10-K

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO

SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

(Mark One)
þ	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the fiscal year ended December 31, 2006
OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the transition period from          to

Commission file number 0-29440

SCM MICROSYSTEMS, INC.

(Exact Name of Registrant as Specified in its Charter)

Delaware	77-0444317
(State or other jurisdiction of Incorporation or organization)	(I.R.S. Employer Identification Number)
Oskar-Messter-Strasse 13, Ismaning, Germany	85737
(Address of Principal Executive Offices)	(Zip Code)

Registrant’s telephone number, including area code:

+49 89 95 95 5000

Securities Registered Pursuant to Section 12(b) of the Act:

None

Securities Registered Pursuant to Section 12(g) of the Act:

Common Stock, $0.001 par value, and associated Preferred Share Purchase Rights

(Title of Class)

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

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

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements or any amendment to this Form 10-K.  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

Based on the closing sale price of the Registrant’s Common Stock on the NASDAQ National Market System on June 30, 2006, the last business day of the Registrant’s most recently completed second fiscal quarter, the aggregate market value of Common Stock held by non-affiliates of the Registrant was $39,279,106. For purposes of this disclosure, shares of Common Stock held by beneficial owners of more than 5% of the outstanding shares of Common Stock and shares held by officers and directors of the registrant, have been excluded in that such persons may be deemed to be affiliates of the Registrant. This determination is not necessarily conclusive.

At March 9, 2007, the registrant had outstanding 15,698,278 shares of Common Stock.

DOCUMENTS INCORPORATED BY REFERENCE

The Company’s Proxy Statement and Notice of Annual Meeting to be filed within 120 days after the Registrant’s fiscal year end of December 31, 2006 is incorporated by reference into Part II, Item 5 and Part III of this Report.

SCM Microsystems, Inc.

Form 10-K
For the Fiscal Year Ended December 31, 2006

TABLE OF CONTENTS

		Page
PART I
Item 1	Business		1
Item 1A	Risk Factors		11
Item 1B	Unresolved Staff Comments		22
Item 2	Properties		22
Item 3	Legal Proceedings		22
Item 4	Submission of Matters to a Vote of Security Holders		23
PART II
Item 5	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities		24
Item 6	Selected Financial Data		25
Item 7	Management’s Discussion and Analysis of Financial Condition and Results of Operations		26
Item 7A	Quantitative and Qualitative Disclosures About Market Risk		36
Item 8	Financial Statements and Supplementary Data		37
Item 9	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		37
Item 9A	Controls and Procedures		37
Item 9B	Other Information		37
PART III
Item 10	Directors and Executive Officers of the Registrant		38
Item 11	Executive Compensation		38
Item 12	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		38
Item 13	Certain Relationships and Related Transactions		38
Item 14	Principal Accountant Fees and Services		38
PART IV
Item 15	Exhibits and Financial Statement Schedule		38
Signatures			42
Consolidated Financial Statements			F-1
EXHIBIT 10.22
EXHIBIT 10.26
EXHIBIT 21.1
EXHIBIT 23.1
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32

SCM, CHIPDRIVE, EasyTAN and SmartOS are registered trademarks and Opening the Digital World is a trademark of SCM Microsystems. Other product and brand names may be trademarks or registered trademarks of their respective owners.

PART I

This Annual Report on Form 10-K 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 “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 Annual Report on Form 10-K 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 Annual Report on Form 10-K. 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 factors that could cause our actual results to differ materially from our expectations in the “Customers,” “Research and Development,” Competition,” Proprietary Information and Technology” and “Risk Factors” sections and elsewhere in this Annual Report on Form 10-K. These cautionary statements qualify all of the forward-looking statements included in this Annual Report on Form 10-K that are attributable to us or persons acting on our behalf.

ITEM 1.   BUSINESS

Description of Business

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 to our consolidated financial statements that are attached to this Annual Report on Form 10-K.)

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Overview of the Market for Secure Digital Access Products

Individuals, businesses, governments and educational institutions increasingly rely upon computer networks, the Internet and intranets for information, entertainment and services. The proliferation of and reliance upon electronic data and electronic transactions has created an increasing need to protect the integrity of digital data, as well as to control access to electronic networks and the devices that connect to them. For government entities and large corporate enterprises, there is a need to restrict and manage access to shared networks and intranets to prevent loss of proprietary data. In addition, there is a need to manage and monitor access to information stored on identification cards used in new government-driven programs around the world, such as electronic passports, drivers’ licenses and citizen ID and healthcare cards. In some cases, there may also be a need to expand the capability of electronic networks to protect or restrict access to physical facilities for corporate employees or government personnel. Finally, for consumers and online merchants or banks, there is a need to authenticate credit cardholders or bank clients for Internet transactions without jeopardizing sensitive personal account information. In all of these areas, we believe standards-based devices that easily connect to a PC or network to provide secure, controlled access to digital content or services are an easily deployed and effective solution.

PC Security Market

The proliferation of personal computers in both the home and office, combined with widespread access to computer networks and the Internet, have created significant opportunities for electronic transactions of all sorts, including business-to-business, e-government, e-commerce and home banking. In government agencies and corporate enterprises, the desire to link disparate divisions or offices, reduce paperwork and streamline operations is also leading to the adoption of more computer- and network-based programs and processes. Network-based programs are also used to track and manage data about large groups of people, for example, citizens of a particular country. While the benefits of computer networks may be significant, network and Internet-based transactions also pose a significant threat of fraud, eavesdropping and data theft for both groups and individuals. To combat this threat, parties at both ends of the transaction must be assured of the integrity of the transaction. Online merchants and consumers need assurance that customers are correctly identified and that the authenticity and confidentiality of information such as credit card numbers is established and maintained. Corporate, government and other networks need security systems that ensure the security of individuals’ data and protect the network from manipulation or abuse both from within and without the enterprise.

Increasingly, large organizations such as corporations, government agencies and banks are adopting systems that protect the network, the information in it and the people using it by authenticating each user as the user logs on and off the network. Authentication of a user’s identity is typically accomplished by one of two approaches: passwords, which are codes known only by specific users; and tokens, which are user-specific physical devices that only authorized users possess. Passwords, while easier to use, are also less secure because they tend to be short and static, and are often transmitted without encryption. As a result, passwords are vulnerable to decoding or observation and subsequent use by unauthorized persons. Tokens range from simple credit card-size objects to more complex devices capable of generating time-synchronized or challenge-response access codes. Certain token-based systems require both possession of the token itself and a personal identifier, such as a fingerprint or personal identification number, or PIN, to indicate that the token is being used by an authorized user. Such an approach, referred to as two-factor authentication, provides much greater security than single factor systems such as passwords or the simple possession of a token.

One example of a token used in two-factor authentication is the smart card, which contains an embedded microprocessor, memory and a secure operating system. In addition to their security capabilities, smart cards are able to store data such as account information, healthcare records, merchant coupons, still or video images and, in some cases, cash. Smart cards are typically about the size of a credit card and can easily be carried in a wallet or attached to a badge. Smaller cards designed for use with small devices such as mobile phones are also increasingly being utilized. Depending on the application for which they are being used, smart cards can be designed to insert into a reader attached to a PC or other device, or can include wireless capabilities for contactless interface. Worldwide shipments of smart cards topped 2.6 billion in 2005 and are estimated to grow to nearly 3.3 billion in 2006 for applications ranging from mobile communications to corporate security to online banking, according to the European smart card industry organization, Eurosmart. Demand for readers used in conjunction with those cards

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is also expected to grow. Research firm Frost & Sullivan predicts that reader shipments will grow from 6.9 million in 2004 to 33 million in 2010. We believe that the combination of smart cards and readers provides a secure solution for network access, personal identification, electronic commerce and other transactions where authentication of the user is critical.

To date, the largest and one of the most advanced deployments of smart cards for digital security purposes has been the U.S. Department of Defense’s Common Access Card (“CAC”) program. Beginning in October 2000, the U.S. Department of Defense has distributed smart cards to more than four million military personnel. These cards are being used as the standard identification credential for military personnel, and are also being used for secure authentication and network access. Beginning in 2006, new deployments of the cards have also begun to include capabilities for contactless interface with security terminals at doorways and other entrances to provide secure physical access at government facilities. The U.S. government’s decision to deploy an integrated, agency-wide, common smart card platform will continue to raise the awareness of smart card technology and hence increase the demand for contactless smart card proximity readers in both public and private sectors, according to IMS Research. The firm predicts the Americas’ market for electronic physical access control equipment will reach $766.7 million in 2009, with a forecast compound annual growth rate of 9.1%.

Because CAC cards store and protect personnel data, they are also being used wherever a digital signature is required; for example, processing travel orders or expense claims online, electronic voting, contractor verification and in department specific programs. As a result of the CAC program, other government agencies are also employing smart cards as secure ID tokens. The U.S. General Services Administration estimates they will issue smart cards to two million users in various agencies between February 2007 and December 2008.

The U.S. government is actively driving the use of smart cards outside the boundaries of the country as well, with the request in 2002 to 27 visa waiver countries to develop electronic passports that will include biometric data to authenticate the holder. Under the auspices of the International Civil Aviation Organization (ICAO), 13 countries have been working together to define and develop standards for e-passports based on contactless smart card technology. The goal of the program is to ensure that these e-passports cannot be copied or altered, and that the biometric facial image stored on the card could be used to positively identify the holder. All of ICAO’s 188 Contracting States must begin issuing only machine readable (i.e., electronic) passports no later than April 1, 2010. 24 of the 27 visa waiver countries met the October 2006 deadline to begin issuing electronic passports and altogether 40 countries worldwide have introduced the new documents, including Australia, Belgium, Canada, China, Denmark, Hong Kong, Japan, Korea, Macao, Malaysia, the Netherlands, Singapore, Sweden, the United Kingdom and the U.S.

In many countries, both local and federal governments are beginning to use smart card technology for internal programs, such as new or enhanced national ID cards, storing digital certificates for online transactions, residency permits and visas, and drivers’ licenses. Some examples of programs include national ID rollouts in Thailand and China and deployment of electronic drivers’ licenses in Japan. According to IMS Research Group, more than one billion smart cards will be used in identity programs by governments and other public bodies worldwide by 2010.

In addition, many governments are also evaluating or making plans to develop electronic healthcare record systems, which would include smart card-based healthcare cards for participants. Puerto Rico, South Africa, Taiwan and several European countries, including Austria, Belgium, France, Germany, Italy and Slovenia, are among the countries and regions that have already deployed or are deploying electronic healthcare cards to millions of healthcare users. These cards identify the user and store insurance and medical information that can be accessed by doctors and hospitals, for example. To date, the largest program actively underway is in Germany, where the government plans to begin distribution of 82 million eHealth cards to citizens in 2007 and have the corresponding network and card reader infrastructure in place for doctors, hospitals, pharmacies and other healthcare providers by 2008.

Outside the government sector, many corporate enterprises are adopting smart card technology to protect access to buildings and computer networks. Several smart card-based employee identification programs have already been put in place by companies such as Boeing, Chevron, Hitachi, Microsoft, Nissan, Pfizer, Royal Dutch/Shell Group and Sun Microsystems.

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In the financial industry, major credit card companies in many parts of the world have embraced smart card technology as a more secure way to safeguard transactions and eliminate fraud, the cost of which can be significant. The majority of credit cards issued worldwide now comply with the Europay Mastercard Visa (EMV) standard for securing financial transactions using a smart card. Canada, most of Europe and Asia/Pacific and some markets in the Middle East, Africa and Latin America are rapidly moving to EMV smart cards to reduce fraud. Smart cards are also expected to have a growing role in online banking. Western Europe, in particular has a high percentage of consumers banking online, and Germany is one of the first countries to coordinate e-government initiatives requiring digital signatures to leverage smart cards issued to bank customers.

Our PC Security Products

We offer a full range of smart card reader technology solutions to address the need for smart card-based security for a range of applications and environments, including PCs, networks, physical facilities and authentication programs. Our products include smart card readers, application specific integrated circuits, or ASICs, and small office productivity packages based on smart cards. We sell our readers and ASICs primarily to PC original equipment manufacturers, or OEMs, smart card solutions providers and government systems integrators to support specific security programs, such as secure logon for employees, secure home banking or the Common Access Card program; as well as to OEMs that incorporate our products into their devices, such as PCs or keyboards. We sell our small office productivity packages primarily to end users via retail channels and the Internet.

Smart Card Readers.  We are one of the world’s largest suppliers of smart card readers for security-oriented applications. Our smart card readers are hardware devices that connect either externally or internally with a computer or other processing platform to verify the identity of, or authenticate, the user, and thus control access. Much like a lock works with a key, our readers work with a smart card to admit or deny access to a computer or network, or to authenticate the card holder for identification and access to facilities, programs or services. Our readers are used to authenticate users in order to support security programs and applications for corporations, financial institutions, governments and individuals. These security programs and applications include secure network logon; personnel identification for programs such as healthcare delivery, drivers’ licenses and electronic passports; secure home banking; digital signatures; and secure e-commerce.

Our products employ an open-systems architecture that provides compatibility across a range of hardware platforms and software environments and accommodates remote upgrades so that compatibility can be maintained as the security infrastructure evolves. We have made significant investments in software embedded in our products that enable our smart card readers and components to read the majority of smart cards in the world, regardless of manufacturer or application. Our smart card readers are also available with a variety of interfaces, including biometric (fingerprint), wireless/contactless, keypad, USB, PCMCIA, ExpressCard and serial port, and offer various combinations of interfaces integrated into one device in order to further increase the level of security.

To address the varied needs of our customers, we offer an array of smart card readers. These include readers designed for various platforms, such as desktop and notebook computers; as well as readers offering incremental levels of protection against unauthorized use, from simple PC Card reader devices to more complex PIN entry systems, which require both a smart card and a user’s personal identification number to authenticate the user. Our smart card reader product line includes:

•  Secure Card Readers — internal or external card readers requiring only a smart card to provide secure authentication;

•  Secure PINpad Readers — external readers with a numeric PINpad that utilize a smart card in conjunction with a personal identification code to ensure “two factor” authentication of the user;

•  Contactless Readers and Dual Interface Readers — internal and external readers that address the demand for contactless interface used in many security programs based on smart cards, for example public transport, e-banking, e-purse and e-passport personalization and verification;

•  Physical Access Control Terminal (PACT) — designed to address the requirements of the U.S. government for secure access to facilities. The PACT terminal combines new technologies such as contactless and

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biometric interface with existing control systems as well as CAC and newer ID cards, to provide support for new connectivity options going forward.

•  eHealth terminal — specifically designed to meet the requirements of the German Health Card, to support Germany’s intended rollout of healthcare cards to 82 million citizens. The eHealth100 terminal reads and operates both with Germany’s current memory card-based health card as well as the new chip-based card, and is compliant for use with three different card types: the electronic health card (eGK), the health professional card (HPC), and the Secure Module Cards (SMC) used for secure data communication;

•  ePassport readers — designed to read all electronic passports currently in use or planned for distribution. Ranked among the highest in interoperability and versatility in international interoperability tests. We offer both complete ePassport readers and ePassport modules that can be incorporated into customer terminals and designs;

•  Mobile Readers — unconnected devices that enable secure network access and user authentication by generating one-time passwords; and

•  Keyboard Readers — reader interfaces that are designed to be embedded into a computer keyboard at the manufacturer.

Our readers are developed in compliance with relevant industry standards related to the applications for which they will be used. For example, many of our readers, including the SCRx31 Secure Card Reader line, conform to Europay, MasterCard and Visa (EMV) international standards for financial transactions. We typically customize our smart card readers with unique casing designs and configurations to address the specific requirements of each customer.

In addition, we also offer ASICs/Chip Sets, which provide smart card interface capabilities for embedded platforms, such as desktop computers or keyboards. We offer two levels of ASICs to provide both basic smart card interface capability and support for multiple interfaces and reader devices. All of our ASICs comply with all relevant security standards for applications in the smart card industry. In addition, our advanced chip allows on-board flash upgrades for future firmware and application enhancements.

CHIPDRIVE Productivity Solutions.  We offer several CHIPDRIVE packages, consisting of smart cards, readers and software applications, for small and medium sized businesses. These products support applications such as smart card-enabled logon to Microsoft^® Windows and smart card-based, secure electronic time recording.

Flash Media Reader Market

Digital cameras have gained rapid popularity over the last few years, resulting in more than half of U.S. households owning a digital camera at the end of 2005, according to research firm InfoTrends. InfoTrends also estimates that U.S. output of digital photo prints exceeded 13.2 billion in 2005 and will increase to 16 billion by 2009. Flash media cards, which store digital images on the majority of digital cameras, are the key driver behind digital print growth. Higher capacity memory cards allow digital camera users to take more pictures before having to download images or swap out the card. As card capacities increase, more time is needed to download images. This uses more of the camera’s battery life, which already may be insufficient for many camera owners. To print without draining the camera battery, the flash media card can be removed and inserted into a card reader — on a PC, printer or kiosk — to download and print images.

Retail photo kiosks and minilabs, which give instant, high-quality printouts of digital images, make printing photos more convenient for the consumer and typically provide higher quality prints than home printers. According to an August 2006 survey conducted by InfoTrends, 41% of digital camera owners who print photos had obtained prints at a retail location in 2005, and the number is expected to grow. As flash memory card capacities increase and digital cameras continue to proliferate, we believe consumers will increasingly use photo kiosks and minilabs to download and print their digital pictures. Each photo kiosk or minilab requires a variety of media card readers to download images from the various media cards in use in digital cameras on the market

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Our Flash Media Reader Products

We offer digital media readers that provide an interface to the various formats of digital media cards to download digital images and other content. We sell our digital media readers primarily to photo kiosk manufacturers. Our digital media readers allow photo kiosk makers and others to build flash media interface capabilities into their products. Our product offerings provide interface capabilities for all major memory card formats, including PCMCIA I and II, CompactFlash^® I and II, MultiMediaCard^tm, Secure Digital Card^®, SmartMedia^tm, Sony Memory Stick^® and xD-Picture Card^tm. Our digital media readers leverage our interface chips to enable each reader slot to read multiple types of cards. Our digital media reader product line includes:

•  Preconfigured Drives — our 3.5 inch 5- and 6-bay drives provide plug-and-play interface for photo kiosks and mini labs. Marketed as Professional Card Drive (PCD) readers, these drives are designed to support heavy commercial usage and support multiple media card formats in either an integrated or a modular form factor.

•  Configurable Drives — our single board drives provide flexible interface solutions for print kiosks, photo labs and other applications requiring flash media interface. Single board drives can be configured using any combination of media interface and drive placement to address the specific requirements of each kiosk or other product environment.

Business Segment Financial Information

See Note 11 to our consolidated financial statements that are attached to this Annual Report on Form 10-K for financial information regarding revenue and gross margin for our reported business segments through 2006. See “Management’s Discussion and Analysis of Financial Conditional and Results of Operations” for historical financial information, including revenue and gross margin.

Technology

Most of the markets in which we participate are in their early stages of development and we expect they will continue to evolve. For example, early markets such as ours typically require complete hardware solutions, but over time requirements shift to critical components such as silicon or software as OEM customers increase their knowledge and sales volumes of the technologies being provided. We are committed to developing products using standards compliant technologies. Our core technologies, listed below, leverage our development efforts to benefit customers across our product lines and markets.

Chip-Level Integration.  We have implemented a number of our core interface and processing technologies into silicon chips for each of our two primary product areas.

Silicon and Firmware.  For our PC Security products, we have developed interface technology that provides interoperability between PCs and smart cards from many different smart card manufacturers. Our interoperable architecture includes an International Standards Organization, or ISO, compliant layer as well as an additional layer for supporting non-ISO compliant smart cards. Through our proprietary integrated circuits and firmware, our smart card readers can be updated electronically to accommodate new types of smart cards without the need to change the reader’s hardware. For our Flash Media Reader products, we have developed interface technology that provides interoperability and compatibility between various digital appliances, computer platforms and flash memory cards.

Complete Hardware Solutions.  We provide complete hardware solutions for a range of secure digital access applications, and we can customize these solutions in terms of physical design and product feature set to accommodate the specific requirements of each customer. For example, we have designed and manufactured smart card readers that incorporate specific features, such as a transparent case and removable USB cable, to address the needs of specific OEM customers.

Customers

Our products are targeted at government contractors and systems integrators, as well as manufacturers of computers, computer components, consumer electronics and photographic equipment. Sales to a relatively small

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number of customers historically have accounted for a significant percentage of our total sales. Sales to our top ten customers accounted for approximately 53% of revenue in 2006, 54% of revenue in 2005 and 54% of revenue in 2004. In each of 2006 and 2004, one customer accounted for more than 10% of revenue. In 2005, two customers accounted for more than 10% of revenue. We expect that sales of our products to a limited number of customers will continue to account for a high percentage of our total sales for the foreseeable future. The loss or reduction of orders from a significant customer, including losses or reductions due to manufacturing, reliability or other difficulties associated with our products, changes in customer buying patterns, or market, economic or competitive conditions in the digital information security business, could harm our business and operating results.

Sales and Marketing

We utilize a direct sales and marketing organization, supplemented by distributors, value added resellers, systems integrators and resellers. As of December 31, 2006, we had 26 full-time employees engaged in sales and marketing activities. Our direct sales staff solicits prospective customers, provides technical advice and support with respect to our products and works closely with customers, distributors and OEMs. In support of our sales efforts, we conduct sales training courses, targeted marketing programs and advertising, and ongoing customer and third-party communications programs, and we participate in trade shows.

Backlog

A significant portion of our sales are made from inventory on a current basis. Sales are made primarily pursuant to purchase orders for current delivery or agreements covering purchases over a period of time. Our customer contracts generally do not require fixed long-term purchase commitments. In view of our order and shipment patterns and because of the possibility of customer changes in delivery schedules or cancellation of orders, we do not believe that such agreements provide meaningful backlog figures or are necessarily indicative of actual sales for any succeeding period.

Collaborative Industry Relationships

We are party to collaborative arrangements with a number of third parties and are a member of several industry consortia. We evaluate, on an ongoing basis, potential strategic alliances and intend to continue to pursue such relationships. Our future success will depend significantly on the success of our current arrangements and our ability to establish additional arrangements. These arrangements may not result in commercially successful products.

PCMCIA.  We are a member of Personal Computer Memory Card International Association, or PCMCIA, an international standards body and trade association with more than 100 member companies. We have been a member of PCMCIA since 1990. PCMCIA was founded in 1989 to establish standards for integrated circuit cards and to promote interchangeability among mobile PCs.

PC/SC Workgroup.  We are an associate member of the PC/SC workgroup, a consortium of technology companies that seeks to set the standard for integrating smart cards and smart card readers into the mainstream computing environment.

Silicon Trust.  We are a member of Silicon Trust, an industry forum sponsored by Infineon Technologies that focuses on silicon based security solutions, including smart cards, biometrics, and trusted platforms.

Smart Card Alliance.  We are a member of the Smart Card Alliance, a U.S.-based, multi-industry association of member firms working to accelerate the widespread acceptance of multiple applications for smart card technology. We are also members of Smart Card Alliance’s Leadership Council and the Physical Access Council, which focuses on issues relating to the implementation of physical access systems. We regularly contribute to Smart

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Card Alliance research and education materials including white papers, for example a paper defining key policy, process and technology considerations for a secure smart card-based personal ID system.

Teletrust.  We are a member of Teletrust, a German organization whose goal is to provide a legally accepted means to adopt digital signatures. Digital signatures are encrypted personal identifiers, typically stored on a secure smart card, which allow for a high level of security through internationally accepted authentication methods. We are a member of the smart card terminal committee, which defines the standards for connecting smart cards to computers for applications such as secure electronic commerce over the Internet.

We are also members of several flash media card organizations, including CompactFlash Association, Memory Stick Developers Forum, MultiMediaCard Association, SD Card Association, SSFDC SmartMedia Forum, xD-Picture Card Forum, Photo Marketing Association International and USB Implementers Forum.

Research and Development

To date, we have made substantial investments in research and development, particularly in the areas of smart card-based physical and network access devices and digital connectivity and interface devices. Our engineering design teams work cross-functionally with marketing managers, applications engineers and customers to develop products and product enhancements to meet customer and market requirements. We also strive to develop and maintain close relationships with key suppliers of components and technologies in order to be able to quickly introduce new products that incorporate the latest technological advances. Our future success will depend upon our ability to develop and to introduce new products that keep pace with technological developments and emerging industry standards while addressing the increasingly sophisticated needs of our customers.

Our research and development expenses were approximately $3.8 million, $4.1 million and $4.8 million for the years ended December 31, 2006, 2005 and 2004, respectively. As of December 31, 2006, we had 83 full-time employees engaged in research and development activities, including software and hardware engineering, testing and quality assurance and technical documentation. The majority of our research and development activities occur in India. We fund a small portion of our research and development activities with technology development revenues received from OEM customers in connection with design and development of specific products.

Manufacturing and Sources of Supply

Through September 2005, we manufactured our products primarily using internal resources in Singapore, supplemented by contract manufacturers in Asia. Since October 2005, we have ceased to manufacture any of our own components or products internally and have shifted these activities to contract manufacturers in Singapore and China. We have implemented a global sourcing strategy that we believe enables us to achieve greater economies of scale, better gross margins and more uniform quality standards for our products. In the event any of our contract manufacturers are unable or unwilling to continue to manufacture our products, we may have to rely on other current manufacturing sources or identify and qualify new contract manufacturers. Any significant delay in our ability to obtain adequate supplies of our products from current or alternative sources would harm our business and operating results.

We believe that our success will depend in large part on our ability to provide quality products and services while ensuring the highest level of security for our products during the manufacturing process. We have a formal quality control program to satisfy our customers’ requirements for high quality and reliable products. To ensure that products manufactured by others are consistent with our standards, we manage all key aspects of the production process, including establishing product specifications, selecting the components to be used to produce our products, selecting the suppliers of these components and negotiating the prices for these components. In addition, we work with our suppliers to improve process control and product design. As of December 31, 2006, we had 11 full-time employees engaged in manufacturing and logistics activities, focused on coordinating product management and supply chain activities between SCM and our contract manufacturers.

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

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components in our smart card readers from TaiSol Electronics. Wherever possible, we have added a second source of supply for mechanical components such as printed circuit boards or casing. However, risk remains that we may be adversely impacted by an inadequate supply of components, price increases, late deliveries or poor component quality. In addition, some of the basic components we use in our products, such as flash media, may at any time be in great demand. This can result in the components not being available to us timely or at all, particularly if larger companies have ordered more significant volumes of the components; or in higher prices being charged for the components. Disruption or termination of the supply of components or software used in our products could delay shipments of our products, which could have a material adverse effect on our business and operating results. These delays could also damage relationships with current and prospective customers.

Competition

The PC Security and Flash Media Reader markets are competitive and characterized by rapidly changing technology. We believe that competition in these markets is likely to intensify as a result of anticipated increased demand for digital access products. We currently experience competition from a number of sources, including:

•  Advanced Card Systems, Gemalto (formerly Gemplus and Axalto), O2Micro and OmniKey in smart card readers, ASICs and universal smart card reader interfaces for PC and network access;

•  AMAG Technology, Bioscrypt, BridgePoint Systems, HID, Integrated Engineering, Precise Biometrics, XceedID and XTec in physical access control terminals; and

•  Atech, Datafab, ePOINT, OnSpec and YE Data for digital media readers.

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. 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 data security and access control products may ultimately be dominated by approaches other than the approach marketed by us.

We believe that the principal competitive factors affecting the market for our products include:

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

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

•  technical features;

•  quality and reliability;

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

•  ease of use;

•  strength of distribution channels; and

•  price.

While we believe that we compete favorably with respect to these factors, we may not be able to continue to successfully compete due to these or other factors and competitive pressures we face could materially and adversely affect our business and operating results.

Proprietary Technology and Intellectual Property

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. Although we often seek to protect our proprietary technology through patents, it is possible that no new patents will be issued, that our proprietary products or technologies are not patentable, and that any issued patent will fail to provide us with any competitive advantages.

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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 there is no assurance that we would 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 substantial 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, 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.

In addition, we have from time to time received claims that we are infringing upon third parties’ intellectual property rights. Future disputes with third parties may arise and these disputes may not be resolved on terms acceptable to us. As the number of products and competitors in our target markets grows, the likelihood of infringement claims also increases. Any claims or litigation may be time-consuming and costly, divert management resources, cause product shipment delays, or require us to redesign our products, accept product returns or to write off inventory. Any of these events could have a material adverse effect on our business and operating results.

Employees

As of December 31, 2006, we had 156 full-time employees, of which 83 were engaged in engineering, research and development; 26 were engaged in sales and marketing; 11 were engaged in manufacturing and logistics; and 36 were engaged in general management and administration. We are not subject to any collective bargaining agreements and, to our knowledge, none of our employees are currently represented by a labor union. To date, we have experienced no work stoppages and believe that our employee relations are generally good.

Foreign Operations

Our corporate headquarters are in Ismaning, Germany and we lease small sales and marketing facilities in California and in Japan. We conduct our research and development activities from our facility in Chennai, India.

Please see Note 11 to our consolidated financial statements attached to this Annual Report on Form 10-K which are included in response to Item 8 for financial information about geographic areas in which we have operations.

Availability of SEC Filings

We make available through our website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports free of charge as soon as reasonably practicable after we electronically file such material with the Securities and Exchange Commission. Our Internet address is www.scmmicro.com. The content on our website is not incorporated by reference into this filing.

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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 risk, 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 $191.7 million as of December 31, 2006. 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, 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;

•  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.

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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;

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•  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 53% of revenue in 2006, 54% of revenue in 2005 and 54% of revenue in 2004. 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;

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•  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.

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 and 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;

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•  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.

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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.

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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

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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 57% of our revenue for the year ended December 31, 2006 and approximately 58% of our revenue for the year ended December 31, 2005 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;

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•  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

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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), as of January 1, 2006 we were required to apply certain expense recognition

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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 $0.6 million in fiscal year 2006. 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

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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.

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 1B.   UNRESOLVED STAFF COMMENTS

SCM has no unresolved comments from the Securities and Exchange Commission.

ITEM 2.   PROPERTIES

Our corporate headquarters are in Ismaning, Germany, where we lease approximately 36,000 square feet pursuant to a lease agreement that expires November 15, 2008. We also lease small sales and marketing facilities in California and in Japan. We own a research and development facility of approximately 17,600 square feet in Chennai, India. We consider these properties as adequate for our business needs.

We also lease approximately 69,000 square feet at a facility in Guilford, Connecticut, where the lease term expires February 2011. During 2003, we discontinued operations at the Guilford facility and we are currently attempting to sublease the unused space. We lease premises of approximately 11,200 square feet in the U.K. where the lease term expires September 2016. During 2003, we discontinued operations in the U.K. Currently, we have subleased the premises for a part of the remaining leasing period to an unrelated business.

