINATION

                In the event Landlord’s title or leasehold interest is now or hereafter encumbered in order to secure a loan to Landlord, Tenant shall, at the request of Landlord or the lender, execute in writing an agreement subordinating its rights under this lease to the lien of such encumbrance, or, if so requested, agreeing that the lien of lender’s encumbrance shall be or remain subject and subordinate to the rights of Tenant under this lease. Tenant hereby irrevocably appoints Landlord the attorney-in-fact of Tenant to execute, deliver and record any such instrument or instruments for and in the name and on behalf of Tenant. Notwithstanding any such subordination, Tenant’s possession under this lease shall not be disturbed if Tenant is not in default and so long as Tenant shall pay all amounts due hereunder and otherwise observe and perform all provisions of this lease. In addition, if in connection with any such loan the lender shall request reasonable modifications of this lease as a condition to such financing, Tenant will not unreasonably withhold, delay or defer its consent thereof, provided that such modifications do not increase the obligations of Tenant hereunder or materially adversely affect the leasehold interest hereby created or Tenant’s rights hereunder.

                Within ten (10) days after written request from Landlord, Tenant shall deliver to Landlord such financial statements as are reasonably required by Landlord or Landlord’s lender to verify the net worth of Tenant. In addition, Tenant shall deliver to Landlord’s lender any financial statements required by such holder to facilitate the financing or refinancing of Landlord’s interest in the Project. Tenant represents and warrants to Landlord that each such financial statement is a true and accurate statement as of the date of such statement. All financial statements shall be confidential and shall be used only for the purposes set forth herein.

        27.  CERTIFICATE OF ESTOPPEL

                Each party shall, within five (5) calendar days after request therefor, execute and deliver to the other party, in recordable form, a certificate stating that the lease is unmodified and in full force and effect, or in full force and effect as modified and stating the modifications. The certificate shall also state the amount of the monthly rent, the date to which monthly rent has been paid in advance, the amount of the security deposit and/or prepaid monthly rent, and, if the request is made by Landlord, shall include such other items as Landlord or Landlord’s lender may reasonably request. Failure to deliver such certificate within such time shall constitute a conclusive acknowledgment by the party failing to deliver the certificate that the lease is in full force and effect and has not been modified except as may be represented by the party requesting the Certificate. Any such Certificate requested by Landlord may be conclusively relied upon by any prospective purchaser or encumbrance of the Premises or Project. Further, within five (5) calendar days following written request made from time to time by Landlord, Tenant shall furnish to Landlord current financial statements of Tenant.

        28.  SALE BY LANDLORD

                In the event the original Landlord hereunder, or any successor owner of the Project or Premises, shall sell or convey the Project or Premises, all liabilities and obligations on the part of the original Landlord, or such successor owner, under this lease accruing thereafter shall terminate, and thereupon all such liabilities and obligations shall be binding upon the new owner. Tenant agrees to attorn to such new owner and to look solely to such new owner for performance of any and all such liabilities and obligations.

        29.  ATTORNMENT TO LENDER OR THIRD PARTY

                In the event the interest of Landlord in the land and buildings in which the Premises are located (whether such interest of Landlord is a fee title interest or a leasehold interest) is encumbered by deed of trust, and such interest is acquired by a lender or any other third party through judicial foreclosure or by exercise of a power of sale at private trustee’s foreclosure sale, Tenant hereby agrees to release Landlord of any obligation arising on or after any such foreclosure sale and to attorn to the purchaser at any such foreclosure sale and to recognize such purchaser as the Landlord under this lease.

        30.  DEFAULT BY LANDLORD

                Landlord shall not be in default unless Landlord fails to perform obligations required of Landlord within a reasonable time but in no event earlier than thirty (30) days after written notice by Tenant to Landlord and to the holder of any first mortgage or deed of trust covering the Premises specifying wherein Landlord has failed to perform such obligations, provided, however, that if the nature of Landlord’s obligations is such that more than thirty (30) days are required by performance, then Landlord shall not be in default if Landlord commences performance within such thirty (30) day

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period and thereafter diligently prosecutes the same to completion.

                If Landlord is in default of this lease, Tenant’s sole remedy shall be to institute suit against Landlord in a court of competent jurisdiction, and Tenant shall have no right to offset any sums expended by Tenant as a result of Landlord’s default against future rent and other sums due and payable pursuant to this lease. If Landlord is in default of this lease, and as a consequence Tenant recovers a money judgment against Landlord, the judgment shall be satisfied only out of the proceeds of sale received on execution of the judgment and levy against the right, title and interest of Landlord in the Project of which the Premises are a part, and out of rent or other income from such real property receivable by Landlord or out of the consideration received by Landlord from the sale or other disposition of all or any part of Landlord’s right, title and interest in the Project of which the Premises are a part. Neither Landlord nor any of the partners comprising the partnership designated as Landlord shall be personally liable for any deficiency.

        31.  CONSTRUCTION CHANGES

                It is understood that the description of the Premises and the location of ductwork, plumbing and other facilities therein are subject to such changes as Landlord or Landlord’s architect determines to be desirable in the course of construction of the Premises and/or the improvements constructed or being constructed therein and no such changes or any changes in plans for any other portions of the Project, shall affect this lease or entitle Tenant to any reduction of rent hereunder or result in any liability of Landlord to Tenant.

        32.  MEASUREMENT OF PREMISES

                Tenant understands and agrees that any reference to square footage of the Premises is approximate only and includes all interior partitions, columns and exterior walls, and one-half of the partitions separating the Premises from the rest of the Project, Tenant’s proportionate share of the Common Area and, if applicable, covered areas immediately outside the entry doors or loading docks. Tenant waives any claim against Landlord regarding the accuracy of any such measurement and agrees that there shall not be any adjustment in basic rent or common area charges or other amounts payable hereunder by reason of inaccuracies in such measurement.

        33.  ATTORNEY FEES

                If either party commences an action against the other party arising out of or in connection with this lease, the prevailing party shall be entitled to have and recover from the losing party all expenses of litigation, including, without limitation, travel expenses, reasonable attorney fees, expert witness fees, trial and appellate court costs, and deposition and transcript expenses. If either party becomes a party to any litigation concerning this lease, or concerning the Premises of the Project, by reason of any act or omission of the other party or its authorized representatives, the party that causes the other party to become involved in the litigation shall be liable to the other party for all expenses of litigation reasonably incurred, including, without limitation, travel expenses, attorney fees, expert witness fees, trial and appellate court costs, and deposition and transcript expenses.

        34.  SURRENDER

                The voluntary or other surrender of this lease or the Premises by Tenant, or a mutual cancellation of this lease, shall not work a merger, and at the option of Landlord shall either terminate all or any existing subleases or subtenancies or operate as an assignment to Landlord of all or any such subleases or subtenancies.

        35.  WAIVER

                No delay or omission in the exercise of any right or remedy of either party on any default by the other party shall impair such right or remedy or be construed as a waiver. The receipt and acceptance by Landlord of delinquent rent or other payments shall not constitute a waiver of any other default and acceptance of partial payments shall not be construed as a waiver of the balance of such payment due. No act or conduct of Landlord, including, without limitation, the acceptance of keys to the Premises, shall constitute an acceptance of the surrender of the Premises by Tenant before the expiration of the term. Only a written notice from Landlord to Tenant shall constitute acceptance of the surrender of the Premises and accomplish a termination of this lease. Landlord’s consent to or approval of any act by Tenant requiring Landlord’s consent or approval shall not be deemed to waive or render unnecessary Landlord’s consent to or approval of any subsequent act by Tenant. Any waiver by Landlord of any default must be in writing and shall not be a waiver of any other default concerning the same or any other provision of this lease.

        36.  EASEMENTS; AIRSPACE RIGHTS

                Landlord reserves the right to alter the boundaries of the Project and grant easements and dedicate for public use portions of the Project without Tenant’s consent, provided that no such grant or dedication shall interfere with Tenant’s use of the Premises or otherwise cause Tenant to incur cost or expense. From time to time, and upon Landlord’s demand, Tenant shall execute, acknowledge and

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deliver to Landlord, in accordance with Landlord’s instructions, any and all documents, instruments, maps or plats necessary to effectuate Tenant’s covenants hereunder.

                This lease confers no rights either with regard to the subsurface of or airspace above the land on which the Project is located or with regard to airspace above the building of which the Premises are a part. Tenant agrees that no diminution or shutting off of light or view by a structure which is or may be erected (whether or not by Landlord) on property adjacent to the building of which the Premises are a part or to property adjacent thereto, shall in any way affect this lease, or entitle Tenant to any reduction of rent, or result in any liability of Landlord to Tenant.

