Edgar Filing: SCM MICROSYSTEMS INC

e10vq

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10 – Q


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

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2007


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: 0-29440

SCM MICROSYSTEMS, INC.

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)


DELAWARE		77-0444317
(STATE OR OTHER JURISDICTION OF		(I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION)		IDENTIFICATION NUMBER)

Oskar-Messter-Str. 13, 85737 Ismaning, Germany
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES INCLUDING ZIP CODE)

+ 49 89 95 95 5000
(REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE)

(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGED SINCE LAST REPORT)

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 þ No o

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 o Accelerated filer o Non-accelerated filer þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No þ

At May 8, 2007, 15,727,307 shares of common stock were outstanding.

SCM MICROSYSTEMS, INC.

FORM 10-Q

QUARTER ENDED MARCH 31, 2007

TABLE OF CONTENTS


	Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements		3
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		18
Item 3. Quantitative and Qualitative Disclosures About Market Risk		24
Item 4. Controls and Procedures		24

PART II. OTHER INFORMATION
Item 1. Legal Proceedings		25
Item 1A Risk Factors		25
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		36
Item 3. Defaults Upon Senior Securities		36
Item 4. Submission of Matters to a Vote of Security Holders		36
Item 5. Other Information		36
Item 6. Exhibits		36

SIGNATURES		37
EXHIBIT INDEX		38
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)


	Three Months Ended
	March 31,
	2007			2006
Net revenue	$	8,457		$	7,427
Cost of revenue		4,717			4,777


Gross profit		3,740			2,650


Operating expenses:
Research and development		720			969
Selling and marketing		1,559			1,839
General and administrative		1,400			2,084
Amortization of intangible assets		175			160
Restructuring and other charges		—			422


Total operating expenses		3,854			5,474


Loss from operations		(114	)		(2,824	)
Interest and other income, net		308			134


Income (loss) from continuing operations before income taxes		194			(2,690	)

Provision for income taxes		(60	)		(11	)


Income (loss) from continuing operations		134			(2,701	)

Loss from discontinued operations, net of income taxes		(17	)		(942	)
Gain on sale of discontinued operations, net of income taxes		23			21


Net income (loss)	$	140		$	(3,622	)

Income (loss) per share from continuing operations:
Basic and diluted	$	0.01		$	(0.17	)


Loss per share from discontinued operations:
Basic and diluted		—		$	(0.06	)


Net income (loss) per share:
Basic and diluted	$	0.01		$	(0.23	)


Shares used to compute basic income (loss) per share		15,700			15,593


Shares used to compute diluted income (loss) per share		15,742			15,593


Comprehensive income (loss):
Net income (loss)	$	140		$	(3,622	)
Unrealized gain on investments		10			16
Foreign currency translation adjustment		228			253


Total comprehensive income (loss)	$	378		$	(3,353	)

See notes to condensed consolidated financial statements.

SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except par value)
(unaudited)


	March 31,			December 31,
	2007			2006
ASSETS

Current assets:
Cash and cash equivalents	$	31,453		$	32,103
Short-term investments		4,987			4,799
Accounts receivable, net of allowances of $813 and $867 as of March 31, 2007 and December 31, 2006		6,089			6,583
Inventories		2,821			1,927
Other current assets		1,780			2,489


Total current assets		47,130			47,901

Property and equipment, net		1,516			1,457

Intangible assets, net		97			272

Other assets		1,775			1,725


Total assets	$	50,518		$	51,355


LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:
Accounts payable	$	4,270		$	4,572
Accrued compensation and related benefits		1,398			1,729
Accrued restructuring and other charges		3,228			3,431
Accrued professional fees		792			1,063
Accrued royalties		849			971
Other accrued expenses		2,054			2,289
Income taxes payable		209			1,879


Total current liabilities		12,800			15,934


Long-term income taxes payable		168			—

Deferred tax liability		105			103

Commitments and contingencies (see Notes 10 and 11)		—			—

Total liabilities		13,073			16,037


Stockholders’ equity:
Common stock, $0.001 par value: 40,000 shares authorized; 16,344 and 16,316 shares issued and 15,727 and 15,698 shares outstanding as of March 31, 2007 and December 31, 2006, respectively		16			16
Additional paid-in capital		228,782			228,580
Treasury stock		(2,777	)		(2,777	)
Accumulated deficit		(190,028	)		(191,714	)
Other cumulative comprehensive gain		1,452			1,213


Total stockholders’ equity		37,445			35,318


Total liabilities and stockholders’ equity	$	50,518		$	51,355

See notes to condensed consolidated financial statements.

SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)


	Three Months
	Ended March 31,
	2007			2006
Cash flows from operating activities:
Net income (loss)	$	140		$	(3,622	)
Adjustments to reconcile net loss to net cash used in operating activities:
Loss (gain) from discontinued operations		(6	)		921
Deferred income taxes		2			2
Depreciation and amortization		244			274
Loss (gain) on disposal of property and equipment		(6	)		15
Stock compensation expense		128			171
Changes in operating assets and liabilities:
Accounts receivable		498			(288	)
Inventories		(886	)		(955	)
Other assets		790			(170	)
Accounts payable		(95	)		435
Accrued expenses		(1,283	)		88
Income taxes payable		42			21

Net cash used in operating activities from continuing operations		(432	)		(3,108	)
Net cash provided (used) in operating activities from discontinued operations		(218	)		216

Net cash used in operating activities		(650	)		(2,892	)


Cash flows from investing activities:
Capital expenditures		(101	)		—
Purchase of restricted short-term investments		—			(2,000	)
Maturities of short-term investments		3,763			5,833
Purchases of short-term investments		(3,940	)		(2,878	)

Net cash provided by (used in) investing activities		(278	)		955


Cash flows from financing activities:
Proceeds from issuance of equity securities		74			—

Net cash provided by financing activities		74			—

Effect of exchange rates on cash and cash equivalents		204			162

Net decrease in cash and cash equivalents		(650	)		(1,775	)
Cash and cash equivalents at beginning of period		32,103			13,660

Cash and cash equivalents at end of period	$	31,453		$	11,885

Supplemental disclosures of cash flow information — cash paid for:
Income taxes	$	19		$	87

Property and equipment invoices in accounts payable	$	—		$	17

See notes to condensed consolidated financial statements.

SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2007

1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulations S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2007 are not necessarily indicative of the results that may be expected for the year ending December 31, 2007. For further information, refer to the financial statements and footnotes thereto included in SCM Microsystems Inc.’s (“SCM” or “the Company”) Annual Report on Form 10-K for the year ended December 31, 2006.

During the review of the preparation of the cash flows from discontinued operations, the Company discovered that in the condensed consolidated statements of cash flows for the three months ended March 31, 2006, in the section “Cash flows from operating activities”, the amounts in lines “Accrued expenses” and “Net cash used in operating activities from continuing operations” had to be reduced by $1.1 million compared to the condensed consolidated statements of cash flows submitted with Form 10-Q for the quarterly period ended March 31, 2006. Simultaneously, the amount in line “Net cash provided (used) in operating activities from discontinued operations” had to be increased by $1.1 million compared to the condensed consolidated statements of cash flows submitted with Form 10-Q for the quarterly period ended March 31, 2006. The adjustment did not have any impact to the cash flows from operating activities in total and was not considered to be material.

Discontinued Operations

On May 22, 2006, the Company completed the sale of substantially all the assets and some of the liabilities associated with its Digital Television solutions (“DTV solutions”) business to Kudelski S.A. (“Kudelski”) for a total consideration of $11 million in cash, of which $9 million has been paid. Based on recent actions by Kudelski and the terms of the purchase agreement, the Company has made demand for payment of the remaining $2 million. The obligation to make the additional $2 million payment is disputed by Kudelski. Accordingly, the Company has not recorded the $2 million as receivable. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, Accounting for the Impairment or Disposal of Long Lived Assets (“SFAS 144”), for the three months ended March 31, 2007 and 2006, this business has been presented as discontinued operations in the condensed consolidated statements of operations and cash flows and all prior periods have been reclassified to conform to this presentation. See Note 3 for further discussion of this transaction.

Accounting Changes

During the first quarter of fiscal 2007, the Company adopted the provisions of, and accounted for uncertain tax positions in accordance with the Financial Accounting Standards Board’s (“FASB”) Interpretation No. 48, Accounting For Uncertain Tax Positions (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. It prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. Differences between the amounts recognized in the statements of financial position prior to the adoption of FIN 48 and the amounts reported after adoption are to be accounted for as an adjustment to the beginning balance of retained earnings.

As a result of the implementation, the Company recognized a $1.5 million decrease to income taxes payable for uncertain tax positions. This decrease was accounted for as an adjustment to the beginning balance of accumulated deficit on the balance sheet. Including this decrease, at the beginning of 2007, the Company had $0.1 million of unrecognized tax benefits included in income taxes payable on the consolidated balance sheet. At March 31, 2007, the Company has $0.2 million of unrecognized tax benefits disclosed in income taxes payable on the consolidated balance sheet. As a result of adoption of FIN 48, unrecognized tax benefits were reclassified to long-term income taxes payable, where applicable.

In addition, $1.6 million of unrecognized tax benefits have existed as of January 1, 2007, which do not have any impact on the consolidated balance sheet or income statement, as these only impact the amounts of losses carried forward by the various entities of the Company as any deferred tax assets on these losses carried forward have been fully reserved for. The amount of these unrecognized tax benefits has not changed during the first quarter of 2007.

The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. As of March 31, 2007, approximately $34,000 of accrued interest related to uncertain tax positions.

The Company files U.S. federal, U.S. state and foreign tax returns. The Company is generally no longer subject to tax examinations for years prior to 1999.

While timing of the resolution and/or finalization of audits is very uncertain, the company does not believe it is reasonably possible that the unrecognized tax benefits would materially change in the next 12 months.

Recent Accounting Pronouncements

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. The provisions of SFAS 157 are effective for the fiscal year beginning January 1, 2008. The Company is currently evaluating the impact of the provisions of SFAS 157 on its financial position, results of operations and cash flows and does not believe the impact of the adoption will be material.

2. Stock Based Compensation

The Company has a stock-based compensation program that provides its Board of Directors discretion in creating employee equity incentives. This program includes incentive and non-statutory stock options under various plans, the majority of which are stockholder approved. Stock options are generally time-based and expire ten years from the grant date. Vesting varies, with some portion of options vesting 25% each year over four years; some vesting 1/12^th per month over one year; some vesting 100% after one year; and some vesting 1/12^th per month commencing four years from date of grant. Additionally, the Company had an Employee Stock Purchase Plan (“ESPP”) that allowed employees to purchase shares of common stock at 85% of the fair market value at the lower of either the date of enrollment or the date of purchase. Shares issued as a result of stock option exercises and the ESPP are newly issued shares. As of March 31, 2007, the Company had approximately 2.0 million shares of common stock reserved for future issuance under its stock option plans. The Company’s ESPP, director option plan and 1997 stock option plan expired in March 2007.

On January 1, 2006, the Company adopted the provisions of SFAS 123(R) for its share-based compensation plans. Under SFAS 123(R), the Company is required to recognize stock-based compensation costs based on the estimated fair value at the grant date for its share-based awards. In accordance to this standard, the Company recognizes the compensation cost of all share-based awards on a straight-line basis over the requisite service period which is the vesting period of the award.

The Company elected to use the modified prospective transition method as permitted by SFAS 123(R) and therefore has not restated its financial results for prior periods. Under this transition method, in the three months ended March 31, 2007 the compensation cost recognized includes the cost for all stock-based compensation awards granted prior to, but not yet vested as of January 1, 2006, based on the grant-date fair value estimated in accordance with the original provisions of SFAS 123. Compensation cost for all share-based compensation awards granted on or subsequent to January 1, 2006 was based on the grant-date fair value estimated in accordance with the provisions of SFAS 123(R). In conjunction with the adoption of SFAS 123(R), the Company changed its method of attributing the value of stock-based compensation expense from the accelerated multiple-option approach to the straight-line single option method. Compensation expense for all share-based payment awards granted prior to January 1, 2006 will continue to be recognized using the accelerated multiple-option approach, while compensation expense for all share-based payment awards granted on or subsequent to January 1, 2006 has been and will continue to be recognized using the straight-line single-option approach.

Compensation expense recognized in the unaudited condensed consolidated statement of operations for the three months ended March, 31, 2007 is based on awards ultimately expected to vest and reflects estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Prior to adoption of SFAS 123(R), the Company accounted for forfeitures as they occurred.