ITEM 3.   LEGAL PROCEEDINGS

From time to time, we 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, our management currently expects that any such liabilities, to the extent not provided for by insurance or otherwise, would not have a material adverse effect on our financial condition, results of operations or cash flows.

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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 had 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, 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 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

For information related to matters submitted to a vote of our security holders at our annual meeting held on November 3, 2006, please see Part II, Item 4 of our quarterly report on Form 10-Q for the quarter ended September 30, 2006, filed with the Securities and Exchange Commission on November 14, 2006.

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PART II

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

Price Range of Common Stock; Number of Holders; Dividends

Our common stock is quoted on the Nasdaq Stock Market’s National Market under the symbol “SCMM” and on the Prime Standard of the Frankfurt Stock Exchange under the symbol “SMY.” According to data available at March 13, 2007, we estimate we had approximately 12,211 stockholders of record and beneficial stockholders. The following table sets forth the high and low closing prices of our common stock for the periods indicated.

	Nasdaq				Prime Standard
	National Market				(Quoted in Euros)
	High		Low		High		Low
Fiscal 2005:
First Quarter	$	4.92	$	3.05	€	3.75	€	2.35
Second Quarter	$	3.50	$	2.77	€	2.70	€	2.33
Third Quarter	$	3.32	$	2.66	€	2.68	€	2.21
Fourth Quarter	$	3.42	$	2.61	€	2.89	€	2.23
Fiscal 2006:
First Quarter	$	3.86	$	2.91	€	3.22	€	2.48
Second Quarter	$	3.90	$	2.91	€	3.10	€	2.26
Third Quarter	$	3.41	$	2.79	€	2.64	€	2.24
Fourth Quarter	$	3.71	$	2.98	€	2.80	€	2.27

We have never declared or paid cash dividends on our common stock or other securities. We currently anticipate that we will retain all of our future earnings for use in the expansion and operation of our business and do not anticipate paying any cash dividends in the foreseeable future.

The disclosure required by Item 201(d) of Regulation S-K is included in Item 12 and incorporated by reference to our 2007 Proxy Statement.

Recent Sales of Unregistered Securities

None.

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

None.

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ITEM 6.   SELECTED FINANCIAL DATA

The table below has been restated to account for the sale of our DTV solutions business in fiscal 2006 and the sale of our retail Digital Media and Video business in fiscal 2003, with both businesses treated as discontinued operations.

SCM MICROSYSTEMS, INC.

SELECTED CONSOLIDATED FINANCIAL DATA

	Years Ended December 31,
	2006			2005			2004			2003			2002
	(In thousands, except per share data)
Consolidated Statement of Operations Data:
Net revenue	$	33,613		$	27,936		$	30,030		$	31,147		$	43,600
Cost of revenue		21,756			17,106			17,724			18,643			29,993
Gross profit		11,857			10,830			12,306			12,504			13,607
Operating expenses:
Research and development		3,767			4,081			4,807			3,958			2,886
Selling and marketing		7,498			7,040			8,560			7,943			6,449
General and administrative		7,548			9,198			9,021			11,018			11,125
Amortization of intangibles		666			673			1,078			1,129			819
Impairment of goodwill and intangibles		—			—			388			—			6,578
Restructuring and other charges		1,120			319			607			3,283			4,296
Total operating expenses		20,599			21,311			24,461			27,331			32,153
Loss from operations		(8,742	)		(10,481	)		(12,155	)		(14,827	)		(18,546	)
Loss from investments		—			—			—			(240	)		(1,242	)
Interest income		1,350			745			806			813			823
Foreign currency gains (losses) and other income (expense)		(225	)		1,731			(1,675	)		2,643			(1,765	)
Loss from continuing operations before income taxes		(7,617	)		(8,005	)		(13,024	)		(11,611	)		(20,730	)
Benefit (provision) for income taxes		(73	)		(150	)		173			2,013			(2,890	)
Loss from continuing operations		(7,690	)		(8,155	)		(12,851	)		(9,598	)		(23,620	)
Gain (loss) from discontinued operations, net of income taxes		3,508			(2,109	)		(6242	)		(13,476	)		(25,454	)
Gain (loss) on sale of discontinued operations, net of income taxes		5,224			(2,171	)		430			(15,102	)		—
Net income (loss)	$	1,042		$	(12,435	)	$	(18,663	)	$	(38,176	)	$	(49,074	)
Basic and diluted loss per share from continuing operations	$	(0.49	)	$	(0.53	)	$	(0.83	)	$	(0.63	)	$	(1.52	)
Basic and diluted income (loss) per share from discontinued operations	$	0.56		$	(0.27	)	$	(0.38	)	$	(1.86	)	$	(1.63	)
Basic and diluted net income (loss) per share	$	0.07		$	(0.80	)	$	(1.21	)	$	(2.49	)	$	(3.15	)
Shares used to compute basic and diluted income (loss) per share		15,638			15,532			15,402			15,317			15,597

	December 31,
	2006		2005		2004		2003		2002
Consolidated Balance Sheet Data:
Cash, cash equivalents and short-term investments	$	36,902	$	32,440	$	46,153	$	55,038	$	55,517
Working capital(1)		31,967		27,371		39,161		50,700		83,997
Total assets		51,355		52,734		73,307		96,442		148,617
Total stockholders’ equity		35,318		32,617		46,829		63,424		100,100

(1) Working capital is defined as current assets less current liabilities

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ITEM 7.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following information should be read in conjunction with the audited consolidated financial statements and notes thereto attached to this Annual Report on Form 10-K. We also urge readers to review and consider our disclosures describing various factors that could affect our business, including the disclosures under the headings “Risk Factors” in this Annual Report on Form 10-K.

Overview

SCM Microsystems designs, develops and sells 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. Our products are sold primarily to original equipment providers, 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, computer manufacturers, as well as banks and other financial institutions for our smart card readers; and computer 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 DTV solutions business to Kudelski S.A. As a result, we have accounted for the DTV solutions business as discontinued operations, and the statements of operations and cash flows for all periods presented reflect the discontinuance of this business. Previously, our operations also included a retail Digital Media and Video business that 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 have been reclassified to reflect the discontinuance of this business. For comparability, certain 2002 figures have been reclassified, where appropriate, to conform to the financial statement presentation used in 2003, 2004, 2005 and 2006. (See Note 3 to our consolidated financial statements attached to this Annual Report on Form 10-K.)

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 both of our primary product segments, 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, resulting in lower gross profits. To address an increasingly competitive environment, we have put in place cost reduction programs that resulted in margin improvement in the fourth quarter of 2006 and that we believe should result in stable margin levels going forward.

We have taken measures to reduce operating expenses over the last several quarters, the bulk of which have been centered around 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 shifted the 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

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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 not experienced until 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.

•  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 December 31, 2006 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.

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•  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 April 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position FASB Interpretation No. 46(R)-6 (“FSP FIN 46(R)-6”), which addresses how a reporting enterprise should determine the variability to be considered in applying FASB Interpretation No. 46, Consolidation of Variable Interest Entities, as amended (“FIN 46(R)”). The variability that is considered in applying FIN 46(R) affects the determination of (a) whether the entity is a variable interest entity, (b) which interests are variable interests in the entity and (c) which party, if any, is the primary beneficiary of the variable interest entity. That variability will affect any calculation of expected losses and expected residual returns, if such a calculation is necessary. FSP FIN 46(R)-6 provides additional guidance to consider for determining variability. FSP FIN 46(R)-6 is effective beginning the first day of the first reporting period beginning after June 15, 2006. After evaluating FSP FIN 46(R)-6, we determined that there is no impact to our consolidated financial position, results of operations or cash flows from its adoption.

In June 2006, the FASB ratified Emerging Issues Task Force (“EITF”) Issue No. 06-03, How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross Versus Net Presentation) (“Issue No. 06-03”). Under Issue No. 06-03, a company must disclose its accounting policy regarding the gross or net presentation of certain taxes. If taxes included in gross revenues are significant, a company must disclose the amount of such taxes for each period for which an income statement is presented (i.e., both interim and annual periods). Taxes within the scope of this Issue are those that are imposed on and concurrent with a specific revenue-producing transaction. Taxes assessed on an entity’s activities over a period of time, such as gross receipts taxes, are not within the scope of the issue. Issue No. 06-03 is effective for the first annual or interim reporting period beginning after December 15, 2006. After evaluating Issue No. 06-03, we determined that there is no impact to our consolidated financial position, results of operations or cash flows from its adoption.

In July 2006, the FASB issued 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.

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We have completed our initial evaluation of the impact of the January 1, 2007, adoption of FIN 48 and determined, that such adoption will most likely result in a reduction of our disclosed income taxes payable of $1.9 million as of December 31, 2006. The expected reduction of income taxes payable will be accounted for as an increase to the January 1, 2007 beginning balance of retained earnings. Our expectation of the impact from the adoption of FIN 48 is subject to revision as management completes its analysis.

In September 2006, the Securities and Exchange Commission (“SEC”) published Staff Accounting Bulletin (SAB) No 108. SAB 108 expresses the staff views regarding the process of quantifying financial statement misstatements. The bulletin prescribes the use of “rollover” and “iron curtain” approaches in quantifying misstatements. “Rollover” approach quantifies a misstatement based on the amount of the error originating in the current year income statement. “Iron curtain” approach quantifies a misstatement based on the effects of correcting the misstatement existing in the balance sheet at the end of the year, irrespective of the misstatement’s year(s) of origination. The statement is effective immediately. We did not have any misstatements that were determined to be material on the basis of either of the approaches mentioned above.

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

The following table sets forth our statements of operations as a percentage of net revenue for the periods indicated:

	Years Ended December 31
	2006			2005			2004
Net revenue		100.0	%		100.0	%		100.0	%
Cost of revenue		64.7			61.2			59.0
Gross profit		35.3			38.8			41.0
Operating expenses:
Research and development		11.2			14.6			16.0
Selling and marketing		22.3			25.2			28.5
General and administrative		22.5			32.9			30.0
Amortization of intangibles		2.0			2.4			3.6
Impairment of goodwill and intangibles		—			—			1.3
Restructuring and other charges (credits)		3.3			1.1			2.0
Total operating expenses		61.3			76.3			81.5
Loss from operations		(26.0	)		(37.5	)		(40.5	)
Interest income, net		4.0			2.7			2.7
Foreign currency gains (losses) and other income (expense)		(0.7	)		6.2			(5.6	)
Loss from continuing operations before income taxes		(22.7	)		(28.7	)		(43.4	)
Benefit (provision) for income taxes		(0.2	)		(0.5	)		0.6
Loss from continuing operations		(22.9	)		(29.2	)		(42.8	)
Gain (loss) from discontinued operations, net of income taxes		10.4			(7.5	)		(20.8	)
Gain (loss) on sale of discontinued operations		15.5			(7.8	)		1.4
Net income (loss)		3.1	%		(44.5	)%		(62.2	)%

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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.

Revenue

The following table sets forth our annual revenues and year-to-year change in revenues by product segment for the fiscal years ended December 31, 2006, 2005 and 2004:

				% Change						% Change
	Fiscal			2005			Fiscal			2004			Fiscal
	2006			to 2006			2005			to 2005			2004
	(In thousands)
PC Security
Revenues	$	23,745			36	%	$	17,415			(13	)%	$	20,017
Percentage of total revenues		71	%					62	%					67	%
Flash Media Readers
Revenues	$	9,868			(6	)%	$	10,521			5	%	$	10,013
Percentage of total revenues		29	%					38	%					33	%
Total revenues	$	33,613			20	%	$	27,936			(7	)%	$	30,030

Fiscal 2006 Revenue Compared with Fiscal 2005 Revenue

Revenue for the year ended December 31, 2006 was $33.6 million, an increase of 20% from $27.9 million in 2005. This increase was driven by higher demand for our PC Security products, offset by a slight decrease in sales of Flash Media Reader products. Sales of our PC Security products accounted for 71% and sales of our Flash Media Reader products accounted for 29% of total revenue in 2006.

Sales of our PC Security products increased 36% to $23.7 million in 2006, compared with $17.4 million in 2005. This 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. In 2006, higher revenue levels were primarily the result of higher sales of smart card readers in the United States for U.S. government security projects as well as growth in demand for our products in Europe primarily related to e-passport projects. We believe that potential growth in sales of our PC Security products has been curtailed by the slow pace at which new smart card programs reach a stage requiring high volumes, which directly drives demand for our readers.

Revenue from our Flash Media Reader product line decreased 6% from $10.5 million in 2005 to $9.9 million in 2006. Flash Media Reader revenue consists 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. The revenue decrease in 2006 was primarily due to a reduction in the price we were able to charge the primary customer for one of our digital media reader products, as the customer had decided they did not need the advanced functionality provided by components we previously had used in the readers. We therefore began to use simpler and less expensive components and thus the price of the product was lowered.

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Fiscal 2005 Revenue Compared with Fiscal 2004 Revenue

Revenue for the year ended December 31, 2005 was $27.9 million, down 7% from $30.0 million in 2004. Sales of our Security products accounted for 62% and sales of our Flash Media Reader products accounted for 38% of total revenue in 2005.

Sales of our PC Security products decreased 13% to $17.4 million in 2005, compared with $20.0 million in 2004. Revenue in this product line is subject to significant variability based on the size and timing primarily of product orders. In 2005, lower revenue levels were primarily the result of fluctuations in order levels, as well as some impact from continued competition for business in Europe, based on price. In particular, we experienced significantly lower sales in the U.S. compared with the prior year period due to the timing of orders for smart card readers for U.S. government security projects.

Revenue from our Flash Media Reader product line increased 5% from $10.0 million in 2004 to $10.5 million in 2005. During the first half of 2005, we ceased to sell certain products within this business, which reduced our revenue base significantly. Beginning in the third quarter, we introduced a new category of digital media reader products designed to be embedded in televisions, which helped us to partially offset this revenue loss and stabilize revenue levels.

Gross Profit

The following table sets forth our gross profit and year-to-year change in gross profit by product segment for the fiscal years ended December 31, 2006, 2005 and 2004:

				% Change						% Change
	Fiscal			2005			Fiscal			2004			Fiscal
	2006			to 2006			2005			to 2005			2004
	(In thousands)
PC Security
Revenues	$	23,745					$	17,415					$	20,017
Gross profit		9,725			59	%		6,120			(25	)%		8,190
Gross profit %		41	%					35	%					41	%
Flash Media Readers
Revenues	$	9,868					$	10,521					$	10,013
Gross profit		2,132			(55	)%		4,710			14	%		4,116
Gross profit %		22	%					45	%					41	%
Total:
Revenues	$	33,613					$	27,936					$	30,030
Gross profit		11,857			9	%		10,830			(12	)%		12,306
Gross profit %		35	%					39	%					41	%

Gross profit for 2006 was $11.9 million, or 35% of revenue. During 2006 gross profit for our PC Security products was impacted by increased pricing pressure, offset by the effect of a more favorable product mix as we increased the number of contactless readers sold, particularly for e-passport applications During the fourth quarter of 2006, we experienced an increase in gross profit in our PC Security business primarily due to better inventory management and cost reduction programs established earlier in the year. In our Flash Media Reader business, gross profit was impacted by pricing pressure, as well as by an increasing proportion of lower margin products sold.

Gross profit for 2005 was $10.8 million, or 39% of revenue. Our 2005 gross profit was negatively impacted by inventory write-downs of approximately $1.3 million in our PC security segment, severance costs for manufacturing personnel in our Singapore facility of $0.5 million, as well as by pricing pressure, mix of products sold and tooling costs.

Gross profit for 2004 was $12.3 million, or 41% of total revenue. Our 2004 gross profit was adversely impacted by inventory write-downs of $0.7 million related to PC Security product inventory and $0.7 million related to Flash Media Reader product inventory.

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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. Accordingly, gross profit percentages are expected to continue to fluctuate from period to period.

Operating Expenses

Research and Development

				% Change						% Change
	Fiscal			2005			Fiscal			2004			Fiscal
	2006			to 2006			2005			to 2005			2004
	(In thousands)
Expenses	$	3,767			(8	)%	$	4,081			(15	)%	$	4,807
Percentage of revenue		11	%					15	%					16	%

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.

We focus the bulk of our research and development activities on the development of products for new and emerging market opportunities. In 2006, we focused primarily on the development of smart card reader technology for the global e-passport market, electronic ID applications and the German e-healthcard program. Research and development expenses were $3.8 million in 2006, or 11% of revenue, compared with $4.1 million in 2005, or 15% of revenue, a decrease of 8%. This decrease was primarily due to a lower level of external resources used, as well as the offsetting effects of approximately $0.2 million of contributions from customer funded development.

In 2005, research and development expenses decreased 15% from 2004 levels of $4.8 million, which represented 16% of revenue. This decrease was primarily due to lower headcount and contract service costs and to the offsetting effect of customer funded development contributions of $0.4 million.

We expect our research and development expenses to vary based on future project demands.

Selling and Marketing

				% Change						% Change
	Fiscal			2005			Fiscal			2004			Fiscal
	2006			to 2006			2005			to 2005			2004
							(In thousands)
Expenses	$	7,498			7	%	$	7,040			(18	)%	$	8,560
Percentage of revenue		22	%					25	%					29	%

Selling and marketing expenses consist primarily of employee compensation as well as tradeshow participation and other marketing costs. We focus a significant proportion of our sales and marketing activities on new and emerging market opportunities. In 2006, these opportunities included e-passport, electronic ID applications and the early stages of the e-healthcard program in Germany. Selling and marketing expenses were $7.5 million in 2006, or 22% of revenue, compared with $7.0 million, or 25% of revenue in 2005, an increase of 7%. The increase primarily consisted of $0.3 million in severance costs related to the consolidation and closure of facilities in the third quarter of 2006, as part of the Company’s efforts to lower expenses. We expect our sales and marketing costs will vary as we continue to align our resources to address existing and new market opportunities.

In 2005, sales and marketing expenses decreased 18% from $8.6 million in 2004, which represented 29% of revenue. This decrease was primarily the result of planned reductions in headcount and tradeshow expenditures as part of the Company’s efforts to lower expenses.

During 2004, selling and marketing expenses decreased in the second half of the year as we completed the launch of several new products. While there was an overall decrease in spending, this decrease was offset in part by increased costs associated with the effect of foreign currency exchange related to the payment of European employees in euros.

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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

				% Change						% Change
	Fiscal			2005			Fiscal			2004			Fiscal
	2006			to 2006			2005			to 2005			2004
							(In thousands)
Expenses	$	7,548			(18	)%	$	9,198			2	%	$	9,021
Percentage of revenue		22	%					33	%					30	%

General and administrative expenses consist primarily of compensation expenses for employees performing our administrative functions, professional fees arising from legal, auditing and other consulting services.

In 2006, general and administrative expenses were $7.5 million, or 22% of revenue, compared with $9.2 million, or 33% of revenue in 2005, a decrease of 18%. The reduction in general and administrative expenses in 2006 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, which also resulted in a more favorable comparison for the year as a whole.

General and administrative expenses in 2005 were relatively unchanged from 2004 levels. While the Company initiated cost reduction measures in the second half of 2004, including a small reduction in headcount and a reduction in expenditures for third-party professional fees, these measures were partially offset by increased costs associated with the effect of foreign currency exchange related to the payment of European employees in euros and increased spending related to Sarbanes-Oxley compliance.

Amortization of Intangibles

Amortization of intangible assets was $0.7 million in 2006, $0.7 million in 2005 and $1.1 million in 2004. Lower amortization amounts in 2005 and 2006 reflect a lower level of intangible assets on our balance sheet.

Impairment of Goodwill and Intangibles

As required under SFAS No. 142, we evaluate the carrying value of goodwill and indefinite-lived intangible assets on our balance sheet from time to time and we will record a charge for impairment whenever events or changes in circumstances indicate that the carrying amount of long-lived assets may not be recoverable.

In 2006 and 2005, no charge for impairment was recorded.

In 2004 we concluded that the carrying value of customer relations and core technology relating to a past acquisition was not supportable because the estimate of future cash flows related to these intangible assets was not sufficient to recover the carrying value of such intangibles. Accordingly, we took a charge of $0.4 million under SFAS No. 144 for intangible asset impairment.

Restructuring and Other Charges (Credits)

During 2006, we recorded restructuring and other charges of $1.4 million, primarily related to severance costs for general and administrative personnel that were affected by our decision to relocate corporate finance and compliance functions from the U.S. to Germany and local finance functions from the U.S. and Singapore to Germany, as well as the outsourcing of our manufacturing operations from our Singapore facility to contract manufacturers. Severance costs for manufacturing personnel of approximately $0.3 million have been recorded in cost of revenue (See Note 8 to our consolidated financial statements attached to this Annual Report on Form 10-K).

During 2005, we incurred restructuring and other charges of $0.8 million, which included $0.2 million of severance costs related to a reduction in force of non-manufacturing personnel at our Singapore facility, resulting

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from our decision to outsource manufacturing operations to contract manufacturers. Severance costs for manufacturing personnel of $0.5 million were recorded in cost of revenue. (See Note 8 to our consolidated financial statements attached to this Annual Report on Form 10-K.) Restructuring and other charges in 2005 also included $0.1 million primarily related to changes in estimates for European tax related matters.

During 2004, we incurred restructuring and other credits related to continuing operations of $0.6 million, which resulted primarily from restructuring costs related to cost reduction actions taken by management during the second half of the year that included employee severance charges of $0.6 million.

Loss from Investments

From time to time, we may make strategic investments in both private and public companies. During each quarter, we evaluate our investments for possible asset impairment. We examine 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.

We had no strategic investments in 2006, 2005 or 2004 and therefore did not record a loss or gain related to investments during these periods.

Interest Income, Net

Interest income, net consists of interest earned on invested cash, offset by interest paid or accrued on outstanding debt.

Interest income resulting from cash balances was $1.4 million in 2006, $0.7 million in 2005 and $0.8 million in 2004. Higher interest income in 2006 resulted from higher interest rates and a greater amount of cash invested. The 2005 period includes a cumulative adjustment to interest income taken in the second quarter for the correction of an error in accounting for the amortization of premiums and discounts on investments. The correction of the error resulted in a reduction of interest income in the second quarter and the year of 2005 of approximately $0.3 million.

Reductions in invested cash balances in 2005 compared with 2004 were offset by higher rates of return on invested funds.

Foreign Currency Gains and Losses and Other Income and Expense

We recorded foreign currency exchange losses and other expense of $0.2 million in 2006, foreign currency exchange gains and other income of $1.7 million in 2005, and foreign currency losses and other expenses of $1.7 million in 2004. Changes in currency valuation in all periods presented were primarily a result of exchange rate movements between the U.S. dollar and the euro.

During 2006, foreign currency losses were $0.3 million, due primarily to the devaluation of the U.S. dollar. Other income was $0.1 million.

During 2005, foreign currency gains were $1.6 million, due primarily to the revaluation of dollar holdings in an entity where the euro is the functional currency. Other income was $0.1 million, primarily attributable to the settlement of transactional tax issues in Europe.

During 2004, net foreign currency losses resulted from foreign currency losses of $1.6 million, due primarily to the decrease in the value of the U.S. dollar as compared with the euro.

Income Taxes

In 2006 and 2005, we recorded provisions for income taxes of $0.1 million and $0.2 million, respectively, primarily resulting from taxes payable in foreign jurisdictions that are not offset by operating loss carryforwards.

In 2004, we recorded a net benefit for income taxes of $0.2 million, primarily due to changes in estimates for taxes related to foreign tax jurisdictions.

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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. Revenue for the DTV solutions business was $13.5 million, $20.8 million and $19.1 million in 2006, 2005 and 2004, respectively. Operating loss for the DTV solutions business was $1.3 million, $1.9 million and $6.6 million in 2006, 2005 and 2004, respectively. Net gain (loss) for the DTV solutions business in 2006, 2005 and 2004 was $3.0 million, $(1.6) million and $(6.1) million, respectively.

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.

Revenue for the retail Digital Media and Video business in 2006, 2005 and 2004 was $0, $0 and $16,000, respectively. Operating loss for the retail Digital Media and Video business for the same periods was $0.2 million, $0.3 million and $0.3 million, respectively. Net gain (loss) for the retail Digital Media and Video business for 2006, 2005 and 2004 was $0.5 million, $(0.5) million and $(0.2) million, respectively.

During 2006, we recorded a net gain on disposal of discontinued operations of $5.2 million, primarily related to the sale of the assets of the DTV solutions business.

During 2005, our net loss on disposal of discontinued operations was $2.2 million, of which the majority related to the settlement of litigation with DVD Cre8, Inc. and related legal costs.

During 2004, our net gain on disposal of discontinued operations was $0.4 million and included $1.6 million of inventory and asset recoveries, offset in part by changes in estimate of lease commitments of $0.4 million and legal costs of $0.8 million.

Liquidity and Capital Resources

As of December 31, 2006, our working capital, which we have defined as current assets less current liabilities, was $32.0 million, compared to $27.3 million as of December 31, 2005. Working capital increased in 2006 by approximately $4.7 million. While current assets increased by $0.5 million resulting from an increase in cash, cash equivalents and short-term investments of $4.5 million which was mainly offset in part by a reduction in inventories of $4.1 million, current liabilities decreased by $4.1 million resulting primarily from lower accounts payable by $1.1 million, reduced accruals by $2.6 million and a decrease in income taxes payable by $0.4 million.

In 2006, cash and cash equivalents increased by $18.4 million, primarily due to the maturity of short-term investments which have been invested short-term in cash. Operating activities provided $0.2 million, investing activities provided $17.5 million, financing activities resulted in a positive cash flow of $0.3 million and the effect of exchange rates on cash and cash equivalents was $0.5 million.

Cash used in continuing operations of $10.3 million was primarily due to a net loss before discontinued operations and depreciation and amortization of $6.7 million. The remaining $3.6 million cash used in continuing operations resulted mainly from the net effect of changes in working capital. Cash provided in operating activities from discontinued operations was $10.5 million and consisted primarily of the $9.0 million received in the sale of the DTV solutions business offset in part by the value of the sold working capital positions as well as the $5.0 million received from Aston for a VAT refund.

Cash provided by investing activities from continuing operations of $14.0 million resulted primarily from the maturity of short-term investments of $16.9 million, partially offset by purchases of $2.9 million.

Cash provided by investing activities from discontinued operations resulted from the sale of the DTV solutions business. The $3.5 million represented the net book value of sold assets and liabilities in the transaction.

Cash provided by financing activities was from the issuance of common stock of $0.3 million related to the Company’s employee stock purchase and stock option programs. At December 31, 2006, our outstanding stock options as a percentage of outstanding shares were 11%, compared to 18% at December 31, 2005.

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During 2006, we used $10.3 million in cash to fund continuing operations. 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.

Off-Balance Sheet Arrangements

We have not entered into off-balance sheet arrangements, or issued guarantees to third parties.

Contractual Obligations

The following summarizes expected cash requirements for contractual obligations as of December 31, 2006 (in thousands):

			Less Than 1		1-3		3-5		More Than 5
	Total		Year		Years		Years		Years
Operating leases	$	6,284	$	1,795	$	2,368	$	1,038	$	1,083
Purchase commitments		8,635		8,635		—		—		—
Total Obligations	$	14,919	$	10,430	$	2,368	$	1,038	$	1,083

Approximately $1.8 million of the purchase commitments relate to the sold DTV solutions business.

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Foreign Currencies

We transact business in various foreign currencies and accordingly, we are subject to exposure from adverse movements in foreign currency exchange rates. This exposure is primarily related to local currency denominated sales and operating expenses in Europe, Singapore, India and Japan, where we conduct business in both local currencies and U.S. dollars. We assess the need to utilize financial instruments to hedge foreign currency exposure on an ongoing basis.

Our foreign currency exchange gains and losses are primarily the result of the revaluation of intercompany receivables/payables (denominated in U.S. dollars) and trade receivables (denominated in a currency other than the functional currency) to the functional currency of the subsidiary. We have performed a sensitivity analysis as of December 31, 2006 and 2005 using a modeling technique which evaluated the hypothetical impact of a 10% movement in the value of the U.S. dollar compared to the functional currency of the subsidiary, with all other variables held constant, to determine the incremental transaction gains or losses that would have been incurred. The foreign exchange rates used were based on market rates in effect at December 31, 2006 and 2005. The results of this hypothetical sensitivity analysis indicated that a hypothetical 10% movement in foreign currency exchange rates would result in increased foreign currency gains or losses of $1.1 million and $1.0 million for 2006 and 2005, respectively.

Fixed Income Investments

We do not use derivative financial instruments in our investment portfolio. We do, however, limit our exposure to interest rate and credit risk by establishing and strictly monitoring clear policies and guidelines for our fixed income portfolios. At the present time, the maximum duration of any investment in our portfolio is limited to less than one year. The guidelines also establish credit quality standards, limits on exposure to one issue or issuer, as well as to the type of instrument. Due to the limited duration and credit risk criteria we have established, our exposure to market and credit risk is not expected to be material.

At December 31, 2006, we had $32.1 million in cash and cash equivalents and $4.8 million in short-term investments. Based on our cash and cash equivalents and short term investments as of December 31, 2006, a hypothetical 10% change in interest rates along the entire interest rate yield curve would not be expected to materially affect the fair value of our financial instruments that are exposed to changes in interest rates.

36

At December 31, 2005, we had $13.7 million in cash and cash equivalents and $18.8 million in short-term investments. Based on our cash and cash equivalents and short term investments as of December 31, 2005, a hypothetical 10% change in interest rates along the entire interest rate yield curve would not materially affect the fair value of our financial instruments that are exposed to changes in interest rates.

ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The information required by this Item is incorporated by reference to pages F-1 through F-28 of this Form 10-K.

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

None.

ITEM 9A.  CONTROLS AND PROCEDURES

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 December 31, 2006. Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective, 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.

Report on Internal Control over Financial Reporting

As a result of the SEC’s extension of the deadline for non-accelerated filers’ compliance with the internal control requirements of Section 404 of the Sarbanes-Oxley Act of 2002, as a non-accelerated filer we are not subject to these requirements in our annual report on Form 10-K for the fiscal year ending December 31, 2006. We will be required to provide management’s report on internal control over financial reporting beginning with our annual report for the fiscal year ending on December 31, 2007. Further, we will be required to file the auditor’s attestation report on internal control over financial reporting beginning with our annual report for the fiscal year ending on December 31, 2008.

Changes in Internal Control Over Financial Reporting

In connection with our continued monitoring and maintenance of our controls procedures in relation to the provisions of the Sarbanes-Oxley Act of 2002, 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 fourth quarter of 2006 that have materially affected, or that are reasonably likely to materially affect, our internal control over financial reporting.

ITEM 9B.   OTHER INFORMATION

Not applicable.

