10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

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

For the fiscal year ended December 31, 2005

OR

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

For the transition period from ________to _________

Commission file number 0-15930

Southwall Technologies Inc.

(Exact name of Registrant as specified in its Charter)

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

3975 East Bayshore Road

Palo Alto, California    94303

(Address of Principal Executive Offices including Zip Code)

(650) 962-9111

(Registrant's Telephone Number, Including Area Code)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock

(Title of Class)

___________

1

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes  ¨  No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15 (d) of the Act. Yes  ¨  No  x

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this

Form 10-K. Yes  ¨  No  x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12B-2 of the Exchange Act). Yes  ¨ No x

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

Large accelerated filer  ¨

Accelerated filer  ¨

Non-accelerated filer  x

The approximate aggregate market value of the Common Stock held by non-affiliates of the registrant on July 3, 2005 (based upon the closing sales price of the Common Stock on the Over-the-Counter Bulletin Market on such date) was $16 million. For purposes of this disclosure, Common Stock held by stockholders whose ownership exceeds five percent of the Common Stock outstanding as of July 3, 2005, and Common Stock held by officers and directors of the registrant has been excluded in that such persons may be deemed to be "affiliates" as that term is defined in the rules and regulations promulgated under the Securities Act of 1933, as amended. This determination is not necessarily conclusive.

The number of shares of the registrant's Common Stock outstanding on March 1, 2006 was 26,792,681.

Documents Incorporated by Reference

Document Description	10-K Part
Portions of the Registrant’s Proxy Statement	III
for the Annual Meeting of Stockholders to
be held May 25, 2006

2

SOUTHWALL TECHNOLOGIES INC.

2005 ANNUAL REPORT ON FORM 10-K

Table of Contents

Part I.			Page
	Item 1.	Business	5
	Item 1A.	Risk Factors	16
	Item 1B.	Unresolved Staff Comments	24
	Item 2.	Properties	25
	Item 3.	Legal Proceedings	25
	Item 4.	Submission of Matters to a Vote of Security Holders	26
		Executive Officers of the Registrant	26
Part II.
	Item 5.	Market for Registrant's Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities	29
	Item 6.	Selected Consolidated Financial Data	30
	Item 7.	Management's Discussion and Analysis of Financial Condition and Results of Operations	34
	Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	55
	Item 8.	Financial Statements and Supplementary Data	56
	Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosures	91
	Item 9A.	Controls and Procedures	91
	Item 9B	Other Information	91
Part III.
	Item 10.	Directors and Executive Officers of the Registrant	92
	Item 11.	Executive Compensation	92
	Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	92
	Item 13.	Certain Relationships and Related Transactions	92
	Item 14.	Principal Accounting Fees and Services	93
Part IV.
	Item 15.	Exhibits and Financial Statement Schedules	94
		Signatures	95

3

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

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

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

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

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

· our projected need for additional borrowings and future liquidity;

· statements about our ability to implement and maintain effective controls and procedures;

· statements about the future size of markets;

· pending and threatened litigation and its outcome;

· our competition; and

· our projected capital expenditures.

You should not place undue reliance on our forward-looking statements. Actual events or results may differ materially. In evaluating these statements, you should specifically consider various factors, including the risks outlined under "Risk Factors" below. These 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.

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.

4

PART I

ITEM 1. BUSINESS

Overview

We are a global developer, manufacturer and marketer of thin film coatings for the automotive glass, electronic display, architectural glass and window film markets. We have developed a variety of products that control sunlight in automotive glass, reduce light reflection, reduce potentially harmful electromagnetic emissions and improve image quality in electronic display products, and conserve energy via the application of our architectural and after-market window film products. Our products consist of transparent solar-control films for automotive glass; anti-reflective films for computer screens and reflective films for back-lighting in liquid crystal displays; transparent conductive films for use in touch screen and plasma panel displays; energy control films for architectural glass; and various other coatings.

We maintain a website with the address of www.southwall.com. We are not including the information contained on our website as a part of, or incorporating it by reference into, this Annual Report on Form 10-K. We make available free of charge through our website our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after we electronically file such material with, or furnish such material to, the Securities and Exchange Commission. In addition, we intend to disclose on our website any amendments to, or waivers from, our code of business conduct and ethics that are required to be publicly disclosed pursuant to the rules of the Securities and Exchange Commission.

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 applications to control the transmission and reflection of light and the flow of energy. Thin film coatings can modify the transmission, reflection and absorption of both visible and non-visible light, such as infrared and ultra-violet light, to enhance the performance and characteristics of the material.

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.

5

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 pyrolytic 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 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.

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

The primary markets for thin film coated substrates that we manufacture are the automotive glass, electronic display, architectural glass and window film 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

The 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.

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 inside the automobile.

6

Electronic display products

The thin film coated products we sell in this market primarily block electromagnetic emissions and infrared energy, and enhance the light output of certain displays. Our thin film coated substrates are used in liquid crystal and plasma displays, and in applications such as touch screens. In 2002, we started shipping production quantities and sizes of an anti-reflective film specifically designed for the liquid crystal display, or LCD, market. In 2003, we started shipments of coatings for the plasma display panel, or PDP, market. Thin film coated substrates in this market are generally sold to OEMs, which apply the film to flat screens.

Architectural glass products

The 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; thus, the primary source of heat build-up and loss in buildings is through the glass windows.

Window Film

The thin film coated substrates we sell in this market are similar to the films sold into the automotive and architectural glass markets. Differences include certain product characteristics that allow the architectural window film products to be sold in the aftermarket rather than through the OEMs. In addition, our automotive window film products are used for retrofit application to the inside surface of a vehicle window and are sold through resellers who install the film.

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.

We rely extensively upon trade secrets and know-how to develop and maintain our competitive position. We have 29 patents and 10 patent applications pending in the United States and 63 patents and more than 31 patent applications pending outside the United States that cover materials, processes, products and production equipment. Of our existing patents, four U.S. patents and one international patent 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.

7

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 Sekurit Pilkington PLC AGC Automotive Americas Guardian Glass
Electronic display	Liquid crystal display (LCD) screens	Anti-reflective clear (ARC)	Clear anti-reflective product	Berliner Glass Mitsui Chemicals
	LCD reflector for lighting sources	Silver reflecting	95% Reflecting Light-weight mirror
	Plasma display panels (PDP)	Infrared reflective (TCP)	Clear and Conductive Clear infrared blocking	Mitsui Chemicals
Architectural glass	New and retrofit residential and commercial windows and doors	Suspended Heat Mirror	Cool in summer Warm in winter UV blocking Noise reducing	Kensington Windows Zamil Glass Traco
	Commercial buildings	Laminated (XIR)	Infrared reflecting UV blocking Cool in summer Noise reducing	Gulf Glass Industries Cristales Curvados
Window film	After-market installation	Solis/V-KOOL Huper Optik	Transmits up to 75% visible light Reflects up to 85% of infrared heat energy	Globamatrix Huper Optik
			Infrared reflecting UV blocking Cool in summer Noise reducing

Automotive glass products

Direct-to-glass sputtering for automotive windshields has not historically been well developed because of the need to bend the glass before it can be coated and then installed in an automobile. Coating flat glass and then bending it to match complex automobile designs is less difficult. Therefore, coating flat glass and then bending it is the method currently used by most windshield glass producers. Our sputter coated flexible substrates can be applied to windshields with different curvatures and incorporated into most in-line windshield production processes used by glass companies today.

8

Our XIR coated solar-control films are 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.

Our net revenues from sales of automotive glass products were $19.6 million, $20.6 million and $20.3 million in 2005, 2004 and 2003, respectively.

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.

Anti-reflective films. Our anti-reflective films minimize reflection of visible light while allowing high picture quality. Our anti-reflective clear, or ARC, films are clear and used in LCD and plasma display panel screens.

Silver reflecting films. Our silver reflecting film is a mirror-like product used as a reflector in LCD backlit screens and for mirrors in rear-projection TV systems.

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.

Our net revenues from sales of electronic display products were $14.0 million, $20.6 million and $19.0 million in 2005, 2004 and 2003, respectively.

Architectural glass 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. Our products allow architectural glass manufacturers 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.

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 more than 50 Heat Mirror licenses in approximately 20 countries. We currently offer 11 different Heat Mirror films for architectural applications.

9

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 more than 20 licenses for this architectural film product in approximately 15 countries.

Our net revenues from sales of architectural products were $5.9 million, $7.0 million and $6.3 million in 2005, 2004 and 2003, respectively.

Window Film Products

Our Solis/V-KOOL and Huper Optik solar-control films for automotive glass and architectural glass aftermarket installation use our XIR and other patented coating technologies. These products are applied to existing windows and have a protective hard coat over the patented, transparent solar-control coating on one side and an adhesion layer on the other. Solis/V-KOOL and Huper Optik are sold through a worldwide distribution network of companies owned by or affiliated with Globamatrix.

Our net revenues from sales of window film products were $15.1 million, $9.4 million and $7.7 million in 2005, 2004 and 2003, respectively.

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, and has exclusive manufacturing and distribution rights for certain of our electronic products using our proprietary sputtering technology.

We supply our Heat Mirror architectural products to approximately 50 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 6 regionally based architectural glass sales representatives.

We sell our Solis/V-KOOL and Huper Optik 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 74%, 79% and 89% of our net revenues during 2005, 2004 and 2003, respectively. The principal foreign markets for our products in 2005 were Japan ($12 million) and France ($11 million).

10

Quality claims

We accept sales returns for quality claims on our products, which we believe are competitive for the markets in which those products are sold. The nature and extent of these quality claims depend on the product, the market, and in some cases the customer being served. We carry liability insurance. However, our insurance does not cover quality 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 Sekurit, Pilkington PLC, and Asahi, who sell glass to automobile manufacturers including DaimlerChrysler, Renault, Audi, BMW, Volvo, Volkswagen and the PSA Group (which includes Peugot and Citroen). Our supply agreement with Saint Gobain Sekurit expired on December 31, 2005. We entered into a new agreement with Saint Gobain Sekurit in March of 2006. The new agreement will expire on February 29, 2008. Our failure to produce the required amounts of products under the new agreement could result in price penalties on future sales under the agreements.

Our customers in the electronic display market include Mitsui Chemicals and a number of other small accounts. Sales to Mitsui represented 23% of our total sales in 2005.

In 2005, our customers in the architectural market included approximately 50 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 a set amount 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. For each year after 2004 through and including 2011, Globamatrix is required to purchase an amount of product equal to 110% of the amount of product it was required to purchase in the prior year. Globamatrix was obligated to purchase $10.3 million of products in 2005. During 2005, Globamatrix purchased approximately $14.9 million of product. Globamatrix is obligated to purchase at least $11.3 million from us in 2006.

A small number of customers have accounted for a substantial portion of our revenues. Our ten largest customers accounted for approximately 81%, 79% and 84% of our net sales in, 2005, 2004 and 2003, respectively. During 2005, Mitsui Chemicals, Saint Gobain Sekurit, V-Kool and Pilkington PLC accounted for 22.7%, 19.8%, 19.5% and 7.1%, respectively, of our net revenues. During 2004, Mitsui Chemicals, Saint Gobain Sekurit, V-Kool and Pilkington PLC accounted for 28.4%, 17.8%, 11.4% and 10.9%, respectively, of our net revenues. During 2003, Mitsui Chemicals, Saint Gobain Sekurit, Pilkington PLC and V-Kool accounted for 21.4%, 17.2%, 13.7% and 10.0%, respectively, of our net revenues. 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.

11

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 and applied engineering. Our research and development expenditures totaled $5.1 million, $3.2 million and $6.7 million, or approximately 9.3%, 5.6% and 12.6% of total net revenues, in 2005, 2004 and 2003, 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, in 2002 we began shipping production quantities and sizes of an anti-reflective film 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. In 2003, we developed a new conductive film to satisfy Class B infrared shielding requirements for plasma display panels. In 2004, the Class B film was sold in substantial quantities for the first time for use in PDP televisions sets. In 2005, we began development and sampling of a new class of films with improved performance that we believe will be beneficial across our product lines. We also initiated significant research and development into thin film technology that we anticipate will enable Southwall to produce products for new applications and markets. We cannot guarantee that we will be successful in developing or marketing these applications or that our films will continue to meet the demanding requirements of the changing technology.

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.

In 2005, we hired a new Chief Technology Officer and expanded our engineering organization by hiring an additional eight engineers. We are committed to developing new technologies and expanding our product offerings.

12

Manufacturing

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

Machine Number	Location	Primary Markets For Current Production	Year Commercial Production Initiated	Estimated Annual Capacity (Millions of Sq. Ft.) (1)
PM 1	Palo Alto	Architectural	1980	none
PM 2	Palo Alto	Electronic display (currently not in use)	1982	6.0
PM 4A	Palo Alto	Automotive, architectural, electronic display and window film	1991	12.0
PM 4B	Palo Alto	Automotive, architectural, electronic display and window film	1991	12.0
PM 8	Dresden	Automotive, architectural, electronic display and window film	2000	16.0
PM 9	Dresden	Automotive, architectural, electronic displayand window film	2001	16.0
PM 10	Dresden	Automotive, architectural, electronic display and window film	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.

On January 19, 2006, we commenced restructuring actions to improve our cost structure for 2006 and beyond. These actions include the closure of our Palo Alto, California manufacturing facility in the first half of 2006. We intend to scrap or sell our production machines (PM 2, PM 4A and PM 4B) used for manufacturing in Palo Alto. We will transfer our U.S. manufacturing operations to our site located near Dresden, Germany in the first half of 2006.

Our Dresden, Germany facility is ISO 9001/2000 certified.

Dresden, Germany facility

We own a production plant in Grossroehrsdorf, Germany, near the city of Dresden. The plant has three production machines and manufactures approximately 60% of our products. Southwall’s Dresden plant is a supplier of automotive and architectural energy management films used by glass companies to enhance the thermal performance of their products; it is also a supplier of electronic display and window film.

Environmental Matters

We use potentially 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 both 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.

13

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, the substrate we use in the manufacture of the Heat Mirror product is currently available from one main qualified source, Teijin Limited. The loss of our current source could adversely affect our ability to meet our scheduled product deliveries to customers. 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 such sources.

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 February 28, 2006 and February 28, 2005, we had a backlog of orders able to be shipped over the next 12 months of approximately $8.2 million and $7.6 million, respectively. Some of these orders are not firm orders and 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. Large, worldwide glass laminators typically have divisions selling products to the commercial flat glass industry and provide solar control products in the automotive OEM market. We face technological competition from companies, such as PPG Industries, Pilkington PLC, Saint Gobain, Asahi, Guardian, and Glaverbel that have direct-to-glass sputtering capability. We may also be subject to future competition from companies that are able to infuse glass with solar control properties. We estimate that in 2005 our coated substrates were used in less than 1% of the total worldwide automotive OEM glass produced.

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 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 2005 our coated substrates were applied to less than 4% of the products in the worldwide, flat screen plasma display market.

14

Architectural glass market. Products that provide solar control and energy conservation have been available to this market for almost 25 years. Since our introduction of our Heat Mirror suspended film product in 1979, large glass producers, such as Guardian, PPG, Apogee Enterprises, Pilkington, Saint Gobain Sekurit, 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 2005 our coated substrates were used in less than 1% of the glass used worldwide in residential and commercial buildings.

Window film market. In the applied film segment of the 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.

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;

• Our state-of-the-art coating facility in a low-cost labor environment, which receives 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 December 31, 2005, we had 179 full-time and 5 part-time employees, of whom 25 were engaged in engineering, 110 in manufacturing, 19 in sales and marketing, and 30 in general management, finance and administration. We are highly dependent upon the continuing services of certain technical and management personnel. None of our U.S. employees is represented by a labor union. To our knowledge, none of our German employees are represented by a labor union. We consider our employee relations to be good.

15

ITEM 1A. RISK FACTORS

Financial Risks

Our working capital position, financial commitments and historical performance may raise doubt about our ability to have positive earnings in the future.

We incurred net losses in 2004 and 2003 and negative cash flows from operations in 2003. These factors together with our working capital position and our significant debt service and other contractual obligations at December 31, 2005, may raise doubt about our ability to restore profitable operations, generate cash flow from operating activities and obtain additional financing. These and other factors related to our business during recent years, our past failure to comply with covenants in our financing agreements and our voluntary delisting from NASDAQ in March 2004 may make it difficult for us to secure the required additional borrowings on favorable terms or at all. We intend to seek additional borrowings or alternative sources of financing; however, difficulties in borrowing money or raising financing could have a material adverse effect on our operations, planned capital expenditures and ability to comply with the terms of government grants.

A few stockholders own a majority of our shares and will be able to exert control over us and our significant corporate decisions.

As a result of the consummation of the financing transactions in December 2003 and February 2004 with Needham & Company, Inc and its affiliates and Dolphin Direct Equity Partners, L.P., these shareholders at December 31, 2005 owned securities convertible into 57% of our outstanding common stock. As our largest stockholder and the guarantor of our line of credit, Needham could prevent us from seeking additional borrowings or alternative sources of financing that we require for future operations, could delay or prevent a change of control of our company, or otherwise control the company in ways that might have a material adverse effect on our company or our other shareholders.

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

As of December 31, 2005, we had total outstanding obligations under our credit and other loan agreements of $13.1 million. Our inability to make timely payments of interest or principal under these facilities could materially adversely affect our ability to borrow money under existing credit facilities, to secure additional borrowings or to function as a going concern. Our current credit facilities contain financial covenants that will require us to meet certain financial performance targets and operating covenants that limit our discretion with respect to business matters. Among other things, these covenants restrict our ability to borrow additional money, create liens or other encumbrances, and make certain payments including dividends and capital expenditures. Many of these loans contain provisions that permit the lender to declare the loans immediately due if there is a material adverse change in our business. These credit facilities also contain events of default that could require us to pay off indebtedness before its maturity. The restrictions imposed by these credit facilities or the failure of lenders to advance funds under these facilities could force us to curtail our operations or have a material adverse effect on our liquidity.

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

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

16

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

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

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

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

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

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

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

• 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.

17

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

In 2003, 2004 and 2005, approximately 34%, 31% and 32% of our revenues, respectively, were denominated in euros, primarily related to sales from our Dresden operation, including sales to one of our largest customers, a European automotive glass manufacturer. In addition, other customers may request to make payments in foreign currencies. Also, certain transactions with foreign suppliers are denominated in foreign currencies, primarily Japanese Yen.

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 and cash flows. These fluctuations could also cause prospective customers to cancel or delay orders because of the increased relative cost of our products.

Our suppliers and subcontractors may impose more onerous payment terms on us.

As a result of our financial performance and voluntary delisting from NASDAQ, our suppliers and creditors may impose more onerous payment terms on us, which may have a material adverse effect on our financial performance and our liquidity. For example, one of our subcontractors has required us to provide it with a security interest in all of our inventory held by it and has limited the amount of unpaid invoices we may have outstanding with it at any time.

Operational Risks

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

Our ten largest customers accounted for approximately 82%, 79%, and 84% of net revenues in 2005, 2004 and 2003, respectively. We expect to continue to derive a significant portion of our net sales from this relatively small number of customers. Accordingly, the loss of a large customer could materially hurt our business, and the deferral or loss of anticipated orders from a large customer or a small number of customers could materially reduce our revenue and operating results in any period. Some of our largest automotive glass customers have used a technology—direct-to-glass sputtering—as an alternative to our window films, which in 2003 resulted in a decrease in orders from these customers. The continued or expanded use of this technology by our automotive glass customers would have a material adverse effect on our results of operations and financial position.

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:

18

• 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 tri-acetate cellulose, or TAC;

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

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

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

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

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 may not 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.

19

If one of our customers is able to enforce a European automotive film patent, we may be restricted from using the methods present in such patent to produce some of our products.

On March 3, 2005, the European Patent Office allowed a European patent owned by Pilkington Automotive GmBH entitled "Method for producing a laminated glass pane free of optical obstruction caused by warping, use of a particular carrier film for the production of the laminated glass pane and carrier films particularly suitable for the method of use." This European patent covers certain laminated films and methods of using them, which may prevent us from producing certain films designed for the automotive markets. Our inability to use this technology could adversely affect our ability to provide a full range of products to the automotive film market. We participated in opposing the European patent and have appealed the European Patent Office decision.

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 long-term contracts with only two 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 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.

20

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. Direct-to-glass sputtering represents the principal alternative technology to our sputter-coated film products. Direct-to-glass is a mature, well-known process for applying thin film coatings directly to glass, which is used by some of our current and potential customers to produce products that compete with our products. This technology is commonly used to manufacture products that conserve energy in buildings and automobiles. 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.

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. 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 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.

21

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, during 2005, we experienced a decrease of 32% from 2004 in our net revenues in the electronic display market primarily due to lower demand for our sputtered thin film filter products for Plasma Display Panel products due to increased competition, and we expect this trend to continue. Mitsubishi Electric was the only CRT manufacturer that buys our anti-reflective, or AR, film and it decided to consolidate all of the manufacturing of this product to Japan. In connection with that consolidation, Mitsubishi ceased production of the 17" AR product in its Mexico plant during the third quarter of 2003. In 2005, we stopped converting (cutting the film to the customer’s specifications) one of our window film product models and agreed with our customers that they would complete this process. This resulted in higher revenues on our TX products as our customers bought more products to fill their distribution pipeline.  

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. One of our U.S. patents relating to our architectural products, heat mirror, will expire in 2006. 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.

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:

22

• delays in collecting accounts receivable;

• higher manufacturing costs;

• additional warranty and service expenses; and

• reduced or cancelled orders.

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

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

In addition to our dependence on our technical personnel, our success also depends on our continuing ability to attract and retain other highly skilled employees. We depend on the continued services of our senior management, particularly Thomas G. Hood, our President and Chief Executive Officer and Neil Bergstrom, our Chief Technology Officer and Senior Vice President. 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.

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

Revenues from international sales amounted to approximately 74%, 79% and 89% of our net revenues during 2005, 2004 and 2003, respectively. The distance between our two manufacturing sites 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.

23

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. 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.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

24

ITEM 2. PROPERTIES

Our administrative, sales and marketing, research and development, engineering and manufacturing facilities are located in three buildings totaling approximately 58,000 square feet in Palo Alto, California. One of the buildings is occupied under a lease that expired on January 31, 2006, and the other two are occupied under leases that expire on July 31, 2006 and October 31, 2007. On January 19, 2006, we announced our plans to vacate our current Palo Alto facilities. We intend to relocate to another Silicon Valley facility for these functions. We are working out a surrender plan with the landlord for these premises. On February 19, 2004, we entered into the second amendment to the lease that was due to expire on January 31, 2006. This amendment reflected a payment schedule for a rent deferral for this facility. In January of 2006, we paid off approximately $1.2 million of this deferred rent. On July 14, 2005, we moved our warehouse from 210 Littlefield, So. San Francisco, CA into 2629B Terminal Blvd., Mountain View, CA. The term of this lease is a period of one year, commencing on August 1, 2005 and terminating on July 31, 2006, with monthly rent payments of $5,655. In addition, we own a 60,000 square foot building in Dresden, Germany, which we took possession of in May 2000.

ITEM 3. LEGAL PROCEEDINGS

The Company was named as a defendant, along with Bostik, Inc., in an action captioned WASCO Products, Inc. v. Southwall Technologies, Inc. and Bostik, Inc., Civ. Action No. C 02 2926 SBA, which was filed in Federal District Court for the Northern District of California on June 18, 2002. We were served with the Complaint in this matter on July 1, 2002. The plaintiff filed the matter as a class action on behalf of all entities and individuals in the United States who manufactured and/or sold and warranted the service life of insulated glass units manufactured between 1989 and 1999, which contained Southwall Heat Mirror film and were sealed with a specific type of sealant manufactured by Bostik, Inc. The plaintiff alleged that the sealant provided by Bostik, Inc. was defective, resulting in elevated warranty replacement claims and costs. The plaintiff asserted claims against us for breach of an implied warranty of fitness, misrepresentation, fraudulent concealment, negligence, negligent interference with prospective economic advantage, breach of contract, unfair business practices and false or misleading business practices. The plaintiff sought recovery on behalf of the class of $100 million for damages allegedly resulting from elevated warranty replacement claims, restitution, injunctive relief, and non-specific compensation for lost profits. By Order entered December 22, 2003, the Court dismissed all claims against us. The plaintiff has filed a notice of appeal to the Ninth Circuit Court of Appeals. On January 13, 2006, the Court of Appeals affirmed the lower court decision. On January 26, 2006, the plaintiff filed a petition for rehearing with the Ninth Circuit Court of Appeals. In March of 2006, the Ninth Circuit Court of Appeals denied the plaintiff’s petition. A percentage of the Company’s defense costs are being paid by its insurance carriers under reservation of rights.

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

25

On June 13, 2002, Plaintiff Charles Ikekwere (“Plaintiff”) filed a Complaint against Southwall in the Superior Court of California in and for the County of Santa Clara, Case No. CV808644. Mr. Ikekwere is a former employee of our company. Plaintiff’s Complaint alleged claims for race discrimination, national origin discrimination, retaliation, medical condition discrimination, breach of contract, breach of fiduciary duty, fraud, negligence, intentional infliction of emotional distress, and punitive damages. We challenged the sufficiency of certain of Plaintiff’s allegations, which caused him to file a First Amended Complaint alleging essentially the same claims. We also challenged certain of Plaintiff’s allegations in his First Amended Complaint, which caused him to file a Second Amended Complaint. Following our legal challenges to Plaintiff’s Second Amended Complaint, the following claims remain at issue in the litigation: (1) race discrimination; (2) national origin discrimination; (3) retaliation; (4) medical condition discrimination; (5) breach of contract; (6) violation of California Constitution Article I; and (7) fraud and deceit. In light of certain deposition testimony given by Plaintiff, we removed this matter to Federal Court on January 6, 2004. The basis for our removal was that certain of Plaintiff’s allegations were preempted by the Employee Retirement Income and Security Act (ERISA). On February 4, 2004, Plaintiff filed a Motion to Remand the case to State Court, which the Court denied. Plaintiff subsequently amended his Second Amended Complaint to add a claim under ERISA. The parties have almost completed all discovery, with just one deposition remaining. The parties have finished expert discovery. We have filed a summary judgment motion, which, if granted, will dispose of the entire action. If Plaintiff defeats our summary judgment motion, trial is scheduled for July 2006. Until discovery is completed and the Court rules on our summary judgment motion, it is not possible to predict how Plaintiff’s claims will be resolved, whether we will be found liable, or the nature and extent of Plaintiff’s alleged damages.

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.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

Executive Officers of Registrant

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

Name	Age	Position
Thomas G. Hood	50	President, Chief Executive Officer and Director
Neil Bergstrom	56	Chief Technology Officer and Senior Vice President, Engineering
Dennis Capovilla	46	Senior Vice President, Sales and Marketing
Sylvia Kamenski	53	Vice President, Finance
Sicco W.T. Westra	55	Vice President, Business Development
Wolfgang Heinze	57	Vice President, General Manager Southwall Europe GmbH

Thomas G. Hood has served as our President and Chief Executive Officer since July 1998 and as a member of our board of directors 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 our patents. Mr. Hood has an MS degree in Mechanical Engineering from New Mexico State University.

26

Neil Bergstromjoined Southwall in June 2005 as Chief Technology Officer and Senior Vice President, Engineering. His responsibilities include technology development, new product development, and thin film engineering. From 2004 to 2005, Dr. Bergstrom was Vice President of Engineering at Qualcomm MEMS Technologies, an LCD displays manufacturer, and from 2002 to 2004, held the same position at Iridigm Display, the iMoD displays manufacturer, prior to its acquisition by Qualcomm. In this strategic role, he successfully developed and transferred new MEMS display technology into existing LCD display manufacturing lines. Dr. Bergstrom joined Iridigm Display as Vice President of Business Development and successfully established key offshore manufacturing partnerships. From 1997 to 2002, Dr. Bergstrom served as Chief Technology Officer at Inviso, an international provider of high technology video/audio/data transport, signal management and display solutions for television broadcast, telecommunications, cable television and video production, and headed the technology development team and established ongoing relationships with the company's key technology partners and suppliers. From 1992 to 1996, he was with Apple Computer where he managed the Advanced Display Department and initiated Apple's move into flat panel monitor products. Dr. Bergstrom began his career at Intel Corporation as a researcher and as Process Integration Manager for memory chip technologies in the Technology Development Division from 1982 until 1986. He holds a Ph.D. in Physics from U.C. Berkeley.

Dennis Capovilla joined Southwall in July 2003. Mr. Capovilla came to Southwall from Palm, Inc., a manufacturer of personal digital assistant devices, where he was the Vice President, Enterprise sales since 2002. From 1997 to 2002 he was with FATBRAIN, LLC, an e-commerce provider of books and information products, as the President and Chief Executive Officer from 2000-2002, the President and Chief Operating Officer from 1999 to 2000, and the VP of Sales and Business Development from 1997-1999. From 1993-1997, Mr. Capovilla was with Apple Computer, Inc., a computer manufacturer, as the Director, Americas Imaging Division and Worldwide Printer Supplies (1996-1997), Manager Printer Supplies Business unit (1995-1996) and as Worldwide Product Marketing Manager, Imaging Systems (1993-1995). Prior, Mr. Capovilla held various Sales and Marketing Management positions with Versatec, Inc. and Xerox Corporation. Dennis holds a B.S. in Marketing from the University of Santa Clara.

Sylvia Kamenski has been our Vice President of Finance since December 16, 2005. She joined Southwall in June of 2004 as Corporate Controller. Ms. Kamenski was appointed as Acting CFO in June 2005, and has played an expanded role in the management of the financial operations for the Company. Prior to joining Southwall from 2001 to 2003, Ms. Kamenski worked as Corporate Controller at Genus, Inc., a manufacturer of capital equipment and deposition processes for advanced semiconductor manufacturing, and from 1991 to 1997 in senior financial positions at Acuson Corporation, a manufacturer of high-performance systems that generate, display, archive and retrieve medical diagnostic ultrasound images. From 1984 until 1989, Ms. Kamenski worked for Raychem Corporation, a manufacturer of a variety of high-performance products for applications in electronics, telecommunications, transportation, infrastructure, and energy networks markets. Ms. Kamenski began her career in the audit and tax departments of Price Waterhouse, LLP (now PricewaterhouseCoopers), where she received her Certified Public Accountant certification. Ms. Kamenski holds a B.S. in Business Administration with a major in accounting from the University of San Francisco.

27

Sicco W. T. Westra has been Vice President, Business Development since June 2002. From August 1998 until June 2002, he was the Senior Vice President, Engineering and Chief Technical Officer of Southwall. From February 1998 until August 1998, he served as the Director of Global Production Management for Applied Materials, Inc., a provider of products and services to the semiconductor industry. From March 1994 to August 1998, he served as a Manager of Business Development for BOC Coating Technology, Inc., a manufacturer of sputter-coating equipment. 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, General Manager Southwall Europe GmbH. Prior to joining Southwall; Mr. Heinze had been the Chief Executive Officer of FUBA Printed Circuits, GmbH, a manufacturer of printed circuit boards, from February 1991 to April 1998. Mr. Heinze has a MD of Commercial Science from the Technical University in Merseburg, Germany.

28

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock is traded on the Over-the-Counter Bulletin Board Market under the symbol "SWTX.OB". From the completion of our initial public offering in June 1987 until March 26, 2004, our common stock was traded on the NASDAQ National Market System. Effective March 26, 2004, we voluntarily de-listed from NASDAQ and applied to begin trading on the Over-the-Counter Bulletin Board Market. As a result of our February 2004 financing transactions, in which we issued convertible promissory notes and warrants, we were no longer in compliance with certain NASDAQ listing requirements. We felt that a voluntary delisting from NASDAQ and move to the Over-the-Counter Bulletin Board Market would provide the best option to our stockholders by retaining liquidity in our common stock. Prices in the following table represent the high and low closing sales prices per share for our common stock as reported by NASDAQ and Over-the-Counter Bulletin Board Market during the periods indicated.

	High		Low
2005
1st Quarter	$	1.82	$	1.00
2nd Quarter		1.65		1.07
3rd Quarter		1.25		0.85
4th Quarter		0.89		0.52
2004
1st Quarter	$	2.09	$	0.98
2nd Quarter		0.94		0.40
3rd Quarter		0.85		0.48
4th Quarter		1.72		0.48

On February 28, 2006, the last reported sale price for our common stock as reported on the Over-the-Counter Bulletin Board Market was $0.73 per share. On such date, there were approximately 289 holders of record of our common stock, and we believe there were approximately 3,000 beneficial owners of our common stock.

Dividends

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. The Series A 10% Preferred Stock is entitled to cumulative dividends of 10% per year, payable at the discretion of our Board of Directors. We currently intend to retain future earnings, if any, to fund the expansion and growth of our business. Furthermore, payment of cash dividends on our common stock is prohibited without the consent of our Series A 10% Preferred stockholders. Per our credit agreement with Wells Fargo Bank, we are allowed to declare and pay up to $600,000 in preferred stock dividends on a per annum basis.

29

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

The following selected consolidated financial data as of and for each of the five years ended December 31, 2005 are derived from our audited consolidated financial statements. 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 report.

Consolidated Statements of Operations Data:

	Years Ended December 31,
	2005			2004			2003			2002			2001
	(in thousands, except per share data)
Net revenues	$	54,574		$	57,573		$	53,326		$	68,759		$	82,976
Cost of revenues		37,241			36,787			45,914			49,614			60,148
Gross profit		17,513			20,786			7,412			19,145			22,828
Gross profit %		32.0	%		36.1	%		13.9	%		27.8	%		27.5	%
Operating expenses:
Research and development		5,104			3,199			6,714			7,685			5,456
Selling, general and administrative		8,332			10,217			12,348			12,450			11,036
Restructuring costs (recoveries)		--			--			(65	)		2,624			--
Impairment charge (recoveries) for long-lived assets		(170	)		(1,513	)		27,990			--			--
Total operating expenses		13,266			11,903			46,987			22,759			16,492
Income (loss) from operations		4,247			8,883			(39,575	)		(3,614	)		6,336
Interest expense, net		(973	)		(2,206	)		(1,590	)		(1,734	)		(2,872	)
Costs of warrants issued		--			(6,782	)		(865	)		--			--
Other income, net		75			534			419			1,070			1,385
Income (loss) before provision for (benefit from) income taxes		3,349			429			(41,611	)		(4,278	)		4,849
Provision for (benefit from) income taxes..		29			614			681			(87	)		214
Net income (loss)		3,320			(185	)		(42,292	)		(4,191	)		4,635
Deemed dividend on preferred stock		490			--			--			--			--
Net income (loss) attributable to common stockholders	$	2,830		$	(185	)	$	(42,292	)	$	(4,191	)	$	4,635
Net income (loss) per share:
Basic	$	0.11		$	(0.01	)	$	(3.37	)	$	(0.40	)	$	0.58
Diluted	$	0.10		$	(0.01	)	$	(3.37	)	$	(0.40	)	$	0.57
Weighted average shares used in computing net income (loss) per share:
Basic		26,743			14,589			12,537			10,418			8,032
Diluted		32,895			14,589			12,537			10,418			8,186

30

Consolidated Balance Sheet Data:

	As of December 31,
	2005		2004		2003			2002		2001
	(in thousands)
Cash, cash equivalents and restricted cash	$	7,002	$	5,233	$	1,891		$	2,629	$	3,362
Working capital (deficit)		8,691		6,528		(4,210	)		588		(6,471	)
Property, plant and equipment		16,857		21,110		21,787			50,251		47,841
Total assets		39,641		44,947		41,721			76,582		73,158
Term debt and capital leases including current portion		10,107		13,107		15,700			16,752		22,828
Total liabilities		23,702		30,374		40,000			36,108		46,706
Preferred stock		4,810		4,810		--			--		--
Total stockholders' equity		11,129		9,763		1,721			40,474		26,452

Selected Cash Flow Data:

	Years Ended December 31,
	2005			2004			2003			2002			2001
	(in thousands)
Net cash provided by (used in) operating activities	$	4,006		$	3,830		$	(2,990	)	$	(2,824	)	$	13,792
Net cash provided by (used in) investing activities		(342	)		1,261			(2,775	)		(6,014	)		(5,698	)
Net cash provided by (used in) financing activities		(1,566	)		(2,249	)		5,548			7,679			(4,628	)

Quarterly Financial Data:

The following table sets forth consolidated statements of operations data for the eight fiscal quarters ended December 31, 2005. This information has been derived from our unaudited condensed consolidated financial statements and has been prepared on the same basis as our audited consolidated financial statements contained in this report. It includes all adjustments, consisting only of normal recurring adjustments 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 report.

31

Selected Quarterly Financial Information (Unaudited):

	Quarters Ended
	Apr. 3, 2005		Jul. 3, 2005		Oct. 2, 2005			Dec. 31, 2005
	(in thousands, except per share amounts)
Net revenues	$	15,647	$	15,172	$	12,025		$	11,910
Cost of revenues		11,270		9,788		7,921			8,262
Gross profit		4,377		5,384		4,104			3,648
Income (loss) before provision for (benefit from) income taxes		1,846		1,580		465			(542	)
Net income		1,699		1,395		15			211
Deemed dividend on preferred stock		123		120		120			127
Net income (loss) attributable to common stockholders	$	1,576	$	1,275	$	(105	)	$	84
Net income per share:
Basic	$	0.06	$	0.05	$	0.00		$	0.00
Diluted	$	0.05	$	0.04	$	0.00		$	0.01
Weighted average shares used in computing net income per share:
Basic		26,613		26,782		26,788			26,790
Diluted		33,181		33,094		32,720			32,375

	Quarters Ended
	Mar. 28, 2004			Jun. 27, 2004		Sep. 26, 2004		Dec. 31, 2004
	(in thousands, except per share amounts)
Net revenues	$	11,067		$	14,548	$	15,932	$	16,026
Cost of revenues		8,466			8,936		10,152		9,233
Gross profit		2,601			5,612		5,780		6,793
Income (loss) before provision for (benefit from) income taxes		(6,335	)		1,529		1,834		3,401
Net income (loss)	$	(6,690	)	$	1,186	$	2,132	$	3,187
Net income (loss) per share:
Basic	$	(0.53	)	$	0.09	$	0.17	$	0.16
Diluted	$	(0.53	)	$	0.04	$	0.07	$	0.10
Weighted average shares used in computing net income (loss) per share:
Basic		12,548			12,548		12,550		20,327
Diluted		12,548			31,416		31,218		32,697

Our results of operations have varied significantly from quarter to quarter, and we expect them to continue to do so in the future. As a result of our high fixed costs, if revenues fall below our expectations, we may not be able to reduce our spending sufficiently to prevent a loss from operations. We anticipate that our sales 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 continue to vary significantly.