        37.  RULES AND REGULATIONS

                Landlord shall have the right from time to time to promulgate reasonable rules and regulations for the safety, care and cleanliness of the Premises, the Project and the Common Area, or for the preservation of good order. On delivery of a copy of such rules and regulations to Tenant, Tenant shall comply with the rules and regulations, and a violation of any of them shall constitute a default by Tenant under this lease. If there is a conflict between the rules and regulations and any of the provisions of this lease, the provisions of this lease shall prevail. Such rules and regulations may be amended by Landlord from time to time with or without advance notice. No such rules and regulations shall require Tenant to pay additional rent under this lease.

        38.  NOTICES

                All notices, demands, requests, consents and other communications which may be given or are required to be given by either party to the other shall be in writing and shall be sufficiently made and delivered if personally served or if sent by United States first class mail, postage prepaid. All such communications from Landlord to Tenant shall be addressed to Tenant at the Premises. All such communications by Tenant to Landlord shall be sent to Landlord at its offices at 360 S. San Antonio Road, Suite 14, Los Altos, California 94022. Either party may change its address by notifying the other of such change. Each such communication shall be deemed received on the date of the personal service or mailing thereof in the manner herein provided, as the case may be.

        39.  NAME

                Tenant shall not use the name of the Project for any purpose, other than as the address of the business conducted by Tenant in the Premises, without the prior written consent of Landlord.

        40.  GOVERNING LAW; SEVERABILITY

                This lease shall in all respects be governed by and construed in accordance with the laws of the State of California. If any provision of this lease shall be held or rendered invalid, unenforceable or ineffective for any reason whatsoever, all other provisions hereof shall be and remain in full force and effect.

        41.  DEFINITIONS

                As used in this lease, the following words and phrases shall have the following meanings:

Additional Rent any amount described in paragraph 53, below.

Authorized representatives any of officer, agent, employee or independent contractor retained or employed by either party, acting within authority given him by that party.

Encumbrance: any deed of trust, mortgage or other written security device or agreement affecting the Premises or the Project that constitutes security for the payment of a debt or performance of an obligation, and the note or obligation secured by such deed of trust, mortgage or other written security device or agreement.

Lease month: the period of time determined by reference to the day of the month in which the term commences and continuing to one day short of the same numbered day of the next succeeding month; e.g., the tenth day of one month to and including the ninth day in the next succeeding month.

Lender:  the beneficiary, mortgagee or other holder of an encumbrance, as defined above.

Lien: a charge imposed on the Premises by someone other than Landlord, by which the Premises are made security for the performance of an act. Most of the liens referred to in this lease are mechanic’s liens.

Maintenance: repairs, replacement, repainting and cleaning

Monthly Rent:  the sum of the monthly payments of basic rent and common area charges.

Person: one or more human beings, or legal entities or other artificial persons, including,

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without limitation, partnerships, corporations, trusts, estates, associations and any combination of human being and legal entities.

Provision: any term, agreement, covenant, condition, clause, qualification, restriction, reservation or other stipulation in the lease that defines or otherwise controls, establishes or limits the performance required or permitted by either party

Punchlist items: minor repairs to painting, carpets, walls and other interior improvements as described in paragraph 9, above.

Rent:  basic rent, common area charges, additional rent, and all other amounts payable by Tenant to Landlord required by this lease or arising by subsequent actions of the parties made pursuant to this lease.

                Words used in any gender include other genders. If there be more than one Tenant, the obligations of Tenant hereunder are joint and several. All provisions whether covenants or conditions, on the part of Tenant shall be deemed to be both covenants and conditions. The paragraph headings are for convenience of reference only and shall have no effect upon the construction or interpretation of any provision hereof.

        42.  TIME

                Time is of the essence of this lease and of each and all of its provisions.

        43.  EXAMINATION OF LEASE

                Submission of this lease for examination or signature by Tenant does not constitute a reservation or option for a lease, and this lease is not effective until its execution and delivery by both Landlord and Tenant.

        44.  INTEREST ON PAST DUE OBLIGATIONS; LATE CHARGE

                Any amount due from Tenant to Landlord hereunder which is not paid within thirty (30) days of the date due shall bear interest at the rate of ten percent (10%) per annum from when due until paid, unless otherwise specifically provided herein, but the payment of such interest shall not excuse or cure any default by Tenant under this lease. In addition, Tenant acknowledges that late payment by Tenant to Landlord of basic rent or common area charges or of any other amount due Landlord from Tenant, will cause Landlord to incur costs not contemplated by this lease, the exact amount of such costs being extremely difficult and impractical to fix. Such costs include, without limitation, processing and accounting charges, and late charges that may be imposed on Landlord, e.g., by the terms of any encumbrance and note secured by any encumbrance covering the Premises. Therefore, if any such payment due from Tenant is not received by Landlord within five (5) days of the date due (without the requirement of providing Tenant notice), Tenant shall pay to Landlord an additional sum of five percent (5%) of the overdue payment as a late charge. The parties agree that this late charge represents a fair and reasonable estimate of the costs that Landlord will incur by reason of late payment by Tenant. Acceptance of any late charge shall not constitute a waiver of Tenant’s default with respect to the overdue amount, nor prevent Landlord from exercising, any of the other rights and remedies available to Landlord. No notice to Tenant of failure to pay shall be required prior to the imposition of such interest and/or late charge, and any notice period provided for in paragraph 20 shall not affect the imposition of such interest and/or late charge.

        45.  ENTIRE AGREEMENT

                This lease, including any exhibits and attachments, constitutes the entire agreement between Landlord and Tenant relative to the Premises and this lease and the exhibits and attachments may be altered, amended or revoked only by an instrument in writing signed by both Landlord and Tenant, Landlord and Tenant agree hereby that all prior or contemporaneous oral agreements between and among themselves or their agents or representatives relative to the leasing of the Premises are merged in or revoked by this lease.

        46.  CORPORATE AUTHORITY

                If Tenant is a corporation, each individual executing this lease on behalf of the corporation represents and warrants that he is duly authorized to execute and deliver this lease on behalf of the corporation in accordance with a duly adopted resolution of the Board of Directors of said corporation and that this lease is binding upon said corporation in accordance with its terms. If Tenant is a corporation, Tenant shall deliver to Landlord, within ten (10) days of the execution of this lease, a copy of the resolution of the Board of Directors of Tenant authorizing the execution of this lease and naming the officers that are authorized to execute this lease on behalf of Tenant, which copy shall be certified by Tenant’s president or secretary as correct and in full force and effect.

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        47.  RECORDING

                Neither Landlord nor Tenant shall record this lease or any short form memorandum heretofore without the consent of the other.

        48. REAL ESTATE BROKERS

Each party represents that it has nor had dealings with any real estate broker finder or other person with respect to this lease in any manner Each party shall hold harmless the other party from all damages resulting from any claims that may be asserted against the other party by any broker, finder or other person with whom the other party has or purportedly has dealt.

        49.  EXHIBITS AND ATTACHMENTS

                All exhibits and attachments to this lease are a part hereof.

        50.  ENVIRONMENTAL MATTERS

                A. Tenant’s Covenants Regarding Hazardous Materials.

(1) Without limiting Tenant’s obligations under paragraph 7 hereof, Tenant shall comply with and shall cause the Project to comply with, all federal, state, and local laws, statutes, rules, regulations, codes, ordinances, and other governmental requirements (including, without limitation, permits, licenses, consent decrees and administrative orders) now or hereafter in effect relating or pertaining in any way to (i) human health, safety or protection, (ii) workplace safety, (iii) industrial hygiene, (iv) the use, generation, handling, maintenance, treatment, removal, transportation, storage, release, discharge, disposal, or disclosure of Hazardous Materials, or (v) the protection or regulation of the environment, all as amended and modified from time to time (collectively, “Environmental Requirements”) Tenant shall cause all governmental permits and other approvals relating in the use or operation of the Project required by applicable Environmental Requirements or any other applicable laws to all times remain in effect, and Tenant shall at all times comply with such permits and other approvals.

                        (2) Tenant shall not cause, or permit to occur, any release, discharge, use, generation, manufacture, storage, treatment, transportation, or disposal by Tenant or any of its employees, agents, contractors, visitors, clients, customers, sublessees, assignees, successors licensees or invitees, of any Hazardous Materials on, in, under, about, or from the Premises or any other part of the Project. However, notwithstanding the foregoing, Tenant may use on the Premises, without Landlord’s prior written consent, but only upon written notice to Landlord and in compliance with all Environmental Requirements and other applicable laws, any ordinary and customary materials reasonably required for use by Tenant in the normal course of the permitted use described in paragraph 7 hereof and further, but only so long as such use is not a Reportable Use (defined below) and does not expose the Premises or any other part of the Project or neighboring properties to any meaningful risk of contamination or damage or expose Landlord to any liability whatsoever therefor ... In addition, Landlord may (but without any obligation to do so) condition its consent to any Reportable Use of any Hazardous Materials by Tenant upon Tenant’s giving Landlord such additional assurances as Landlord in its sole discretion, deems necessary to protect itself, the public, the Premises, the Project, and the environment against damage, contamination or injury and/or liability therefor, including but not limited to the installation (and, at Landlord’s option, removal on or before the expiration or earlier termination of this lease) of reasonably necessary protective modifications to the Premises (such as concrete encasement) and/or the deposit of an additional security deposit. As used herein, “Reportable Use” shall mean (i) the installation or use of any above or below ground storage tank, (ii) the release, generation, possession, storage, use, transportation, discharge or disposal of any Hazardous Materials that requires a permit from, or with respect to which a report, notice, registration or business plan is required to be filed with, any governmental agency or authority, and (iii) the presence in, on or about the Premises, the Project of any Hazardous Materials with respect to which any Environmental Requirements or other applicable laws require that a notice be given to persons entering or occupying the Premises, the Project or neighboring properties.