In calculating the compensation cost, the Company estimates the fair value of each option grant on the date of grant using the Black-Scholes-Merton options pricing model. The Black-Scholes-Merton option pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, the Black-Scholes-Merton model requires the input of highly subjective assumptions including the expected stock price volatility.

As a result of adopting SFAS 123(R), for the three months ended March 31, 2007, the Company’s income from continuing operations before income tax provision and net income from continuing operations was $0.1 million lower than if it had continued to account for share-based compensation under Accounting Principles Board Opinion No 25, Accounting for Stock Issued to Employees (“APB 25”). For the three months ended March 31, 2006, the Company’s loss from continuing operations before income tax provision and net loss from continuing operations was $0.2 million higher than under APB 25. Basic and diluted net income per share and net loss per share for the three months ended March 31, 2007 and 2006 would have been $0.01 lower and $0.01 higher, respectively, if the Company had not adopted SFAS 123(R). There was no effect on the condensed consolidated statements of cash flows for the three months ended March 31, 2007 from adopting SFAS 123(R).

On November 10, 2005, the FASB issued FASB Staff Position No. 123(R)-3, Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards (“FAS 123(R)-3”). The Company has elected to adopt the alternative transition method provided in the FASB Staff Position for calculating the tax effects of stock-based compensation pursuant to SFAS 123(R). The alternative transition method includes simplified methods to establish the beginning balance of the additional paid-in capital pool (“APIC pool”) related to the tax effects of employee stock-based compensation, and to determine the subsequent impact on the APIC pool and consolidated statements of cash flows of the tax effects of employee stock-based compensation awards that are outstanding upon adoption of SFAS 123(R).

The following table illustrates the stock-based compensation expense resulting from stock options and ESPP included in the unaudited condensed consolidated statement of operations for the three-month periods ended March 31, 2007 and 2006 (in thousands):


	Three months
	Ended March 31,
	2007		2006
Cost of revenue	$	15	$	6
Research and development		22		27
Selling and marketing		30		42
General and administrative		61		96

Stock-based compensation expense before income taxes	$	128	$	171
Income tax benefit		—		—

Stock-based compensation expense after income taxes	$	128	$	171

Stock Option Plans

The Company’s director option plan, ESPP and the 1997 stock option plan expired in March 2007. A total of 113,047 shares of common stock was reserved for future option grants under the remaining plans as of March 31, 2007.

Summary of activity under stock option plans for the three months ended March 31, 2007:


											Weighted
							Weighted				Average
	Options			Number of			Average				Remaining
	Available			Options			Exercise Price		Aggregate		Contractual Life
	for Grant			Outstanding			per share		Intrinsic Value		(in years)
Balance at December 31, 2006		4,084,775			1,783,255		$	12.58	$	81,808		5.79
Options granted		(330,071	)		330,071		$	4.19		—		—
Options cancelled or expired		(3,641,657	)		(75,383	)	$	19.63		—		—
Options exercised					(902	)	$	3.31	$	753		—

Balance at March 31, 2007		113,047			2,037,041		$	10.96	$	927,048		6.27


Vested or expected to vest at March 31, 2007					1,864,224		$	11.63	$	821,811

Exerciseable at March 31, 2007					1,170,237		$	16.42	$	299,041		4.19

The weighted-average grant date fair value per option for options granted during the three months ended March 31, 2007 and 2006 was $2.09 and $1.83, respectively. The total intrinsic value of options exercised during the three months ended March 31, 2007 and 2006 was $750 and $0, respectively. Cash proceeds from the exercise of stock options were $3,000 and $0 for the three months ended March 31, 2007 and 2006, respectively. No income tax benefit was realized from stock option exercises during the three-month period ended March 31, 2007 and 2006. At March 31, 2007, there was $1.2 million of unrecognized stock-based compensation expense, net of estimated forfeitures related to non-vested options, that is expected to be recognized over a weighted-average period of 1.9 years.

The fair value of option grants was estimated by using the Black-Scholes-Merton model with the following weighted-average assumptions for the three months ended March 31, 2007 and 2006, respectively:


	Three Months Ended March 31,
	2007			2006
Expected volatility		60	%		72	%

Dividend yield		0			0

Risk-free interest rate		4.54	%		4.82	%

Expected term (in years)		4.00			3.92

Expected Volatility: The Company’s computation of expected volatility for the three-month period ended March 31, 2007 is based on the historic volatility of the Company’s stock for a time period equivalent to the expected life.

Dividend Yield: The dividend yield assumption is based on the Company’s history and expectation of dividend payouts.

Risk-Free Interest Rate: The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for the expected term of the option.

Expected Term: The Company’s expected term represents the period that the Company’s stock-based awards are expected to be outstanding after the vest date and was determined for the three-month period ended March 31, 2007 based on historical experience of similar awards, giving consideration to the contractual terms of the stock-based awards, vesting schedules and expectations of future employee behavior. Stock options are generally granted with vesting periods between one and five years.

Forfeiture Rates: Compensation expense recognized in the condensed consolidated statement of operations for the three months ended March 31, 2007 is based on awards ultimately expected to vest and it reflects estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Prior to adoption of SFAS 123(R), the Company accounted for forfeitures as they occurred.

1997 Employee Stock Purchase Plan

The Company’s ESPP permitted eligible employees to purchase common stock through payroll deductions up to 10% of their base wages at a purchase price of 85% of the lower of fair market value of the common stock at the beginning or end of each offering period. The Company had a two-year rolling plan with four purchases every six months within the offering period. If the fair market value per share was lower on the purchase date than the beginning of the offering period, the current offering period terminated and a new two year offering period would have commenced. The Company’s ESPP restricted the maximum amount of shares purchased by an individual to $25,000 worth of common stock each year. As of March 31, 2007, no shares were available for future issuance under the Company’s ESPP, as the plan expired in March 2007.

The fair value of issuances under the Company’s ESPP was estimated on the issuance date by applying the principles of FASB Technical Bulletin 97-1 (“FTB 97-1”), Accounting under Statement 123 for Certain Employee Stock Purchase Plan with a Look Back Option, and using the Black-Scholes-Merton options pricing model. Stock-based compensation expense related to the Company’s ESPP recognized under SFAS 123(R) for the three months ended March 31, 2007 was a benefit of $40,000, which stemmed from the expiration of the plan before the expected offering periods had terminated. At March 31, 2007, there was no further unrecognized stock-based compensation expense related to outstanding ESPP shares as the plan expired in March 2007.

3. Discontinued Operations

On May 22, 2006, the Company completed the sale of substantially all the assets and some of the liabilities associated with its DTV solutions business to Kudelski for a total expected consideration of $11 million in cash, of which $9 million has been received as of December 31, 2006. As part of the purchase contract, the remaining $2 million was to be paid to the Company upon fulfillment of certain conditions. Based on recent actions by Kudelski and the terms of the purchase agreement, the Company has made demand for payment of the remaining $2 million. The obligation to make the additional $2 million payment is disputed by Kudelski. Accordingly, the Company has not recorded the $2 million as a receivable. In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long Lived Assets, for the three months ended March 31, 2007 and 2006, the DTV solutions business has been presented as discontinued operations in the consolidated statements of operations and cash flows and all prior periods have been reclassified to conform to this presentation.

Based on the carrying value of the assets and the liabilities attributed to the DTV solutions business on May 22, 2006, and the estimated costs and expenses incurred in connection with the sale, the Company recorded a net pretax gain of approximately $5.5 million, excluding the $2 million noted above.

Based on a “Transition Services and Side Agreement” between the Company and Kudelski, revenues relating to the discontinued operations of the DTV solutions business were generated for a limited time after the sale of the DTV solutions business. Under this agreement, a service fee was earned by the Company for its services related to ordering products from a supplier and selling these products to Kudelski. The agreement was terminated at the end of the first quarter of 2007 and revenues ceased to be generated after this period.

The operating results for the discontinued operations of the DTV solutions business for the three months ended March 31, 2007 and during the same period for 2006 are as follows (in thousands):


	Three Months Ended March 31,
	2007		2006
Net revenue	$	496	$	5,790

Operating gain (loss)	$	34	$	(900	)

Income (loss) before income taxes	$	57	$	(899	)

Income tax benefit	$	—	$	60

Gain (loss) from discontinued operations	$	57	$	(839	)

During 2003, the Company completed two transactions to sell its retail Digital Media and Video business. On July 25, 2003, the Company completed the sale of its digital video business to Pinnacle Systems and on August 1, 2003, the Company completed the sale of its retail digital media reader business to Zio Corporation. As a result of these sales, the Company has accounted for the retail Digital Media and Video business as discontinued operations.

The operating results for the discontinued operations of the retail Digital Media and Video business for the three months ended March 31, 2007 and during the same period for 2006 are as follows (in thousands):


	Three Months Ended March 31,
	2007			2006
Operating loss	$	(80	)	$	(70	)

Net loss before income taxes	$	(74	)	$	(62	)

Income tax provision	$	—		$	(41	)

Loss from discontinued operations	$	(74	)	$	(103	)

4. Short-Term Investments

At March 31, 2007, all of the short-term investment portfolio matures in 2007. The fair value of short-term investments at March 31, 2007 and December 31, 2006 was as follows (in thousands):


	March 31, 2007
			Unrealized			Estimated
	Amortized		Loss on			Fair
	Cost		Investments			Value
Corporate notes	$	3,974	$	(2	)	$	3,972
U.S. government agencies		1,017		(2	)		1,015


Total	$	4,991	$	(4	)	$	4,987


	December 31, 2006
			Unrealized			Estimated
	Amortized		Loss on			Fair
	Cost		Investments			Value
Corporate notes	$	1,021	$	(2	)	$	1,019
U.S. government agencies		3,792		(12	)		3,780


Total	$	4,813	$	(14	)	$	4,799

During each quarter, the Company evaluates investments for possible asset impairment by examining a number of factors, including the current economic conditions and markets for each investment, as well as its cash position and anticipated cash needs for the short and long term. In addition, the Company evaluates severity and duration in each reporting period. At March 31, 2007, approximately $5.0 million of the short-term investment portfolio has an unrealized loss and approximately $1.0 million of those investments have been in an unrealized loss position for more than one year. Of the $4,000 unrealized loss at March 31, 2007, approximately $2,000 relates to investments that have been in an unrealized loss position for more than one year. The Company believes these fair value declines are the result of rising short-term interest rates. For the three months ended March 31, 2007 and 2006, no impairment of the investments was identified based on the evaluations performed.

5. Inventories

Inventories consist of (in thousands):


	March 31,		December 31,
	2007		2006
Raw materials	$	1,543	$	754
Finished goods		1,278		1,173


Total	$	2,821	$	1,927

6. Property and Equipment

Property and equipment consists of (in thousands):


	March 31,			December 31,
	2007			2006
Land	$	129		$	127
Building and leasehold impovements		1,789			1,789
Furniture, fixtures and office equipment		2,961			2,851
Automobiles		31			1
Purchased software		3,256			3,209


Total		8,166			7,977

Accumulated depreciation		(6,650	)		(6,520	)

Property and equipment, net	$	1,516		$	1,457

Depreciation expense was $0.1 million for the first three months of 2007 and $0.1 million for the same period of 2006.

7. Intangible Assets

Intangible assets are associated with the Company’s European operations and consist of the following (in thousands):


		March 31, 2007							December 31, 2006
		Gross							Gross
	Amortization	Carrying		Accumulated					Carrying		Accumulated
	Period	Value		Amortization			Net		Value		Amortization			Net

Customer relations	60 months	$	1,662	$	(1,624	)	$	38	$	1,639	$	(1,520	)	$	119
Core technology	60 months		1,883		(1,824	)		59		1,858		(1,705	)		153


Total intangible assets		$	3,545	$	(3,448	)	$	97	$	3,497	$	(3,225	)	$	272

In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, the Company’s intangible assets relating to core technology and customer relations are subject to amortization.

Amortization expense related to intangible assets for continuing operations was $0.2 million for the first three months of 2007 and $0.2 million for the same period of 2006.

The net value of $0.1 million as of March 31, 2007 is expected to be amortized completely during the second quarter of 2007.

8. Restructuring and Other Charges

Continuing Operations

In the first three months of 2007 and 2006, the Company incurred net restructuring and other charges related to continuing operations of approximately $0 and $0.5 million, respectively.