32

Other factors that could affect our quarterly operating results include those described elsewhere in this report 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;

· our ability to maintain sufficient liquidity;

· 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;

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

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

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

· 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; and

· product returns and customer allowances stemming from product quality defects.

33

ITEM 7. 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 Item 6, "Selected Consolidated Financial Data", our consolidated financial statements and notes thereto appearing elsewhere in this report and the risk factors set forth in Item 1A. 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.

Overview

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

Our cash and cash equivalents increased by $2.1 million from $4.5 million at December 31, 2004 to $6.6 million at December 31, 2005. Cash provided by operating activities increased by $0.2 million from $3.8 million in 2004 to $4.0 million in 2005. The increase in cash provided by operating activities during 2005 was primarily the result of net income for the year of $3.3 million, non-cash depreciation of $2.2 million, and decreases in inventories of $2.5 million and in other current and non-current assets of $0.9 million partially offset by impairment recoveries from long-lived assets of $0.2 million, change in deferred income taxes of $0.5 million, an increase in accounts receivable of $0.9 million and a decrease in accounts payable and accrued liabilities of $3.4 million. Cash used in investing activities in 2005 was $0.3 million compared to $1.3 million provided by investing activities in 2004. The decrease was primarily due to proceeds from the sale of a fixed asset of $1.6 million in 2004. Cash used in financing activities decreased by $0.6 million from $2.2 million used in financing activities in 2004 to $1.6 million used in financing activities in 2005. The decrease was the result of less debt outstanding in 2005, which resulted in lower principal repayments.

Demand for our customers' products, which has a significant effect on our results, has changed rapidly from time to time in the past and may do so in the future. For example, as a result of changing demand in the personal computer industry from 1999 through 2003, our electronic display revenues rose from $16.0 million in 1999 to $47.7 million in 2000 then declined to $29.7 million, $26.6 million and $19.0 million in 2001, 2002, and 2003, respectively, increased to $20.6 million in 2004 and decreased to $14.0 million in 2005. Similarly, revenues from our automotive segment rose from $20.2 million in 2000, to $37.4 million in 2001, and declined to $20.4 million, $20.3 million, $20.6 million and $19.6 million in 2002, 2003, 2004, and 2005 respectively, because of competition from alternative technology solutions. Demand for our products 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.

Our research and development expenditures increased from $3.2 million in 2004 to $5.1 million in 2005. In 2005, we began development and sampling of a new class of films with improved performance that we believe will be beneficial across our product lines. We also initiated significant research and development into thin film technology that we anticipate will enable Southwall to produce products for new applications and markets. In 2005, we hired a new Chief Technology Officer and expanded our engineering organization by hiring an additional eight engineers. We are committed to developing new technologies and expanding our product offerings.

34

On January 19, 2006, we commenced restructuring actions to improve our cost structure for 2006 and beyond. These actions include the closure of our Palo Alto, California manufacturing facility and a reduction in force at our Palo Alto site during the first half of 2006. We will transfer our U.S. manufacturing operations to the European site located near Dresden, Germany in the first half of 2006. As a result of these restructuring actions, we expect to substantially reduce our total operating expenses.

Financing and Related Transactions

Background.

During 2003, we experienced a significant decline in sales which led to a significant deterioration in our working capital position, which raised concerns about our ability to fund our operations and continue as a going concern in the short term and our ability to meet obligations coming due over the following few years.

At this time, management developed a restructuring plan that included:

• Shutting down a majority of our domestic manufacturing and transferring that production to our Dresden, Germany facility;

• Beginning a series of staggered layoffs;

• Arranging new payment terms with all major creditors and vendors to extend or reduce our payment obligations;

• Accelerating our cash collections;

• Reducing our operating expenses and inventory levels; and

• Minimizing our capital expenditures.

We also began to solicit and receive proposals from potential investors and lenders. We evaluated a variety of public and private market alternatives to raise additional capital, as well as alternatives to restructure our upcoming payment obligations without raising additional capital. Our access to the traditional capital markets was, and continues to be, constrained, however, by a number of factors, including the risks described under "Risk Factors" in Item 1A. As a result, we concluded that a private equity investment was the most attractive alternative to continue as a going concern. On December 18, 2003, in order to raise cash to fund our operations and continue as a going concern, we entered into an investment agreement with Needham & Company, Inc., Needham Capital Partners II, L.P., Needham Capital Partners II (Bermuda), L.P., Needham Capital Partners III, L.P., Needham Capital Partners IIIA, L.P., Needham Capital Partners III (Bermuda), L.P., (together referred to as “Needham Company and its Affiliates”) and Dolphin Direct Equity Partners, LP (collectively with Needham Company and its Affiliates, “the Investors”). On January 19, 2004, due to the structure of the transaction contemplated by the investment agreement, we did not have enough authorized and un-issued shares to satisfy the existing commitments had all outstanding warrants been exercised thereby triggering liability classification for all outstanding warrants. We measured and re-measured the fair value of the warrants at the issuance dates and each subsequent quarter end based on a methodology used by a third party until our stockholders approved the increase of the number of authorized shares of our common stock in the fourth quarter of 2004.

35

On February 20, 2004, we amended and restated the investment agreement and issued $4.5 million of Secured Convertible Promissory Notes that were convertible into our Series A 10% Cumulative Convertible Preferred Stock, par value $0.001 per share, or the Series A shares, at a conversion price of $1.00 per share, together with warrants initially exercisable for 13,881,535 shares of our common stock at a nominal exercise price. Each of the Series A shares is convertible into common stock at any time at the option of the holder at a conversion price of $1.00 per share, subject to adjustment, plus accumulated but unpaid dividends. The securities issued were exempt from registration under Regulation D of the Securities Act of 1933, as amended.

On October 5, 2004, our stockholders approved an amendment to our certificate of incorporation to increase the number of authorized shares of common stock from 20,000,000 to 50,000,000 and the total number of authorized shares of capital stock from 25,000,000 to 55,000,000. This provided us with sufficient number of available shares to cover all possible future conversions and exercises of all outstanding notes and warrants. We reclassified $8.1 million of accrued warrant liability from other long term liabilities to additional paid in capital in the fourth quarter of 2004 in connection with the stockholder approval.

On November 4, 2004, Needham Company and its Affiliates received a total of 9,155,379 shares of our common stock upon the exercise of warrants. In exercising the warrants, the Needham entities elected to use a “cashless exercise option” in which 98,977 of the shares underlying the warrants were surrendered in lieu of paying in cash the exercise price. The warrants were originally exercisable for 9,254,356 shares of our common stock at an exercise price of $0.01 per share of common stock. The value of the 98,977 shares of common stock surrendered was based upon the average trading price on November 3, 2004 of our common stock on the Over-the-Counter Bulletin Board Market.

On November 24, 2004, Dolphin Direct Equity Partners, LP exercised warrants to purchase a total of 4,627,179 shares of our common stock. Dolphin paid approximately $46,000 in cash as the exercise price.

On December 31, 2004, Needham Company and its Affiliates and Dolphin Direct Equity Partners, LP elected to convert all outstanding principal of, and accrued but unpaid interest on, their Secured Convertible Promissory Notes into Series A shares. The Secured Convertible Promissory Notes by their terms were convertible at the option of the holders into Series A shares at a rate of one share for each $1.00 of principal or interest converted. The aggregate principal amount of the Secured Convertible Promissory Notes was $4,500,000 and interest accrued thereon as of the time of conversion was $392,500. The aggregate number of shares of Series A shares issued as a result of the conversion was 4,892,500. In particular, Needham Company and its Affiliates received 3,261,667 shares and Dolphin Direct Equity Partners, LP received 1,630,833 shares. In 2005, we accrued $0.5 million of deemed dividend on preferred stock as a result of the conversion of our secured convertible promissory notes into shares of Series A preferred stock in December 2004.

At December 31, 2005, Needham Company and Affiliates and Dolphin Direct Equity Partners, LP own 31.9% and 17.3%, respectively, of our outstanding common stock. In addition, if Needham Company and its Affiliates and Dolphin had converted their Series A shares into common stock at December 31, 2005, they would have owned 37.2% and 19.8%, respectively, of our outstanding common stock.

36

Material Terms of the Series A Shares

Our Series A share have the following terms:

• Dividends. Each of the Series A shares have a stated value of $1.00 and are entitled to a cumulative dividend of 10% per year, payable at the discretion of the Board of Directors. Dividends on the Series A shares accrue daily commencing on the date of issuance and are deemed to accrue whether or not earned or declared and whether or not there are profits, surplus or other funds legally available for the payment of dividends. Accumulated dividends, when and if declared by the Board, will be paid in cash.

• Restrictions. So long as any Series A shares are outstanding, unless all accrued dividends on all Series A shares have been paid, we are prohibited from taking certain actions, including redeeming or purchasing shares of our common stock and paying dividends on our common stock.

• General Voting Rights. Except under certain circumstances or as otherwise provided by law, the holders of Series A shares have no voting rights. The approval of the holders of a majority of the Series A shares voting separately as a class will be required to effect certain corporate actions.

• Liquidation Preference. Upon a liquidation or dissolution of Southwall, the holders of Series A shares are entitled to be paid a liquidation preference out of assets legally available for distribution to our stockholders before any payment may be made to the holders of common stock. The liquidation preference is equal to the stated value of the Series A shares, which is $1.00 per share, plus any accumulated but unpaid dividends. Mergers, the sale of all or substantially all of our assets, or the acquisition of Southwall by another entity and certain other similar transactions may be deemed to be liquidation events for these purposes.

• Conversion. Each of the Series A shares is convertible into common stock at any time at the option of the holder. Each of the Series A shares is convertible into a number of shares of common stock equal to the sum of its stated value plus any accumulated but unpaid dividends, divided by the conversion price of the Series A shares. The conversion price of the Series A shares is $1.00 per share and is subject to adjustment in the event of any stock dividend, stock split, reverse stock split or combination affecting such shares. The Series A shares also have anti-dilution protection that adjusts the conversion price downwards using a weighted-average calculation in the event we issue certain additional securities at a price per share less than the closing price per share of our common stock on any stock exchange on which our common stock is listed. Each Series A share is initially convertible into one share of common stock. If the closing price of our common stock on any stock exchange on which our common stock is listed is $4.00 or more per share (subject to appropriate adjustment if a stock split, reverse split or similar transaction is affected) for 30 consecutive days, all outstanding Series A shares shall automatically be converted.

• Redemption. The Series A shares are not redeemable.

37

Agreements with Major Creditors

Judd Properties, LLC. In January 2004, we reached an agreement with Judd Properties, L.P., or Judd, to modify our obligations under the lease for our executive offices. We agreed to a payment schedule that extends our obligations and provides us with options to extend the lease. We further agreed to issue a warrant issuable for 4% of our capital stock on a fully diluted basis to be held in an escrow account as security for our obligations in the event we fail to restore the property in accordance with the original lease terms upon our departure from the premises. Upon our departure, if we fail to restore the property in accordance with the original lease the warrant will be released to Judd. The warrant is exercisable for 1,410,426 shares of our common stock at a nominal exercise price. The other terms of the warrant mirror the terms of the warrants issued to the Investors. Judd will hold certain registration rights with respect to the warrant shares. Because we did not have available enough authorized shares of common stock to issue upon exercise of the warrant, we were required to issue a letter of credit in the amount of $1.0 million to be held by Judd as security for our obligations until such time as the requisite number of authorized shares were approved by our stockholders on the condition that we are in compliance with the settlement agreement. The letter of credit is collateralized by $1.0 million of our cash, which will not be released by the bank that issued the letter of credit until Judd releases the letter of credit. Following the approval of the charter amendment by our stockholders, Judd maintained that we were not fully in compliance with the settlement agreement and refused to release the letter of credit. Judd continues to hold the letter of credit pending the resolution of discussions regarding the restoration of the property. At December 31, 2005 and December 31, 2004, our accrued liability to Judd Properties L.P. was approximately $1.2 million and $0.9 million, respectively. On January 19, 2006, the Company announced its plans to vacate its current Palo Alto facility, which also serves as its headquarters and houses its research and development, sales and marketing and general and administrative functions. The Company intends to relocate to another Silicon Valley facility for these functions. The lease expired on January 31, 2006 and the Company is working out a surrender plan with Judd Properties L.P. for these premises. On January 31, 2006, the Company paid its accrued liability of $1.2 million to Judd. Until an agreement is reached, the Company intends to pay its monthly rent obligation to Judd.

Portfolio Financial Servicing Company, Bank of America and Lehman Brothers. On February 20, 2004, we entered into a settlement agreement with Portfolio Financial Services, Bank of America and Lehman Brothers, which extinguished a claim arising out of sale-leaseback agreements, which we entered into in connection with the acquisition of two of our production machines. As part of the settlement, we agreed to pay a total of $2.0 million plus interest over a period of 6 years. The settlement required us to make an interest payment in 2004, and beginning in 2005, we will make quarterly principal and interest payments until 2010. We also agreed to return the production machines in question. If we fail to make the required payments, Portfolio Financial Services, Bank of America and Lehman Brothers may enter a confession of judgment against us in the amount of $5.9 million. In 2005, we paid Portfolio Financial Services $0.2 million in principal and interest payments.

Richard A. Christina and Diane L. Christina Trust. On December 1, 2003, we reached an agreement with the Richard A. Christina and Diane L. Christina Trust (the "Trust") to modify the lease agreement for a building located in Palo Alto, California. Under the terms of the agreement we agreed to the Trust's claim for damages in the amount of $0.3 million. At December 31, 2005 and December 31, 2004, our accrued liability to the Trust was approximately $0.2 million and $0.3 million, respectively.

Other Factors Affecting Our Financial Condition and Results of Operations

Restructuring activities. As a consequence of the decline in our revenues and negative cash flows, we implemented several cost cutting and business restructuring activities during 2003 and 2004. These activities, which included employee layoffs and the closure of several facilities (including the closure of our Tempe manufacturing facility in the fourth quarter of 2003), were designed to improve our cash flow from operations to allow us to continue as a going concern. During the fourth quarter of 2003 and the first quarter of 2004, we agreed to new payment terms with all of our major creditors and vendors, which extended or reduced our payment obligations. We also entered into the investment agreement described above pursuant to which we issued $4.5 million of convertible promissory notes and warrants to investors. The convertible promissory notes were converted to Series A shares and the warrants were exercised for shares of common stock in the fourth quarter of 2004. Our line of credit facility with Pacific Business Funding (“PBF”) expired on May 5, 2005. On April 28, 2005, we entered into a credit agreement (the “Credit Agreement”) with Wells Fargo HSBC Trade Bank, N.A. (the “Bank”). The Credit Agreement provides for two facilities. All amounts borrowed under both facilities under the Credit Agreement must be repaid on or before May 31, 2006. On January 19, 2006, the Company announced restructuring activities that included the closure of it Palo Alto, California manufacturing plant and reduction in force of approximately 22% of worldwide headcount. The Company will accrue restructuring costs in 2006.

38

See Note 13 of Notes to Consolidated Financial Statements (Item 8)- Subsequent Events.

Voluntary Delisting from NASDAQ. Effective March 26, 2004, we voluntarily delisted from the NASDAQ National Market and applied to begin trading on the Over-the-Counter Bulletin Board Market. Due to the structure of the transaction contemplated by the investment agreement discussed above, we were no longer in compliance with certain NASDAQ listing requirements. We felt that a voluntary delisting from NASDAQ and a move to the Over-the-Counter Bulletin Board Market would provide the best option to our shareholders by retaining liquidity in our common stock.

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

Our customers in the automotive glass market include Pilkington PLC, Saint Gobain Sekurit and Globamatrix Holdings Pte. Ltd., or Globamatrix, which collectively accounted for approximately 54%, 45% and 45% of our total revenues in 2005, 2004 and 2003, respectively.

In September 2003, we entered into an amendment of the agreement with Globamatrix to materially reduce the quantity of product they are required to purchase from us. The adjustment was due to certain events beyond the control of the parties, including the Asian SARs epidemic, which affected the demand for our film products distributed by Globamatrix. The amendment provided that Globamatrix was required to purchase at least $7.6 million of product in 2003 (rather than $13.25 million as required in the original distribution agreement). In December 2003, the distribution agreement was further amended to set Globamatrix's 2004 minimum purchase commitments at $9.0 million. Under the original distribution agreement, Globamatrix had been required to purchase at least $15.25 million of product in 2004. For each year after 2004 through and including 2011, Globamatrix is required to purchase an amount of product equal to 110% of the amount of product it was required to purchase in the prior year. Globamatrix was obligated to purchase $10.3 million of products in 2005. During 2005, Globamatrix purchased approximately $14.9 million of product. For the year ended December 31, 2005, Globamatrix is obligated to purchase $11.3 million of products in 2006.

Sales returns and allowances. Our gross margins and profitability have been adversely affected from time to time by product quality claims. From 2002 to 2005, our sales returns provision has averaged approximately 2.7% to 4.5% of gross revenues. During 2005, our sales returns provision has averaged approximately 3.4% of our gross revenues due to fewer quality claims received during the period.

39

Restructuring costs. Based on lower revenue expectations, in December 2002, we transferred most of our product manufacturing from our Palo Alto manufacturing site to our Tempe and Dresden manufacturing facilities, which have lower cost structures. In addition, we implemented a reduction in force at our Palo Alto location in December 2002, and consolidated our Palo Alto facilities. As a result, we incurred a restructuring charge of $2.6 million in 2002 relating to employee severance packages and the remaining rents due on excess facilities in Palo Alto that would no longer be occupied. Of the $2.6 million, approximately $0.2 million of the restructuring costs were paid in fiscal 2002. During the first quarter of 2003, we recorded a $65,000 reduction to our restructuring accrual as a result of modifications to the severance packages of certain employees. In the second quarter of 2003, we implemented a reduction in force in our Tempe and Palo Alto locations. As a result, we incurred a charge and made cash payments of $0.1 million relating to employee severance packages, which is recorded in cost of sales. During the fourth quarter of fiscal 2003, we implemented another reduction-in-force as well as closed our Tempe manufacturing facility; however, no restructuring charges were incurred in the fourth quarter of 2003. We also did not incur restructuring charges during the year ended December 31, 2005 and December 31, 2004.

Impairment charge for long-lived assets. During 2003, we experienced shortfalls in revenue compared to our budgeted and forecasted revenues. In addition, in the third quarter of 2003, we determined that due to reduced demand for our products, anticipated revenues through the remainder of 2003 and 2004 would be substantially below historical levels. As our U.S. operations have a higher operating cash break-even point compared to our Dresden operations, we believed that the lower than anticipated revenues indicated that an impairment analysis of the long-lived assets of our U.S. operations was necessary at September 28, 2003. Subsequently, in the fourth quarter of 2003, as a result of our decision to close the Tempe operation, we concluded that a further impairment analysis of the long-lived assets of the U.S. operation was necessary at December 31, 2003. Our evaluation concluded that an impairment charge was required to write down the carrying amount of our long-lived assets to their fair market values of $19.4 million and $8.6 million for the periods ended September 28, 2003 and December 31, 2003, respectively.

In June 2004, we had a recovery for long-lived assets as a result of selling a production machine from our Tempe manufacturing facility to a third party. The sale value was $1.7 million, which included the price of the production machine, other miscellaneous hardware, training to be provided by us and operating software to run the machine. All of our obligations were completed and we recognized a gain of $1.5 million, representing 90% of the sale value, less book value of the machine of $0.1 million. Collection of the final 10% was contingent on installation of the machine by a third party or 120 days after shipment. We collected the final 10% in January 2005 and recognized the gain in the amount of $0.2 million in the first quarter of 2005.

Critical Accounting Policies and Estimates

The preparation of our consolidated 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 consolidated financial statements. If we used different judgments or different estimates, there might be material differences in the amount and timing of revenues and expenses we report. See Note 1 of our Notes to Consolidated Financial Statements (Item 8) for details of our accounting policies. The critical accounting policies, judgment and estimates, which we believe have the most significant effect on our consolidated financial statements, are set forth below:

40

• Revenue recognition;

• Allowances for doubtful accounts and sales returns;

• Valuation of inventories;

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

• Restructuring costs;

• Impairment charge for long-lived assets; 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 allowances. We adjust these allowances periodically to reflect our actual and anticipated experience. If any of these conditions to recognize revenue are not met, we defer revenue recognition.

Allowances for doubtful accounts and sales returns. We establish allowances for doubtful accounts and sales returns for specifically identified, as well as anticipated, doubtful accounts and product quality claims based on credit profiles of our customers, current economic trends, contractual terms and conditions, and historical payment and sales returns experience. As of December 31, 2005, our consolidated balance sheet included allowances for doubtful accounts and sales returns of $0.2 million and $1.6 million, respectively. As of December 31, 2004, our consolidated balance sheet included allowances for doubtful accounts and sales returns of $0.3 million and $2.7 million, respectively. During 2005, 2004 and 2003, we recorded sales return costs of $0.7 million, $2.4 million and $2.5 million, respectively. Bad debt expenses were $0.3 million in 2003. We incurred a credit of $0.1 million and $0.5 million in 2005 and 2004, respectively, as a result of our customers paying written-off receivable balances. If our actual bad debt and product quality costs differ 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 2005, 2004 and 2003, we charged $1.5 million, $2.1 million and $0.9 million, respectively, against cost of sales for excess and obsolete inventories. If our actual experience of excess and obsolete inventories differs from estimates or we adjust our estimates, or changes occur in 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. 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 that a liability is likely of being 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 to proceed against us to recoup a portion or all of the settlements paid to plaintiffs.

41

Restructuring costs. We have recorded reserves/accruals for restructuring costs related to the restructuring of operations. The restructuring reserves include payments to employees for severance, termination fees associated with leases and other contracts, and other costs related to the closure of facilities. After the adoption of Statement of Financial Accounting Standards ("SFAS") No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”, (“SFAS 146”) on January 1, 2003, the reserves have been recorded when management has approved a plan to restructure operations and a liability has been incurred rather than the date upon which management has approved and announced a plan. The restructuring reserves are based upon management estimates at the time they are recorded. These estimates can change depending upon changes in facts and circumstances subsequent to the date the original liability was recorded. Accruals for facility leases under which we ceased using the benefits conveyed to us under the lease may change if market conditions for subleases change or if we later negotiate a termination of the lease. Prior to the adoption of SFAS 146, restructuring reserves were recorded at the time we announced a plan to exit certain activities and were based on estimates of the costs and length of time to exit those activities. See Note 2 - Balance Sheet Detail of the Notes to the Consolidated Financial Statements (Item 8) for a complete discussion of our restructuring actions and all related restructuring reserves by type as of December 31, 2005.

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

Accounting for income taxes. In preparing our consolidated 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 deferred 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 U.S. deferred tax assets. The valuation allowances were $21.7 million and $22.3 million at December 31, 2005 and 2004, respectively, which fully reserved our net deferred tax assets related to temporary differences, net operating loss carry forwards and other tax credits. Future income tax liabilities may 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.

42

Recently issued accounting pronouncements

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

In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), which replaces SFAS No. 123, “Accounting for Stock-Based Compensation,” (“SFAS 123”), and supercedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values beginning with the first fiscal year after June 15, 2005, with early adoption encouraged. The pro forma disclosures previously permitted under SFAS 123 no longer will be an alternative to financial statement recognition. We are required to adopt SFAS 123R beginning January 1, 2006. The Company will apply the Black-Scholes valuation model in determining the fair value of share-based payments to employees, which will then be amortized on a straight-line basis over the requisite service period. The Company will apply the modified prospective method, which requires that compensation expense be recorded for all unvested stock options and restricted stock upon adoption of SFAS 123R.

In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (“SAB 107”) regarding the SEC’s interpretation of SFAS 123R and the valuation of share-based payments for public companies. The Company is evaluating the requirements of SFAS 123R and SAB 107 and expects that the adoption of SFAS 123R on January 1, 2006 will have a material impact on the Company’s consolidated results of operations and earnings per share beginning in the first quarter of 2006.

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

In March 2005, the FASB issued FASB Interpretations No. 47, “Accounting for Conditional Asset Retirement Obligations, an interpretation of FASB Statement No. 143.” This interpretation clarifies that the term conditional asset retirement obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the entity. FIN 47 is effective no later than the end of fiscal years ending after December 15, 2005; retrospective application for interim financial information is permitted but not required. The Company is evaluating the effect that the adoption of FIN 47 will have on its consolidated result of operations and financial condition in the future and has determined that it cannot ascertain the fair value of any potential obligation because the settlement date and method of settlement for our obligation have not been specified. See Note 13 of Notes to Consolidated Financial Statements (Item 8) - Subsequent Events.

43

In May 2005, the FASB issued SFAS No. 154, “Accounting and Error Correction” (“SFAS 154”), which replaces APB Opinion No. 20, “Accounting Changes” and SFAS No 3, “Reporting Changes in Interim Financial Statements - An Amendment of APB Opinion No. 28.” SFAS 154 provides guidance on the accounting and reporting of accounting changes and error corrections. It establishes retrospective application, or the latest practicable date, as the required method for reporting a change in accounting principle and the reporting of a correction of an error. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005 and is required to be adopted by the Company in the first quarter of fiscal 2006. The Company is currently evaluating the effect that adoption of SFAS 154 will have on its consolidated results of operations and financial condition but does not expect it to have a material impact.

In February 2006, FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments”—an amendment of FASB Statements No. 133 and 140 (“SFAS 155”). SFAS 155 permits fair value measurement for any hybrid financial instrument that contains an embedded derivative, clarifies which interest-only strips and principal-only strips are not subject to the requirement of Statement 133, establishes a requirement to evaluate interests in securitized financial assets, clarifies the concentrations of credit risk, and eliminates the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument. SFAS 133 improves financial reporting by eliminating the exemption from applying Statement 133 to interest in securitized financial assets and allowing to elect fair value measurement at acquisition, at issuance, or when a previously recognized financial instrument is subject to a measurement. SFAS 155 is effective for all financial instruments acquired or issued in fiscal years beginning after September 15, 2006. The implementation of SFAS 155 is not expected to have a material impact on the Company’s consolidated results of operations, financial position or cash flows.

44

Results of Operations

Consolidated Statements of Operations Data:

	Years Ended December 31,
	2005			Percent Change			2004			Percent Change			2003
	(dollars in thousands)
Net revenues, by product:
Automotive glass	$	19,647			(5	)%	$	20,584			1	%	$	20,297
Electronic display		14,039			(32	)		20,554			8			19,019
Architectural		5,934			(15	)		7,010			11			6,297
Window film		15,134			61			9,425			22			7,713
Total net revenues		54,754			(5	)		57,573			8			53,326
Cost of sales		37,241			1			36,787			(20	)		45,914
Gross profit		17,513			(16	)		20,786			180			7,412
Operating expenses:
Research and development		5,104			60			3,199			(52	)		6,714
Selling, general and administrative		8,332			(18	)		10,217			(17	)		12,348
Restructuring expenses (recoveries)		--			--			--			--			(65	)
Impairment charge (recoveries) for long-lived assets.		(170	)		(89	)		(1,513	)		nm*			27,990
Total operating expenses		13,266			12			11,903			(75	)		46,987
Income (loss) from operations		4,247			52			8,883			nm*			(39,575	)
Interest expense, net		(973	)		(56	)		(2,206	)		(39	)		(1,590	)
Costs of warrants issued		--			nm*			(6,782	)		(684	)		(865	)
Other income, net		75			(86	)		534			27			419
Income (loss) before provision for income taxes		3,349			681			429			nm*			(41,611	)
Provision for income taxes		29			(95	)		614			(10	)		681
Net income (loss)		3,320			nm*			(185	)		(100	)		(42,292	)
Deemed dividend on preferred stock		490			--			--			--			--
Net income (loss) attributable to common stockholders	$	2,830			nm*		$	(185	)		(100	)%	$	(42,292	)

*not meaningful

45

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

	Year Ended December 31,
	2005			2004			2003
Net Revenues:
Automotive glass		35.9	%		35.8	%		38.0	%
Electronic display		25.6			35.7			35.7
Architectural		10.8			12.2			11.8
Window film		27.6			16.4			14.5
Total net revenues		100.0			100.0			100.0
Cost of sales		68.0			63.9			86.1
Gross profit		32.0			36.1			13.9
Research and development		9.3			5.6			12.6
Selling, general and administrative		15.2			17.7			23.2
Restructuring expenses (recoveries)		--			--			(0.1	)
Impairment charge (recoveries) for long-lived assets		(0.3	)		(2.6	)		52.4
Total operating expenses		24.2			20.7			88.1
Income (loss) from operations		7.8			15.4			(74.2	)
Interest expense		(1.8	)		(3.8	)		(3.0	)
Cost of warrants issued		--			(11.8	)		(1.6	)
Other income, net		0.1			0.9			0.8
Income (loss) before provision for income taxes		6.1			0.7			(78.0	)
Provision for income taxes		0.1			1.0			1.3
Net income (loss)		6.1			(0.3	)		(79.3	)
Deemed dividend on preferred stock		0.9			--			--
Net income (loss) attributable to common stockholders		5.2	%		(0.3)	%		(79.3)	%

Net revenues

Net revenues were $54.8 million in 2005, $57.6 million in 2004, and $53.3 million in 2003. Net revenues for 2005 decreased by $2.8 million, or 5% from 2004, and net revenues for 2004 increased by $4.2 million, or 8% from 2003.

Our net revenues in the automotive market decreased by $0.9 million, or 5%, from $20.6 million in 2004 to $19.6 million in 2005. The decrease was primarily due to a reduction in demand by the OEMs for solar control features in the automotive market. Our net revenues in the automotive market remained relatively the same in 2004 and 2003 at $20.6 million and $20.3 million, respectively.

Our net revenues in the electronic display market decreased by $6.5 million, or 32%, from $20.6 million in 2004 to $14.0 million in 2005. The decrease was primarily due to lower average selling prices for Plasma Display Panel products, resulting in price pressures on all suppliers in the market. Mitsui Chemicals is our primary customer in the electronic display market. Sales to Mitsui decreased $3.9 million from $16.4 million in 2004 to $12.4 million in 2005. In addition, we phased out our unprofitable anti-reflective product lines and stopped selling these products in 2005, resulting in a decrease of $0.8 million over 2004. Our net revenues in the electronic display market increased by 8% or $1.5 million in 2004 when compared to 2003 as a result of increased sales to Mitsui Chemicals in the plasma display market, partially offset by decreased sales to Mitsubishi as Mitsubishi ceased production of their 17-inch CRT monitor. The decline in our CRT business of $4.0 million was partially offset by an increase in sales of our reflective film products of $5.0 million used in liquid crystal displays, or LCDs, which provide backlighting for laptop computers, and our plasma display film product, TCP, which provides electronic and infrared shielding for the PDP market. Revenues from these products increased to $16.4 million in 2004 from $11.4 million in 2003.

46

Our net revenues in the architectural market decreased 15% or $1.1 million in 2005 when compared to 2004. The decrease was due to softness in the Asian market and a decrease in business from one of our largest accounts in Europe and the Middle East. Our net revenues in the architectural market increased 11% or $0.7 million in 2004 when compared to 2003 due to an increase in sales from our customers in all regions.

Our net revenues in our window film market increased 61% or $5.7 million in 2005 when compared to 2004. In 2005, we stopped converting (cutting the film to the customer’s specification) one of our window film product models and agreed with our customers that they would complete this process. This resulted in higher revenues on our TX products as our customers bought more products to fill their distribution pipelines. In addition, we experienced higher demand for our Solis product in 2005. Our net revenues in our window film market increased 22% or $1.7 million in 2004 when compared to 2003. We sell our window film products primarily to customers located in the Pacific Rim and the Middle East.

Cost of Sales

Cost of sales increased 1.2% or $0.5 million in 2005 from 2004. As a percent of sales, cost of sales was 68% in 2005 compared to 63.9% in 2004. Facility costs, depreciation expense and labor costs have historically comprised the majority of our manufacturing expenses, and these costs are relatively fixed and do not fluctuate proportionately with net revenues. The increase in 2005 from 2004 was the result of increased material costs for component materials and increased production levels in the United States which has higher manufacturing costs than in Germany. The production levels have increased in 2005 compared to 2004 due to the increase in customers’ demand for our products as well as due to the transfer of Tempe manufacturing to Palo Alto manufacturing facility.

Cost of sales decreased 20% or $9.1 million in 2004 from 2003. As a percent of sales, cost of sales was 63.9% in 2004 compared to 86.1% in 2003. The reduction in 2004 from 2003 in cost of goods sold was the result of a reduction of overhead costs, the increased production from our Dresden facility which has lower manufacturing costs and lower fixed costs than in the United States as a result of our restructuring actions taken in 2003. Depreciation expense is lower for our Dresden plant due to the grants and investment allowances for plant and equipment provided to us by the Saxony government. The grants and allowances are recorded as a reduction of property and equipment costs, thereby lowering the depreciation base of those assets.

Gross margin

Gross margin decreased from 36.1% in 2004 to 32% in 2005. The decrease in gross margin was largely the result of product mix and increased component material costs. Our window film products cost more to make than other products. Gross margin increased from 13.9% in 2003 to 36.1% in 2004. The improvement in gross margin was largely due to product mix and manufacturing efficiencies. Continued improvements in our Dresden operations, combined with stabilized U.S. production, have played an important role in the increase of our gross margin in 2004 when compared to 2003.

47

Operating expenses

Research and development spending increased 60% or $1.9 million in 2005 compared to 2004. The increase was due in part to an increase in labor and employee benefits costs as a result of expanding our engineering organization. In June 2005, we hired a new Chief Technology Officer/ Senior Vice President. In 2005, we hired an additional eight employees in the engineering department. Research and development spending decreased 52% or $3.5 million in 2004 compared to 2003. The decrease was due to lower headcount in 2004 of 16 compared to 33 in 2003 as a result of restructuring activities in 2003. Also, patent service costs, tool and allocation expenses were all reduced in 2004 compared to 2003.

Our selling, general and administrative expenses decreased 18% or $1.9 million in 2005 from 2004. The decrease in general and administrative expenses in 2005 was primarily due to higher legal and accounting fees of $0.8 million, outside services and consulting expense of $0.5 million, and compensation expense of $0.5 million in 2004, partially offset by higher Sarbanes-Oxley compliance expenses of $0.3 million in 2005 and higher adjustment to bad debt expense of $0.4 million in 2004. Our selling, general and administrative expenses decreased 17% or $2.1 million in 2004 from 2003 due to lower business insurance premiums of $0.5 million, lower bad debts of $0.7 million, lower depreciation expenses of $0.5 million, reduced legal fees of $0.5 million and decrease in accounting fees of $0.2 million, offset by higher consulting fees of $0.3 million and outside services of $0.2 million.

Restructuring costs

In 2003, we recorded a credit to operating expenses of $65,000 as a result of modifications to the severance packages of certain employees. During 2005 and 2004, we did not incur restructuring costs.

Impairment charge/recoveries for long-lived assets

During 2003, we experienced shortfalls in revenue compared to our budgeted and forecast revenues. In the third quarter of 2003, we determined that, due to reduced demand for our products, anticipated revenues through the remainder of 2003 and 2004 would be substantially below historical levels. We believed that the reduced demand for our products was caused by the decline in personal computer sales worldwide, competition from alternative technologies in the automotive glass segment, as well as declines in certain residential and commercial construction markets as a result of the economic recession in the U.S. As our U.S. operations have a higher operating cash break-even point compared to our Dresden operations, we believed that the lower than anticipated revenues indicated that an impairment analysis of the assets of our U.S. operations was necessary at September 28, 2003. As a result of our decision to close the Tempe operations in the fourth quarter, we concluded that a further impairment analysis of the long-lived assets of the U.S. operations was necessary at December 31, 2003. We, therefore, performed an evaluation of the recoverability of long-lived assets related to the U.S. business at September 28, 2003 and December 31, 2003 in accordance with Statement of Financial Accounting Standards ("SFAS") No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". For long-lived assets to be held and used, the determination of recoverability is based on an estimate of undiscounted cash flows expected to result from the use and eventual disposition of the assets. Our evaluation concluded that the undiscounted expected future cash flows were less than the carrying values of these assets, and an impairment charge was required. The impairment charge represents the amount required to write-down long-lived assets to our best estimate of fair value. For long-lived assets to be disposed of by sale or abandonment, principally the long-lived assets located at the Tempe operation, the impairment loss is estimated as the excess of the carrying value of the assets over fair value. As a result of our assessment we recorded non-cash, impairment charges of $19.4 million and $8.6 million for the periods ended September 28, 2003 and December 31, 2003, respectively. The factors considered by us in performing this assessment included current operating results, trends, and prospects, the closure of our Tempe operation, as well as the effects of obsolescence, demand, competition, and other economic factors.

48

In June 2004, we had a recovery for long-lived assets as a result of selling a production machine from our Tempe manufacturing facility to a third party. The sale value was $1.7 million, which included the price of the production machine, other miscellaneous hardware, training to be provided by us and operating software to run the machine. All of our obligations were completed and we recognized a gain of $1.5 million, representing 90% of the sale value, less book value of the machine of $0.1 million. Collection of the final 10% was contingent on installation of the machine by a third party or 120 days after shipment. We collected the final 10% in January 2005 and recognized the gain in the amount of $0.2 million in the first quarter of 2005.

Income (loss) from operations

Income from operations decreased from $8.9 million in 2004 to $4.2 million in 2005. The decrease was a result of lower revenues, higher research and development expenses, and lower recoveries for long-lived assets. Income from operations was $8.9 million in 2004 compared to loss from operations of $39.6 million in 2003. Income from operations in 2004 was a result of higher net sales and gross profit margin, lower operating expenses and recovery from long-lived assets.

Interest expense, net

Interest expense decreased from $2.2 million in 2004 to $1.0 million in 2005. The decrease in interest expense was primarily attributable to less outstanding debt in 2005 compared to 2004. Interest expense increased from $1.6 million in 2003 to $2.2 million in 2004. The increase in interest expense in 2004 compared to 2003 was mainly due to a $0.3 million interest expense incurred for amortization of debt issuance costs related to warrants, $0.4 million interest expense attributable to interest incurred on our convertible promissory notes and $0.2 million interest incurred with our line of credit, offset by interest income of $0.2 million.

Cost of warrants issued

Warrants issued in connection with the Letter of Intent

In connection with the November 11, 2003 Letter of Intent signed between Needham & Company, Inc., or Needham, and us outlining the proposed debt guarantee and equity financing, we issued a warrant for 1,254,235 shares of common stock, representing 10% of the outstanding common stock of Southwall, exercisable at $0.01 per share. We valued the warrant at $0.1 million and the amount was recorded as a non-operating expense. This warrant terminated upon signing of definitive documentation with Needham on December 18, 2003.