                        (3) If Tenant knows, or has reasonable cause to believe, that any Hazardous Materials have come to be located in, on, under or about the Premises or the Project (other than those Hazardous Materials that have come to be located beneath and/or in the vicinity of the Project prior to the date of this lease and other than those Hazardous Materials as previously consented to by Landlord in writing, if any), to by Landlord, Tenant shall immediately give Landlord written notice thereof, together with a copy of any statement, report, notice, registration, application, permit, business plan, license, claim, action, or proceeding, given to, or received from, any governmental authority or private party concerning the presence, spill, release, discharge of, or exposure to, such Hazardous Materials including but not limited to all such documents as may be involved in any Reportable Use involving the Premises or the Project. Landlord’s receipt of any notice, documents or other information from Tenant as provided above in this paragraph shall not create any obligation on the part of Landlord to respond in any way to such notice, documents or information or the conditions described therein.

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                        (4) Tenant shall immediately notify Landlord and provide copies upon receipt of all written complaints, claims, citations, demands, inquiries, reports, or notices relating to the condition of the Premises or compliance with Environmental Requirements (provided, however, that Landlord’s receipt of any of the foregoing shall in no way create or impose any duty or obligation upon Landlord to respond thereto. Tenant shall promptly cure and have dismissed with prejudice any of those actions and proceedings to the satisfaction of Landlord.

                        (5) Landlord, its agents, employees, contractors and designated representatives, and the holders of any mortgages, deeds of trust or ground leases on the Premises or Project shall have the right, but not the obligation, to enter the Premises at any time in the case of an emergency, and otherwise at reasonable times, for the purpose of inspecting the condition of the Premises and for verifying compliance by Tenant with this lease (including compliance with Environmental Requirements) and Landlord shall be entitled to employ experts and/or consultants in connection therewith to advise Landlord with respect to Tenant’s activities, including but not limited to Tenant’s use, storage, handling, transportation, maintenance, or removal of any Hazardous Materials on or from the Premises. The costs and expenses of any such inspections shall be paid by the party requesting same, unless a default or breach of this lease by Tenant or a violation of any Environmental Requirement or a contamination caused or materially contributed to by the Tenant as found to exist or to be imminent, or unless the inspection is requested or ordered by a governmental agency or authority as the result of any such existing or imminent violation or contamination, in such case, Tenant shall upon request reimburse Landlord, for the costs and expenses of such inspections.

                        (6) If Tenant breaches any of its warranties, representations, or covenants under this paragraph 50, Landlord may, without obligation, cause the removal (or other cleanup or other response acceptable to Landlord) of any Hazardous Materials from the Project, and the costs of any Hazardous Materials removal, remediation, detoxification, or other response (including, without limitation, disposal, transportation and storage costs and all costs of refitting or otherwise altering the Premises or any other part of the Project shall be covered by the indemnity in paragraph 50B, below, whether or not a court or other governmental authority has ordered such removal, remediation, detoxification or other response and those costs shall become due and payable on demand by Landlord. Tenant shall give Landlord, its agents, contractors, and employees access to the Premises to remove, remediate, detoxify, clean up or otherwise respond to any Hazardous Materials, and this lease shall not be construed as creating any such obligation.

                B. Indemnification of Landlord. Tenant agrees to indemnify, defend (with counsel acceptable to Landlord and at Tenant’s sole cost), and hold Landlord and Landlord’s partners, employees, agents, attorneys, successors and assigns free and harmless from and against any and all losses, liabilities, obligations, penalties, claims, litigation, orders, demands, defenses, costs, judgments, suits, penalties, proceedings, damages (including, without limitation, consequential damages, diminution of the value of the Premises or Project, disbursements, losses, or expenses of any kind (including, without limitation, attorneys’ and experts’ fees and expenses incurred in investigating, defending, or prosecuting any litigation, claim, or proceeding) that may at any time be imposed upon, suffered by, incurred by, or asserted or awarded against Landlord or any of its partners, employees, agents, attorneys, successors or assigns in connection with or arising directly or indirectly out of:

                        (1) Any release, threatened release, discharge, handling, use, storage, presence, transportation, or disposal of any Hazardous Materials (whether or not the use thereof is a Reportable Use or has been consented to by Landlord on, in, under, or affecting all or any part of the Premises or Project which is (or are) attributable, in whole or in part, directly or indirectly, to any act or omission of Tenant or any employee, agent, contractor, visitor, client, customer, sublessee, assignee, successor, licensee or invitee of Tenant;

                        (2) Any misrepresentation, inaccuracy, or breach of any warranty, covenant, or agreement contained or referred to in this paragraph 50;

                        (3) Any failure by Tenant or any employee, agent, contractor, visitor, customer, sublessee, assignee, successor, client, licensee or invitee of Tenant to comply with any Environmental Requirement or other applicable law, whether such failure was made knowingly or unknowingly or intentionally or unintentionally.

                This indemnification is the personal obligation of Tenant and shall survive the expiration or sooner termination of this lease. Tenant, its successors, and assigns waive, release, and agree not to make any claim or bring any cost recovery action against Landlord under the Comprehensive Environmental Response, Compensation and Liability Act, as amended and reauthorized to date (42 U.S.C. § § 9601 et seq.) (“CERCLA”), or any state equivalent or any similar law now existing or enacted after this date. To the extent that Landlord is strictly liable under any such law, regulation, ordinance, or requirement, Tenant’s obligation to Landlord under this indemnity shall also be without regard to fault on the part of Tenant with respect to the violation or condition that results in liability to Landlord.

                C. Definition of Hazardous Materials. “Hazardous Materials” means any product substance, chemical, material or waste whose presence, nature, quantity and/or intensity or existence, use, manufacture, disposal, transportation, spill, release, or effect, either by itself or in combination with any other materials, substances or chemicals is either (i) potentially injurious or harmful to the

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                        (4) Tenant shall immediately notify Landlord and provide copies upon receipt of all written complaints, claims, citations, demands, inquiries, reports or notices relating to the condition of the Premises or compliance with Environmental Requirements (provided, however, that Landlord’s receipt of any of the foregoing shall in no way create or impose any duty or obligation upon Landlord to respond thereto. Tenant shall promptly cure and have dismissed with prejudice any of those actions and proceedings to the satisfaction of Landlord.

                        (5) Landlord, its agents, employees, contractors and designated representatives, and the holders of any mortgages, deeds of trust or ground leases on the Premises or Project shall have the right, but not the obligation, to enter the Premises at any time in the case of an emergency, and otherwise at reasonable times, for the purpose of inspecting the condition of the Premises and for verifying compliance by Tenant with this lease (including compliance with Environmental Requirements) and Landlord shall be entitled to employ experts and/or consultants in connection therewith to advise Landlord with respect to Tenant’s activities, including but not limited to Tenant’s use, storage, handling, transportation, maintenance, or removal of any Hazardous Materials on or from the Premises. The costs and expenses of any such inspections shall be paid by the party requesting same, unless a default or breach of this lease by Tenant or a violation of any Environmental Requirement or a contamination caused or materially contributed to by the Tenant is found to exist or to be imminent, or unless the inspection is requested or ordered by a governmental agency or authority as the result of any such existing or imminent violation or contamination, in such case, Tenant shall upon request reimburse Landlord, for the costs and expenses of such inspections.