Accrued liabilities related to restructuring actions and other activities during the first three months of 2007 and during the year ended December 31, 2006 consist of the following (in thousands):


	Lease/Contract						Other
	Commitments			Severance			Costs		Total
Balances as of January 1, 2006	$	32		$	152		$	9	$	193

Provision for 2006		33			1,320			—		1,353
Changes in estimates		(2	)		4			—		2

		31			1,324			—		1,355
Payments and other changes in 2006		(48	)		(1,370	)		—		(1,418	)

Balances as of December 31, 2006		15			106			9		130

Provision for Q1 2007		—			—			—		—
Changes in estimates		—			—			—		—

		—			—			—		—
Payments and other changes in Q1 2007		(1	)		(101	)		—		(102	)

Balances as of March 31, 2007	$	14		$	5		$	9	$	28

During 2006 SCM executed and completed restructuring activities in connection with a reduction in force resulting from the Company’s decision to transfer all manufacturing operations from its Singapore facility to contract manufacturers as well as the decision to transfer the corporate headquarter functions of the Company from California to Germany . For the three months ended March 2007, no further restructuring costs from continuing operations were incurred.

Discontinued Operations

In the first three months of 2007 and 2006, SCM incurred restructuring and other charges related to discontinued operations of approximately $13,000 and $0, respectively.

Accrued liabilities related to the Digital Media and Video restructuring actions and other activities during the first three months of 2007 and during the year ended December 31, 2006 consist of the following (in thousands):


	Lease/Contract			Other
	Commitments			Costs			Total
Balances as of January 1, 2006	$	3,198		$	506		$	3,704

Provision for 2006		2			5			7
Changes in estimates		87			—			87

		89			5			94
Payments and other changes in 2006		(338	)		(159	)		(497	)

Balances as of December 31, 2006		2,949			352			3,301

Provision for Q1 2007		—						—
Changes in estimates		(13	)		—			(13	)

		(13	)		—			(13	)
Payments and other changes in Q1 2007		(92	)		4			(88	)

Balances as of March 31, 2007	$	2,844		$	356		$	3,200

Discontinued operation costs for the three months ended March 31, 2007 primarily related to changes in estimates for lease obligations.

9. Segment Reporting, Geographic Information and Major Customers

SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, establishes standards for the reporting by public business enterprises of information about operating segments, products and services, geographic areas, and major customers. The method for determining what information to report is based on the way that management organizes the operating segments within the company for making operating decisions and assessing financial performance. The Company’s chief operating decision maker is considered to be its executive staff, consisting of the Chief Executive Officer, Chief Financial Officer and Vice President Sales.

The Company’s continuing operations provide secure digital access solutions to OEM customers in two markets segments: PC Security and Flash Media Readers. The executive staff reviews financial information and business performance along these two business segments. The Company evaluates the performance of its segments at the revenue and gross profit level. The Company’s reporting systems do not track or allocate operating expenses or assets by segment. The Company does not include intercompany transfers between segments for management purposes.

Summary information by segment for the three months ended March 31, 2007 and during the same period for 2006 is as follows (in thousands):


	Three Months Ended
	March 31,
	2007			2006
PC Security:
Net revenue	$	7,096		$	4,553
Gross profit		3,243			1,913
Gross profit %		46	%		42	%

Flash Media Readers:
Net revenue	$	1,361		$	2,874
Gross profit		497			737
Gross profit %		37	%		26	%

Total:
Net revenue	$	8,457		$	7,427
Gross profit		3,740			2,650
Gross profit %		44	%		36	%

Geographic net revenue is based primarily on the location of the purchasing customer. Information regarding net revenue by geographic region is as follows (in thousands):


	Three Months Ended
	March 31,
	2007			2006
Net revenue
United States	$	3,799		$	3,014
Europe		2,408			2,955
Asia-Pacific		2,250			1,458


Total	$	8,457		$	7,427


% of net revenue
United States		45	%		40	%
Europe		28	%		40	%
Asia-Pacific		27	%		20	%

Customers comprising 10% or greater of the Company’s net revenue are summarized as follows:


	Three Months Ended
	March 31,
	2007			2006
Customer A based in the USA		18	%		*
Customer B based in Asia		15	%		*
Customer C based in the USA		13	%		*
Customer D based in the USA		*			16	%
Customer E based in Europe		*			12	%


Total		46	%		28	%


*		Net revenue derived from customer represented less than 10% for the period.

Customers representing 10% or greater of the Company’s accounts receivable are summarized as follows:


	March 31,			December 31,
	2007			2006
Customer A based in the USA		23	%		*
Customer B based in the USA		18	%		17	%
Customer C based in Asia		12	%		19	%


Total		53	%		36	%


*		Customer’s accounts receivable represented less than 10% for the periods presented.

Long-lived assets by geographic location as of March 31, 2007 and December 31, 2006, are as follows (in thousands):


	March 31,		December 31,
	2007		2006
Property and equipment, net:
United States	$	23	$	27
Europe		195		150
Asia-Pacific		1,298		1,280


Total	$	1,516	$	1,457

10. Commitments

The Company leases its facilities, certain equipment, and automobiles under noncancelable operating lease agreements. These lease agreements expire at various dates during the next ten years.

Purchases for inventories are highly dependent upon forecasts of the customers’ demand. Due to the uncertainty in demand from its customers, the Company may have to change, reschedule, or cancel purchases or purchase orders from its suppliers. These changes may lead to vendor cancellation charges on these purchases or contractual commitments. As of March 31, 2007, total purchase and contractual commitments were approximately $5.0 million.

The Company provides warranties on certain product sales, which range from twelve to twenty-four months, and allowances for estimated warranty costs are recorded during the period of sale. The determination of such allowances requires the Company to make estimates of product return rates and expected costs to repair or to replace the products under warranty. The Company currently establishes warranty reserves based on historical warranty costs for each product line combined with liability estimates based on the prior twelve months’ sales activities. If actual return rates and/or repair and replacement costs differ significantly from the Company’s estimates, adjustments to recognize additional cost of sales may be required in future periods.

Components of the reserve for warranty costs for the three months ended March 31, 2007 and 2006 were as follows (in thousands):


	2007			2006
Balances at January 1	$	34		$	153
Additions related to sales during the period		17			29
Warranty costs incurred during the period		(16	)		(22	)
Adjustments to accruals related to prior period sales		2			(100	)

Balances at March 31	$	37		$	60

11. Net Income (Loss) per Common Share

The following table sets forth the computation of basic and diluted net income (loss) per common share (in thousands, except per share amounts):


	For the Three Months Ended
	March 31,
	2007		2006
Net income (loss) from continuing operations	$	134	$	(2,701	)
Income (loss) from discontinued operations		6		(921	)

Net income (loss)	$	140	$	(3,622	)


Shares used in income (loss) per common share — basic		15,700		15,593
Effect of dilutive securities:
Employee and director stock options		42		—

Shares used in income (loss) per common share — diluted		15,742		15,593
Net income (loss) per common share — basic and diluted
Continuing operations	$	0.01	$	(0.17	)
Discontinued operations	$	0.00	$	(0.06	)

Net income (loss) per common share — basic and diluted	$	0.01	$	(0.23	)

The computation of diluted net income per common share for the three months ended March 31, 2007, excludes the effect of the potential exercise of options to purchase approximately 1.6 million shares, because the option exercise price was greater than the average market price of the common shares and the effect would have been anti-dilutive.

The computation of diluted net loss per common share for the three months ended March 31, 2006, excludes the effect of the potential exercise of options to purchase approximately 30,000 shares, because the effect would be anti-dilutive in periods when there is a net loss. The computation of diluted net loss per common share for the three months ended March 31, 2006, also excludes the effect of the potential exercise of options to purchase approximately 2.5 million shares, because the stock option exercise price was greater that the average market price of the common shares and the effect would have been anti-dilutive.

12. Legal Proceedings

From time to time, SCM could be subject to claims arising in the ordinary course of business or could be a defendant in lawsuits. While the outcome of such claims or other proceedings cannot be predicted with certainty, SCM’s management expects that any such liabilities, to the extent not provided for by insurance or otherwise, will not have a material adverse effect on the Company’s financial condition, results of operations or cash flows.

In December 2005, a complaint was filed in France against SCM Microsystems GmbH (“SCM GmbH”), one of the Company’s wholly-owned subsidiaries, by Aston France S.A.S., alleging participation by SCM GmbH in the counterfeiting of Aston’s conditional access modules. Aston was one of SCM GmbH’s Digital Television customers until November 2002, when

SCM GmbH entered into a settlement agreement (the “2002 Settlement”) with Aston that included SCM GmbH’s agreement to cancel binding orders made by Aston and the return by Aston of unsold inventory to SCM GmbH. In April 2005, SCM GmbH entered into an agreement with Aston whereby Aston agreed to (i) seek a refund from the French government for approximately $4.7 million in value added taxes that SCM GmbH paid to the French government with respect to products that Aston purchased from SCM GmbH prior to November 2002 and (ii) remit the refunded amount to SCM GmbH. On October 13, 2005 the French government refunded approximately $4.7 million (the “VAT Refund”) to Aston, but Aston did not remit such amount to SCM GmbH. In its complaint filed in France, Aston claimed damages in the amount of EUR 57 million. Further, in November 2005 Aston obtained a preliminary injunction in France to block a payment obligation by Aston to SCM GmbH of the VAT Refund. On February 2, 2006, SCM GmbH filed a counterclaim against Aston in Germany alleging damages in the amount of approximately EUR 11.5 million resulting from Aston’s fraudulent misrepresentation and breach of contract in connection with the 2002 Settlement. On June 6, 2006, following a court decision in favor of SCM GmbH, Aston paid to SCM GmbH the full amount of the VAT Refund, including currency gains, in the amount of US$5 million. Effective January 22, 2007, all disputes between and among the parties were settled and withdrawn, with no further payment between the parties, apart from reimbursement in a nominal amount from SCM GmbH to Aston of court awarded legal fees previously paid by Aston to SCM GmbH.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q contains forward-looking statements for purposes of the safe harbor provisions under the Private Securities Litigation Reform Act of 1995. For example, statements, other than statements of historical facts regarding our strategy, future operations, financial position, projected results, estimated revenues or losses, projected costs, prospects, plans, market trends, competition and objectives of management constitute forward-looking statements. In some cases, you can identify forward-looking statements by terms such as “will”, “believe,” “could,” “should,” “would,” “may,” “anticipate,” “intend,” “plan,” “estimate,” “expect,” “project” or the negative of these terms or other similar expressions. Although we believe that our expectations reflected in or suggested by the forward-looking statements that we make in this Quarterly Report on Form 10-Q are reasonable, we cannot guarantee future results, performance or achievements. You should not place undue reliance on these forward-looking statements. All forward-looking statements speak only as of the date of this Quarterly Report on Form 10-Q. While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our expectations change, whether as a result of new information, future events or otherwise. We also caution you that such forward-looking statements are subject to risks, uncertainties and other factors, not all of which are known to us or within our control, and that actual events or results may differ materially from those indicated by these forward-looking statements. We disclose some of the important factors that could cause our actual results to differ materially from our expectations under “Part II — Item 1A, Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q. These cautionary statements qualify all of the forward-looking statements included in this Quarterly Report on Form 10-Q that are attributable to us or persons acting on our behalf.

The following information should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto set forth in Part I — Item 1 of this Quarterly Report on Form 10-Q. We also urge readers to review and consider our disclosures describing various factors that could affect our business, including the disclosures under the headings “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors” and the audited financial statements and notes thereto contained in our Annual Report on Form 10-K and Amended Annual Report on Form 10-K/A for the year ended December 31, 2006.

Overview

SCM Microsystems, Inc. (“SCM”, the “Company”, “we” and “us”) was incorporated in 1996 under the laws of the state of Delaware. We design, develop and sell hardware, software and silicon solutions that enable people to conveniently and securely access digital content and services. We sell our secure digital access products into two market segments: PC Security and Flash Media Readers.

	•		For the PC Security market, we offer smart card reader technology that enables authentication of individuals for applications such as electronic passports, electronic healthcare cards, secure logical access to PCs and networks, and physical access to facilities.

	•		For the Flash Media Reader market, we offer digital media readers that are used to transfer digital content to and from various flash media. These readers are primarily used in digital photo kiosks.

We sell our products primarily to original equipment manufacturers, or OEMs, who typically either bundle our products with their own solutions, or repackage our products for resale to their customers. Our OEM customers include: government contractors, systems integrators, large enterprises and computer manufacturers, as well as banks and other financial institutions for our smart card readers; and computer electronics and photographic equipment manufacturers for our digital media readers. We sell and license our products through a direct sales and marketing organization, as well as through distributors, value added resellers and systems integrators worldwide.