Warrants issued in connection with the investment agreement

In accordance with the investment agreement, warrants were to be issued to the Investors on the closing of each guarantee and equity tranche. However, the terms of the investment agreement were such that the Investors were entitled to receive the 752,892 warrants associated with the second tranche of equity regardless of whether the second equity closing occurred. This term was included as further incentive for the Investors to enter into definitive agreements. Because we had an enforceable obligation to issue the warrants and because the terms of the warrant were known as of the date of the investor agreement, the warrants were considered issued for accounting purposes as of December 18, 2003.

49

Because they were issued as an incentive to enter into definitive agreements for transactions to which the Investors are not committed, we determined that the value of the warrants should be recorded as a non-operating expense. We determined the value of the warrants to be $0.3 million.

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

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

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

In December 2003, additional warrants totaling 409,246 were triggered by note or debt issuances. We determined the value of the warrants to be $0.2 million. The fair value of the warrants was recorded as a non-operating expense.

Warrants issued in connection with the guarantee from Needham

In connection with the guarantee from Needham and as additional incentive to complete the financing closings, as contemplated in the investment agreement, we issued warrants for 941,115 shares of common stock. We have determined the value of the guarantee and warrants at $0.1 million and $0.4 million, respectively.

We recorded the amount of the warrant value equal to the fair value of the guarantee, $0.1 million, as debt issuance costs to be amortized as interest expense over the life of our line of credit with our senior lender. The residual value of the warrants, $0.3 million, is recorded as a non-operating expense, because it represented an incentive to enter into definitive agreements for transactions to which Needham is not committed.

In the first quarter of 2004, due to the structure of the transaction contemplated by the investment agreement, the Company had insufficient authorized and un-issued shares to satisfy the existing commitments had all outstanding warrants been exercised, thereby triggering liability classification for all outstanding warrants and a charge to non-operating expense. The Company re-measured the fair value of the warrants at the issuance date and each subsequent quarter-end, based on a methodology used by a third party, until the Company’s stockholders approved the increase of the number of authorized shares of its common stock in the fourth quarter of 2004. As a result of this, the Company incurred $6.8 million in cost of warrants issued in 2004. No warrants were issued in 2005.

50

Other income, net

Other income decreased from $0.5 million in 2004 to $0.1 million in 2005. Other income, net, reflects foreign exchange transaction gains and losses. Some of our transactions with foreign customers are denominated in foreign currencies, principally the Euro. As exchange rates fluctuate relative to the U.S. dollar, exchange gains and losses occur. The reduction in other income in 2005 from 2004 was primarily attributable to the net exchange loss due to Euro fluctuation of $0.3 million. Other income increased from $0.4 million in 2003 to $0.5 million in 2004. The increase in other income in 2004 from 2003 was attributable to an increase in foreign currency gain recognized from receivables denominated in Euros and VAT refunds, also denominated in Euros.

Income (loss) before provision for income taxes

The pre-tax income increase from $0.4 million in 2004 to $3.3 million in 2005 was a result of lower interest expense and no cost of warrants issued. The pre-tax income in 2004 compared to the pre-tax loss in 2003 was a result of higher net revenue and gross profit margin, lower operating expenses, and impairment recovery for long-lived assets, partially offset by interest expense and cost of warrants issued.

Provision for income taxes

The provision for income taxes in 2005, 2004 and 2003 was related to our German subsidiary, Southwall Europe Gmbh (“SEG”). In 2005, our provision for income taxes decreased approximately $0.6 million. The decrease relates to a reversal of approximately $0.4 million of foreign income tax accrual relating to prior years, recognition of deferred tax assets of approximately $0.1 million at December 31, 2005 and lower taxable income in our German subsidiary. The decrease in the provision for income taxes in 2004 from 2003 was due to lower taxable income for SEG in 2004 compared to 2003. In 2003, we fully utilized our operating loss carry forward for German statutory tax purposes, and as a result, we expect to incur tax obligations related to our Dresden plant for the foreseeable future based on expected continuing profitability of our German operations on a stand-alone basis.

Net income (loss)

The increase from net loss of $0.2 million in 2004 to net income of $3.3 million in 2005 was a result of lower interest expense, no cost of warrants issued and lower provision for income taxes. The decrease in net loss in 2004 compared to the loss in 2003 was a result of higher net revenue and gross profit margin, lower operating expenses, and impairment recovery for long-lived assets, partially offset by interest expense and cost of warrants issued.

Deemed dividend on preferred stock

We accrued $0.5 million of deemed dividend on preferred stock in 2005 as a result of the conversion of our secured convertible promissory notes into shares of Series A preferred stock in December 2004. The Series A preferred stock carries a 10% cumulative dividend rate. There was no such dividend in 2004 and 2003.

51

Liquidity and capital resources

Liquidity

Our principal liquidity requirements are for working capital, consisting primarily of accounts receivable and inventories. We believe that because of the relatively long production cycle of certain of our products, our inventories will continue to represent a significant portion of our working capital. We incurred a net income in 2005 and net loss in 2004 and 2003 and negative cash flows from operations in 2003. We incurred positive cash flow from operations in 2005 and 2004.

Our cash and cash equivalents increased by $2.1 million from $4.5 million at December 31, 2004 to $6.6 million at December 31, 2005. Cash provided by operating activities increased by $0.2 million from $3.8 million provided by operations in 2004, to $4.0 million provided by operations in 2005. The increase in cash provided by operating activities during 2005 was primarily the result of net income for the year of $3.3 million, non-cash depreciation of $2.2 million, and decreases in inventories of $2.5 million and in other current and non-current assets of $0.9 million partially offset by impairment recoveries from long-lived assets of $0.2 million, change in deferred income taxes of $0.5 million, an increase in accounts receivable of $0.9 million and a decrease in accounts payable and accrued liabilities of $3.4 million. Cash used in investing activities in 2005 was $0.3 million compared to $1.3 million provided by investing activities in 2004. The decrease was primarily due to proceeds from the sale of a fixed asset of $1.6 million in 2004. Cash used in financing activities decreased by $0.6 million from $2.2 million used in financing activities in 2004 to $1.6 million used in financing activities in 2005. The decrease was the result of less debt outstanding in 2005, which resulted in lower principal repayments.

We entered into an agreement with the Saxony government in May 1999 under which we receive investment grants. As of December 31, 2005, we had received 5.0 million Euros, or $5.0 million at historical rate 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. Additionally, as of December 31, 2005, we had a balance remaining from the government grants received in May 1999 of 0.3 million Euros, or $0.4 million, which has been recorded as an advance and held as restricted cash until we receive approval from the Saxony government to apply the funds to reduce our capital expenditures. If we fail to meet certain requirements in connection with these grants, the Saxony government has the right to demand repayment of the grants. 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 in Germany 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.

Borrowing arrangements

On April 28, 2005, we entered into a credit agreement (the “Credit Agreement”) with Wells Fargo HSBC Trade Bank, N.A. (the “Bank”). The Credit Agreement provides for two facilities. All amounts borrowed under both facilities under the Credit Agreement must be repaid on or before May 31, 2006. It is our intention to renew this credit facility in May 2006.

52

The first facility is a revolving line of credit under which we may from time to time borrow up to $3 million, subject to satisfaction of certain conditions. Amounts borrowed under the first facility bear interest at the prime rate minus 1.75% per annum or LIBOR plus 1% per annum, at our option. We borrowed approximately $3.0 million from this facility on April 28, 2005 which amount remained outstanding as of December 31, 2005.

The second facility is a formula line under which we may, from time to time, borrow up to $3 million, subject to certain conditions, with advances of up to 80% of eligible accounts receivable. Amounts borrowed under the second facility bear interest at the prime rate minus 0.25% per annum. We may borrow under the second facility only if we meet certain financial covenants. As of December 31, 2005, we met these financial covenants. There is no balance outstanding under the second facility.

All borrowings under both facilities are collateralized by our inventory, receivables, raw material and work in progress. In addition, the first facility under the Credit Agreement is collateralized by a letter of credit posted by Needham & Company, one of our stockholders.

The terms of the Credit Agreement, among other things, limit our ability to (i) incur, assume or guarantee additional indebtedness in excess of $13.5 million (other than pursuant to the Credit Agreement), (ii) pay dividends or repurchase stock (except up to $0.6 million per year of dividends on preferred stock), (iii) incur liens upon the collateral pledged to the bank, (iv) make any loans or advances to, or investments in, any person or entity outside the ordinary course of business, (v) merge, consolidate, sell or otherwise dispose of substantially all or a substantial or material portion of our assets, (vi) enter into transactions with affiliates, and (vii) make acquisitions other than up to an aggregate amount of $3 million and (viii) to make capital expenditures in any fiscal year in excess of $1.5 million.

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

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

Our borrowing arrangements with various German banks as of December 31, 2005 are described in Note 5 of Notes to our Consolidated Financial Statements (Item 8) set forth herein. We are in compliance with all of the covenants of the German bank loans, and we have classified $1.0 million and $7.2 million outstanding under the German bank loans as a short-term liability and long-term liability, respectively, at December 31, 2005. We are obligated to pay an aggregate of $1.0 million in principal amount under our German bank loans in 2006.

As of December 31, 2003, we were in default under a master sale-leaseback agreement with respect to two of our production machines. We had withheld lease payments in connection with a dispute with the leasing company, Matrix Funding Corporation. An agent purporting to act on behalf of the leasing company filed suit against us to recover the unpaid lease payments and the alleged residual value of the machines, totaling $6.5 million in the aggregate. In February 2004, we reached a settlement agreement with the agent for $2.0 million to be repaid over six years at a stepped rate of interest, and we returned the equipment in question to the plaintiffs (See Note 5 of Notes to Consolidated Financial Statements (Item 8) - Term Debt and Capital Leases). At December 31, 2005, the carrying value of the liability was $4.3 million ($1.9 million of principal, plus $2.4 million of accrued interest). We are obligated to pay an aggregate of $0.3 million under this agreement in 2006.

53

Capital expenditures

We spent approximately $0.4 million in capital expenditures in 2004. We spent approximately $0.8 million in capital expenditures in 2005, primarily to maintain and upgrade our production facilities. We expect to spend approximately $1.5 million in 2006 on maintenance of the production machines and research and development tools.

Future Obligations

Our future payment obligations on our borrowings pursuant to our term debt, capital lease obligations, non-cancelable operating leases and other non-cancelable contractual commitments are as follows (in thousands):

	Total		Less Than 1 Year		1-3 Years		3-5 Years		Greater Than 5 Years
Contractual Obligations:
Term debt (1)	$	10,107	$	1,317	$	1,961	$	4,322	$	2,507
Line of credit		2,996		2,996		--		--		--
Operating Leases (2)		1,844		1,586		250		8		--
Total Contractual Cash Obligations	$	14,947	$	5,899	$	2,211	$	4,330	$	2,507

________________

(1) Represents loan agreements with Portfolio Financing Servicing Company, Bank of America and Lehman Brothers, and several German banks.

(2) Represents the remaining rents owed on a building we rent in Palo Alto, California. On July 14, 2005, we moved our warehouse from 210 Littlefield, So. San Francisco, CA into 2629B Terminal Blvd., Mountain View, CA. The term of this lease is a period of one year, commencing on August 1, 2005 and terminating on July 31, 2006, with monthly rent payments of $5,655.

54

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

Financing risk: Our exposure to market rate risk for changes in interest rates relates primarily to our line of credit which bears an interest rate equal to 1.0% above the bank LIBOR rate (which was 5.5% at December 31, 2005) and is calculated based on amounts borrowed under the facility. In addition, the interest rate on one of our German loans has been reset to the prevailing market rate of 5.75% and another of our German loans will have its interest rate reset to the prevailing market rate in 2009. Fluctuations or changes in interest rates may adversely affect our expected interest expense. The effect of a 10% fluctuation in the interest rate on our line of credit would have had an effect of about $21,000 on our interest expense for 2005.

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 of our floating rate securities would have had an adverse effect of less than $10,000 for 2005.

Foreign currency risk: International revenues (defined as sales to customers located outside of the United States) accounted for approximately 74% of our total sales in 2005. Approximately 44% of our international revenues were denominated in Euros relating to sales from our Dresden operation in 2005. The other 56% of our international sales were denominated in US dollars. In addition, certain transactions with foreign suppliers are denominated in foreign currencies (principally Japanese Yen). The effect of a 10% fluctuation in the Euro exchange rate would have had an effect of approximately $2.2 million on net revenues for 2005 and the effect on expenses of a 10% fluctuation in the Yen exchange rate would have been immaterial.

55

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

TABLE OF CONTENTS

	Page
Report of Independent Registered Public Accounting Firm	57
Report of Independent Registered Public Accounting Firm	58
Consolidated Balance Sheets	59
Consolidated Statements of Operations	60
Consolidated Statements of Stockholders’ Equity	61
Consolidated Statements of Cash Flows	62
Notes to Consolidated Financial Statements	63

56

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

Southwall Technologies Inc.

We have audited the accompanying consolidated balance sheets of Southwall Technologies Inc. and its subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the two years in the period ended December 31, 2005. Our audits also included the financial statement schedule listed in the Index at Item 15(a)(2). These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Southwall Technologies Inc. and its subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2005, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule, when considered in relation to the consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

/s/ Burr, Pilger & Mayer LLP

Palo Alto, California

February 17, 2006

57

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of

Southwall Technologies Inc.

In our opinion, the consolidated statements of operations, shareholders’ equity and cash flowspresent fairly, in all material respects, the results of operations of Southwall Technologies Inc. and its subsidiaries and their cash flows for the year ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the accompanying financial statements schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audit. We conducted our audit of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States), which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as going concern. The Company incurred a net loss and negative cash flow from operating activities in 2003 and had significant debt service and other contractual obligations at December 31, 2003. These factors raise substantial doubt about its ability to continue as a going concern. The consolidated financial statements do not include any adjustments that may result from the ultimate resolution of this matter.

/s/ PricewaterhouseCoopers LLP

San Jose, California

April 13, 2004

58

SOUTHWALL TECHNOLOGIES INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except per share data)

	December 31,
	2005			2004
ASSETS
Current Assets:
Cash and cash equivalents	$	6,600		$	4,547
Restricted cash		402			686
Accounts receivable, net of allowance for doubtful accounts of $208 and $292 in 2005 and 2004, respectively		6,780			6,186
Inventories, net		5,879			8,355
Other current assets		982			1,757
Total current assets		20,643			21,531
Property, plant and equipment, net		16,857			21,110
Restricted cash loans		995			1,149
Other assets		1,146			1,157
Total assets	$	39,641		$	44,947
LIABILITIES, PREFERRED STOCK AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current portion of long term debt and capital leases	$	1,317		$	1,463
Short term obligations		2,996			2,975
Accounts payable		1,402			2,544
Accrued compensation		1,161			1,378
Other accrued liabilities		5,076			6,643
Total current liabilities		11,952			15,003
Term debt and capital leases		8,790			11,644
Government grants advanced.		396			505
Other long term liabilities		2,564			3,222
Total liabilities		23,702			30,374
Commitments and contingencies (Note 11)
Series A convertible preferred stock, $0.001 par value; 5,000 shares authorized, 4,893 shares outstanding at 2005 and 2004, respectively (Liquidation preference: $5,383 and $4,893 at 2005 and 2004, respectively)		4,810			4,810
Stockholders' Equity:
Common stock, $0.001 par value; 50,000 shares authorized, and 26,793 and 26,488 shares outstanding at 2005 and 2004, respectively		27			26
Capital in excess of par value		77,828			77,957
Accumulated other comprehensive income
Translation gain on subsidiary		2,532			4,358
Accumulated deficit		(69,258	)		(72,578	)
Total stockholders' equity		11,129			9,763
Total liabilities, preferred stock and stockholders' equity	$	39,641		$	44,947

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

59

SOUTHWALL TECHNOLOGIES INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

	Years Ended December 31,
	2005			2004			2003
Net revenues	$	54,754		$	57,573		$	53,326
Cost of revenues		37,241			36,787			45,914
Gross profit		17,513			20,786			7,412
Operating expenses:
Research and development		5,104			3,199			6,714
Selling, general and administrative		8,332			10,217			12,348
Restructuring expenses (recoveries)		--			--			(65	)
Impairment charge (recoveries) for long-lived assets		(170	)		(1,513	)		27,990
Total operating expenses		13,266			11,903			46,987
Income (loss) from operations		4,247			8,883			(39,575	)
Interest expense, net		(973)			(2,206	)		(1,590	)
Costs of warrants issued		--			(6,782	)		(865	)
Other income, net		75			534			419
Income (loss) before provision for income taxes		3,349			429			(41,611	)
Provision for incomes taxes		29			614			681
Net income (loss)		3,320			(185	)		(42,292	)
Deemed dividend on preferred stock		490			--			--
Net income (loss) attributable to common stockholders	$	2,830		$	(185	)	$	(42,292	)
Net income (loss) per share:
Basic	$	0.11		$	(0.01	)	$	(3.37	)
Diluted	$	0.10		$	(0.01	)	$	(3.37	)
Weighted average shares used in computing net income (loss) per share:
Basic		26,743			14,589			12,537
Diluted		32,895			14,589			12,537

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

60

SOUTHWALL TECHNOLOGIES INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

(in thousands)

											Accumulated
											Other
					_________						Compre-						Total			Compre-
					Capital in						hensive						Stock-			hensive
	Common Stock				Excess of			Notes			Income			Accumulated			holders’			Income
	Shares		Amount		Par Value			Receivable			(Loss)			Deficit			Equity			(Loss)
Balances, January 1, 2003		12,527	$	12	$	69,657		$	(126	)	$	1,032		$	(30,101	)	$	40,474
Issuance of shares to employees under stock purchase plan		21		1		21			--			--			--			22
Issuance of warrants to investors		--		--		865			--			--			--			865
Issuance of warrants to creditors		--		--		201			--			--			--			201
Issuance of shares to directors		--		--		83			--			--			--			83
Accelerated vesting on exercise of stock option		--		--		34			--			--			--			34
Forgiveness of notes receivable		--		--		--			126			--			--			126
Foreign currency translation adjustment		--		--		--			--			2,208			--			2,208		$	2,208
Net loss		--		--		--			--			--			(42,292	)		(42,292	)		(42,292	)
Balances, December 31, 2003		12,548		13		70,861			--			3,240			(72,393	)		1,721			(40,084	)
Issuance of shares to employees under stock purchase plan		7		--		2			--			--			--			2
Issuance of warrants to investors		--		--		6,990			--			--			--			6,990
Issuance of shares to directors		150		--		72			--			--			--			72
Issuance of shares from exercise of warrants		13,783		13		32			--			--			--			45
Foreign currency translation adjustment		--		--		--			--			1,118			--			1,118			1,159
Net loss		--		--		--			--			--			(185	)		(185	)		(185	)
Balances, December 31, 2004		26,488		26		77,957			--			4,358			(72,578	)		9,763			974
Issuance of shares to employees under stock purchase plan		13		1		11			--			--			--			12
Issuance of shares on stock options exercise.		38		--		19			--			--			--			19
Issuance of shares to directors		24		--		15			--			--			--			15
Issuance of shares under executive performance bonus plan		230		--		271			--			--			--			271
Compensation expense for vesting modification		--		--		45			--			--			--			45
Dividend accrual on Series A Preferred Stock.		--		--		(490	)		--			--			--			(490	)
Foreign currency translation adjustment		--		--		--			--			(1,826	)		--			(1,826	)		(1,826	)
Net income		--		--		--			--			--			3,320			3,320			3,320
Balances, December 31, 2005		26,793	$	27	$	77,828		$	--		$	2,532		$	(69,258	)	$	11,129		$	1,494

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

61

SOUTHWALL TECHNOLOGIES INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

	Years Ended December 31,
	2005			2004			2003
Cash flows provided by (used in) operating activities:
Net income (loss)	$	3,320		$	(185	)	$	(42,292	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Deferred income tax		(508	)		--			--
Impairment (recoveries) charge for long-lived assets		(170	)		(1,513	)		27,990
Depreciation and amortization		2,195			2,503			6,071
(Gain)/loss on disposal of capital equipment		--			(26	)		39
Stock-based compensation charge		45			--			117
Amortization of debt issuance costs		--			274			28
Amortization of debt discount		--			115			--
Accrued interest on convertible notes payable		--			393			--
Warrants issued to investors and creditors		--			6,782			865
Common stock issued for services		15			72			--
Officer loan forgiveness		--			--			126
Changes in operating assets and liabilities:
Accounts receivable		(914	)		910			1,899
Inventories		2,476			(1,525	)		1,707
Other current and non-current assets		898			(137	)		2,344
Accounts payable and accrued liabilities		(3,351	)		(3,833	)		(1,884	)
Net cash provided by (used in) operating activities		4,006			3,830			(2,990	)
Cash flows provided by (used in) investing activities:
Restricted cash		254			3			--
Proceeds from sale of fixed assets		170			1,640			--
Expenditures for property, plant and equipment and other assets		(766	)		(382	)		(2,775	)
Net cash provided by (used in) investing activities		(342	)		1,261			(2,775	)
Cash flows provided by (used in) financing activities:
Proceeds from borrowings		--			--			88
Principal payments on borrowings		(1,532	)		(2,769	)		(2,962	)
Borrowings on line of credit		2,996			--			--
Repayments of line of credit		(2,975	)		(3,869	)		6,844
Repayments under capital lease		(44	)		--			--
Proceeds from (use of) investment allowances		(42	)		(158	)		1,556
Proceeds from stock option, warrant and employee stock purchase plan exercises		31			47			22
Proceeds from convertible promissory notes		--			4,500			--
Net cash provided by (used in) financing activities		(1,566	)		(2,249	)		5,548
Effect of foreign exchange rate changes on cash		(45	)		553			(629	)
Net increase (decrease) in cash and cash equivalents		2,053			3,395			(846	)
Cash and cash equivalents, beginning of year		4,547			1,152			1,998
Cash and cash equivalents, end of year	$	6,600		$	4,547		$	1,152
Supplemental cash flow disclosures:
Interest paid	$	854		$	1,019		$	1,153
Income taxes paid	$	764		$	135		$	211
Supplemental schedule of non-cash investing and financing activities:
Dividends accrued	$	490		$	--		$	--
Warrants issued to creditors and investors	$	--		$	--		$	1,060
Conversion of convertible promissory notes and accrued interest to Series A convertible preferred stock		--		$	4,810			--

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

62

SOUTHWALL TECHNOLOGIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(amounts in thousands, except per share data)

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

The Company

Southwall Technologies Inc. (“Southwall”, “we”, “us”, “our”, and the “Company” refer to Southwall Technologies Inc. and its subsidiaries) is a global developer, manufacturer and marketer of thin film coatings on flexible substrates for the automotive glass, electronic display, window film, and architectural glass markets. We have developed a variety of products that control sunlight in automotive glass, reduce light reflection, reduce electromagnetic radiation and improve image quality in electronic display products and conserve energy in architectural products. Our products consist of transparent solar-control films for automotive glass; anti-reflective films for computer screens, including flat panel displays, plasma displays, and transparent conductive films for use in touch screen and liquid crystal displays; energy control films for architectural glass; and various other coatings.

Principles of consolidation

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

Foreign currency translation

The Company's German subsidiary uses the Euro as its functional currency. Accordingly, the financial statements of this subsidiary are translated into U.S. dollars in accordance with Statement of Financial Accounting Standards ("SFAS") No. 52, "Foreign Currency Translation." Assets and liabilities are translated at exchange rates in effect at the balance sheet date and revenue and expense accounts at average exchange rates during the quarter. Exchange gains or losses from the translation of assets and liabilities of $1,826 in 2005 are included in the cumulative translation adjustment component of accumulated other comprehensive income (loss). Gains and losses arising for transactions denominated in currencies other than the functional currency were $320, $457, and $37 in 2005, 2004, and 2003, respectively, and were included in other income, net.

Management estimates

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

Cash and cash equivalents

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

63

Restricted cash

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

Revenue recognition

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

The Company has agreements under which it receives fees for certain licensing rights to technology and products. The Company does not allocate cost of sales to license revenues because such costs are insignificant. License revenues associated with these agreements are recognized ratably over the period of the contract when collection of the resulting receivable is probable. License revenues were $57, $191 and $525 in 2005, 2004 and 2003, respectively.

Accounts receivable and allowances for doubtful accounts

Accounts receivable are recorded at the invoiced amount and are not interest bearing. We establish allowances for doubtful accounts for specifically identified, as well as anticipated, doubtful accounts based on credit profiles of our customers, current economic trends, contractual terms and conditions and historical payment. As of December 31, 2005 and 2004, our balance sheets included allowances for doubtful accounts of $208 and $292, respectively.

Accrual for sales returns and warranties

We establish allowances for sales returns for specifically identified product quality claims as well as estimated potential future claims based on our sales returns and warranty experience. We offer a ten-year, five-year and less than a year quality claim periods for our products. As of December 31, 2005 and 2004, our balance sheets included accrual for sales returns and warranties of $1,556 and $2,701, respectively.

Concentration of credit risk

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

The Company invests in a variety of financial instruments such as certificates of deposits and money market funds. By policy, the Company limits the amount of credit exposure to any one financial institution or commercial issuer. For US funds, we have $5.1 million in excess of $0.1 million of FDIC coverage. We also have approximately $1.7 million in foreign banks.

64

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

Our ten largest customers accounted for approximately 81%, 79% and 84% of our net sales in, 2005, 2004 and 2003, respectively. During 2005, Mitsui Chemicals, Saint Gobain Sekurit, V-Kool and Pilkington PLC accounted for 22.7%, 19.8%, 19.5% and 7.1%, respectively, of our net revenues. During 2004, Mitsui Chemicals, Saint Gobain Sekurit, V-Kool and Pilkington PLC accounted for 28.4%, 17.8%, 11.4% and 10.9%, respectively, of our net revenues. During 2003, Mitsui Chemicals, Saint Gobain Sekurit, Pilkington PLC and V-Kool accounted for 21.4%, 17.2%, 13.7% and 10.0%, respectively, of our net revenues.

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

At December 31, 2005, receivables from three customers represented 24%, 20% and 13% of the Company's total accounts receivable. At December 31, 2004, receivables from three customers represented 27%, 25% and 12% of the Company's total accounts receivable.

Inventories

Inventories are stated at the lower of standard cost (determined on a first-in, first-out basis) or market (net realizable value). Standard costs, which approximate actual, includes materials, labor and manufacturing overhead. The Company establishes provisions for excess and obsolete inventories to reduce such inventories to their estimated net realizable value. Such provisions are charged to cost of sales.

Property, plant and equipment

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

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

Depreciation and amortization expense related to property and equipment for 2005, 2004 and 2003 was $2,195, $2,503 and $6,071, respectively.

65

Impairment of long-lived assets

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

Fair value disclosures of financial instruments

The Company has estimated the fair value amounts of its financial instruments, including cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities using available market information and valuation methodologies considered to be appropriate and have determined that the book value of those instruments at December 31, 2005 and 2004 approximates fair value. Based on borrowing rates currently available to the Company for debt and capital leases with similar terms, the carrying value of its term debt and capital leases approximate fair value.

Derivative financial instruments

The Company accounts for derivative financial instruments under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133 establishes methods of accounting for derivative financial instruments and hedging activities related to those instruments as well as other hedging activities. As of December 31, 2005, we did not have any derivative financial instruments or hedging activities.

Stock-based compensation expense

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

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

66

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

	Years Ended December 31,
	2005			2004			2003
Net income (loss) attributable to common stockholders
As reported	$	2,830		$	(185	)	$	(42,292	)
Add: Stock-based employee compensation expense included in reported net income (loss), net of related tax effects		45			--			34
Deduct: Total stock-based employee compensation determined under fair value based method for all awards, net of related tax effects		(686	)		(693	)		(695	)
Pro forma net income (loss)	$	2,189		$	(878	)	$	(42,258	)
Net income (loss) per share:
As reported - basic	$	0.11		$	(0.01	)	$	(3.37	)
As reported - diluted	$	0.10		$	(0.01	)	$	(3.37	)
Pro forma - basic	$	0.08		$	(0.06	)	$	(3.37	)
Pro forma - diluted	$	0.08		$	(0.06	)	$	(3.37	)

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 2005, 2004, and 2003, respectively: expected volatility of 117%, 116 % and 99%; risk-free interest rate of 4.2%, 2.9% and 2.3%; and expected lives from vesting date of 2.17, 1.70 and 2.77 years. Southwall has not paid dividends and assumed no dividend yield. The weighted-average fair value of stock options granted in 2005, 2004 and 2003 was $0.46, $0.54 and $1.00 per share, respectively.

For the employee stock purchase plan, 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 2005, 2004, and 2003 respectively: expected volatility of 116%, 116% and 99%; risk-free interest rate of 3.9%, 3.6% and 2.7%; 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 2005, 2004, and 2003 was $0.61, $0.23 and $0.56 per right, respectively.

Research and development expense

Research and development costs are expensed as incurred. Costs included in research and development expense are salaries, building costs, utilities, administrative expenses and allocation costs.

Comprehensive income (loss)

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

67

Restructuring costs

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

Income taxes

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

Net income (loss) per share

Basic net income (loss) per share is computed by dividing net income (loss) attributable to common stockholders (numerator) by the weighted average number of common shares outstanding (denominator) for the period. Diluted net income (loss) per share gives effect to all dilutive common shares potentially outstanding during the period, including stock options, warrants to purchase common stock and convertible preferred stock. Preferred stock dividends are added back to net income attributable to common stockholders since they would not have been accrued if the preferred stock had been converted to common stock at the beginning of the period.

The Company excludes options from the computation of diluted weighted average shares outstanding if the exercise price of the options is greater than the average market price of the shares because the inclusion of these options would be anti-dilutive to earnings per share.  Accordingly, at December 31, 2005, stock options to purchase 2,284 shares at a weighted average price of $2.83 per share were excluded from the computation of diluted weighted average shares outstanding.

In net loss periods, the basic and diluted weighted average shares of common stock and common stock equivalents are the same because inclusion of common stock equivalents would be anti-dilutive. Accordingly, at December 31, 2004 and 2003, there was no difference between the denominators used for the calculation of basic and diluted net income (loss) per share. At December 31, 2004 and 2003, there were 4,039 and 2,087 anti-dilutive options, respectively, excluded from the net loss per share calculation.

68

Tables summarizing net income (loss) attributable to common stockholders, for diluted net income (loss) per share, and shares outstanding are shown below (in thousands):

	Years Ended December 31,
	2005		2004			2003
Net income (loss) attributable to common stockholders-basic	$	2,830	$	(185	)	$	(42,292	)
Add: Deemed dividend on preferred stock		490		--			--
Net income (loss) attributable to common stockholders-diluted	$	3,320	$	(185	)	$	(42,292	)
Weighted average common shares outstanding-basic		26,743		14,589			12,537
Dilutive effect of warrants		356		--			--
Dilutive effect of performance shares		38		--			--
Dilutive effect of Series A preferred shares		4,893		--			--
Dilutive effect of stock options		865		--			--
Weighted average common shares outstanding - diluted		32,895		14,589			12,537

Reclassifications

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

Recently issued accounting pronouncements

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

In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), which replaces SFAS No. 123, “Accounting for Stock-Based Compensation,” (“SFAS 123”), and supercedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values beginning with the first fiscal year after June 15, 2005, with early adoption encouraged. The pro forma disclosures previously permitted under SFAS 123 no longer will be an alternative to financial statement recognition. We are required to adopt SFAS 123R beginning January 1, 2006. The Company will apply the Black-Scholes valuation model in determining the fair value of share-based payments to employees, which will then be amortized on a straight-line basis over the requisite service period. The Company will apply the modified prospective method, which requires that compensation expense be recorded for all unvested stock options and restricted stock upon adoption of SFAS 123R.

In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (“SAB 107”) regarding the SEC’s interpretation of SFAS 123R and the valuation of share-based payments for public companies. The Company is evaluating the requirements of SFAS 123R and SAB 107 and expects that the adoption of SFAS 123R on January 1, 2006 will have a material impact on the Company’s consolidated results of operations and earnings per share beginning in the first quarter of 2006.

69

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

In March 2005, the FASB issued FASB Interpretations No. 47, “Accounting for Conditional Asset Retirement Obligations, an interpretation of FASB Statement No. 143.” This interpretation clarifies that the term conditional asset retirement obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the entity. FIN 47 is effective no later than the end of fiscal years ending after December 15, 2005; retrospective application for interim financial information is permitted but not required. The Company is evaluating the effect that the adoption of FIN 47 will have on its consolidated result of operations and financial condition and has determined that it cannot ascertain the fair value of any potential obligation because the settlement date and method of settlement for our obligation have not been specified.

In May 2005, the FASB issued SFAS No. 154, “Accounting and Error Correction” (“SFAS 154”), which replaces APB Opinion No. 20, “Accounting Changes” and SFAS No 3, “Reporting Changes in Interim Financial Statements - An Amendment of APB Opinion No. 28.” SFAS 154 provides guidance on the accounting and reporting of accounting changes and error corrections. It establishes retrospective application, or the latest practicable date, as the required method for reporting a change in accounting principle and the reporting of a correction of an error. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005 and is required to be adopted by the Company in the first quarter of fiscal 2006. The Company is currently evaluating the effect that adoption of SFAS 154 will have on its consolidated results of operations and financial condition but does not expect it to have a material impact.

In February 2006, FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments”—an amendment of FASB Statements No. 133 and 140 (“SFAS 155”). SFAS 155 permits fair value measurement for any hybrid financial instrument that contains an embedded derivative, clarifies which interest-only strips and principal-only strips are not subject to the requirement of Statement 133, establishes a requirement to evaluate interests in securitized financial assets, clarifies the concentrations of credit risk, and eliminates the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument. SFAS 155 improves financial reporting by eliminating the exemption from applying Statement 133 to interest in securitized financial assets and allowing to elect fair value measurement at acquisition, at issuance, or when a previously recognized financial instrument is subject to a measurement. SFAS 155 is effective for all financial instruments acquired or issued in fiscal years beginning after September 15, 2006. The implementation of SFAS 155 is not expected to have a material impact on the Company’s consolidated results of operations, financial position or cash flows.

70

NOTE 2 - BALANCE SHEET DETAIL

	December 31,
	2005		2004
Inventories, net:
Raw materials	$	3,482	$	4,945
Work-in-process		1,409		2,059
Finished goods		988		1,351
	$	5,879	$	8,355

	December 31,
	2005			2004
Property, plant and equipment, net:
Land, buildings and leasehold improvements	$	7,296		$	8,363
Machinery and equipment		28,592			32,242
Furniture and fixtures		946			1,737
		36,834			42,343
Less - accumulated depreciation and amortization		(19,977	)		(21,233	)
Total property, plant and equipment, net	$	16,857		$	21,110

Restructuring costs.

In December 2002, we implemented a reduction in force at our Palo Alto location and elected to vacate certain buildings in Palo Alto. As a result of these actions, we incurred a restructuring charge of $2,624 in 2002 relating to employee severance packages and the remaining rents due on excess facilities in Palo Alto that we no longer occupy. In 2003, we recorded a credit to operating expenses of $65 as a result of modifications to the severance packages of certain employees.

The following tables set forth the beginning and ending liability balances relating to the above described restructuring activity as well as activity during 2005, 2004 and 2003 (in thousands):

	Workforce Reduction			Excess Facilities			Total
Balance at January 1, 2003	$	125		$	2,281		$	2,406
Provisions		143			--			143
Adjustment to reserve		(65	)		--			(65	)
Cash payments		(203	)		(712	)		(915	)
Balance at December 31, 2003	$	--		$	1,569		$	1,569
Provisions		--			--			--
Adjustment to reserve		--			(926	)		(926	)
Cash payments		--			(369	)		(369	)
Balance at December 31, 2004	$	--		$	274		$	274
Provisions		--			--			--
Adjustment to reserve		--			--			--
Cash payments		--			(75	)		(75	)
Balance at December 31, 2005	$	--		$	199		$	199

71

At December 31, 2005, $106 was included in other accrued liabilities, and $93 was included in other long-term liabilities on the consolidated balance sheet.

Guarantees.

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

	Balance at December 31, 2003		Provision		Utilized			Balance at December 31, 2004
Accrued sales returns and warranties	$	1,851	$	2,359	$	(1,509	)	$	2,701

As of December 31, 2005, our reserve for sales returns and warranties was as follows:

	Balance at December 31, 2004		Provision		Utilized			Balance at December 31, 2005
Accrued sales returns and warranties	$	2,701	$	720	$	(1,865	)	$	1,556

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

Indemnification obligations.

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

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

72

NOTE 3 - FINANCING AGREEMENTS

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

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

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

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

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

On December 31, 2004, Needham and its Affiliates and Dolphin elected to convert all outstanding principal of, and accrued but unpaid interest on, their secured convertible promissory notes of the Company into shares of the Company’s Series A 10% Cumulative Preferred Stock. The Convertible Notes by their terms were convertible at the option of the holders into Series A Stock at a rate of one share for each $1.00 of principal or interest converted. The aggregate principal amount of the Convertible Notes converted by the Note Holders was $4,500 and interest accrued thereon as of the time of conversion was $392. The aggregate number of shares of Series A Stock issued as a result of the conversion was 4,893. In particular, Needham and its Affiliates received 3,262 shares; and, Dolphin received 1,631 shares.

73

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

So long as any Series A Shares are outstanding, unless all accrued dividends have been paid, the Company is generally prohibited from taking certain actions. Except for certain matters with respect to which the approval of the holders of a majority of the Series A Shares voting separately as a class is required, the holders of the Series A Stock have no voting rights. Upon a liquidation or dissolution of the Company (and for these purposes a sale of all or substantially all of the Company’s assets or the acquisition of the Company by another entity are considered liquidation events), the holders of the Series A Stock are entitled to be paid a liquidation preference equal to $1.00 per share plus accumulated but unpaid dividends, out of assets legally available for distribution to stockholders. As of December 31, 2005, $490 has been accrued in dividends and is included in other accrued liabilities in the accompanying balance sheet.

Material Terms of the Series A Shares

Our Series A shares have the following terms:

• Dividends. Each of the Series A shares have a stated value of $1.00 and are entitled to a cumulative dividend of 10% per year, payable at the discretion of the Board of Directors. Dividends on the Series A shares accrue daily commencing on the date of issuance and are deemed to accrue whether or not earned or declared and whether or not there are profits, surplus or other funds legally available for the payment of dividends. Accumulated dividends, when and if declared by the Board, will be paid in cash.