37

PART III

ITEM 10.   DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by Item 10 concerning our directors and officers will be set forth under the captions “Election of Directors” and “Matters Relating to the Board of Directors” in our Proxy Statement relating to our 2007 Annual Meeting of Stockholders, referred to in the Annual Report on Form 10-K as the “Proxy Statement,” which we expect will be filed within 120 days of the end of our fiscal year pursuant to General Instruction G(3) of Form 10-K. Such information is incorporated herein by reference. The information required by this item concerning compliance with Section 16(a) of the Exchange Act is incorporated by reference to the section captioned “Section 16(a) Beneficial Ownership Compliance” that will be set forth in the Proxy Statement. The information required by this item concerning our code of ethics is incorporated by reference to the section captioned “Code of Conduct and Ethics” that will be set forth in the Proxy Statement. The information required by this item concerning the Audit Committee of our Board of Directors is incorporated by reference to the section captioned “Board Committees” in our Proxy Statement.

ITEM 11.   EXECUTIVE COMPENSATION

The information required by Item 11 will be set forth under the section captioned “Executive Compensation” contained in the Proxy Statement, which information is incorporated herein by reference.

ITEM 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information required by Item 12 will be set forth under the captions “Security Ownership of Certain Beneficial Owners and Management” and “Equity Compensation Plan Information” in the Proxy Statement, which information is incorporated herein by reference.

ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by Item 13 will be set forth under the caption “Certain Relationships and Related Transactions” in the Proxy Statement, which information is incorporated herein by reference.

ITEM 14.   PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information required by Item 14 will be set forth under the caption “Principal Accountant Fees and Services” in the Proxy Statement, which information is incorporated herein by reference.

PART IV

ITEM 15.   EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a) Documents Filed with Report

1. Financial Statements

The following Consolidated Financial Statements and Independent Auditors’ Reports are incorporated by reference to pages F-1 through F-28 of this Form 10-K.

a. The consolidated balance sheets as of December 31, 2006 and 2005, and the consolidated statements of operations, stockholders’ equity and comprehensive loss, and cash flows for each of the years in the three-year period ended December 31, 2006, together with the notes thereto.

b. The report of our Independent Registered Public Accounting Firm.

38

2. Financial Statement Schedule

The following financial statement schedule should be read in conjunction with the consolidated financial statements and the notes thereto.

Schedule II — Valuation and Qualifying Accounts

	Balance at						Balance at
	Beginning of						End of
Classification	Period		Additions		Deductions		Period
	(In thousands)
Accounts receivable allowances
Year ended December 31, 2004	$	3,303	$	119	$	1,215	$	2,207
Year ended December 31, 2005		2,207		—		1,235		972
Year ended December 31, 2006		972		119		224		867
Warranty accrual
Year ended December 31, 2004	$	326	$	423	$	505	$	244
Year ended December 31, 2005		244		409		500		153
Year ended December 31, 2006		153		227		346		34

3. Exhibits

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.
	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.

39

Exhibit
Number			Description of Document
	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	Purchase Agreement between SCM Microsystems and Kudelski S.A.
	10	.23(16)*	Restrictive Covenant between Kudelski S.A. and Robert Schneider dated May 22, 2006.
	10	.24(16)*	Amended Employment Agreement between SCM Microsystems GmbH and Robert Schneider dated May 22, 2006.
	10	.25(16)*	Amended Employment Agreement between SCM Microsystems GmbH and Dr. Manfred Mueller dated June 8, 2006.
	10	.26	Lease dated July 15, 2006 between SCM Microsystems and Rreef America Reit II Corp.
	10	.27(17)*	Supplementary Employment Agreement between SCM Microsystems GmbH and Stephan Rohaly dated December 12, 2006.
	21	.1	Subsidiaries of the Registrant.
	23	.1	Consent of Independent Registered Public Accounting Firm.
	31	.1	Certification of Chief Executive Officer pursuant to Rule 13a-14 and Rule 15D-14 of the Securities Exchange Act, as amended.
	31	.2	Certification of Chief Financial Officer pursuant to Rule 13a-14 and Rule 15D-14 of the Securities Exchange Act, as amended.
	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).

40

(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 Quarterly Report on Form 10-Q for the quarter ended June 30, 2006 (see SEC File No. 000-29440).
(17)	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.

41

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.

By:  /s/  Robert Schneider

Robert Schneider

Chief Executive Officer and Director

March 19, 2007

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

Signature	Capacity in Which Signed	Date
/s/  Werner Koepf Werner Koepf	Chairman of the Board	March 19, 2007
/s/  Robert Schneider Robert Schneider	Chief Executive Officer (Principal Executive Officer) and Director	March 19, 2007
/s/  Stephan Rohaly Stephan Rohaly	Chief Financial Officer and Secretary (Principal Financial and Accounting Officer)	March 19, 2007
/s/  Manuel Cubero Manuel Cubero	Director	March 19, 2007
/s/  Hagen Hultzsch Hagen Hultzsch	Director	March 19, 2007
/s/  Steven Humphreys Steven Humphreys	Director	March 19, 2007
/s/  Ng Poh Chuan Ng Poh Chuan	Director	March 19, 2007
/s/  Simon Turner Simon Turner	Director	March 19, 2007

42

SCM MICROSYSTEMS, INC. AND SUBSIDIARIES

Index to Consolidated Financial Statements

	Page
Report of Independent Registered Public Accounting Firm		F-2
Consolidated Balance Sheets as of December 31, 2006 and 2005		F-3
Consolidated Statements of Operations for the Years Ended December 31, 2006, 2005 and 2004		F-4
Consolidated Statements of Stockholders’ Equity and Comprehensive Income (Loss) for the Years Ended December 31, 2006, 2005 and 2004		F-5
Consolidated Statements of Cash Flows for the Years Ended December 31, 2006, 2005 and 2004		F-6
Notes to Consolidated Financial Statements		F-7

F-1

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders

of SCM Microsystems, Inc.:

We have audited the accompanying consolidated balance sheets of SCM Microsystems, Inc. and subsidiaries (the Company) as of December 31, 2006 and 2005, and the related consolidated statements of operations, stockholders’ equity and comprehensive income (loss), and cash flows for each of the three years in the period ended December 31, 2006. Our audits also included the financial statement schedule listed in the Index at Item 15(a)(2). These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of SCM Microsystems, Inc. and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

/s/  DELOITTE & TOUCHE GMBH

WIRTSCHAFTSPRÜFUNGSGESELLSCHAFT

Munich, Germany

March 20, 2007

F-2

SCM MICROSYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands)

	December 31,
	2006			2005
ASSETS
Current assets:
Cash and cash equivalents	$	32,103		$	13,660
Short-term investments		4,799			18,780
Accounts receivable, net of allowances of $867 and $972 as of December 31, 2006 and 2005, respectively		6,583			6,904
Inventories		1,927			6,005
Other current assets		2,489			2,038
Total current assets		47,901			47,387
Property and equipment, net		1,457			3,050
Intangible assets, net		272			879
Other assets		1,725			1,418
Total assets	$	51,355		$	52,734
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	4,572		$	5,700
Accrued compensation and related benefits		1,729			2,708
Accrued restructuring and other charges		3,431			3,897
Accrued professional fees		1,063			1,644
Accrued royalties		971			1,244
Other accrued expenses		2,289			2,565
Income taxes payable		1,879			2,258
Total current liabilities		15,934			20,016
Deferred tax liability		103			101
Commitments and contingencies (see Notes 12 and 14)		—			—
Stockholders’ equity:
Common stock, $0.001 par value: 40,000 shares authorized; 16,316 and 16,211 shares issued and 15,698 and 15,593 shares outstanding as of December 31, 2006 and 2005, respectively		16			16
Additional paid-in capital		228,580			227,676
Treasury stock, 618 shares		(2,777	)		(2,777	)
Accumulated deficit		(191,714	)		(192,756	)
Other cumulative comprehensive income		1,213			458
Total stockholders’ equity		35,318			32,617
Total liabilities and stockholders’ equity	$	51,355		$	52,734

See notes to consolidated financial statements.

F-3

SCM MICROSYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

	Years Ended December 31,
	2006			2005			2004
	(In thousands, except per share data)
Net revenue	$	33,613		$	27,936		$	30,030
Cost of revenue		21,756			17,106			17,724
Gross profit		11,857			10,830			12,306
Operating expenses:
Research and development		3,767			4,081			4,807
Selling and marketing		7,498			7,040			8,560
General and administrative		7,548			9,198			9,021
Amortization of intangibles		666			673			1,078
Impairment of intangibles		—			—			388
Restructuring and other charges		1,120			319			607
Total operating expenses		20,599			21,311			24,461
Loss from operations		(8,742	)		(10,481	)		(12,155	)
Interest income		1,350			745			806
Foreign currency gains (losses) and other income (expense), net		(225	)		1,731			(1,675	)
Loss from continuing operations before income taxes		(7,617	)		(8,005	)		(13,024	)
Benefit (provision) for income taxes		(73	)		(150	)		173
Loss from continuing operations		(7,690	)		(8,155	)		(12,851	)
Gain (loss) from discontinued operations, net of income taxes		3,508			(2,109	)		(6,242	)
Gain (loss) on sale of discontinued operations, net of income taxes		5,224			(2,171	)		430
Net income (loss)	$	1,042		$	(12,435	)	$	(18,663	)
Basic and diluted loss per share from continuing operations	$	(0.49	)	$	(0.53	)	$	(0.83	)
Basic and diluted income (loss) per share from discontinued operations	$	0.56		$	(0.27	)	$	(0.38	)
Basic and diluted net income (loss) per share	$	0.07		$	(0.80	)	$	(1.21	)
Shares used to compute basic and diluted income (loss) per share		15,638			15,532			15,402

See notes to consolidated financial statements.

F-4

SCM MICROSYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND
COMPREHENSIVE INCOME (LOSS)
Years Ended December 31, 2006, 2005 and 2004

													Other
													Cumulative
					Additional								Comprehensive			Total			Comprehensive
	Common Stock				Paid-in		Treasury			Accumulated			Income			Stockholders’			Income
	Shares		Amount		Capital		Stock			Deficit			(Loss)			Equity			(Loss)
	(In thousands)
Balances, January 1, 2004		15,300		15		226,582		(2,777	)		(161,658	)		1,262			63,424
Issuance of common stock upon exercise of options		70		—		413		—			—			—			413
Issuance of common stock under Employee Stock Purchase Plan		114		—		371		—			—			—			371
Non-employee stock-based compensation expense		—		—		32		—			—			—			32
Unrealized loss on investments		—		—		—		—			—			(202	)		(202	)	$	(202	)
Foreign currency translation adjustment		—		—		—		—			—			1,454			1,454			1,454
Net loss		—		—		—		—			(18,663	)		—			(18,663	)		(18,663	)
Comprehensive loss		—		—		—		—			—			—			—		$	(17,411	)
Balances, December 31, 2004		15,484		15		227,398		(2,777	)		(180,321	)		2,514			46,829
Issuance of common stock upon exercise of options		2		—		6		—			—			—			6
Issuance of common stock under Employee Stock Purchase Plan		107		1		272		—			—			—			273
Realized gain on investments adjustments		—		—		—		—			—			(49	)		(49	)	$	(49	)
Unrealized gain on investments		—		—		—		—			—			229			229			229
Foreign currency translation adjustment		—		—		—		—			—			(2,236	)		(2,236	)		(2,236	)
Net loss		—		—		—		—			(12,435	)		—			(12,435	)		(12,435	)
Comprehensive loss		—		—		—		—			—			—			—		$	(14,491	)
Balances, December 31, 2005		15,593	$	16	$	227,676	$	(2,777	)	$	(192,756	)	$	458		$	32,617
Issuance of common stock upon exercise of options		26		—		72		—			—			—			72
Issuance of common stock under Employee Stock Purchase Plan		79		—		190		—			—			—			190
Stock-based compensation expense		—		—		642		—			—			—			642
Unrealized gain on investments		—		—		—		—			—			71			71		$	71
Foreign currency translation adjustment		—		—		—		—			—			684			684			684
Net income		—		—		—		—			1,042			—			1,042			1,042
Comprehensive income		—		—		—		—			—			—			—		$	1,797
Balances, December 31, 2006		15,698	$	16	$	228,580	$	(2,777	)	$	(191,714	)	$	1,213		$	35,318

See notes to consolidated financial statements.

F-5

SCM MICROSYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

	Years Ended December 31,
	2006			2005			2004
	(In thousands)
Cash flows from operating activities:
Net income (loss)	$	1,042		$	(12,435	)	$	(18,663	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities from continuing operations:
Loss (gain) from discontinued operations		(8,732	)		4,280			5,812
Deferred income taxes		2			(30	)		(224	)
Depreciation and amortization		1,036			1,703			2,933
Stock-based compensation expense		632			—			32
Loss (gain) on disposal of property and equipment		46			(128	)		58
Impairment of intangibles		—			—			388
Changes in operating assets and liabilities:
Accounts receivable		(2,388	)		2,414			(1,366	)
Inventories		398			(1,021	)		2,005
Other assets		(574	)		367			6,060
Accounts payable		81			1,860			(1,936	)
Accrued expenses		(1,990	)		(5,402	)		(3,264	)
Income taxes payable		102			174			(652	)
Net cash used in operating activities from continuing operations		(10,345	)		(8,218	)		(8,817	)
Net cash provided by (used in) operating activities from discontinued operations		10,524			(4,595	)		(2,355	)
Net cash provided by (used in) operating activities		179			(12,813	)		(11,172	)
Cash flows from investing activities:
Capital expenditures		(73	)		(57	)		(166	)
Proceeds from disposal of property and equipment		11			381			32
Sales and maturities of short-term investments		16,918			12,055			4,849
Purchases of short-term investments		(2,878	)		(15,851	)		(14,385	)
Net cash provided by (used in) investing activities from continuing operations		13,978			(3,472	)		(9,670	)
Net cash provided by (used in) investing activities from discontinued operations		3,484			(17	)		(196	)
Net cash provided by (used in) investing activities		17,462			(3,489	)		(9,866	)
Cash flows from financing activities:
Proceeds from issuance of equity securities, net		262			279			784
Net cash provided by financing activities		262			279			784
Effect of exchange rates on cash and cash equivalents		540			(1,498	)		2,053
Net increase (decrease) in cash and cash equivalents		18,443			(17,521	)		(18,201	)
Cash and cash equivalents, beginning of year		13,660			31,181			49,382
Cash and cash equivalents, end of year	$	32,103		$	13,660		$	31,181
Supplemental disclosures of cash flow information:
Income tax refunds received	$	—		$	96		$	730
Income taxes paid	$	133		$	40		$	144

See notes to consolidated financial statements.

F-6

SCM MICROSYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.   Organization and Summary of Significant Accounting Policies

SCM Microsystems (“SCM” or “the Company”) was incorporated under the laws of the State of Delaware in December 1996. SCM’s principal business activity is the design, development and sale of hardware, software and silicon solutions that enable people to conveniently and securely access digital content and services. The Company sells its products primarily into two market segments: PC Security and Flash Media Readers. In the PC Security market, the Company provides smart card reader technology that enables secure access to PCs, networks and physical facilities. In the Flash Media Reader market, the Company provides digital media readers that are used to transfer digital content to and from various flash media. SCM’s target customers are primarily original equipment manufacturers, or OEMs, who typically either bundle the Company’s products with their own solutions, or repackage the products for resale to their customers. OEM customers include: government contractors, systems integrators, large enterprises, computer manufacturers, as well as banks and other financial institutions for SCM’s smart card readers; and computer and photographic equipment manufacturers for the Company’s digital medial readers. SCM sells and licenses its products through a direct sales and marketing organization, as well as through distributors, value-added resellers and system integrators worldwide.

SCM maintains its corporate headquarters in Ismaning, Germany, with additional facilities in India, the United States and Japan for research and development and sales and marketing.

Principles of Consolidation and Basis of Presentation — The accompanying consolidated financial statements include the accounts of SCM and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

Discontinued Operations — The financial information related to SCM’s former Digital Television solutions (“DTV solutions”) business and retail Digital Media and Video business is reported as discontinued operations for all periods presented as discussed in Note 3.

Use of Estimates — The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires SCM’s management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Such management estimates include an allowance for doubtful accounts receivable, provision for inventory, lower of cost or market adjustments, valuation allowances against deferred income taxes, estimates related to recovery of long-lived assets and accruals of product warranty, restructuring reserves and accruals, and other liabilities. Actual results could differ from these estimates.

Cash Equivalents — SCM considers all highly liquid debt investments with maturities of three months or less at the date of acquisition to be cash equivalents.

Short-term Investments — Short-term investments consist of corporate notes and United States government agency instruments, and are stated at fair value based on quoted market prices. Short-term investments are classified as available-for-sale. The difference between amortized cost and fair value representing unrealized holding gains or losses is recorded as a component of stockholders’ equity as other cumulative comprehensive gain or loss. Gains and losses on sales of investments are determined on a specific identification basis. Short-term investments are evaluated for impairment on a quarterly basis and are written down to their fair value when impairment indicators present are considered to be other than temporary.

Fair Value of Financial Instruments — SCM’s financial instruments include cash and cash equivalents, short-term investments, trade receivables and payables, and long-term investments. At December 31, 2006 and 2005, the fair value of cash and cash equivalents, trade receivables and payables approximated their financial statement carrying amounts because of the short-term maturities of these instruments. (See Note 4 for fair value of investments.)

F-7

SCM MICROSYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Inventories — Inventories are stated at the lower of standard cost, which approximates cost, or market value. Cost is determined on the first-in, first-out method.

Property and Equipment — Property and equipment are stated at cost. Depreciation and amortization are computed using the straight-line method over estimated useful lives of three to five years except for buildings which are depreciated over twenty-five to thirty years. Leasehold improvements are amortized over the shorter of the lease term or their useful life.

Intangible and Long-lived Assets — The Company evaluates long-lived assets under Statement of Financial Accounting Standard (“SFAS”) No. 144, Accounting for the Impairment or Disposal of Long-lived Assets. SCM evaluates its long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets or intangibles may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net undiscounted cash flows expected to be generated by an asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceed the fair value of the assets. Intangible assets with definite lives are being amortized using the straight-line method over the useful lives of the related assets, from two to five years. During the fourth quarter of 2004, SCM recognized an impairment charge of $0.4 million relating to the intangible assets from a past acquisition.

Revenue Recognition — SCM recognizes revenue pursuant to Staff Accounting Bulletin (“SAB”) No. 104, Revenue Recognition.  Accordingly, revenue from product sales is recognized upon product shipment, provided that risk and title have transferred, a purchase order has been received, the sales price is fixed and determinable and collection of the resulting receivable is probable. Maintenance revenue is deferred and amortized ratably 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.

Research and Development — Research and development expenses are expensed as incurred and consist primarily of employee compensation and fees for the development of prototype products. Cost contributions by customers are accounted for as reductions in research and development expenses.

Freight Costs — SCM reflects the cost of shipping its products to customers as cost of revenue. Since 2005, reimbursements received from customers for freight costs are recognized in revenue. Customer reimbursements for freight are not significant.

Income Taxes — SCM accounts for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes, which requires the asset and liability approach for financial accounting and reporting of income taxes. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. A valuation allowance is provided to reduce the net deferred tax asset to an amount that is more likely than not to be realized. At December 31, 2006 and 2005, a full valuation allowance was provided against the net deferred tax assets.

Stock-based Compensation — During the first quarter of fiscal 2006, the Company adopted the provisions of, and accounted for stock-based compensation in accordance with, the Financial Accounting Standards Board’s (“FASB”) SFAS No. 123 — revised 2004 (“SFAS 123(R)”), Share-Based Payment, which replaced SFAS No. 123, Accounting for Stock-Based Compensation and supersedes Accounting Principles Board (“APB”) Opinion No. 25 (“APB 25”), Accounting for Stock Issued to Employees. Under the fair value recognition provisions of this statement, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense on a straight-line basis over the requisite service period, which is the vesting period. The Company elected to use the modified-prospective method, under which prior periods are not revised for comparative purposes. The valuation provisions of SFAS 123(R) apply to new grants and to grants that were outstanding as of the effective date and are subsequently modified. Estimated compensation for grants that were outstanding as of the effective date will be recognized over the remaining service period using the compensation cost estimated for the SFAS 123 pro forma disclosures.

F-8

SCM MICROSYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The adoption of SFAS 123(R) did not have a material impact on the Company’s consolidated financial position, results of operations and cash flows. See Note 2 for further information regarding the Company’s stock-based compensation assumptions and expenses, including pro forma disclosures for prior periods as if the Company had recorded stock-based compensation expense in accordance with SFAS 123.

Net Income or Loss Per Share — Basic and diluted net income or loss per share is based upon the weighted average number of common shares outstanding during the period. Diluted net income per share is based upon the weighted average number of common shares and dilutive-potential common share equivalents outstanding during the period. Dilutive-potential common share equivalents are excluded from the computation in loss periods as their effect would be antidilutive. If there is a loss from continuing operations, diluted net income per share would be computed in the same manner as basic net income per share is computed, even if an entity has net income after adjusting for a discontinued operation, an extraordinary item, or the cumulative effect of an accounting change.

Foreign Currency Translation and Transactions — The functional currencies of SCM’s foreign subsidiaries are the local currencies, except for the Singapore subsidiary, which, effective January 1, 2004, uses the U.S. dollar as its functional currency. The change in the functional currency of the Singapore subsidiary was in accordance with SFAS 52, Foreign Currency Translation, and reflects the changed economic facts and circumstances of the Singapore subsidiary. The books of record of the Singapore subsidiary are maintained in its functional currency, the U.S. dollar. For those subsidiaries whose functional currency is the local currency, SCM translates assets and liabilities to U.S. dollars using period end exchange rates and translate revenues and expenses using average exchange rates during the period. Exchange gains and losses arising from translation of foreign entity financial statements are included as a component of other comprehensive income (loss). Gains and losses from transactions denominated in currencies other than the functional currencies of SCM or its subsidiaries are included in other income and expense. SCM recorded a currency loss of $0.3 million in fiscal year 2006, a currency gain of $1.7 million in fiscal 2005 and a currency loss of $1.6 million in fiscal 2004.

Concentration of Credit Risk — Financial instruments that potentially expose the Company to concentrations of credit risk consist primarily of cash and cash equivalents, accounts receivable and short-term investments. SCM’s cash equivalents primarily consist of money market accounts and commercial paper with maturities of less than three months. SCM primarily sells its products to companies in the United States, Asia and Europe. One U.S. based customer represented 17% and one Asia based customer represented 19% of accounts receivable at December 31, 2006. The Company does not require collateral or other security to support accounts receivable. To reduce risk, SCM’s management performs ongoing credit evaluations of its customers’ financial condition. SCM maintains allowances for potential credit losses.

Comprehensive Gain (Loss) — SFAS No. 130, Reporting Comprehensive Income requires an enterprise to report, by major components and as a single total, the change in net assets during the period from non-owner sources. Comprehensive income (loss) for the years ended December 31, 2006, 2005 and 2004 has been disclosed within the consolidated statements of stockholders’ equity and comprehensive income (loss).

Recently Issued Accounting Standards

In April 2006, the FASB issued FASB Staff Position FASB Interpretation No. 46(R)-6 (“FSP FIN 46(R)-6”), which addresses how a reporting enterprise should determine the variability to be considered in applying FASB Interpretation No. 46, Consolidation of Variable Interest Entities, as amended (“FIN 46(R)”). The variability that is considered in applying FIN 46(R) affects the determination of (a) whether the entity is a variable interest entity, (b) which interests are variable interests in the entity and (c) which party, if any, is the primary beneficiary of the variable interest entity. That variability will affect any calculation of expected losses and expected residual returns, if such a calculation is necessary. FSP FIN 46(R)-6 provides additional guidance to consider for determining variability. FSP FIN 46(R)-6 is effective beginning the first day of the first reporting period beginning after June 15, 2006. After evaluating FSP FIN 46(R)-6, the Company determined that there is no impact to its consolidated financial position, results of operations or cash flows from its adoption.

F-9

SCM MICROSYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

In June 2006, the FASB ratified Emerging Issues Task Force (“EITF”) Issue No. 06-03, How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross Versus Net Presentation) (“Issue No. 06-03”). Under Issue No. 06-03, a company must disclose its accounting policy regarding the gross or net presentation of certain taxes. If taxes included in gross revenues are significant, a company must disclose the amount of such taxes for each period for which an income statement is presented (i.e., both interim and annual periods). Taxes within the scope of this Issue are those that are imposed on and concurrent with a specific revenue-producing transaction. Taxes assessed on an entity’s activities over a period of time, such as gross receipts taxes, are not within the scope of the issue. Issue No. 06-03 is effective for the first annual or interim reporting period beginning after December 15, 2006. After evaluating Issue No. 06-03, the Company determined that there is no impact to its consolidated financial position, results of operations or cash flows from its adoption.

In July 2006, the FASB issued 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.

The Company has completed its initial evaluation of the impact of the January 1, 2007, adoption of FIN 48 and determined, that such adoption will most likely result in a reduction of its disclosed income taxes payable of $1.9 million as of December 31, 2006. The expected reduction of income taxes payable will be accounted for as an increase to the January 1, 2007 beginning balance of retained earnings. The Company’s expectation of the impact from the adoption of FIN 48 is subject to revision as management completes its analysis.

In September 2006, the Securities and Exchange Commission (“SEC”) published Staff Accounting Bulletin (“SAB”) No 108. SAB 108 expresses the staff views regarding the process of quantifying financial statement misstatements. The bulletin prescribes the use of “rollover” and “iron curtain” approaches in quantifying misstatements. “Rollover” approach quantifies a misstatement based on the amount of the error originating in the current year income statement. “Iron curtain” approach quantifies a misstatement based on the effects of correcting the misstatement existing in the balance sheet at the end of the year, irrespective of the misstatement’s year(s) of origination. The statement is effective immediately. The Company did not have any misstatements that were determined to be material on the basis of either of the approaches mentioned above.

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. 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.   Stockholders’ Equity and Stock Based Compensation

Repurchase Plan

In October 2002, SCM’s Board of Directors approved a stock repurchase program in which up to $5.0 million may be used to purchase shares of the Company’s common stock on the open market in the United States or Germany from time to time over two years, depending on market conditions, share prices and other factors. During 2003 and 2002, SCM repurchased a total of 618,400 shares of its common stock under the program for an aggregate of $2.8 million. The stock repurchase program ended in the fourth quarter of 2004.

F-10

SCM MICROSYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Stockholders Rights Plan

On November 8, 2002, SCM’s Board of Directors approved a stockholders rights plan. Under the plan, the Company declared a dividend of one preferred share purchase right for each share of the Company’s common stock held by SCM stockholders of record as of the close of business on November 25, 2002. Each preferred share purchase right entitles the holder to purchase from SCM one one-thousandth of a share of Series A participating preferred stock, par value $0.001 per share, at a price of $30.00, subject to adjustment. The rights are not immediately exercisable, however, and will become exercisable only upon the occurrence of certain events. If a person or group acquires, or announces a tender or exchange offer that would result in the acquisition of 15% or more of SCM’s common stock while the stockholder rights plan remains in place, then, unless the rights are redeemed by SCM for $0.001 per right, the rights will become exercisable by all rights holders except the acquiring person or group for shares of the Company or the third party acquirer having a value of twice the right’s then-current exercise price. The stockholder rights plan may have the effect of deterring or delaying a change in control of the Company.

Stock Based Compensation Plans

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, vesting 25% each year over four years and expire ten years from the grant date. Additionally, the Company has an Employee Stock Purchase Plan (“ESPP”) that allows 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 December 31, 2006, the Company had approximately 4.5 million shares of common stock reserved for future issuance under the stock option plans and ESPP. The Company’s ESPP, its director option plan and one of its employee stock option plans will expire in March 2007.

On January 1, 2006, the Company adopted the provision 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 year ended December 31, 2006, 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 to 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 consolidated statement of operations for the year ended December 31, 2006 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.

F-11

SCM MICROSYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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), the Company’s loss from continuing operations before the income tax provision and net loss from discontinued operations for the year ended December 31, 2006 was $0.6 million higher than it would have been had the Company continued to account for share-based compensation under APB 25. Basic and diluted net loss per share from continuing operations for the year ended December 31, 2006 would have been $0.04 lower, if the Company had not adopted SFAS 123(R). There was no effect on the condensed consolidated statements of cash flows for the year ended December 31, 2006 from adopting SFAS 123(R).

On November 10, 2005, the FASB issued FASB Staff Position No. FAS 123(R)-3 (“SFAS 123(R)-3”), Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards. 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 shares issued under the ESPP included in the audited condensed consolidated statement of operations for the year ended December 31, 2006 (in thousands):

	Year Ended
	December 31,
	2006
Cost of revenue	$	36
Research and development		110
Selling and marketing		163
General and administrative		323
Stock-based compensation expense before income taxes	$	632
Income tax benefit		—
Stock-based compensation expense after income taxes	$	632

Stock Option Plans

A total of 4,084,775 shares of common stock are currently reserved for future grant under the Company’s stock option plans.