On May 22, 2006 we completed the sale of our Digital Television solutions (“DTV solutions”) business to Kudelski S.A. As a result, we have accounted for the DTV solutions business as a discontinued operation, and the statements of operations and cash flows for all periods presented reflect the discontinuance of this business. In addition, our operations previously included a retail Digital Media and Video business, which we sold in the third quarter of 2003. As a result of this sale and divestiture, beginning in the second quarter of fiscal 2003, we have accounted for the retail Digital Media and Video business as a discontinued operation, and statements of operations for all periods presented reflect the discontinuance of this business. (See Note 3.)

In our continuing operations, revenues have grown over the past few quarters, but the rate and sustainability of this progress is unpredictable due to significant variations in demand for our products quarter to quarter. This is particularly true for our PC Security products, many of which are targeted at new smart card-based ID programs run by various U.S., European and Asian governments. Sales of our smart card readers and chips for government programs are impacted by testing and compliance schedules of government bodies as well as roll-out schedules for application deployments, both of which contribute to variability in demand from quarter to quarter. Sales of our Flash Media Reader products are less subject to this variability; however, we are dependent on a small number of customers in this product segment, which can result in fluctuations in sales levels from one period to another.

We have adopted a strategy to grow revenue that is based on introducing new PC Security and Flash Media Reader products to address new market opportunities. During 2006, we experienced increased demand for our smart card readers, primarily from the government sector, where we began to provide readers for new and emerging programs such as e-passports and e-healthcare. While we believe that e-passport and other government authentication programs will continue to grow in the future and that we will continue to play an active role in providing smart card readers to these programs, it is very difficult to estimate the level or timing of demand in any given period.

In both our PC Security and Flash Media Reader businesses, pricing pressure has increased over the last several quarters. To address an increasingly competitive environment, during 2006 we put in place cost reduction programs that, beginning in the fourth quarter of 2006 and continuing into the first quarter of 2007, have resulted in improvement to gross profit. We believe these reductions will help us to maintain stable margin levels going forward.

During late 2005 and throughout 2006, we implemented a number of measures to reduce operating expenses, including the outsourcing of our manufacturing operations and the consolidation of facilities and functions. Beginning in October 2005, we began the closure of our Singapore manufacturing facility and the transfer of manufacturing of our products and components to external contract manufacturers in Singapore and China. During fiscal 2006, we completed the closure of our Singapore office and moved all corporate finance and compliance functions from California to Germany. In addition, during 2006 we reduced headcount and the use of outside contract personnel, and further curtailed marketing expenses such as tradeshow participation. The full effect of these cost cutting actions was first experienced in the fourth quarter of 2006, when our GAAP operating expenses decreased from an average of $5.7 million for the first three quarters of fiscal 2006 to $3.5 million in the fourth quarter.

Critical Accounting Policies and Estimates

Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgments, including those related to product returns, customer incentives, bad debts, inventories, asset impairment, deferred tax assets, accrued warranty reserves, restructuring costs, contingencies and litigation. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Management believes the following critical accounting policies, among others, affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

	•		We recognize product revenue upon shipment provided that risk and title have transferred, a purchase order has been received, collection is determined to be reasonably assured and no significant obligations remain. Maintenance revenue is deferred and amortized over the period of the maintenance contract. Provisions for estimated warranty repairs and returns and allowances are provided for at the time products are shipped. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances might be required, which could have a material impact on our results of operations.

	•		We typically plan our production and inventory levels based on internal forecasts of customer demand, which are highly unpredictable and can fluctuate substantially. We regularly review inventory quantities on hand and record an estimated provision for excess inventory, technical obsolescence and no sale-ability based primarily on our historical sales and expectations for future use. Actual demand and market conditions may be different from those projected by our management. This could have a material effect on our operating results and financial position. If we were to make different judgments or utilize different estimates, the amount and timing of our write-down of inventories could be materially different. Excess inventory frequently remains saleable. When excess inventory is sold, it yields a gross profit margin of up to 100%. Sales of excess inventory have the effect of increasing the gross profit margin beyond that which would otherwise occur, because of previous write-downs. Once we have written down inventory below cost, we do not subsequently write it up.

	•		We adopted Financial Accounting Standards Board’s (“FASB”) Interpretation No. 48, Accounting For Uncertain Tax Positions (“FIN 48”) in the first quarter of 2007. See “Note 1” in the Notes to Consolidated Financial Statements of this Form 10-Q for further discussion. We are required to make certain judgments and estimates in determining income tax expense for financial statement purposes. Significant changes to these estimates may result in an increase or decrease to our tax provision in a subsequent period. The calculation of our tax liabilities requires dealing with uncertainties in the application of complex tax regulations. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. It is inherently difficult and subjective to estimate such amounts. We reevaluate such uncertain tax positions on a quarterly basis based on factors such as, but not limited to, changes in tax laws, issues settled under audit and changes in facts or circumstances. Such changes in recognition or measurement might result in the recognition of a tax benefit or an additional charge to the tax provision in the period.

	•		The carrying value of our net deferred tax assets reflects that we have been unable to generate sufficient taxable income in certain tax jurisdictions. A valuation allowance is provided for deferred tax assets if it is more likely than not these items will either expire before we are able to realize their benefit, or that future deductibility is uncertain. Management evaluates the realizability of the deferred tax assets quarterly. At March 31, 2007 we have recorded valuation allowances against substantially all of our deferred tax assets. The deferred tax assets are still available for us to use in the future to offset taxable income, which would result in the recognition of a tax benefit and a reduction in our effective tax rate. Actual operating results and the underlying amount and category of income in future years could render our current assumptions, judgments and estimates of the realizability of deferred tax assets inaccurate, which could have a material impact on our financial position or results of operations.

	•		We accrue the estimated cost of product warranties during the period of sale. While we engage in extensive product quality programs and processes, including actively monitoring and evaluating the quality of our component suppliers, our warranty obligation is affected by actual warranty costs, including material usage or service delivery costs incurred in correcting a product failure. If actual material usage or service delivery costs differ from our estimates, revisions to our estimated warranty liability would be required, which could have a material impact on our results of operations.

	•		During previous years, we have recorded restructuring charges as we rationalized operations in light of strategic decisions to align our business focus on certain markets. These measures, which included major changes in senior management, workforce reduction, facilities consolidation and the transfer of our production to contract manufacturers, were largely intended to align our capacity and infrastructure to anticipate customer demand and to transition our operations to better cost efficiencies. In connection with plans we have adopted, we recorded estimated expenses for severance and

outplacement costs, lease cancellations, asset write-offs and other restructuring costs. Statement of Financial Accounting Standard (“SFAS”) No. 146, Accounting for Costs Associated with Exit or Disposal Activities, requires that a liability for a cost associated with an exit or disposal activity initiated after December 31, 2002 be recognized when the liability is incurred and that the liability be measured at fair value. Given the significance of, and the timing of the execution of such activities, this process is complex and involves periodic reassessments of original estimates. We continually evaluate the adequacy of the remaining liabilities under our restructuring initiatives. Although we believe that these estimates accurately reflect the costs of our restructuring and other plans, actual results may differ, thereby requiring us to record additional provisions or reverse a portion of such provisions.

Recent Accounting Pronouncements

In September 2006, FASB issued SFAS No. 157, Fair Value Measurements. SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. The provisions of SFAS 157 are effective for the fiscal year beginning January 1, 2008. We are currently evaluating the impact of the provisions of SFAS 157 on our financial position, results of operations and cash flows and do not believe the impact of the adoption will be material.

Results of Operations

Net Revenue. Summary information by product segment for the three month periods ended March 31, 2007 and 2006 is as follows (dollars in thousands):


	Three months						Three months
	ended March 31,			% change period			ended March 31,
	2007			to period			2006
PC Security
Net revenue	$	7,096			56	%	$	4,553
Gross profit		3,243			70	%		1,913
Gross profit %		46	%					42	%

Flash Media Readers
Net revenue	$	1,361			(53	)%	$	2,874
Gross profit		497			(33	)%		737
Gross profit %		37	%					26	%

Total:
Net revenue	$	8,457			14	%	$	7,427
Gross profit		3,740			41	%		2,650
Gross profit %		44	%					36	%

Net revenue for the three months ended March 31, 2007 was $8.5 million, compared to $7.4 million for the same period in 2006, an increase of 14%. Within these results, sales of our PC Security products increased 56% year over year and sales of our Flash Media Reader products decreased 53% year over year.

In our PC Security product line, sales increased $2.5 million, or 56%, from $4.6 million in the first three months of 2006 to $7.1 million in the first three months of 2007. The increase was primarily due to a large order for contactless readers from a customer in Asia and higher volumes of smart card readers sold in the U.S. for various government agencies related to Homeland Security Presidential Directive-12 (“HSPD-12”). Our PC Security product line consists of smart card readers and related chip technology that are utilized principally in security programs where smart cards are used to identify and authenticate people in order to control access to computers and computer networks, buildings or other facilities and border entry points. Revenue in this product line is subject to significant variability based on the size and timing of product orders. The majority of product orders are tied to government or corporate security projects that typically deploy our smart card readers in one or more stages, resulting in order volumes that can range from small to very large over a series of months or years. The timing of any new projects that may create or increase demand for smart card readers is unpredictable.

Revenues from our Flash Media Reader product line decreased $1.5 million, or 53%, to $1.4 million in the first three months of 2007, compared with $2.9 million in the first three months of 2006. The decrease was primarily due to the loss of a major customer and a reduction in the price we are able to charge for one of our Flash Media Reader products, based on our customers’ need for a less sophisticated, and less expensive, solution. Flash Media Reader revenues consist of sales of digital

media readers and related ASIC technology used to provide an interface for flash memory cards in computer printers and digital photography kiosks, which are used to download and print digital photos; and in consumer electronics products such as televisions to download and view digital photos.

Gross Profit. Gross profit for the three months ended March 31, 2007 was $3.7 million, or 44% of revenue, compared to $2.7 million, or 36% of revenue in the same period of 2006. Gross profit for the first three months of 2006 included approximately $0.1 million in severance costs related to the outsourcing of our Singapore manufacturing operations to contract manufacturers (See Note 8 to Condensed Consolidated Financial Statements). Gross profit for our PC Security products was 46% for the first three months of 2007 compared with 42% for the first three months of 2006. The increase in gross profit in the first three months of 2007 compared with the first three months of 2006 primarily reflected a more favorable mix of higher margin products; better inventory management and product cost reductions as a result of programs implemented in late 2006; and additional contributions received from customers for ongoing research and development projects. Gross profit for our Flash Media Reader products was 37% for the first three months of 2007, compared with 26% for the first three months of 2006. This increase primarily reflects cost reductions achieved through changes in components and suppliers during late 2006.

We expect there will be some variation in our gross profit from period to period, as our gross profit has been and will continue to be affected by a variety of factors, including competition, the volume of sales in any given quarter, product configuration and mix, the availability of new products, product enhancements, software and services, inventory write-downs and the cost and availability of components.

Research and Development.


	Three months			% change			Three months
	ended March 31,			period to			ended March 31,
(dollars in thousands)	2007			period			2006

Expenses	$	720			(26	%)	$	969
Percentage of total revenues		9	%					13	%

Research and development expenses consist primarily of employee compensation and fees for the development of prototype products. Research and development costs are primarily related to hardware and chip development. For the first three months of 2007, research and development expenses were $0.7 million, or 9% of revenue, compared with $1.0 million, or 13% of revenue, in the first three months of 2006. This decrease was primarily due to a lower level of external resources used. We expect our research and development expenses to vary based on future project demands.

Selling and Marketing.


	Three months			% change			Three months
	ended March 31,			period to			ended March 31,
(dollars in thousands)	2007			period			2006

Expenses	$	1,559			(15	%)	$	1,839
Percentage of total revenues		18	%					25	%

Selling and marketing expenses consist primarily of employee compensation as well as tradeshow participation and other marketing costs. Selling and marketing expenses in the first three months of 2007 were $1.6 million, or 18% of revenue, compared with $1.8 million in the first three months of 2006, or 25% of revenue. We expect our sales and marketing costs will vary as we continue to align our resources to address existing and new market opportunities.

General and Administrative.