• Restrictions. So long as any Series A shares are outstanding, unless all accrued dividends on all Series A shares have been paid, we are prohibited from taking certain actions, including redeeming or purchasing shares of our common stock and paying dividends on our common stock.

• General Voting Rights. Except under certain circumstances or as otherwise provided by law, the holders of Series A shares have no voting rights. The approval of the holders of a majority of the Series A shares voting separately as a class will be required to effect certain corporate actions.

• Liquidation Preference. Upon a liquidation or dissolution of Southwall, the holders of Series A shares are entitled to be paid a liquidation preference out of assets legally available for distribution to our stockholders before any payment may be made to the holders of common stock. The liquidation preference is equal to the stated value of the Series A shares, which is $1.00 per share, plus any accumulated but unpaid dividends. Mergers, the sale of all or substantially all of our assets, or the acquisition of Southwall by another entity and certain other similar transactions may be deemed to be liquidation events for these purposes.

74

• Conversion. Each of the Series A shares is convertible into common stock at any time at the option of the holder. Each of the Series A shares is convertible into a number of shares of common stock equal to the sum of its stated value plus any accumulated but unpaid dividends, divided by the conversion price of the Series A shares. The conversion price of the Series A shares is $1.00 per share and is subject to adjustment in the event of any stock dividend, stock split, reverse stock split or combination affecting such shares. The Series A shares also have anti-dilution protection that adjusts the conversion price downwards using a weighted-average calculation in the event we issue certain additional securities at a price per share less than the closing price per share of our common stock on any stock exchange on which our common stock is listed. Each Series A share is initially convertible into one share of common stock. If the closing price of our common stock on any stock exchange on which our common stock is listed is $4.00 or more per share (subject to appropriate adjustment if a stock split, reverse split or similar transaction is affected) for 30 consecutive days, all outstanding Series A shares shall automatically be converted.

• Redemption. The Series A shares are not redeemable.

NOTE 4 - LINE OF CREDIT

On April 28, 2005, we entered into a credit agreement (the “Credit Agreement”) with Wells Fargo HSBC Trade Bank, N.A. (the “Bank”). The Credit Agreement provides for two facilities. All amounts borrowed under both facilities under the Credit Agreement must be repaid on or before May 31, 2006.

The first facility is a revolving line of credit under which we may from time to time borrow up to $3 million, subject to satisfaction of certain conditions. Amounts borrowed under the first facility bear interest at the prime rate minus 1.75% per annum or LIBOR plus 1% per annum, at our option. We borrowed approximately $3.0 million from this facility on April 28, 2005, which amount remained outstanding as of December 31, 2005.

The second facility is a formula line under which we may, from time to time, borrow up to $3 million, subject to certain conditions, with advances of up to 80% of eligible accounts receivable. Amounts borrowed under the second facility bear interest at the prime rate minus 0.25% per annum. We may borrow under the second facility only if we meet certain financial covenants. As of December 31, 2005, we met these financial covenants. There was no amount outstanding under the second facility at December 31, 2005.

All borrowings under both facilities are collateralized by our inventory, receivables, raw material, and work in progress. In addition, the first facility under the Credit Agreement is collateralized by a letter of credit posted by Needham & Company, one of our stockholders.

The terms of the Credit Agreement, among other things, limit our ability to (i) incur, assume or guarantee additional indebtedness in excess of $13.5 million (other than pursuant to the Credit Agreement), (ii) pay dividends or repurchase stock (except up to $0.6 million per year of dividends on preferred stock), (iii) incur liens upon the collateral pledged to the bank, (iv) make any loans or advances to, or investments in, any person or entity outside the ordinary course of business, (v) merge, consolidate, sell or otherwise dispose of substantially all or a substantial or material portion of our assets, (vi) enter into transactions with affiliates, and (vii) make acquisitions other than up to an aggregate amount of $3 million and (viii) to make capital expenditures in any fiscal year in excess of $1.5 million.

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

75

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

NOTE 5 - TERM DEBT

The Company's term debt consisted of the following:

				Balance at December 31,		Due in
Description	Rate			2005		2006
Term debt:
German bank loan dated May 12, 1999		6.13	%(1)	$	1,609	$	402
German bank loan dated May 28, 1999		7.10	%(2)		2,949		--
German bank loan dated May 28, 1999		3.75	%		337		337
German bank loan dated May 28, 2000		7.15	%(3)		1,321		278
German bank loan dated August 14, 1999 (due June 30, 2009)		5.75	%		1,991		--
Settlement agreement dated February 20, 2004			(4)		1,900		300
Total term debt					10,107	$	1,317
Less current portion					1,317
Term debt, non-current				$	8,790

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

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

(3) Interest rate will be reset to the then prevailing market rate in 2006.

(4) Interest rate was 4% for 2005, and will increase by one percentage point per year until 2010.

Settlement agreement

During 1999, Southwall entered into a master equipment sale-leaseback agreement with a leasing company, Matrix Funding Corporation ("lessor"). The Company was in dispute with the lessor over the interpretation of certain terms of the lease agreement and withheld lease payments due from March 2001 until February 2004. The lessor notified the Company that it considered the Company to be in default and in January 2002 drew down on a letter of credit in the amount of $0.5 million that collateralized the Company's obligations. In May 2002, a suit was filed against the Company by an agent of the successor to the lease demanding payment of unpaid lease payments and alleged residual values. (See Note 11- Commitments and Contingencies.) In February 2004, the Company entered into a settlement agreement with the agents pursuant to which the Company agreed to pay an aggregate of $2.0 million bearing interest at a stepped rate. The settlement required the Company to make an interest payment in 2004, and beginning in 2005, to make quarterly principal payments of between $75,000 and 125,000, plus interest payments until 2010. At December 31, 2005, the carrying value of the liability was $4,254 ($1,900 of principal, plus $2,354 of accrued interest). The agreement included a confession of judgment, whereby the Company acknowledges that it would owe damages of $5,900 in the event of payment defaults under the settlement agreement.

76

The Company performed an assessment under SFAS 15 and EITF 02-04 to assess whether this debt restructuring constituted a troubled debt restructuring.The Company concluded that the debt restructuring was in fact a troubled debt restructuring as the Company was in financial difficulty and the lessors had granted a concession to the Company, under the definitions of such conditions as set forth in EITF 02-04. The reduction in the amount of the debt indicated that a concession had been granted. SFAS 15 requires an assessment of the total future cash payments specified by the new terms of the debt, including principal, interest and contingent payments. If the payments are less than the carrying amount of the payable, the Company should reduce the carrying amount to an amount equal to the total future cash payments specified by the new terms and should recognize a gain on restructuring of payables equal to the amount of the reduction. In its assessment, management factored in the $5,900 confession of judgment as a contingent payment, thereby eliminating any potential gain on restructuring. The carrying value of the debt remains on the consolidated balance sheet and the liability will be reduced as payments are made, with a potential gain to be recorded at the date of the final payment and the expiry of the confession of judgment. Based on a SFAS 5 determination, when the Company considers default probable, the liability would be increased to the $5,900 confession of judgment value. The excess of the carrying value over the $2,000 was recorded in other long-term liabilities on the balance sheet. The remaining balance at December 31, 2005 is $1,900.

Loans from German Banks

On May 12, 1999, the Company entered into a loan agreement with a German bank that provides for borrowings up to 3,100 Euros ($3,900). Under the terms of this agreement, the funds were used solely for the purpose of capital investment by Southwall's German subsidiary. The term of the loan is for a period of 10 years and the principal is repayable in Euros after the end of one year in 36 quarterly payments. The loan bears interest at 6.125% per annum until December 31, 2005, after which it will be revised to the prevailing rate. Of the borrowings outstanding of $1,609 under this bank loan at December 31, 2005, $1,207 was classified as non-current in the accompanying consolidated balance sheet.

On May 28, 1999, the Company entered into a general loan agreement with a German bank. Under the terms of the loan agreement, funds were made available in three tranches, and were used solely for the purpose of capital investment by the Company's German subsidiary. The agreement contains various covenants with which the Company was in compliance at December 31, 2005; the Company is current with respect to all principal and interest payments due under the loan agreement. Under the first tranche, the Company borrowed 2,500 Euros ($3,200) for a term of twenty years beginning on May 28, 1999. The principal is repayable in Euros beginning after ten years in twenty equal, semi-annual payments. The loan bears fixed interest of 7.1% per annum for the first ten years, after which time the rate will be adjusted to a current prevailing rate. Of the borrowings outstanding under this tranche of $2,949 at December 31, 2005, $2,949 was classified as non-current in the accompanying balance sheet. Under the second tranche, the Company borrowed 1,700 Euros ($2,100) for a term of seven years beginning May 28, 1999 and the principal is repayable after one year in twelve equal, semi-annual payments. The loan bears fixed interest at 3.75% per annum for the period of seven years. At December 31, 2005, the amount due under this second tranche was $337, and $0 was classified as a non-current liability. Under the third tranche, the Company borrowed 2,100 Euros ($2,700) for a term of ten years beginning on May 28, 2000, and the principal is repayable after one year, in 36 equal quarterly payments. The loan bears fixed interest of 7.15% per annum for the first five years, after which time the rate will be adjusted to a current prevailing market rate. At December 31, 2005, the amount due was $1,321; of this amount, $1,043 was classified as non-current in the accompanying balance sheet.

77

On August 14, 1999, the Company entered into a loan agreement with a German bank that provides for borrowings up to 1,700 Euros ($2,300). As required by this agreement, the funds were used solely for the purpose of capital investment by the Company's German subsidiary. The principal balance is due in a single payment on June 30, 2009 and bears interest at a rate of 5.75% per annum. The interest is payable quarterly in Euros. Fifty percent of the loan proceeds are restricted in an escrow account for the duration of the loan period and are classified as a non-current asset "Restricted cash loans" in the accompanying balance sheet. The amount due under this bank loan at December 31, 2005 was $1,991, which was classified as a non-current liability in the accompanying balance sheet.

The preceding German bank loans are collateralized by the production equipment, building and land owned by the Company's German subsidiary. The dollar equivalent value of the remaining balances for the preceding German bank loans has been calculated using the Euro exchange rate as of December 31, 2005.

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

	Amount
2006	$	1,317
2007		981
2008		980
2009		3,318
2010		1,004
Thereafter		2,507
Total	$	10,107

The Company incurred total interest on indebtedness of $1,156, $2,300, and $1,600 in 2005, 2004 and 2003, respectively.

NOTE 6 - GOVERNMENT GRANTS AND INVESTMENT ALLOWANCES

The Company has an agreement to receive cash grant awards (the "Grant"), which was approved by the Saxony government in May 1999. As of December 31, 2005, the Company had received approximately 5,000 Euros ($5,000 at historical rate) under this Grant since 1999 and accounted for the Grant by applying the proceeds received to reduce the cost of fixed assets of the Dresden manufacturing facility. Additionally, as of December 31, 2005, the Company had a balance remaining from the government grants received in May 1999 of 335 Euros ($396), which has been recorded as an advance and held as restricted cash until the Company receives approval from the Saxony government to apply the funds to reduce its capital expenditures.

78

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

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

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

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

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

If the Company fails to meet the above requirements, the Saxony government has the right to demand repayment of the Grant. In addition to the Grant, the Company is further eligible for cash investment allowances from the Saxony government calculated based on the total projected capital investment by the Company in its Dresden facility of 47,000 Euros ($59,400), subject to European Union regulatory approval. During 2000, 2001, 2002, 2003, 2004 and 2005 the Company received 1,200 Euros ($1,500), 2,500 Euros ($3,200), 1,200 Euros ($1,500), 1,300 Euros ($1,600), 400 Euros ($500), and 158 Euros ($190), respectively, in investment allowances from the Saxony government, and those proceeds were applied to reduce the capitalized construction cost of the Dresden facility. These investment allowances are subject to the following requirements:

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

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

If the Company fails to meet the above requirements, the Saxony government has the right to demand repayment of the allowances. The Grants and investment allowances, if any, that the Company is entitled to seek from the Saxony government vary from year to year based upon the amount of capital expenditures that meet the above requirements. Generally, Southwall is not eligible to seek total investment grants for any year in excess of 33% of its eligible capital expenditures for that year. The Company cannot guarantee that it will be eligible for or receive additional grants or allowances in the future. As of December 31, 2005, we were in compliance with the requirements mentioned above.

79

NOTE 7 - INCOME TAXES

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

	2005		2004			2003
Domestic	$	1,826	$	( 1,893	)	$	(43,847	)
Foreign		1,523		2,322			2,236
Total	$	3,349	$	429		$	(41,611	)

The provision for income taxes for the years then ended December 31, 2005, 2004 and 2003 consist of the following:

	2005			2004		2003
Current:
Federal	$	--		$	--	$	--
State		(17	)		32		18
Foreign		554			525		316
Total current	$	537		$	557	$	334
Deferred:
Federal	$	--		$	--	$	--
State		--			--		--
Foreign		(508	)		57		347
Total deferred	$	(508	)	$	57	$	347
Total provision	$	29		$	614	$	681

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

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

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

	December 31,
	2005			2004
Deferred Tax Assets (Liabilities):
Federal and state net operating losses	$	12,160		$	12,112
Research, MIC, and other tax credits		1,822			2,422
Accruals		2,191			3,473
Depreciation and amortization		5,545			4,341
Foreign temporary differences		118			(397	)
Other		--			--
Net deferred tax assets		21,836			21,951
Deferred tax assets valuation allowance		(21,718	)		(22,348	)
Net deferred tax asset (liability)	$	118		$	(397	)

80

The 2005 net deferred tax asset is included in other current assets and the 2004 net deferred tax liability is included in other accrued liabilities in the accompanying balance sheets.

Realization of deferred tax assets is dependent upon future earnings, if any, the timing and amount of which are uncertain. Accordingly, the net deferred tax assets for U.S. components have been fully offset by a valuation allowance. The valuation allowance decreased by $630 for the period ended December 31, 2005.

As of December 31, 2005, the Company has net operating loss carry forwards for federal income tax purposes of approximately $33,606, which expire beginning in the year 2006 through 2026. The Company also has California net operating loss carry forwards of approximately $6,915, which expire beginning in the year 2006 through 2016.

The Company has federal and California research and development tax credits of $590 and $1,205, respectively. The federal research credits will begin to expire in the year 2019 and the California research credits have no expiration date. The Company also has California Manufacturers’ Investment Credit of $339, a portion of which is currently expiring yearly.

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

NOTE 8 - STOCK OPTION AND EMPLOYEE STOCK PURCHASE PLANS COMPENSATION

Stock Option Plans

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

Options granted under the plans prior to October 2004 generally vest at a rate of 25% per year, are non-transferable and expire over terms not exceeding ten years from the date of grant or three months after the optionee terminates his relationship with the Company. In October 2004, the board of directors changed the vesting. Grants from and after October 2004 under both plans vest at a rate of 25% after six months and then evenly monthly thereafter for the remaining 42 months.

81

As of December 31, 2005, there were 2,578 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, 2003		1,953		$	2.13 - $15.00	$	5.64
Granted		719		$	0.88 - $ 2.28		1.65
Exercised		--			--		--
Cancelled or expired		(585	)	$	1.92 - $15.00		5.18
Options outstanding at December 31, 2003		2,087		$	1.56 - $11.50		4.39
Granted Adjustments		300		$	0.88 - $ 0.88		0.88
Granted		2,379		$	0.50 - $ 1.81		0.95
Exercised		--			--		--
Cancelled or expired		(727	)	$	0.50 - $15.00		4.01
Options outstanding at December 31, 2004		4,039		$	2.13 - $15.00		4.19
Granted		2,327		$	0.57 - $ 1.65		0.79
Exercised		(38	)	$	0.50 - $ 1.05		0.51
Cancelled or expired		(766	)	$	0.50 - $11.50		2.82
Granted Adjustments		10		$	0.50 - $11.50		1.54
Options outstanding at December 31, 2005		5,572		$	0.50 - $15.00	$	1.53

The following table summarizes information about stock options outstanding at December 31, 2005:

	Options Outstanding						Options Exercisable
Range of Exercise Prices	Number Out-standing		Weighted Average Remaining Contractual Life (years)		Weighted Average Exercise Price		Number Exercisable		Weighted Average Exercise Price
$ 0.50 -- $0.50		1,233		8.38	$	0.50		1,023	$	0.50
$ 0 52 -- $0.52		2		8.81		0.52		1		0.52
$ 0.58 -- $0.58		1,250		9.94		0.58		0		0.00
$ 0.64 -- $0.88		578		8.86		0.80		200		0.88
$ 0.89 -- $1.20		625		7.94		1.13		210		1.11
$ 1.22 -- $1.81		1,004		6.83		1.62		447		1.65
$ 1.92 -- $6.88		578		3.51		3.28		478		3.52
$ 7.00 -- $8.72		248		3.55		7.77		191		7.71
$ 9.90 -- $9.90		52		3.32		9.90		40		9.90
$15.00 --$15.00		2		3.30		15.00		1		15.00
$ 0.50 --$15.00		5,572		7.68	$	1.53		2,591	$	2.02

Employee Stock Purchase Plan

In March 1997, the Company adopted the 1997 Employee Stock Purchase Plan ("the 1997 Plan") and reserved 100 shares of Common Stock for issuance there under. Employees, subject to certain limitations, may purchase shares at 85% of the lower of the fair market value of the Common Stock at the beginning of the six-month offering period, or the last day of the purchase period. During 2005, 2004 and 2003, 13, 7 and 21 shares, respectively, were sold under the 1997 Plan. At December 31, 2005, there were 57 shares available for issuance under the 1997 Plan.

82

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 fifteen hundred 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, 2005, 2004 and 2003. Matching contributions during 2005, 2004 or 2003 were $80, $100 and $100, respectively.

NOTE 9 - WARRANTS

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

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

Balance sheet classification of warrants:

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

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

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

83

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

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

Warrants issued in connection with the Letter of Intent:

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

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

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

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

Warrants issued in connection with the investment agreement:

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

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

84

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

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

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

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

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

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

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

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

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

85

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

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

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

Issuance Of Warrants In Connection With The Convertible Debt:

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

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

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

Embedded Derivatives:

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

86

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

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

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

NOTE 10 - SEGMENT REPORTING

Southwall operates in one segment.

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

	2005		2004		2003
Automotive glass	$	19,647	$	20,584	$	20,297
Electronic display		14,039		20,554		19,019
Architectural		5,934		7,010		6,297
Window film		15,134		9,425		7,713
Total net revenues	$	54,754	$	57,573	$	53,326

The following is a summary of net revenue by geographic area (based on location of customer):

	2005		2004		2003
United States	$	14,362	$	12,186	$	5,707
Japan		12,499		18,387		17,118
France		10,870		10,283		9,327
Pacific Rim		10,461		7,228		7,335
Germany		3,831		5,787		7,079
Rest of the world		2,731		3,702		6,760
Total net revenues	$	54,754	$	57,573	$	53,326

87

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

	December 31,
	2005		2004
United States	$	667	$	21
Germany		16,190		21,089
Consolidated	$	16,857	$	21,110

NOTE 11 - COMMITMENTS AND CONTINGENCIES

Commitments

The Company leases certain property and equipment as well as its facilities under noncancellable operating and capital leases. These leases expire at various dates through 2008. As of December 31, 2005, the future minimum payments under these leases are as follows:

Year Ending December 31,	Operating Leases
2006	$	1,586
2007		239
2008		11
2009		8
Future minimum lease payments	$	1,844

Rent expense under operating leases was approximately $861, $1,600 and $2,200 in 2005, 2004 and 2003, respectively. On January 19, 2006, the Company announced its plans to close its Palo Alto manufacturing facility (see Note 13 Subsequent Events). As a result of this decision, the Company is in negotiation with its landlord to decommission and surrender these premises. No liability has been recognized at this time because the Company cannot ascertain the fair value of any potential obligation to the landlord because the settlement date and method of settlement for our obligation have not been specified, and the Company currently does not have sufficient information to reasonably estimate any potential obligation. The Company believes that it can resolve this issue with the landlord and will pay for any potential obligations in 2006. It is possible that our estimate of our lease obligation could change in the near term.

On February 19, 2004, the Company entered into the second amendment to the lease for this Palo Alto facility. This amendment reflected a payment schedule for a rent deferral for this facility. In January of 2006, the Company paid off approximately $1.2 million of this deferred rent.

Contingencies

The Company was named as a defendant, along with Bostik, Inc., in an action captioned WASCO Products, Inc. v. Southwall Technologies, Inc. and Bostik, Inc., Civ. Action No. C 02 2926 SBA, which was filed in Federal District Court for the Northern District of California on June 18, 2002. We were served with the Complaint in this matter on July 1, 2002. The plaintiff filed the matter as a class action on behalf of all entities and individuals in the United States who manufactured and/or sold and warranted the service life of insulated glass units manufactured between 1989 and 1999, which contained Southwall Heat Mirror film and were sealed with a specific type of sealant manufactured by Bostik, Inc. The plaintiff alleged that the sealant provided by Bostik, Inc. was defective, resulting in elevated warranty replacement claims and costs. The plaintiff asserted claims against us for breach of an implied warranty of fitness, misrepresentation, fraudulent concealment, negligence, negligent interference with prospective economic advantage, breach of contract, unfair business practices and false or misleading business practices. The plaintiff sought recovery on behalf of the class of $100 million for damages allegedly resulting from elevated warranty replacement claims, restitution, injunctive relief, and non-specific compensation for lost profits. By Order entered December 22, 2003, the Court dismissed all claims against us. The plaintiff has filed a notice of appeal to the Ninth Circuit Court of Appeals. On January 13, 2006, the Court of Appeals affirmed the lower court decision. On January 26, 2006, the plaintiff filed a petition for rehearing with the Ninth Circuit Court of Appeals. In March of 2006, the Ninth Circuit Court of Appeals denied the plaintiff’s petition. A percentage of the Company’s defense costs are being paid by its insurance carriers under reservation of rights. It is not possible to predict how Plaintiff’s claims will be resolved, whether the Company will be found liable, or the nature and extent of Plaintiff’s alleged damages.

88

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

On June 13, 2002, Plaintiff Charles Ikekwere (“Plaintiff”) filed a Complaint against the Company in the Superior Court of California in and for the County of Santa Clara, Case No. CV808644. Mr. Ikekwere is a former employee of the Company. Plaintiff’s Complaint alleged claims for race discrimination, national origin discrimination, retaliation, medical condition discrimination, breach of contract, breach of fiduciary duty, fraud, negligence, intentional infliction of emotional distress, and punitive damages. The Company challenged the sufficiency of certain of Plaintiff’s allegations, which caused him to file a First Amended Complaint alleging essentially the same claims. The Company also challenged certain of Plaintiff’s allegations in his First Amended Complaint, which caused him to file a Second Amended Complaint. Following the Company’s legal challenges to Plaintiff’s Second Amended Complaint, the following claims remain at issue in the litigation: (1) race discrimination; (2) national origin discrimination; (3) retaliation; (4) medical condition discrimination; (5) breach of contract; (6) violation of California Constitution Article I; and (7) fraud and deceit. In light of certain deposition testimony given by Plaintiff, the Company removed this matter to Federal Court on January 6, 2004. The basis for the Company’s removal was that certain of Plaintiff’s allegations were preempted by the Employee Retirement Income and Security Act (ERISA). On February 4, 2004, Plaintiff filed a Motion to Remand the case to State Court, which the Court denied. Plaintiff subsequently amended his Second Amended Complaint to add a claim under ERISA. The parties have almost completed all discovery, with just one deposition remaining. The parties have finished expert discovery. The Company has filed a summary judgment motion, which, if granted, will dispose of the entire action. If Plaintiff defeats the Company’s summary judgment motion, trial is scheduled for July 2006. Until discovery is completed and the Court rules on the Company’s summary judgment motion, it is not possible to predict how Plaintiff’s claims will be resolved, whether the Company will be found liable, or the nature and extent of Plaintiff’s alleged damages.

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.

89

NOTE 12 - IMPAIRMENT OF LONG-LIVED ASSETS

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

During 2005 and 2004, the Company recovered $170 and $1,513, respectively, from the sale of a previously written-down machine.

NOTE 13 - SUBSEQUENT EVENTS

On January 19, 2006, we commenced restructuring actions to improve our cost structure for 2006 and beyond. These actions include the closure of our Palo Alto, California manufacturing facility and a reduction in force at our Palo Alto site in the first half of 2006. We will transfer our U.S. manufacturing operations to the European site located in Dresden, Germany in the first half of 2006. The reduction in force will affect approximately 40 positions, or 22% of Southwall's total worldwide headcount. Severance costs associated with these positions are estimated to be approximately $0.3 million. After this reduction, Southwall will employ approximately 40 people in non-manufacturing positions at our site in California and 90 people in Germany and 7 in various remote sales offices.

The Company plans to vacate its current Palo Alto facility, which also serves as its headquarters and houses its research and development, sales and marketing and general and administrative functions. The Company intends to relocate to another Silicon Valley facility for these functions. Under the current lease agreement, which expired on January 31, 2006, the Company is obligated to decommission and surrender its manufacturing premises. The Company is in negotiation with the landlord regarding its obligation to decommission and surrender these premises and no liability has been recognized at this time because the Company cannot ascertain the fair value of this obligation at December 31, 2005 (See Note 11 Commitments and Contingencies). On February 19, 2004, the Company entered into the second amendment to the lease for this Palo Alto facility. This amendment reflected a payment schedule for a rent deferral for this facility. In January of 2006, the Company paid off approximately $1.2 million of this deferred rent.

90

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

None

ITEM 9A. CONTROLS AND PROCEDURES

(a) Evaluation and Disclosure Controls and Procedures. Under the supervision and with the participation of our management, including our chief executive officer and vice president of finance, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, as of December 31, 2005. Based on this evaluation, our chief executive officer and vice president of finance concluded as of the Evaluation Date that our disclosure controls and procedures were effective such that the information relating to the Company, including our consolidated subsidiaries, required to be disclosed in our Securities and Exchange Commission (“SEC”) reports (i) is recorded, processed, summarized and reported with the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to our management, including our chief executive officer and vice president of finance, as appropriate to allow timely decisions regarding required disclosure.

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

(c) Changes in Internal Controls. There were no changes during 2005 in our internal controls over financial reporting that have materially effected, or are reasonably likely to materially affect, the internal controls over financial reporting.

ITEM 9B. OTHER INFORMATION

Not applicable.

91

PART III

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

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT

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

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

ITEM 11. EXECUTIVE COMPENSATION

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

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

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

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

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

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

92

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

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

93

PART IV

ITEM 15. EXHIBITS, AND FINANCIAL STATEMENT SCHEDULES

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

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

	Page Number
Report of Independent Registered Public Accounting Firm	57
Report of Independent Registered Public Accounting Firm	58
Consolidated Balance Sheets as of December 31, 2005 and 2004	59
Consolidated Statements of Operations for the years ended December 31, 2005, 2004 and 2003	60
Consolidated Statements of Stockholders' Equity for the years ended December 31, 2005, 2004 and 2003	61
Consolidated Statements of Cash Flows for the years ended December 31, 2005, 2004 and 2003	62
Notes to Consolidated Financial Statements	63

(2) Financial Statement Schedule.

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

Description	Balance at Beginning of Year		Additions			Deductions			Balance at End of Year
2005
Inventory reserves	$	1,254	$	1,531		$	2,205	(2)	$	580
Allowance for Doubtful Accounts	$	292	$	--		$	84	(2)	$	208
Reserves for warranty and sales returns	$	2,701	$	720	(1)	$	1,865	(2)	$	1,556
Tax valuation allowance	$	22,348	$	--		$	630	(2)	$	21,718
2004
Inventory reserves	$	1,440	$	2,129		$	2,315	(2)	$	1,254
Allowance for Doubtful Accounts	$	778	$	--		$	486	(2)	$	292
Reserves for warranty and sales returns	$	1,851	$	2,359	(1)	$	1,509	(2)	$	2,701
Tax valuation allowance	$	29,521	$	--		$	7,173	(2)	$	22,348
2003
Inventory reserves	$	988	$	908		$	456	(2)	$	1,440
Allowance for Doubtful Accounts	$	552	$	275		$	49	(2)	$	778
Reserves for warranty and sales returns	$	2,069	$	2,271	(1)	$	2,489	(2)	$	1,851
Tax valuation allowance	$	14,671	$	14,850		$	--		$	29,521

(1) Charged against revenue.

(2) Reserves utilized during the year.

(3) Exhibits.

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

94

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, as of the day of March 29, 2006.

SOUTHWALL TECHNOLOGIES INC.
By:	/s/ Thomas G. Hood
	Thomas G. Hood
	President

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities indicated, as of March 29, 2006.

Signature	Title
/s/Thomas G. Hood Thomas G. Hood	President, Chief Executive Officer and Director (Principal Executive Officer)
/s/Sylvia Kamenski Sylvia Kamenski	Vice President of Finance (Principal Accounting Officer)
/s/George Boyadjieff George Boyadjieff	Chairman, Board of Directors
/s/William A. Berry William A. Berry	Director
/s/Jami K. Nachtsheim Jami K. Nachtsheim	Director
/s/Joseph B. Reagan Joseph B. Reagan	Director
/s/Walter C. Segdwick Walter C. Segdwick	Director
/s/Peter E. Salas Peter E. Salas	Director

95

EXHIBIT INDEX

Exhibit No.	Exhibit
3.1(1)	Restated Certificate of Incorporation of the Company.
3.1.1(30)	Amendment to Amended and Restated Certificate of Incorporation of the Company
3.2(1)	By-laws of the Company.
3.3(26)	Amended and Restated Certificate of Designation, Preferences and Rights of Series A 10% Cumulative Preferred Stock of the Company filed with the Secretary of State of Delaware on January 30, 2004.
10.35.1(11)	Lease Agreement for the facilities at 3941 East Bayshore Road, dated October 7, 1999, between the Company and Straube Associates, Inc.
10.36(1)	Lease Agreement for the facilities at 3961 East Bayshore Road, dated March 20, 1979, between the Company and Allan F. Brown and Robert V. Brown.
10.36.1(11)	Amendment, dated October 12, 1999, between the Company and Brown Investment Company to the Lease Agreement for the facilities at 3961 East Bayshore Road, dated March 20, 1979, between the Company and Allan F. Brown and Robert V. Brown.
10.59(3)	Lease Agreement for the facilities at 3969-3975 East Bayshore Road Palo Alto, California, dated January 1, 1989, between the Company and Bay Laurel Investment Company.
10.59.1(11)	Amendment, effective January 1, 2000, between the Company and Judd Properties, LLC to the Lease Agreement for the facilities at 3969-3975 East Bayshore Road Palo Alto, California, dated January 1, 1989, between the Company and Bay Laurel Investment Company.
10.59.2(27)	Second Amendment to Lease for the facilities at 3969-3975 East Bayshore Road Palo Alto, California, dated February 19, 2004, between the Company and Judd Properties, LLC.
10.60.1(11)	Amendment, effective January 1, 2000, between the Company and Judd Properties, LLC to the Lease Agreements for the facilities at 3977-3995 East Bayshore Road Palo Alto, California, dated January 1, 1989, between the Company and Bay Laurel Investment Company.
10.60.2(27)	Surrender and Termination Agreement for the facilities at 3977- 3995 East Bayshore Road Palo Alto, California, dated February 19, 2004, between the Company and Judd Properties, LLC.
10.71(4)	Lease Agreement for the facilities at 3780 Fabian Way, Palo Alto, California, dated June 11, 1990, between the Company and The Fabian Building.
10.72(4)	License Agreement between Mitsui and the Company, dated December 28, 1990.
10.72.1(19)	Amendment to the License Agreement dated as of December 28, 1990 between Mitsui and the Company, dated August 2000.
10.78(5)	Amendment to property lease dated February 2, 1994 to extend lease period on building at 3961 E. Bayshore Road, Palo Alto, California. Original lease filed as Exhibit No. 10.36 above.
10.92(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.
10.99(15)*	1998 Stock Plan for Employees and Consultants.
10.103(15)	German bank loan dated May 12, 1999.
10.104(15)	German bank loan dated May 28, 1999.
10.105(22)	German bank loans dated May 28, 1999 and December 1, 1999.
10.106(15)	German bank loan due June 30, 2009.
10.107(15)	German bank loan dated June 29, 2000.
10.108(15)	German bank loan dated July 10, 2000.
10.109(15)	German bank loans dated December 18, 2000 and December 19, 2000.
10.111(19)	Master Lease Agreement between Matrix Funding Corporation and the Company, dated July 19, 1999.
10.116(18)	Distribution Agreement between Globamatrix Holdings Pte. Ltd. and the Company, dated as of January 1, 2002 (portions of this exhibit have been omitted based on a request for confidential treatment; the non-public information has been filed with the Commission).
10.116.1(27)	Letter Agreement dated August 28, 2003 between Globamatrix Holdings Pte. Ltd. and the Company amending the Distribution Agreement between the parties dated January 1, 2002.
10.116.2(27)	Letter Agreement dated December 17, 2003 between Globamatrix Holdings Pte. Ltd. and the Company amending the Distribution Agreement between the parties dated January 1, 2002.
10.117(17)	Teijin Waiver Letter dated May 9, 2002.
10.118(17)	Sanwa Bank Waiver Letter dated May 15, 2002.
10.119(19)	Standard Industrial Lease dated October 1999 for the facilities at 1029 Corporation Way, Palo Alto, California between the Company and C&J Development.
10.120(19)	Guarantee Agreement Regarding 10 million US$ Credit Facility between Teijin Limited and the Company, dated May 6, 1997.
10.120.1(21)	Memorandum Amendment to the Guarantee Agreement between Teijin Limited and the Company, dated August 1999.
10.121. (23)	Pilkington Supply and Purchase Agreement dated September 1, 2002.
10.122. (23)	Xinyi Group (Glass) Co. LTD. Purchase Agreement dated September 5, 2002.
10.123 (24)	Domestic Factoring Agreement dated May 16, 2003, between Pacific Business Funding and the Company.
10.123.1 (24)	Amendment to the Domestic Factoring Agreement dated June 16, 2003, between Pacific Business Funding and the Company.
10.124 (24)	Intellectual Property Security Agreement dated May 16, 2003, between Pacific Business Funding and the Company.
10.125 (24)	Export-Import Working Capital Guarantee Program Borrower Agreement, between Pacific Business Funding and the Company.
10.126 (24)	Export-Import Factoring Agreement dated May 16, 2003, between Pacific Business Funding and the Company.
10.126.1 (24)	Amendment to the Export- Import Factoring Agreement dated June 16, 2003, between Pacific Business Funding and the Company.
10.127 (24)	Manufacturing and Supply Agreement between the Company and Mitsui Chemicals, Inc. dated July 19, 2003 (portions of this exhibit have been omitted based on a request for confidential treatment; the non-public information has been filed with the Commission).
10.128(27)	Guaranteed Loan Agreement dated January 19, 2004, between Teijin Limited and the Company.
10.128.1(29)	Amendment No. 1, dated June 9, 2004, to Guaranteed Loan Agreement by and between Southwall and Teijin, Limited.
10.129(27)	Guaranty Agreement dated January 19, 2004, between Teijin Limited and Southwall Europe GmbH.
10.130(27)	Supply Agreement between Saint Gobain Sekurit France and the Company, effective January 1, 2004 (portions of this exhibit have been omitted based on a request for confidential treatment; the non-public information has been filed with the Commission).

96

10.131 (26)	Amended and Restated Investment Agreement, dated February 20, 2004, by and among the Company and Needham & Company, Inc., Needham Capital Partners II, L.P., Needham Capital Partners II (Bermuda), L.P., Needham Capital Partners III, L.P., Needham Capital Partners IIIA, L.P., Needham Capital Partners III (Bermuda), L.P., and Dolphin Direct Equity Partners, LP (collectively, the "Investors").
10.132 (26)	Amended and Restated Registration Rights Agreement, dated February 20, 2004, by and among the Company, Pacific Business Funding, Judd Properties, LLC, and the Investors.
10.133 (26)	Form of Secured Convertible Promissory Note issued by the Company to the Investors.
10.134 (26)	Pledge Agreement, dated February 20, 2004, between the Company and Needham & Company, Inc.
10.135 (25)	Form of Warrant to purchase shares of the Company's common stock.
10.136 (25)	Loan and Security Agreement, dated December 18, 2003, between the Company and Pacific Business Funding.
10.136.1(28)	First Amendment to Loan and Security Agreement dated as of December 18, 2003, dated April 29, 2004.
10.137 (25)	Forbearance Agreement, dated December 18, 2003, between the Company and Pacific Business Funding.
10.137.1(27)	First Amendment to Forbearance Agreement, dated December 29, 2003, between the Company and Pacific Business Funding.
10.137.2 (26)	Second Amendment to Forbearance Agreement, dated February 20, 2004, between the Company and Pacific Business Funding.
10.138(27)	Mutual Release and Settlement Agreement dated February 20, 2004, by and among the Company and Bank of America, N.A., Portfolio Financial Servicing Company and Lehman Brothers. Agreement relates to the Master Lease Agreement between Matrix Funding Corporation and the Company filed as Exhibit 10.111.
10.139(28)	Third Amendment to Domestic Factoring Agreement, dated April 29, 2004.
10.140	Lease agreement for the facilities at 3780 Fabian Way, Palo Alto, CA, dated October 04, 2005 between the Company, Richard Christina and Diane Christina.
10.141	Lease agreement for the facilities at 2629B Terminal Boulevard, Mountain View, CA, dated July 14, 2005 between the Company and Dymond Development Company, LLC.
14(27)	Code of Ethics.
21(15)	List of Subsidiaries of the Company.
23.1	Consent of Independent Registered Public Accounting Firm (Burr, Pilger & Mayer LLP).
23.2	Consent of Independent Registered Public Accounting Firm (PricewaterhouseCoopers LLP).
31.1	Certification pursuant to Exchange Act Rules 13a-14 and 15d-14 of the Chief Executive Officer
31.2	Certification pursuant to Exchange Act Rules 13a-14 and 15d-14 of the Chief Financial Officer
32.1	Certification pursuant to 18 U.S.C. Section 1350 of the Chief Executive Officer
32.2	Certification pursuant to 18 U.S.C. Section 1350 of the Chief Financial Officer

_____

* Relates to management contract or compensatory plan or arrangement.

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

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

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

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

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

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

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

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

(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.