                        (6) If Tenant breaches any of its warranties, representations, or covenants under this paragraph 50, Landlord may, without obligation, cause the removal (or other cleanup or other response acceptable to Landlord) of any Hazardous Materials from the Project, and the costs of any Hazardous Materials removal, remediation, detoxification, or other response (including, without limitation, disposal, transportation and storage costs and all costs of refitting or otherwise altering the Premises or any other part of the Project shall be covered by the indemnity in paragraph 50B, below, whether or not a court or other governmental authority has ordered such removal, remediation, detoxification or other response and those costs shall become due and payable on demand by Landlord. Tenant shall give Landlord, its agents, contractors, and employees access to the Premises to remove, terminate, detoxify, clean up or otherwise respond to any Hazardous Materials, and this lease shall not be construed as creating any such obligation

                8. Indemnification of Landlord. Tenant agrees to indemnify, defend (with counsel acceptable to Landlord and at Tenant’s sole cost), and hold Landlord and Landlord’s partners, employees, agents, attorneys, successors and assigns free and harmless from and against any and all losses, liabilities, obligations, penalties, claims, litigation, orders, demands, defenses, costs, judgments, suits, penalties, proceedings, damages (including, without limitation, consequential damages, diminution of the value of the Premises or Project, disbursements, losses, or expenses of any kind (including, without limitation, attorney’s and experts’ fees and expenses incurred in investigating, defending, or prosecuting any litigation, claim, or proceeding) that may at any time be imposed upon, suffered by, incurred by, or asserted or awarded against Landlord or any of its partners, employees, agents, attorneys, successors or assigns in connection with or arising directly or indirectly out of:

                        (1) Any release, threatened release, discharge, handling, use, storage, presence, transportation, or disposal of any Hazardous Materials (whether or not the use thereof is a Reportable Use or has been consented to by Landlord on, in, under, or affecting all or any part of the Premises or Project which is (or are) attributable, in whole or in part, directly or indirectly, to any act or omission of Tenant or any employee, agent, contractor, visitor, client, customer, sublessee, assignee, successor, license or invitee of Tenant;

                        (2) Any misrepresentation, inaccuracy, or breach of any warranty, covenant, or agreement contained or referred to in this paragraph 50;

                        (3) Any failure by Tenant or any employee, agent, contractor, visitor, customer, sublessee, assignee, successor, client, licensee or invitee of Tenant to comply with any Environmental Requirement or other applicable law, whether such failure was made knowingly or unknowingly or intentionally or unintentially.

                This indemnification is the personal obligation of Tenant and shall survive the expiration or sooner termination of this lease. Tenant, its successors, and assigns waive, release, and agree not to make any claim or bring any cost recovery action against Landlord under the Comprehensive Environmental Response, Compensation and Liability Act, as amended and reauthorized to date (42 U.S.C. § § 9601 et seq.) (“CERCLA”), or any state equivalent or any similar law now existing or enacted after this date. To the extent that Landlord is strictly liable under any such law, regulation, ordinance, or requirement, Tenant’s obligation to Landlord under this indemnity shall also be without regard to fault on the part of Tenant with respect to the violation or condition that results in liability to Landlord.

                C. Definition of Hazardous Materials. “Hazardous Materials” means any product substance, chemical, material or waste whose presence, nature, quantity and/or intensity or existence, use, manufacture, disposal, transportation, spill, release, or effect, either by itself or in combination with any other materials, substances or chemicals is either (i) potentially injurious or harmful to the

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Public health, safety or welfare, the Premises, or the environment (including, without limitation, any soil, air, groundwater, and subsurface media on, in, under, above or about the Project); (ii) regulated or monitored by any federal, state or local governmental authority; or (iii) a basis for potential liability of Landlord to any governmental agency, private party, or other third party under any Environmental Requirement or any other applicable statute, regulation, code, ordinance or common law theory. Without limiting the scope or generality of the foregoing, Hazardous Material shall include, but not be limited to any petroleum or petroleum byproducts or petroleum hydrocarbons, flammable explosives, asbestos, urea formaldehyde, radioactive materials or waste and any “hazardous substance” or “toxic waste” as those terms are defined under the provision of the California Health and Safety Code and/or CERCLA.

                D. Survival. The provisions of this paragraph 50 shall survive the expiration or earlier termination of the term of this lease.

                E. Limitation on Tenant Liability. Notwithstanding the provisions in this lease to the contrary, Tenant shall have no obligation to clean up or to reimburse, release, indemnify, or defend Landlord with respect to removal or liability respecting Hazardous Materials unless the Hazardous Materials in question were stored, used, generated, manufactured, treated, analyzed, released, threaten to be released, discharged, disposed, transported or otherwise caused to be present in, on or about the Premises or the Project by Tenant or its agent’s, employees, contractors, visitors, clients; customers, sublessees, assignees, successors, licensees, invitees or others acting for or on behalf of Tenant (whether or not they are negligent, intentional, willful or unlawful).

        51.  SIGNAGE

                Tenant shall not, without obtaining the prior written consent of Landlord, install or attach any sign or advertising material on any part of the outside of the Premises, or on any part of the inside of the Premises which is visible from the outside of the Premises, or in the halls, lobbies, windows or elevators of the building in which the Premises are located or on or about any other portion of the Common Area or Project. If Landlord consents to the installation of any sign or other advertising material, the location, size, design, color and other physical aspects thereof shall be subject to Landlord’s prior written approval and shall be in accordance with any sign program applicable to the Project. In addition to any other requirements of this paragraph 51, the installation of any sign or other advertising material by or for Tenant must comply with all applicable laws, statutes, requirements, rules, ordinances and any C.C.&R.’s or other similar requirements. With respect to any permitted sign installed by or for Tenant, Tenant shall maintain such sign or other advertising material in good condition and repair and shall remove such sign or other advertising material on the expiration or earlier termination of the term of this lease. The cost of any permitted sign or advertising material and all costs associated with the installation, maintenance and removal thereof shall be paid for solely by Tenant. If Tenant fails to properly maintain or remove any permitted sign or other advertising material, Landlord may do so at Tenant’s expense. Any cost incurred by Landlord in connection with such maintenance or removal shall be deemed additional rent and shall be paid by Tenant to Landlord within ten (10) days following notice from Landlord. Landlord may remove any unpermitted sign or advertising material without notice to Tenant and the cost of such removal shall be additional rent and shall be paid by Tenant within ten (10) days following notice from Landlord. Landlord shall not be liable to Tenant for any damage, loss or expense resulting from Landlord’s removal of any sign or advertising material in accordance with this paragraph 51. The provisions of this paragraph 51 shall survive the expiration or earlier termination of this lease.

        52.  SUBMISSION OF LEASE

                The submission of this lease to Tenant is not an offer to lease the Premises, or an agreement by Landlord to reserve the Premises for Tenant. Landlord will not be bound to Tenant until Tenant has duly executed and delivered duplicate original leases to Landlord and Landlord has duly executed and delivered one of those duplicate original leases to Tenant.

        53.  ADDITIONAL RENT

                All costs, charges, fees, penalties, interest and any other payments (including Tenant’s reimbursement to Landlord of costs incurred by Landlord) which Tenant is required to make to Landlord pursuant to the terms and conditions of this lease and any amendments to this lease shall be and constitute additional rent payable by Tenant to Landlord when due as specified in this lease and any amendments to this lease.

        54.  PREMISES TAKEN “AS IS”

                Tenant is leasing the Premises from Landlord “as is” in its existing condition as of the date hereof. Landlord shall have no obligation to alter or improve the Premises except only to paint the exterior of the building in which the Premises are located. The cost of such exterior painting shall be deemed a common area charge as provided in paragraph 16 and shall be amortized over the remaining term of the lease.

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                Tenant acknowledges that, except as expressly contained in this lease, neither Landlord nor anyone acting for or on behalf of Landlord has made any representation, warranty or promise to Tenant concerning the physical aspects or condition of any of the Project; the feasibility, desirability or convertibility of any of the Project into any particular use; the zoning, building or land use restrictions applicable to the zoning, building or land use restrictions applicable to the Project; the projected income or expenses for any of the Project or any business conducted thereon; the suitability of the Project for any particular use; or the presence or absence of any Hazardous Materials; and that in entering into this lease, Tenant has not relied upon any representation, statement or warranty of Landlord or anyone acting for or on behalf of Landlord, other than as expressly contained in this lease, and that all matters concerning the Premises shall be independently verified by Tenant and that Tenant shall enter into this lease on Tenant’s own examination thereof (or Tenant’s election not to do so). Tenant does hereby waive, and Landlord does hereby disclaim, all warranties of any type or kind whatsoever with respect to the Project, express or implied, including by way of description, but not limitation, those of fitness for a particular purpose, tenantability, habitability and use. Tenant hereby expressly assumes the risk that adverse physical conditions and the full extend thereof (including, without limitation, soil, groundwater and surface water contamination and air pollution from Hazardous Materials), may not be revealed by Tenant’s inspections, reviews and studies of the Project prior to the date of possession.

                No person acting on behalf of Landlord is authorized to make, and by execution hereof Tenant acknowledges that no such person has made, any representation, warranty, guaranty or promise except as may be expressly set forth herein; and no agreement, statement, representation, guaranty or promise made by any such person which is not expressly contained herein shall be valid or binding on Landlord and Landlord’s agents, heirs, successors or assigns. The only representations or warranties outstanding with respect to the Project, or Landlord, either express or implied by law, are expressly set forth herein.