	Three months			% change			Three months
	ended March 31,			period to			ended March 31,
(dollars in thousands)	2007			period			2006

Expenses	$	1,400			(33	%)	$	2,084
Percentage of total revenues		17	%					28	%

General and administrative expenses consist primarily of compensation expenses for employees performing our administrative functions, and professional fees arising from legal, auditing and other consulting services. In the first three months of 2007, general and administrative expenses were $1.4 million, or 17% of revenue, compared with $2.1 million, or 28% of revenue in the first three months of 2006. This reduction primarily related to the consolidation and transfer of our corporate finance and compliance functions from the U.S. to Germany and the transfer of local finance functions from Singapore and the

U.S. to Germany. These actions have resulted in a more streamlined and efficient audit process and a decrease in the number of personnel required to prepare our financial statements. The streamlining of general and administrative functions was accompanied by a further reduction in expenditures for third-party professional fees. The majority of the decrease occurred in the fourth quarter of 2006.

Amortization of Intangibles. During the first three months of 2007 and 2006, amortization of intangibles was $0.2 million.

Restructuring and Other Charges. We recorded restructuring and other charges of $0 in the first three months of 2007. We recorded restructuring and other charges of $0.5 million in the first three months of 2006 (including $0.1 million included in the cost of revenue), primarily related to severance costs for general and administrative personnel that were affected by our decision to relocate corporate finance and compliance functions in California to Germany as well as the outsourcing of our manufacturing operations from our Singapore facility to contract manufacturers. Severance costs for manufacturing personnel were recorded in cost of revenue.

Interest and Other Income, Net. Interest and other income, net consists of interest earned on invested cash, foreign currency gains or losses and other income and expense. In the first quarter of 2007, interest income resulting from invested cash balances was $0.4 million, compared with interest income of $0.3 million in the first quarter of 2006. Foreign currency transaction losses were $0.1 million in both the first three months of 2007 and the first three months of 2006. Other income and expense for the three months ended March 31, 2007 and 2006 were $0 and $5,000, respectively.

Income Taxes. In the first quarter of 2007, we recorded a provision for income taxes of $60,000, primarily for minimum taxation and other tax issues, which could not be offset with operating loss carryforwards. In the first three months of 2006, we recorded a provision for income taxes of $11,000, primarily resulting from taxes payable in foreign jurisdictions that were not offset by operating loss carryforwards.

Discontinued Operations. On May 22, 2006, we completed the sale of substantially all the assets and some of the liabilities associated with our DTV solutions business to Kudelski S.A. Net revenue for the DTV solutions business during the three months ended March 31, 2007 and 2006 was $0.5 million and $5.8 million, respectively. Operating gain for the DTV solutions business for the three months ended March 31, 2007 was $34,000. Operating loss for the DTV solutions business for the three months ended March 31, 2006 was $0.9 million.

During 2003, we completed two transactions to sell our retail Digital Media and Video business. On July 25, 2003, we completed the sale of our digital video business to Pinnacle Systems and on August 1, 2003, we completed the sale of our retail digital media reader business to Zio Corporation. Net revenue for the retail Digital Media and Video business was $0 in each of the three-month periods ended March 31, 2007 and 2006. Operating loss for the Digital Media and Video business was $0.1 million in the three months ended March 31, 2007 and in the three months ended March 31, 2006.

During the three months ended March 31, 2007, net gain on the disposal of discontinued operations was approximately $23,000. During the three months ended March 31, 2006, net gain on the disposal of discontinued operations was $21,000.

Liquidity and Capital Resources

As of March 31, 2007 our working capital, which we have defined as current assets less current liabilities, was $34.3 million, compared to $32.0 million as of December 31, 2006, an increase of approximately $2.3 million. The rise in working capital for the first three months of 2007 primarily reflects the decrease in current liabilities of $3.1 million, offset in part by lower cash and cash equivalents and short-term investments of $0.5 million and a reduction of accounts receivable, inventories and other current assets combined of approximately $0.3 million.

Cash and cash equivalents and short-term investments were $36.4 million as of March 31, 2007, a decrease of approximately $0.5 million, compared to the balance of $36.9 million as of December 31, 2006.

The following summarizes our cash flows for the three months ended March 31, 2007 (in thousands):


	Three Months
	Ended
	March 31,
	2007
Operating cash used in continuing operations	$	(432	)
Operating cash used in discontinued operations		(218	)
Investing cash used		(278	)
Financing cash flow		74
Effect of exchange rate changes on cash and cash equivalents		204


Decrease in cash and cash equivalents		(650	)
Cash and cash equivalents at beginning of period		32,103

Cash and cash equivalents at end of period	$	31,453

During the first three months of 2007, cash used in operating activities was $0.7 million. Net income of $0.1 million and cash flow adjustments for depreciation, amortization and stock compensation totaling $0.4 million were more than offset by the cash use of approximately $1.2 million from changes in operating assets and liabilities and cash used in operating activities from discontinued operations.

Significant commitments that will require the use of cash in future periods include obligations under operating leases, inventory purchase commitments and other contractual agreements. Gross committed lease obligations were approximately $5.9 million and inventory and other purchase commitments were approximately $5.0 million at March 31, 2007.

We currently expect that our current capital resources and available borrowings should be sufficient to meet our operating and capital requirements through at least the end of 2007. We may, however, seek additional debt or equity financing prior to that time. There can be no assurance that additional capital will be available to us on favorable terms or at all. The sale of additional debt or equity securities may cause dilution to existing stockholders.

Cash used in investing activities was primarily for purchases of short-term investments of $3.9 million, offset by maturities of $3.8 million.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

There has been no significant change in our exposure to market risk during the first three months of 2007. For discussion of SCM’s exposure to market risk, refer to Item 7A, Quantitative and Qualitative Disclosures About Market Risk, contained in the Company’s Annual Report incorporated by reference in Form 10-K for the year ended December 31, 2006.

Item 4. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, as of March 31, 2007. Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of March 31, 2007, such that the information relating to our business and operations, including our consolidated subsidiaries, required to be disclosed in our Securities and Exchange Commission (“SEC”) reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

(b) Changes in Internal Controls

In connection with our continued monitoring and maintenance of our controls procedures in relation to the provisions of Sarbanes-Oxley, we continue to review, revise and improve the effectiveness of our internal controls. We made no changes to our internal control over financial reporting during the first quarter of 2007 that have materially affected, or that are reasonably likely to materially affect, our internal control over financial reporting.

PART II: OTHER INFORMATION

Item 1. Legal Proceedings

From time to time, we could be subject to claims arising in the ordinary course of our business or could be a defendant in lawsuits. While the outcome of such claims or other proceedings cannot be predicted with certainty, our management expects that any such liabilities, to the extent not provided for by insurance or otherwise, will not have a material adverse effect on our financial condition, results of operations or cash flows.

In December 2005, a complaint was filed in France against SCM Microsystems GmbH (“SCM GmbH”), one of our wholly-owned subsidiaries, by Aston France S.A.S., alleging participation by SCM GmbH in the counterfeiting of Aston’s conditional access modules. Aston was one of SCM GmbH’s Digital Television customers until November 2002, when SCM GmbH entered into a settlement agreement (the “2002 Settlement”) with Aston that included SCM GmbH’s agreement to cancel binding orders made by Aston and the return by Aston of unsold inventory to SCM GmbH. In April 2005, SCM GmbH entered into an agreement with Aston whereby Aston agreed to (i) seek a refund from the French government for approximately $4.7 million in value added taxes that SCM GmbH paid to the French government with respect to products that Aston purchased from SCM GmbH prior to November 2002 and (ii) remit the refunded amount to SCM GmbH. On October 13, 2005 the French government refunded approximately $4.7 million (the “VAT Refund”) to Aston, but Aston did not remit such amount to SCM GmbH. In its complaint filed in France, Aston claimed damages in the amount of EUR 57 million. Further, in November 2005 Aston obtained a preliminary injunction in France to block a payment obligation by Aston to SCM GmbH of the VAT Refund. On February 2, 2006, SCM GmbH filed a counterclaim against Aston in Germany alleging damages in the amount of approximately EUR 11.5 million resulting from Aston’s fraudulent misrepresentation and breach of contract in connection with the 2002 Settlement. On June 6, 2006, following a court decision in favor of SCM GmbH, Aston paid to SCM GmbH the full amount of the VAT Refund, including currency gains, in the amount of US$5 million. Effective January 22, 2007, all disputes between and among the parties were settled and withdrawn, with no further payment between the parties, apart from reimbursement in a nominal amount from SCM GmbH to Aston of court awarded legal fees previously paid by Aston to SCM GmbH.

Item 1A. Risk Factors

Our business and results of operations are subject to numerous risks, uncertainties and other factors that you should be aware of, some of which are described below. The risks, uncertainties and other factors described below are not the only ones facing our company. Additional risks, uncertainties and other factors not presently known to us or that we currently deem immaterial may also impair our business operations.

Any of the risks, uncertainties and other factors could have a materially adverse effect on our business, financial condition, results of operations, cash flows or product market share and could cause the trading price of our common stock to decline substantially.

We have incurred operating losses and may not achieve profitability.

We have a history of losses with an accumulated deficit of $188.8 million as of March 31, 2007. We may continue to incur losses in the future and may be unable to achieve or maintain profitability.

Our quarterly and annual operating results will likely fluctuate.

Our quarterly and annual operating results have varied greatly in the past and will likely vary greatly in the future depending upon a number of factors. Many of these factors are beyond our control. Our revenues, gross profit and operating results may fluctuate significantly from quarter to quarter due to, among other things:

	•		business and economic conditions overall and in our markets;

	•		the timing and amount of orders we receive from our customers that may be tied to budgetary cycles, seasonal demand, product plans or program roll-out schedules;

	•		cancellations or delays of customer product orders, or the loss of a significant customer;

	•		our ability to obtain an adequate supply of components on a timely basis;

	•		poor quality in the supply of our components;

	•		delays in the manufacture of our products;

	•		our backlog and inventory levels;

	•		our customer and distributor inventory levels and product returns;

	•		competition;

	•		new product announcements or introductions;

	•		our ability to develop, introduce and market new products and product enhancements on a timely basis, if at all;

	•		our ability to successfully market and sell products into new geographic or market segments;

	•		the sales volume, product configuration and mix of products that we sell;

	•		technological changes in the markets for our products;

	•		the rate of adoption of industry-wide standards;

	•		reductions in the average selling prices that we are able to charge due to competition or other factors;

	•		strategic acquisitions, sales and dispositions;

	•		fluctuations in the value of foreign currencies against the U.S. dollar;

	•		the timing and amount of marketing and research and development expenditures;

	•		loss of key personnel; and

	•		costs related to events such as dispositions, organizational restructuring, headcount reductions, litigation or write-off of investments.

Due to these and other factors, our revenues may not increase or even remain at their current levels. In particular, although we have indicated that we believe we will be profitable for fiscal 2007 as a whole, we may not be able to reach profitability in any quarterly period of 2007 or for the year as a whole, because of the risks outlined above. Because a majority of our operating expenses are fixed, a small variation in our revenues can cause significant variations in our operational results from quarter to quarter and our operating results may vary significantly in future periods. Therefore, our historical results may not be a reliable indicator of our future performance.

It is difficult to estimate operating results prior to the end of a quarter.

We do not typically maintain a significant level of backlog. As a result, revenue in any quarter depends on contracts entered into or orders booked and shipped in that quarter. Historically, many of our customers have tended to make a significant portion of their purchases towards the end of the quarter, in part because they believe they are able to negotiate lower prices and more favorable terms. This trend makes predicting revenues difficult. The timing of closing larger orders increases the risk of quarter-to-quarter fluctuation in revenues. If orders forecasted for a specific group of customers for a particular quarter are not realized or revenues are not otherwise recognized in that quarter, our operating results for that quarter could be materially adversely affected. In addition, from time to time, we may experience unexpected increases in demand for our products resulting from fluctuations in our customers’ deployment schedules as they implement smart card-based programs. These occurrences are not always predictable and can have a significant impact on our results in the period in which they occur.

Our listing on both the NASDAQ Stock Market and the Prime Standard of the Frankfurt Stock Exchange exposes our stock price to additional risks of fluctuation.

Our common stock is listed both on the NASDAQ Stock Market and the Prime Standard of the Frankfurt Stock Exchange and we typically experience a significant volume of our trading on the Prime Standard. Because of this, factors that would not

otherwise affect a stock traded solely on the NASDAQ Stock Market may cause our stock price to fluctuate. For example, European investors may react differently and more positively or negatively than investors in the United States to events such as acquisitions, dispositions, one-time charges and higher or lower than expected revenue or earnings announcements. A positive or negative reaction by investors in Europe to such events could cause our stock price to increase or decrease significantly. The European economy and market conditions in general, or downturns on the Prime Standard specifically, regardless of the NASDAQ Stock Market conditions, also could negatively impact our stock price.