97

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

98

EX-10.140

Exhibit 10.140

	AIR COMMERCIAL REAL ESTATE ASSOCIATION
	STANDARD INDUSTRIAL/COMMERCIAL
	MULTI-TENANT LEASE - NET

1.  Basic Provisions ("Basic Provisions").

1.1Parties: This Lease ("Lease"), dated for reference purposes only _____________, 2005, is made by and between Richard A. Cristina and Diane L. Cristina, Trustees of the Richard A. Cristina and Diane L. Cristina Trust, dated December 20, 1995, as amended ("Lessor") and SOUTHWALL TECHNOLOGIES INC., a Delaware corporation ("Lessee"), (collectively the "Parties", or individually a "Party").

1.2(a)      Premises: That certain portion of the Project (as defined below), including all improvements therein or to be provided by Lessor under the terms of this Lease, commonly known by the street address of 3780 Fabian Way, located in the City of Palo Alto, County of Santa Clara, State of California, with zip code 94303, as outlined on Exhibit ____ attached hereto ("Premises") and generally described as (describe briefly the nature of the Premises): approximately 7,774 square feet of a larger concrete industrial/research and development building. In addition to Lessee's rights to use and occupy the Premises as hereinafter specified, Lessee shall have non-exclusive rights to any utility raceways of the building containing the Premises ("Building") and to the Common Areas (as defined in Paragraph 2.7 below), but shall not have any rights to the roof or exterior walls of the Building or to any other buildings in the Project. The Premises, the Building, the Common Areas, the land upon which they are located, along with all other buildings and improvements thereon, are herein collectively referred to as the "Project." (See also Paragraph 2)

1.2(b)      Parking: 26.32% of the unreserved vehicle parking spaces. (See also Paragraph 2.6)

1.3Term: Two (2) years and No (0) months ("Original Term") commencing November 1, 2005 ("Commencement Date") and ending October 31, 2007 ("Expiration Date"). (See also Paragraph 3)

1.4Early Possession: N/A ("Early Possession Date"). (See also Paragraphs 3.2 and 3.3)

1.5Base Rent: $4,800.00 per month ("Base Rent"), payable on the first day of each month commencing November 1, 2005. (See also Paragraph 4) & Paragraph 50).

x If this box is checked, there are provisions in this Lease for the Base Rent to be adjusted.

1.6Lessee's Share of Common Area Operating Expenses: 26.32 percent (26.3%) ("Lessee's Share"). Lessee's Share has been calculated by dividing the approximate square footage of the Premises by the approximate square footage of the Project. In the event that the size of the Premises and/or the Project are modified during the term of this Lease, Lessor shall recalculate Lessee's Share to reflect such modification.

1.7Base Rent and Other Monies Paid Upon Execution:

(a) Base Rent: $ N/A for the period  _____________________________________.

(b) Common Area Operating Expenses: $__________ for the period ____________.

(c) Security Deposit: $10,504.00 ("Security Deposit"). (See also Paragraph 5) & Paragraph 51).

(d) Other: $___________ for__________________________________________.

(e) Total Due Upon Execution of this Lease: $_________.

1.8Agreed Use: ___________________________________________________________. (See also Paragraph 6)

1.9Insuring Party: Lessor is the "Insuring Party". (See also Paragraph 8)

1.12         Attachments. Attached hereto are the following, all of which constitute a part of this Lease:

oan Addendum consisting of Paragraphs ______ through ______;

oa site plan depicting the Premises;

oa site plan depicting the Project;

oa current set of the Rules and Regulations for the Project;

oa current set of the Rules and Regulations adopted by the owners' association;

oa Work Letter;

oother (specify):____________________________________________________________________.

2.  Premises.

2.1Letting. Lessor hereby leases to Lessee, and Lessee hereby leases from Lessor, the Premises, for the term, at the rental, and upon all of the terms, covenants and conditions set forth in this Lease. Unless otherwise provided herein, any statement of size set forth in this Lease, or that may have been used in calculating Rent, is an approximation which the Parties agree is reasonable and any payments based thereon are not subject to revision whether or not the actual size is more or less. NOTE: Lessee is advised to verify the actual size prior to executing this Lease.

2.2Condition. Lessor shall deliver that portion of the Premises contained within the Building ("Unit") to Lessee broom clean and free of debris on the Commencement Date or the Early Possession Date, whichever first occurs ("Start Date"), and, so long as the required service contracts described in Paragraph 7.1(b) below are obtained by Lessee and in effect within thirty days following the Start Date, warrants that the existing electrical, plumbing, fire sprinkler, lighting, heating, ventilating and air conditioning systems ("HVAC"), loading doors, sump pumps, if any, and all other such elements in the Unit, other than those constructed by Lessee, shall be in good operating condition on said date, that the structural elements of the roof, bearing walls and foundation of the Unit shall be free of material defects, and that the Unit does not contain hazardous levels of any mold or fungi defined as toxic under applicable state or federal law. If a non-compliance with such warranty exists as of the Start Date, or if one of such systems or elements should malfunction or fail within the appropriate warranty period, Lessor shall, as Lessor's sole obligation with respect to such matter, except as otherwise provided in. this Lease, promptly after receipt of written notice from Lessee setting forth with specificity the nature and extent of such non-compliance, malfunction or failure, rectify same at Lessor's expense. The warranty periods shall be as follows: (i) 6 months as to the HVAC systems, and (ii) 30 days as to the remaining systems and other elements of the Unit. If Lessee does not give Lessor the required notice within the appropriate warranty period, correction of any such non-compliance, malfunction or failure shall be the obligation of Lessee at Lessee's sole cost and expense (except for the repairs to the fire sprinkler systems, roof, foundations, and/or bearing walls - see Paragraph 7).

Initials PAGE 1 Initials

©1999-AIR Commercial Real Estate Association FORM MTN-4-8/04

2.3Compliance. Lessor warrants that to the best of its knowledge the improvements on the Premises and the Common Areas comply with the building codes that were in effect at the time that each such improvement, or portion thereof, was constructed, and also with all applicable laws, covenants or restrictions of record, regulations, and ordinances in effect on the Start Date ("Applicable Requirements"). Said warranty does not apply to the use to which Lessee will put the Premises, modifications which may be required by the Americans with Disabilities Act or any similar laws as a result of Lessee's use (see Paragraph 49), or to any Alterations or Utility Installations (as defined in Paragraph 7.3(a)) made or to be made by Lessee. NOTE: Lessee is responsible for determining whether or not the Applicable Requirements and especially the zoning are appropriate forLessee's intended use, and acknowledges that past uses of the Premises may no longer be allowed. If the Premises do not comply with said warranty, Lessor shall, except as otherwise provided, promptly after receipt of written notice from Lessee setting forth with specificity the nature and extent of such non-compliance, rectify the same at Lessor's expense. If Lessee does not give Lessor written notice of a non-compliance with this warranty within 6 months following the Start Date, correction of that non-compliance shall be the obligation of Lessee at Lessee's sole cost and expense. If the Applicable Requirements are hereafter changed so as to require during the term of this Lease the construction of an addition to or an alteration of the Unit, Premises and/or Building, the remediation of any Hazardous Substance, or the reinforcement or other physical modification of the Unit, Premises and/or Building ("Capital Expenditure"),Lessor and Lessee shall allocate the cost of such work as follows:

(a)  Subject to Paragraph 2.3(c) below, if such Capital Expenditures are required as a result of the specific and unique use of the Premises by Lessee as compared with uses by tenants in general, Lessee shall be fully responsible for the cost thereof, provided, however that if such Capital Expenditure is required during the last 2 years of this Lease and the cost thereof exceeds 6 months' Base Rent, Lessee may instead terminate this Lease unless Lessor notifies Lessee, in writing, within 10 days after receipt of Lessee's termination notice that Lessor has elected to pay the difference between the actual cost thereof and the amount equal to 6 months' Base Rent. If Lessee elects termination, Lessee shall immediately cease the use of the Premises which requires such Capital Expenditure and deliver to Lessor written notice specifying a termination date at least 90 days thereafter. Such termination date shall, however, in no event be earlier than the last day that Lessee could legally utilize the Premises without commencing such Capital Expenditure.

(b)  If such Capital Expenditure is not the result of the specific and unique use of the Premises by Lessee (such a governmentally mandated seismic modifications), then Lessor and Lessee shall allocate the obligation to pay for the portion of such costs reasonably attributable to the Premises pursuant to the formula set out in Paragraph 7.1(d); provided, however, that if such Capital Expenditure is required during the last 2 years of this Lease or if Lessor reasonably determines that it is not economically feasible to pay its share thereof, Lessor shall have the option to terminate this Lease upon 90 days prior written notice to Lessee unless Lessee notifies Lessor, in writing, within 10 days after receipt of Lessor's termination notice that Lessee will pay for such Capital Expenditure. If Lessor does not elect to terminate, and fails to tender its share of any such Capital Expenditure, Lessee may advance such funds and deduct same, with Interest, from Rent until Lessor's share of such costs have been fully paid. If Lessee is unable to finance Lessor's share, or if the balance of the Rent due and payable for the remainder of this Lease is not sufficient to fully reimburse Lessee on an offset basis, Lessee shall have the right to terminate this Lease upon 30 days written notice to Lessor.

(c)  Notwithstanding the above, the provisions concerning Capital Expenditures are intended to apply only to non-voluntary, unexpected, and new Applicable Requirements. If the Capital Expenditures are instead triggered by Lessee as a result of an actual or proposed change in use/change in intensity of use, or modification to the Premises then, and in that event, Lessee shall either: (i) immediately cease such changed use or intensity of use and/or take such other steps as may be necessary to eliminate the requirement for such Capital Expenditure, or (ii) complete such Capital Expenditure at its own expense. Lessee shall not have any right to terminate this Lease.

2.4Acknowledgements. Lessee acknowledges that: (a) it has been advised by Lessor and/or Brokers to satisfy itself with respect to the condition of the Premises (including but not limited to the electrical, HVAC and fire sprinkler systems, security, environmental aspects, and compliance with Applicable Requirements and the Americans with Disabilities Act), and their suitability for Lessee's intended use, (b) Lessee has made such investigation as it deems necessary with reference to such matters and assumes all responsibility therefor as the same relate to its occupancy of the Premises, and (c) neither Lessor, Lessor's agents, nor Brokers have made any oral or written representations or warranties with respect to said matters other than as set forth in this Lease. In addition, Lessor acknowledges that: (i) Brokers have made no representations, promises or warranties concerning Lessee's ability to honor the Lease or suitability to occupy the Premises, and (ii) it is Lessor's sole responsibility to investigate the financial capability and/or suitability of all proposed tenants.

2.5Lessee as Prior Owner/Occupant. The warranties made by Lessor in Paragraph 2 shall be of no force or effect if immediately prior to the Start Date Lessee was the owner or occupant of the Premises. In such event, Lessee shall be responsible for any necessary corrective work.

2.6Vehicle Parking. Lessee shall be entitled to use the number of parking spaces specified in Paragraph 1.2(b) on those portions of the Common Areas designated from time to time by Lessor for parking. Lessee shall not use more parking spaces than said number. Said parking spaces shall be used for parking by vehicles no larger than full-size passenger automobiles or pick-up truck herein called "Permitted Size Vehicles." Lessor may regulate the loading and unloading of vehicles by adopting Rules and Regulation as provided in Paragraph 2.9. No vehicles other than Permitted Size Vehicles may be parked in the Common Area without the prior written permission of Lessor. In addition:

(a)     Lessee shall not permit or allow any vehicles that belong to or are controlled by Lessee or Lessee's employees, suppliers, shippers, customers, contractors or invitees to be loaded, unloaded, or parked in areas other than those designated by Lessor for such activities.

(b)     Lessee shall not service or store any vehicles in the Common Areas.

(c)     If Lessee permits or allows any of the prohibited activities described in this Paragraph 2.6, then Lessor shall have the right, without notice, in addition to such other rights and remedies that ii may have, to remove or tow away the vehicle involved and charge the cost to Lessee, which cost shall be immediately payable upon demand by Lessor.

2.7Common Areas - Definition. The term "Common Areas" is defined as all areas and facilities outside the Premises and within the exterior boundary line of the Project and interior utility raceways and installations within the Unit that are provided and designated by the Lessor from time to time for the general non-exclusive use of Lessor, Lessee and other tenants of the Project and their respective employees, suppliers, shippers, customers, contractors and invitees, including parking areas, loading and unloading areas, trash areas, roadways, walkways, driveways and landscaped areas.

2.8Common Areas - Lessee's Rights. Lessor grants to Lessee, for the benefit of Lessee and its employees, suppliers, shippers, contractors, customers and invitees, during the term of this Lease, the non-exclusive right to use, in common with others entitled to such use, the Common Areas as they exist from time to time, subject to any rights, powers, and privileges reserved by Lessor under the terms hereof or under the terms of any rules and regulations or restrictions governing the use of the Project. Under no circumstances shall the right herein granted to use the Common Areas be deemed to include the right to store any property, temporarily or permanently, in the Common Areas. Any such storage shall be permitted only by the prior written consent of Lessor or Lessor's designated agent, which consent may be revoked at any time. In the event that any unauthorized storage shall occur then Lessor shall have the right, without notice, in addition to such other rights and remedies that it may have, to remove the property and charge the cost to Lessee, which cost shall be immediately payable upon demand by Lessor.

Initials PAGE 2 Initials

©1999-AIR Commercial Real Estate Association FORM MTN-4-8/04

2.9Common Areas - Rules and Regulations. Lessor or such other person(s) as Lessor may appoint shall have the exclusive control and management of the Common Areas and shall have the right, from time to time, to establish, modify, amend and enforce reasonable rules and regulations ("Rules and Regulations") for the management, safety, care, and cleanliness of the grounds, the parking and unloading of vehicles and the preservation of good order, as well as for the convenience of other occupants or tenants of the Building and the Project and their invitees. Lessee agrees to abide by and conform to all such Rules and Regulations, and shall use its best efforts to cause its employees, suppliers, shippers, customers, contractors and invitees to so abide and conform. Lessor shall not be responsible to Lessee for the non-compliance with said Rules and Regulations by other tenants of the Project.

2.10         Common Areas - Changes. Lessor shall have the right, in Lessor's sole discretion, from time to time:

(a)     To make changes to the Common Areas, including, without limitation, changes in the location, size, shape and number of driveways, entrances, parking spaces, parking areas, loading and unloading areas, ingress, egress, direction of traffic landscaped areas, walkways and utility raceways;

(b)     To close temporarily any of the Common Areas for maintenance purposes so long as reasonable access to the Premises remains available;

(c)     To designate other land outside the boundaries of the Project to be a part of the Common Areas;

(d)     To add additional buildings and improvements to the Common Areas;

(e)     To use the Common Areas while engaged in making additional improvements, repairs or alterations to the Project, or any portion thereof; and

(f)      To do and perform such other acts and make such other changes in, to or with respect to the Common Areas and Project as Lessor may, in the exercise of sound business judgment, deem to be appropriate.

3.  Term.

3.1Term. The Commencement Date, Expiration Date and Original Term of this Lease are as specified in Paragraph 1.3.

3.2Early Possession. If Lessee totally or partially occupies the Premises prior to the Commencement Date, the obligation to pay Base Rent shall be abated for the period of such early possession. All other terms of this Lease (including but not limited to the obligations to pay Lessee's Share of Common Area Operating Expenses, Real Property Taxes and insurance premiums and to maintain the Premises) shall be in effect during such period. Any such early possession shall not affect the Expiration Date.

3.3Delay In Possession. Lessor agrees to use its best commercially reasonable efforts to deliver possession of the Premises to Lessee by the Commencement Date. If, despite said efforts, Lessor is unable to deliver possession as agreed, Lessor shall not be subject to any liability therefor, nor shall such failure affect the validity of this Lease or change the Expiration Date. Lessee shall not, however, be obligated to pay Rent or perform its other obligations until Lessor delivers possession of the Premises and any period of rent abatement that Lessee would otherwise have enjoyed shall run from the date of the delivery of possession and continue for a period equal to what Lessee would otherwise have enjoyed, but minus any days of delay caused by the acts or omissions of Lessee. If possession is not delivered within 60 days after the Commencement Date, Lessee may, at its option, by notice in writing within 10 days orthe end of such 60 day period, cancel this Lease, in which event the Parties shall be discharged from all obligations hereunder. If such written notice is not received by Lessor within said 10 day period, Lessee's right to cancel shall terminate. Except as otherwise provided, if possession is not tendered to Lessee by the Start Date and Lessee does not terminate this Lease, as aforesaid, any period of rent abatement that Lessee would otherwise have enjoyed shall run from the date of delivery of possession and continue for a period equal to what Lessee would otherwise have enjoyed under the terms hereof, but minus any days of delay caused by the acts or omissions of Lessee. If possession of the Premises is not delivered within 4 months after the Commencement Date, this Lease shall terminate unless other agreements are reached between Lessor and Lessee, in writing.

3.4Lessee Compliance. Lessor shall not be required to tender possession of the Premises to Lessee until Lessee complies with its obligation to provide evidence of insurance (Paragraph 8.5). Pending delivery of such evidence, Lessee shall be required to perform all of its obligations under this Lease from and after the Start Date, including the payment of Rent, notwithstanding Lessor's election to withhold possession pending receipt of such evidence of insurance: Further, if Lessee is required to perform any other conditions prior to or concurrent with the Start Date, the Start Date shall occur but Lessor may elect to withhold possession until such conditions are satisfied.

4.  Rent.

4.1Rent Defined. All monetary obligations of Lessee to Lessor under the terms of this Lease (except for the Security Deposit) are deemed to be rent ("Rent").

4.2Common Area Operating Expenses. Lessee shall pay to Lessor during the term hereof, in addition to the Base Rent, Lessee's Share (as specified in Paragraph 1.6) of all Common Area Operating Expenses, as hereinafter defined, during each calendar year of the term of this Lease, in accordance with the following provisions:

(a)"Common Area Operating Expenses" are defined, for purposes of this Lease, as all costs incurred by Lessor relating to the ownership and operation of the Project, including, but not limited to, the following:

(i)     The operation, repair and maintenance, in neat, clean, good order and condition, and if necessary the replacement, of the following:

 (aa)     The Common Areas and Common Area improvements, including parking areas, loading and unloading areas, trash areas, roadways, parkways, walkways, driveways, landscaped areas, bumpers, irrigation systems, Common Area lighting facilities, fences and gates, elevators, roofs, and roof drainage systems.

(bb)     Exterior signs and any tenant directories.

(cc)     Any fire sprinkler systems.

(ii) The cost of water, gas, electricity and telephone to service the Common Areas and any utilities not separately metered.

(iii) Trash disposal, pest control services, property management, security services, owner's association dues and fees, the cost to repaint the exterior of any structures and the cost of any environmental inspections.

(iv) Reserves set aside for maintenance, repair and/or replacement of Common Area improvements and equipment.

(v) Real Property Taxes (as defined in Paragraph 10).

(vi) The cost of the premiums for the insurance maintained by Lessor pursuant to Paragraph 8. (vii) Any deductible portion of an insured loss concerning the Building or the Common Areas. (viii) Auditors', accountants' and attorneys' fees and costs related to the operation, maintenance, repair and replacement of the Project.

(ix) The cost of any capital improvement to the Building or the Project not covered under the provisions of Paragraph 2.3 provided; however, that Lessor shall allocate the cost of any such capital improvement over a 12 year period and Lessee shall not be required to pay more than Lessee's Share of 1/144th of the cost of such capital improvement in any given month.

(x) Any other services to be provided by Lessor that are stated elsewhere in this Lease to be a Common Area Operating Expense.

(b)Any Common Area Operating Expenses and Real Property Taxes that are specifically attributable to the Unit, the Building or to any other building in the Project or to the operation, repair and maintenance thereof, shall be allocated entirely to such Unit, Building, or other building. However, any Common Area Operating Expenses and Real Property Taxes that are not specifically attributable to the Building or to any other building or to the operation, repair and maintenance thereof, shall be equitably allocated by Lessor to all buildings in the Project.

(c)The inclusion of the improvements, facilities and services set forth in Subparagraph 4.2(a) shall not be deemed to impose an obligation upon Lessor to either have said improvements or facilities or to provide those services unless the Project already has the same, Lessor already provides the services, or Lessor has agreed elsewhere in this Lease to provide the same or some of them.

Initials PAGE 3 Initials

©1999-AIR Commercial Real Estate Association FORM MTN-4-8/04

(d)Lessee's Share of Common Area Operating Expenses is payable monthly on the same day as the Base Rent is due hereunder. The amount of such payments shall be based on Lessor's estimate of the annual Common Area Operating Expenses. Within 60 days after written request (but not more than once each year) Lessor shall deliver to Lessee a reasonably detailed statement showing Lessee's Share of the actual Common Area Operating Expenses incurred during the preceding year. If Lessee's payments during such year exceed Lessee's Share, Lessor shall credit the amount of such over-payment against Lessee's future payments. If Lessee's payments during such year were less than Lessee's Share, Lessee shall pay to Lessor the amount of the deficiency within 10 days after delivery by Lessor to Lessee of the statement.

(e)Common Area Operating Expenses shall not include any expenses paid by any tenant directly to third parties, or as to which Lessor is otherwise reimbursed by any third party, other tenant, or insurance proceeds.

4.3Payment. Lessee shall cause payment of Rent to be received by Lessor in lawful money of the United States, without offset or deduction (except as specifically permitted in this Lease), on or before the day on which it is due. All monetary amounts shall be rounded to the nearest whole dollar. In the event that any invoice prepared by Lessor is inaccurate such inaccuracy shall not constitute a waiver and Lessee shall be obligated to pay the amount set forth in this Lease. Rent for any period during the term hereof which is for less than one full calendar month shall be prorated based upon the actual number of days of said month. Payment of Rent shall be made to Lessor at its address stated herein or to such other persons or place as Lessor may from time to time designate in writing. Acceptance of a payment which is less than the amount then due shall not be a waiver of Lessor's rights to the balance of such Rent, regardless of Lessor's endorsement of any check so stating. In the event that any check, draft, or other instrument of payment given by Lessee to Lessor is dishonored for any reason, Lessee agrees to pay to Lessor the sum of $25 in addition to any Late Charge and Lessor, at its option, may require all future Rent be paid by cashier's check. Payments will be applied first to accrued late charges and attorney's fees, second to accrued interest, then to Base Rent and Common Area Operating Expenses, and any remaining amount to any other outstanding charges or costs.

5.  Security Deposit. Lessee shall deposit with Lessor upon execution hereof the Security Deposit as security for Lessee's faithful performance of its obligations under this Lease. If Lessee fails to pay Rent, or otherwise Defaults under this Lease, Lessor may use, apply or retain all or any portion of said Security Deposit for the payment of any amount due Lessor or to reimburse or compensate Lessor for any liability, expense, loss or damage which Lessor may suffer or incur by reason thereof. If Lessor uses or applies all or any portion of the Security Deposit, Lessee shall within 10 days after written request therefor deposit monies with Lessor sufficient to restore said Security Deposit to the full amount required by this Lease. If the Base Rent increases during the term of this Lease, Lessee shall, upon written request from Lessor, deposit additional moneys with Lessor so that the total amount of the Security Deposit shall at all times bear the same proportion to the increased Base Rent as the initial Security Deposit bore to the initial Base Rent. Should the Agreed Use be amended to accommodate a material change in the business of Lessee or to accommodate a sublessee or assignee, Lessor shall have the right to increase the Security Deposit to the extent necessary, in Lessor's reasonable judgment, to account for any increased wear and tear that the Premises may suffer as a result thereof. If a change in control of Lessee occurs during this Lease and following such change the financial condition of Lessee is, in Lessor's reasonable judgment, significantly reduced, Lessee shall deposit such additional monies with Lessor as shall be sufficient to cause the Security Deposit to be at a commercially reasonable level based on such change in financial condition. Lessor shall not be required to keep the Security Deposit separate from its general accounts. Within 14 days after the expiration or termination of this Lease, if Lessor elects to apply the Security Deposit only to unpaid Rent, and otherwise within 30 days after the Premises have been vacated pursuant to Paragraph 7.4(c) below, Lessor shall return that portion of the Security Deposit not used or applied by Lessor. No part of the Security Deposit shall be considered to be held in trust, to bear interest or to be prepayment for any monies to be paid by Lessee under this Lease.

6.  Use.

6.1Use. Lessee shall use and occupy the Premises only for the Agreed Use, or any other legal use which is reasonably comparable thereto, and for no other purpose. Lessee shall not use or permit the use of the Premises in a manner that is unlawful, creates damage, waste or a nuisance, or that disturbs occupants of or causes damage to neighboring premises or properties. Other than guide, signal and seeing eye dogs, Lessee shall not keep or allow in the Premises any pets, animals, birds, fish, or reptiles. Lessor shall not unreasonably withhold or delay its consent to any written request for a modification of the Agreed Use, so long as the same will not impair the structural integrity of the Building or the mechanical or electrical systems therein, and/or is not significantly more burdensome to the Project. If Lessor elects to withhold consent, Lessor shall within 7 days after such request give written notification of same, which notice shall include an explanation of Lessor's objections to the change in the Agreed Use.

6.2Hazardous Substances.

(a)  Reportable Uses Require Consent. The term "Hazardous Substance" as used in this Lease shall mean any product, substance, or waste whose presence, use, manufacture, disposal, transportation, or release, either by itself or in combination with other materials expected to be on the Premises, is either: (i) potentially injurious to the public health, safety or welfare, the environment or the Premises, (ii) regulated or monitored by any governmental authority, or (iii) a basis for potential liability of Lessor to any governmental agency or third party under any applicable statute or common law theory. Hazardous Substances shall include, but not be limited to, hydrocarbons, petroleum, gasoline, and/or crude oil or any products, by-products or fractions thereof. Lessee shall not engage in any activity in or on the Premises which constitutes a Reportable Use of Hazardous Substances without the express prior written consent of Lessor and timely compliance (at Lessee's expense) with all Applicable Requirements. "Reportable Use" shall mean (i) the installation or use of any above or below ground storage tank, (ii) the generation, possession, storage, use, transportation, or disposal of a Hazardous Substance 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 authority, and/or (iii) the presence at the Premises of a Hazardous Substance with respect to which any Applicable Requirements requires that a notice be given to persons entering or occupying the Premises or neighboring properties. Notwithstanding the foregoing, Lessee may use any ordinary and customary materials reasonably required to be used in the normal course of the Agreed Use, ordinary office supplies (copier toner, liquid paper, glue, etc.) and common household cleaning materials, so long as such use is in compliance with all Applicable Requirements, is not a Reportable Use, and does not expose the Premises or neighboring property to any meaningful risk of contamination or damage or expose Lessor to any liability therefor. In addition, Lessor may condition its consent to any Reportable Use upon receiving such additional assurances as Lessor reasonably deems necessary to protect itself, the public, the Premises and/or the environment against damage, contamination, injury and/or liability, including, but not limited to, the installation (and removal on or before Lease expiration or termination) of protective modifications (such as concrete encasements) and/or increasing the Security Deposit.

(b)  Duty to Inform Lessor. If Lessee knows, or has reasonable cause to believe, that a Hazardous Substance has come to be located in, on, under or about the Premises, other than as previously consented to by Lessor, Lessee shall immediately give written notice of such fact to Lessor, and provide Lessor with a copy of any report, notice, claim or other documentation which it has concerning the presence of such Hazardous Substance.

(c)  Lessee Remediation. Lessee shall not cause or permit any Hazardous Substance to be spilled or released in, on, under, or about the Premises (including through the plumbing or sanitary sewer system) and shall promptly, at Lessee's expense, comply with all Applicable Requirements and take all investigatory and/or remedial action reasonably recommended, whether or not formally ordered or required, for the cleanup of any contamination of, and for the maintenance, security and/or monitoring of the Premises or neighboring properties, that was caused or materially contributed to by Lessee, or pertaining to or involving any Hazardous Substance brought onto the Premises during the term of this Lease, by or for Lessee, or any third party.

(d)  Lessee Indemnification. Lessee shall indemnify, defend and hold Lessor, its agents, employees, lenders and ground lessor, if any, harmless from and against any and all loss of rents and/or damages, liabilities, judgments, claims, expenses, penalties, and attorneys' and consultants' fees arising out of or involving any Hazardous Substance brought onto the Premises by or for Lessee, or any third party (provided, however, that Lessee shall have no liability under this Lease with respect to underground migration of any Hazardous Substance under the Premises from areas outside of the Project not caused or contributed to by Lessee). Lessees obligations shall include, but not be limited to, the effects of any contamination or injury to person, property or the environment created or suffered by Lessee, and the cost of investigation, removal, remediation, restoration and/or abatement, and shall survive the expiration or termination of this Lease. No termination, cancellation or release agreement entered into by Lessor and Lessee shall release Lessee from its obligations under this Lease with respect to Hazardous Substances, unless specifically so agreed by Lessor in writing at the time of such agreement.

Initials PAGE 4 Initials

©1999-AIR Commercial Real Estate Association FORM MTN-4-8/04

(e)  Lessor Indemnification. Lessor and its successors and assigns shall indemnify, defend, reimburse and hold Lessee, Its employees and lenders, harmless from and against any and all environmental damages, including the cost of remediation, which are suffered as a direct result of Hazardous Substances on the Premises prior to Lessee taking possession or which are caused by the gross negligence or willful misconduct of Lessor, its agents or employees. Lessor's obligations, as and when required by the Applicable Requirements, shall include, but not be limited to, the cost of investigation, removal, remediation, restoration and/or abatement and shall survive the expiration or termination of this Lease.

(f)   Investigations and Remediations. Lessor shall retain the responsibility and pay for any investigations or remediation measures required by governmental entities having jurisdiction with respect to the existence of Hazardous Substances on the Premises prior to Lessee taking possession, unless such remediation measure is required as a result of Lessee's use (including "Alterations", as defined in paragraph 7.3(a) below) of the Premises, in which event Lessee shall be responsible for such payment. Lessee shall cooperate fully in any such activities at the request of Lessor, including allowing Lessor and Lessor's agents to have reasonable access to the Premises at reasonable times in order to carry out Lessor's investigative and remedial responsibilities.

(g)  Lessor Termination Option. If a Hazardous Substance Condition (see Paragraph 9.1(e)) occurs during the term of this Lease, unless Lessee is legally responsible therefor (in which case Lessee shall make the investigation and remediation thereof required by the Applicable Requirements and this Lease shall continue in full force and effect, but subject to Lessor's rights under Paragraph 6.2(d) and Paragraph 13), Lessor may, at Lessor's option, either (i) investigate and remediate such Hazardous Substance Condition, if required, as soon as reasonably possible at Lessor's expense, in which event this Lease shall continue in full force and effect, or (ii) if the estimated cost to remediate such condition exceeds 12 times the then monthly Base Rent or $100,000, whichever is greater, give written notice to Lessee, within 30 days after receipt by Lessor of knowledge of the occurrence of such Hazardous Substance Condition, of Lessor's desire to terminate this Lease as of the date 60 days following the date of such notice. In the event Lessor elects to give a termination notice, Lessee may, within 10 days thereafter, give written notice to Lessor of Lessee's commitment to pay the amount by which the cost of the remediation of such Hazardous Substance Condition exceeds an amount equal to 12 times the then monthly Base Rent or $100,000, whichever is greater. Lessee shall provide Lessor with said funds or satisfactory assurance thereof within 30 days following such commitment. In such event, this Lease shall continue in full force and effect, and Lessor shall proceed to make such remediation as soon as reasonably possible after the required funds are available. If Lessee does not give such notice and provide the required funds or assurance thereof within the time provided, this Lease shall terminate as of the date specified in Lessor's notice of termination.

6.3Lessee's Compliance with Applicable Requirements. Except as otherwise provided in this Lease, Lessee shall, at Lessee's sole expense, fully, diligently and in a timely manner, materially comply with all Applicable Requirements, the requirements of any applicable fire insurance underwriter or rating bureau, and the recommendations of Lessor's engineers and/or consultants which [illegible] in any manner to such Requirements, without regard to whether said Requirements are now in effect or become effective after the Court Date. Lessee shall, within 10 days after receipt of Lessor's written request, provide Lessor with copies of all permits and other documents, and other information evidencing Lessee's compliance with any Applicable Requirements specified by Lessor, and shall immediately upon receipt, notify Lessor in writing (with copies of any documents involved) of any threatened or actual claim, notice, citation, warning, complaint or report pertaining to or involving the failure of Lessee or the Premises to comply with any Applicable Requirements. Likewise, Lessee shall immediately give written notice to Lessor of: (i) any water damage to the Premises and any suspected seepage, pooling, dampness or other condition conducive to the production of mold; or (ii) any mustiness or other odors that might indicate the presence of mold in the Premises.

6.4Inspection; Compliance. Lessor and Lessor's "Lender" (as defined in Paragraph 30) and consultants shall have the right to enter into Premises at any time, in the case of an emergency, and otherwise at reasonable times after reasonable notice, for the purpose of inspecting the condition of the Premises and for verifying compliance by Lessee with this Lease. The cost of any such inspections shall be paid by Lessor, unless a violation of Applicable Requirements, or a Hazardous Substance condition (see Paragraph 9.1) is found to exist or be imminent, or the inspection is requested or ordered by a governmental authority. In such case, Lessee shall upon request reimburse Lessor for the cost of such inspection, so long as such inspection is reasonably related to the violation or contamination. In addition, Lessee shall provide copies of all relevant material safety data sheets (MSDS) to Lessor within 10 days of the receipt of written request therefor.

7.  Maintenance; Repairs, Utility Installations; Trade Fixtures and Alterations.

7.1Lessee's Obligations.

(a)  In General. Subject to the provisions of Paragraph 2.2 (Condition), 2.3 (Compliance), 6.3 (Lessee's Compliance with Applicable Requirements), 7.2 (Lessor's Obligations), 9 (Damage or Destruction), and 14 (Condemnation), Lessee shall, at Lessee's sole expense, keep the Premises, Utility Installations (intended for Lessee's exclusive use, no matter where located), and Alterations in good order, condition and repair (whether or not the portion of the Premises requiring repairs, or the means of repairing the same, are reasonably or readily accessible to Lessee, and whether or not the need for such repairs occurs as a result of Lessee's use, any prior use, the elements or the age of such portion of the Premises), including, but not limited to, ail equipment or facilities, such as plumbing, HVAC equipment, electrical, lighting facilities, boilers, pressure vessels, fixtures, interior walls, interior surfaces of exterior walls, ceilings, floors, windows, doors, plate glass, and skylights but excluding any items which are the responsibility of Lessor pursuant to Paragraph 7.2. Lessee, in keeping the Premises in good order, condition and repair, shall exercise and perform good maintenance practices, specifically including the procurement and maintenance of the service contracts required by Paragraph 7.1(b) below. Lessee's obligations shall include restorations, replacements or renewals when necessary to keep the Premises and all improvements thereon or a part thereof in good order, condition and state of repair.

(b)  Service Contracts. Lessee shall, at Lessee's sole expense, procure and maintain contracts, with copies to Lessor, in customary form and substance for, and with contractors specializing and experienced in the maintenance of the following equipment and improvements, if any, if and when installed on the Premises: (i) HVAC equipment, (ii) boiler and pressure vessels, (iii) clarifiers, and (iv) any other equipment, if reasonably required by Lessor. However, Lessor reserves the right, upon notice to Lessee, to procure and maintain any or all of such service contracts, and Lessee shall reimburse Lessor, upon demand, for the cost thereof.

(c)  Failure to Perform. If Lessee fails to perform Lessee's obligations under this Paragraph 7.1, Lessor may enter upon the Premises after 10 days' prior written notice to Lessee (except in the case of an emergency, in which case no notice shall be required), perform such obligations on Lessee's behalf, and put the Premises in good order, condition and repair, and Lessee shall promptly pay to Lessor a sum equal to 115% of the cost thereof.

(d)  Replacement. Subject to Lessee's indemnification of Lessor as set forth in Paragraph 8.7 below, and without relieving Lessee of liability resulting from Lessee's failure to exercise and perform good maintenance practices, if an item described in Paragraph 7.1(b) cannot be repaired other than at a cost which is in excess of 50% of the cost of replacing such item, then such item shall be replaced by Lessor, and the cost thereof shall be prorated between the Parties and Lessee shall only be obligated to pay, each month during the remainder of the term of this Lease, on the date on which Base Rent is due, an amount equal to the product of multiplying the cost of such replacement by a fraction, the numerator of which is one, and the denominator of which is 144 (ie. 1/144th of the cost per month). Lessee shall pay Interest on the unamortized balance but may prepay its obligation at any time.

7.2Lessor's Obligations. Subject to the provisions of Paragraphs 2.2 (Condition), 2.3 (Compliance), 4.2 (Common Area Operating Expenses), 6 (Use), 7.1 (Lessee's Obligations), 9 (Damage or Destruction) and 14 (Condemnation), Lessor, subject to reimbursement pursuant to Paragraph 4.2, shall keep in good order, condition and repair the foundations, exterior walls, structural condition of interior bearing walls, exterior roof, fire sprinkler system, Common Area fire alarm and/or smoke detection systems, fire hydrants, parking lots, walkways, parkways, driveways, landscaping, fences, signs and utility systems serving the Common Areas and all parts thereof, as well as providing the services for which there is a Common Area Operating Expense pursuant to Paragraph 4.2. Lessor shall not be obligated to paint the exterior or interior surfaces of exterior walls nor shall Lessor be obligated to maintain, repair or replace windows, doors or plate glass on the Premises. Lessee expressly waives the benefit of any statute now or hereafter in effect to the extent it is inconsistent with the terms of this Lease.

Initials PAGE 5 Initials

©1999-AIR Commercial Real Estate Association FORM MTN-4-8/04

7.3Utility Installations; Trade Fixtures; Alterations.

(a)  Definitions. The term "Utility Installations" refers to all floor and window coverings, air and/or vacuum lines, power panels, electrical distribution, security and fire protection systems, communication cabling, lighting fixtures, HVAC equipment, plumbing, and fencing in or on the Premises. The term "Trade Fixtures" shall mean Lessee's machinery and equipment that can be removed without doing material damage to the Premises. The term "Alterations" shall mean any modification of the improvements, other than Utility Installations or Trade Fixtures, whether by addition or deletion. "Lessee Owned Alterations and/or Utility Installations" are defined as Alterations and/or Utility Installations made by Lessee that are not yet owned by Lessor pursuant to Paragraph 7.4(a).