F-12

SCM MICROSYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

A summary of the activity under the Company’s stock option plans for the three years ended December 31, 2006 is as follows:

											Weighted
							Weighted				Average
	Options			Number of			Average				Remaining
	Available			Options			Exercise Price		Aggregate		Contractual
	for Grant			Outstanding			per Share		Intrinsic Value		Life (in years)
Balance at December 31, 2003 (1,756,560 exercisable at $29.54)		2,880,435			2,979,859		$	22.92
Options Authorized		35,000			—			—
Options granted		(512,897	)		512,897		$	3.95
Options cancelled or expired		495,693			(495,693	)	$	25.36
Options exercised		—			(69,477	)	$	5.95	$	130,700
Balance at December 31, 2004 (1,936,445 exercisable at $27.03)		2,898,231			2,927,586		$	19.58
Options Authorized		35,000			—			—
Options granted		(331,928	)		331,928		$	3.49
Options cancelled or expired		435,005			(435,005	)	$	28.93
Options exercised		—			(1,748	)	$	3.31	$	1,901
Balance at December 31, 2005 (2,099,539 exercisable at $20.56)		3,036,308			2,822,761		$	16.26		—		6.07
Options Authorized		35,000			—			—
Options granted		(376,794	)		376,794		$	3.26		—		—
Options cancelled or expired		1,390,261			(1,390,261	)	$	17.71		—		—
Options exercised		—			(26,039	)	$	2.78	$	8,716		—
Balance at December 31, 2006		4,084,775			1,783,255		$	12.58	$	81,808		5.79
Vested or expected to vest at December 31, 2006					1,660,044		$	13.28	$	70,111		—
Exerciseable at December 31, 2006					1,208,481		$	17.02	$	43,299		4.35

The following table summarizes information about options outstanding as of December 31, 2006:

	Options Outstanding
			Weighted				Options Exercisable
			Average		Weighted				Weighted
			Remaining		Average				Average
	Number		Contractual		Exercise		Number		Exercise
Range of Exercise Prices	Outstanding		Life (Years)		Price		Exercisable		Price
$ 2.65 - $ 3.08		368,690		8.34	$	2.89		150,041	$	2.82
$ 3.10 - $ 3.41		388,646		8.78		3.32		53,495		3.29
$ 3.44 - $ 8.08		513,988		5.23		7.02		493,563		7.10
$ 8.10 - $45.56		381,680		1.93		24.75		381,131		24.77
$47.88 - $83.00		130,251		3.19		53.89		130,251		53.89
$ 2.65 - $83.00		1,783,255		5.79	$	12. 58		1,208,481	$	17.02

The weighted-average grant date fair value per option for options granted during the years ended December 31, 2006, 2005 and 2004 was $1.71, $2.76, and $3.01, respectively. The total intrinsic value of options exercised during the years ended December 31, 2006, 2005 and 2004 was $8,716, $1,901, and $130,700, respectively. Cash proceeds from the exercise of stock options were $72,000, $5,800 and $414,000 for the three years ended December 31, 2006,

F-13

SCM MICROSYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

2005 and 2004, respectively. No income tax benefit was realized from the stock option exercises during the three year period ended December 31, 2006. Stock-based compensation expense related to stock options recognized under SFAS 123(R) for the year ended December 31, 2006 was $0.6 million. At December 31, 2006, there was $0.8 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 1.59 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 years ended December 31, 2006, respectively:

	2006			2005			2004
Risk-free interest rate		4.81	%		3.84	%		3.43	%
Expected volatility		67	%		90	%		93	%
Expected term in years		3.92			4.00			4.00
Dividend yield		None			None			None

Expected Volatility:  The Company’s computation of expected volatility for the year ended December 31, 2006 is based on the historical volatility of the Company’s stock for a time period equivalent to the expected life. Prior to the year ended December 31, 2006, the Company had used its historical stock price volatility in accordance with SFAS 123 for purposes of its pro forma information.

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 and was determined for the year ended December 31, 2006 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 four years.

Forfeiture Rates:  Compensation expense recognized in the consolidated statement of operations for the fiscal year 2006 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

Under the Company’s ESPP, up to 1,021,887 shares of the Company’s common stock may be issued. The Company’s ESPP permits 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 has a two-year rolling plan with four purchases every six months within the offering period. If the fair market value per share is lower on the purchase date than the beginning of the offering period, the current offering period terminates and a new two-year offering period will commence. The Company’s ESPP restricts the maximum amount of shares purchased by an individual to $25,000 worth of common stock each year. During 2006, 2005 and 2004, a total of 78,679, 107,526 and 114,151 shares, respectively, were issued under the plan. As of December 31, 2006, 354,899 shares were available for future issuance under the Company’s ESPP. The ESPP will expire in March 2007.

The fair value of issuances under the Company’s ESPP is 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

F-14

SCM MICROSYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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 year ended December 31, 2006 was $111,000. At December 31, 2006, there was $61,000 of unrecognized stock-based compensation expense related to outstanding ESPP shares that is expected to be recognized over a twenty two month period.

The following weighted average assumptions are included in the estimated grant date fair value calculations for rights to purchase stock under the Purchase Plan:

	2006	2005	2004
Expected life	15 months	6 months	6 months
Risk-free interest	4.90%	2.56%	2.00%
Volatility	49%	76%	73%
Dividend yield	None	None	None

The weighted-average fair value of purchase rights granted under the Purchase Plan in 2006, 2005 and 2004 was $1.36, $1.08 and $1.89 per share, respectively.

Prior to 2006, the Company accounted for its employee stock option and employee stock purchase plans under the intrinsic value recognition and measurement principles of APB No. 25 and related Interpretations, and had adopted the disclosure-only provisions of SFAS 123, as amended by SFAS 148, Accounting for Stock-Based Compensation — Transition and Disclosures. As the exercise price of the Company’s employee stock options equals the market price of the underlying stock on the date of the grant, no compensation expense was recognized in the Company’s financial statements.

In calculating pro forma compensation, the fair value of each option grant is estimated 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 the Company’s stock-based awards to employees have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of its stock-based awards to its employees.

Had the Company determined stock-based compensation costs based on the estimated fair value at the grant date for its stock options and the estimated fair value at the issuance date for its ESPP, the Company’s net loss and net loss per share for the fiscal years ended December 31, 2005 and 2004 would have been as follows (in thousands, except per share data):

	Year Ended			Year Ended
	December 31,			December 31,
	2005			2004
Net loss as reported	$	(12,435	)	$	(18,663	)
Add: Stock-based compensation expense included in reported net loss, net of related tax effects		—			—
Less: Stock-based compensation expense determined under fair value method for all awards		(1,363	)		(2,494	)
Pro forma net loss	$	(13,798	)	$	(21,157	)
Net loss per share, as reported — basic and diluted	$	(0.80	)	$	(1.21	)
Pro forma loss per share — basic and diluted	$	(0.89	)	$	(1.37	)

F-15

SCM MICROSYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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 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 fiscal years ended December 31, 2006, 2005 and 2004, 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 will be generated for a limited time. Based on this agreement, a service fee is earned by the Company for its services to order products with a supplier of DTV solutions business products and to sell these products to Kudelski. It is expected that these revenues will be generated until approximately the second quarter of 2007.

The operating results for the discontinued operations of the DTV solutions business for the fiscal years ended December 31, 2006, 2005 and 2004 are as follows (in thousands):

	Years Ended December 31,
	2006			2005			2004
Net revenue	$	13,513		$	20,785		$	19,054
Operating loss	$	(1,287	)	$	(1,868	)	$	(6,571	)
Income (loss) before income taxes	$	2,953		$	(1,791	)	$	(6,096	)
Income tax benefit	$	67		$	183		$	5
Gain (loss) from discontinued operations	$	3,020		$	(1,608	)	$	(6,091	)

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 years ended December 31, 2006, 2005 and 2004 are as follows (in thousands):

	Years Ended December 31,
	2006			2005			2004
Net revenue	$	—		$	—		$	16
Operating loss	$	(168	)	$	(287	)	$	(257	)
Loss before income taxes	$	(76	)	$	(430	)	$	(151	)
Income tax benefit (provision)	$	564		$	(71	)	$	—
Gain (loss) from discontinued operations	$	488		$	(501	)	$	(151	)

The operating loss for the Digital Media and Video business resulted from general and administrative expenses for the discontinued entities in the U.S. and UK, mainly in connection with the remaining long-term lease agreements from the discontinued operations.

F-16

SCM MICROSYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

During 2006, net loss on disposal of the retail Digital Media and Video business was $0.1 million, which was related to changes in estimates for lease commitments.

During 2005, net loss on disposal of the retail Digital Media and Video business was $2.2 million, of which the majority was related to the settlement of litigation with DVD Cre8, Inc. and related legal costs (see Note 8).

During 2004, net gain on disposal of the retail Digital Media and Video business was $0.4 million and included $1.6 million of inventory and asset recoveries, offset by changes in estimates for lease commitments of $0.4 million and legal costs of $0.8 million.

4.   Short-Term Investments

At December 31, 2006, all of the short-term investment portfolio matures in 2007. The fair value of short-term investments at December 31, 2006 and 2005 was as follows (in thousands):

	December 31, 2006
			Unrealized		Unrealized			Estimated
	Amortized		Gain on		Loss on			Fair
	Cost		Investments		Investments			Value
Corporate notes	$	1,021	$	—	$	(2	)	$	1,019
U.S. government agencies		3,792		—		(12	)		3,780
Total	$	4,813	$	—	$	(14	)	$	4,799

	December 31, 2005
			Unrealized		Unrealized			Estimated
	Amortized		Gain on		Loss on			Fair
	Cost		Investments		Investments			Value
Corporate notes	$	9,369	$	6	$	(34	)	$	9,341
U.S. government agencies		9,490		—		(51	)		9,439
Total	$	18,859	$	6	$	(85	)	$	18,780

Cumulative Adjustment to Interest Income and Other Cumulative Comprehensive Gain

In July 2005, during a review of the Company’s investment holdings and the calculation of interest income and unrealized gains and losses on investments, the Company discovered an error in the recording of the amortization of investment premiums and discounts and the related interest income and unrealized gain (loss) on investments. As a result, interest income and unrealized loss on investments and the balance of unrealized loss included in other cumulative comprehensive gain for the years ended December 31, 2004 and 2003 were overstated. The cumulative overstatement of interest income and unrealized loss on investments for periods prior to the three months ended June 30, 2005 was approximately $0.3 million. The effect of the error was not material to any relevant prior period and had the amounts been recorded correctly in the prior periods, there would have been no effect on reported comprehensive loss or total stockholder’s equity. To correct this error, the Company recorded the cumulative $0.3 million as a reduction in interest income and a decrease in unrealized loss on investments during the three-month period ended June 2005.

During each quarter, SCM 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 December 31, 2006, approximately $4.8 million of the short-term investment portfolio has an unrealized loss and approximately $2.7 million of those investments have been in an unrealized loss position for more than one year. Of the $14,000 unrealized loss at December 31, 2006, approximately $4,000 relates to investments that have been in an unrealized loss position for more than one year. The Company believes these fair

F-17

SCM MICROSYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

value declines are the result of rising short-term interest rates. For the years ended December 31, 2006, 2005 and 2004, no impairment of the investments was identified based on the evaluations performed.

5.   Inventories

Inventories consist of (in thousands):

	December 31,
	2006		2005
Raw materials	$	754	$	2,430
Work-in-process		—		2,435
Finished goods		1,173		1,140
Total	$	1,927	$	6,005

6.   Property and Equipment

Property and equipment, net consist of (in thousands):

	December 31,
	2006			2005
Land	$	127		$	260
Building and leasehold improvements		1,789			3,187
Furniture, fixtures and office equipment		2,851			5,333
Automobiles		1			58
Purchased software		3,209			4,018
Total		7,977			12,856
Accumulated depreciation		(6,520	)		(9,806	)
Property and equipment, net	$	1,457		$	3,050

SCM recorded depreciation expenses in the amount of $0.3 million, $1.0 million and $1.8 million for the years ended December 31, 2006, 2005 and 2004, respectively.

7.   Intangible Assets

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

	December 31, 2006									December 31, 2005
			Gross							Gross
	Amortization		Carrying		Accumulated					Carrying		Accumulated
	Period		Value		Amortization			Net		Value		Amortization			Net
Customer relations		60 months	$	1,639	$	(1,520	)	$	119	$	1,476	$	(1,071	)	$	405
Core technology		60 months		1,858		(1,705	)		153		1,673		(1,199	)		474
Total intangible assets			$	3,497	$	(3,225	)	$	272	$	3,149	$	(2,270	)	$	879

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

Amortization expense related to intangible assets for continuing operations was $0.7 million, $0.7 million and $1.1 million, for the years ended December 31, 2006, 2005 and 2004, respectively.

F-18

SCM MICROSYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Estimated future amortization of intangible assets is as follows (in thousands):

Fiscal Year	Amount
2007	$	272

SCM evaluates long-lived assets under SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. In the fourth quarter of 2004, the Company determined that the intangible assets from a past acquisition were impaired and recorded a charge of $0.4 million.

8.   Restructuring and Other Charges

Continuing Operations

During 2006, 2005 and 2004, SCM incurred net restructuring and other charges (credits) related to continuing operations of approximately $1.4 million, $0.8 million and $0.6 million, respectively.

Accrued liabilities related to restructuring actions and other activities during 2006, 2005 and 2004 consist of the following (in thousands):

				Asset
	Lease/Contract			Write						Other
	Commitments			Downs			Severance			Costs			Total
Balances as of January 1, 2004		124			49			114			33			320
Provision for 2004		9			17			567			23			616
Changes in estimates		20			(20	)		(6	)		(1	)		(7	)
		29			(3	)		561			22			609
Payments or write offs in 2004		(101	)		(46	)		(521	)		(34	)		(702	)
Balances as of December 31, 2004		52			—			154			21			227
Provision for 2005		—			—			699			6			705
Changes in estimates		7			—			(8	)		129			128
		7			—			691			135			833
Payments or write offs in 2005		(27	)		—			(693	)		(147	)		(867	)
Balances as of December 31, 2005		32			—			152			9			193
Provision for 2006		33			—			1,320			—			1,353
Changes in estimates		(2	)		—			4			—			2
		31			—			1,324			—			1,355
Payments or write offs in 2006		(48	)		—			(1,370	)		—			(1,418	)
Balances as of December 31, 2006	$	15		$	—		$	106		$	9		$	130

For the fiscal year ended December 31, 2006, restructuring and other charges primarily related to severance costs 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 from California to Germany and local finance functions from the U.S. and Singapore to Germany. Approximately $0.3 million of the restructuring amount relates to severance for manufacturing personnel and is therefore recorded in cost of revenue. The remaining $1.1 million is recorded in operating expenses and is primarily made up of severance for non-manufacturing personnel. The Company believes the restructuring activity is substantially completed and that any future costs incurred will be insignificant.

F-19

SCM MICROSYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

During 2005, SCM incurred net restructuring and other charges of approximately $0.8 million, which was primarily related to severance costs 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. Approximately $0.5 million of the restructuring amount relates to severance for manufacturing personnel and is therefore recorded in cost of revenue. The remaining $0.3 million is recorded in operating expenses and is primarily made up of $0.2 million of severance for non-manufacturing personnel and $0.1 million of changes in estimates related to European tax matters.

During 2004, SCM incurred restructuring and other credits related to continuing operations of $0.6 million, which resulted primarily from restructuring costs related to cost reduction actions taken by management during the second half of the year that included employee severance charges of $0.6 million.

Discontinued Operations

During 2006, 2005, and 2004, SCM incurred restructuring and other charges related to discontinued operations of approximately $0.1 million, $2.3 million and $0.5 million, respectively.

Accrued liabilities related to restructuring actions and other activities during 2006, 2005 and 2004 consist of the following (in thousands):

							Asset
	Legal			Lease/Contract			Write						Other
	Settlements			Commitments			Downs			Severance			Costs			Total
Balances as of January 1, 2004		—			3,912			9			275			7,119			11,315
Provision for 2004		620			43			22			271			909			1,865
Changes in estimates		(19	)		450			—			(65	)		(1,740	)		(1,374	)
		601			493			22			206			(831	)		491
Payments or write offs in 2004		(601	)		(445	)		(31	)		(204	)		(873	)		(2,154	)
Balances as of December 31, 2004		—			3,960			—			277			5,415			9,652
Provision for 2005		1,700			—			—			—			667			2,367
Changes in estimates		—			(111	)		—			(4	)		(2	)		(117	)
		1,700			(111	)		—			(4	)		665			2,250
Payments or write offs in 2005		(1,700	)		(651	)		—			(273	)		(5,574	)		(8,198	)
Balances as of December 31, 2005		—			3,198			—			—			506			3,704
Provision for 2006		—			2			—			—			5			7
Changes in estimates		—			87			—			—			—			87
		—			89			—			—			5			94
Payments or write offs in 2006		—			(338	)		—			—			(159	)		(497	)
Balances as of December 31, 2006	$	—		$	2,949		$	—		$	—		$	352		$	3,301

Discontinued operation costs for the fiscal year ended December 31, 2006 primarily related to changes in estimates for lease obligations.

Exit costs for the year ended December 31, 2005 primarily related to the settlement of litigation with DVD Cre8, Inc. and legal costs, as well as changes in estimates for lease obligations.

As shown in the table above in “Payments or write offs in 2005 — Other Costs,” in April 2005, SCM made a payment to the French government of approximately $4.7 million as then calculated, related to Value Added Tax (“VAT”) in respect of sales transactions with a former customer. In connection with this payment, SCM entered into

F-20

SCM MICROSYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

an agreement with the customer whereby the customer agreed to seek a refund from the French government for the VAT paid with respect to the products it purchased from the Company, and then remit the refunded amount to SCM. On June 9, 2006, the customer remitted to the Company the full amount including currency gains totaling $5.0 million, of which $4.2 million was recognized as other income from discontinued operations. The difference between the $5.0 million remittance and the $4.2 million other income were receivables which were realizable independently from the outcome of the aforementioned agreement. See Note 14 for further discussion.

During 2004, restructuring expenses related to discontinued operations were $0.5 million. Expenses consisted of approximately $0.6 million for legal settlements for claims asserted by a European customer, as well as other legal settlements and related legal costs, $0.5 million of lease and contract commitments, $0.2 million severance expenses and $0.9 million of legal and professional fees. These expenses were offset by $1.7 million resulting from changes in estimates to European tax related matters.

9.   Income Taxes

Loss before income taxes for domestic and non-U.S. continuing operations is as follows (in thousands):

	2006			2005			2004
Income (loss) from continuing operations before income taxes:
U.S.	$	(2,709	)	$	24,017		$	(3,074	)
Foreign		(4,908	)		(32,022	)		(9,950	)
Loss from continuing operations before income taxes	$	(7,617	)	$	(8,005	)	$	(13,024	)

The benefit (provision) for income taxes consisted of the following (in thousands):

	December 31,
	2006			2005			2004
Deferred:
Federal	$	—		$	—		$	—
State		—			—			—
Foreign		(2	)		33			228
		(2	)		33			228
Current
Federal		—			—			—
State		(4	)		(162	)		(2	)
Foreign		(67	)		(21	)		(53	)
		(71	)		(183	)		(55	)
Total benefit (provision) for income taxes	$	(73	)	$	(150	)	$	173

F-21

SCM MICROSYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Significant items making up deferred tax assets and liabilities are as follows (in thousands):

	December 31,
	2006			2005
Deferred tax assets:
Allowances not currently deductible for tax purposes	$	1,370		$	1,420
Net operating loss carryforwards		44,814			43,602
Accrued and other		1,286			1,405
		47,470			46,427
Less valuation allowance		(47,366	)		(46,090	)
		104			337
Deferred tax liability:
Other		(207	)		(438	)
Net deferred tax liability	$	(103	)	$	(101	)

SCM has $5.2 million of foreign net operating loss carryforwards related to an acquisition in Germany. When realized, the benefits will be credited first to reduce to zero any non-current intangible assets related to the acquisition and second to reduce income tax expense.

During the years ended December 31, 2006 and 2005, SCM recognized a benefit of $0.8 million and $0.2 million, respectively, from the utilization of foreign net operating loss carryforwards for which the Company had previously established a full valuation allowance. Because of the full valuation allowance against the deferred tax assets, the benefit from the utilization of this tax attribute had not been previously recognized.

The benefit (provision) for taxes reconciles to the amount computed by applying the statutory federal rate to loss before income taxes from continuing operations as follows:

	2006			2005			2004
Computed expected tax benefit		34	%		34	%		34	%
State taxes, net of federal benefit		—			—			(1	)%
Foreign taxes benefits provided for at rates other than U.S. statutory rate		10	%		8	%		(8	)%
Impairment of nondeductible goodwill and intangibles		—			—			(1	)%
Change in valuation allowance		(44	)%		(41	)%		(29	)%
Other		(1	)%		(3	)%		6	%
Benefit (provision) for income taxes		(1	)%		(2	)%		1	%

As of December 31, 2006, SCM has net operating loss carryforwards of approximately $78.9 million for federal, $32.4 million for state and $50.2 million for foreign income tax purposes. If not utilized, these carryforwards will begin to expire beginning in 2019 for federal purposes and have already begun to expire for state and foreign purposes.

SCM has research credit carryforwards of approximately $0.7 million and $0.5 million for federal and state income tax purposes, respectively. If not utilized, the federal credit carryforwards will expire in various amounts beginning in 2019. The California credits can be carried forward indefinitely.

The Tax Reform Act of 1986 limits the use of net operating loss and tax credit carryforwards in certain situations where changes occur in the stock ownership of a company. In the event SCM has a change in ownership, utilization of the carryforwards could be restricted.

F-22

SCM MICROSYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

SCM has no present intention of remitting undistributed earnings of foreign subsidiaries, and accordingly, no deferred tax liability has been established relative to these undistributed earnings.

10.   Earnings / Net Loss Per Share

The following is a reconciliation of the numerators and denominators used in computing basic and diluted net loss per share from continuing operations (in thousands, except per share amounts).

	Years Ended December 31,
	2006			2005			2004
Loss from continuing operations	$	(7,690	)	$	(8,155	)	$	(12,851	)
Discontinued operations		8,732			(4,280	)		(5,812	)
Net income (loss)	$	1,042		$	(12,435	)	$	(18,663	)
Shares (denominator):
Weighted average common shares outstanding used in computation of basic and diluted income (loss) per share		15,638			15,532			15,402
Income (loss) per share — Basic and diluted:
Continuing operations	$	(0.49	)	$	(0.53	)	$	(0.83	)
Discontinued operations		0.56			(0.27	)		(0.38	)
Net income (loss)	$	0.07		$	(0.80	)	$	(1.21	)

As SCM has incurred losses from continuing operations during each of the last three fiscal years, shares issuable under stock options are excluded from the computation of diluted earnings per share as their effect is anti-dilutive. Common equivalent shares issuable under stock options and their weighted average exercise price for the three years ended December 31, 2006 are as follows:

	Years Ended December 31,
	2006		2005		2004
Common equivalent shares issuable		24,094		48,533		205,773
Weighted average exercise price of shares issuable	$	2.78	$	2.84	$	3.64

11.   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 Marketing.

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. In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long Lived Assets, for the fiscal years ended December 31, 2006, 2005 and 2004, 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.

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 margin level. The Company’s reporting systems do not track or allocate operating expenses

F-23

SCM MICROSYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

or assets by segment. The Company does not include intercompany transfers between segments for management purposes.

Summary information by segment for the years ended December 31, 2006, 2005 and 2004 is as follows (in thousands):

	Years Ended December 31,
	2006			2005			2004
PC Security:
Revenues	$	23,745		$	17,415		$	20,017
Gross profit		9,725			6,120			8,190
Gross profit %		41	%		35	%		41	%
Flash Media Readers:
Revenues	$	9,868		$	10,521		$	10,013
Gross profit		2,132			4,710			4,116
Gross profit %		22	%		45	%		41	%
Total:
Revenues	$	33,613		$	27,936		$	30,030
Gross profit		11,857			10,830			12,306
Gross profit %		35	%		39	%		41	%

Geographic revenue is based on selling location. Information regarding revenue by geographic region is as follows (in thousands):

	Years Ended December 31,
	2006			2005			2004
Revenues
Europe	$	13,294		$	9,749		$	8,540
United States		14,695			11,623			13,852
Asia-Pacific		5,624			6,564			7,638
Total	$	33,613		$	27,936		$	30,030
% of revenues
Europe		40	%		35	%		29	%
United States		43	%		42	%		46	%
Asia-Pacific		17	%		23	%		25	%

One customer exceeded 10% of total revenue for each of 2006 and 2004 and two customers exceeded 10% of total revenue for 2005.

One Asia-based customer and one U.S.-based customer represented 19% and 17%, respectively, of the Company’s accounts receivable balance at December 31, 2006. One Asia-based customer and one U.S. based customer represented 18% and 17%, respectively, of the Company’s accounts receivable balance at December 31, 2005.

F-24

SCM MICROSYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Long-lived assets by geographic location as of December 2006 and 2005 are as follows (in thousands):

	December 31,
	2006		2005
Property and equipment, net:
United States	$	27	$	37
Europe		150		1,369
Asia-Pacific		1,280		1,644
Total	$	1,457	$	3,050

12.   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.

Future minimum lease payments under noncancelable operating leases as of December 31, 2006 are as follows for the years ending (in thousands):

2007	$	1,795
2008		1,577
2009		791
2010		725
2011		313
Thereafter		1,083
Committed gross lease payments		6,284
Less: sublease rental income		(482	)
Net operating lease obligation	$	5,802

At December 31, 2006, the Company has accrued approximately $2.9 million of restructuring charges in connection with a portion of the above lease commitments. Rent expense from continuing operations was $1.5 million, $1.8 million and $1.8 million in 2006, 2005 and 2004, respectively.

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 December 31, 2006, purchase and contractual commitments were approximately $8.6 million, of which approximately $1.8 million relate to the sold DTV solutions business. See Note 3 for further discussion regarding the ongoing transactions of the discontinued operations.

SCM 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. SCM 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 SCM’s estimates, adjustments to recognize additional cost of sales may be required in future periods.

F-25

SCM MICROSYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Components of the reserve for warranty costs during the years ended December 31, 2006, 2005 and 2004 were as follows (in thousands):

	Continuing
	Security			Discontinued
	Operations			Operations			Total
Balance at January 1, 2004		200			126			326
Additions related to current period sales		259			164			423
Warranty costs incurred in the current period		(289	)		(184	)		(473	)
Adjustments to accruals related to prior period sales		(20	)		(12	)		(32	)
Balance at December 31, 2004		150			94			244
Additions related to current period sales		158			251			409
Warranty costs incurred in the current period		(67	)		(53	)		(120	)
Adjustments to accruals related to prior period sales		(185	)		(195	)		(380	)
Balance at December 31, 2005		56			97			153
Additions related to current period sales		215			12			227
Warranty costs incurred in the current period		(64	)		(13	)		(77	)
Adjustments to accruals related to prior period sales		(173	)		(96	)		(269	)
Balance at December 31, 2006	$	34		$	0		$	34

13.   Related Party Transactions

During 2006 SCM incurred license expenses of approximately $0.2 million to Gemplus International S.A. a company engaged in the development and distribution of smart-card based systems. Approximately $76,000 of this amount related to continuing operations. License expenses of approximately $0.4 million and $0.1 million were incurred for 2005 and 2004, respectively, of which approximately $232,000 and $25,000 related to continuing operations in 2005 and 2004, respectively. As of December 31, 2006, approximately $30,000 were due as accounts payable to Gemplus. No accounts payable to Gemplus were due as of December 31, 2005 and 2004. SCM’s business relationship with Gemplus has been in existence for many years and predates Werner Koepf’s appointment to the Company’s Board of Directors in February 2006. At Gemplus, Mr. Koepf serves as a director and as Chairman of the Compensation Committee. Mr. Koepf was not directly compensated for revenue transactions between the two companies.

During 2004 SCM recognized revenue of approximately $0.6 million from sales to Conax AS, a company engaged in the development and provision of smart-card based systems. As of December 31, 2004, no accounts receivable amounts were due from Conax. Oystein Larsen, a former board member of SCM, served as Executive Vice President Business Development and New Business of Conax through December 31, 2004 and as a member of SCM’s board until July 2005. Mr. Larsen was not directly compensated for revenue transactions between the two companies.

14.   Legal Proceedings

From time to time, SCM could be subject to claims arising in the ordinary course of business or 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

F-26

SCM MICROSYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

counterfeiting of Aston’s conditional access modules. Aston was one of SCM GmbH’s Digital Television customers until November 2002, when the 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 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.

15.   Quarterly Results of Operations (Unaudited)

The following is a summary of the unaudited quarterly results of operations for 2006 and 2005, (in thousands, except per share data):

	Quarter Ended
	March 31			June 30			September 30			December 31
	(Unaudited)
2006:
Net revenue	$	7,427		$	9,362		$	7,396		$	9,428
Gross profit		2,650			3,159			2,125			3,923
Income (loss) from operations		(2,824	)		(2,281	)		(4,030	)		393
Income (loss) from continuing operations		(2,701	)		(1,991	)		(3,680	)		682
Gain (loss) from discontinued operations, net of income taxes		(942	)		3,948			(213	)		715
Gain (loss) on sale of discontinued operations, net of income taxes		21			5,242			24			(63	)
Net income (loss)		(3,622	)		7,199			(3,869	)		1,334
Basic and diluted income (loss) per share from continuing operations	$	(0.17	)	$	(0.13	)	$	(0.24	)	$	0.05
Basic and diluted income (loss) per share from discontinued operations	$	(0.06	)	$	0.59		$	(0.01	)	$	0.04
Basic and diluted net income (loss) per share	$	(0.23	)	$	0.46		$	(0.25	)	$	0.09
Shares used to compute basic income (loss) per share:		15,593			15,627			15,648			15,683
Shares used to compute diluted income (loss) per share:		15,593			15,627			15,648			15,714

F-27

SCM MICROSYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

	Quarter Ended
	March 31			June 30			September 30			December 31
	(Unaudited)
2005:
Net revenue	$	6,744		$	5,739		$	8,051		$	7,402
Gross profit		3,043			1,887			3,103			2,797
Loss from operations		(2,394	)		(3,216	)		(2,231	)		(2,640	)
Loss from continuing operations		(1,270	)		(2,718	)		(1,950	)		(2,217	)
Income (loss) from discontinued operations		(1,706	)		(892	)		(8	)		497
Gain (loss) on sale of discontinued operations(1)		55			(40	)		(89	)		(2,097	)
Net loss		(2,921	)		(3,650	)		(2,047	)		(3,817	)
Basic and diluted loss per share from continuing operations	$	(0.08	)	$	(0.18	)	$	(0.12	)	$	(0.14	)
Basic and diluted loss per share from discontinued operations	$	(0.11	)	$	(0.06	)	$	(0.01	)	$	(0.11	)
Basic and diluted net loss per share	$	(0.19	)	$	(0.24	)	$	(0.13	)	$	(0.25	)
Shares used to compute basic and diluted loss per share:		15,485			15,522			15,542			15,576

(1) Includes $2.1 million in the fourth quarter for the settlement of litigation with DVD Cre8, Inc. and related (1) legal expenses. See Note 8.

F-28

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.
	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	Purchase Agreement between SCM Microsystems and Kudelski S.A.
	10	.23(16)*	Restrictive Covenant between Kudelski S.A. and Robert Schneider dated May 22, 2006.
	10	.24(16)*	Amended Employment Agreement between SCM Microsystems GmbH and Robert Schneider dated May 22, 2006.
	10	.25(16)*	Amended Employment Agreement between SCM Microsystems GmbH and Dr. Manfred Mueller dated June 8, 2006.
	10	.26	Lease dated July 15, 2006 between SCM Microsystems and Rreef America Reit II Corp.
	10	.27(17)*	Supplementary Employment Agreement between SCM Microsystems GmbH and Stephan Rohaly dated December 12, 2006.
	21	.1	Subsidiaries of the Registrant.
	23	.1	Consent of Independent Registered Public Accounting Firm.
	31	.1	Certification of Chief Executive Officer pursuant to Rule 13a-14 and Rule 15D-14 of the Securities Exchange Act, as amended.
	31	.2	Certification of Chief Financial Officer pursuant to Rule 13a-14 and Rule 15D-14 of the Securities Exchange Act, as amended.

Exhibit
Number		Description of Document
	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 Quarterly Report on Form 10-Q for the quarter ended June 30, 2006 (see SEC File No. 000-29440).
(17)	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.