Our stock price has been and is likely to remain volatile.

Over the past few years, the NASDAQ Stock Market and the Prime Standard of the Frankfurt Exchange have experienced significant price and volume fluctuations that have particularly affected the market prices of the stocks of technology companies. Volatility in our stock price on either or both exchanges may result from a number of factors, including, among others:

	•		low volumes of trading activity in our stock, particular in the U.S.;

	•		variations in our or our competitors’ financial and/or operational results;

	•		the fluctuation in market value of comparable companies in any of our markets;

	•		expected, perceived or announced relationships or transactions with third parties;

	•		comments and forecasts by securities analysts;

	•		trading patterns of our stock on the NASDAQ Stock Market or Prime Standard of the Frankfurt Stock Exchange;

	•		the inclusion or removal of our stock from market indices, such as groups of technology stocks or other indices;

	•		loss of key personnel;

	•		announcements of technological innovations or new products by us or our competitors;

	•		announcements of dispositions, organizational restructuring, headcount reductions, litigation or write-off of investments;

	•		litigation developments; and

	•		general market downturns.

In the past, companies that have experienced volatility in the market price of their stock have been the object of securities class action litigation. If we were the object of securities class action litigation, it could result in substantial costs and a diversion of our management’s attention and resources.

A significant portion of our sales typically comes from a small number of customers and the loss of one or more of these customers or variability in the timing of orders could negatively impact our operating results.

Our products are generally targeted at OEM customers in the consumer electronics, digital photography and computer industries, as well as the government sector and corporate enterprises. Sales to a relatively small number of customers historically have accounted for a significant percentage of our revenues. For example, sales to our top ten customers accounted for approximately 66% of revenue in the first quarter of 2007 and 53% of revenue in fiscal 2006. We expect that sales of our products to a relatively small number of customers will continue to account for a high percentage of our total sales for the foreseeable future, particularly in our Flash Media Reader business. The loss of a customer or reduction of orders from a significant customer, including those due to product performance issues, changes in customer buying patterns, or market, economic or competitive conditions in our market segments, would increase our dependence on a smaller group of our remaining customers. Likewise, variations in the timing or patterns of customer orders could also increase our dependence on other customers in any particular period. Dependence on a small number of customers and variations in order levels period to period could result in decreased revenues, decreased margins, and/or inventory or receivables write-offs and otherwise harm our business and operating results.

Sales of our products depend on the development of emerging applications in our target markets.

We sell our products primarily to address emerging applications that have not yet reached a stage of mass adoption or deployment. For example, we sell our smart card readers for use in e-passport programs in Europe and for authentication of

personnel within various U.S. government agencies, both of which are new applications that are not yet widely implemented. If demand for products for applications such as these does not develop further and grow sufficiently, our revenue and gross profit margins could decline or fail to grow. We cannot predict the future growth rate, if any, or size or composition of the market for any of our products. Our target markets have not consistently grown or developed as quickly as we had expected, and we have experienced delays in the development of new products designed to take advantage of new market opportunities. Since new target markets are still evolving, it is difficult to assess the competitive environment or the size of the market that may develop. The demand and market acceptance for our products, as is common for new technologies, is subject to high levels of uncertainty and risk and may be influenced by various factors, including, but not limited to, the following:

•		general economic conditions;

•		the ability of our competitors to develop and market competitive solutions for emerging applications in our target markets and our ability to win business in advance of and against such competition;

•		the adoption and/or continuation of industry or government regulations or policies requiring the use of products such as our smart card readers;

•		the timing of adoption of smart cards by the U.S. and other governments, European banks and other enterprises for large scale security programs beyond those in place today;

•		the ability of financial institutions, corporate enterprises, the U.S. government and other governments to agree on industry specifications and to develop and deploy smart card-based applications that will drive demand for smart card readers such as ours; and

•		the ability of high capacity flash memory cards to drive demand for digital media readers, such as ours, that enable rapid transfer of large amounts of data, for example digital photographs.

Our products may have defects, which could damage our reputation, decrease market acceptance of our products, cause us to lose customers and revenue and result in costly litigation or liability.

Products such as our smart card readers and digital media readers may contain defects for many reasons, including defective design or manufacture, defective material or software interoperability issues. Often, these defects are not detected until after the products have been shipped. If any of our products contain defects or perceived defects or have reliability, quality or compatibility problems or perceived problems, our reputation might be damaged significantly, we could lose or experience a delay in market acceptance of the affected product or products and we might be unable to retain existing customers or attract new customers. In addition, these defects could interrupt or delay sales or our ability to recognize revenue for products shipped. In the event of an actual or perceived defect or other problem, we may need to invest significant capital, technical, managerial and other resources to investigate and correct the potential defect or problem and potentially divert these resources from other development efforts. If we are unable to provide a solution to the potential defect or problem that is acceptable to our customers, we may be required to incur substantial product recall, repair and replacement and even litigation costs. These costs could have a material adverse effect on our business and operating results.

We provide warranties on certain product sales, which range from twelve to twenty-four months, and allowances for estimated warranty costs are recorded during the period of sale. The determination of such allowances requires us to make estimates of product return rates and expected costs to repair or to replace the products under warranty. We currently establish warranty reserves based on historical warranty costs for each product line combined with liability estimates based on the prior twelve months’ sales activities. If actual return rates and/or repair and replacement costs differ significantly from our estimates, adjustments to recognize additional cost of sales may be required in future periods.

In addition, because our customers rely on our PC Security products to prevent unauthorized access to PCs, networks or facilities, a malfunction of or design defect in our products (or even a perceived defect) could result in legal or warranty claims against us for damages resulting from security breaches. If such claims are adversely decided against us, the potential liability could be substantial and have a material adverse effect on our business and operating results. Furthermore, the publicity associated with any such claim, whether or not decided against us, could adversely affect our reputation. In addition, a well-publicized security breach involving smart card-based or other security systems could adversely affect the market’s perception of products like ours in general, or our products in particular, regardless of whether the breach is actual or attributable to our products. Any of the foregoing events could cause demand for our products to decline, which would cause our business and operating results to suffer.

If we do not accurately anticipate the correct mix of products that will be sold, we may be required to record charges related to excess inventories.

Due to the unpredictable nature of the demand for our products, we are required to place orders with our suppliers for components, finished products and services in advance of actual customer commitments to purchase these products. Significant unanticipated fluctuations in demand could result in costly excess production or inventories. In order to minimize the negative financial impact of excess production, we may be required to significantly reduce the sales price of the product to increase demand, which in turn could result in a reduction in the value of the original inventory purchase. If we were to determine that we could not utilize or sell this inventory, we may be required to write down its value, which we have done in the past. Writing down inventory or reducing product prices could adversely impact our cost of revenues and financial condition.

Our business could suffer if our third-party manufacturers cannot meet production requirements.

Our products are manufactured outside the United States by contract manufacturers. Our reliance on foreign manufacturing poses a number of risks, including, but not limited to:

	•		difficulties in staffing;

	•		currency fluctuations;

	•		potentially adverse tax consequences;

	•		unexpected changes in regulatory requirements;

	•		tariffs and other trade barriers;

	•		political and economic instability;

	•		lack of control over the manufacturing process and ultimately over the quality of our products;

	•		late delivery of our products, whether because of limited access to our product components, transportation delays and interruptions, difficulties in staffing, or disruptions such as natural disasters;

	•		capacity limitations of our manufacturers, particularly in the context of new large contracts for our products, whether because our manufacturers lack the required capacity or are unwilling to produce the quantities we desire; and

	•		obsolescence of our hardware products at the end of the manufacturing cycle.

In the second half of 2005 we shifted all product and component manufacturing previously performed by our employees to contract manufacturers, while continuing to manage demand planning, procurement and other related activities within SCM. The exclusive use of contract manufacturing reduces the flexibility we have in our operations and requires us to exercise strong planning and management in order to ensure that our products are manufactured on schedule, to correct specifications and to a high standard of quality. If any of our contract manufacturers cannot meet our production requirements, we may be required to rely on other contract manufacturing sources or identify and qualify new contract manufacturers. We may be unable to identify or qualify new contract manufacturers in a timely manner or at all or with reasonable terms and these new manufacturers may not allocate sufficient capacity to us in order to meet our requirements. Any significant delay in our ability to obtain adequate supplies of our products from our current or alternative manufacturers would materially and adversely affect our business and operating results. In addition, if we are not successful at managing the contract manufacturing process, the quality of our products could be jeopardized or inventories could be too low or too high, which could result in damage to our reputation with our customers and in the marketplace, as well as possible write-offs of excess inventory.

We have a limited number of suppliers of key components, and may experience difficulties in obtaining components for which there is significant demand.

We rely upon a limited number of suppliers of several key components of our products. For example, we currently utilize the foundry services of Atmel and Samsung to produce our ASICs for smart cards readers; we use chips and antenna components from Philips in our contactless smart card readers; and we use various mechanical components in our smart card readers from TaiSol Electronics. Our reliance on a limited number of suppliers may expose us to various risks including, without limitation, an inadequate supply of components, price increases, late deliveries and poor component quality. This could result in components not being available to us in a timely manner or at all, particularly if larger companies have ordered more significant volumes of those components, or in higher prices being charged for components. Disruption or termination of the supply of components or software used in our products could delay shipments of these products. These delays could have a material adverse effect on our business and operating results and could also damage relationships with current and prospective customers.

Our future success will depend on our ability to keep pace with technological change and meet the needs of our target markets and customers.

The markets for our products are characterized by rapidly changing technology and the need to meet market requirements and to differentiate our products through technological enhancements, and in some cases, price. Our customers’ needs change, new technologies are introduced into the market, and industry standards are still evolving. As a result, product life cycles are often short and difficult to predict, and frequently we must develop new products quickly in order to remain competitive in light of new market requirements. Rapid changes in technology, or the adoption of new industry standards, could render our existing products obsolete and unmarketable. If a product is deemed to be obsolete or unmarketable, then we might have to reduce revenue expectations or write down inventories for that product.

Our future success will depend upon our ability to enhance our current products and to develop and introduce new products with clearly differentiated benefits that address the increasingly sophisticated needs of our customers and that keep pace with technological developments, new competitive product offerings and emerging industry standards. We must be able to demonstrate that our products have features or functions that are clearly differentiated from existing or anticipated competitive offerings, or we may be unsuccessful in selling these products. In addition, in cases where we are selected to supply products based on features or capabilities that are still under development, we must be able to complete our product design and delivery process on a timely basis, or risk losing current and any future revenue from those products. In developing our products, we must collaborate closely with our customers, suppliers and other strategic partners to ensure that critical development, marketing and distribution projects proceed in a coordinated manner. Also, this collaboration is important because these relationships increase our exposure to information necessary to anticipate trends and plan product development. If any of our current relationships terminate or otherwise deteriorate, or if we are unable to enter into future alliances that provide us with comparable insight into market trends, our product development and marketing efforts may be adversely affected, and we could lose sales. We expect that our product development efforts will continue to require substantial investments and we may not have sufficient resources to make the necessary investments.

In some cases, we depend upon partners who provide one or more components of the overall solution for a customer in conjunction with our products. If our partners do not adapt their products and technologies to new market or distribution requirements, or if their products do not work well, then we may not be able to sell our products into certain markets.

Because we operate in markets for which industry-wide standards have not yet been fully set, it is possible that any standards eventually adopted could prove disadvantageous to or incompatible with our business model and product lines. If any of the standards supported by us do not achieve or sustain market acceptance, our business and operating results would be materially and adversely affected.

Our markets are highly competitive.

The markets for our products are competitive and characterized by rapidly changing technology. We believe that the principal competitive factors affecting the markets for our products include:

	•		the extent to which products must support existing industry standards and provide interoperability;

	•		the extent to which standards are widely adopted and product interoperability is required within industry segments;

	•		the extent to which products are differentiated based on technical features, quality and reliability, ease of use, strength of distribution channels and price; and

	•		the ability of suppliers to develop new products quickly to satisfy new market and customer requirements.

We currently experience competition from a number of companies in each of our target market segments and we believe that competition in our markets is likely to intensify as a result of anticipated increased demand for secure digital access products. We may not be successful in competing against offerings from other companies and could lose business as a result.