(b)  Consent. Lessee shall not make any Alterations or Utility Installations to the Premises without Lessor's prior written consent. Lessee may, however, make non-structural Utility Installations to the interior of the Premises (excluding the roof) without such consent but upon notice to Lessor, as long as they are not visible from the outside, do not involve puncturing, relocating or removing the roof or any existing walls, will not affect the electrical, plumbing, HVAC, and/or life safety systems, and the cumulative cost thereof during this Lease as extended does not exceed a sum equal to 3 month's Base Rent in the aggregate or a sum equal to one month's Base Rent in any one year. Notwithstanding the foregoing, Lessee shall not make or permit any roof penetrations and/or install anything on the roof without the prior written approval of Lessor. Lessor may, as a precondition to granting such approval, require Lessee to utilize a contractor chosen and/or approved by Lessor. Any Alterations or Utility Installations that Lessee shall desire to make and which require the consent of the Lessor shall be presented to Lessor in written form with detailed plans. Consent shall be deemed conditioned upon Lessee's: (i) acquiring all applicable governmental permits, (ii) furnishing Lessor with copies of both the permits and the plans and specifications prior to commencement of the work, and (iii) compliance with all conditions of said permits and other Applicable Requirements in a prompt and expeditious manner. Any Alterations or Utility Installations shall be performed in a workmanlike manner with good and sufficient materials. Lessee shall promptly upon completion furnish Lessor with as-built plans and specifications. For work which costs an amount in excess of one month's Base Rent, Lessor may condition its consent upon Lessee providing a lien and completion bond in an amount equal to 150% of the estimated cost of such Alteration or Utility Installation and/or upon Lessee's posting an additional Security Deposit with Lessor.

(c)  Liens; Bonds. Lessee shall pay, when due, all claims for labor or materials furnished or alleged to have been furnished to or for Lessee at or for use on the Premises, which claims are or may be secured by any mechanic's or materialmen's lien against the Premises or any interest therein. Lessee shall give Lessor not less than 10 days notice prior to the commencement of any work in, on or about the Premises, and Lessor shall have the right to post notices of non-responsibility. If Lessee shall contest the validity of any such lien, claim or demand, then Lessee shall, at its sole expense defend and protect itself, Lessor and the Premises against the same and shall pay and satisfy any such adverse judgment that may be rendered thereon before the enforcement thereof. If Lessor shall require, Lessee shall furnish a surety bond in an amount equal to 150% of the amount of such contested lien, claim or demand, indemnifying Lessor against liability for the same. If Lessor elects to participate in any such action, Lessee shall pay Lessor's attorneys' fees and costs.

7.4Ownership; Removal; Surrender; and Restoration.

(a)  Ownership. Subject to Lessor's right to require removal or elect ownership as hereinafter provided, all Alterations and Utility Installations made by Lessee shall be the property of Lessee, but considered a part of the Premises. Lessor may, at any time, elect in writing to be the owner of all or any specified part of the Lessee Owned Alterations and Utility Installations. Unless otherwise instructed per paragraph 7.4(b) hereof, all Lessee Owned Alterations and Utility Installations shall, at the expiration or termination of this Lease, become the property of Lessor and be surrendered by Lessee with the Premises.

(b)Removal. By delivery to Lessee of written notice from Lessor not earlier than 90 and not later than 30 days prior to the end of the term of this Lease, Lessor may require that any or all Lessee Owned Alterations or Utility Installations be removed by the expiration or termination of this Lease. Lessor may require the removal at any time of all or any part of any Lessee Owned Alterations or Utility Installations made without the required consent.

(c)Surrender; Restoration. Lessee shall surrender the Premises by the Expiration Date or any earlier termination date, with all of the improvements, parts and surfaces thereof broom clean and free of debris, and in good operating order, condition and state of repair, ordinary wear and tear excepted. "Ordinary wear and tear" shall not include any damage or deterioration that would have been prevented by good maintenance practice. Notwithstanding the foregoing, if this Lease is for 12 months or less, then Lessee shall surrender the Premises in the same condition as delivered to Lessee on the Start Date with NO allowance for ordinary wear and tear. Lessee shall repair any damage occasioned by the installation, maintenance or removal of Trade Fixtures, Lessee owned Alterations and/or Utility Installations, furnishings, and equipment as well as the removal of any storage tank installed by or for Lessee. Lessee shall also completely remove from the Premises any and all Hazardous Substances brought onto the Premises by or for Lessee, or any third party (except Hazardous Substances which were deposited via underground migration from areas outside of the Premises) even if such removal would require Lessee to perform or pay for work that exceeds statutory requirements. Trade Fixtures shall remain the property of Lessee and shall be removed by Lessee. Any personal property of Lessee not removed on or before the Expiration Date or any earlier termination date shall be deemed to have been abandoned by Lessee and may be disposed of or retained by Lessor as Lessor may desire. The failure by Lessee to timely vacate the Premises pursuant to this Paragraph 7.4(c) without the express written consent of Lessor shall constitute a holdover under the provisions of Paragraph 26 below.

8.  Insurance; Indemnity.

8.1Payment of Premiums. The cost of the premiums for the insurance policies required to be carried by Lessor, pursuant to Paragraphs 8.2(b), 8.3(a) and 8.3(b), shall be a Common Area Operating Expense. Premiums for policy periods commencing prior to, or extending beyond, the term of this Lease shall be prorated to coincide with the corresponding Start Date or Expiration Date.

8.2Liability Insurance.

(a)  Carried by Lessee. Lessee shall obtain and keep in force a Commercial General Liability policy of insurance protecting Lessee and Lessor as an additional insured against claims for bodily injury, personal injury and property damage based upon or arising out of the ownership, use, occupancy or maintenance of the Premises and all areas appurtenant thereto. Such insurance shall be on an occurrence basis providing single limit coverage in an amount not less than $2000,000 per occurrence with an annual aggregate of not less than $2,000,000. Lessee shall add Lessor as an additional insured by means of an endorsement at least as broad as the Insurance Service Organization's "Additional Insured-Managers or Lessors of Premises" Endorsement and coverage shall also be extended to include damage caused by heat, smoke or fumes from a hostile fire. The policy shall not contain any intra-insured exclusions as between insured persons or organizations, but shall include coverage for liability assumed under this Lease as an "insured contract" for the performance of Lessee's indemnity obligations under this Lease. The limits of said insurance shall not, however, limit the liability of Lessee nor relieve Lessee of any obligation hereunder. Lessee shall provide an endorsement on its liability policy(ies) which provides that its insurance shall be primary to and not contributory with any similar insurance carried by Lessor, whose insurance shall be considered excess insurance only.

(b)  Carried by Lessor. Lessor shall maintain liability insurance as described in Paragraph 8.2(a), in addition to, and not in lieu of, the insurance required to be maintained by Lessee. Lessee shall not be named as an additional insured therein.

8.3Property Insurance - Building, Improvements and Rental Value.

(a)  Building and Improvements. Lessor shall obtain and keep in force a policy or policies of insurance in the name of Lessor, with loss payable to Lessor, any ground-lessor, and to any Lender insuring loss or damage to the Premises. The amount of such insurance shall be equal to the full insurable replacement cost of the Premises, as the same shall exist from time to time, or the amount required by any Lender, but in no event more than the commercially reasonable and available insurable value thereof Lessee Owned Alterations and Utility Installations, Trade Fixtures, and Lessee's personal property shall be insured by Lessee under Paragraph 8.4. If the coverage is available and commercially appropriate, such policy or policies shall insure against all risks of direct physical loss; or damage (except the perils of flood and/or earthquake unless required by a Lender), including coverage for debris removal and the enforcement of any Applicable Requirements requiring the upgrading, demolition, reconstruction or replacement of any portion of the Premises as the result of a covered loss. Said policy or policies shall also contain an agreed valuation provision in lieu of any coinsurance clause, waiver of subrogation, and inflation guard protection causing an increase in the annual property insurance coverage amount by factor of not less than the adjusted U.S. Department of Labor Consumer Price Index for All Urban Consumers for the city nearest to where the Premises are located. If such insurance coverage has a deductible clause, the deductible amount shall not exceed $1,000 per occurrence.

Initials PAGE 6 Initials

©1999-AIR Commercial Real Estate Association FORM MTN-4-8/04

(b)  Rental Value. Lessor shall also obtain and keep in force a policy or policies in the name of Lessor with loss payable ("Rental Value") insuring the loss of the full Rent for one year with an extended period of indemnity for an additional 180 days ("Rental Value Insurance"). Said insurance shall contain an agreed valuation provision in lieu of any coinsurance clause, and the amount of coverage shall be adjusted annually to reflect the projected Rent otherwise payable by Lessee, for the next 12 month period.

(c)  Adjacent Premises. Lessee shall pay for any increase in the premiums for the property insurance of the Building and for the Common Areas or other buildings in the Project if said increase is caused by Lessee's acts, omissions, use or occupancy of the Premises.

(d)  Lessee's Improvements. Since Lessor is the Insuring Party, Lessor shall not be required to insure Lessee Owned Alterations and Utility Installations unless the item in question has become the property of Lessor under the terms of this Lease

8.4Lessee's Property; Business Interruption Insurance.

(a)  Property Damage. Lessee shall obtain and maintain insurance coverage on all of Lessee's personal property Trade Fixtures, and Lessee Owned Alterations and Utility Installations. Such insurance shall be full replacement cost coverage with a deductible not to exceed $1,000 per occurrence. The proceeds from any such insurance shall be used by Lessee for the replacement of personal property, Trade Fixtures and Lessee Owned Alterations and Utility Installations. Lessee shall provide Lessor with written evidence that such insurance is in force.

(b)  Business Interruption. Lessee shall obtain and maintain loss of income and extra expense insurance in amounts as will reimburse Lessee for direct or indirect loss of earnings attributable to all perils commonly insured against by prudent lessees in the business of Lessee or attributable to prevention of access to the Premises as a result of such perils.

(c)  No Representation of Adequate Coverage. Lessor makes no representation that the limits or forms of coverage of insurance specified herein are adequate to cover Lessee's property, business operations or obligations under this Lease.

8.5Insurance Policies. Insurance required herein shall be by companies duly licensed or admitted to transact business in the state where the Premises are located, and maintaining during the policy term a "General Policyholders Rating" of at least A-, VI, as set forth in the most current issue of "Best's Insurance Guide", or such other rating as may be required by a Lender. Lessee shall not do or permit to be done anything which invalidates the required insurance policies. Lessee shall, prior to the Start Date, deliver to Lessor certified copies of policies of such insurance or certificates evidencing the existence and amounts of the required insurance. No such policy shall be cancelable or subject to modification except after 30 days prior written notice to Lessor. Lessee shall, at least 10 days prior to the expiration of such policies, furnish Lessor with evidence of renewals or "insurance binders" evidencing renewal thereof, or Lessor may order such insurance and charge the cost thereof to Lessee, which amount shall be payable by Lessee to Lessor upon demand. Such policies shall be for a term of at least one year, or the length of the remaining term of this Lease, whichever is less. If Former Party shall fail to procure and maintain the insurance required to be carried by it, the other Party may, but shall not be required to, procure and maintain the same.

8.6Waiver of Subrogation. Without affecting any other rights or remedies, Lessee and Lessor each hereby release and relieve the other, and waive their entire right to recover damages against the other, for loss of or damage to its property arising out of or incident to the perils required to be insured against herein. The effect of such releases and waivers is not limited by the amount of insurance carried or required, or by any deductibles applicable hereto. The Parties agree to have their respective property damage insurance carriers waive any right to subrogation that such companies may have against Lessor or Lessee, as the case may be, so long as the insurance is not invalidated thereby.

8.7Indemnity. Except for Lessor's gross negligence or willful misconduct, Lessee shall indemnify, protect, defend and hold harmless the Premises, Lessor and its agents, Lessor's master or ground lessor, partners and Lenders, from and against any and all claims, loss of rents and/or damages, liens, judgments, penalties, attorneys' and consultants' fees, expenses and/or liabilities arising out of, involving, or in connection with, the use and/or occupancy of the Premises by Lessee. If any action or proceeding is brought against Lessor by reason of any of the foregoing matters, Lessee shall upon notice defend the same at Lessee's expense by counsel reasonably satisfactory to Lessor and Lessor shall cooperate with Lessee in such defense. Lessor need not have first paid any such claim in order to be defended or indemnified.

8.8Exemption of Lessor from Liability. Lessor shall not be liable for injury or damage to the person or goods, wares, merchandise or other property of Lessee, Lessee's employees, contractors, invitees, customers, or any other person in or about the Premises, whether such damage or injury is caused by or results from fire, steam, electricity, gas, water or rain, indoor air quality, the presence of mold or from the breakage, leakage, obstruction or other defects of pipes, fire sprinklers, wires, appliances, plumbing, HVAC or lighting fixtures, or from any other cause, whether the said injury or damage results from conditions arising upon the Premises or upon other portions of the Building, or from other sources or places. Lessor shall not be liable for any damages arising from any act or neglect of any other tenant of Lessor nor from the failure of Lessor to enforce the provisions of any other lease in the Project. Notwithstanding Lessor's negligence or breach of this Lease, Lessor shall under no circumstances be liable for injury to Lessee's business or for any loss of income or profit therefrom.

8.9Failure to Provide Insurance. Lessee acknowledges that any failure on its part to obtain or maintain the insurance required herein will expose Lessor to risks and potentially cause Lessor to incur costs not contemplated by this Lease, the extent of which will be extremely difficult to ascertain. Accordingly, for any month or portion thereof that Lessee does not maintain the required insurance and/or does not provide Lessor with the required binders or certificates evidencing the existence of the required insurance, the Base Rent shall be automatically increased, without any requirement for notice to Lessee, by an amount equal to 10% of the then existing Base Rent or $100, whichever is greater. The parties agree that such increase in Base Rent represents fair and reasonable compensation for the additional risk/costs that Lessor will incur by reason of Lessee's failure to maintain the required insurance. Such increase in Base Rent shall in no event constitute a waiver of Lessee's Default or Breach with respect to the failure to maintain such insurance, prevent the exercise of any of the other rights and remedies granted hereunder, nor relieve Lessee of its obligation to maintain the insurance specified in this Lease.

9.  Damage or Destruction.

9.1Definitions.

(a)  "Premises Partial Damage" shall mean damage or destruction to the improvements on the Premises, other than Lessee Owned Alterations and Utility Installations, which can reasonably be repaired in 3 months or less from the date of the damage or destruction, and the cost thereof does not exceed a sum equal to 6 month's Base Rent. Lessor shall notify Lessee in writing within 30 days from the date of the damage or destruction as to whether or not the damage is Partial or Total. Notwithstanding the foregoing, Premises Partial Damage shall not include damage to windows, doors, and/or other similar items which Lessee has the responsibility to repair or replace pursuant to the provisions of Paragraph 7.1.

(b)  "Premises Total Destruction" shall mean damage or destruction to the improvements on the Premises, other than Lessee Owned Alterations and Utility Installations and Trade Fixtures, which cannot reasonably be repaired in 3 months or less from the date of the damage or destruction and/or the cost thereof exceeds a sum equal to 6 month's Base Rent. Lessor shall notify Lessee in writing within 30 days from the date of the damage or destruction as to whether or not the damage is Partial or Total.

(c)  "Insured Loss" shall mean damage or destruction to improvements on the Premises, other than Lessee Owned Alterations and Utility Installations and Trade Fixtures, which was caused by an event required to be covered by the insurance described in Paragraph 8.3(a), irrespective of any deductible amounts or coverage limits involved.

(d)  "Replacement Cost" shall mean the cost to repair or rebuild the improvements owned by Lessor at the time of the occurrence to their condition existing immediately prior thereto, including demolition, debris removal and upgrading required by the operation of Applicable Requirements, and without deduction for depreciation.

Initials PAGE 7 Initials

©1999-AIR Commercial Real Estate Association FORM MTN-4-8/04

(e)  "Hazardous Substance Condition" shall mean the occurrence or discovery of a condition involving the presence of, or a contamination by, a Hazardous Substance as defined in Paragraph 6.2(a), in, on, or under the Premises which requires repair, remediation, or restoration.

9.2Partial Damage - Insured Loss. If a Premises Partial Damage that is an Insured Loss occurs, then Lessor shall, at Lessor's expense, repair such damage (but not Lessee's Trade Fixtures or Lessee Owned Alterations and Utility Installations) as soon as reasonably possible and this Lease shall continue in full force and effect; provided, however, that Lessee shall, at Lessor's election, make the repair of any damage or destruction the total cost to repair of which is $10,000 or less, and, in such event, Lessor shall make any applicable insurance proceeds available to Lessee on a reasonable basis for that purpose. Notwithstanding the foregoing, if the required insurance was not in force or the insurance proceeds are not sufficient to effect such repair, the Insuring Party shall promptly contribute the shortage in proceeds as and when required to complete said repairs. In the event, however, such shortage was due to the fact that, by reason of the unique nature of the improvements, full replacement cost insurance coverage was not commercially reasonable and available, Lessor shall have no obligation to pay for the shortage in insurance proceeds or to fully restore the unique aspects of the Premises unless Lessee provides Lessor with the funds to cover same, or adequate assurance thereof, within 10 days following receipt of written notice of such shortage and request therefor. If Lessor receives said funds or adequate assurance thereof within said 10 day period, the party responsible for making the repairs shall complete them as soon as reasonably possible and this Lease shall remain in full force and effect. If such funds or assurance are not received, Lessor may nevertheless elect by written notice to Lessee within 10 days thereafter to: (i) make such restoration and repair as is commercially reasonable with Lessor paying any shortage in proceeds, in which case this Lease shall remain in full force and effect, or (ii) have this Lease terminate 30 days thereafter. Lessee shall not be entitled to reimbursement of any funds contributed by Lessee to repair any such damage or destruction. Premises Partial Damage due to flood or earthquake shall be subject to Paragraph 9.3, notwithstanding that there may be some insurance coverage, but the net proceeds of any such insurance shall be made available for the repairs if made by either Party.

9.3Partial Damage - Uninsured Loss. If a Premises Partial Damage that is not an Insured Loss occurs, unless caused by a negligent or willful act of Lessee (in which event Lessee shall make the repairs at Lessee's expense), Lessor may either: (i) repair such damage as soon as reasonably possible at Lessor's expense, in which event this Lease shall continue in full force and effect, or (ii) terminate this Lease by giving written notice to Lessee within 30 days after receipt by Lessor of knowledge of the occurrence of such image. Such termination shall be effective 60 days following the date of such notice. In the event Lessor elects to terminate this Lease, Lessee shall have the right within 10 days after receipt of the termination notice to give written notice to Lessor of Lessee's commitment to pay for the repair of such damage without reimbursement from Lessor. Lessee shall provide Lessor with said funds or satisfactory assurance thereof within 30 days after making such commitment. In such event this Lease shall continue in full force and effect, and Lessor shall proceed to make such repairs as soon as reasonably possible after the required funds are available. If Lessee does not make the required commitment, this Lease shall terminate as of the date specified in the termination notice.

9.4Total Destruction. Notwithstanding any other provision hereof, if a Premises Total Destruction occurs, this Lease shall terminate 60 days following such Destruction. If the damage or destruction was caused by the gross negligence or willful misconduct of Lessee, Lessor shall have the right to recover Lessor's damages from Lessee, except as provided in Paragraph 8.6.

9.5Damage Near End of Term. If at any time during the last 6 months of this Lease there is damage for which the cost to repair exceeds one month's Base Rent, whether or not an Insured Loss, Lessor may terminate this Lease effective 60 days following the date of occurrence of such damage by giving a written termination notice to Lessee within 30 days after the date of occurrence of such damage. Notwithstanding the foregoing, if Lessee at that time has an exercisable option to extend this Lease or to purchase the Premises, then Lessee may preserve this Lease by, (a) exercising such option and (b) providing Lessor with any shortage in insurance proceeds (or adequate assurance thereof) needed to make the repairs on or before the earlier of (i) the date which is 10 days after Lessee's receipt of Lessor's written notice purporting to terminate this Lease, or (ii) the day prior to the date upon which such option expires. If Lessee duly exercises such option during such period and provides Lessor with funds (or adequate assurance thereof) to cover any shortage in insurance proceeds, Lessor shall, at Lessor's commercially reasonable expense, repair such damage as soon as reasonably possible and this Lease shall continue in full force and effect. If Lessee fails to exercise such option and provide such funds or assurance during such period, then this Lease shall terminate on the date specified in the termination notice and Lessee's option shall be extinguished.

9.6Abatement of Rent; Lessee's Remedies.

(a)  Abatement. In the event of Premises Partial Damage or Premises Total Destruction or a Hazardous Substance Condition for which Lessee is not responsible under this Lease, the Rent payable by Lessee for the period required for the repair, remediation or restoration of such damage shall be abated in proportion to the degree to which Lessee's use of the Premises is impaired, but not to exceed the proceeds received from the Rental Value insurance. All other obligations of Lessee hereunder shall be performed by Lessee, and Lessor shall have no liability for any such damage, destruction, remediation, repair or restoration except as provided herein.

(b)  Remedies. If Lessor shall be obligated to repair or restore the Premises and does not commence, in a substantial and meaningful way, such repair or restoration within 90 days after such obligation shall accrue, Lessee may, at any time prior to the commencement of such repair or restoration, give written notice to Lessor and to any Lenders of which Lessee has actual notice, of Lessee's election to terminate this Lease on a date not less than 60 days following the giving of such notice. If Lessee gives such notice and such repair or restoration is not commenced within 30 days thereafter, this Lease shall terminate as of the date specified in said notice. If the repair or restoration is commenced within such 30 days, this Lease shall continue in full force and effect. "Commence" shall mean either the unconditional authorization of the preparation of the required plans, or the beginning of the actual work on the Premises, whichever first occurs.

9.7Termination; Advance Payments. Upon termination of this Lease pursuant to Paragraph 6.2(g) or Paragraph 9, an equitable adjustment shall be made concerning advance Base Rent and any other advance payments made by Lessee to Lessor. Lessor shall, in addition, return to Lessee so much of Lessee's Security Deposit as has not been, or is not then required to be, used by Lessor.

9.8Waive Statutes. Lessor and Lessee agree that the terms of this Lease shall govern the effect of any damage to or destruction of the Premises with respect to the termination of this Lease and hereby waive the provisions of any present or future statute to the extent inconsistent herewith.

10.Real Property Taxes.

10.1Definition. As used herein, the term "Real Property Taxes" shall include any form of assessment; real estate, general, special, ordinary or extraordinary, or rental levy or tax (other than inheritance, personal income or estate taxes); improvement bond; and/or license fee imposed upon or levied against any legal or equitable interest of Lessor in the Project, Lessor's right to other income therefrom, and/or Lessor's business of leasing, by any authority having the direct or indirect power to tax and where the funds are generated with reference to the Project address and where the proceeds so generated are to be applied by the city, county or other local taxing authority of a jurisdiction within which the Project is located. The term "Real Property Taxes" shall also include any tax, fee, levy, assessment or charge, or any increase therein: (i) imposed by reason of events occurring during the term of this Lease, including but not limited to, a change in the ownership of the Project, (ii) a change in the improvements thereon, and/or (iii) levied or assessed on machinery or equipment provided by Lessor to Lessee pursuant to this Lease. In calculating Real Property Taxes for any calendar year, the Real Property Taxes for any real estate tax year shall be included in the calculation of Real Property Taxes for such calendar year based upon the number of days which such calendar year and tax year have in common.

10.2          Payment of Taxes. Except as otherwise provided in Paragraph 10.3, Lessor shall pay the Real Property Taxes applicable to the Project, and said payments shall be included in the calculation of Common Area Operating Expenses in accordance with the provisions of Paragraph 4.2.

10.3          Additional Improvements. Common Area Operating Expenses shall not include Real Property Taxes specified in the tax assessor's records and work sheets as being caused by additional improvements placed upon the Project by other lessees or by Lessor for the exclusive enjoyment of such other lessees. Notwithstanding Paragraph 10.2 hereof, Lessee shall, however, pay to Lessor at the time Common Area Operating Expenses are payable under Paragraph 4.2, the entirety of any increase in Real Property Taxes it assessed solely by reason of Alterations, Trade Fixtures or Utility Installations placed upon the Premises by Lessee or at Lessee's request or by reason of any alterations or improvements to the Premises made by Lessor subsequent to the execution of this Lease by the Parties.

Initials PAGE 8 Initials

©1999-AIR Commercial Real Estate Association FORM MTN-4-8/04

10.4          Joint Assessment. If the Building is not separately assessed, Real Property Taxes allocated to the Building shall be an equitable proportion of the Real Property Taxes for all of the land and improvements included within the tax parcel assessed such proportion to be determined by Lessor from the respective valuations assigned in the assessor's work sheets or such other information as may be reasonably available. Lessor's reasonable determination thereof, in good faith, shall be conclusive.

10.5          Personal Property Taxes. Lessee shall pay prior to delinquency all taxes assessed against and levied upon Lessee Owned Alterations and Utility Installations, Trade Fixtures, furnishings, equipment and all personal property of Lessee contained in the Premises. When possible, Lessee shall cause its Lessee Owned Alterations and Utility Installations, Trade Fixtures, furnishings equipment and all other personal property to be assessed and billed separately from the real property of Lessor. If any of Lessee's said property shall be assessed with Lessor's real property, Lessee shall pay Lessor the taxes attributable to Lessee's property within 10 days after receipt of a written statement setting forth the taxes applicable to Lessee's property.

11. Utilities and Services. Lessee shall pay for all water, gas, heat, light, power, telephone, trash disposal and other utilities and services supplied to the Premises, together with any taxes thereon. Notwithstanding the provisions of Paragraph 4.2, if at any time in Lessor's sole judgment, Lessor determines that Lessee is using a disproportionate amount of water, electricity or other commonly metered utilities, or that Lessee is generating such a large volume of trash as to require an increase in the size of the trash receptacle and/or an increase in the number of times per month that it is emptied, then Lessor may increase Lessee's Base Rent by an amount equal to such increased costs. There shall be no abatement of Rent and Lessor shall not be liable in any respect whatsoever for the inadequacy, stoppage, interruption or discontinuance of any utility or service due to riot, strike, labor dispute, breakdown, accident, repair or other cause beyond Lessor's reasonable control or in cooperation with governmental request or directions

12.           Assignment and Subletting.

12.1         Lessor's Consent Required.

(a) Lessee shall not voluntarily or by operation of law assign, transfer, mortgage or encumber (collectively, "assign or assignment") or sublet all or any part of Lessee's interest in this Lease or in the Premises without Lessor's prior written consent.

(b)Unless Lessee is a corporation and its stock is publicly traded on a national stock exchange, a change in the control of Lessee shall constitute an assignment requiring consent. The transfer, on a cumulative basis, of 25% or more of the voting control of Lessee shall constitute a change in control for this purpose.

(c)  The involvement of Lessee or its assets in any transaction, or series of transactions (by way of merger, sale, acquisition, financing, transfer, leveraged buy-out or otherwise), whether or not a formal assignment or hypothecation of this Lease or Lessee's assets occurs, which results or will result in a reduction of the Net Worth of Lessee by an amount greater than 25% of such Net Worth as it was represented at the time of the execution of this Lease or at the time of the most recent assignment to which Lessor has consented, or as it exists immediately prior to said transaction or transactions constituting such reduction, whichever was or is later, shall be considered an assignment of this Lease to which Lessor may withhold its consent. "Net Worth of Lessee" shall mean net worth of Lessee (excluding any guarantors) established under generally accepted accounting principles.

(d)  An assignment or subletting without consent shall, at Lessor's option, be a Default curable after notice per Paragraph 13.1(c), or a noncurable Breach without the necessity of any notice and grace period. If Lessor elects to treat such unapproved assignment or subletting as a noncurable Breach, Lessor may either: (i) terminate this Lease, or (ii) upon 30 days written notice, increase the monthly Base Rent to 110% of the Base Rent then in effect. Further, in the event of such Breach and rental adjustment, (i) the purchase price of any option to purchase the Premises held by Lessee shall be subject to similar adjustment to 110% of the price previously in effect, and (ii) all fixed and non-fixed rental adjustments scheduled during the remainder of the Lease term shall be increased to 110% of the scheduled adjusted rent.

(e)  Lessee's remedy for any breach of Paragraph 12.1 by Lessor shall be limited to compensatory damages and/or injunctive relief.

(f)  Lessor may reasonably withhold consent to a proposed assignment or subletting if Lessee is in Default at the time consent is requested.

(g) Notwithstanding the foregoing, allowing a diminimus portion of the Premises, ie. 20 square feet or less, to be used by a third party vendor in connection with the installation of a vending machine or payphone shall not constitute a subletting.

12.2         Terms and Conditions Applicable to Assignment and Subletting.

(a)  Regardless of Lessor's consent, no assignment or subletting shall: (i) be effective without the express written assumption by such assignee or sublessee of the obligations of Lessee under this Lease, (ii) release Lessee of any obligations hereunder, or (iii) alter the primary liability of Lessee for the payment of Rent or for the performance of any other obligations to be performed by Lessee.

(b)  Lessor may accept Rent or performance of Lessee's obligations from any person other than Lessee pending approval or disapproval of an assignment. Neither a delay in the approval or disapproval of such assignment nor the acceptance of Rent or performance shall constitute a waiver or estoppel of Lessor's right to exercise its remedies for Lessee's Default or Breach.

(c)   Lessor's consent to any assignment or subletting shall not constitute consent to any subsequent assignment or subletting.

(d)  In the event of any Default or Breach by Lessee, Lessor may proceed directly against Lessee, any Guarantors or anyone else responsible for the performance of Lessee's obligations under this Lease, including any assignee or sublessee, without first exhausting Lessor's remedies against any other person or entity responsible therefore to Lessor, or any security held by Lessor.

(e)  Each request for consent to an assignment or subletting shall be in writing, accompanied by information relevant to Lessor's determination as to the financial and operational responsibility and appropriateness of the proposed assignee or sublessee, including but not limited to the intended use and/or required modification of the Premises, if any, together with a fee of $500 as consideration for Lessor's considering and processing said request. Lessee agrees to provide Lessor with such other or additional information and/or documentation as may be reasonably requested. (See also Paragraph 36)

(f)  Any assignee of, or sublessee under, this Lease shall, by reason of accepting such assignment, entering into such sublease, or entering into possession of the Premises or any portion thereof, be deemed to have assumed and agreed to conform and comply with each and every term, covenant, condition and obligation herein to be observed or performed by Lessee during the term of said assignment or sublease, other than such obligations as are contrary to or inconsistent with provisions of an assignment or sublease to which Lessor has specifically consented to in writing.

(g) Lessor's consent to any assignment or subletting shall not transfer to the assignee or sublessee any Option granted to the original Lessee by this Lease unless such transfer is specifically consented to by Lessor in writing. (See Paragraph 39.2)

12.3         Additional Terms and Conditions Applicable to Subletting. The following terms and conditions shall apply to any subletting by Lessee of all or any part of the Premises and shall be deemed included in all subleases under this Lease whether or not expressly incorporated therein:

(a)  Lessee hereby assigns and transfers to Lessor all of Lessee's interest in all Rent payable on any sublease, and Lessor may collect such Rent and apply same toward Lessee's obligations under this Lease; provided, however, that until a Breach shall occur in the performance of Lessee's obligations, Lessee may collect said Rent. In the event that the amount collected by Lessor exceeds Lessee's then outstanding obligations any such excess shall be refunded to Lessee. Lessor shall not, by reason of the foregoing or any assignment of such sublease, nor by reason of the collection of Rent, be deemed liable to the sublessee for any failure of Lessee to perform and comply with any of Lessee's obligations to such sublessee. Lessee hereby irrevocably authorizes and directs any such sublessee, upon receipt of a written notice from Lessor stating that a Breach exists in the performance of Lessee's obligations under this Lease, to pay to Lessor all Rent due and to become due under the sublease. Sublessee shall rely upon any such notice from Lessor and shall pay all Rents to Lessor without any obligation or right to inquire as to whether such Breach exists, notwithstanding any claim from Lessee to the contrary.

Initials PAGE 9 Initials

©1999-AIR Commercial Real Estate Association FORM MTN-4-8/04

(b)  In the event of a Breach by Lessee, Lessor may, at its option, require sublessee to attorn to Lessor, in which event Lessor shall undertake the obligations of the sublessor under such sublease from the time of the exercise of said option to the expiration of such sublease; provided, however, Lessor shall not be liable for any prepaid rents or security deposit paid by such sublessee to such sublessor or for any prior Defaults or Breaches of such sublessor.

(c)  Any matter requiring the consent of the sublessor under a sublease shall also require the consent of Lessor.

(d)  No sublessee shall further assign or sublet all or any part of the Premises without Lessor's prior written consent.

(e)  Lessor shall deliver a copy of any notice of Default or Breach by Lessee to the sublessee, who shall have the right to cure the Default of Lessee within the grace period, if any, specified in such notice. The sublessee shall have a right of reimbursement and offset from and against Lessee for any such Defaults cured by the sublessee.

13.Default; Breach; Remedies.

13.1        Default; Breach. A "Default" is defined as a failure by the Lessee to comply with or perform any of the terms, covenants, conditions or Rules and Regulations under this Lease. A "Breach" is defined as the occurrence of one or more of the following Defaults, and the failure of Lessee to cure such Default within any applicable grace period:

(a)  The abandonment of the Premises; or the vacating of the Premises without providing a commercially reasonable level of security, or where the coverage of the property insurance described in Paragraph 8.3 is jeopardized as a result thereof, or without providing reasonable assurances to minimize potential vandalism.

(b) The failure of Lessee to make any payment of Rent or any Security Deposit required to be made by Lessee hereunder, whether to Lessor or to a third party, when due, to provide reasonable evidence of insurance or surety bond, or to fulfill any obligation under this Lease which endangers or threatens life or property, where such failure continues for a period of 3 business days following written notice to Lessee.

(c)  The commission of waste, act or acts constituting public or private nuisance, and/or an illegal activity on the Premises by Lessee, where such actions continue for a period of 3 business days following written notice to Lessee.

(d) The failure by Lessee to provide (i) reasonable written evidence of compliance with Applicable Requirements, (ii) the service contracts, (iii) the rescission of an unauthorized assignment or subletting, (iv) an Estoppel Certificate, (v) a requested subordination, (vi) evidence concerning any guaranty and/or Guarantor, (vii) any document requested under Paragraph 41, (viii) material data safety sheets (MSDS), or (ix) any other documentation or information which Lessor may reasonably require of Lessee under the terms of this Lease, where any such failure continues for a period of 10 days following written notice to Lessee.

(e)  A Default by Lessee as to the terms, covenants, conditions or provisions of this Lease, or of the rules adopted under Paragraph 2.9 hereof, other than those described in subparagraphs 13.1(a), (b), (c) or (d), above, where such Default continues for a period of 30 days after written notice; provided, however, that if the nature of Lessee's Default is such that more than 30 days are reasonably required for its cure, then it shall not be deemed to be a Breach if Lessee commences such cure within said 30 day period and thereafter diligently prosecutes such cure to completion.

(f)  The occurrence of any of the following events: (i) the making of any general arrangement or assignment for the benefit of creditors; (ii) becoming a "debtor" as defined in 11 U.S.C. '101 or any successor statute thereto (unless, in the case of a petition filed against Lessee, the same is dismissed within 60 days); (iii) the appointment of a trustee or receiver to take possession of substantially all of Lessee's assets located at the Premises or of Lessee's interest in this Lease, where possession is not restored to Lessee within 30 days; or (iv) the attachment, execution or other judicial seizure of substantially all of Lessee's assets located at the Premises or of Lessee's interest in this Lease, where such seizure is not discharged within 30 days; provided, however, in the event that any provision of this subparagraph is contrary to any applicable law, such provision shall be of no force or effect, and not affect the validity of the remaining provisions.

(g) The discovery that any financial statement of Lessee or of any Guarantor given to Lessor was materially false.

(h)  If the performance of Lessee's obligations under this Lease is guaranteed: (i) the death of a Guarantor, (ii) the termination of a Guarantor's liability with respect to this Lease other than in accordance with the terms of such guaranty, (iii) a Guarantor's becoming insolvent or the subject of a bankruptcy filing, (iv) a Guarantor's refusal to honor the guaranty, or (v) a Guarantor's breach of its guaranty obligation on an anticipatory basis, and Lessee's failure, within 60 days following written notice of any such event, to provide written alternative assurance or security, which, when coupled with the then existing resources of Lessee, equals or exceeds the combined financial resources of Lessee and the Guarantors that existed at the time of execution of this Lease.

13.2         Remedies. If Lessee fails to perform any of its affirmative duties or obligations, within 10 days after written notice (or in case of an emergency, without notice), Lessor may, at its option, perform such duty or obligation on Lessee's behalf, including but not limited to the obtaining of reasonably required bonds, insurance policies, or governmental licenses, permits or approvals. Lessee shall pay to Lessor an amount equal to 115% of the costs and expenses incurred by Lessor in such performance upon receipt of an invoice therefor. In the event of a Breach, Lessor may, with or without further notice or demand, and without limiting Lessor in the exercise of any right or remedy which Lessor may have by reason of such Breach:

(a)Terminate Lessee's right to possession of the Premises by any lawful means, in which case this Lease shall terminate and Lessee shall immediately surrender possession to Lessor. In such event Lessor shall be entitled to recover from Lessee: (i) the Unpaid Rent which had been earned at 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 the Lessee proves could have been reasonably avoided; (iii) the worth at the time of 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 the Lessee proves could be reasonably avoided; and (iv) any other amount necessary to compensate Lessor for all the detriment proximately caused by the Lessee's failure to perform its obligations under this Lease or which in the ordinary course of things would be likely to result therefrom, including but not limited to the cost of recovering possession of the Premises, expenses of reletting, including necessary renovation and alteration of the Premises, reasonable attorneys' fees, and that portion of any leasing commission paid by Lessor in connection with this Lease applicable to the unexpired term of this Lease. The worth at the time of award of the amount referred to in provision (iii) of the immediately preceding sentence shall be computed by discounting such amount at the discount rate of the Federal Reserve Bank of the District within which the Premises are located at the time of award plus one percent. Efforts by Lessor to mitigate damages caused by Lessee's Breach of this Lease shall not waive Lessor's right to recover damages under Paragraph 12. If termination of this Lease is obtained through the provisional remedy of unlawful detainer, Lessor shall have the right to recover in such proceeding any unpaid Rent and damages as are recoverable therein, or Lessor may reserve the right to recover all or any part thereof in a separate suit. If a notice and grace period required under Paragraph 13.1 was not previously given, a notice to pay rent or quit, or to perform or quit given to Lessee under the unlawful detainer statute shall also constitute the notice required by Paragraph 13.1. In such case, the applicable grace period required by Paragraph 13.1 and the unlawful detainer statute shall run concurrently, and the failure of Lessee to cure the Default within the greater of the two such grace periods shall constitute both an unlawful detainer and a Breach of this Lease entitling Lessor to the remedies provided for in this Lease and/or by said statute.