EX-10.22

Exhibit 10.22

Execution Version

ASSET PURCHASE AGREEMENT

between

SCM MICROSYSTEMS, INC.,

as the Seller

and

KUDELSKI S.A.,

as the Buyer

Dated as of April 5, 2006

TABLE OF CONTENTS

			Page
ARTICLE I PURCHASE AND SALE				1
	Section 1.1	Purchase and Sale of Assets		1
	Section 1.2	Excluded Assets		2
	Section 1.3	Assumed Liabilities		3
	Section 1.4	Excluded Liabilities		4
	Section 1.5	Consents to Certain Assignments		4
	Section 1.6	Consideration		5
	Section 1.7	Allocation of Purchase Price		5
	Section 1.8	Closing		6
	Section 1.9	Transfer of Business Employees		6
ARTICLE II REPRESENTATIONS AND WARRANTIES OF THE SELLER				7
	Section 2.1	Organization		7
	Section 2.2	Authority		7
	Section 2.3	No Conflict; Required Filings and Consents		8
	Section 2.4	Absence of Certain Changes or Events		8
	Section 2.5	Compliance with Law; Permits		8
	Section 2.6	Litigation		9
	Section 2.7	Employee Plans		9
	Section 2.8	Labor and Employment Matters		9
	Section 2.9	Property		9
	Section 2.10	Intellectual Property		10
	Section 2.11	Taxes		11
	Section 2.12	Material Contracts		11
	Section 2.13	Inventory		12
	Section 2.14	Subsidies		12
	Section 2.15	Brokers		12
ARTICLE III REPRESENTATIONS AND WARRANTIES OF THE BUYER				12
	Section 3.1	Organization		12
	Section 3.2	Authority		12
	Section 3.3	No Conflict; Required Filings and Consents		13
	Section 3.4	Financing		13
	Section 3.5	Brokers		13
	Section 3.6	No Knowledge of Breaches		13
ARTICLE IV COVENANTS				14
	Section 4.1	Conduct of Business Prior to the Closing		14
	Section 4.2	Covenants Regarding Information		14
	Section 4.3	Update of Disclosure Schedules; Knowledge of Breach		14
	Section 4.4	Notification of Certain Matters		15
	Section 4.5	Confidentiality		15
	Section 4.6	Consents and Filings; Further Assurances		15
	Section 4.7	Release of Guarantees		15

i

TABLE OF CONTENTS
(Continued)

			Page
	Section 4.8	Corporate Name		16
	Section 4.9	Refunds and Remittances		16
	Section 4.10	Joint and Several Liability		17
	Section 4.11	Public Announcements		17
	Section 4.12	Conditional Access Module Agreements		17
ARTICLE V TAX MATTERS				18
	Section 5.1	Cooperation		18
	Section 5.2	Allocation of taxes		18
	Section 5.3	Sales and Use Taxes		19
	Section 5.4	Other Taxes		19
	Section 5.5	Tax Certificates		20
ARTICLE VI CONDITIONS TO CLOSING				20
	Section 6.1	General Conditions		20
	Section 6.2	Conditions to Obligations of the Seller		21
	Section 6.3	Conditions to Obligations of the Buyer		21
ARTICLE VII TERMINATION				22
	Section 7.1	Termination		22
	Section 7.2	Effect of Termination		23
ARTICLE VIII GENERAL PROVISIONS				23
	Section 8.1	Nonsurvival of Representations, Warranties and Covenants		23
	Section 8.2	Fees and Expenses		23
	Section 8.3	Amendment and Modification		24
	Section 8.4	Waiver		24
	Section 8.5	Notices		24
	Section 8.6	Interpretation		25
	Section 8.7	Entire Agreement		25
	Section 8.8	No Third-Party Beneficiaries		25
	Section 8.9	Governing Law		25
	Section 8.10	Submission to Jurisdiction		25
	Section 8.11	Disclosure Generally		26
	Section 8.12	Personal Liability		26
	Section 8.13	Assignment; Successors		26
	Section 8.14	Severability		26
	Section 8.15	Waiver of Jury Trial		26
	Section 8.16	Counterparts		26
	Section 8.17	No Consequential Damages		26
	Section 8.18	Disclaimer of Implied Warranties		27
ARTICLE IX DEFINITIONS				27
	Section 9.1	Certain Defined Terms		27

ii

Exhibits

Exhibit A	-	Disclosure Schedules
Exhibit B	-	Bill of Sale and Assignment and Assumption Agreement
Exhibit C	-	French Assets Purchase Agreement
Exhibit D	-	French Real Property Purchase Agreement
Exhibit E	-	German Transfer and Assumption Agreement
Exhibit F	-	IP Transfer Agreements
Exhibit G	-	License Agreement
Exhibit H	-	Singapore Transfer and Assumption Agreement
Exhibit I	-	Robert Schneider Non-Compete Agreement

Asset Purchase Agreement Schedules

Schedule 1.1(a)	-	Contracts
Schedule 1.1(c)	-	Business Intellectual Property
Schedule 1.1(d)	-	Tangible Personal Property
Schedule 1.1(e)	-	Inventory
Schedule 1.1(f)	-	Permits
Schedule 1.1(h)	-	Prepaid Expenses and Security Deposits
Schedule 1.2(c)	-	Excluded Trademarks
Schedule 1.2(j)	-	Licensed Intellectual Property
Schedule 1.3	-	Assumed Liabilities
Schedule 1.4	-	Excluded Liabilities
Schedule 1.5	-	Required Consents
Schedule 1.6	-	Casper Chip Testing Procedures
Schedule 1.7	-	Purchase Price Allocation
Schedule 1.9	-	Business Employees
Schedule 4.7	-	Guarantees
Schedule 9.1(m)	-	Knowledge

Disclosure Schedules

Disclosure Schedules attached hereto as Exhibit A.

iv

ASSET PURCHASE AGREEMENT

     ASSET PURCHASE AGREEMENT, dated as of April 5, 2006 (this “Agreement”), between SCM Microsystems, Inc., a Delaware corporation (the “Seller”), and Kudelski S.A., a corporation organized under the laws of Switzerland (together with its Subsidiaries which will purchase the Transferred Assets and assume the Assumed Liabilities, the “Buyer”).

RECITALS

     A. The Seller is engaged in the business of designing, developing, manufacturing selling and supporting software, silicon and conditional access module products relating to digital television security solutions at various locations around the world (the “Business”).

     B. The Seller wishes to sell to the Buyer, and the Buyer wishes to purchase from the Seller, certain assets related to the Business, and, in connection therewith, the Buyer is willing to assume certain liabilities and obligations of the Seller and its Affiliates relating to the Business, all upon the terms and subject to the conditions set forth in this Agreement.

AGREEMENT

     In consideration of the foregoing and the mutual covenants and agreements herein contained and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, and intending to be legally bound hereby, the parties agree as follows:

ARTICLE I
PURCHASE AND SALE

     Section 1.1 Purchase and Sale of Assets. Upon the terms and subject to the conditions of this Agreement, including, without limitation, the schedules and exhibits hereto, at the Closing, the Seller shall, and shall cause its Subsidiaries to, sell, assign, transfer, convey and deliver to the Buyer all of the Seller’s or such Subsidiary’s right, title and interest as of the time of the Closing in, to and under the Transferred Assets, and the Buyer shall purchase, acquire, accept and pay for the Transferred Assets. “Transferred Assets” shall mean all of the Seller’s or any of its Subsidiaries’ right, title and interest in, to and under the following enumerated assets (except to the extent they are Excluded Assets) as they exist at the time of the Closing, as set forth in the schedules referenced below:

          (a) (i) all contracts, licenses, leases, customer and supplier agreements, purchase orders (including purchase orders for Business inventory components and product assembly) and other agreements listed on Schedule 1.1(a), and (ii) all other contracts, leases, customer and supplier agreements, purchase orders and other agreements to which the Seller or any of its Subsidiaries is a party or by which the Seller or any such Subsidiary is bound, in each case, that relate exclusively to, in the ordinary course of business out of the operation of, the Business (collectively, the “Contracts”);

          (b) the property known as 216 avenue du Serpolet, 13704 La Ciotat, France, together with the Seller’s or any of its Subsidiaries’ right, title and interest in, to and under all

1

buildings, improvements and fixtures thereon and all appurtenances thereto (the “Real Property”);

          (c) all patents and patent applications, registered trademarks or service marks and applications to register any trademarks or service marks, copyrights, software and trade secrets, in each case, owned by the Seller or any of its Subsidiaries that are listed on Schedule 1.1(c) (the “Business Intellectual Property”);

          (d) all machinery, equipment, furniture, furnishings, parts, spare parts, vehicles and other tangible personal property owned by the Seller or any of its Subsidiaries (i) that is listed on Schedule 1.1(d) or (ii) that is used or held for use exclusively in the Business (collectively, the “Tangible Personal Property”);

          (e) all raw materials, work-in-progress, finished goods, supplies, packaging materials and other inventories owned by the Seller or any of its Subsidiaries that are listed in Schedule 1.1(e) (the “Inventory”);

          (f) subject to Section 1.5 hereof, all Permits used or held for use by Seller or any of its Subsidiaries exclusively in the Business that are listed on Schedule 1.1(f), to the extent that such Permits are transferable to the Buyer (the “Business Permits”);

          (g) all personnel records (to the extent permitted by applicable law) related to the Transferred Employees, customers’ and suppliers’ lists, sales and promotional literature and manuals owned by the Seller or any of its Subsidiaries, in each case, relating exclusively to the Business (the “Books and Records”); and

          (h) all prepaid expenses and security deposits relating exclusively to the Business that are listed on Schedule 1.1(h).

     Section 1.2 Excluded Assets. Notwithstanding anything contained in Section 1.1 to the contrary, neither the Seller nor any of its Subsidiaries is selling, assigning, transferring or conveying, and the Buyer is not purchasing or acquiring, any assets other than those specifically listed or described in Section 1.1 and, without limiting the generality of the foregoing, the term “Transferred Assets” shall expressly exclude the following assets of the Seller and its Subsidiaries, all of which shall be retained by the Seller or such Subsidiary (collectively, the “Excluded Assets”):

          (a) all of the cash and cash equivalents of the Seller and its Subsidiaries and all accounts receivable, notes receivable and other receivables due to the Seller or any of its Subsidiaries, together with any unpaid interest or fees accrued thereon or other amounts due with respect thereto;

          (b) the corporate books and records of internal corporate proceedings, accounting and financial records, tax records, work papers and books and records of the Seller and its Subsidiaries and any internal reports relating to the business activities of the Seller and its Subsidiaries, other than those expressly included as Transferred Assets pursuant to Section 1.1(g);

2

          (c) all rights in the names and marks and any variation or derivation thereof listed in Schedule 1.2(c);

          (d) all of the bank accounts of the Seller and its Subsidiaries;

          (e) any interest in or right to any refund of or credit for taxes of any kind, whether or not relating to the Business, the Transferred Assets, or the Assumed Liabilities, for, or applicable to, any Pre-Closing Tax Period;

          (f) any insurance policies and rights, claims or causes of action thereunder, except those policies, rights, claims or causes of action governed by French law which will be automatically transferred to the Buyer;

          (g) all rights, claims and causes of action relating to any Excluded Asset or any Excluded Liability;

          (h) all rights of the Seller and its Subsidiaries under this Agreement and the Ancillary Agreements;

          (i) the capital stock owned by Seller and/or its Subsidiaries in each of Seller’s Subsidiaries;

          (j) (i) the Casing Patents and other intellectual property listed on Schedule 1.2(j) (collectively, the “Licensed Intellectual Property”), and with respect to which the parties will enter into the License Agreement, and (ii) any and all other intellectual property of the Seller that is not listed on, or referred to in, Schedule 1.1(c), including, without limitation, the items identified in Section 1.2(c);

          (k) all St@rKeyÒ and mobile terrestrial receiver products comprised in the Inventory and any agreements relating thereto; and

          (l) any leased real property.

     Section 1.3 Assumed Liabilities. In connection with the purchase and sale of the Transferred Assets pursuant to this Agreement, at the Closing, the Buyer shall assume and pay, discharge, perform or otherwise satisfy when due all liabilities and obligations set forth on Schedule 1.3 (collectively, the “Assumed Liabilities”). Buyer further agrees to and shall indemnify, defend and hold Seller and Seller’s Affiliates harmless for and against any and all liabilities, burdens and obligations associated with such Assumed Liabilities and any claim, loss, liability, damage or injury suffered by Seller or any of Seller’s Affiliates relating to the Assumed Liabilities or arising out of any failure by Buyer to satisfy when due the liabilities, burdens and obligations under, pursuant to, or relating to the Assumed Liabilities.

     The Buyer’s obligations under this Section 1.3 shall not be subject to offset or reduction by reason of any actual or alleged breach of any representation, warranty or covenant or any other obligation unrelated to this Agreement and the Ancillary Agreements. The Buyer agrees to reimburse the Seller and its Affiliates, dollar for dollar, in the event that any Person offsets from any amount such Person otherwise owes to the Seller or any of its Affiliates an amount that is (or

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is part of) an Assumed Liability. The Seller will provide notice to the Buyer of any such offset for which the Seller or any of its Affiliates is entitled to be reimbursed by the Buyer pursuant to this Section 1.3 as soon as reasonably practicable after Seller receives the same and the Buyer shall pay the Seller or such Affiliate promptly following receipt of such notice.

     Section 1.4 Excluded Liabilities. Notwithstanding any other provision of this Agreement to the contrary, the Buyer is not assuming, and the Seller and its Subsidiaries, as applicable, shall pay, perform or otherwise satisfy when due, all liabilities and obligations of Seller and its Subsidiaries that are not Assumed Liabilities, including those set forth on Schedule 1.4 (the “Excluded Liabilities”). Seller agrees to and shall indemnify, defend and hold Buyer and Buyer’s Affiliates harmless for and against the obligation of Seller to pay and/or reimburse the Buyer for the Seller’s Portion of the Transferred Employee Liabilities and the Seller’s Portion of the Korean Rebates (each as defined in Schedule 1.4) and any claim, loss, liability, damage or injury suffered by Buyer or any of Buyer’s Affiliates relating to the Seller’s Portion of the Transferred Employee Liabilities and the Seller’s Portion of the Korean Rebates or arising out of any failure by Seller to satisfy when due the Seller’s Portion of the Transferred Employee Liabilities and the Seller’s Portion of the Korean Rebate.

     Section 1.5 Consents to Certain Assignments.

          (a) Notwithstanding anything in this Agreement or any Ancillary Agreement to the contrary, this Agreement and the Ancillary Agreements shall not constitute an agreement to sell, transfer or assign any asset, agreement, Permit, claim or right or any benefit arising thereunder or resulting therefrom if an assignment or attempted assignment thereof, without the consent of a Person, would constitute a breach or other contravention under any agreement or applicable law to which the Seller or any of its Subsidiaries is a party or by which it is bound. The Seller shall endeavor to obtain the consents or waivers listed on Schedule 1.5, which has been mutually agreed to by Seller and Buyer; provided that in no event shall Seller or any of its Subsidiaries be required to make any payment to any Person or otherwise expend any amount in order for such Person to agree to grant any such consent or waiver. The Buyer agrees that neither the Seller nor any of its Affiliates shall have any liability to the Buyer arising out of or relating to the failure to obtain any consent or waiver that may be required in connection with the transactions contemplated by this Agreement or the Ancillary Agreements or because of any circumstances resulting therefrom. The Buyer further agrees that no representation or warranty of the Seller herein shall be breached or deemed breached and, except as set forth in Section 6.3(d), no condition shall be deemed not satisfied, as a result of (i) the failure to obtain any consent or waiver or any circumstances resulting therefrom, (ii) any suit, action, proceeding or investigation commenced or threatened by or on behalf of any Person arising out of or relating to the failure to obtain any such consent or waiver or any circumstances resulting therefrom, or (iii) any termination of a Contract that is a Transferred Asset by a third party to such Contract in the event such Contract grants such third party the right to terminate as a result of Seller or any of its Subsidiaries entering into the transactions contemplated by this Agreement or the Ancillary Agreements, or otherwise.

     (b) Without prejudice to the provisions of Sections 6.3 (d), if any such consent or waiver is not obtained on or prior to Closing and, as a result thereof, the Buyer shall be prevented by a third party from receiving the rights and benefits with respect to such Transferred

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Asset intended to be transferred hereunder, or if any transfer or assignment or attempted transfer or assignment would adversely affect the rights of the Seller or any of its Subsidiaries thereunder so that the Buyer would not in fact receive all such rights or the Seller or any of its Subsidiaries would forfeit or otherwise lose the benefit of rights that the Seller or any of its Subsidiaries is entitled to retain, the Seller and the Buyer shall cooperate in any lawful and commercially reasonable arrangement, as the Seller and the Buyer shall agree, under which the Buyer would, to the extent practicable, obtain the economic claims, rights and benefits under such asset and assume the liabilities, economic burdens and obligations with respect thereto in accordance with this Agreement, including, without limitation, by subcontracting, sublicensing or subleasing to the Buyer; provided that all reasonable out-of-pocket expenses of such cooperation and related actions shall be paid by the Buyer. The Seller shall pay to the Buyer when received all monies received by the Seller or any of its Subsidiaries with respect to any such Transferred Asset or any claim or right or any benefit arising thereunder and the Buyer shall indemnify and promptly pay the Seller and its Affiliates for all liabilities, economic burdens and obligations of the Seller or any of its Affiliates associated with such Transferred Asset or any claim or right or any benefit arising thereunder.

     Section 1.6 Consideration. In full consideration for the sale, assignment, transfer, conveyance and delivery of the Transferred Assets to the Buyer, at the Closing, the Buyer shall (a) pay to the Seller an aggregate amount equal to Eleven Million United States Dollars (US$11,000,000) (the “Purchase Price”) and (b) assume the Assumed Liabilities. The Purchase Price shall be payable as follows:

          (i) on the Closing Date, Buyer shall pay to Seller by wire transfer to a bank account designated in writing by the Seller, in immediately available funds in United States dollars, the sum of Nine Million United States Dollars (US$9,000,000), and

          (ii) on the later of (A) the Closing Date and (B) the date two (2) weeks after the date of the completion, in all material respects and consistent with reasonable engineering standards, of the tests outlined in Section 7 of the procedures relating to the Casper Chip that are attached as Schedule 1.6 and the release for production of the Casper Chip, Buyer shall pay to Seller by wire transfer to a bank account designated in writing by the Seller, in immediately available funds in United States dollars, an amount equal to (1) the sum of Two Million United States Dollars (US$2,000,000) minus (2) the aggregate amount of all reasonable and documented out-of-pocket third party expenses for coding, synthesis, simulation, verification, layout or mask changes that are actually incurred by Buyer after the Closing Date and directly applicable to a respin/redesign resulting in the re-manufacturing of engineering sample ASIC’s required to complete, after the Closing Date, any of the procedures set forth on Schedule 1.6 that were not completed prior to the Closing Date, and to enable a product that has substantially the same functionality as WorldCam.

     Section 1.7 Allocation of Purchase Price. The Purchase Price shall be allocated among the Transferred Assets in a manner to be finally agreed upon by the parties at or prior to Closing, which shall be substantially as set forth in Schedule 1.7. Buyer and Seller shall report the purchase and sale of the Transferred Assets in accordance with such allocation for all tax purposes in all relevant jurisdictions (including, without limitation, the filing of the forms

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prescribed under Section 1060 of the Internal Revenue Code of 1986 and Treasury Regulations promulgated thereunder).

     Section 1.8 Closing.

          (a) The sale and purchase of the Transferred Assets and the assumption of the Assumed Liabilities contemplated by this Agreement shall take place at a closing (the “Closing”) to be held at the offices of Gibson, Dunn & Crutcher LLP, Paris, France, on the third Business Day following the satisfaction or, to the extent permitted by applicable law, waiver of all conditions to the obligations of the parties set forth in Article VI (other than such conditions as may, by their terms, only be satisfied at the Closing or on the Closing Date), or at such other place or at such other time or on such other date as the Seller and the Buyer mutually may agree in writing. The day on which the Closing takes place is referred to as the “Closing Date”.

          (b) At the Closing, the Seller shall deliver or cause to be delivered to the Buyer the following documents:

               (i) duly executed originals of each of the Ancillary Agreements;

               (ii) a duly executed certificate of the secretary of the Seller in customary form;

               (iii) a duly executed certificate of an executive officer of the Seller pursuant to Section 6.3(a); and

               (iv) copies of the settlement agreements entered into with, or written objections received from, any Excluded Employee as of the Closing Date.

          (c) At the Closing, the Buyer shall deliver or cause to be delivered to the Seller the following documents:

               (i) duly executed originals of each of the Ancillary Agreements;

               (ii) a duly executed certificate of the secretary of the Buyer in customary form; and

               (iii) a duly executed certificate of an executive officer of the Buyer pursuant to Section 6.2(a).

     Section 1.9 Transfer of Business Employees.

          (a) Schedule 1.9 contains a list (divided into Singapore, France and Germany) of the individuals employed by the Seller or its Subsidiaries immediately prior to the Closing Date whose duties relate primarily to the operations of the Business, regardless of the company payroll on which such individuals are listed, and whose employment contracts are governed by Singapore, French or German law, respectively, hereinafter referred to as the “Singapore Business Employees,” “French Business Employees” and “German Business Employees,” respectively, and, together, the “Business Employees”). Each of the Business Employees is

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intended to be transferred to the Buyer in accordance with the process and procedures set forth on Schedule 1.9. Schedule 1.9 also contains a list of four employees whose employment contracts are governed by German law and who could claim that their respective duties relate primarily to the operations of the Business and that they are assigned to the Business, but with respect to whom the Buyer has indicated that it does not wish to retain (the “Excluded GBEs”). To the extent that any Business Employee or Excluded GBE is actually transferred to the Buyer as of the Closing Date, such Business Employee or Excluded GBE shall be referred to as a “Transferred Employee.” To the extent that any Business Employee or Excluded GBE effectively objects to being transferred to the Buyer as of the Closing Date in accordance with applicable law and is not in fact transferred to the Buyer as of the Closing Date, such Business Employee or Excluded GBE shall be referred to as an “Excluded Employee.”

          (b) To the extent an Excluded Liability relates to any Transferred Employee (a “Transferred Employee Liability”), the Seller agrees to and shall indemnify, defend and hold Buyer and its Affiliates harmless for and against any and all liabilities, burdens and obligations associated with such Transferred Employee Liability and any claim, loss, liability, damage or injury suffered by Buyer or any of its Affiliates relating to such Transferred Employee Liability or arising out of any failure by Seller or its Subsidiaries to satisfy when due the Transferred Employee Liability. To the extent that the Buyer is required to make and makes a payment to a Transferred Employee or any Governmental Authority that constitutes a Transferred Employee Liability, the Seller shall promptly reimburse the Buyer for any such amount actually paid by Buyer or its Affiliates.

ARTICLE II
REPRESENTATIONS AND WARRANTIES
OF THE SELLER

     Except as set forth in and subject to the Disclosure Schedules attached hereto as Exhibit A (collectively, the “Disclosure Schedules”), the Seller hereby represents and warrants to the Buyer as follows:

     Section 2.1 Organization. The Seller is a corporation duly organized, validly existing and in good standing under the laws of the state of Delaware and has all necessary corporate power and authority to own, lease and/or operate the Transferred Assets and to carry on the Business as it is now being conducted.

     Section 2.2 Authority. The Seller has full corporate power and authority to execute and deliver this Agreement and each of the Ancillary Agreements to which it will be a party, to perform its obligations hereunder and thereunder and to consummate the transactions contemplated hereby and thereby. The execution and delivery by the Seller of this Agreement and each of the Ancillary Agreements to which it will be a party and the consummation by the Seller of the transactions contemplated hereby and thereby have been duly and validly authorized by all necessary corporate action. This Agreement has been, and upon their execution each of the Ancillary Agreements to which the Seller will be a party will have been, duly executed by the Seller. This Agreement constitutes, and upon their execution and delivery each of the Ancillary Agreements to which the Seller will be a party will constitute, the legal, valid and binding obligations of the Seller, enforceable against the Seller in accordance with their respective terms,

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except as enforcement may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or similar laws affecting creditors’ rights generally and by general principles of equity (regardless of whether considered in a proceeding in equity or at law).

     Section 2.3 No Conflict; Required Filings and Consents.

          (a) The execution, delivery and performance by the Seller of this Agreement and each of the Ancillary Agreements to which the Seller will be a party, and the consummation of the transactions contemplated hereby and thereby, do not and will not: (i) conflict with or violate the certificate of incorporation or bylaws of the Seller; (ii) conflict with or violate any law applicable to the Seller, the Business or any of the Transferred Assets or by which the Seller, the Business or any of the Transferred Assets may be bound or affected; or (iii) conflict with, result in any breach of, constitute a default (or an event that, with notice or lapse of time or both, would become a default) under, or require any consent of any Person pursuant to, any Contract; except, in the case of clause (ii) or (iii), for any such conflicts, violations, breaches, defaults or other occurrences that would not, individually or in the aggregate, reasonably be expected to have a Material Adverse Effect or that arise as a result of any facts or circumstances relating to the Buyer or any of its Affiliates.

          (b) The Seller or one of its Subsidiaries has consulted with the works council for its branch in France and obtained the works council’s opinion with respect to the transactions contemplated by this Agreement prior to the execution of this Agreement by Seller. Unless otherwise provided herein, the Seller is not required to file, seek or obtain any notice, authorization, approval, order, permit, consent or clearance of or with any United States or non-United States national, supranational, federal, state, provincial, local or similar governmental, regulatory or administrative authority, branch, agency or commission or any judicial or arbitral body (a “Governmental Authority”) in connection with the execution, delivery and performance by the Seller of this Agreement and each of the Ancillary Agreements to which the Seller will be a party or the consummation of the transactions contemplated hereby or thereby, except for (i) filings made or consents, approvals or authorizations obtained on or prior to the Closing, (ii) any filings required to be made under any applicable antitrust or merger control laws, (iii) where failure to obtain such consent, approval, authorization or action, or to make such filing or notification, would not, individually or in the aggregate, reasonably be expected to have a Material Adverse Effect or (iv) as may be necessary as a result of any facts or circumstances relating to the Buyer or any of its Affiliates.

     Section 2.4 Absence of Certain Changes or Events. Since January 1, 2006, there has not occurred any Material Adverse Effect. The Buyer acknowledges that there may be disruption to the operation of the Business solely as a result of (i) the announcement by the Seller of its intention to sell the Business, (ii) the execution of this Agreement or the Ancillary Agreements, including, without limitation, as a result of the identity of the Buyer, and (iii) the consummation of the transactions contemplated hereby, and the Buyer agrees that any such disruptions do not and shall not constitute a breach of this Section 2.4 or a Material Adverse Effect.

     Section 2.5 Compliance with Law; Permits. To the Knowledge of the Seller, the Business is being conducted in material compliance with all applicable laws, except as would

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not, individually or in the aggregate, reasonably be expected to have a Material Adverse Effect. The Seller or its Subsidiaries are in possession of all permits, licenses, franchises, approvals, certificates, consents, waivers, concessions, exemptions, orders, registrations, notices or other authorizations of any Governmental Authority necessary for it to own, lease and operate the Transferred Assets and to conduct the Business as currently conducted (the “Permits”), except where the failure to have, or the suspension or cancellation of, any of the Permits would not, individually or in the aggregate, reasonably be expected to have a Material Adverse Effect.

     Section 2.6 Litigation. As of the date hereof, there is no action, suit, arbitration or proceeding by or before any Governmental Authority in connection with the Business pending, or to the Knowledge of the Seller, threatened in writing that would, individually or in the aggregate, reasonably be expected to have a Material Adverse Effect or would affect the legality, validity or enforceability of this Agreement or any Ancillary Agreement or the consummation of the transactions contemplated hereby or thereby.

     Section 2.7 Employee Plans. Except for employee compensation and benefit plans required under applicable law, Schedule 2.7 of the Disclosure Schedules sets forth all material employee benefit and compensation plans, contracts, policies, programs and arrangements sponsored, maintained or contributed to by the Seller or its Subsidiaries in connection with the Business in effect as of the date hereof, including all pension, profit sharing, savings and thrift, bonus, stock bonus, stock option or other cash or equity-based incentive or deferred compensation, severance pay and medical and life insurance plans in which any of the Business Employees or their dependents participate.

     Section 2.8 Labor and Employment Matters. Other than amounts that are or will become Assumed Liabilities, including, without limitation, accrued vacation and RTT Days (as defined in Schedule 1.9), the Seller has paid or has caused its Subsidiaries to pay, as the case may be, all salaries, reimbursement of expenses and other compensation and compensation related obligations to which the Transferred Employees are entitled pursuant to applicable law and their employment contracts that have become due and payable as of the date hereof, and the related social security charges and taxes that have become due and payable as of the date hereof, and will pay such amounts that become due and payable prior to the Closing Date. No written employment contract of any of the Transferred Employees contains materially more favorable clauses, including as regards severance indemnities, than those provided by applicable law or any applicable collective bargaining agreements. Except as would not reasonably be expected to have a Material Adverse Effect, (i) neither the Seller nor any of its Subsidiaries is in breach of, or default under, any employment agreement with a Transferred Employee and (ii) all such employment agreements are in full force and effect and are valid and binding on the Seller and/or its Subsidiaries (as the case may be) and, to the Knowledge of the Seller, the applicable employee.

     Section 2.9 Property.

          (a) The Seller or one of its Subsidiaries is the sole owner of, and has valid title to, the Real Property, which title is recorded on the relevant land registry (Conservation des Hypothèques). Other than Permitted Encumbrances, the preemptive right provided by Article L. 211-1 of the French Code de l’Urbanisme and any other exception that is recorded on

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the registry of the Conservation des Hypothèques or would not reasonably be expected to have a Material Adverse Effect, the Real Property is (i) free and clear of any charges, claims, attachment, mortgages, leases, liens, pledges or security interests or restrictions of any kind, (ii) free of any specific planning and zoning (urbanisme) measure or regulation which might materially affect the value of the Real Property and (iii) not affected by any easement, contractual preemptive right, option or similar right in favor of a third party, and Seller has not received any written notice of any claim in this regard or that the Real Property is subject to any administrative or court action. The Real Property has been maintained in the ordinary course of Seller’s or its Subsidiary’s business. To the Knowledge of Seller, the Real Property does not qualify as a classified installation (“installation classée”) for environmental purposes.

          (b) Schedule 1.1(d) of the Disclosure Schedules lists each piece of Tangible Personal Property owned by the Seller or one of its Subsidiaries that is material to, and used exclusively in, the Business. The Seller or one if its Subsidiaries has good and marketable title to all Tangible Personal Property, free and clear of all charges, claims, mortgages, leases, liens, options, pledges or security interests or other restrictions of any kind, other than Permitted Encumbrances and any such exceptions that would not, individually or in the aggregate, reasonably be expected to have a Material Adverse Effect.