We also experience indirect competition from certain of our customers who currently offer alternative products or are expected to introduce competitive products in the future. For example, we sell our products to many OEMs who incorporate our products into their offerings or who resell our products in order to provide a more complete solution to their customers. If our

OEM customers develop their own products to replace ours, this would result in a loss of sales to those customers, as well as increased competition for our products in the marketplace. In addition, these OEM customers could cancel outstanding orders for our products, which could cause us to write down inventory already designated for those customers. We may in the future face competition from these and other parties that develop digital data security products based upon approaches similar to or different from those employed by us. In addition, the market for digital information security and access control products may ultimately be dominated by approaches other than the approach marketed by us.

Many of our current and potential competitors have significantly greater financial, technical, marketing, purchasing and other resources than we do. As a result, our competitors may be able to respond more quickly to new or emerging technologies or standards and to changes in customer requirements. Our competitors may also be able to devote greater resources to the development, promotion and sale of products and may be able to deliver competitive products at a lower end user price. Current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products to address the needs of our prospective customers. Therefore, new competitors, or alliances among competitors, may emerge and rapidly acquire significant market share. Increased competition is likely to result in price reductions, reduced operating margins and loss of market share.

Sales of our smart card readers to the U.S. government are impacted by uncertainty of timelines and budgetary allocations, as well as by the delay of standards for information technology (“IT”) projects.

Historically, we have sold a significant proportion of our smart card reader products to the U.S. government and we anticipate that some portion of our future revenues will also come from this sector. The timing of U.S. government smart card projects is not always certain. For example, while the U.S. government has announced plans for several new smart card-based security projects, few have yet reached a stage of sustained high volume card or reader deployment, in part due to delays in reaching agreement on specifications for a new federally mandated set of identity credentials. In addition, government expenditures on IT projects have varied in the past and we expect them to vary in the future. As a result of shifting priorities in the federal budget and in the Department of Homeland Security, U.S. government spending may be reallocated away from IT projects, such as smart card deployments. The slowing or delay of government projects for any reason could negatively impact our sales.

We may have to take back unsold inventory from our customers.

If demand is less than anticipated, customers may ask that we accept returned products that they do not believe they can sell. We may determine that it is in our best interest to accept returns in order to maintain good relations with our customers. Returns may increase beyond present levels in the future. Once these products have been returned, we may be required to take additional inventory reserves to reflect the decreased market value of slow-selling returned inventory, even if the products are in good working order.

Large stock holdings outside the U.S. make it difficult for us to achieve quorum at stockholder meetings and this could restrict, delay or prevent our ability to implement future corporate actions, as well as have other effects, such as the delisting of our stock from the NASDAQ Stock Market.

To achieve a quorum at a regular or special stockholder meeting, at least one-third of all shares of our stock entitled to vote must be present at such a meeting in person or by proxy. As of August 7, 2006, the record date for our 2006 Annual Meeting of Stockholders, more than two-thirds of our shares outstanding were held by retail stockholders in Germany, through German banks and brokers. Securities regulations and customs in Germany result in very few German banks and brokers providing our proxy materials to our stockholders in Germany and in very few German stockholders voting their shares even when they do receive such materials. In addition, the absence of a routine “broker non-vote” in Germany typically requires the stockholder to return the proxy card to us before the votes it represents can be counted for purposes of establishing a quorum.

We expect that a significant percentage of our shares will continue to be held by retail stockholders in Germany through German banks and brokers. As a result, it is difficult and costly for us, and requires considerable management resources, to achieve a quorum at annual and special meetings of our stockholders, if we are able to do so at all. For example, because of the large pool of shares in Germany that were not voted, we had to adjourn our 2006 Annual Meeting of Stockholders from its original date of October 6, 2006, until November 3, 2006, in order to solicit enough votes to achieve quorum. This resulted in additional cost and diversion of management resources from our operations. We may not be successful in obtaining proxies from a sufficient number of our stockholders to constitute a quorum in the future. If we are unable to achieve a quorum at a future annual or special meeting of our stockholders, corporate actions requiring stockholder approval could be restricted, delayed or even prevented. These include, but are not limited to, actions and transactions that may be of benefit to our stockholders, part of

our strategic plan or necessary for our corporate governance, such as corporate mergers, acquisitions, dispositions, sales or reorganizations, financings, stock incentive plans or the election of directors. Even if we are able to achieve a quorum for a particular meeting, some of these actions or transactions require the approval of a majority of the total number of our shares then outstanding, and we may not be successful in obtaining such approval.

The future failure to hold an annual meeting of stockholders may result in our being out of compliance with Delaware law and the qualitative listing requirements of the NASDAQ Stock Market, each of which requires us to hold an annual meeting of our stockholders. Our inability to obtain a quorum at any such meeting may not be an adequate excuse for such failure. In accordance with Section 211 of the Delaware General Corporation Law, if there has been a failure to hold an annual meeting, the Court of Chancery may order a meeting to be held upon the application of any stockholder or director. Lack of compliance with the qualitative listing requirements of the NASDAQ Stock Market could result in the delisting of our common stock on the NASDAQ Stock Market. Either of these events would divert management’s attention from our operations and would likely be costly and could also have an adverse effect on the trading price of our common stock.

We have global operations, which require significant financial, managerial and administrative resources.

Our business model includes the management of separate product lines that address disparate market opportunities that are geographically dispersed. While there is some shared technology across our products, each product line requires significant research and development effort to address the evolving needs of our customers and markets. To support our development and sales efforts, we maintain company offices and business operations in several locations around the world, including Germany, India, Japan and the United States. We also must manage contract manufacturers in Singapore and China. Managing our various development, sales, administrative and manufacturing operations places a significant burden on our financial systems and has resulted in a level of operational spending that is disproportionately high compared to our current revenue levels.

Operating in diverse geographic locations also imposes significant burdens on our managerial resources. In particular, our management must:

	•		divert a significant amount of time and energy to manage employees and contractors from diverse cultural backgrounds and who speak different languages;

	•		travel between our different company offices;

	•		maintain sufficient internal financial controls in multiple geographic locations that may have different control environments;

	•		manage different product lines for different markets;

	•		manage our supply and distribution channels across different countries and business practices; and

	•		coordinate these efforts to produce an integrated business effort, focus and vision.

Any failure to effectively manage our operations globally could have a material adverse effect on our business and operating results.

We conduct a significant portion of our operations outside the United States. Economic, political, regulatory and other risks associated with international sales and operations could have an adverse effect on our results of operation.

In addition to our corporate headquarters being located in Germany, we conduct a substantial portion of our business in Europe and Asia. Approximately 55% of our revenue for the first quarter of 2007 and approximately 57% of our revenue for the year ended December 31, 2006 were derived from customers located outside the United States. Because a significant number of our principal customers are located in other countries, we anticipate that international sales will continue to account for a substantial portion of our revenues. As a result, a significant portion of our sales and operations may continue to be subject to risks associated with foreign operations, any of which could impact our sales and/or our operational performance. These risks include, but are not limited to:

	•		changes in foreign currency exchange rates;

	•		changes in a specific country’s or region’s political or economic conditions and stability, particularly in emerging markets;

	•		unexpected changes in foreign laws and regulatory requirements;

	•		potentially adverse tax consequences;

	•		longer accounts receivable collection cycles;

	•		difficulty in managing widespread sales and manufacturing operations; and

	•		less effective protection of intellectual property.

Fluctuations in the valuation of foreign currencies could result in currency exchange losses.

A significant portion of our business is conducted in foreign currencies, principally the euro. Fluctuations in the value of foreign currencies relative to the U.S. dollar will continue to cause currency exchange gains and losses. We cannot predict the effect of exchange rate fluctuations upon future quarterly and annual operating results. We may experience currency losses in the future. To date, we have not adopted a hedging program to protect us from risks associated with foreign currency fluctuations.

Our key personnel are critical to our business, and such key personnel may not remain with us in the future.

We depend on the continued employment of our senior executive officers and other key management and technical personnel. If any of our key personnel were to leave and not be replaced with sufficiently qualified and experienced personnel, our business could be adversely affected.

We also believe that our future success will depend in large part on our ability to attract and retain highly qualified technical and management personnel. However, competition for such personnel is intense. We may not be able to retain our key technical and management employees or to attract, assimilate or retain other highly qualified technical and management personnel in the future.

Likewise, as a small, dual-traded company, we are challenged to identify, attract and retain experienced professionals with diverse skills and backgrounds who are qualified and willing to serve on our Board of Directors. The increased burden of regulatory compliance under the Sarbanes-Oxley Act of 2002 creates additional liability and exposure for directors and financial losses in our business and lack of growth in our stock price make it difficult for us to offer attractive director compensation packages. If we are not able to attract and retain qualified board members, our ability to practice a high a level of corporate governance could be impaired.

We are subject to a lengthy sales cycle and additional delays could result in significant fluctuations in our quarterly operating results.

Our initial sales cycle for a new customer usually takes a minimum of six to nine months. During this sales cycle, we may expend substantial financial and managerial resources with no assurance that a sale will ultimately result. The length of a new customer’s sales cycle depends on a number of factors, many of which we may not be able to control. These factors include the customer’s product and technical requirements and the level of competition we face for that customer’s business. Any delays in the sales cycle for new customers could delay or reduce our receipt of new revenue and could cause us to expend more resources to obtain new customer wins. If we are unsuccessful in managing sales cycles, our business could be adversely affected.

We face risks associated with strategic transactions.

A component of our ongoing business strategy is to seek to buy businesses, products and technologies that complement or augment our existing businesses, products and technologies. We have in the past acquired or made, and from time to time in the future may acquire or make, investments in companies, products and technologies that we believe are complementary to our existing businesses, products and technologies. Any future acquisition could expose us to significant risks, including, without limitation, the use of our limited cash balances or potentially dilutive stock offerings to fund such acquisitions; costs of any necessary financing, which may not be available on reasonable terms or at all; accounting charges we might incur in connection with such acquisitions; the difficulty and expense of integrating personnel, technologies, customer, supplier and distributor relationships, marketing efforts and facilities acquired through acquisitions; diversion of our management resources; failure to realize anticipated benefits; costly fees for legal and transaction-related services and the unanticipated assumption of liabilities. Any of the foregoing could have a material adverse effect on our financial condition and results of operations. We may not be successful with any such acquisition.

Our business strategy also contemplates divesting portions of our business from time to time, if and when we believe we would be able to realize greater value for our stockholders in so doing. We have in the past sold, and may from time to time in the future sell, all or one or more portions of our business. For example, in the second quarter of 2006, we completed the sale of our DTV solutions business to Kudelski. Any divestiture or disposition could expose us to significant risks, including, without limitation, costly fees for legal and transaction-related services; diversion of management resources; loss of key personnel; and reduction in revenue. Further, we may be required to retain or indemnify the buyer against certain liabilities and obligations in connection with any such divestiture or disposition and we may also become subject to third party claims arising out of divestiture or disposition. In addition, any such divestiture or disposition could result in our recognition of an operating loss to the extent that the proceeds received by us in the divestiture or disposition are less than the book value of the assets sold. Regarding the sale of our DTV solutions business in particular, risks include our ability to collect the remaining $2 million in disputed payments for the business, and our ability to improve operational efficiencies or reduce operating costs through the transfer of our DTV solutions business. Failure to overcome these risks could have a material adverse effect on our financial condition and results of operations.

We may be exposed to risks of intellectual property infringement by third parties.

Our success depends significantly upon our proprietary technology. We currently rely on a combination of patent, copyright and trademark laws, trade secrets, confidentiality agreements and contractual provisions to protect our proprietary rights, which afford only limited protection. We may not be successful in protecting our proprietary technology through patents, it is possible that no new patents will be issued, that our proprietary products or technologies are not patentable or that any issued patent will fail to provide us with any competitive advantages.

There has been a great deal of litigation in the technology industry regarding intellectual property rights, and from time to time we may be required to use litigation to protect our proprietary technology. This may result in our incurring substantial costs and we may not be successful in any such litigation.

Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to use our proprietary information and software without authorization. In addition, the laws of some foreign countries do not protect proprietary and intellectual property rights to the same extent as do the laws of the United States. Because many of our products are sold and a significant portion of our business is conducted outside the United States, our exposure to intellectual property risks may be higher. Our means of protecting our proprietary and intellectual property rights may not be adequate. There is a risk that our competitors will independently develop similar technology or duplicate our products or design around patents or other intellectual property rights. If we are unsuccessful in protecting our intellectual property or our products or technologies are duplicated by others, our business could be harmed.

Changes to financial accounting standards may affect our results of operations and cause us to change our business practices.