(b)Continue the Lease and Lessee's right to possession and recover the Rent as it becomes due, in which event Lessee may sublet or assign, subject only to reasonable limitations. Acts of maintenance, efforts to relet, and/or the appointment of a receiver to protect the Lessor's interests, shall not constitute a termination of the Lessee's right to possession.

(c)Pursue any other remedy now or hereafter available under the laws or judicial decisions of the state wherein the Premises are located. The expiration or termination of this Lease and/or the termination of Lessee's right to possession shall not relieve Lessee from liability under any indemnity provisions of this Lease as to matters occurring or accruing during the term hereof or by reason of Lessee's occupancy of the Premises.

13.3         Inducement Recapture. Any agreement for free or abated rent or other charges, or for the giving or paying by Lessor to or for Lessee of any cash or other bonus, inducement or consideration for Lessee's entering into this Lease, all of which concessions are hereinafter referred to as "Inducement Provisions," shall be deemed conditioned upon Lessee's full and faithful performance of all of the terms, covenants and conditions of this Lease. Upon Breach of this Lease by Lessee, any such Inducement Provision shall automatically be deemed deleted from this Lease and of no further force or effect, and any rent, other charge, bonus, inducement or consideration theretofore abated, given or paid by Lessor under such an Inducement Provision shall be immediately due and payable by Lessee to Lessor, notwithstanding any subsequent cure of said Breach by Lessee. The acceptance by Lessor of rent or the cure of the Breach which initiated the operation of this paragraph shall not be deemed a waiver by Lessor of the provisions of this paragraph unless specifically so stated in writing by Lessor at the time of such acceptance.

Initials PAGE 10 Initials

©1999-AIR Commercial Real Estate Association FORM MTN-4-8/04

13.4         Late Charges. Lessee hereby acknowledges that late payment by Lessee of Rent will cause Lessor to incur costs not contemplated by this Lease, the exact amount of which will be extremely difficult to ascertain. Such costs include, but are not limited to, processing and accounting charges, and late charges which may be imposed upon Lessor by any Lender. Accordingly, if any Rent shall not be received by Lessor within 5 days after such amount shall be due, then, without any requirement for notice to Lessee, Lessee shall immediately pay to Lessor a one-time late charge equal to 10% of each such overdue amount or $100, whichever is greater. The parties hereby agree that such late charge represents a fair and reasonable estimate of the costs Lessor will incur by reason of such late payment. Acceptance of such late charge by Lessor shall in no event constitute a waiver of Lessee's Default or Breach with respect to such overdue amount, nor prevent the exercise of any of the other rights and remedies granted hereunder. In the event that a late charge is payable hereunder, whether or not collected, for 3 consecutive installments of Base Rent, then notwithstanding any provision of this Lease to the contrary, Base Rent shall, at Lessor's option, become due and payable quarterly in advance.

13.5         Interest. Any monetary payment due Lessor hereunder, other than late charges, not received by Lessor, when due as to scheduled payments (such as Base Rent) or within 30 days following the date on which it was due for non-scheduled payment, shall bear interest from the date when due, as to scheduled payments, or the 31st day after it was due as to non-scheduled payments. The interest ("Interest") charged shall be computed at the rate of 10% per annum but shall not exceed the maximum rate allowed by law. Interest is payable in addition to the potential late charge provided for in Paragraph 13.4.

13.6         Breach by Lessor.

(a)  Notice of Breach. Lessor shall not be deemed in breach of this Lease unless Lessor fails within a reasonable time to perform an obligation required to be performed by Lessor. For purposes of this Paragraph, a reasonable time shall in no event be less than 30 days after receipt by Lessor, and any Lender whose name and address shall have been furnished Lessee in writing for such purpose, of written notice specifying wherein such obligation of Lessor has not been performed; provided, however, that if the nature of Lessor's obligation is such that more than 30 days are reasonably required for its performance, then Lessor shall not be in breach if performance is commenced within such 30 day period and thereafter diligently pursued to completion.

(b)  Performance by Lessee on Behalf of Lessor. In the event that neither Lessor nor Lender cures said breach within 30 days after receipt of said notice, or if having commenced said cure they do not diligently pursue it to completion, then Lessee may elect to cure said breach at Lessee's expense and offset from Rent the actual and reasonable cost to perform such cure, provided however, that such offset shall not exceed an amount equal to the greater of one month's Base Rent or the Security Deposit, reserving Lessee's right to reimbursement from Lessor for any such expense in excess of such offset. Lessee shall document the cost of said cure and supply said documentation to Lessor.

14.Condemnation. If the Premises or any portion thereof are taken under the power of eminent domain or sold under the threat of exercise of said power (collectively "Condemnation"), this Lease shall terminate as to the part taken as of the date the condemning authority takes title or possession, whichever first occurs. If more than 10% of the floor area of the Unit, or more than 25% of Lessee's Reserved Parking Spaces, is taken by Condemnation, Lessee may, at Lessee's option, to be exercised in writing within 10 days after Lessor shall have given Lessee written notice of such taking (or in the absence of such notice, within 10 days after the condemning authority shall have taken possession) terminate this Lease as of the date the condemning authority takes such possession. If Lessee does not terminate this Lease in accordance with the foregoing, this Lease shall remain in full force and effect as to the portion of the Premises remaining, except that the Base Rent shall be reduced in proportion to the reduction in utility of the Premises caused by such Condemnation. Condemnation awards and/or payments shall be the property of Lessor, whether such award shall be made as compensation for diminution in value of the leasehold, the value of the part taken, or for severance damages; provided, however, that Lessee shall be entitled to any compensation for Lessee's relocation expenses, loss of business goodwill and/or Trade Fixtures, without regard to whether or not this Lease is terminated pursuant to the provisions of this Paragraph. All Alterations and Utility Installations made to the Premises by Lessee, for purposes of Condemnation only, shall be considered the property of the Lessee and Lessee shall be entitled to any and all compensation which is payable therefor. In the event that this Lease is not terminated by reason of the Condemnation, Lessor shall repair any damage to the Premises caused by such Condemnation.

16.Estoppel Certificates.

(a)  Each Party (as "Responding Party") shall within 10 days after written notice from the other Party (the "Requesting Party") execute, acknowledge and deliver to the Requesting Party a statement in writing in form similar to the then most current "Estoppel Certificate" form published by the AIR Commercial Real Estate Association, plus such additional information, confirmation and/or statements as may be reasonably requested by the Requesting Party.

(b)If the Responding Party shall fail to execute or deliver the Estoppel Certificate within such 10 day period, the Requesting Party may execute an Estoppel Certificate stating that: (i) the Lease is in full force and effect without modification except as may be represented by the Requesting Party, (ii) there are no uncured defaults in the Requesting Party's performance, and (iii) if Lessor is the Requesting Party, not more than one month's rent has been paid in advance. Prospective purchasers and encumbrancers may rely upon the Requesting Party's Estoppel Certificate, and the Responding Party shall be estopped from denying the truth of the facts contained in said Certificate.

(c)If Lessor desires to finance, refinance, or sell the Premises, or any part thereof, Lessee and all Guarantors shall deliver to any potential lender or purchaser designated by Lessor such financial statements as may be reasonably required by such lender or purchaser, including but not limited to Lessee's financial statements for the past 3 years. All such financial statements shall be received by Lessor and such lender or purchaser in confidence and shall be used only for the purposes herein set forth.

17.Definition of Lessor. The term "Lessor" as used herein shall mean the owner or owners at the time in question of the fee title to the Premises, or, if this is a sublease, of the Lessee's interest in the prior lease. In the event of a transfer of Lessor's title or interest in the Premises or this Lease, Lessor shall deliver to the transferee or assignee (in cash or by credit) any unused Security Deposit held by Lessor. Except as provided in Paragraph 15, upon such transfer or assignment and delivery of the Security Deposit, as aforesaid, the prior Lessor shall be relieved of all liability with respect to the obligations and/or covenants under this Lease thereafter to be performed by the Lessor. Subject to the foregoing, the obligations and/or covenants in this Lease to be performed by the Lessor shall be binding only upon the Lessor as hereinabove defined.

Initials PAGE 11 Initials

©1999-AIR Commercial Real Estate Association FORM MTN-4-8/04

18.Severability. The invalidity of any provision of this Lease, as determined by a court of competent jurisdiction, shall in no way affect the validity of any other provision hereof.

19.Days. Unless otherwise specifically indicated to the contrary, the word "days" as used in this Lease shall mean and refer to calendar days.

20.Limitation on Liability. The obligations of Lessor under this Lease shall not constitute personal obligations of Lessor, or its partners, members, directors, officers or shareholders, and Lessee shall look to the Premises, and to no other assets of Lessor, for the satisfaction of any liability of Lessor with respect to this Lease, and shall not seek recourse against Lessor's partners, members, directors, officers or shareholders, or any of their personal assets for such satisfaction.

21.           Time of Essence. Time is of the essence with respect to the performance of all obligations to be performed or observed by the Parties under this Lease.

22.          No Prior or Other Agreements; Broker Disclaimer. This Lease contains all agreements between the Parties with respect to any matter mentioned herein, and no other prior or contemporaneous agreement or understanding shall be effective. Lessor and Lessee each represents and warrants to the Brokers that it has made, and is relying solely upon, its own investigation as to the nature, quality, character and financial responsibility of the other Party to this Lease and as to the use, nature, quality and character of the Premises. Brokers have no responsibility with respect thereto or with respect to any default or breach hereof by either Party. The liability (including court costs and attorneys' fees), of any Broker with respect to negotiation, execution, delivery or performance by either Lessor or Lessee under this Lease or any amendment or modification hereto shall be limited to an amount up to the fee received by such Broker pursuant to this Lease; provided, however, that the foregoing limitation on each Broker's liability shall not be applicable to any gross negligence or willful misconduct of such Broker.

23.Notices.

23.1Notice Requirements. All notices required or permitted by this Lease or applicable law shall be in writing and may be slivered in person (by hand or by courier) or may be sent by regular, certified or registered mail or U.S. Postal Service Express Mail, with postage prepaid, or by facsimile transmission, and shall be deemed sufficiently given if served in a manner specified in this Paragraph 23. The addresses noted adjacent to a Party's signature on this Lease shall be that Party's address for delivery or mailing of notices. Either Party may by written notice to the other specify a different address for notice, except that upon Lessee's taking possession of the Premises, the Premises shall constitute Lessee's address for notice. A copy of all notices to Lessor shall be concurrently transmitted to such party or parties at such addresses as Lessor may from time to time hereafter designate in writing.

23.2Date of Notice. Any notice sent by registered or certified mail, return receipt requested, shall be deemed given on the date of delivery shown on the receipt card, or if no delivery date is shown, the postmark thereon. If sent by regular mail the notice shall be deemed given 72 hours after the same is addressed as required herein and mailed with postage prepaid. Notices delivered by United States Express Mail or overnight courier that guarantee next day delivery shall be deemed given 24 hours after delivery of the same to the Postal Service or courier. Notices transmitted by facsimile transmission or similar means shall be deemed delivered upon telephone confirmation of receipt (confirmation report from fax machine is sufficient), provided a copy is also delivered via delivery or mail. If notice is received on a Saturday, Sunday or legal holiday, it shall be deemed received on the next business day.

24.Waivers. No waiver by Lessor of the Default or Breach of any term, covenant or condition hereof by Lessee, shall be deemed a waiver of any other term, covenant or condition hereof, or of any subsequent Default or Breach by Lessee of the same or of any other term, covenant or condition hereof. Lessor's consent to, or approval of, any act shall not be deemed to render unnecessary the obtaining of Lessor's consent to, or approval of, any subsequent or similar act by Lessee, or be construed as the basis of an estoppel to enforce the provision or provisions of this Lease requiring such consent. The acceptance of Rent by Lessor shall not be a waiver of any Default or Breach by Lessee. Any payment by Lessee may be accepted by Lessor on account of moneys or damages due Lessor, notwithstanding any qualifying statements or conditions made by Lessee in connection therewith, which such statements and/or conditions shall be of no force or effect whatsoever unless specifically agreed to in writing by Lessor at or before the time of deposit of such payment.

25.Disclosures Regarding The Nature of a Real Estate Agency Relationship.

(a)When entering into a discussion with a real estate agent regarding a real estate transaction, a Lessor or Lessee should from the outset understand what type of agency relationship or representation it has with the agent or agents in the transaction. Lessor and Lessee acknowledge being advised by the Brokers in this transaction, as follows:

(i)Lessor's Agent. A Lessor's agent under a listing agreement with the Lessor acts as the agent for the Lessor only. A Lessor's agent or subagent has the following affirmative obligations: To the Lessor: A fiduciary duty of utmost care, integrity, honesty, and loyalty in dealings with the Lessor. To the Lessee and the Lessor: a. Diligent exercise of reasonable skills and care in performance of the agent's duties. b. A duty of honest and fair dealing and good faith. c. A duty to disclose all facts known to the agent materially effecting the value or desirability of the property that are not known to, or within the diligent attention and observation of, the Parties. An gent is not obligated to reveal to either Party any confidential information obtained from the other Party which does not involve the affirmative duties set forth above.

(ii)          Lessee's Agent. An agent can agree to act as agent for the Lessee only. In these situations, the agent is not the Lessor's agent, even if by agreement the agent may receive compensation for services rendered, either in full or in part from the Lessor. An agent acting only for a Lessee has the following affirmative obligations. To the Lessee: A fiduciary duty of utmost care, integrity, honesty, and loyalty in dealings with the Lessee. To the Lessee and the Lessor: a. Diligent exercise of reasonable skills and care in performance of the agent's duties. b. A duty of honest and fair dealing and good faith. c. A duty to disclose all facts known to the agent materially affecting the value or desirability of the property that are not known to, or within the diligent attention and observation of, the Parties. An agent is not obligated to reveal to either Party any confidential information obtained from the other Party which does not involve the affirmative duties set forth above.

(iii)        Agent Representing Both Lessor and Lessee. A real estate agent, either acting directly or through one or more associate licenses, can legally be the agent of both the Lessor and the Lessee in a transaction, but only with the knowledge and consent of both the Lessor and the Lessee. In a dual agency situation, the agent has the following affirmative obligations to both the Lessor and the Lessee: a. A fiduciary duty of utmost care, integrity, honesty and loyalty in the dealings with either the Lessor or the Lessee. b. Other duties to the Lessor and the Lessee as stated above in subparagraphs (i) or (ii). In representing both Lessor and Lessee, the agent may not without the express permission of the respective Party, disclose to the other Party that the Lessor will accept rent in an amount less than that indicated in the listing or that the Lessee is willing to pay a higher rent than that offered. The above duties of the agent in a real estate transaction do not relieve a Lessor or Lessee from the responsibility to protect their own interests. Lessor and Lessee should carefully read all agreements to assure that they adequately express their understanding of the transaction. A real estate agent is a person qualified to advise about real estate. If legal or tax advice is desired, consult a competent professional.

(b)Brokers have no responsibility with respect to any default or breach hereof by either Party. The Parties agree that no lawsuit or other legal proceeding involving any breach of duty, error or omission relating to this Lease may be brought against Broker more than one year after the Start Date and that the liability (including court costs and attorneys' fees), of any Broker with respect to any such lawsuit and/or legal proceeding shall not exceed the fee received by such Broker pursuant to this Lease; provided, however, that the foregoing limitation on each Broker's liability shall not be applicable to any gross negligence or willful misconduct of such Broker

(c)Buyer and Seller agree to identify to Brokers as "Confidential" any communication or information given Brokers that is considered by such Party to be confidential.

26.No Right To Holdover. Lessee has no right to retain possession of the Premises or any part thereof beyond the expiration or termination of this Lease. In the event that Lessee holds over, then the Base Rent shall be increased to 150% of the Base Rent applicable immediately preceding the expiration or termination. Nothing contained herein shall be construed as consent by Lessor to any holding over by Lessee.

Initials PAGE 12 Initials

©1999-AIR Commercial Real Estate Association FORM MTN-4-8/04

27.Cumulative Remedies. No remedy or election hereunder shall be deemed exclusive but shall, wherever possible, be cumulative with all other remedies at law or in equity.

28.Covenants and Conditions; Construction of Agreement. All provisions of this Lease to be observed or performed by Lessee both covenants and conditions. In construing this Lease, all headings and titles are for the convenience of the Parties only and shall not be considered a part of this Lease. Whenever required by the context, the singular shall include the plural and vice versa. This Lease shall not be construed as if prepared by one of the Parties, but rather according to its fair meaning as a whole, as if both Parties had prepared it.

29.Binding Effect; Choice of Law. This Lease shall be binding upon the parties, their personal representatives, successors and assigns and be governed by the laws of the State in which the Premises are located. Any litigation between the Parties hereto concerning this Lease shall be initiated in the county in which the Premises are located.

30.Subordination; Attornment; Non-Disturbance.

30.1Subordination. This Lease and any Option granted hereby shall be subject and subordinate to any ground lease mortgage, deed of trust, or other hypothecation or security device (collectively, "Security Device"), now or hereafter placed upon the Premises, to any and all advances made on the security thereof, and to all renewals, modifications, and extensions thereof Lessee agrees that the holders of any such Security Devices (in this Lease together referred to as ("Lender") shall have no liability or obligation to perform any of the obligations of Lessor under this Lease. Any Lender may elect to have this Lease and/or any Option granted hereby superior to the lien of its Security Device by giving written notice thereof to Lessee, whereupon this Lease and such Options shall be deemed prior to such Security Device, notwithstanding the relative dates of the documentation or recordation thereof.

30.2Attornment. In the event that Lessor transfers title to the Premises, or the Premises are acquired by another upon the foreclosure or termination of a Security Device to which this Lease is subordinated (i) Lessee shall, subject to the non-disturbance provisions of Paragraph 30.3, attorn to such new owner, and upon request, enter into a new lease, containing all of the terms and provisions of this Lease, with such new owner for the remainder of the term hereof, or, at the election of the new owner, this Lease will automatically become a new lease between Lessee and such new owner, and (ii) Lessor shall thereafter be relieved of any further obligations hereunder and such new owner shall assume all of Lessor's obligations, except that such new owner shall not: (a) be liable for any act or omission of any prior lessor or with respect to events occurring prior to acquisition of ownership; (b) be subject to any offsets or defenses which Lessee might have against any prior lessor, (c) be bound by prepayment of more than one month's rent, or (d) be liable for the return of any security deposit paid to any prior lessor.

30.3Non-Disturbance. With respect to Security Devices entered into by Lessor after the execution of this Lease, Lessee's subordination of this Lease shall be subject to receiving a commercially reasonable non-disturbance agreement (a "Non-Disturbance Agreement")from the Lender which Non-Disturbance Agreement provides that Lessee's possession of the Premises, and this Lease, including any options to extend the term hereof, will not be disturbed so long as Lessee is not in Breach hereof and attorns to the record owner of the Premises. Further, within 60 days after the execution of this Lease, Lessor shall use its commercially reasonable efforts to obtain a Non-Disturbance Agreement from the holder of any pre-existing Security Device which is secured by the Premises. In the event that Lessor is unable to provide the Non-Disturbance Agreement within said 60 days, then Lessee may, at Lessee's option, directly contact Lender and attempt to negotiate for the execution and delivery of a Non-Disturbance Agreement.

30.4Self-Executing. The agreements contained in this Paragraph 30 shall be effective without the execution of any further documents; provided, however, that, upon written request from Lessor or a Lender in connection with a sale, financing or refinancing of the Premises, Lessee and Lessor shall execute such further writings as may be reasonably required to separately document any subordination, attornment and/or Non-Disturbance Agreement provided for herein.

31.Attorneys' Fees. If any Party or Broker brings an action or proceeding involving the Premises whether founded in tort, contract or equity, or to declare rights hereunder, the Prevailing Party (as hereafter defined) in any such proceeding, action, or appeal thereon, shall be entitled to reasonable attorneys' fees. Such fees may be awarded in the same suit or recovered in a separate suit, whether or not such action or proceeding is pursued to decision or judgment. The term, "Prevailing Party" shall include, without limitation, a Party or Broker who substantially obtains or defeats the relief sought, as the case may be, whether by compromise, settlement, judgment, or the abandonment by the other Party or Broker of its claim or defense. The attorneys' fees award shall not be computed in accordance with any court fee schedule, but shall be such as to fully reimburse all attorneys' fees reasonably incurred. In addition, Lessor shall be entitled to attorneys' fees, costs and expenses incurred in the preparation and service of notices of Default and consultations in connection therewith, whether or not a legal action is subsequently commenced in connection with such Default or resulting Breach ($200 is a reasonable minimum per occurrence for such services and consultation).

32.Lessor's Access; Showing Premises; Repairs. Lessor and Lessor's agents shall have the right to enter the Premises at any time, in the case of an emergency, and otherwise at reasonable times after reasonable prior notice for the purpose of showing the same to prospective purchasers, lenders, or tenants, and making such alterations, repairs, improvements or additions to the Premises as Lessor may deem necessary or desirable and the erecting, using and maintaining of utilities, services, pipes and conduits through the Premises and/or other premises as long as there is no material adverse effect on Lessee's use of the Premises. All such activities shall be without abatement of rent or liability to Lessee.

33.Auctions. Lessee shall not conduct, nor permit to be conducted, any auction upon the Premises without Lessor's prior written consent. Lessor shall not be obligated to exercise any standard of reasonableness in determining whether to permit an auction.

34.Signs. Lessor may place on the Premises ordinary "For Sale" signs at any time and ordinary "For Lease" signs during the last 6 months of the term hereof. Except for ordinary "For Sublease" signs which may be placed only on the Premises, Lessee shall not place any sign upon the Project without Lessor's prior written consent. All signs must comply with all Applicable Requirements.

35.Termination; Merger. Unless specifically stated otherwise in writing by Lessor, the voluntary or other surrender of this Lease by Lessee, the mutual termination or cancellation hereof, or a termination hereof by Lessor for Breach by Lessee, shall automatically terminate any sublease or lesser estate in the Premises; provided, however, that Lessor may elect to continue any one or all existing subtenancies. Lessor's failure within 10 days following any such event to elect to the contrary by written notice to the holder of any such higher interest, shall constitute Lessor's election to have such event constitute the termination of such interest.

36.Consents. Except as otherwise provided herein, wherever in this Lease the consent of a Party is required to an act by or for the other Party, such consent shall not be unreasonably withheld or delayed. Lessor's actual reasonable costs and expenses (including but not limited to architects', attorneys', engineers' and other consultants' fees) incurred in the consideration of, or response to, a request by Lessee for any Lessor consent, including but not limited to consents to an assignment, a subletting or the presence or use of a Hazardous Substance, shall be paid by Lessee upon receipt of an invoice and supporting documentation therefor. Lessor's consent to any act, assignment or subletting shall not constitute an acknowledgment that no Default or Breach by Lessee of this Lease exists, nor shall such consent be deemed a waiver of any then existing Default or Breach, except as may be otherwise specifically stated in writing by Lessor at the time of such consent. The failure to specify herein any particular condition to Lessor's consent shall not preclude the imposition by Lessor at the time of consent of such further or other conditions as are then reasonable with reference to the particular matter for which consent is being given. In the event that either Party disagrees with any determination made by the other hereunder and reasonably requests the reasons for such determination, the determining party shall furnish its reasons in writing and in reasonable detail within 10 business days following such request.

37.Guarantor.

37.1Execution. The Guarantors, if any, shall each execute a guaranty in the form most recently published by the AIR Commercial Real Estate Association.

37.2Default. It shall constitute a Default of the Lessee if any Guarantor fails or refuses, upon request to provide: (a) evidence of the execution of the guaranty, including the authority of the party signing on Guarantor's behalf to obligate Guarantor, and in the case of a corporate Guarantor, a certified copy of a resolution of its board of directors authorizing the making of such guaranty, (b) current financial statements, (c) an Estoppel Certificate, or (d) written confirmation that the guaranty is still in effect.

38.Quiet Possession. Subject to payment by Lessee of the Rent and performance of all of the covenants, conditions and provisions on Lessee's part to be observed and performed under this Lease, Lessee shall have quiet possession and quiet enjoyment of the Premises during the term hereof.

Initials PAGE 13 Initials

©1999-AIR Commercial Real Estate Association FORM MTN-4-8/04

39.Options. If Lessee is granted an option, as defined below, then the following provisions shall apply.

39.1         Definition. "Option" shall mean: (a) the right to extend the term of or renew this Lease or to extend or renew any lease that Lessee has on other property of Lessor; (b) the right of first refusal or first offer to lease either the Premises or other property of Lessor; (c) the right to purchase or the right of first refusal to purchase the Premises or other property of Lessor.

39.2         Options Personal To Original Lessee. Any Option granted to Lessee in this Lease is personal to the original Lessee, and cannot be assigned or exercised by anyone other than said original Lessee and only while the original Lessee is in full possession of the Premises and, if requested by Lessor, with Lessee certifying that Lessee has no intention of thereafter assigning or subletting.

39.3         Multiple Options. In the event that Lessee has any multiple Options to extend or renew this Lease, a later Option cannot be exercised unless the prior Options have been validly exercised.

39.4         Effect of Default on Options.

(a)  Lessee shall have no right to exercise an Option: (i) during the period commencing with the giving of any notice of Default and continuing until said Default is cured, (ii) during the period of time any Rent is unpaid (without regard to whether notice thereof is given Lessee), (iii) during the time Lessee is in Breach of this Lease, or (iv) in the event that Lessee has been given 3 or more notices of separate Default, whether or not the Defaults are cured, during the 12 month period immediately preceding the exercise of the Option.

(b)  The period of time within which an Option may be exercised shall not be extended or enlarged by reason of Lessee's inability to exercise an Option because of the provisions of Paragraph 39.4(a).

(c)An Option shall terminate and be of no further force or effect, notwithstanding Lessee's due and timely exercise of the Option, if, after such exercise and prior to the commencement of the extended term or completion of the purchase, (i) Lessee fails to pay Rent for a period of 30 days after such Rent becomes due (without any necessity of Lessor to give notice thereof),or (ii) if Lessee commits a Breach of this Lease.

40.Security Measures. Lessee hereby acknowledges that the Rent payable to Lessor hereunder does not include the cost of guard service or other security measures, and that Lessor shall have no obligation whatsoever to provide same. Lessee assumes all responsibility for the protection of the Premises, Lessee, its agents and invitees and their property from the acts of third parties.

41.Reservations. Lessor reserves the right: (i) to grant, without the consent or joinder of Lessee, such easements, rights and indications that Lessor deems necessary, (ii) to cause the recordation of parcel maps and restrictions, and (iii) to create and/or install new utility raceways, so long as such easements, rights, dedications, maps, restrictions, and utility raceways do not unreasonably interfere with the use of the Premises by Lessee. Lessee agrees to sign any documents reasonably requested by Lessor to effectuate such rights.

42.Performance Under Protest. If at any time a dispute shall arise as to any amount or sum of money to be paid by one Party to the other under the provisions hereof, the Party against whom the obligation to pay the money is asserted shall have the right to make payment "under protest" and such payment shall not be regarded as a voluntary payment and there shall survive the right on the part of said Party to institute suit for recovery of such sum. If it shall be adjudged that there was no legal obligation on the part of said Party to pay such sum or any part thereof, said Party shall be entitled to recover such sum or so much thereof as it was not legally required to pay. A Party who does not initiate suit for the recovery of sums paid "under protest" within 6 months shall be deemed to have waived its right to protest such payment.

43.Authority; Multiple Parties; Execution.

(a)If either Party hereto is a corporation, trust, limited liability company, partnership, or similar entity, each individual executing this Lease on behalf of such entity represents and warrants that he or she is duly authorized to execute and deliver this Lease on its behalf. Each Party shall, within 30 days after request, deliver to the other Party satisfactory evidence of such authority.

(b)  If this Lease is executed by more than one person or entity as "Lessee", each such person or entity shall be jointly and severally liable hereunder. It is agreed that any one of the named Lessees shall be empowered to execute any amendment to this Lease, or other document ancillary thereto and bind all of the named Lessees, and Lessor may rely on the same as if all of the named Lessees had executed such document.

(c)This Lease may be executed by the Parties in counterparts, each of which shall be deemed an original and all of which together shall constitute one and the same instrument.

44.Conflict. Any conflict between the printed provisions of this Lease and the typewritten or handwritten provisions shall be controlled by the typewritten or handwritten provisions.

45.Offer. Preparation of this Lease by either party or their agent and submission of same to the other Party shall not be deemed an offer to lease to the other Party. This Lease is not intended to be binding until executed and delivered by all Parties hereto.

46.Amendments. This Lease may be modified only in writing, signed by the Parties in interest at the time of the modification. As long as they do not materially change Lessee's obligations hereunder, Lessee agrees to make such reasonable non-monetary modifications to this Lease as may be reasonably required by a Lender in connection with the obtaining of normal financing or refinancing of the Premises

47.Waiver of Jury Trial. THE PARTIES HEREBY WAIVE THEIR RESPECTIVE RIGHTS TO TRIAL BY JURY IN ANY ACTION OR PROCEEDING INVOLVING THE PROPERTY OR ARISING OUT OF THIS AGREEMENT.

48.Mediation and Arbitration of Disputes. An Addendum requiring the Mediation and/or the Arbitration of disputes between the Parties and/or Brokers arising out of this Lease o is o is not attached to this Lease.

49.Americans with Disabilities Act. Since compliance with the Americans with Disabilities Act (ADA) is dependent upon Lessee's specific use of the Premises, Lessor makes no warranty or representation as to whether or not the Premises comply with ADA or any similar legislation. In the event that Lessee's use of the Premises requires modifications or additions to the Premises in order to be in ADA compliance, Lessee agrees to make any such necessary modifications and/or additions at Lessee's expense.

*** SEE ADDENDUM ATTACHED ***

LESSOR AND LESSEE HAVE CAREFULLY READ AND REVIEWED THIS LEASE AND EACH TERM AND PROVISION CONTAINED HEREIN, AND BYTHE EXECUTION OF THIS LEASE SHOW THEIR INFORMED AND VOLUNTARY CONSENT THERETO. THE PARTIES HEREBY AGREE THAT, AT THE TIME THIS LEASE IS EXECUTED, THE TERMS OF THIS LEASE ARE COMMERCIALLY REASONABLE AND EFFECTUATE THE INTENT AND PURPOSE OF LESSOR AND LESSEE WITH RESPECT TO THE PREMISES.

ATTENTION: NO REPRESENTATION OR RECOMMENDATION IS MADE BY THE AIR COMMERCIAL REAL ESTATE ASSOCIATION OR BY ANY BROKER AS TO THE LEGAL SUFFICIENCY, LEGAL EFFECT, OR TAX CONSEQUENCES OF THIS LEASE OR THE TRANSACTION TO WHICH IT RELATES. THE PARTIES ARE URGED TO:

1.SEEK ADVICE OF COUNSEL AS TO THE LEGAL AND TAX CONSEQUENCES OF THIS LEASE.

2.RETAIN APPROPRIATE CONSULTANTS TO REVIEW AND INVESTIGATE THE CONDITION OF THE PREMISES. SAID INVESTIGATION SHOULD INCLUDE BUT NOT BE LIMITED TO: THE POSSIBLE PRESENCE OF HAZARDOUS SUBSTANCES, THE ZONING OF THE PREMISES, THE STRUCTURAL INTEGRITY, THE CONDITION OF THE ROOF AND OPERATING SYSTEMS, COMPLIANCE WITH THE AMERICANS WITH DISABILITIES ACT AND THE SUITABILITY OF THE PREMISES FOR LESSEE'S INTENDED USE.

WARNING: IF THE PREMISES ARE LOCATED IN A STATE OTHER THAN CALIFORNIA, CERTAIN PROVISIONS OF THE LEASE MAY NEED TO BE REVISED TO COMPLY WITH THE LAWS OF THE STATE IN WHICH THE PREMISES ARE LOCATED.

Initials PAGE 14 Initials

©1999-AIR Commercial Real Estate Association FORM MTN-4-8/04

ADDENDUM TO LEASE DATED                       2005

BY AND BETWEEN

RICHARD A. CRISTINA AND DIANE L. CR1STINA, TRUSTEES, AS LESSOR

AND

SOUTHWALL TECHNOLOGIES, INC., AS LESSEE

FOR THE PREMISES LOCATED AT

3780 FABIAN WAY, PALO ALTO, CALIFORNIA

50.Base Rent. The Base Rent for the period November 1, 2005 through October 31, 2006 shall be $4,800 per month. The Base Rent for the period November 1, 2006 through October 31, 2007 shall be $5,000 per month.

51.Prior Lease/Unpaid Rent. Upon execution of this Lease by both parties, and effective as of November 1, 2005, the prior Lease between the Lessee and Lessor's predecessor in interest, dated June 11, 1990, as modified ("Prior Lease"), shall terminate; provided, however, that any obligations that survive the expiration or termination of said Lease shall remain in full force and effect, and provided further, that the Security Deposit in the sum of $10,504 held by the Lessor pursuant to said Lease shall be applied to and become a part of the Security Deposit to be held by Lessor pursuant to this Lease.

The Parties agree that Lessee is currently indebted to Lessor in the sum of $220,000 in unpaid rent and other charges due under the terms of the Prior Lease. Lessee shall pay Lessor the sum of $220,000, without interest, by payment of the sum of $27,500 on December 1, 2005, and $27,500 every third month thereafter until the total sum of $220,000 has been paid. Should Lessee be in default under the terms of said Lease, the Lessor shall be entitled to collect the full amount in default plus interest thereon.

52.Real Property Taxes. Notwithstanding the provisions of Paragraph 10 of the Lease, Lessee shall not be responsible for any increase in taxes which solely result from the sale by Lessor of the Premises.

LESSOR:	LESSEE:
	SOUTHWALL TECHNOLOGIES, INC.,
	a Delaware corporation
/s/ Richard A. Cristina
Richard A. Cristina, Trustee
/s/ Diane L. Cristina	By: /s/ S. Kamenski
Diane L. Cristina, Trustee	Title: Acting CFO

The parties hereto have executed this Lease at the place and on the dates specified above their respective signatures.

Executed at:		Executed at:	Palo Alto, California
on:		on:	10/4/05
By LESSOR:		By LESSEE:
		SOUTHWALL TECHNOLOGIES, INC., A
		Delaware corporation
By:	/s/ Richard A. Cristina	By:	/s/ S. Kamenski
Name Printed:	Richard A. Cristina	Name Printed:	Sylvia Kamenski
Title:	Trustee	Title:	Acting CFO
By:		By:
Name Printed:	Diane L. Cristina	Name Printed:
Title:	Trustee	Title:
Address:	625 Charles Street	Address:
	San Jose, CA 95112
Telephone:	(408) 938-4918	Telephone:	(650) 962-9115
Facsimile:	(408) 279-4088	Facsimile:
Federal ID No.		Federal ID No.

These forms are often modified to meet changing requirements of law and needs of the Industry. Always write or call to make sure you are utilizing the most current form: AIR COMMERCIAL REAL ESTATE ASSOCIATION, 700 South Flower Street, Suite 600, Los Angeles, CA 90017. (213)687-8777.

©Copyright 1999-By AIR Commercial Real Estate Association.

All rights reserved.

No part of these works may be reproduced in any form without permission In writing.

PAGE 15 

©1999-AIR Commercial Real Estate Association FORM MTN-4-8/04

EX-10.141

Exhibit 10.141

LEASE AGREEMENT

This Lease, dated July 14, 2005 by and between:

Dymond Development Company, LLC, a California Limited Liability Company ("Lessor") and Southwall Technologies, Inc., A California Corporation, ("Lessee"), is made with reference to the following facts:

Lessor is the owner of a certain "Industrial Building" located at 2629B Terminal Boulevard, Mountain View, California, consisting of approximately 14,750 square feet and related parking facilities and landscaped areas, which property is legally describe on Exhibit "A" attached hereto and made a part hereof.

Lessee desires to rent a portion of the industrial building and Lessor has agreed to lease the same to Lessee on the terms and conditions hereinafter set forth.

NOW, THEREFORE, the parties agree as follows:

ARTICLE 1. DEMISED PREMISES AND COMMON AREAS

1.01       Lessor does hereby lease to Lessee, and Lessee does hereby rent from Lessor, that portion of the Industrial Building located at 2629B Terminal Boulevard, Mountain View, California and consisting of approximately 9,750 square feet as shown on the drawing attached hereto as Exhibit "A" and made a part hereof, (the "Demised Premises"), together with the right to use the Common Areas of the Industrial Center as hereinafter describes. The parties hereby stipulate and agree that the Demised Premises constitutes 66.10% of the total leasable floor area of the Industrial Building.

1.02       Lessee shall have the non-exclusive right to use the Common Areas of the able Common Areas of the Industrial Center, subject to any reasonable rules and regulations concerning such use as may be adopted from time to time by Lessor. The term "Common Areas" shall mean those areas adjacent to the Industrial Building provided and designated by Lessor for the general non-exclusive use by the occupants of the Industrial Building and their respective employees, customers and invitees, including parking areas, loading and unloading areas, trash areas, roadways, sidewalks, walkways, driveways, and landscaped areas. Lessor reserves the right of exclusive control and management of the Common Areas, including the right, in Lessor's sole discretion:

(a) To make alterations or construct additional improvements within the Common Areas, so long as reasonable access to the demised Premises Remains available and so long as the conduct of Lessees business is not unreasonably interfered with.

(b) To temporarily close any of the Common Areas for maintenance purposes, so long as reasonable access to the Demised Premises remains available, and so long as the conduct of Lessee's business is not unreasonably interfered with.

(c) To use the Common Areas while engaged in making additional improvements, repairs or alterations to the Industrial Center, or any portion thereof.

ARTICLE 2. TERM

2.01       The term of this Lease shall be a period of One (1) year, commencing on August 1 2005 ("Commencement Date"), and terminating on July 31, 2006, unless sooner terminated as provided herein ("Initial Term").

2.02       If Lessor for any reason whatsoever, is unable to deliver possession of the Demised Premises to Lessee on the commencement date specified in Section 2.01 above, Lessor shall not be liable to Lessee for any loss or damage resulting therefrom, but in such event Lessee shall not be liable for rent or other sums due Lessor until possession of premises within 30 days of the commencement of the said term as specified above, this Lease may be declared void or voidable at option of Lessee.

ARTICLE 3. RENT

3.01       Lessee shall pay to Lessor as Base Rent for the Demised Premises, in lawful money of the United States, payable in advance on or before the first day of each calendar month without any deduction, offset or demand, the following amounts:

MONTH	RENT	RENT/Sq.Ft.
1-12	$5,655.00     per month	$ 0.58 NNN

3.02       If the Commencement Date is not the first day of a calendar month, or if the Termination Date is not the last day or a calendar month, the monthly Base Rental for the fractional month shall be prorated on the basis of a thirty (30) day month.