          (c) Subject to Section 2.4 and the fact that (i) the Business has not heretofore been conducted by the Seller and its Subsidiaries separate and distinct from the other businesses of the Seller and its Subsidiaries, (ii) the Buyer is only purchasing segregated assets from the Seller, rather than a complete and separate company with all of its administration and operational functions, information technology, accounting and other systems and infrastructure, (iii) the Buyer does not intend to take and/or retain all of the employees of Seller and its Subsidiaries involved in the Business, (iv) the intellectual property listed on Schedule 1.2(c) is an Excluded Asset, (v) certain Permits, Contracts and other agreements and items may not be transferable or assignable by the Seller to the Buyer, (vi) the Transferred Assets do not constitute all of the assets, properties, agreements and other items that the Seller and its Subsidiaries used prior to the Closing in the conduct of the Business, and (vii) the Buyer intends to conduct a portion of the Business through the CAM Agreements and may instruct the Seller to transfer certain of the Contracts to third parties, and assuming that (1) the Buyer has all of the necessary administration and operational functions, information technology systems, infrastructure and employees in place at Closing and (2) no customer, employee, supplier or other Person terminates or modifies its business or other relationship with the Business and there is no other change with respect to the Business or the industry in which the Business operates, the Transferred Assets, taken together with the Licensed Intellectual Property, are sufficient to enable the Buyer to continue to operate the Business after the Closing Date, in all material respects, in the same manner in which it was conducted by the Seller prior to the Closing Date.

     Section 2.10 Intellectual Property. The Seller or one of its Subsidiaries holds sole title to the Business Intellectual Property, free from any encumbrance, lien, pledge or security interest, other than any such exceptions that would not, individually or in the aggregate, be expected to be material. The patents and trademarks that are included in the Business Intellectual Property have been validly registered and maintained in force in favor of the Seller or its Subsidiaries, except as would not, individually or in the aggregate, reasonably be expected to have an adverse and material effect on the use of such patents or trademarks in the Business.

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The Seller or its Subsidiaries has paid all due and payable related fees related to the Business Intellectual Property, except as would not, individually or in the aggregate, be expected to have a Material Adverse Effect. To the Knowledge of the Seller, no written claim has been asserted or threatened that the use or exploitation by the Seller or any of its Subsidiaries of any Business Intellectual Property infringes the intellectual property of any third party. Neither Seller nor any of its Subsidiaries owns any patent, trademark, trade name or copyright that is used in, and is material to, the Business, other than the Business Intellectual Property, the License Intellectual Property and the items listed on Schedule 1.2(c).

     Section 2.11 Taxes. The Seller has filed or caused to be filed all tax and social security charge or similar tax returns relating to the Business which have become due and payable (taking into account valid extensions of time to file) prior to the date hereof, except as would not reasonably be expected to have a Material Adverse Effect, and the Seller has paid or caused to be paid all taxes and related charges due and payable therein, in each case, to the extent the Buyer would reasonably be expected to incur liability for the Seller’s failure to file such returns or pay such taxes (subject to Section 5.2 below).

     Section 2.12 Material Contracts.

          (a) Schedule 2.12 of the Disclosure Schedules lists each of the following written Contracts (such Contracts described in this Section 2.12 being “Material Contracts”) to which the Seller or any of its Subsidiaries is a party or bound: (i) all Contracts that provide for payment or receipt by the Seller or any of its Subsidiaries in connection with the Business of more than US$300,000 per year; (ii) all Contracts that limit or purport to limit the ability of the Business to compete in any line of business or with any Person or in any geographic area or during any period of time; (iii) all joint venture, partnership or similar Contracts; and (iv) any other Contract that is believed by the Seller to be material to the Business, taken as a whole. Except as would not, individually or in the aggregate, reasonably be expected to have a Material Adverse Effect, each Material Contract is valid and binding on the Seller and its Subsidiaries (as the case may be) and, to the Knowledge of the Seller, the counterparties thereto, and is in full force and effect. Except as requested by Buyer or as otherwise contemplated by this Agreement or the Schedules hereto, to the Knowledge of Seller, as of the date hereof, no customer, supplier, employee or other Person who is a counter-party to a Material Contract has informed the Seller that it intends to terminate or modify its business relationship with the Business, the result of which would reasonably be expected to have a Material Adverse Effect. Neither the Seller nor any of its Subsidiaries is in breach of, or default under, any Material Contract to which it is a party, except for such breaches or defaults that would not, individually or in the aggregate, reasonably be expected to have a Material Adverse Effect.

          (b) Seller has made available to Buyer copies of the South Korean supply agreements between SCM Microsystems (Asia) Pte Ltd and (i) CJ Cablenet dated May 20, 2004, (ii) Korean Digital Cable Media Center Co., Ltd. dated June 1, 2005, and (iii) Qrix Networks, Inc. dated March 17, 2005 (together, the “Korean Contracts”), which agreements are included in the definition of “Contracts” pursuant to Section 1.1(a) and constitute “Transferred Assets” hereunder. The Korean Contracts are governed by Singapore law and none of the Korean Contracts contain specific prohibitions against the assignment of the rights and benefits of Seller and its Subsidiaries under such supply agreements nor any express requirement that Seller shall

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obtain the prior consent of the relevant contract counter-party to such agreement. To the knowledge of Seller and subject to an exception relating to the performance of personal services, which Seller does not believe is applicable to the Korean Contracts, Singapore common law generally allows the assignment of the rights and benefits under an agreement in the absence of a specific prohibition against assignment.

     Section 2.13 Inventory. Since December 31, 2005, Seller has in all material respects managed its inventory in the ordinary course of business consistent with past practices and its practices relating to its other businesses and, as Seller believes, a reasonably prudent person conducting the Business as a going concern would have managed its inventory.

     Section 2.14 Subsidies. There is no subsidy that would reasonably be expected to be transferred to the Buyer in connection with the transactions contemplated by this Agreement.

     Section 2.15 Brokers. Except for Avondale Partners, LLC, the fees of which will be paid by the Seller, no broker, finder or investment banker is entitled to any brokerage, finder’s or other fee or commission in connection with the transactions contemplated hereby based upon arrangements made by or on behalf of the Seller.

ARTICLE III
REPRESENTATIONS AND WARRANTIES OF THE BUYER

     The Buyer hereby represents and warrants to the Seller as follows:

     Section 3.1 Organization. Kudelski S. A. is a corporation duly organized, validly existing and in good standing under the laws of Switzerland and has all necessary corporate power and authority to own, lease and operate its properties and to carry on its business as it is now being conducted.

     Section 3.2 Authority. The Buyer has full corporate power and authority to execute and deliver this Agreement and each of the Ancillary Agreements to which it will be a party, to perform its obligations hereunder and thereunder and to consummate the transactions contemplated hereby and thereby. The execution and delivery by the Buyer of this Agreement and each of the Ancillary Agreements to which it will be a party and the consummation by the Buyer of the transactions contemplated hereby and thereby have been duly and validly authorized by all necessary corporate action. This Agreement has been, and upon their execution each of the Ancillary Agreements to which the Buyer will be a party will have been, duly and validly executed by the Buyer. This Agreement constitutes, and upon their execution and delivery each of the Ancillary Agreements to which the Buyer will be a party will constitute, the legal, valid and binding obligations of the Buyer, enforceable against the Buyer in accordance with their respective terms, except as enforcement may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or similar laws affecting creditors’ rights generally and by general principles of equity (regardless of whether considered in a proceeding in equity or at law).

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     Section 3.3 No Conflict; Required Filings and Consents.

          (a) The execution, delivery and performance by the Buyer of this Agreement and each of the Ancillary Agreements to which the Buyer will be a party, and the consummation of the transactions contemplated hereby and thereby, do not and will not: (i) conflict with or violate the certificate of incorporation or bylaws of the Buyer; (ii) conflict with or violate any law applicable to the Buyer or by which any property or asset of the Buyer is bound or affected; or (iii) conflict with, result in any breach of, constitute a default (or an event that, with notice or lapse of time or both, would become a default) under, or require any consent of any Person pursuant to, any material contract or agreement to which the Buyer is a party; except, in the case of clause (ii) or (iii), for any such conflicts, violations, breaches, defaults or other occurrences that would not, individually or in the aggregate, reasonably be expected to have a material adverse effect on the ability of the Buyer to perform its obligations under this Agreement or the Ancillary Agreements to which it will be a party or to consummate the transactions contemplated hereby or thereby (a “Buyer Material Adverse Effect”) or that arise as a result of any facts or circumstances relating to the Seller or any of its Affiliates.

          (b) To the Knowledge of the Buyer, the Buyer is not required to file, seek or obtain any notice, authorization, approval, order, permit or consent of or with any Governmental Authority in connection with the execution, delivery and performance by the Buyer of this Agreement and each of the Ancillary Agreements to which it will be party or the consummation of the transactions contemplated hereby or thereby, except for (i) filings made or consents, approvals or authorizations obtained on or prior to the Closing, (ii) where failure to obtain such consent, approval, authorization or action, or to make such filing or notification, would not, individually or in the aggregate, reasonably be expected to have a Buyer Material Adverse Effect or (iii) as may be necessary as a result of any facts or circumstances relating to the Seller or any of its Affiliates.

     Section 3.4 Financing. The Buyer has sufficient funds to permit the Buyer to consummate the transactions contemplated by this Agreement and the Ancillary Agreements. The Buyer has provided the Seller with accurate and complete copies of the commitment letters or other materials satisfactory to the Seller evidencing the Buyer’s possession of sufficient funds for the transactions contemplated by this Agreement. Notwithstanding anything to the contrary contained herein, the parties acknowledge and agree that it shall not be a condition to the obligations of the Buyer to consummate the transactions contemplated hereby that the Buyer shall have obtained financing for payment of the Purchase Price.

     Section 3.5 Brokers. No broker, finder or investment banker is entitled to any brokerage, finder’s or other fee or commission in connection with the transactions contemplated hereby based upon arrangements made by or on behalf of the Buyer.

     Section 3.6 No Knowledge of Breaches. The Buyer has no Knowledge or reason to believe that any of the representations or warranties made by the Seller as of the date hereof are untrue, incomplete or inaccurate.

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ARTICLE IV
COVENANTS

     Section 4.1 Conduct of Business Prior to the Closing. Between the date of this Agreement and the Closing Date, unless the Buyer shall otherwise agree in writing, the Business shall be conducted only in the ordinary course of business in all material respects, and the Seller shall use its commercially reasonable efforts to preserve the material business relationships with customers, suppliers, distributors and others with whom the Seller deals in connection with the conduct of the Business in the ordinary course.

     Section 4.2 Covenants Regarding Information.

          (a) From the date hereof until the Closing Date, upon reasonable notice, the Seller shall afford the Buyer, at the Buyer’s expense, during normal business hours, under the supervision of the Seller’s or any of its Subsidiaries’ personnel, reasonable access to the properties, offices, plants and other facilities, books and records of the Seller and its Subsidiaries relating exclusively to the Business, and shall furnish the Buyer with such financial, operating and other data and information to the extent relating exclusively to the Business as the Buyer may reasonably request. Notwithstanding anything to the contrary in this Agreement, the Seller shall not be required to disclose any information to the Buyer if such disclosure would, in the Seller’s sole discretion, (i) contravene any applicable laws or fiduciary duty (ii) have a material adverse effect on Seller, or (iii) relate to any consolidated, combined or unitary tax return filed by the Seller or any Affiliate thereof or any of their respective predecessor entities.

          (b) In order to facilitate the resolution of any claims made against or incurred by a party (as it relates to the Business), for a period of ten years after the Closing or, if shorter, the applicable period specified in a party’s document retention policy, each party shall (i) retain the books and records relating to the Business relating to periods prior to the Closing and (ii) upon reasonable notice, afford the other party reasonable access (including the right to make, at the other party’s expense, photocopies), during normal business hours, to such books and records; each party shall notify the other party in writing at least 30 days in advance of destroying any such books and records prior to the tenth anniversary of the Closing Date in order to provide the other party the opportunity to copy such books and records in accordance with this Section 4.2(b).

     Section 4.3 Update of Disclosure Schedules; Knowledge of Breach. The Seller shall have the right from time to time prior to the Closing to supplement or amend the Disclosure Schedules with respect to any event, condition or matter hereafter arising or discovered which if existing or known at the date of this Agreement would have been included or described in the Disclosure Schedules. Any such supplemental or amended disclosure shall be deemed to have cured any breach of any representation or warranty made in this Agreement for purposes of determining whether or not the conditions set forth in Article VI have been satisfied. Notwithstanding the foregoing, any such supplemental or amended disclosure shall be subject to the prior written consent of Buyer, which consent shall not be unreasonably withheld or delayed, in order to be part of this Agreement.

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     Section 4.4 Notification of Certain Matters. Until the Closing, each party hereto shall notify the other party in writing as soon as reasonably practicable of any fact, change, condition, circumstance or occurrence or nonoccurrence of any event of which it is or becomes aware that will or is reasonably likely to result in any of the conditions set forth in Article VI of this Agreement becoming incapable of being satisfied.

     Section 4.5 Confidentiality. The terms and provisions of the confidentiality agreement dated September 21, 2005 between the Buyer and the Seller (the “Confidentiality Agreement”) are incorporated by reference herein and made a part hereof and Buyers obligations thereunder shall continue in full force and effect and survive after the Closing Date. Seller may disclose the existence of this Agreement as required by applicable law or in connection with any proposed sale or merger of Seller.

     Section 4.6 Consents and Filings; Further Assurances. Each of the parties shall use all commercially reasonable efforts to take, or cause to be taken, all appropriate action to do, or cause to be done, all things necessary, proper or advisable under applicable law or otherwise to consummate and make effective the transactions contemplated by this Agreement and the Ancillary Agreements as promptly as practicable, including, without limitation, to (i) obtain from Governmental Authorities and other Persons all consents, approvals, authorizations, qualifications and orders as are necessary for the consummation of the transactions contemplated by this Agreement and the Ancillary Agreements, (ii) promptly make all necessary filings, and thereafter make any other required submissions, with respect to this Agreement or the Ancillary Agreements required under any applicable law. In addition, immediately after the execution of this Agreement, the Seller shall, or procure that the relevant persons shall, (i) launch the regularization process of the building permit (number PC 13 028 87 B 0298 dated December 10, 1987) aiming at obtaining a compliance certificate (permis de construire de régularisation) from the town hall which has delivered such permit and to (ii) file such request with the relevant town hall on or before the Closing Date. All costs and fees relating to such regularization process (including those relating to the ordering of the construction plans and the work of the architect to be designated in connection with this process, i.e, the preparation of the request and the follow-up until the town hall has rendered its decision) shall be borne by the Seller. In the event the compliance certificate has not been issued prior to the Closing Date, the Seller shall deliver a copy of the regularization file and related documents, and introduce the designated architect, to the Purchaser, who will then handle the follow-up and supervision of the regularization process, at Purchaser’s costs (except for architect’s fees relating to the follow-up during the instruction period of the request), with the cooperation of the Seller, using commercially reasonable efforts. Each of the parties shall promptly notify the other party of any communication it or any of its Affiliates receives from any Governmental Authority relating to the matters that are the subject of this Agreement or the Ancillary Agreements and permit the other party to review in advance any proposed communication by such party to any Governmental Authority. The parties will coordinate and cooperate fully with each other in exchanging such information and providing such assistance as the other party may reasonably request in connection with the foregoing and in seeking early termination of any applicable waiting periods.

     Section 4.7 Release of Guarantees. The parties hereto agree to cooperate and use their commercially reasonable efforts to obtain the release of the Seller and its Affiliates that are a

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party to each of the guarantees, performance bonds, bid bonds and other similar agreements listed in Schedule 4.7 (the “Guarantees”). In the event any of the Guarantees are not released prior to or at the Closing, the Buyer will provide the Seller at the Closing with a guarantee that indemnifies and holds the Seller and its Affiliates that are a party to each such Guarantee harmless for any and all payments required to be made under, and costs and expenses incurred in connection with, such Guarantee by the Seller or its Affiliates that are a party to such Guarantee until such Guarantee is released.

     Section 4.8 Corporate Name; Website; Email. The Buyer acknowledges that, from and after the Closing Date, the Seller and any of its Affiliates shall have the absolute and exclusive proprietary right to all names, marks, trade names and trademarks incorporating all or part of “SCM Microsystems” or the other names and marks listed on Schedule 1.2(c), by itself or in combination with any other name or mark, and that none of the rights thereto or goodwill represented thereby or pertaining thereto are being transferred hereby or in connection herewith. The Buyer agrees that from and after the Closing Date it will not, nor will it permit any of its Affiliates to, use any name, phrase or logo incorporating all or part of “SCM Microsystems” or the other names and marks listed on Schedule 1.2(c), in or on any of its literature, sales materials or products or otherwise in connection with the sale of any products or services; provided, however, that the Buyer may continue to use any printed literature, sales materials, purchase orders and sales forms (collectively, “Printed Forms”) and sell any products, in each case, that are included in the Inventory on the Closing Date and that bear a name, phrase or logo incorporating all of part of “SCM Microsystems” (as limited by any existing agreements the Seller may have with third parties) until the supplies thereof existing on the Closing Date have been exhausted, but in any event, for not longer than nine months after the Closing Date; provided further, that, with respect to any such Printed Forms or products, from and after such nine-months period the Buyer shall sticker or otherwise mark such Printed Forms and products as necessary in order to indicate clearly that neither the Seller nor any of its Affiliates is a party to such Printed Forms or is selling such products. From and after the expiration of such nine-months period, the Buyer shall cease to use any such Printed Forms, delete or cover (as by stickering) any such name, phrase or logo from any item included in the Inventory that bears such name, phrase or logo and take such other commercially reasonable actions as may be necessary or advisable to clearly and prominently indicate that neither the Buyer nor any of its Affiliates is affiliated with the Seller or any of its Affiliates. In addition, for a period of up to sixty (60) days after the Closing Date, (i) the Seller shall provide a link on its website for customers of the Business to access the Buyers website and (ii) the Seller shall forward to Buyer email messages relating to the Business that have been sent to the prior email addresses of the Transferred Employees on the Sellers domain.

     Section 4.9 Refunds and Remittances. After the Closing: (i) if the Seller or any of its Affiliates receives any refund or other amount that is a Transferred Asset or is otherwise properly due and owing to the Buyer in accordance with the terms of this Agreement, the Seller promptly shall remit, or shall cause to be remitted, such amount to the Buyer and (ii) if the Buyer or any of its Affiliates receives any refund or other amount that is an Excluded Asset or is otherwise properly due and owing to the Seller or any of its Affiliates in accordance with the terms of this Agreement, the Buyer promptly shall remit, or shall cause to be remitted, such amount to Seller.

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     Section 4.10 Joint and Several Liability. To the extent that Kudelski S.A. causes one or more of its Affiliates to purchase the Transferred Assets, assume the Assumed Liabilities and/or perform any other obligation of Buyer hereunder or under any of the Ancillary Agreements, Kudelski S.A. and such Affiliate(s) shall be jointly and severally liable for the performance of such obligations; provided that it is expressly agreed by the parties that each Affiliate of Kudelski S.A. shall be liable only for the performance of the obligations relating to the Transferred Assets, the Assumed Liabilities and the other obligations of Buyer purchased and/or assumed by it pursuant to or in connection with this Agreement and/or the Ancillary Agreements and that such Affiliate shall not be liable for the performance of the obligations relating to Transferred Assets, Assumed Liabilities or other obligations of Buyer purchased and/or assumed by any other Affiliate of Kudelski S.A. To the extent that one of the Seller’s Affiliates is a party to one or more of the Ancillary Agreements, the Seller and such Affiliate shall be jointly and severally liable for the performance by such Subsidiary of such Affiliate’s obligations under such Ancillary Agreement; provided that it is expressly agreed by the parties that each Affiliate of the Seller shall be liable only for the performance of its obligations set forth in such Ancillary Agreement and that such Affiliate shall not be liable for the performance of any obligation of any other Affiliate of Seller set forth in such Ancillary Agreement or any other Ancillary Agreement.

     Section 4.11 Public Announcements. On and after the date hereof and through the Closing Date, the parties shall consult with each other before issuing any press release or otherwise making any public statements with respect to this Agreement, the Ancillary Agreements or the transactions contemplated hereby or thereby, and neither party shall issue any press release or make any public statement prior to obtaining the other party’s written approval, which approval shall not be unreasonably withheld or delayed, except that no such approval shall be necessary to the extent disclosure may be required by applicable law or any listing agreement of either party hereto.

     Section 4.12 Conditional Access Module Agreements. The Seller will provide the Buyer with reasonable cooperation (and the Buyer will reimburse the Seller for any out-of pocket expenses actually incurred by the Seller, other than payroll for the Seller’s employees and travel and administrative costs, but, for the avoidance of any doubt, including, without limitation, any amount the Seller may have to pay to any third party reseller or third party licensor), prior to and, if necessary and requested by the Buyer, after the Closing Date, to assist the Buyer in the Buyer’s effort to (i) negotiate and enter into an agreement with a certain third party reseller relating to the sale by the Business of conditional access modules to such third party reseller and the subsequent resale of such conditional access modules by the third party reseller to end users and (ii) cause such third party reseller to negotiate and enter into a license agreement with a certain third party licensor that will allow the third party reseller to incorporate the conditional access systems of the third party licensor into such conditional access modules on terms substantially similar to such third party licensor’s then current standard license terms and conditions.

     Section 4.13 Non-Compete. Until December 31, 2009, the Seller shall, and shall cause its Subsidiaries that exist on the Closing Date to, refrain from, directly or indirectly, selling products that directly compete with the digital television security solution products of the Business that exist as of the Closing Date; provided, however, that the foregoing restriction shall not apply to, restrict or bind, in any way, (a) Seller with respect to the production and sale of

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digital media readers, including those that might be use in digital televisions and (b) any Person that may at any time in the future (i) acquire the Seller or any of its Affiliates or any of the assets or properties of the Seller or any of its Affiliates, (ii) be acquired by the Seller or any of its Affiliates, (iii) merge or consolidate with or into the Seller or any of its Affiliates, or (iv) otherwise succeed to the business or operations of the Seller or any of its Affiliates. The Seller shall cause Robert Schneider, the Seller’s Chief Executive Officer, to enter into a similar non-compete agreement with a term of two (2) years (the “Schneider Agreement”) that is substantially in the form attached hereto as Exhibit I.

     Section 4.14 Notice to German Employees. The Buyer shall prepare and provide to the Seller and each of the German Business Employees promptly, and in any event, within three (3) business days, after the execution of this Agreement the notice required under the applicable statutory provisions, including Section 613a (5), (6), of the German Civil Code (BGB). The Seller will provide the Buyer with reasonable cooperation in connection with the Buyer’s preparation of such notice. Prior to the notice being delivered to the Excluded GBEs, Seller shall inform each Excluded GBE of their respective rights as a result of the consummation of the transactions contemplated by this Agreement and that the Buyer does not desire to retain such Excluded GBE after the Closing Date.

ARTICLE V
TAX MATTERS

     Section 5.1 Cooperation. From and after the Closing Date, the parties hereto agree to furnish or cause to be furnished to one another, upon request, as promptly as practicable, such information and assistance relating to the Transferred Assets as is reasonably necessary for the filing of all returns and other filings with respect to taxes of any kind, and making of any election related to taxes, the preparation for any audit by any taxing authority, and the prosecution or defense of any claim, action or proceeding relating to taxes. The parties hereto shall cooperate with each other in the conduct of any audit or other claim, action or proceeding related to taxes involving the Transferred Assets and each shall execute and deliver such powers of attorney and other documents as are necessary to carry out the intent of this Section 5.1.

     Section 5.2 Allocation of Taxes. All taxes of any kind (including, without limitation, personal property taxes and similar ad valorem obligations and business taxes, but — for the avoidance of doubt — excluding income tax or tax on capital gains upon the sale of the Transferred Assets) levied with respect to the Transferred Assets or the Business for a taxable period that includes (but does not end on) the Closing Date shall be apportioned prorata temporis between the Seller and the Buyer as of the Closing Date based on the number of days of such taxable period included in the Pre-Closing Tax Period and the number of days of such taxable period included in the Post-Closing Tax Period. The Seller shall be liable for the proportionate amount of such taxes that is attributable to the Pre-Closing Tax Period, and the Buyer shall be liable for the proportionate amount of such taxes that is attributable to the Post-Closing Tax Period. Within a reasonable period after the Closing, the Seller and the Buyer shall present a statement to the other setting forth the amount of reimbursement to which each is entitled under this Section 5.2, together with such supporting evidence as is reasonably necessary to calculate the proration amount. The proration amount shall be paid by the party owing it to the other within ten (10) days after delivery of such statement. From time to time after the

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Closing, as may be necessary, the Seller shall notify the Buyer upon receipt of any bill for tax relating to the Transferred Assets or the Business (such as personal property taxes and business taxes), part or all of which are attributable to the Post-Closing Tax Period, and shall promptly deliver such bill to the Buyer who shall pay the same to the appropriate taxing authority, provided that if such bill covers any part of the Pre-Closing Tax Period, the Seller shall also remit prior to the due date of assessment to the Buyer payment for the proportionate amount of such bill that is attributable to the Pre-Closing Tax Period. In the event that either the Seller or the Buyer shall thereafter make a payment for which it is entitled to reimbursement under this Section 5.2, the other party shall make such reimbursement promptly, but in no event later than thirty (30) days after the presentation of a statement setting forth the amount of reimbursement to which the presenting party is entitled along with such supporting evidence as is reasonably necessary to calculate the amount of reimbursement. Any payment required under this Section 5.2 and not made when due shall bear interest at the rate of seven and one-half percent (7.5%) per annum.

     Section 5.3 Sales and Use Taxes. If any sales, use and any other similar transfer taxes or any registration, stamp or other duties arise out of or become due as the result of the transfer of the Transferred Assets (“Sales Tax”), such taxes and duties shall be determined at Closing based on the Purchase Price allocation described in Section 1.7 and shall be paid by the Buyer. To the extent permitted by applicable law, the Buyer and the Seller shall cooperate fully in minimizing the Sales Tax. To the extent a taxing authority provides notice to the Seller of an audit of the Sales Tax, the Seller shall promptly notify the Buyer and the Buyer shall assume responsibility for such audit and shall pay when due any additional Sales Tax ultimately assessed with respect to the transactions contemplated by this Agreement. The Buyer shall have complete authority to control, settle or defend any proposed adjustment to the Sales Tax subject to the Seller’s approval, which shall not be unreasonably withheld, and the Seller shall cooperate fully with the Buyer in its defense or settlement of any proposed adjustment to the Sales Tax. Buyer hereby agrees to indemnify, defend, and hold Seller and its Affiliates harmless for any claims, losses, costs, fines, assessments, fees, liabilities, damages or injuries suffered by Seller or its Affiliates relating to the Sales Taxes or arising out of any failure by Buyer to pay the Sales Taxes.

     Section 5.4 Other Taxes. Taxes attributable to the Transferred Assets, other than those treated specifically in Sections 5.2 and 5.3, shall be borne by the party incurring such taxes (other than solely by reason of successor liability or similar provisions of law) under applicable law, and each party shall indemnify, defend and hold the other party harmless from and against all taxes for which such party is liable pursuant to this Section 5.4. The Buyer shall prepare and file (or cause to be prepared and filed) on a timely basis all tax returns and other filings for all taxable periods beginning after the Closing Date, shall pay all taxes shown to be due on such returns and other filings, and shall indemnify and hold the Seller harmless against, from and respect of all taxes (i) for any taxable year or period commencing after the Closing Date, and (ii) for any taxable period beginning before and ending after the Closing Date, other than taxes attributable to the Pre-Closing Tax Period. The provisions of Section 5.2 regarding payment, verification, and interest shall apply to the taxes that are subject to this Section 5.4.

     The Seller will be entitled to invoice to the Buyer any French VAT due to the French Treasury as a result of the sale of the French properties in accordance with articles 210 Schedule

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II of the French tax code. More generally, the Seller will be entitled to claim to the Buyer any VAT due as a result of the sale of the Business.

     The Seller and the Buyer agree that the sale, purchase and transfer of the German Transferred Assets qualifies as a transfer of a going concern (Geschäftsveräußerung im Ganzen). The Buyer guarantees by way of an independent, no-fault promise of guarantee pursuant to Section 311 para. 1 of the German Civil Code to the Seller that all legal requirements for the transfer of a going concern as laid down in the German Value Added Tax Act (“German VATA”, Umsatzsteuergesetz) are met. In this regard, the Buyer explicitly guarantees to the Seller to continue to conduct the Business with the German Transferred Assets.

     If a later tax audit (Betriebsprüfung) turns out that the sale, purchase and transfer of the German Transferred Asset cannot be qualified as a transfer of a going concern, the Buyer shall pay to SCM Microsystems GmbH, in exchange for an invoice described in Section 5.5, an amount equal to the German VAT and interest hereon payable, if any, on the aggregate of the Purchase Price and the value of the German Assumed Liabilities pursuant to Section 1.3 as far as the Purchase Price and the value of the German Assumed Liabilities pursuant to Section 1.3 are attributable to the German Transferred Assets, except for German VAT which is payable by the Buyer directly to the German tax authorities according to Section 13b German VATA (reverse charge). This additional amount will be due ten (10) days after receipt of the tax assessment following the tax audit.

     If the sale, purchase and transfer of the Singapore Transferred Assets qualifies as a transfer of a business of a going concern for the purposes of Section 34A(1) of the Singapore Goods and Services Tax Act (Chapter 117A) (“GST Act”), neither the Buyer nor the Seller shall not be liable for the payment of tax under the GST Act for the transfer of the Singapore Transferred Assets. However, if such sale, purchase and transfer of the Singapore Transferred Assets is subject to payment of goods and services tax under the GST Act, the parties agree that such tax shall be borne solely by the Buyer.

     Section 5.5 Tax Certificates. As soon as reasonably practicable, the Seller will provide Buyer with appropriate invoices for VAT purposes on the inventory to be acquired by the Buyer from the Seller under this Agreement.

ARTICLE VI
CONDITIONS TO CLOSING

     Section 6.1 General Conditions. The respective obligations of the Buyer and the Seller to consummate the transactions contemplated by this Agreement shall be subject to the fulfillment, at or prior to the Closing, of each of the following conditions, any of which may, to the extent permitted by applicable law, be waived in writing by either party in its sole discretion (provided that such waiver shall only be effective as to the obligations of the waiving party):

          (a) No Governmental Authority shall have enacted, issued, promulgated, enforced or entered any law (whether temporary, preliminary or permanent), including, without limitation, any law that may be administered by the U.S. Department of Treasury’s Office of Foreign Assets Controls (OFAC), that is then in effect and that enjoins, restrains, makes illegal

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or otherwise prohibits the consummation of the transactions contemplated by this Agreement or the Ancillary Agreements.