                Tenant acknowledges that any and all documentary information, soil reports, environmental audits, site assessments, analyses or reports, insurance policies or other information of whatever type which Tenant has received or may receive from Landlord or Landlord’s agents is furnished on the express condition that Tenant shall make Tenant’s own independent verification of the accuracy and completeness of such information. Tenant agrees that Tenant shall not attempt to assert any liability upon Landlord or Landlord’s agents for furnishing such information and Tenant does hereby release Landlord and Landlord’s agents, heirs, successors and assigns free and harmless from and against, any and all such claims or liability.

        55.  CAPITAL EXPENDITURES

                Notwithstanding anything to the contrary in paragraphs 7, 8 and 9, (i) as to any required capital improvement to the Premises of a structural nature (and including, when necessary in Landlord’s sole judgment, replacement of the roof and individual heating, ventilating and air-conditioning units but excluding capital improvements required for ADA compliance except where such ADA compliance is the responsibility of Landlord as described in this lease) having a useful life of more than one year and which is not required by reason of Tenant’s specific use of or activities on the Premises, Landlord shall make such capital improvement and Tenant shall pay to Landlord, as additional rent and in equal monthly installments over the remaining term of this lease, the fraction of the cost of such capital improvements equal to the remaining term of this lease over the useful life of such capital improvement; (ii) as to any required capital improvement to the common area having a useful life of more than one year and which is not required by Tenant’s specific use of or activities on the Premises, the cost thereof shall be included within common area charges ratably over the useful life of such capital improvement. Any determination of useful life, as such term is used in this paragraph 55, shall be reasonably made by Landlord.

                IN WITNESS WHEREOF, Landlord and Tenant have executed and delivered this lease on the date first above written.

Landlord:			Tenant:
C&J Development Co., a California Limited Partnership			Southwall Technologies, Inc., a Delaware corporation
By:	/s/ Sandra M. Simons	By:	/s/ Bill R. Finley
Sandra M. Simons, as Trustee under the Charles S. and Jean A. McCandless Inter Vivos Trust Agreement dated January 25, 1977, a General Partner			(Signature)
			Bill R. Finley
			(Name)
			Vice President and CFO
			(Title)
Date:	Oct-14, 1999	Date:	13 October 1999

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Exhibit A

[Drawing of Premises]

Exhibit B

[Drawing of Project]

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EX-10.120

EXHIBIT 10.120

GUARANTEE AGREEMENT

REGARDING

10 MILLION US$ CREDIT FACILITY

                This Agreement is made as of May 6, 1997 by and between Southwall Technologies Inc., a Delaware corporation whose principal business offices are at 1029 Corporation Way, Palo Alto, California 94303 (hereinafter called "Southwall")

and

                Teijin Limited, a Japanese corporation whose registered office is at 6-7, Minami-honmachi 1-chome, Chuo-ku, Osaka 541, Japan (hereinafter called "Teijin").

WITNESSETH:

                WHEREAS, Southwall wishes to obtain a loan facility amounting to Ten Million US Dollars (US$10,000,000, hereinafter called the "LOAN") from The Sanwa Bank, Limited, San Francisco Branch at 444 Market Street, 18th Floor, San Francisco, CA 94111 (hereinafter called "LENDER") and Southwall requests that TEIJIN provide LENDER with a letter of guarantee (hereinafter called "L/G") as an inducement to LENDER to extend a LOAN to Southwall;

                WHEREAS, Teijin is, on the above request from Southwall, willing to issue a L/G to LENDER;

                NOW THEREFORE, the parties hereto have agreed as follows:

ARTICLE 1. LOAN FACILITY

                The summary of the LOAN extended to Southwall by LENDER is described below:

(1)	Date of Credit Agreement by and between Southwall and LENDER:
	May 6, 1997
(2)	Principal amount: US$10,000,000.00
(3)	First Draw-Down Date: May 6, 1997, for US$5,000,000.00
	Second Draw-Down Date: November 6, 1997, for the balance of the principal amount
(4)	Grace period: Four (4) years after the First Draw-Down Date. During this period, Southwall shall make semi-annual, interest-only payments.
(5)	Repayments: Eight (8) semi-annual equivalent principal repayments, plus accrued interest starting forty-eight (48) months after the First Draw-Down Date.
(6)	Interest rate: The LIBOR Rate, as defined in the Credit Agreement between LENDER and Southwall, plus 0.4375%.
(7)	Prepayment: Southwall may have the right to prepay this LOAN in full or in part, subject to the terms of the Credit Agreement.
(8)	Kind of assurance: L/G issued by Teijin

ARTICLE 2.  L/G & RISK BEARING COMMISSION

2.1	Teijin hereby agrees to submit the L/G to LENDER on the condition that Southwall pays Teijin a risk bearing commission as a Guarantee Fee (hereinafter called "Guarantee Fee") at the rate of 0.5625% per year on the outstanding amount of the principal amount of the LOAN.
2.2	The Guarantee Fee shall be paid in arrears on each Interest Payment Date for the Period commencing either on and including the date of the

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	First Draw-Down, or on and including the immediately preceding Interest Payment Date up to and including the date immediately preceding such relevant Interest Payment Date.
2.3	The Guarantee Fee shall accrue daily and shall be computed on the basis of a year of three hundred and sixty (360) days and the actual number of days elapsed.
ARTICLE 3.  PAYMENT
3.1	Guarantee Fee shall be made by wire transfer by Southwall to Teijin in US Dollars to Teijin's account No. 403-401 with The Sanwa Bank, Limited, Osaka Head Office.
3.2	Any taxes, charges, or other expenses with respect to each Guarantee Fee payment made to Teijin by Southwall shall be borne by Southwall. Nevertheless, Southwall may deduct withholding tax duly levied on Guarantee Fee payments to the extent that a tax credit will be obtained by such party under the convention for the avoidance of double taxation between the governments of U.S.A. and Japan. Southwall shall secure for Teijin a tax receipt acceptable to Japanese tax authorities for the said tax purpose and send it to Teijin within thirty (30) days after such payment.
ARTICLE 4.  FINANCIAL COVENANTS
	During the term of the LOAN, Southwall shall maintain the following financial covenants, as measured on a quarterly basis as of the last day of each fiscal quarter of Southwall from financial data publicly reported in Southwall's Form 10-Q and Form 10-K Reports filed with the Securities and Exchange Commission, or from supporting data for such reports:

(1) Minimum Quick Ratio:   1.00 to 1.00

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	Minimum Quick Ration is defined as Cash and Equivalents plus Short Term Investments plus Accounts Receivables to Total Current Liabilities.
(2)	Minimum Tangible Net Worth:  $24,000,000 and to increase annually by 50% of annual Net After Tax Profits, such increases to be cumulative. Southwall shall remain profitable in each fiscal year.
	Tangible Net Worth is defined as Stockholders Equity plus Subordinated Debt minus Intangible Assets (including Goodwill, Patents and Licenses).
	Net After Tax Profits is defined as Net Operating Income minus recorded Tax Provision for the period, excluding any extraordinary adjustments due to changes in accounting rules as provided by the Financial Accounting Standard Board or for recording of Net Operating Loss Carryforward or other tax assets or liabilities relating to prior year results or activities.
(3)	Maximum Debt to Tangible Net Worth ratio: 0.65 to 1.00
	Debt is defined as Total Liabilities minus Subordinated Debt.
	Southwall shall provide to Teijin with a quarterly certificate, signed by a responsible officer of Southwall, together with a copy of the current quarter's Form 10-Q Report, as early as reasonably possible but no later than sixty (60) days following the last day of the fiscal quarter, or following the end of Southwall's fiscal fourth quarter, a copy of the Form 10-K Report, as early as reasonably possible but no later than one hundred and twenty (120) days following the last day of the fiscal quarter.

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ARTICLE 5. DEFAULT
5.1	In the event of any actual or expected default by Southwall in any payment of principal or interest on the LOAN or of any actual or expected default by Southwall in any financial covenants in ARTICLE 4, Southwall shall immediately give a written notice of such actual or expected default to Teijin. Such notice shall include detailed information on the LOAN including the payment amount and due date for the payment which is or may become in default. After receiving such notice, the parties hereto shall call a meeting and discuss the concerned matter.
5.2	If Teijin shall make a payment when due of any amount demanded by LENDER under L/G, then Teijin shall have the right to exercise any right of reimbursement, indemnity or subrogation against Southwall.
ARTICLE 6.  OFFER OF COLLATERAL SECURITY
	In order to secure the repayment obligation of Southwall to Teijin referred to in paragraph 5.2, Southwall shall execute and deliver to Teijin a Reimbursement and Security Agreement substantially in the form of Exhibit A attached hereto.
ARTICLE 7.  VALIDITY
	This Agreement shall come into effect on the day when signed by the parties hereto.
ARTICLE 8. MISCELLANEOUS
8.1	This Agreement shall be interpreted and construed in accordance with the laws of Japan.