We prepare our financial statements to conform with generally accepted accounting principles, or GAAP, in the United States. These accounting principles are subject to interpretation by the Financial Standards Accounting Board, the American Institute of Certified Public Accountants, the Securities and Exchange Commission and various other bodies formed to interpret and create appropriate accounting rules and policies. A change in those rules or policies could have a significant effect on our reported results and may affect our reporting of transactions completed before a change is announced. For example, under the recently issued Financial Accounting Standard Board Statement No. 123(R) (“FAS 123(R)”), as of January 1, 2006 we were required to apply certain expense recognition provisions to share-based payments to employees using the fair value method. Adoption of SFAS 123R resulted in our recording stock option compensation expense of $0.1 million in the first quarter of 2007. Any other changes in accounting policies in the future may also result in significant accounting charges. See Note 2 to our consolidated financial statements attached to the Annual Report on Form 10-K for the expense disclosures under SFAS No. 123R.

We face costs and risks associated with maintaining effective internal controls over financial reporting.

Under Section 302 of the Sarbanes-Oxley Act of 2002, on a quarterly basis our management is required to make certain certifications regarding our disclosure controls and internal controls over financial reporting. The process of maintaining and evaluating the effectiveness of these controls is expensive, time-consuming and requires significant attention from our management and staff. We have found a material weakness in our internal controls in the past and we cannot be certain in the future that we will be able to report that our controls are without material weakness or to complete our evaluation of those controls in a timely fashion.

If we fail to maintain an effective system of disclosure controls or internal control over financial reporting, we may discover material weaknesses that we would then be required to disclose. We may not be able to accurately or timely report on our financial results, and we might be subject to investigation by regulatory authorities. As a result, the financial position of our business could be harmed; current and potential future shareholders could lose confidence in us and/or our reported financial results, which may cause a negative effect on the trading price of our common stock; and we could be exposed to litigation or regulatory proceedings, which may be costly or divert management attention.

In addition, all internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to the preparation and presentation of financial statements. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.

We face risks from litigation.

From time to time, we may be subject to litigation, which could include claims regarding infringement of the intellectual property rights of third parties, product defects, employment-related claims, and claims related to acquisitions, dispositions or restructurings. For example, in December 2005, a complaint was filed in France against SCM Microsystems GmbH, one of our wholly-owned subsidiaries, by Aston France S.A. alleging participation by SCM Microsystems GmbH in the counterfeiting of Aston’s conditional access modules and claiming damages in the amount of approximately $69 million. While this claim was subsequently withdrawn, any such claims or litigation may be time-consuming and costly, divert management resources, cause product shipment delays, require us to redesign our products, require us to accept returns of products and to write off inventory, or have other adverse effects on our business. Any of the foregoing could have a material adverse effect on our results of operations and could require us to pay significant monetary damages.

We expect the likelihood of intellectual property infringement and misappropriation claims may increase as the number of products and competitors in our markets grows and as we increasingly incorporate third-party technology into our products. As a result of infringement claims, we could be required to license intellectual property from a third party or redesign our products. Licenses may not be offered when we need them or on acceptable terms. If we do obtain licenses from third parties, we may be required to pay license fees or royalty payments or we may be required to license some of our intellectual property to others in return for such licenses. If we are unable to obtain a license that is necessary for us or our third party manufacturers to manufacture our allegedly infringing products, we could be required to suspend the manufacture of products or stop our suppliers from using processes that may infringe the rights of third parties. We may also be unsuccessful in redesigning our products. Our suppliers and customers may be subject to infringement claims based on intellectual property included in our products. We have historically agreed to indemnify our suppliers and customers for patent infringement claims relating to our products. The scope of this indemnity varies, but may, in some instances, include indemnification for damages and expenses, including attorney’s fees. We may periodically engage in litigation as a result of these indemnification obligations. Our insurance policies exclude coverage for third-party claims for patent infringement.

We are exposed to credit risk on our accounts receivable. This risk is heightened in times of economic weakness.

We distribute our products both through third-party resellers and directly to certain customers. A substantial majority of our outstanding trade receivables are not covered by collateral or credit insurance. We may not be able to monitor and limit our exposure to credit risk on our trade and non-trade receivables, we may not be effective in limiting credit risk and avoiding losses. Additionally, if the global economy and regional economies deteriorate, one or more of our customers could experience a weakened financial condition and we could incur a material loss or losses as a result.

Provisions in our agreements, charter documents, Delaware law and our rights plan may delay or prevent our acquisition by another company, which could decrease the value of your shares.

Our certificate of incorporation and bylaws and Delaware law contain provisions that could make it more difficult for a third party to acquire us or enter into a material transaction with us without the consent of our Board of Directors. These provisions include a classified Board of Directors and limitations on actions by our stockholders by written consent. Delaware law imposes some restrictions on mergers and other business combinations between us and any holder of 15% or more of our outstanding common stock. In addition, our Board of Directors has the right to issue preferred stock without stockholder approval, which could be used to dilute the stock ownership of a potential hostile acquirer.

You may experience dilution of your ownership interests due to the future issuance of additional shares of our stock, and future sales of shares of our common stock could have an adverse effect on our stock price.

We may in the future issue previously authorized and unissued securities, resulting in the dilution of the ownership interests of our current stockholders. We are currently authorized to issue up to 40,000,000 shares of common stock. As of May 8, 2007, 15,727,307 shares of common stock were outstanding.

As of March 31, 2007, we had approximately 0.1 million shares of common stock reserved for future issuance under our stock option plans and 2.0 million shares of common stock were subject to outstanding options. We may also issue additional shares of our common stock or other securities that are convertible into or exercisable for common stock in connection with the hiring of personnel, future acquisitions, future private placements, or future public offerings of our securities for capital raising or for other business purposes. If we issue additional securities, the aggregate percentage ownership of our existing stockholders will be reduced. In addition, any new securities that we issue may have rights senior to those of our common stock.

In addition, the potential issuance of additional shares of common stock or preferred stock, or the perception that such issuances could occur, may create downward pressure on the trading price of our common stock.

We have adopted a stockholder rights plan. The triggering and exercise of the rights would cause substantial dilution to a person or group that attempts to acquire us on terms or in a manner not approved by our Board of Directors, except pursuant to an offer conditioned upon redemption of the rights. While the rights are not intended to prevent a takeover of our company, they may have the effect of rendering more difficult or discouraging an acquisition of us that was deemed to be undesirable by our Board of Directors.

These provisions will apply even if the offer were to be considered adequate by some of our stockholders. Also, because these provisions may be deemed to discourage a change of control, they could decrease the value of our common stock.

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

None

Item 3. Defaults upon Senior Securities.

None

Item 4. Submission of Matters to a Vote of Security Holders.

None

Item 5. Other Information.

None.

Item 6. Exhibits

Exhibits are listed on the Index to Exhibits at the end of this Quarterly Report. The exhibits required by Item 601 of Regulation S-K, listed on such Index in response to this Item, are incorporated herein by reference.

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.


	Registrant SCM MICROSYSTEMS, INC.
May 15, 2007	By:	/s/ Robert Schneider
		Robert Schneider
		Chief Executive Officer


May 15, 2007		/s/ Stephan Rohaly
		Stephan Rohaly
		Chief Financial Officer and Secretary

EXHIBIT INDEX


Exhibit
Number		Description of Document
3.1(1)		Fourth Amended and Restated Certificate of Incorporation.

3.2(5)		Amended and Restated Bylaws of Registrant.

3.3(6)		Certificate of Designation of Rights, Preferences and Privileges of Series A Participating Preferred Stock of SCM Microsystems, Inc.

4.1(1)		Form of Registrant’s Common Stock Certificate.

4.2(6)		Preferred Stock Rights Agreement, dated as of November 8, 2002, between SCM Microsystems, Inc. and American Stock Transfer and Trust Company.

10.1(1)*		Form of Director and Officer Indemnification Agreement.

10.2(8)*		Amended 1997 Stock Plan.

10.3(1)*		1997 Employee Stock Purchase Plan.

10.4(1)*		1997 Director Option Plan.

10.5(1)*		1997 Stock Option Plan for French Employees.

10.6(1)*		1997 Employee Stock Purchase Plan for Non-U.S. Employees.

10.7(2)*		2000 Non-statutory Stock Option Plan.

10.8(2)*		Dazzle Multimedia, Inc. 1998 Stock Plan.

10.9(2)*		Dazzle Multimedia, Inc. 2000 Stock Option Plan.

10.10(3)		Sublease Agreement, dated December 14, 2000 between Microtech International and Golden Goose LLC.

10.11(1)*		Form of Employment Agreement between SCM Microsystems GmbH and Robert Schneider.

10.12(4)		Tenancy Agreement dated August 31, 2001 between SCM Microsystems GmbH and Claus Czaika.

10.13(11)		Shuttle Technology Group Unapproved Share Option Scheme.

10.14(12)*		Form of Employment Agreement between SCM Microsystems GmbH and Colas Overkott.

10.15(13)*		Description of Executive Compensation Arrangement.


Exhibit
Number		Description of Document
10.16(14)*		Management by Objective (MBO) Bonus Program Guide.

10.17(15)*		Bonus Agreement between SCM Microsystems and Colas Overkott dated January 13, 2006.

10.18(15)*		Separation Agreement between SCM Microsystems and Colas Overkott dated January 13, 2006.

10.19(15)*		Employment Agreement between SCM Microsystems and Steven L. Moore dated January 17, 2006.

10.20(15)*		Separation Agreement between SCM Microsystems and Ingo Zankel dated January 27, 2006.

10.21(15)*		Employment Agreement between SCM Microsystems and Stephan Rohaly dated March 14, 2006.

10.22(16)		Purchase Agreement between SCM Microsystems and Kudelski S.A.

10.23(17)*		Restrictive Covenant between Kudelski S.A. and Robert Schneider dated May 22, 2006.

10.24(17)*		Amended Employment Agreement between SCM Microsystems GmbH and Robert Schneider dated May 22, 2006.

10.25(17)*		Amended Employment Agreement between SCM Microsystems GmbH and Dr. Manfred Mueller dated June 8, 2006.

10.26(16)		Lease dated July 15, 2006 between SCM Microsystems and Rreef America Reit II Corp.

10.27(18)*		Supplementary Employment Agreement between SCM Microsystems GmbH and Stephan Rohaly dated December 12, 2006.

31.1		Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.

31.2		Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.

32		Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


(1)		Filed previously as an exhibit to SCM’s Registration Statement on Form S-1 (See SEC File No. 333-29073).

(2)		Filed previously as an exhibit to SCM’s Registration Statement on Form S-8 (See SEC File No. 333-51792).

(3)		Filed previously as an exhibit to SCM’s Annual Report on Form 10-K for the year ended December 31, 2000 (See SEC File No. 000-22689).

(4)		Filed previously as an exhibit to SCM’s Annual Report on Form 10-K for the year ended December 31, 2001 (See SEC File No. 000-22689).

(5)		Filed previously as an exhibit to SCM’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2002 (see SEC File No. 000-22689).

(6)		Filed previously as an exhibit to SCM’s Registration Statement on Form 8-A (See SEC File No. 000-29440).


(7)		Filed previously as an exhibit to SCM’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2003 (see SEC File No. 000-29440).

(8)		Filed previously as an exhibit to SCM’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2003 (see SEC File No. 000-29440).

(9)		Filed previously as exhibit 99.1 to SCM’s Current Report on Form 8-K, dated July 28, 2003 (see SEC File No. 000-29440).

(10)		Filed previously as an exhibit to SCM’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2003 (see SEC File No. 000-29440).

(11)		Filed previously as an exhibit to SCM’s Registration Statement on Form S-8 (See SEC File No. 333-73061).

(12)		Filed previously as an exhibit to SCM’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2004 (see SEC File No. 000-29440).

(13)		Filed previously in the description of the Executive Compensation Arrangement set forth in SCM’s Current Report on Form 8-K, dated September 21, 2004 (see SEC File No. 000-29440).

(14)		Filed previously as an exhibit to SCM’s Annual Report on Form 10-K for the year ended December 31, 2004 (See SEC File No. 000-29440).

(15)		Filed previously as an exhibit to SCM’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2006 (see SEC File No. 000-29440).

(16)		Filed previously as an exhibit to SCM’s Annual Report on Form 10-K for the year ended December 31, 2006 (See SEC File No. 000-29440).

(17)		Filed previously as an exhibit to SCM’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2006 (see SEC File No. 000-29440).

(18)		Filed previously as an exhibit to SCM’s Current Report on Form 8-K, dated December 18, 2006 (see SEC File No. 000-29440).

*		Denotes management compensatory arrangement.

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