          (b) Any waiting period (and any extension thereof) under any antitrust or merger control law applicable to the transactions contemplated by this Agreement and the Ancillary Agreements shall have expired or shall have been terminated. All consents of, or registrations, declarations or filings with, any Governmental Authority legally required for the consummation of the transactions contemplated by this Agreement and the Ancillary Agreements shall have been obtained or filed.

     Section 6.2 Conditions to Obligations of the Seller. The obligations of the Seller to consummate the transactions contemplated by this Agreement shall be subject to the fulfillment, at or prior to the Closing, of each of the following conditions, any of which may be waived in writing by the Seller in its sole discretion:

          (a) The representations and warranties of the Buyer contained in this Agreement or any Ancillary Agreement or any certificate delivered pursuant hereto shall be true and correct both when made and as of the Closing Date, or in the case of representations and warranties that are made as of a specified date, such representations and warranties shall be true and correct as of such specified date, except where the failure to be so true and correct (without giving effect to any limitation or qualification as to “materiality” (including, without limitation, the word “material”) or “Material Adverse Effect” set forth therein) would not, individually or in the aggregate, have a Buyer Material Adverse Effect. The Buyer shall have performed all obligations and agreements and complied in all material respects with all covenants and conditions required by this Agreement or any Ancillary Agreement to be performed or complied with by it prior to or at the Closing. The Seller shall have received from the Buyer a certificate to the effect set forth in the preceding sentences, signed by a duly authorized officer thereof.

          (b) The Seller shall have received an executed counterpart of each of the Ancillary Agreements, signed by each party other than the Seller and its Subsidiaries.

          (c) Buyer shall have delivered each of the documents set forth in Section 1.8(c) to Seller.

     Section 6.3 Conditions to Obligations of the Buyer. The obligations of the Buyer to consummate the transactions contemplated by this Agreement shall be subject to the fulfillment, at or prior to the Closing, of each of the following conditions, any of which may be waived in writing by the Buyer in its sole discretion:

          (a) The representations and warranties of the Seller contained in this Agreement or any Ancillary Agreement or any certificate delivered pursuant hereto shall be true and correct both when made and as of the Closing Date, or in the case of representations and warranties that are made as of a specified date, such representations and warranties shall be true and correct as of such specified date, except where the failure to be so true and correct (without giving effect to any limitation or qualification as to “materiality” (including, without limitation, the word “material”) or “Material Adverse Effect” set forth therein) would not, individually or in the aggregate, reasonably be expected to have a Material Adverse Effect. The Seller shall have

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performed all obligations and agreements and complied in all material respects with all covenants and conditions required by this Agreement to be performed or complied with by it prior to or at the Closing. The Buyer shall have received from the Seller a certificate to the effect set forth in the preceding sentences, signed by a duly authorized officer thereof.

          (b) The Buyer shall have received an executed counterpart of each of the Ancillary Agreements and the Schneider Agreement, signed by each party other than the Buyer and its Affiliates.

          (c) Seller shall have or shall have caused to be delivered each of the documents set forth in Section 1.8(b) to Buyer.

          (d) The third party consents listed on Schedule 1.5 shall have been obtained.

          (e) The applicable one-month period during which any Excluded GBE shall be entitled to object to his/her transfer as provided in Schedule 1.9 shall have lapsed, provided that the Buyer shall have shall have complied with Section 4.14 hereof.

          (f) Except as set forth on Schedule 2.4, no Material Adverse Effect shall have occurred between the date hereof and the Closing Date.

          (g) The following documents relating to the Real Property shall have been provided to the Buyer, subject to the Buyer or its agents making an advance of at least 300 Euros to the Seller’s real property notary on or prior to the date of this Agreement:

• Construction plans relating to the 1987 building permit;

• Zoning documents relating to “ZAC” where the Real Property is located;

• Easement plans;

• Insurance certificate acknowledging the absence of any material claims since the acquisition of the Real Property by the Seller;

• Urbanism certificate (note d’urbanisme);

• Certificate that the air conditioning system is not affected by legionella;

• A copy of the request relating to the regularization of the building permit filed with the town hall in accordance with Section 4.6.

ARTICLE VII
TERMINATION

     Section 7.1 Termination. This Agreement may be terminated at any time prior to the Closing:

          (a) by mutual written consent of the Buyer and the Seller;

          (b) (i) by the Seller, if the Buyer breaches or fails to perform in any respect any of its representations, warranties or covenants contained in this Agreement or any Ancillary Agreement and such breach or failure to perform (A) would give rise to the failure of a condition

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set forth in Section 6.2, (B) cannot be or has not been cured within 15 days following delivery of written notice of such breach or failure to perform, and (C) has not been waived by the Seller or (ii) by the Buyer, if the Seller breaches or fails to perform in any respect any of its representations, warranties or covenants contained in this Agreement or any Ancillary Agreement and such breach or failure to perform (x) would give rise to the failure of a condition set forth in Section 6.3, (y) cannot be or has not been cured within 15 days following delivery of written notice of such breach or failure to perform, and (z) has not been waived by the Buyer; or

          (c) by either the Seller or the Buyer if the Closing shall not have occurred by the date 120 days after the date hereof (the “Termination Date”); provided, that the right to terminate this Agreement under this Section 7.1(d) shall not be available if the failure of the party so requesting termination to fulfill any obligation under this Agreement shall have been the cause of the failure of the Closing to occur on or prior to such date.

The party seeking to terminate this Agreement pursuant to this Section 7.1 (other than Section 7.1(a)) shall give prompt written notice of such termination to the other party.

     Section 7.2 Effect of Termination. In the event of termination of this Agreement as provided in Section 7.1, this Agreement shall forthwith become void and there shall be no liability on the part of either party, except that (a) the obligations set forth in, Sections 2.15 and 3.5 relating to broker’s fees and finder’s fees, Section 4.5 relating to confidentiality, Section 4.11 relating to public announcements, Article VIII and this Section 7.2 shall survive any termination of this Agreement and the parties shall continue to have liability thereunder and (b) nothing herein shall relieve either party from liability for any breach of this Agreement or any agreement made as of the date hereof or subsequent thereto pursuant to this Agreement.

ARTICLE VIII
GENERAL PROVISIONS

     Section 8.1 Non-survival of Representations, Warranties and Covenants. The respective representations, warranties and covenants of the Seller and the Buyer contained in this Agreement and any certificate delivered pursuant hereto shall terminate at, and not survive, the Closing; provided that this Section shall not limit any covenant or agreement of the parties that by its terms requires performance after the Closing, including, but not limited to, Sections 1.3, 1.4, 1.5, 1.6, 1.7 and 1.9, Sections 2.15 and 3.5 relating to broker’s fees and finder’s fees, Section 4.2(b) relating to the retention of records, Section 4.5 relating to confidentiality, Section 4.6 relating to consents and filings and further assurances, Section 4.7 relating to guarantees, Section 4.8 relating to corporate name, Section 4.9 relating to refunds, Section 4.10 relating to joint and several liability, Section 4.11 relating to public announcements, Article V relating to taxes, this Article VIII, and Section 7.2 regarding the effect of termination.

     Section 8.2 Fees and Expenses. Except as otherwise provided herein, all fees and expenses incurred in connection with or related to this Agreement and the Ancillary Agreements and the transactions contemplated hereby and thereby shall be paid by the party incurring such fees or expenses, whether or not such transactions are consummated.

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     Section 8.3 Amendment and Modification. This Agreement may not be amended, modified or supplemented in any manner, whether by course of conduct or otherwise, except by an instrument in writing signed on behalf of each party and otherwise as expressly set forth herein.

     Section 8.4 Waiver. No failure or delay of either party in exercising any right or remedy hereunder shall operate as a waiver thereof, nor shall any single or partial exercise of any such right or power, or any abandonment or discontinuance of steps to enforce such right or power, or any course of conduct, preclude any other or further exercise thereof or the exercise of any other right or power. The rights and remedies of the parties hereunder are cumulative and are not exclusive of any rights or remedies which they would otherwise have hereunder. Any agreement on the part of either party to any such waiver shall be valid only if set forth in a written instrument executed and delivered by a duly authorized officer on behalf of such party.

     Section 8.5 Notices. All notices and other communications hereunder shall be in writing and shall be deemed duly given (a) on the date of delivery if delivered personally, or if by facsimile, upon electronic confirmation of delivery by facsimile, (b) on the first Business Day following the date of dispatch if delivered utilizing a next-day service by a recognized next-day courier or (c) on the earlier of confirmed receipt or the fifth Business Day following the date of mailing if delivered by registered or certified mail, return receipt requested, postage prepaid. All notices hereunder shall be delivered to the addresses set forth below, or pursuant to such other instructions as may be designated in writing by the party to receive such notice:

          (a) if to the Seller, to:

SCM Microsystems, Inc.

466 Kato Terrace

Fremont California 94539

Attention: Steven Moore

Facsimile: +49-89-9595-59-5506

          with a copy (which shall not constitute notice) to:

Gibson, Dunn & Crutcher LLP

1881 Page Mill Road

Palo Alto, California 94304

Attention: Joseph Barbeau

Facsimile: (650) 849-5333

          (b) if to the Buyer, to:

Adrienne Corboud

Executive Vice President Business Development, Kudelski Group

Route de Geneve 22

CH — 1033 Cheseaux

Phone + 41 21 732 01 20

Fax + 41 21 732 03 00

E-mail: adrienne.corboud@nagra.com

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          with a copy (which shall not constitute notice) to:

Christine Bougis-Stentz

Member of the Paris and New York Bars, Partner

Correspondent DLA Piper Rudnick Gray Cary US LLP

12 rue de la Paix

75002 Paris, France

Tel: +33 (0)1 40 15 24 00

Fax: +33 (0)1 40 15 24 03

Email: christine.bougisstentz@dlapiper.com

     Section 8.6 Interpretation. When a reference is made in this Agreement to a paragraph, section, article or exhibit, such reference shall be to a paragraph, section, article or exhibit of this Agreement unless otherwise indicated. This Agreement has been negotiated and written in the English language and the English text hereof shall be the controlling text in the event of any discrepancy that may exist between the English text and any translation therefrom. The parties agree that this Agreement shall be interpreted according to its plain meaning and not strictly for or against any party. No party to this Agreement has relied upon the advice of any other party or that party’s agents as to the legal, tax or other consequences of this Agreement. Each of the Buyer and the Seller acknowledges that each party to this Agreement has been represented by counsel in connection with this Agreement and the transactions contemplated by this Agreement. Accordingly, any rule of law or any legal decision that would require interpretation of any claimed ambiguities in this Agreement against the drafting party has no application and is expressly waived.

     Section 8.7 Entire Agreement. This Agreement (including the exhibits and schedules hereto), the Ancillary Agreements and the Confidentiality Agreement constitute the entire agreement among the parties with respect to the subject matter of this Agreement and supersede all prior written agreements, arrangements, communications and understandings.

     Section 8.8 No Third-Party Beneficiaries. Nothing in this Agreement, express or implied, is intended to or shall confer upon any other Person any legal or equitable right, benefit or remedy of any nature under or by reason of this Agreement, except with respect to the Business Employees and the Excluded GBEs to the extent expressly set forth in Section 1.9 or Schedule 1.9. For the avoidance of any doubt, the stockholders of Seller are not third party beneficiaries under this Agreement and shall have no right to rely on the representations and warranties contained herein as characterizations of the actual state of facts or condition of the Seller or any of its Subsidiaries.

     Section 8.9 Governing Law. This Agreement and all disputes or controversies arising out of or relating to this Agreement or the transactions contemplated hereby shall be governed exclusively by, and construed in accordance with, the internal laws of the State of Delaware, without regard to the laws of any other jurisdiction. The conflicts of laws principles of the State of Delaware and the United Nations Convention on Contracts for the International Sale of Goods (CISG) are expressly excluded.

     Section 8.10 Submission to Arbitration. The Parties hereby irrevocably consent and agree that any dispute arising in connection with this Agreement shall be finally settled under the

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Rules of Arbitration of the International Chamber of Commerce by three arbitrators appointed in accordance with said Rules. The place of arbitration shall be Paris, France and the language of the arbitral proceedings shall be English.

     Section 8.11 Disclosure Generally. The fact that any item of information is disclosed in any Disclosure Schedule shall not be construed to mean that such information is required to be disclosed by this Agreement. Any item of information disclosed in any Disclosure Schedule and the dollar thresholds set forth herein shall not be used as a basis for interpreting the terms “material” or “Material Adverse Effect” or other similar terms in this Agreement.

     Section 8.12 Personal Liability. This Agreement shall not create or be deemed to create or permit any personal liability or obligation on the part of any direct or indirect stockholder of the Seller or the Buyer or any officer, director, employee, representative or investor of either party hereto.

     Section 8.13 Assignment; Successors. Neither this Agreement nor any of the rights, interests or obligations under this Agreement may be assigned or delegated, in whole or in part, by operation of law or otherwise, by either party without the prior written consent of the other party, and any such assignment without such prior written consent shall be null and void. Subject to the preceding sentence, this Agreement will be binding upon, inure to the benefit of, and be enforceable by, the parties and their respective successors and assigns.

     Section 8.14 Severability. Whenever possible, each provision or portion of any provision of this Agreement shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision or portion of any provision of this Agreement is held to be invalid, illegal or unenforceable in any respect under any applicable law or rule in any jurisdiction, such invalidity, illegality or unenforceability shall not affect any other provision or portion of any provision in such jurisdiction, and this Agreement shall be reformed, construed and enforced in such jurisdiction as if such invalid, illegal or unenforceable provision or portion of any provision had never been contained herein.

     Section 8.15 Waiver of Jury Trial. EACH OF THE PARTIES TO THIS AGREEMENT HEREBY IRREVOCABLY WAIVES ALL RIGHT TO A TRIAL BY JURY IN ANY ACTION, PROCEEDING OR COUNTERCLAIM ARISING OUT OF OR RELATING TO THIS AGREEMENT ANY ANCILLARY AGREEMENT OR THE TRANSACTIONS CONTEMPLATED HEREBY OR THEREBY.

     Section 8.16 Counterparts. This Agreement may be executed in two or more counterparts, all of which shall be considered one and the same instrument and shall become effective when one or more counterparts have been signed by each of the parties and delivered to the other party. This Agreement may be executed by facsimile signature and a facsimile signature shall constitute an original for all purposes.

     Section 8.17 No Consequential Damages. The parties hereto expressly acknowledge and agree that, except with respect to a breach of Section 4.5 or 4.8 hereof, no party hereto shall have any liability under any provision of this Agreement for any punitive, incidental, consequential, special or indirect damages, including, without limitation, business interruption,

26

loss of future revenue, profits or income, or loss of business reputation or opportunity relating to the breach or alleged breach of this Agreement.

     Section 8.18 Disclaimer of Implied Warranties.

          (a) Except for the representations and warranties expressly set forth in this Agreement, (i) neither party nor any of such party’s Subsidiaries, Affiliates or representatives is making any representation or warranty whatsoever, whether oral or written or express or implied, as to the accuracy or completeness of any information regarding the Business, the Transferred Assets or the Assumed Liabilities, and (ii) neither party is relying on any statement, representation or warranty, whether oral or written or express or implied, made by the other party or any of such party’s Subsidiaries, Affiliates or representatives. Without limiting the generality of the foregoing, the Buyer acknowledges and agrees that, except as expressly otherwise stated in this Agreement, neither the Seller nor any of its Subsidiaries, Affiliates or representatives makes any representations or warranties relating to the maintenance, repair, condition, design, performance or marketability of any Transferred Asset, including, without limitation, merchantability or fitness for a particular purpose. The Buyer acknowledges and agrees that it shall obtain rights in the Transferred Assets in their present condition and state of repair, “as is” and “where is.”

          (b) In connection with the Buyer’s investigation of the Business, the Buyer has received certain estimates, projections and other forecasts regarding the Business and the Transferred Assets. The Buyer acknowledges that there are uncertainties inherent in attempting to make such estimates, projections and other forecasts, that the Buyer is familiar with such uncertainties and that the Buyer is taking full responsibility for making its own evaluation of the adequacy and accuracy of all estimates, projections and other forecasts so furnished to it (including, without limitation, the reasonableness of the assumptions underlying such estimates, projections and forecasts). Accordingly, the Seller makes no representation or warranty with respect to such estimates, projections and other forecasts (including, without limitation, the reasonableness of the assumptions underlying such estimates, projections and forecasts).

ARTICLE IX
DEFINITIONS

     Section 9.1 Certain Defined Terms. For purposes of this Agreement:

          (a) “Affiliate”, with respect to any specified Person, means any other Person that directly, or indirectly through one or more intermediaries, controls, is controlled by, or is under common control with, such specified Person, including, but not limited to, affiliates within the meaning of Sec. 15 et seq. of the German Stock Corporation Act (AktG).

          (b) “Ancillary Agreements” means the Assumption Agreement, the License Agreement, the French Assets Purchase Agreement, the French Real Property Purchase Agreement, the German Transfer and Assumption Agreement, the IP Transfer Agreements and the Singapore Transfer and Assumption Agreement.

          (c) “Assumption Agreement” means an instrument of bill of sale and assignment and assumption substantially in the form attached hereto as Exhibit B and reasonably

27

satisfactory to the Buyer and the Seller pursuant to which (i) the Seller and its Subsidiaries shall transfer to the Buyer the tangible property owned or held by the Seller or any of its Subsidiaries as of the Closing Date that is included in the Transferred Assets and not otherwise transferred pursuant to the French Assets Purchase Agreements, the French Real Property Purchase Agreement, the German Transfer and Assumption Agreement or the Singapore Transfer and Assumption Agreement, and (ii) the Seller and its Subsidiaries shall assign to the Buyer and the Buyer shall assume the liabilities of the Seller or any of its Subsidiaries as of the Closing Date that are included in the Assumed Liabilities and not otherwise assigned and assumed pursuant to the French Assets Purchase Agreement, the French Real Property Purchase Agreement, the German Transfer and Assumption Agreement or the Singapore Transfer and Assumption Agreement.

          (d) “control”, including the terms “controlled by” and “under common control with”, means the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of a Person, whether through the ownership of voting securities, as trustee or executor, as general partner or managing member, by contract or otherwise.

          (e) “French Assets Purchase Agreement” means an agreement in French qualifying as a convention de successeur substantially in the form of the agreement attached hereto as Exhibit C, pursuant to which (i) the Seller and/or SCM Microsystems GmbH shall transfer to the Buyer the French Transferred Assets and (ii) the Buyer shall assume all of the French Assumed Liabilities.

          (f) “French Assumed Liabilities” means all of the Assumed Liabilities relating to French Transferred Assets or that are otherwise assumed and to be paid, discharged, performed or otherwise satisfied when due by the Buyer pursuant to this Agreement and the French Assets Purchase Agreement.

          (g) “French Real Property Purchase Agreement” means a notarized agreement in French (acte de vente) substantially in the form of the agreement attached hereto as Exhibit D, pursuant to which the Buyer shall purchase from the Seller or SCM Microsystems GmbH the Real Property.

          (h) “French Transferred Assets” means all of the Transferred Assets that are located in France or that are attached to the operation of the Business in France.

          (i) “German Assumed Liabilities” means all the of Assumed Liabilities relating to German Transferred Assets or that are otherwise assumed and to be paid, discharged, performed or otherwise satisfied when due by the Buyer pursuant to this Agreement and the German Transfer and Assumption Agreement.

          (j) “German Transfer and Assumption Agreement” means the agreement substantially in the form of the agreement attached hereto as Exhibit E, pursuant to which (i) the Seller and/or SCM Microsystems GmbH shall transfer to the Buyer the German Transferred Assets and (ii) the Buyer shall assume the German Assumed Liabilities.

          (k) “German Transferred Assets” means all of the Transferred Assets that are located in Germany or that are attached to the operation of the Business in Germany.

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          (l) “IP Transfer Agreements” means the local patent, trademark and copyrights transfer agreements substantially in the form of the agreements attached hereto as Exhibit F and such other forms and agreements as may be reasonably required for the Seller and its Subsidiaries to assign and transfer to the Buyer the Business Intellectual Property.

          (m) “Knowledge” means the actual (but not constructive or imputed) knowledge of the persons listed in Schedule 9.1(m) as of the date of this Agreement (or, with respect to a certificate delivered pursuant to this Agreement, as of the date of delivery of such certificate).

          (n) “License Agreement” means that certain License Agreement substantially in the form of the agreement attached hereto as Exhibit G pursuant to which Seller grants to Buyer a royalty free and fully paid, sublicenseable, perpetual and irrevocable nonexclusive license to use the Licensed Intellectual Property in the Business.

          (o) “Material Adverse Effect” means any event, change, circumstance, effect or state of facts that is materially adverse to the Business or results of operations of the Business, taken as a whole; provided, however, that “Material Adverse Effect” shall not include the effect of any circumstance, change, development, event or state of facts arising out of or attributable to any of the following, either alone or in combination: (1) the markets in which the Business operates generally, (2) general economic or political conditions, (3) the public announcement of this Agreement or of the consummation of the transactions contemplated hereby, (4) acts of war (whether or not declared), sabotage or terrorism, military actions or the escalation thereof or other force majeure events occurring after the date hereof or (5) any changes in applicable laws, regulations or accounting rules.

          (p) “Permitted Encumbrance” means (a) statutory liens for current taxes not yet due or delinquent (or which may be paid without interest or penalties) or the validity or amount of which is being contested in good faith by appropriate proceedings, (b) mechanics’, carriers’, workers’, repairers’, landlords’ and other similar liens arising or incurred in the ordinary course of business relating to obligations as to which there is no default on the part of the Seller or any of its Subsidiaries for a period greater than 60 days, or the validity or amount of which is being contested in good faith by appropriate proceedings, or pledges, deposits or other liens securing the performance of bids, trade contracts, leases or statutory obligations (including, without limitation, workers’ compensation, unemployment insurance or other social security legislation), (c) zoning, entitlement, conservation restriction and other land use and environmental regulations by Governmental Authorities and (d) all exceptions, restrictions, easements, leases, imperfections of title, retention of title, charges, rights-of-way and other charges, claims, mortgages, leases, liens, options, pledges or security interests or other restrictions of any kind that do not materially interfere with the present use of the Transferred Assets in the Business taken as a whole in each relevant jurisdiction.

          (q) “Person” means an individual, corporation, partnership, limited liability company, limited liability partnership, syndicate, person, trust, association, organization or other entity, including, without limitation, any Governmental Authority, and including any successor, by merger or otherwise, of any of the foregoing.

29

          (r) “Post-Closing Tax Period” means any tax period (or portion thereof) beginning on or after the Closing Date and ending after the Closing Date.

          (s) “Pre-Closing Tax Period” means any tax period (or portion thereof) ending on or before the close of business on the day prior to the Closing Date.

          (t) “Singapore Transfer and Assumption Agreement” means the agreement substantially in the form of the agreement attached hereto as Exhibit H, pursuant to which (i) the Seller and/or SCM (Asia) Microsystems PTE Ltd shall transfer to the Buyer the Transferred Assets that are located in Singapore or that are attached to the operation of the Business in Singapore and (ii) the Buyer shall assume all of the Assumed Liabilities relating to such Transferred Assets or that are otherwise assumed and to be paid, discharged, performed or otherwise satisfied when due by the Buyer pursuant to this Agreement and the Singapore Transfer and Assumption Agreement, it being agreed, however, that, for the purposes of the Singapore Transfer and Assumption Agreement, the Buyer may be two Subsidiaries of Kudelski, which will each acquire a portion of such Transferred Assets and assume a portion of the aforementioned Assumed Liabilities.

          (u) “Subsidiary” of any Person means any other Person of which at least 50% of the outstanding voting securities or other voting equity interests are owned, directly or indirectly, by such first Person.

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

30

     IN WITNESS WHEREOF, the Seller and the Buyer have caused this Agreement to be executed as of the date first written above by their respective officers thereunto duly authorized.

SCM MICROSYSTEMS, INC.
By:	/s/ Robert Schneider
	Name:	Robert Schneider
	Title:	Chief Executive Officer

KUDELSKI S.A.
By:	/s/ Jean-Jacques Duvoisin
	Name:	Jean-Jacques Duvoisin
	Title:	VP Finance and Administrative

By:	/s/ Nicolas Goepfschmann
	Name:	Nicolas Goepfschmann
	Title:	Corporate Secretary, Director of Group Administration

SIGNATURE PAGE TO ASSET PURCHASE AGREEMENT

EX-10.26

Exhibit 10.26

LEASE

RREEF AMERICA REIT II CORP. DDD,
a Maryland corporation

Landlord,

and

SCM MICROSYSTEMS, INC.,
a Delaware corporation

Tenant

TABLE OF CONTENTS

		page
1.	USE AND RESTRICTIONS ON USE		1
2.	TERM		2
3.	RENT		2
4.	RENT ADJUSTMENTS		3
5.	SECURITY DEPOSIT		6
6.	ALTERATIONS		6
7.	REPAIR		7
8.	LIENS		8
9.	ASSIGNMENT AND SUBLETTING		8
10.	INDEMNIFICATION		10
11.	INSURANCE		11
12.	WAIVER OF SUBROGATION		11
13.	SERVICES AND UTILITIES		11
14.	HOLDING OVER		12
15.	SUBORDINATION		12
16.	RULES AND REGULATIONS		12
17.	REENTRY BY LANDLORD		13
18.	DEFAULT		13
19.	REMEDIES		14
20.	TENANT’S BANKRUPTCY OR INSOLVENCY		15
21.	QUIET ENJOYMENT		16
22.	CASUALTY		16
23.	EMINENT DOMAIN		17
24.	SALE BY LANDLORD		17
25.	ESTOPPEL CERTIFICATES		18
26.	SURRENDER OF PREMISES		18
27.	NOTICES		19
28.	TAXES PAYABLE BY TENANT		19
29.	RELOCATION OF TENANT		19
30.	DEFINED TERMS AND HEADINGS		19
31.	TENANT’S AUTHORITY		19
32.	FINANCIAL STATEMENTS AND CREDIT REPORTS		20
33.	COMMISSIONS		20
34.	TIME AND APPLICABLE LAW		20
35.	SUCCESSORS AND ASSIGNS		20
36.	ENTIRE AGREEMENT		20
37.	EXAMINATION NOT OPTION		20

i

TABLE OF CONTENTS
(continued)

		page
38.	RECORDATION		20
39.	SIGNAGE		20
40.	OPTION TO RENEW		21
41.	LIMITATION OF LANDLORD’S LIABILITY		21

EXHIBIT A – FLOOR PLAN DEPICTING THE PREMISES

EXHIBIT A-1 – SITE PLAN

EXHIBIT B – INITIAL ALTERATIONS

EXHIBIT C – COMMENCEMENT DATE MEMORANDUM

EXHIBIT D – RULES AND REGULATIONS

[REMAINDER OF PAGE INTENTIONALLY LEFT BLANK]

ii

MULTI-TENANT INDUSTRIAL NET LEASE

REFERENCE PAGES

BUILDING:	41638 – 41758 Christy Street
PROJECT:	Fremont Commerce Center
LANDLORD:	RREEF AMERICA REIT II CORP. DDD,
	a Maryland corporation
LANDLORD’S ADDRESS:	26120 Eden Landing Road, Suite 2
	Hayward, California 94545
	Attn: Property Manager
WIRE INSTRUCTIONS AND/OR ADDRESS FOR RENT PAYMENT:	Fremont Commerce Center
	Dept# 2037
	P.O. Box 39000
	San Francisco, California 94139
LEASE REFERENCE DATE:	June 23, 2006
TENANT:	SCM MICROSYSTEMS, INC.,
	a Delaware corporation
TENANT’S NOTICE ADDRESS:
(a) As of beginning of Term:	The Premises
(b) Prior to beginning of Term (if different):	466 Kato Terrace
	Fremont, California 94539
	Attn: Chief Financial Officer
PREMISES ADDRESS:	41740 Christy Street
	Fremont, California 94568
PREMISES RENTABLE AREA:	Approximately 6,200 sq. ft. (for outline of Premises see Exhibit A)
USE:	General office use, software engineering, laboratory, warehouse, engineering, sales and related uses in conformity with the municipal zoning requirements of the City of Fremont.
COMMENCEMENT DATE:	September 1, 2006
TERM OF LEASE:	Approximately twenty-five (25) months beginning on the Commencement Date and ending on the Termination Date.
TERMINATION DATE:	September 30, 2008

[REMAINDER OF PAGE INTENTIONALLY LEFT BLANK]

iii

ANNUAL RENT and MONTHLY INSTALLMENT OF RENT (Article 3):

Period		Rentable Square		Annual Rent				Monthly Installment
from	through	Footage		Per Square Foot		Annual Rent		of Rent
9/1/2006	8/31/2007		6,200	$	7.68	$	47,616.00	$	3,968.00*
9/1/2007	9/30/2008		6,200	$	7.92	$	49,104.00	$	4,092.00

* Monthly Installment of Rent for the first calendar month of the Term shall be abated pursuant to Section 3.3 of the Lease.

INITIAL ESTIMATED MONTHLY INSTALLMENT OF RENT ADJUSTMENTS (Article 4):	$	992.00
TENANT’S PROPORTIONATE SHARE OF THE BUILDING:		6.33	%
TENANT’S PROPORTIONATE SHARE OF THE PROJECT:		1.86	%
SECURITY DEPOSIT:	$	5,500.00
ASSIGNMENT/SUBLETTING FEE:	$	1,000.00
REAL ESTATE BROKER:	None
TENANT’S SIC CODE:		7372
AMORTIZATION RATE:		N/A

The Reference Pages information is incorporated into and made a part of the Lease. In the event of any conflict between any Reference Pages information and the Lease, the Lease shall control. The Lease includes Exhibits A through D, all of which are made a part of the Lease.

IN WITNESS WHEREOF, Landlord and Tenant have entered into the Lease as of the Lease Reference Date set forth above.

LANDLORD:						TENANT:
RREEF AMERICA REIT II CORP. DDD,						SCM MICROSYSTEMS, INC., a
a Maryland corporation						Delaware corporation
By:	RREEF Management Company, a Delaware
	corporation, its Authorized Agent
By:	/s/ Stephen J. George					By:	/s/ Stephan Rohaly
Name:			Stephen J. George			Name:			Stephan Rohaly
Title:		Regional Director				Title:		Chief Financial Officer
Dated:				August 1	, 2006	Dated:			July 14	, 2006

iv

LEASE

     By this Lease Landlord leases to Tenant and Tenant leases from Landlord the Premises in the Building as set forth and described on the Reference Pages. The Premises are depicted on the floor plan attached hereto as Exhibit A, and the Building is depicted on the site plan attached hereto as Exhibit A-1. The Reference Pages, including all terms defined thereon, are incorporated as part of this Lease.