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8.2	All disputes or controversies concerning the interpretation or construction of this Agreement shall be settled amicably by the parties hereto. In the event the parties cannot reach an amicable settlement, arbitration under paragraph 13.6 of the Basic Agreement dated April 9, 1997 between Southwall and Teijin shall be the final settlement.
8.3	This Agreement shall not be assigned without the prior written consent of the other party hereto.
8.4	This Agreement shall be amended only by a written instrument signed by duly authorized representatives of both parties hereto.

                IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed and signed in their respective names by their duly authorized representatives as of the date and year first above written.

FOR SOUTHWALL TECHNOLOGIES INC.
/s/ L. Ray Christie
Name:	L. Ray Christie
Title:	Vice President, Chief Financial Officer, and Secretary
FOR TEIJIN LIMITED
/s/ Shosaku Yasui
Name:	Shosaku Yasui
Title:	Senior Managing Director
	Member of the Board

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Exhibit A

REIMBURSEMENT AND SECURITY AGREEMENT

                This REIMBURSEMENT AND SECURITY AGREEMENT, dated as of May 6, 1997 (this “Agreement”), is made by SOUTHWALL TECHNOLOGIES, INC., a Delaware corporation (the “Grantor”), and TEIJIN LIMITED, a Japanese corporation, as secured party (the “Secured Party”).

                PRELIMINARY STATEMENTS:

                (1)           The Secured Party has entered into that certain Guarantee Agreement Regarding 10 Million US$ Credit Facility, dated as of the date hereof (said agreement, as it may hereafter be amended or otherwise modified from time to time, the “Guaranty Agreement”; the terms defined therein and not otherwise defined herein are used herein as therein defined), under which the Secured Party has agreed to provide LENDER with a letter of guarantee (the “Letter of Guarantee”) as an inducement to extend a LOAN to the Grantor.

                (2)           It is a condition precedent to the making of the guarantee by the Secured Party under the Guaranty Agreement that the Grantor shall have agreed to the reimbursement and security interest contemplated by this Agreement.

                NOW, THEREFORE, in consideration of the premises and in order to induce the Secured Party to make the guarantee under the Guaranty Agreement, the Grantor hereby agrees with the Secured Party as follows.

                SECTION 1. Reimbursement; Assignment and Grant of Security Interest.

                (a)           The Grantor hereby agrees to reimburse the Secured Party on demand for and in the amount of any payment made by the Secured Party to LENDER under the Letter of Guarantee. All payments made by the Grantor under this Agreement shall be made by the Grantor free and clear of and without deduction for any and all present and future taxes, levies, charges, deductions and withholdings, excluding, in the case of the Secured Party, any of the foregoing imposed on or measured by its net income or gross receipts by the jurisdiction (or any political subdivision thereof) under the laws of which the Secured Party is organized or maintains a lending office (“Taxes”). To the extent applicable law requires a deduction or withholding for Taxes, then the gross amount of such payment made by the Grantor shall be increased at the Grantor’s sole cost and expense such that the net payment to the Secured Party or its assignee equals that amount which the Secured Party or its assignee would have received if such deduction or withholding were not made. In addition, the Grantor shall pay upon demand any stamp or other taxes, levies or charges of any jurisdiction with respect to the execution, delivery, registration, performance and enforcement of this Agreement.

Upon request by the Secured Party,  the Grantor shall furnish evidence satisfactory to the Secured Party that all requisite authorizations and approvals by, and notices to and filings with, governmental authorities and regulatory bodies have been obtained and made and that all requisite taxes, levies and charges have been paid. Any amounts payable by the Grantor to the Secured Party hereunder not paid upon demand shall bear interest at an annual rate equal to the six (6) months LIBOR rate established by BBA at the time of non-payment plus five percent (5%).

                (b)           The Grantor hereby assigns to the Secured Party for its benefit, and hereby grants to the Secured Party for its benefit a security interest in, all of the Grantor’s right, title and interest in and to Grantor’s property set forth on Exhibit A attached hereto (the “Collateral”), andall proceeds of any and all of the foregoing Collateral. The list of Collateral may be amended from time to time by mutual agreement of the parties; provided, however, that the Secured Party shall have no obligation to agree to the amendment of the list of Collateral if it believes that such amendment would impair the security interest in the Grantor’s property created hereunder.

                SECTION 2. Security for Obligations. This Agreement secures the payment of all obligations of the Grantor now or hereafter existing under the Guaranty Agreement and under this Agreement (all such obligations being the “Obligations”).

                SECTION 3.  Representations, Warranties and Covenants.  The Grantor represents and warrants as follows.

                (a)           The Grantor is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware; the Grantor has the lawful power to own its properties and to engage in the businesses it conducts, and is duly qualified and in good standing as a foreign corporation in the jurisdictions wherein the failure to so qualify would have a material adverse effect on the Grantor or its business or prospects.

                (b)           The Grantor is not in default with respect to any of its existing indebtedness, and the making and performance of this Agreement will not (immediately or with the passage of time, the giving of notice, or both):

                                (i)            violate the  articles of  incorporation,  by-laws or other organizational of the Grantor or violate any laws or result in a default under any contract, agreement, or instrument to which the Grantor is a party or by which the Grantor or any of its property is bound; or

                                (ii)           result in the creation or imposition of any security interest in, or lien or encumbrance upon, any of the assets of the Grantor, other than in favor of the Secured Party.

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                (c)           The Grantor has the power and authority to enter into and perform this Agreement and to incur the obligations herein provided for, and has taken all actions necessary to authorize the execution, delivery, and performance of this Agreement.

                (d)           This Agreement is valid, binding, and enforceable in accordance with its terms.

                (e)           The chief place of business and chief executive office of the Grantor and the office where the Grantor keeps its records concerning the Collateral, are located at 1029 Corporation Way, Palo Alto, California 94303.

                (f)            The Grantor is, or as soon as practicable following the Closing will be, the legal and beneficial owner of the Collateral free and clear of any lien, security interest, option or other charge or encumbrance except for the security interest created by this Agreement and Permitted Liens. No effective financing statement or other document similar in effect covering all or any part of the Collateral is on file in any recording office, except such as may have been filed in favor of the Secured Party relating to this Agreement and Permitted Liens. As used herein, “Permitted Liens” means (i) liens to secure taxes, assessments or charges not yet due or which are being contested in good faith and by appropriate proceedings and for which adequate reserves are maintained; (ii) carriers’, mechanics’, warehousemen’s artisans’, repairmen’s or similar liens arising in the ordinary course of business which are not overdue or which are being contested in good faith and by appropriate proceedings and for which adequate reserves are maintained; and (iii) liens and encumbrances which (A) existed on property acquired by the Grantor before the time of its acquisition and was not created in anticipation of such event, or (B) were taken or retained by the seller of such property to secure all or part of its price or created solely for the purpose of securing indebtedness representing, or incurred to finance or refinance the cost of such property; provided that no such Lien shall extend to or cover any property of the Grantor other than the property so acquired and improvements on such property.

                (g)           This Agreement creates a valid and perfected first priority security interest in the Collateral (other than with respect to Permitted Liens given priority as a matter of law), securing the payment of the Obligations, and all filings and other actions necessary or desirable to perfect and protect such security interest have been duly taken.

                (h)           No consent of any other person or entity and no authorization, approval or other action by, and no notice to or filing with, any governmental authority or regulatory body is required (i) for the grant by the Grantor of the assignment and security interest granted hereby or for the execution, delivery or performance of this Agreement by the Grantor, (ii) for the perfection or maintenance of the assignment and security interest created hereby (including the first priority nature of such assignment and security interest) or (iii) except as required by applicable law, for the exercise by the Secured Party of its rights and remedies hereunder.

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                (i)            There are no conditions precedent to the effectiveness of this Agreement that have not been satisfied or waived.

                (j)            Grantor shall pay Secured Party a risk bearing commission as a Guarantee Fee (hereinafter called “Guarantee Fee”) at the rate of 0.5625% per year on the outstanding amount of the principal amount of the LOAN, as specified in the Guaranty Agreement.

                (k)           The Guarantee Fee shall be paid by Grantor in arrears on each Interest Payment Date (as such term is defined in the Guaranty Agreement) for the period commencing either on and including the date of the First Draw-Down, or on and including the immediately preceding Interest Payment Date up to and including the date immediately preceding such relevant Interest Payment Date, as specified in the Guaranty Agreement.

                (l)            The Guarantee Fee shall accrue daily and shall be computed on the basis of a year of three hundred and sixty (360) days and the actual number of days elapsed.