3.03       Lessee acknowledges the late payment of Base Rent and any other charges provided herein will cause Lessor to incur costs not contemplated by this Lease, the exact amount of such costs being extremely difficult and impracticable to determine. Such costs include, without limitation, processing and accounting charges, late charges that may be imposed on Lessor by the terms any encumbrances against the Industrial Building and penalties on delinquent tax payments. Lessee therefore agrees that if any installment of Base Rent or other charge payable by Lessee hereunder is not received by Lessor within fourteen (14) days after the same becomes due, Lessor shall be entitled to collect an additional sum equal to one and one-half percent (1.5%) of the delinquent payment for each month or fraction thereof that he Base Rent or other charge remains unpaid. Acceptance of any late charge shall not constitute a waiver of Lessee's default with respect to the overdue amount, nor prevent Lessor from exercising any other rights and remedies available to Lessor hereunder or provided by law.

2

ARTICLE 4. SECURITY DEPOSIT

4.01       Lessee has deposited with Lessor the sum of FIVE THOUSAND SIX HUNDRED FIFTY-FIVE AND 00/100 DOLLARS ($5,655.00) as and for a security deposit.

4.02       If Lessee defaults with respect to any provision of this Lease, Lessor may use, apply or retain all or any part of the security deposit to cure such default or to compensate Lessor for all damages sustained by Lessor resulting from Lessee's default. If any portion of said deposit is so used or applied, Lessee shall within ten (10) days after receipt of written demand therefore, deposit cash with Lessor in an amount sufficient to restore the security deposit to its original amount, and Lessee's failure to do so shall constitute a material breach of this Lease. Lessor's obligations with respect to the security deposit are those of a debtor and not a trustee. Lessor shall not be required to segregate the security deposit as a separate fund and Lessee shall not be entitled to any interest thereon. If Lessee shall fully and faithfully perform every provision of this Lease, the security deposit or any balance thereof shall be returned to Lessee within ten (10) days after termination of the Lease.

ARTICLE 5. USE

5.01       The Demised Premises shall be used and occupied bylessee solely for an office, distribution and warehouse and for no other or additional purpose without the prior written consent of Lessor.

5.02       Lessee shall not use the Demised Premises or permit anything to be done in or about the Demised Premises which is prohibited by or will in any way conflict with any law, statute ordinance or governmental rule or regulation now in force or which may hereafter be in force, or which is prohibited bythe standard form of fire insurance policy, or will in any way increase the existing rate of any fire or other insurance covering the Industrial Building or any of its contents, or cause any change or cancellation of such insurance. The judgment of any court of competent jurisdiction or the admission of Lessee in any action against Lessee, whether Lessor be a party thereto or not, that Lessee has violated any law, statute, ordinance or governmental rule, regulation or requirement with respect to the use of the Demised Premises, shall be conclusive of that fact as between Lessor and Lessee. Lessee shall not do or permit anything to be done in or about the Demised Premises which will in any way obstruct or interfere with the rights of other tenants in the Industrial Building, or injure or annoy them, or use or allow the Demised Premises to be used for any improper, immoral, unlawful or objectionable purpose, nor shall Lessee cause, maintain or permit any nuisance in, on or about the Demised Premises or commit or suffer to be committed any waste in, on or about the Demised Premises.

3

ARTICLE 6. LEASEHOLD IMPROVEMENTS

6.01       Except as otherwise provided in Exhibit "B" contained herein, Lessor shall not be obligated to perform any alterations or improvements to the Demised Premises. Acceptance of the Demised Premises shall constitute an acknowledgement by Lessee that the Demised Premises are in good order, condition, and repair as of the date Lessee accepts possession of the Demised Premises.

6.02       Except as expressly provided herein, Lessor shall have no obligation to make any alterations or improvements to the Demised Premises for the benefit of Lessee. Lessee acknowledges that neither Lessor nor anyone acting on Lessor's behalf has made any representation or warranty as to the suitability or fitness of the Demised Premises for the conduct of Lessee's business or for any other purpose.

6.03       Notwithstanding anything contained in this Lease to the contrary, on the Commencement Date, the mechanical systems serving the Demised Premises, including the HVAC, electrical, plumbing and sewer, shall be in good operating condition.

ARTICLE 7. UTILITIES AND SERVICE

7.01       Lessor shall provide at Lessors sole expense separate electricity and gas meters for the Demised Premises. Lessee shall establish its own account with the utility company to provide electricity and gas service to the Demised Premises and shall pay all fees and charges for such service directly to the utility company.

7.02       Lessee shall pay, as additional rent, Lessee's pro-rata share the cost of the following utilities and services furnished to the Demised Premises, which pro-rata share shall be the proportion to which the Demised Premises bears to all other buildings which share the common areas.

4

(a)       22.05% of all water, sewer, and Common Area maintenance charges for the Industrial Center as billed to Lessee by Lessor, including but not limited to, landscape maintenance, lighting maintenance, utility charges, and parking lot sweeping.

(b)       Garbage collection charges attributable to the Demised Premises, as billed to Lessee by Lessor according to Lessee's actual usage thereof.

The foregoing charges shall be due and payable to Lessor within ten (10) days after receipt of a billing therefor by Lessee, which billing shall contain evidence of the method by which Lessor calculated Lessee's use of water, sewer and common area maintenance service.

7.03       Lessor shall maintain the Common Areas of the Industrial Building in good condition and repair, except for damage occasioned by negligence or willful misconduct of Lessee or Lessee's agents or invitees, which damage shall be promptly repaired by Lessor in a good and workman like fashion at Lessee's expense. Lessor shall have no obligation to provide janitorial service for the Demised Premises.

7.04       Lessor shall not be in default hereunder or be liable for any damages directly or indirectly resulting from, nor shall the rent provided herein be abated by reason of Lessor's failure to furnish or delay in furnishing any utilities or services when such failure or delay is caused by accident, breakage, repairs, strikes, lockouts or other labor dispute, or by limitation, curtailment, rationing or restrictions on use of electricity, gas, water or other utility, or any other cause, similar or dissimilar, beyond the reasonable control of Lessor. Notwithstanding the above in the event said delay or failure continues for a period longer than ten (10) days, rent abate until said delay or failure is cured.

ARTICLE 8. INDEMNITY AMD INSURANCE

8.01       Lessee hereby waives any and all claims against Lessor for damage to any property or injury to or death of any person in, upon or about the Demised Premises, arising at any time and from any cause except to the extent attributable to the negligence or willful misconduct of Lessor and/or Lessor's agents, employees, invitees and independent contractors. Lessee further expressly indemnifies and holds Lessor harmless from and against any and all third party claims, demands, causes of action, liabilities, costs or expenses, including attorney's fees, occasioned by or in any way connected with the use or misuse of the Demised Premises, or occasioned by any act or omission of Lessee and Lessee's agents, servants, employees, and invitees, except to the extent any such damage to any property or invitees, except to the extent any such damage to any property or injury to or death of any person is attributable to the negligence or willful misconduct of Lessor.

5

8.02       Lessee hereby agrees to maintain in full force and effect at all times during the term or this Lease, at Lessee's expense, a policy or policies of comprehensive general liability insurance, insuring against all liability of Lessee and Lessee's authorized representatives, agents and invitees arising out of or in connection with Lessee's use and occupancy of the Demised Premises and also insuring performance by Lessee of the indemnity provisions set forth in Section 8.01. The initial amount of such insurance shall be at least $2,000,000.00, and shall be subject to periodic increase based on inflation, recommendations by Lessor's insurance advisors, and other relevant factors. However, the amount of such general liability insurance shall not limit Lessee's liability to relieve Lessee of any obligations under is lease. The general liability insurance policy shall name Lessor as an insured party thereunder, and shall be endorsed to provide that no cancellation or reduction in coverage will be made without thirty (30) days prior written notice to Lessor. A copy of the policy or a certificate of insurance shall be furnished to Lessor.

8.03       Lessor shall maintain in full force and effect a policy or policies covering loss or damage to the Industrial Building, to the extent of the replacement value thereof. . Such policy or policies shall provide protection against all perils included within the classification of fire, extended coverage, vandalism, malicious mischief, and any other perils (excluding flood and earthquake) which Lessor reasonably deems necessary. Lessor shall also maintain in full force and effect a rental income insurance policy, with loss payable to Lessor, in an amount equal to one year's gross rent fromthe Industrial Building, insurance shall also cover all real estate taxes and insurance costs for said period as they relate to the Industrial Building. Lessee shall pay to Lessor, as additional rent, an amount equal to 66.10% of the premiums paid by Lessor for the hazard and rental income insurance policies described herein as they pertain to the Demised Premises, such amount to be paid within ten (10) days after Lessee's receipt of a billing therefore from Lessor. Lessee shall be responsible for maintaining its own insurance covering the personal property, trade fixtures and removable leasehold improvements owned by Lessee and located upon the Demised Premises.

8.04       Lessor and Lessee each hereby waive any and all rights of recovery against the other, or against the agents, employees or representatives of the other, on account of loss or damage to the property of the waiving party to the extent that such lossor damage is insured against under any insurance policies which either Lessor or Lessee may have in force at the time of such loss or damage. Lessee shall, upon obtaining the insurance required hereunder, give notice to the insurance carrier that the foregoing mutual waiver of subrogation is contained m this Lease and Lessee shall cause each insurance policy obtained by Lessee to provide that the insurance company waives all right of recovery by way of subrogation against either Lessor or Lessee in connection with any damage covered by such policy.

6

ARTICLE 9. REPAIRS AND MAINTENANCE

9.01       Lessee shall, at all times during the term hereof and at Lessee's own expense, keep and maintain he Demised Premises and every part thereof I good condition and repair. Lessee hereby waives all rights to make repairs at the expense of Lessor or in lie thereof to vacate the Demised Premises as provided by California Civil Code Section 1942 or any other law, statute or ordinance now or hereafter in effect.

9.02       The obligations of Lessee to maintain the Demised Premises shall not include the roof or structural components of the Industrial Building or any replacement of the air conditioning units or replacement of the compressor or heat exchanger within such units. Moreover, Lessor herby warrants to systems within the Demised Premises are in good operation condition and repair and Lessor will be responsible for any necessary repairs or replacements thereof, beyond normal maintenance, for a period of thirty (30) days form commencement of the lease term, provided such repair or replacement is not the result of any failure to maintain or any negligent act or omission by Lessee..

ARTICLE 10. TAXES AND ASSESSMENTS

10.01      Lessee shall pay to Lessor as additional rent, 22.05% of all real property taxes levied or assessed against the Industrial Center during the Lease term, except that:

(a)       Lessee shall pay 100% of any increase in real property taxes occasioned by a sale or transfer of the Industrial Building, or an ownership interest therein, resulting in a complete or partial reassessment of the property.

(b)       Lessee shall not be charged for any increase in real property taxes occasioned by a sale or transfer of the Industrial Building, or an ownership interest therein, resulting in a complete or partial reassessment of the property.

10.02      Payment by Lessee of the real property taxes referred to herein shall be made within ten (10) days after Lessor furnishes to Lessee a copy of the tax bill showing the total amount of property taxes levied or assessed against the Industrial Building, the amount thereof payable by Lessee, and the calculation utilized by Lessor to determine such amount. Billing shall be in two installments made by Lessor on or about February 1, and November 1, of each year of the Lease.

10.03      As used herein, the term "real property taxes" shall include any form of real estate tax or assessment, general, special ordinary or extraordinary, and any license fee, commercial rental tax, improvement bond or bonds, levy or tax imposed on the Industrial Building by any authority having the direct or indirect power to tax, including any city, state or federal agency or any school, sanitary, fire, street, drainage, or other improvement district. The term shall also include any tax, fee, levy assessment, or charge imposed by and taxing authority upon Lessor's right to receive, or the receipt of, rent or income from the Industrial Building, or against Lessor's business of leasing the Industrial Building. However, the term "real property taxes" does not include Lessor's federal or state personal income or franchise taxes.

10.04      Lessee shall pay prior to delinquency all taxes levied or assessed against the trade fixtures, equipment, furnishings, and other personal property of Lessee located upon the Demised Premises. When possible, Lessee shall cause said trade fixtures, equipment, furnishings, and other personal property to be assessed and billed separately form the real property of Lessor. If any of Lessee's personal property shall be assessed with attributable to Lessee within ten (10) days after Lessor furnishes to Lessee a written statement describing the property in question and showing the amount of tax thereon payable by Lessee.

ARTICLE 11. ALTERATIONS AND IMPROVEMENTS

11.01      Lessee shall not, without the prior written consent of Lessor (which consent shall not be unreasonably withheld), make any alterations, additions or improvement in, on or about he Demised Premises. As a condition to giving such consent, Lessor may require Lessee to provide Lessor a surety bond or other reasonable security satisfactory to Lessor to insure Lessor against mechanics' and materialmen's liens and to insure completion of the work.

11.02      All alterations, additions and improvements, whethertemporary or permanent in character, made by Lessee in, on or about the Demised Premises, except movable trade fixtures installed at the expense of Lessee, shall, in the absence or a written request by Lessor for their removal given at the time Lessor consents to the alteration, addition, or improvement, become the property of Lessor and shall remain upon and be surrendered with the Demised Premises at the termination or this Lease by lapse of time or otherwise without compensation to Lessee.

7

ARTICLE 12. DAMAGE OR DESTRUCTION

12.01      If the Demised Premises, are damaged, by fire or other casualty, Lessor shall forthwith repair and restore the same, provided such repairs can, in Lessor's opinion, be completed within thirty (30) days form the date the Demised Premises are damaged. In such event, this Lease shall remain in full force and effect, and the rent payable by Lessee shall be abated while the repairs are being made by the extent to which the Demised Premises are unusable by Lessee in the normal conduct of Lessee's business. In the event the repairs cannot be completed within thirty (30) days form the date the Demised Premises are damaged, and provided the damage affects the Demised Premises or Common Areas necessary to Lessee's use, Lessor shall give written notice of such fact to Lessee within five (5) days after the date on which the damage occurred and either Lessor Lessee may, within thirty (30) days after the giving of such notice, terminate this Lease.

12.02      Notwithstanding the provisions of Section 12.01 above, Lessor shall have the option of terminating the Lease upon thirty (30) days written notice to Lessee of any of the following circumstances:

(a)       Where the damage or destruction arises form a casualty or cause not covered by Lessor's insurance then in force.

(b)       Where the building in which the Demised Premises are located in damaged or destroyed to the extent of 33-1/3 percent or more of the replacement cost thereof, whether the Demised Premises be injured or not.

(c)       Where the repairs cannot be made by reason of any stature, ordinance, rule or regulation of any governmental authority.

12.03      If Lessor is obligated or elects to repair any damage pursuant to this Article, Lessor shall not be required to repair or replace any improvements installed in the Demised Premises by or for Lessee, other than building standard tenant improvements made by Lessor, and Lessee shall, at Lessee's own option and expense, repair and restore Lessee's portion of such improvements.

12.04      A total destruction of the Industrial Building in which the Demised Premises are located shall automatically terminate this Lease, and in such event, Lessor and Lessee shall have no further rights or obligations herein.

12.05      Except as otherwise expressly provided in this Article, Lessee hereby waives the provisions of California Civil Code Sections 1932 (2) and 1933 (4).

8

ARTICLE 13. CONDEMNATION

13.01      If all the Demised Premises or so much thereof is take by right of eminent domain, or purchase in lieu thereof, such that the Demised Premises, are in the reasonable opinion of Lessee, no longer reasonable suitable for Lessee's use, this Lease shall terminate as of the date that possession of the Demised Premises or part thereof is taken, and in such event, Lessor and Lessee shall have no further rights or obligations herein.

13.02      If any part of the Demised Premises is taken and the remaining part thereof (after reconstruction of the then existing building) is reasonably suitable for Lessee's use, this Lease shall, as to the part taken and the rent payable hereunder shall be reduced in the same proportion that the floor area of the portion of the Demised Premises so take (less any addition thereto by reason of any reconstruction) bears to the original floor area of the Demised Premises immediately prior to the taking. Lessor shall, at Lessor's expense, within 120 days of the date all or a portion of the premises are taken, make all necessary repairs or alterations to restore the remaining Demised Premises to a complete architectural unit.

13.03      No award for any partial or entire taking shall be apportioned and Lessee hereby assigns to Lessor all of Lessee's interest therein, except that Lessee shall be entitled to any portion of the award specifically designated as compensation for the taking of personal property belonging as compensation for the interruption of Lessee's business, for Lessee's moving costs and/or loss of goodwill suffered by Lessee. No temporary taking of the Demised Premises shall terminate this Lease. However, to the extent any such temporary taking is covered by any insurance policy procured by Lessor or Lessee hereunder, the Lessee shall have the right to abatement of rent hereunder. Any award recovered by Lessee and Lessor shall have no interest therein. Each party agrees to execute and deliver to the other all instruments and documents that may be required to implement the provisions of this Section.

ARTICLE 14. ASSIGNMENT AND SUBLETTING

14.01      Lessee shall not voluntarily or by operation of law assign, transfer, mortgage, sublet, pledge, hypothecate or encumber all of any part of Lessee's interest in this Lease or in the Demised Premises or any part thereof, without Lessor's prior written consent and any attempt to do so without such consent being first had and obtained shall be wholly void and shall constitute a breach of this Lease. If Lessee is a corporation, or partnership any transfer of a controlling ownership interest in the stock of Lessee shall constitute an assignment hereunder.

9

14.02      If Lessee complies with the following conditions, Lessor shall not unreasonably withhold Lessor's consent to the assignment of this Lease or the subletting of the Demised Premises or any portion thereof. Lessee shall submit in writing to Lessor:

(a)The name and legal composition of the proposed Assignee or Sublessee;

(b)The terms and provisions of the proposed Assignment or Sublease; and

(c)Such financial information as Lessor may reasonably request concerning the proposed Assignee or Sublessee.

14.03No consent by Lessor to any assignment or subletting by Lessee shall relieve Lessee of any obligation to be performed by Lessee under this Lease, whether occurring before or after such consent, assignment or subletting. The consent by Lessor to any assignment or subletting shall not relieve Lessee from the obligation to obtain Lessor's express written consent to any other assignment or subletting. The acceptance or rent by Lessor from any other person shall not be deemed to be a waiver by Lessor of any provisions of this Lease or to be a consent to any assignment, subletting or other transfer. Consent to one assignment, subletting or other transfer shall not be deemed to constitute consent to any subsequent assignment, subletting or other transfer.

ARTICLE 15. TRANSFER OF LESSOR'S INTEREST

15.01Lessor shall have the right at any time to sell, transfer, assign, pledge, hypothecate or otherwise dispose of Lessor's interest in the Demised Premises and in this Lease. In the event of any such sale, transfer, assignment, pledge, hypothecation or other disposition, all obligations of Lessor hereunder shall devolve upon the transferee and Lessor shall be released and discharged from all further obligation or liability hereunder; provided, that Lessor shall be responsible for the Security Deposit and for any other funds in the hands of Lessor in which Lessee has an interest until such funds have been delivered to the transferee. Lessee agrees to attain to the transferee provided all of Lessor's obligations hereunder are assumed by the transferee in writing for the benefit of Lessee.

ARTICLE 16. MECHANICS' LIENS

16.01Lessee shall keep the Demised Premises free and clear of all mechanics' liens resulting from any construction work done by or for Lessee. Lessee shall have the right to contest the correctness or validity of any such lien if, immediately on demand by Lessor, Lessee procures and records a lien release bond issued by a corporation authorized to issue surety bonds in California in an amount equal to one and one-half (1-1/2) times the amount of the claim of lien or other security satisfactory to Lessor. If used, the bond shall meet the requirements of Section 3143 of the California Civil Code and shall provide for the payment of any sum that the claimant may recover on the claim, together with costs of suit. Should Lessee fail to discharge any such lien or cause the same to be released within sixty (60) days from the date the lien is filed, Lessor may, without inquiring into the validity thereof, cause the same to be discharged and all amounts so expended by Lessor, together with reasonable attorney's fees and expenses, shall be paid by Lessee to Lessor as additional rent hereunder, together with interest thereon at the rate of ten percent (10%) per annum. Lessee shall give ten (10) days prior written notice to Lessor of the date on which any construction work will be commenced so as to afford Lessor the opportunity to post a notice of nonresponsibility.

10

ARTICLE 17. ENTRY BY LESSOR

17.01Except for reasons of negligence or willful misconduct of Lessor, Lessor and Lessor's authorized representatives shall have the right to enter the Demised Premises at reasonable hours, after giving prior notice, for any of the following purposes:

(a) To examine and inspect the Demised Premises;

(b) To supply any service to be provided by Lessor to Lessee hereunder;

(c) To perform any necessary maintenance or repairs that Lessor is required or permitted to perform hereunder;

(d) To serve, post or keep posted any notices required or allowed under the provisions of this Lease;

(e) To post "for sale" signs at any time during the term, to post "for rent" or "for lease" signs during the last on hundred twenty (120) days of the Lease term, or during any period while Lessee is in default;

(f) To show the Demised Premises to prospective tenants, buyers, lenders or other persons at any time during the Lease term;

(g) To do any other act or thing necessary for the safety or preservation of the Industrial Building.

17.02Lessee hereby waives any claim for damages for any injury or inconvenience to or interference with Lessee's Business, any loss of occupancy or quiet enjoyment of the Demised Premises or any other loss occasioned by Lessor's entry pursuant to Section 17.01, except for reasons of negligence or willful misconduct of Lessor and or Lessor's agents, employees, invites and independent contractors. Lessor shall at all times have and retain a key with which to unlock all of the doors in, on or about the Demised Premises (excluding Lessee's vaults, safes and other secured areas designated in writing by Lessee in advance); and Lessor shall have the right to use any and all means which Lessor may deem proper to open said doors in an emergency in order to obtain entry to the Demised Premises, and any entry to the Demised Premises obtained by Lessor by any of said means, or otherwise, shall not under any circumstances by construed or deemed to be a forcible or unlawful entry into or a detainer of the Demised Premises, or an eviction, actual or constructive, of Lessee from the Demised Premises, or any portion thereof.

11

ARTICLE 18. DEFAULT BY LESSEE

18.01The occurrence of any one or more of the following events ("Events of Default") shall constitute a material default and breach of this Lease by Lessee:

(a) Any failure by Lessee to pay any rental or any other sum required to be paid by Lessee hereunder, as and when the same becomes due and payable and within five (5) days of Lessee's receipt of Lessor's written notice that such rental or other sum is due.

(b) Any failure by Lessee to observe and perform any other provision of this Lease to be observed or performed by Lessee, where such failure continues for ten (10) days after written notice thereof by Lessor to Lessee; provided, however, that if the nature of such default is such that it cannot reasonably be cured within such ten (10) day period, Lessee shall not be deemed to be in default if Lessee shall within such period commence such cure and thereafter diligently prosecute the same to completion.

(c) The making by Lessee of any general assignment or general arrangement for the benefit of creditors; the filing by or against Lessee of a petition to have Lessee adjudged a bankrupt or a petition for reorganization or arrangement under any law relating to bankruptcy (unless, in the case of a petition filed against Lessee, the same is dismissed within ninety (90) days); the appointment of a trustee or receiver to take possession of substantially all of Lessee's interest in this Lease, where possession is not restored to Lessee within sixty (60) days; or the attachment, execution or other judicial seizure of substantially all of Lessee's assets located at the Demised Premises or of Lessee's interest in this Lease, where such seizure is not discharged within forty-five (45) days.

12

18.02Any notice given under this Article shall specify the Event of Default and the applicable lease provisions, and shall demand that Lessee perform the provisions of this Lease, within the applicable period of time. No such notice shall be deemed a forfeiture or a termination of the Lease provided Lessee cures the default within the applicable period of time.

ARTICLE 19. LESSOR'S REMEDIES UPON DEFAULT

19.01Lessor shall have the following remedies upon the occurrence of an Event of Default, such remedies being cumulative and not exclusive and in addition to any other remedies available to Lessor as now or hereafter provided by law:

(a) Lessor can continue this Lease in full force and effect, and the Lease will continue in effect as along as Lessor does not terminate Lessee's right to possession, and Lessor shall have the right to collect rent when due, irrespective of whether Lessee shall have abandoned the Demised Premises. During the period Lessee is in default, Lessor can enter the Demised Premises and relet them, or any part of them, to third parties for Lessee's account. Lessee shall be liable immediately to Lessor for all reasonable costs Lessor incurs in such reletting, including, without limitation, broker's commissions, expenses of remodeling the Demised Premises required by reletting, and like costs. Reletting can be for period shorter or longer than the remaining term of this Lease. Lessee shall pay to Lessor the rent specified in this Lease on the dates when the same becomes due, less the rent Lessor receives from any reletting. No act by Lessor allowed by this paragraph shall terminate this Lease unless Lessor notifies Lessee that Lessor elects to terminate this Lease. After Lessee's default and for as long as Lessor does not terminate Lessee's right to possession of the Demised Premises, Lessee shall have the right to assign or sublet Lessee's interest in this Lease pursuant to Article 14, but Lessor's consent may be conditioned upon all defaults by Lessee being fully cured at the time of assignment or subletting.

(b) Lessor can terminate Lessee's right to possession of the Demised Premises at any time during Lessee's default. No act by Lessor other than giving written notice to Lessee shall terminate this Lease. Acts of maintenance, efforts to relet the Demised Premises, or the appointment of a receiver on Lessor's initiative to protect Lessor's interest under this Lease shall not constitute a termination of Lessee's right to possession. On termination, Lessor has the right to recover from Lessee:

13

(1) The worth, at the time of the award, of the unpaid rent that has been earned at the time of termination of this Lease; plus

(2) The worth, at the time of the award, of the amount by which the unpaid rent that would have been earned after the date of termination of this Lease until the time of award exceeds the amount of the loss of rent that Lessee proves could have been reasonably avoided; plus

(3) 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 the loss of rent that Lessee proves could have been reasonably avoided; plus

(4) Any other amount, and court costs, necessary to compensate Lessor for all detriment proximately cause Lessee's default.

"The worth, at the time of the award," as used in (1) and (2) above, is to computed by allowing interest at the rate of ten percent (10%) per annum from the date of default. "The worth, at the time of the award" as used in (3) above is to be computed by discounting the amount at the discount rate of the Federal Reserve Bank of San Francisco at the time of the award, plus one percent (1%). The term "rent," as used in this Article shall be deemed to include all monetary sums required to be paid by Lessee pursuant to the terms of this Lease.

ARTICLE 20. LESSOR'S RIGHT TO CURE DEFAULTS

20.01If Lessee shall fail to pay any sum of money, other than rent, required to be paid by Lessee here under, or shall fail to perform any other act on Lessee's part to be performed hereunder, and such failure shall continue for ten (10) days after notice thereof by Lessor, Lessor may, but shall not be obligated to do so, and without waiving or releasing Lessee from any obligations of Lessee, make such payment or perform any such other act on Lessee's part to be made or performed hereunder. All sums expended by Lessor, including necessary incidental costs, shall be deemed additional rent hereunder and shall by payable to Lessor immediately upon demand, together with interest thereon at the rate of ten percent (10%) per annum form the date of expenditure to the date of reimbursement.

ARTICLE 21. COSTS OF SUIT

21.01In the event legal action between Lessor and Lessee shall become necessary in order to enforce or interpret this Lease, or any provision contained herein, the prevailing party shall be entitled to recover all costs and expenses as may be incurred in connection therewith, including reasonable attorney's fees.

14

21.02Should Lessor, without fault on Lessor's part, be made a party to any litigation instituted by Lessee or by any third party against Lessee, or by or against any person holding under or using the Demised Premises by license of Lessee, or for the foreclosure of any lien for labor or materials furnished to or for Lessee or any such other person or otherwise arising out of or resulting from any act or transaction of Lessee or of any such other person, Lessee covenants to save and hold Lessor harmless from any judgment rendered against Lessor or the Demised Premises or any part thereof, and all costs and expenses, including reasonable attorney's fees, incurred by Lessor in connection with such litigation.

ARTICLE 22. SUBORDINATION

22.01In the event the holder of any deed of trust hereafter to be placed against the Demised Premises requires that this Lease be subordinate to any such encumbrance, this Lease shall be subordinate to that encumbrance if Lessor first obtains from the holder of the deed of trust a written Subordination, Non-Disturbance and attornment agreement providing that for so long as Lessee shall perform all of Lessee's duties and obligations hereunder, no foreclosure, deed given in lieu of foreclosure or sale under such deed of trust shall affect Lessee's rights under the Lease. Lessee shall attorn to any purchaser at any foreclosure sale, or to any grantee or transferee designated in any deed given in lieu of foreclosure. Lessee shall execute the written agreement and any other documents required by the holder of the deed of trust to accomplish the purposes of this Article and upon Lessee's failure or refusal to do so within five (5) days after demand, Lessee hereby appoints Lessor as Lessee's attorney-in-fact to execute such agreement or other documents for and on behalf of Lessee. The power of attorney granted herein shall be deemed to be coupled with an interest and to be irrevocable.

ARTICLE 23. ESTOPPEL CERTIFICATE

23.01Each party, within ten (10) days after written notice from the other, shall execute and deliver to the other, in recordable form, a certificate stating that this Lease is unmodified and in full force and effect, or in full force and effect as modified stating the modifications. The certificate also shall state the amount of monthly rent, the dates to which the rent has been paid in advance, the amount of any security deposit or prepaid rent, and shall further certify that there is no incurred default by the other party under the Lease, or specify such default, if any is claimed. Failure to deliver the certificate with the ten (10) days, shall be conclusive upon the party failing to deliver the certificate for the benefit of the party requesting the certificate, and any successor to the party requesting the certificate, that this Lease is in full force and effect and has not been modified except as may be represented by the party requesting the certificate, that there are no incurred defaults by the party requesting the certificate and that not more than one (1) month's rent has been paid in advance.

15

ARTICLE 24. HOLDING OVER

24.01If Lessee remains in possession of all or any part of the Demised Premises after the expiration of the term hereof with the express or implied consent of Lessor, such tenancy shall be from month to month only, and not a renewal hereof or an extension for any further term and in such case rent shall be double the amount payable at the expiration of the term of this Lease and such month to month tenancy and other monetary sums due hereunder shall be subject to every other term, covenant and agreement contained herein.

ARTICLE 25. SURRENDER

25.02Upon the expiration or earlier termination of this Lease, Lessee shall surrender the Demised Premises in the same condition as received, ordinary wear and tear and damage by fire, earthquake, act of God or the elements alone excepted. Lessee shall remove all of Lessee's personal property and moveable trade fixtures and shall repair, at Lessee's expense, any damage to the Demised Premises or the Industrial Building cause by such removal, including, without limitation, repair of floors and patching and repainting of walls where required, all to Lessor's reasonable satisfaction. Any personal property or moveable trade fixtures not removed at the expiration or earlier termination of this Lease shall be pursuant to section 11.02 herein, and deemed abandoned by Lessee. If Lessor so elects, Lessee shall also remove any alterations or improvements installed by or for Lessee which would otherwise remain as part of the Demised Premises and Lessee shall restore the Demised Premises to their condition prior to such installation.

25.02Should Lessee fail to remove any personal property or movable trade fixtures, or fail to remove any alterations or improvements as requested by Lessor pursuant to section 11.02 herein, Lessee shall be liable to Lessor for any and all removal costs, transportation and storage expenses, and the cost of restoring the Demised Premises as required herein. Lessee shall indemnify Lessor against any loss, damage or liability resulting from delay by Lessee in so surrendering the Demised Premises, including, without limitation, any claims made by an succeeding tenants founded on such delay.

16

ARTICLE 26. WAIVER

26.01No covenant, term or condition or the breach thereof shall be deemed waived, except by written consent of the party against whom the waiver is claimed, and any waiver of any covenant, term or condition shall not be deemed to be a waiver of any preceding or succeeding breach of the same or any other covenant, term or condition. Acceptance by Lessor of any performance by Lessee after the time the same shall have become due shall not constitute a waiver by Lessor of the breach or default of any covenant, term or condition unless otherwise expressly agreed to by Lessor in writing. The receipt and acceptance by Lessor of delinquent rent shall constitute only a waiver of timely payment for the particular rent payment involved.

ARTICLE 27. QUIET ENJOYMENT

 Lessor hereby covenants with lessee that upon payment by Lessee of the rent as aforesaid and upon observance and performance of the terms of this Lease by Lessee, Lessee shall peaceably hold and enjoy the Demised Premises for the term hereby demised without hindrance or interruption by Lessor or any person or person lawfully or equitable claiming by, through or under Lessor.

ARTICLE 28. NOTICES

28.01All notices or demands required or permitted to be given hereunder shall be in writing and shall be either personally served or mailed by certified mail, return receipt requested, to the other party at the following addresses:

DYMOND DEVELOPMENT COMPANY, LLC	SOUTHWALL TECHNOLOGIES, INC.
450 FIRST STREET	2629B TERMINAL BOULEVARD
LOS ALTOS,  CALIFORNIA 94022	MOUNTAIN VIEW,  CALIFORNIA 94043

28.02Either party may change the foregoing address by giving notice to the other in the manner provided herein. Any notice sent by mail shall be deemed received on the second business day following the date of deposit of the notice in the United States Mail, with proper postage prepaid thereon.

ARTICLE 29. MISCELLANEOUS PROVISIONS

29.01Captions.The captions used in this Lease are for convenience only and shall not be deemed to be relevant in resolving any question of interpretation or construction of any provision contained herein.

29.02Entire Agreement.This Agreement constitutes the entire agreement between the parties and supersedes and cancels any prior agreements or understandings, whether written or oral. This Agreement can only be modified by a written amendment hereto executed by both parties.

17

[PAGE 18 OF AGREEMENT MISSING]

18

arbitration by choosing three Real Estate Brokers; one (1) by Lessor, one (1) by Lesse and the third by the first two (2) Brokers. The decision of the three (3) Brokers will be binding upon Lessor and Lessee with regards to the "Fair Market Value". Lessee shall give Lessor written notice at least ninety (90) days prior to the expiration date of this Lease of Lessee's intention to exercise said option granted herein. In order for Lessee to avail itself of said option period, Lessee must have lived up to and observed the timely performance of all terms, covenants and conditions contained in the Lease Agreement. In any event, however, Lessee shall not be obligated to any renewal until after Lessee has been advised of the Fair Market Value determined above.

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

LESSOR:		LESSEE:
DYMOND DEVELOPMENT COMPANY, LLC		SOUTHWALL TECHNOLOGIES, INC.
By	/s/ Mitell Kalai	By	/s/ S. Kamenski
DATE	7/22/05	DATE	7/15/05

19

Exhibit C to Lease

Dated

July 12, 2005

Between

Dymond Development Company, LLC (Lessor)

And

Southwall Technologies, Inc. (Lessee)

Lessor, at Lessor's sole cost and expense, agrees to perform the following tenant improvements for the benefit of Lessee as shown in Exhibit B attached herein:

1. Remove the wire cage that is located in the warehouse area.

2. Remove the existing storage room located on the rear wall of the warehouse area between two (2) roll up doors.

3. Raise the existing light fixtures within the designated area, to a height of seventeen (17) feet.

4. Remove three (3) existing walls and three (3) existing doors on the southwest side of the warehouse.

5. Modify one (1) HVAC duct in the warehouse area as requested by Lessee in order for Lessee to gain the required clearance, which they will need.

6. Remove existing HVAC ducts that are no longer necessary due to the removal of the storage room and the offices.

20

EX-23.1

Exhibit 23.1

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (Nos. 33-28599, 33-37247, 33-42753, 33-51758, 33-82138, 333-34287, 333-66277, 333-79359, 333-38530, 333-69486 and 333-96893 and 333-109992 and 333-120147) of Southwall Technologies Inc. of our report dated February 17, 2006, relating to the consolidated financial statements and financial statement schedule, which appears in this Form 10-K.

/s/ Burr, Pilger & Mayer LLP

Palo Alto, California

March 29, 2006

EX-23.2

Exhibit 23.2

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (Nos. 33-28599, 33-37247, 33-42753, 33-51758, 33-82138, 333-34287, 333-66277, 333-79359, 333-38530, 333-69486, 333-96893, 333-109992 and 333-120147) of Southwall Technologies Inc., of our report dated April 13, 2004 relating to the financial statements and financial statement schedule, which appears in this Form 10-K.

/s/ PricewaterhouseCoopers LLP

San Jose, California

March 29, 2006

EX-31.1

Exhibit 31.1

I, Thomas G. Hood, certify that:

1. I have reviewed this annual report on Form 10-K of Southwall Technologies Inc.;

2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

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

4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c) disclosed in this annual report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal controls over financial reporting; and

5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financing reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or person performing the equivalent functions):

a) all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls over financial reporting.

Date: March 29, 2006 /s/ Thomas G. Hood   Thomas G. Hood President Chief Executive Officer

EX-31.2

Exhibit 31.2

I, Sylvia Kamenski, certify that:

1. I have reviewed this annual report on Form 10-K of Southwall Technologies Inc.;

2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

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

4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c) disclosed in this annual report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal controls over financial reporting; and

5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financing reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or person performing the equivalent functions):

a) all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls over financial reporting.

Date: March 29, 2006	/s/ SYLVIA KAMENSKI Sylvia Kamenski Vice President of Finance
	Chief Accounting Officer

EX-32.1

Exhibit 32.1

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of Southwall Technologies Inc. (the "Company") on Form 10-K for the period ending December 31, 2004, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Thomas G. Hood, the Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. 1350, as adopted pursuant 906 of the Sarbanes-Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Thomas G. Hood

Thomas G. Hood

Chief Executive Officer

March 29, 2006

A signed original of this written statement required by Section 906 has been provided to Southwall Technologies Inc. and will be retained by Southwall Technologies Inc. and furnished to the Securities and Exchange Commission or its staff upon request.

EX-32.2

Exhibit 32.2

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of Southwall Technologies Inc. (the "Company") on Form 10-K for the period ending December 31, 2004, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Sylvia Kamenski, the Chief Accounting Officer of the Company, certify, pursuant to 18 U.S.C. 1350, as adopted pursuant 906 of the Sarbanes-Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Sylvia Kamenski

Sylvia Kamenski

Chief Accounting Officer

March 29, 2006

A signed original of this written statement required by Section 906 has been provided to Southwall Technologies Inc. and will be retained by Southwall Technologies Inc. and furnished to the Securities and Exchange Commission or its staff upon request.