                (m)          Guarantee Fee payments shall be made by wire transfer by Grantor to Secured Party in US Dollars to Secured Party’s Account No. 403-401 with The Sanwa Bank, Limited, Osaka Head Office.

                (n)           Any taxes, charges, or other expenses with respect to each Guarantee Fee payment made to Secured Party by Grantor shall be borne by Grantor. Nevertheless, Grantor may deduct withholding tax duly levied on Guarantee Fee payments to the extent that a tax credit will be obtained by such party under the convention for the avoidance of double taxation between the governments of U.S.A. and Japan. Grantor shall secure for Secured Party a tax receipt acceptable to Japanese tax authorities for said tax purpose and will send it to Secured Party within thirty (30) days after such payment.

                (o)           During the term of the LOAN, as specified in the Guaranty Agreement, Grantor shall maintain the following financial covenants, as measured on a quarterly basis as of the last day of each fiscal quarter of Grantor from financial data publicly reported in Grantor’s Form 10-Q and Form 10-K Reports filed with the Securities and Exchange Commission, or from supporting data for such reports:

(1)           Minimum Quick Ratio: 1.00 to 1.00

Minimum Quick Ratio is defined as Cash and Equivalents plus Short Term Investments plus Accounts Receivables to Total Current Liabilities.

(2)           Minimum Tangible Net Worth: $24,000,000 and to increase annually by 50% of
annual Net After Tax Profits, such increases to be cumulative. Grantor shall remain profitable in each fiscal year.

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Tangible Net Worth is defined as Stockholders  Equity plus Subordinated Debt minus Intangible Assets (including Goodwill, Patents and Licenses).

Net After Tax Profits is defined as Net Operating Income minus recorded Tax Provision for the period, excluding any extraordinary adjustments due to changes in accounting rules as provided by the Financial Accounting Standard Board or for recording of Net Operating Loss Carryforward or other tax assets or liabilities relating to prior year results or activities.

Maximum Debt to Tangible Net Worth ratio: 0.65 to 1.00

Debt is defined as Total Liabilities minus Subordinated Debt.

Grantor shall provide to Secured Party a quarterly certificate, signed by a responsible officer of Grantor, together with a copy of the current quarter’s Form 10-Q Report as early as reasonably possible but no later than sixty (60) days following the last day of the fiscal quarter, or following the end of Grantor’s fiscal fourth quarter, a copy of the Form 10-K Report, as early as reasonably possible but no later than one hundred and twenty (120) days following the last day of the fiscal quarter.

                (p)           In the event of any actual or expected default by Grantor in any payment of principal or interest on the LOAN or of any actual or expected default by Grantor in any financial covenants in Section 3(o), Grantor shall immediately give a written notice of such actual or expected default to Secured Party. Such notice shall include detailed information on the LOAN including the payment amount and due date for the payment which is or may become in default.

                SECTION 4. Further Assurances.

                (a)           The Grantor agrees that from time to time, at the expense of the Grantor, the Grantor will promptly execute and deliver all further instruments and documents, and take all further action, that may be necessary or desirable, or that the Secured Party may reasonably request, in order to perfect and protect the assignment and security interest granted or purported to be granted hereby or to enable the Secured Party to exercise and enforce its rights and remedies hereunder with respect to any Collateral. Without limiting the generality of the foregoing, the Grantor will: (i) if any Collateral shall be evidenced by a promissory note or other instrument or chattel paper, promptly notify the Secured Party thereof and, if requested, deliver and pledge to the Secured Party hereunder such note or instrument or chattel paper duly endorsed and accompanied by duly executed instruments of transfer or assignment, all inform and substance reasonably satisfactory to the Secured Party; (ii) execute and file such financing or continuation statements, or amendments thereto, and such other instruments or notices, as may be necessary or desirable, or as the Secured Party may

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reasonably request, in order to perfect and preserve the assignment and security interest granted or purported to be granted hereby; and (iii) mark conspicuously any Collateral and, at the request of the Secured Party, each of its records pertaining to the Collateral with a legend, in form and substance reasonably satisfactory to the Secured Party, indicating that such Collateral is subject to the assignment and security interest granted pursuant hereto.

                (b)           The Grantor hereby authorizes the Secured Party to file one or more financing or continuation statements, and amendments thereto, relating to all or any part of the Collateral without the signature of the Grantor where permitted by law. A photocopy or other reproduction of this Agreement or any financing statement covering the Collateral or any party thereof shall be sufficient as a financing statement where permitted by law.

                (c)           During the term of the LOAN, as specified in the GuarantyAgreement, the amount of Grantor’s inventory, consisting of raw materials, work-in-process and finished goods (“Inventory”), that shall constitute a part of the Collateral will at all times be an amount equal to the difference between 120% of the principal and accrued interest then owing under the LOAN and the net value (defined as the purchase price for the equipment less accumulated depreciation calculated at the rate of 10% per annum) of the equipment and machinery that constitutes a part of the Collateral. The Secured Party agrees that its security interest in Inventory shall be limited to Inventory having a value equal to the amount described in the preceding sentence. The Grantor acknowledges that, upon the occurrence of a Default, the Secured Party intends to look to the components of the Inventory in the following order of priority: finished goods, work-in-process and raw materials.

                (d)           The Secured Party agrees to execute such agreements and documents that may be reasonably necessary to confirm the scope of its interest in the Inventory upon the reasonable request of Grantor.

                SECTION 5. Place of Perfection; Records. The Grantor shall keep its chief place of business and chief executive offices and the offices where it keeps its records concerning the Collateral, and the original copies of all chattel paper or other documents or instruments that evidence the Collateral at the locations therefor specified in Section 3(e) or, upon 30 days’ prior written notice to the Secured Party, at any other locations in a jurisdiction where all action required by Section 4 shall have been taken with respect to the Collateral. The Grantor will hold and preserve such records, and such chattel paper, documents and instruments and will permit representatives of the Secured Party at any time during normal business hours and upon reasonable notice to inspect and make abstracts from such records, chattel paper, documents and instruments.

                SECTION 6. As to the Collateral.

                (a)           The Grantor shall at its expense:

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                                (i)            properly maintain the Collateral and take all such action to such end as may be from time to time reasonably requested by the Secured Party; and

                                (ii)           furnish to the Secured Party promptly upon receipt thereof copies of all notices, requests and other documents received by the Grantor relating to the Collateral, and from time to time (A) furnish to the Secured Party such information and reports regarding the Collateral as the Secured Party may reasonably request and (B) upon request of the Secured Party make to any other party such demands and requests for information and reports or for action as the Grantor is entitled to make, respecting the Collateral.

                (b)           The Grantor shall not:

                                (i)            sell, assign (by operation of law or otherwise) or otherwise dispose of, or grant any option with respect to, any of the Collateral (other than a proposed sale or other disposition of obsolete or worn-out equipment, in which events Grantor shall provide Secured Party with thirty (30) days advanced written notice), or create or permit to exist any lien, security interest, option or other charge or encumbrance upon or with respect to any of the Collateral, except for the assignment and security interest under by this Agreement or Permitted Liens; or

                                (ii)           take any other action in connection with the Collateral which would impair the value thereof or the interest or rights of the Grantor therein or which would impair the interest or rights of the Secured Party therein.

                SECTION 7. Secured Party Appointed Attorney-in-Fact. The Grantor hereby appoints the Secured Party the Grantor’s attorney-in-fact, with full authority in the place and stead of the Grantor and in the name of the Grantor or otherwise, from time to time, after the Secured Party has notified the Grantor of a Default under this Agreement and for so long as any such Default exists, in the Secured Party’s discretion to take any action and to execute any instrument which the Secured Party may deem necessary or advisable to accomplish the purposes of this Agreement, including, without limitation:

                                (i)            to ask, demand, collect, sue for, recover, compromise, receive and give acquitance and receipts for moneys due and to become due under or in connection with the Collateral;

                                (ii)           to receive, endorse and collect any drafts or other instruments, documents and chattel paper in connection therewith; and

                                (iii)          to file any claims or take any action or institute any proceedings which the Secured Party may deem necessary or desirable to enforce the rights of the Secured Party with respect to any of the Collateral.

                SECTION 8. Secured Party May Perform. If the Grantor fails to perform any agreement contained herein after having a reasonable opportunity therefor, the Secured Party may itself perform, or cause performance of, such agreement, and the

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expenses of the Secured Party incurred in connection therewith shall be payable by the Grantor under Section 11(b).

                SECTION 9. The Secured Party’s Duties. The powers conferred on the Secured Party hereunder are solely to protect its interest in the Collateral and shall not impose any duty upon it to exercise any such powers. Except for the safe custody of any Collateral in its possession and the accounting for moneys actually received by it hereunder, the Secured Party shall have no duty as to any Collateral or as to the taking of any necessary steps to preserve rights against any parties or any other rights pertaining to any Collateral. The Secured Party shall be deemed to have exercised reasonable care in the custody and preservation of any Collateral in its possession if such Collateral is accorded treatment substantially equal to that which the Secured Party accords its own property.

                SECTION 10. Remedies. If after five (5) days’ written notice the Grantor fails to reimburse or pay any amounts due to the Secured Party under Section 1(a) of this Agreement, or if the Grantor fails to observe or perform any other material term of this Agreement which continues unremedied for a period of thirty (30) days after written notice thereof (each a “Default”):

                (a)           The Secured Party may exercise any and all legal or equitable rights and remedies of the Grantor in connection with or in respect of the Collateral in any court or other tribunal of proper jurisdiction; the Grantor and the Secured Party acknowledge and agree that the remedies of the Secured Party under this Agreement are not subject to the arbitration provisions set forth in Section 8.2 of the Guaranty Agreement;

                (b)           All payments received by the Grantor in connection or in respect of the Collateral shall be received in trust for the benefit of the Secured Party, shall be segregated from other funds of the Grantor and shall be forthwith paid over to the Secured Party in the same form as so received (with any necessary endorsement);

                (c)           All payments made under or in connection with or in respect of the Collateral, and all cash proceeds in respect of any sale of, collection from, or other realization upon all or any part of the Collateral, received by the Secured Party may, in the discretion of the Secured Party, beheld by the Secured Party as collateral for, and/or then or at any time thereafter applied (after payment of any amounts payable to the Secured Party pursuant to Section 11) in whole or in part by the Secured Party against, all or any part of the Obligations in such order as the Secured Party shall elect. Any surplus of such payments or cash proceeds held by the Secured Party and remaining after payment in full of all the Obligations shall be paid over to the Grantor or to whomsoever may be lawfully entitled to receive such surplus; and

                (d)           The Secured Party may exercise in respect of the Collateral, in addition to other rights and remedies provided for herein or otherwise available to it, all the rights and remedies of a secured party on default under the Uniform Commercial Code in

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effect in the State of California, at that time (the “Code”) (whether or not the Code applies to the affected Collateral).

                SECTION 11. Indemnity and Expenses; Payments.

                (a)           The Grantor agrees to indemnify the Secured Party from and against any and all claims, losses and liabilities (including reasonable attorneys' fees) growing out of or resulting from this Agreement (including, without limitation, enforcement of this Agreement), except claims, losses or liabilities resulting from the Secured Party’s gross negligence or willful misconduct.

                (b)           The Grantor will upon demand pay to the Secured Party the amount of any and all reasonable out-of-pocket expenses, including the reasonable fees and expenses of its counsel and of any experts and agents, which the Secured Party may incur in connection with (i) the administration of this Agreement, (ii) the custody or preservation of, or the sale of, collection from or other realization upon, any of the Collateral, (iii) the exercise or enforcement of any of the rights of the Secured Party hereunder or (iv) the failure by the Grantor to perform or observe any of the provisions hereof.

                SECTION 12. Amendments; etc. No amendment or waiver of any provision of this Agreement, and no consent to any departure by the Grantor here from shall in any event be effective unless the same shall be in writing and signed by the Secured Party, and then such waiver or consent shall be effective only in the specific instance and for the specific purpose for which given.

                SECTION  13.  Addresses  for  Notices.  All  notices and other communications provided for hereunder shall be in writing (including telecopier, telegraphic, telex or cable communication) and mailed, telecopied, telegraphed, telexed, cabled or delivered to it, if to the Grantor, at its address at 1029 Corporation Way, Palo Alto, California 94303, Attention: Chief Executive Officer, Facsimile 415/967-8713, and if to the Secured Party, at its address at 1-1, Uchisaiwaicho 2-Chome, Chiyoda-ku, Tokyo 100, Japan, Attention: General Manager, Films Planning and Administration Dept., Facsimile 011-81-3-3506-4378, or, as to either party, at such other address as shall be designated by such party in a written notice to the other party. All such notices and other communications shall be effective, if sent via facsimile, upon confirmation via telephone of receipt of transmission in legible form, if sent via air courier express delivery, upon the third business day after deposit for delivery with an international air courier service, if sent via telegraph, telex or cable, when delivered to the telegraph company, confirmed by telex answerback or delivered to the cable company, respectively, or if mailed, upon the first business day of the recipient that is after the tenth day after the date deposited into the U.S. or Japanese mail, or if delivered, upon delivery.

                SECTION 14. Continuing Assignment and Security Interest; Assignments Under Credit Agreement. This Agreement shall create a continuing assignment of and

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security interest in the Collateral and shall (i) remain in full force and effect until the later of (X), the payment in full of the Obligations and all other amounts payable under this Agreement and (Y) the expiration or termination of the Guaranty Agreement, (ii) be binding upon the Grantor, its successors and assigns, and (iii) inure, together with the rights and remedies of the Secured Party hereunder, to the benefit of the Secured Party and its successors, transferees and assigns. Without limiting the generality of the foregoing clause (iii), if the Secured Party assigns or otherwise transfers all or any portion of its rights and obligations under the Guaranty Agreement to any other person or entity, such other person or entity shall thereupon become vested with all the benefits in respect hereof granted to the Secured Party herein or otherwise. Upon the later of the payment in full of the Obligations and all other amounts payable under this Agreement and the expiration or termination of the Guaranty Agreement, the security interest granted hereby shall terminate and all rights to the Collateral shall revert to the Grantor. Upon any such termination, the Secured Party will, at the Grantor’s expense, execute and deliver to the Grantor such documents as the Grantor shall reasonably request to evidence such termination.

                SECTION 15. Governing Law; Terms. This Agreement shall be governed by and construed in accordance with the laws of the State of California, except to the extent that the validity or perfection of the assignment and security interest hereunder, or remedies hereunder, in respect of any particular Collateral are governed by the laws of a jurisdiction other than the State of California. Unless otherwise defined herein, terms used in Division 9 of the Uniform Commercial Code in effect in the State of California are used herein as therein defined.

                SECTION 16. Waiver of Jury Trial. THE GRANTOR AND SECURED PARTY BOTH HEREBY KNOWINGLY, VOLUNTARILY, AND INTENTIONALLY WAIVES ANY RIGHTS THEY MAY HAVE TO A TRIAL BY JURY IN RESPECT OF ANY LITIGATION BASED HEREON, OR ARISING OUT OF, UNDER, OR IN CONNECTION WITH, THIS AGREEMENT, OR ANY COURSE OF CONDUCT, COURSE OF DEALING, STATEMENTS (WHETHER VERBAL OR WRITTEN), OR ACTIONS OF THE GRANTOR AND SECURED PARTY.

[REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK]

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                IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed and delivered by their respective officers thereunto duly authorized as of the date first above written.

SOUTHWALL TECHNOLOGIES, INC.
By:	/s/ L. Ray Christie
Name:	L. Ray Christie
Title:	Vice President, Chief Financial Officer
TEIJIN LIMITED
By:	/s/ Shasaku Yasui
Name:	Shasaku Yasui
Title:	Senior Managing Director
	Member of the Board

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EXHIBIT A

1.             Inventory in an amount as described in Section 4(c).

2.             The following equipment and machinery located at the Southwall Technologies, Inc. facility at 8175 S. Hardy Street, Tempe, Arizona 85284:

ITEMS

Custom Designed and Fabricated High Vacuum Planar Magnetron Sputter Roll Coating System, known as PM5

15 Planar Magnetron Sputter Sources with Supported Fixed Flange, Gas Inlets, Electrical Feedthrough, Water Cooling Connections, Backing Plates and Power Adaption Modules, for use with PM5

Power Generation System for use with PM5

Vacuum Deposition Machine, known as PM6

Power Generation System for use with PM6

Trane Chiller RTHB-150 460 A, Process Chilling System

Water Cooled Dual Zone Chiller/Heater, Process Chilling System

Resistance Monitoring Equipment; Non-contact Resistance Monitoring

Solvent Based Tandem Coating Line

5500 SCFM Catalytic System with Allen-Bradley SLC502 PLC networked to coating line

610 Slitter/Rewinder

Toray Sheeting Machine

EX-23.1

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EXHIBIT 23.1

CONSENT OF INDEPENDENT ACCOUNTANTS

        We hereby consent to the use in this Registration Statement on Form S-1 of our report dated March 4, 2002, except as to Note 4, which is dated as of May 17, 2002, and Note 9, which is dated as of May 22, 2002, relating to the financial statements and the financial statement schedule of Southwall Technologies Inc., which appear in such Registration Statement. We also consent to the reference to us under the heading "Experts" in such Registration Statement.

/s/ PricewaterhouseCoopers LLP
San Jose, California
June 25, 2002

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EXHIBIT 23.1

CONSENT OF INDEPENDENT ACCOUNTANTS