1. USE AND RESTRICTIONS ON USE.

     1.1 The Premises are to be used solely for the purposes set forth on the Reference Pages. Tenant shall not do or permit anything to be done in or about the Premises which will in any way obstruct or interfere with the rights of other tenants or occupants of the Building or injure, annoy, or disturb them, or allow the Premises to be used for any improper, immoral, unlawful, or objectionable purpose, or commit any waste. Tenant shall not do, permit or suffer in, on, or about the Premises the sale of any alcoholic liquor without the written consent of Landlord first obtained. Tenant shall comply with all federal, state and city laws, codes, ordinances, rules and regulations (collectively, “Regulations”) applicable to the use of the Premises and its occupancy and shall promptly comply with all governmental orders and directions for the correction, prevention and abatement of any violations in the Building or appurtenant land, caused or permitted by, or resulting from the specific use by, Tenant, or in or upon, or in connection with, the Premises, all at Tenant’s sole expense. Tenant shall not do or permit anything to be done on or about the Premises or bring or keep anything into the Premises which will in any way increase the rate of, invalidate or prevent the procuring of any insurance protecting against loss or damage to the Building or any of its contents by fire or other casualty or against liability for damage to property or injury to persons in or about the Building or any part thereof. Landlord will, at Landlord’s expense, perform all acts required to comply with Regulations in effect as of the date of this Lease and as interpreted and enforced in the county in which the Premises is located, with respect to the foregoing as the same affect the common areas of the Building and the Premises. Landlord will perform all acts required to comply with Regulations in effect (and as interpreted and enforced) after the date of this Lease with respect to the common areas only and such costs shall be a part of Expenses as provided in Article 4 of this Lease. Notwithstanding the foregoing, Landlord shall have the right to contest any alleged violation of any Regulations in good faith, including, without limitation, the right to apply for and obtain a waiver or deferment of compliance, the right to assert any and all defenses allowed by law and the right to appeal any decisions, judgments or rulings to the fullest extent permitted by Regulations. Landlord, after the exhaustion of any and all rights to appeal or contest, will make all repairs, additions, alterations or improvements necessary to comply with the terms of any final order or judgment, provided that if Landlord elects not to contest any alleged violation, Landlord will promptly make necessary all repairs, additions, alterations or improvements. Notwithstanding anything to the contrary contained herein, Tenant, not Landlord, shall be responsible for the correction of any violations that arise out of or in connection with the specific nature of Tenant’s business in the Premises (other than general office use), the acts or omissions of Tenant, its agents, employees or contractors, Tenant’s arrangement of any furniture, equipment or other property in the Premises, any repairs, alterations, additions or improvements performed by or on behalf of Tenant (including the Initial Alterations described on Exhibit B hereto) and any design or configuration of the Premises.

     1.2 Tenant shall not, and shall not direct, suffer or permit any of its agents, contractors, employees, licensees or invitees (collectively, the “Tenant Entities”) to at any time handle, use, manufacture, store or dispose of in or about the Premises or the Building any (collectively “Hazardous Materials”) flammables, explosives, radioactive materials, hazardous wastes or materials, toxic wastes or materials, or other similar substances, petroleum products or derivatives or any substance subject to regulation by or under any federal, state and local laws and ordinances relating to the protection of the environment or the keeping, use or disposition of environmentally hazardous materials, substances, or wastes, presently in effect or hereafter adopted, all amendments to any of them, and all rules and regulations issued pursuant to any of such laws or ordinances (collectively “Environmental Laws”), nor shall Tenant suffer or permit any Hazardous Materials to be used in any manner not fully in compliance with all Environmental Laws, in the Premises or the Building and, if the same may affect or impact the Building and/or the parcel of land upon which the Building is located, or any portions of land benefiting the foregoing by easement, license or other similar rights, any appurtenant land, or allow the environment to become contaminated with any Hazardous Materials if the same may affect or impact the Building and/or the parcel of land upon which the Building is located, or any portions of land benefiting the foregoing by easement, license or other similar rights. Notwithstanding the foregoing, Tenant may handle, store, use or dispose of products containing small quantities of Hazardous Materials (such as aerosol cans containing insecticides, toner for copiers, paints, paint remover and the like) to the extent customary and necessary for the use of the Premises for general office purposes; provided that Tenant shall always handle, store, use, and dispose of any such Hazardous Materials in a safe and lawful manner and never allow such Hazardous Materials to contaminate the Premises, Building and appurtenant land or the environment. Tenant shall protect, defend, indemnify and hold each and all of the Landlord Entities (as defined in Article 30) harmless from and against any and all loss, claims, liability or costs (including court costs and attorney’s fees) incurred by reason of any actual or asserted failure of

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Tenant to fully comply with all applicable Environmental Laws, or the presence, handling, use or disposition in or from the Premises of any Hazardous Materials by Tenant or any Tenant Entity (even though permissible under all applicable Environmental Laws or the provisions of this Lease), or by reason of any actual or asserted failure of Tenant to keep, observe, or perform any provision of this Section 1.2. As of the date hereof, Landlord has not received notice from any governmental agencies that the Building is in violation of any Environmental Laws. Further, to Landlord’s actual knowledge, there are no Hazardous Materials at the Building other than small quantities of Hazardous Materials (such as aerosol cans containing insecticides, toner for copiers, paints, paint remover and the like) to the extent customary and necessary for the use of the Premises for general office purposes. For purposes of this Section, “Landlord’s actual knowledge” shall be deemed to mean and limited to the current actual knowledge of Nicole Aamoth, Property Manager for the Building, at the time of execution of the Lease and not any implied, imputed, or constructive knowledge of said individual or of Landlord or any parties related to or comprising Landlord and without any independent investigation or inquiry having been made or any implied duty to investigate or make any inquiries; it being understood and agreed that such individual shall have no personal liability in any manner whatsoever hereunder or otherwise related to the transactions contemplated hereby.

     1.3 Tenant and the Tenant Entities will be entitled to the non-exclusive use of the common areas of the Building as they exist from time to time during the Term, including the parking facilities, subject to Landlord’s reasonable rules and regulations regarding such use. The rules and regulations shall be generally applicable, and generally applied in the same manner, to all tenants of the Building. However, in no event will Tenant or the Tenant Entities park more vehicles in the parking facilities than Tenant’s Proportionate Share of the total parking spaces available for common use. The foregoing shall not be deemed to provide Tenant with an exclusive right to any parking spaces or any guaranty of the availability of any particular parking spaces or any specific number of parking spaces.

2. TERM.

     2.1 The Term of this Lease shall begin on the date (“Commencement Date”) as shown on the Reference Pages as the Commencement Date and shall terminate on the date as shown on the Reference Pages as the Termination Date (“Termination Date”), unless sooner terminated by the provisions of this Lease. Tenant shall, at Landlord’s request, execute and deliver a memorandum agreement provided by Landlord in the form of Exhibit C attached hereto, setting forth the actual Commencement Date, Termination Date and, if necessary, a revised rent schedule. Should Tenant fail to do so within thirty (30) days after Landlord’s request, the information set forth in such memorandum provided by Landlord shall be conclusively presumed to be agreed and correct.

     2.2 Tenant agrees that in the event of the inability of Landlord to deliver possession of the Premises on the Commencement Date set forth on the Reference Pages for any reason, Landlord shall not be liable for any damage resulting from such inability, but except to the extent such delay is the result of the acts or omissions of Tenant or any Tenant Entities, Tenant shall not be liable for any rent until the time when Landlord delivers possession of the Premises to Tenant. No such failure to give possession on the Commencement Date shall affect the other obligations of Tenant under this Lease, except that the actual Commencement Date shall be postponed until the date that Landlord delivers possession of the Premises to Tenant, except to the extent that such delay is as a result of the acts or omissions of Tenant or any Tenant Entity.

     2.3 In the event Landlord permits Tenant, or any agent, employee or contractor of Tenant, to enter, use or occupy the Premises prior to the Commencement Date, such entry, use or occupancy shall be subject to all the provisions of this Lease other than the payment of rent, including, without limitation, Tenant’s compliance with the insurance requirements of Article 11. Said early possession shall not advance the Termination Date.

3. RENT.

     3.1 Tenant agrees to pay to Landlord the Annual Rent in effect from time to time by paying the Monthly Installment of Rent then in effect on or before the first day of each full calendar month during the Term, except that the second Monthly Installment of Rent and the Security Deposit shall be paid upon the execution of this Lease. The Monthly Installment of Rent in effect at any time shall be one-twelfth (1/12) of the Annual Rent in effect at such time. Rent for any period during the Term which is less than a full month shall be a prorated portion of the Monthly Installment of Rent based upon the number of days in such month. Said rent shall be paid to Landlord, without deduction or offset and without notice or demand, at the Rent Payment Address, as set forth on the Reference Pages, or to such other person or at such other place as Landlord may from time to time designate in writing. If an Event of Default occurs three (3) times or more in any twelve (12) month period during the Term, Landlord may require that Tenant submit Base Rent and Tenant’s Proportionate Share of Expenses and Taxes to Landlord on a quarterly basis (due on or before the first day of each calendar quarter) for the

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following 12 month period. Unless specified in this Lease to the contrary, all amounts and sums payable by Tenant to Landlord pursuant to this Lease shall be deemed additional rent.

     3.2 Tenant recognizes that late payment of any rent or other sum due under this Lease will result in administrative expense to Landlord, the extent of which additional expense is extremely difficult and economically impractical to ascertain. Tenant therefore agrees that if rent or any other sum is not paid when due and payable pursuant to this Lease, a late charge shall be imposed in an amount equal to the greater of: (a) Fifty Dollars ($50.00), or (b) five percent (5%) of the unpaid rent or other payment; provided that Tenant shall be entitled to a grace period of five (5) days for the first late payment of rent or other sum due in a given calendar year. The amount of the late charge to be paid by Tenant shall be reassessed and added to Tenant’s obligation for each successive month until paid. The provisions of this Section 3.2 in no way relieve Tenant of the obligation to pay rent or other payments on or before the date on which they are due, nor do the terms of this Section 3.2 in any way affect Landlord’s remedies pursuant to Article 19 of this Lease in the event said rent or other payment is unpaid after date due.

     3.3 Notwithstanding anything in this Lease to the contrary, so long as Tenant is not in default under this Lease, Tenant shall be entitled to an abatement of Monthly Installment of Rent with respect to the Premises, as originally described in this Lease, in the amount of $3,968.00 (the “Abated Monthly Installment of Rent”) for the first calendar month of the Term. If Tenant defaults under this Lease at any time during the Term and fails to cure such default within any applicable cure period under this Lease, then all Abated Monthly Installment of Rent shall immediately become due and payable. Only Monthly Installment of Rent shall be abated pursuant to this Section, as more particularly described herein, and Tenant’s Proportionate Share of Expenses and Taxes all other rent and other costs and charges specified in this Lease shall remain as due and payable pursuant to the provisions of this Lease.

4. RENT ADJUSTMENTS.

     4.1 For the purpose of this Article 4, the following terms are defined as follows:

          4.1.1 Lease Year: Each fiscal year (as determined by Landlord from time to time) falling partly or wholly within the Term.

          4.1.2 Expenses: All costs of operation, maintenance, repair, replacement and management of the Building, as determined in accordance with generally accepted accounting principles, including the following costs by way of illustration, but not limitation: water and sewer charges; insurance charges of or relating to all insurance policies and endorsements deemed by Landlord to be reasonably necessary or desirable and relating in any manner to the protection, preservation, or operation of the Building or any part thereof; utility costs, including, but not limited to, the cost of heat, light, power, steam, gas; waste disposal; the cost of janitorial services; the cost of security and alarm services (including any central station signaling system); costs of cleaning, repairing, replacing and maintaining the common areas, including parking and landscaping, window cleaning costs; labor costs; costs and expenses of managing the Building including management and/or administrative fees (subject to the limitations expressly set forth below); air conditioning maintenance costs; elevator maintenance fees and supplies; material costs; equipment costs including the cost of maintenance, repair and service agreements and rental and leasing costs; purchase costs of equipment; current rental and leasing costs of items which would be capital items if purchased; tool costs; licenses, permits and inspection fees; wages and salaries for personnel below the level of vice president (provided that if any employee performs services in connection with the Building and other buildings, costs associated with such employee may be proportionately included in Expenses based on the percentage of time such employee spends in connection with the operation, maintenance and management of the Building); employee benefits and payroll taxes; accounting and legal fees; any sales, use or service taxes incurred in connection therewith. In addition, Landlord shall be entitled to recover, as additional rent (which, along with any other capital expenditures constituting Expenses, Landlord may either include in Expenses or cause to be billed to Tenant along with Expenses and Taxes but as a separate item), Tenant’s Proportionate Share of: (i) an allocable portion of the cost of capital improvement items which are reasonably calculated to reduce operating expenses; (ii) the cost of fire sprinklers and suppression systems and other life safety systems (provided that to the extent the foregoing is a capital improvement, the cost thereof shall be amortized over the reasonable life of such expenditures as provided in the following clause (iii)); and (iii) other capital expenses which are required under any governmental laws, regulations or ordinances which were not applicable to the Building as of the date of this Lease; but the costs described in this sentence shall be amortized over the reasonable life of such expenditures in accordance with such reasonable life and amortization schedules as shall be determined by Landlord in accordance with generally accepted accounting principles, with interest on the unamortized amount at one percent (1%) in excess of the Wall Street Journal prime lending rate announced from time to time. Expenses shall not include depreciation or amortization of the Building or equipment in the Building except as provided herein, loan principal payments, costs of alterations of tenants’ premises, leasing commissions, interest expenses on long-term borrowings, advertising costs including the cost of brochures

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and marketing supplies, legal fees in negotiating and preparing lease documents, and construction, improvement and decorating costs in preparing space for initial occupancy by a specific tenant. The following items are also excluded from Expenses and in no event shall Tenant have any obligation to perform, pay directly or reimburse Landlord for any of the following except to the extent expressly provided herein:

     (a) Sums paid to subsidiaries or other affiliates of Landlord for services on or to the Building and/or Premises, but only to the extent that the costs of such services exceed the competitive cost for such services rendered by persons or entities of similar skill, competence and experience.

     (b) Any fines, penalties or interest resulting from the negligence or willful misconduct of the Landlord or its agents, contractors, or employees.

     (c) Fines, costs or penalties incurred as a result and to the extent of a violation by Landlord or other tenants of the project of which Building is a part of any applicable laws.

     (d) Landlord’s charitable and political contributions.

     (e) Ground lease rental.

     (f) Attorney’s fees and other expenses incurred in connection with negotiations or disputes with prospective tenants or tenants or other occupants of the Building.

     (g) The cost or expense of any services or benefits provided generally to other tenants in the Building and not provided or available to Tenant.

     (h) All costs of purchasing or leasing major sculptures, paintings or other major works or objects of art (as opposed to decorations purchased or leased by Landlord for display in the common areas of the Building).

     (i) Any expenses for which Landlord has received actual reimbursement (other than through Expenses).

     (j) Costs incurred by Landlord in connection with the correction of defects in design and original construction of the Building.

     (k) Any cost or expense related to removal, cleaning, abatement or remediation of Hazardous Materials in or about the Building or the common areas, including, without limitation, hazardous substances in the ground water or soil, except to the extent such removal, cleaning, abatement or remediation is related to the general repair and maintenance of the Building and the common areas.

     (l) Costs incurred by Landlord in connection with the correction of defects in design and original construction of the Building.

     (m) Any costs, fines or penalties incurred due to violations by Landlord of any law, order, rule or regulations of any governmental authority which was in effect (and as interpreted and enforced) as of the date of this Lease.

     (n) Penalties, interest and other costs incurred by Landlord in connection with Landlord’s failure to comply with conditions, covenants and restrictions applicable to the Building.

     (o) The cost of repairs and maintenance equitably allocated by Landlord to buildings other than the Building.

     (p) Principal payments of mortgage debt of Landlord.

     (q) Interest (except as provided in this Lease for the amortization of capital improvements).

     (r) Costs of capital improvements except to the extent expressly set forth in this Lease.

     (s) Expense reserves.

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          4.1.3 Taxes: Real estate taxes and any other taxes, charges and assessments which are levied with respect to the Building or the land appurtenant to the Building, or with respect to any improvements, fixtures and equipment or other property of Landlord, real or personal, located in the Building and used in connection with the operation of the Building and said land, any payments to any ground lessor in reimbursement of tax payments made by such lessor; and all fees, expenses and costs incurred by Landlord in investigating, protesting, contesting or in any way seeking to reduce or avoid increase in any assessments, levies or the tax rate pertaining to any Taxes to be paid by Landlord in any Lease Year. Taxes shall not include any corporate franchise, capital levy, capital stock, gift, estate, inheritance or net income tax, or tax imposed upon any transfer by Landlord of its interest in this Lease or the Building, any property taxes allocated to buildings other than the Building and any taxes to be paid by Tenant pursuant to Article 28. In the event that Landlord may elect to pay a special assessment in one payment or over a period of time, regardless of Landlord’s election, any such assessment shall be included in Taxes only to the extent it would have been due over time.

     4.2 Tenant shall pay as additional rent for each Lease Year Tenant’s Proportionate Share of Expenses and Taxes incurred for such Lease Year.

     4.3 The annual determination of Expenses shall be made by Landlord and shall be binding upon Landlord and Tenant, subject to the provisions of this Section 4.3. During the Term, Tenant may review, at Tenant’s sole cost and expense, the books and records supporting such determination in an office of Landlord, or Landlord’s agent, during normal business hours, upon giving Landlord five (5) days advance written notice within ninety (90) days after receipt of such determination, but in no event more often than once in any one (1) year period, subject to execution of a confidentiality agreement acceptable to Landlord, and provided that if Tenant utilizes an independent accountant to perform such review it shall be one of national standing which is reasonably acceptable to Landlord, is not compensated on a contingency basis and is also subject to such confidentiality agreement. Tenant shall be solely responsible for all costs, expenses and fees incurred for such review. However, notwithstanding the foregoing, if Landlord and Tenant determine that Expenses for the Building for the year in question were less than stated by more than 5%, Landlord, within 30 days after its receipt of paid invoices therefor from Tenant, shall reimburse Tenant for the reasonable amounts paid by Tenant to third parties in connection with such review by Tenant. If Tenant fails to object to Landlord’s determination of Expenses within ninety (90) days after receipt, or if any such objection fails to state with specificity the reason for the objection, Tenant shall be deemed to have approved such determination and shall have no further right to object to or contest such determination. In the event that during all or any portion of any Lease Year or Base Year, the Building is not fully rented and occupied Landlord shall make an appropriate adjustment in occupancy-related Expenses for such year for the purpose of avoiding distortion of the amount of such Expenses to be attributed to Tenant by reason of variation in total occupancy of the Building, by employing consistent and sound accounting and management principles to determine Expenses that would have been paid or incurred by Landlord had the Building been at least ninety-five percent (95%) rented and occupied, and the amount so determined shall be deemed to have been Expenses for such Lease Year.

     4.4 Prior to the actual determination thereof for a Lease Year, Landlord may from time to time estimate Tenant’s liability for Expenses and/or Taxes under Section 4.2, Article 6 and Article 28 for the Lease Year or portion thereof. Landlord will give Tenant written notification of the amount of such estimate and Tenant agrees that it will pay, by increase of its Monthly Installments of Rent due in such Lease Year, additional rent in the amount of such estimate. Any such increased rate of Monthly Installments of Rent pursuant to this Section 4.4 shall remain in effect until further written notification to Tenant pursuant hereto.

     4.5 When the above mentioned actual determination of Tenant’s liability for Expenses and/or Taxes is made for any Lease Year and when Tenant is so notified in writing, then:

          4.5.1 If the total additional rent Tenant actually paid pursuant to Section 4.3 on account of Expenses and/or Taxes for the Lease Year is less than Tenant’s liability for Expenses and/or Taxes, then Tenant shall pay such deficiency to Landlord as additional rent in one lump sum within thirty (30) days of receipt of Landlord’s bill therefor; and

          4.5.2 If the total additional rent Tenant actually paid pursuant to Section 4.3 on account of Expenses and/or Taxes for the Lease Year is more than Tenant’s liability for Expenses and/or Taxes, then Landlord shall credit the difference against the then next due payments to be made by Tenant under this Article 4, or, if this Lease has terminated, refund the difference in cash.

     4.6 If the Commencement Date is other than January 1 or if the Termination Date is other than December 31, Tenant’s liability for Expenses and Taxes for the Lease Year in which said Date occurs shall be prorated based upon a three hundred sixty-five (365) day year.

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5. SECURITY DEPOSIT. Tenant shall deposit the Security Deposit with Landlord upon the execution of this Lease. Landlord may commingle the Security Deposit with other funds and shall in no event be required to pay interest or any other charges or fees to Tenant with respect to the Security Deposit. Said sum shall be held by Landlord as security for the faithful performance by Tenant of all the terms, covenants and conditions of this Lease to be kept and performed by Tenant and not as an advance rental deposit or as a measure of Landlord’s damage in case of Tenant’s default. If Tenant defaults with respect to any provision of this Lease beyond the expiration of any applicable notice and cure periods, Landlord may use any part of the Security Deposit for the payment of any rent or any other sum in default, or for the payment of any amount which Landlord may spend or become obligated to spend by reason of Tenant’s default, or to compensate Landlord for any other loss or damage which Landlord may suffer by reason of Tenant’s default. If any portion is so used, Tenant shall within five (5) days after written demand therefor, deposit with Landlord an amount sufficient to restore the Security Deposit to its original amount and Tenant’s failure to do so shall be a material breach of this Lease. Except to such extent, if any, as shall be required by law, Landlord shall not be required to keep the Security Deposit separate from its general funds, and Tenant shall not be entitled to interest on such deposit. If Tenant shall fully and faithfully perform every provision of this Lease to be performed by it, the Security Deposit or any balance thereof shall be returned to Tenant at such time after termination of this Lease when Landlord shall have determined that all of Tenant’s obligations under this Lease have been fulfilled. If Tenant is not in default at the termination of this Lease, Landlord shall return any unapplied balance of the Security Deposit to Tenant within 30 days after Tenant surrenders the Premises to Landlord in accordance with this Lease. In addition to any other deductions Landlord is entitled to make pursuant to the terms hereof, Landlord shall have the right to make a good faith estimate of any unreconciled Expenses and/or Taxes as of the Termination Date and to deduct any anticipated shortfall from the Security Deposit. Such estimate shall be final and binding upon Tenant. Tenant hereby waives the provisions of Section 1950.7 of the California Civil Code, or any similar or successor Regulations or other laws now or hereinafter in effect to the extent the same conflicts with any of the terms and conditions of this Lease.

6. ALTERATIONS.

     6.1 Except for those, if any, specifically provided for in Exhibit B to this Lease, Tenant shall not make or suffer to be made any alterations, additions, or improvements, including, but not limited to, the attachment of any fixtures or equipment in, on, or to the Premises or any part thereof or the making of any improvements as required by Article 7, without the prior written consent of Landlord. So long as the same do not affect the structure of the Building or any of the Building systems, Tenant may install non-attached trade fixtures in the Premises without Landlord’s prior consent but otherwise in accordance with the terms of this Article 6. When applying for such consent, Tenant shall, if requested by Landlord, furnish complete plans and specifications for such alterations, additions and improvements. Landlord’s consent shall not be unreasonably withheld with respect to alterations which (i) are not structural in nature, (ii) are not visible from the exterior of the Building, (iii) do not affect or require modification of the Building’s electrical, mechanical, plumbing, HVAC or other systems, and (iv) in aggregate do not cost more than $5.00 per rentable square foot of that portion of the Premises affected by the alterations in question.

     6.2 In the event Landlord consents to the making of any such alteration, addition or improvement by Tenant, the same shall be made by using either Landlord’s contractor or a contractor reasonably approved by Landlord, in either event at Tenant’s sole cost and expense. If Tenant shall employ any contractor other than Landlord’s contractor and such other contractor or any subcontractor of such other contractor shall employ any non-union labor or supplier, Tenant shall be responsible for and hold Landlord harmless from any and all delays, damages and extra costs suffered by Landlord as a result of any dispute with any labor unions concerning the wage, hours, terms or conditions of the employment of any such labor. In any event Landlord may charge Tenant a construction management fee not to exceed five percent (5%) of the cost of such work to cover its overhead as it relates to such proposed work, plus third-party costs actually incurred by Landlord in connection with the proposed work and the design thereof, with all such amounts being due five (5) days after Landlord’s demand.

     6.3 All alterations, additions or improvements proposed by Tenant shall be constructed in accordance with all Regulations, using Building standard materials where applicable, and Tenant shall, prior to construction, provide the additional insurance required under Article 11 in such case, and also all such assurances to Landlord as Landlord shall reasonably require to assure payment of the costs thereof, including but not limited to, notices of non-responsibility, waivers of lien and surety company performance bonds to protect Landlord and the Building and appurtenant land against any loss from any mechanic’s, materialmen’s or other liens. Tenant shall pay in addition to any sums due pursuant to Article 4, any increase in real estate taxes attributable to any such alteration, addition or improvement for so long, during the Term, as such increase is ascertainable; at Landlord’s election said sums shall be paid in the same way as sums due under Article 4.

     6.4 Notwithstanding anything to the contrary contained herein, so long as Tenant’s written request for consent for a proposed alteration or improvements contains the following statement in large, bold and capped font “PURSUANT TO

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SECTION 6 OF THE LEASE, IF LANDLORD CONSENTS TO THE SUBJECT ALTERATION, LANDLORD SHALL NOTIFY TENANT IN WRITING (1) WHETHER OR NOT LANDLORD WILL REQUIRE SUCH ALTERATION TO BE REMOVED AT THE EXPIRATION OR EARLIER TERMINATION OF THE LEASE AND, (2) IF SUCH REMOVAL IS REQUIRED, WHETHER OR NOT TENANT SHALL BE REQUIRED TO DEPOSIT WITH LANDLORD THE AMOUNT REASONABLY ESTIMATED BY LANDLORD AS SUFFICIENT TO COVER THE COST OF REMOVING SUCH ALTERATIONS OR IMPROVEMENTS AND RESTORING THE PREMISES AND, IF SO, SUCH ESTIMATED AMOUNT.”, at the time Landlord gives its consent for any alterations or improvements, if it so does, Tenant shall also be notified (i) whether or not Landlord will require that such alterations or improvements be removed upon the expiration or earlier termination of this Lease and, (ii) to the extent that such removal is required, whether Landlord shall require Tenant to deposit with Landlord the amount reasonably estimated by Landlord as sufficient to cover the cost of removing such alterations or improvements and restoring the Premises, to the extent required under Section 26.2, and the estimated amount thereof. Notwithstanding anything to the contrary contained in this Lease, at the expiration or earlier termination of this Lease and otherwise in accordance with Article 26 hereof, Tenant shall be required to remove all alterations or improvements made to the Premises except for any such alterations or improvements which Landlord expressly indicates or is deemed to have indicated shall not be required to be removed from the Premises by Tenant. If Tenant’s written notice strictly complies with the foregoing and if Landlord fails to so notify Tenant whether Tenant shall be required to remove the subject alterations or improvements at the expiration or earlier termination of this lease, Tenant is entitled to deliver to Landlord a second written notice (the “Second Notice”) in compliance with the foregoing requirements but also stating in large, bold and capped font the following: “THIS IS TENANT’S SECOND NOTICE TO LANDLORD. LANDLORD FAILED TO RESPOND TO TENANT’S FIRST NOTICE IN ACCORDANCE WITH THE TERMS OF ARTICLE 6 OF THE LEASE. IF LANDLORD FAILS TO RESPOND TO THIS NOTICE IN FIVE BUSINESS DAYS WITH RESPECT TO THE DEPOSIT OF REMOVAL AND RESTORATION FUNDS, TENANT SHALL HAVE NO OBLIGATION TO DEPOSIT WITH LANDLORD THE AMOUNT REASONABLY ESTIMATED BY LANDLORD AS SUFFICIENT TO COVER THE COST OF REMOVING SUCH ALTERATIONS OR IMPROVEMENTS AND RESTORING THE PREMISES. IF LANDLORD FAILS TO RESPOND TO THIS NOTICE IN FIVE BUSINESS DAYS WITH RESPECT TO TENANT’S OBLIGATION TO REMOVE THE SUBJECT ALTERATION, TENANT SHALL HAVE NO OBLIGATION TO REMOVE THE SUBJECT ALTERATION AT THE EXPIRATION OR EARLIER TERMINATION OF ITS LEASE ”. If Landlord fails to respond to the Second Notice within five business days of Landlord’s receipt thereof, it shall be assumed that, with respect to Tenant’s obligation to remove the subject alterations or improvements, Landlord shall not require the removal of the subject alterations or improvements. If Landlord fails to respond to the Second Notice within five business days of Landlord’s receipt thereof, it shall be assumed that, with respect to Tenant’s obligation to deposit sufficient funds with Landlord for the removal of the subject alterations or improvements, Landlord shall not require any such deposit from Tenant with respect thereto.

7. REPAIR.

     7.1 Landlord shall have no obligation to alter, remodel, improve, repair, decorate or paint the Premises except that Landlord shall repair and maintain the following, the cost of which may be included in Expenses as provided in Article 4 of this Lease: the structural portions of the roof, the roof membrane, the common areas, foundation and walls of the Building and the Building mechanical, sprinkler/life safety systems, electrical and plumbing systems servicing the project in general (not specifically servicing the Premises, the repair and maintenance of which shall be Tenant’s responsibility hereunder); provided, however, that, subject to the terms hereof, Tenant, not Landlord shall repair and maintain the heating, ventilating and air conditioning unit(s) servicing the Premises. Notwithstanding the foregoing, Landlord’s repair and maintenance obligations with respect to the following shall be at Landlord’s sole cost and expense: the foundation and the exterior walls of the Building. By taking possession of the Premises, Tenant accepts them as being in good order, condition and repair and in the condition in which Landlord is obligated to deliver them except as otherwise expressly stated in this Lease. It is hereby understood and agreed that no representations respecting the condition of the Premises or the Building have been made by Landlord to Tenant, except as specifically set forth in this Lease. Landlord shall not be liable for any failure to make any repairs or to perform any maintenance unless such failure shall persist for an unreasonable time after written notice of the need of such repairs or maintenance is given to Landlord by Tenant. Notwithstanding the foregoing, Landlord shall perform and construct, and Tenant shall have no responsibility to perform or construct, any repair, maintenance or improvements (a) necessitated by the negligence or willful misconduct of Landlord, and (b) which Landlord shall determine to be capital improvement (the cost thereof may be an Expense pursuant to Section 4.1.2 of this Lease).

     7.2 To the extent the same is not an express obligation of Landlord pursuant to Section 7.1 above, Tenant shall at its own cost and expense keep and maintain all parts of the Premises and such portion of the Building and improvements as are within the exclusive control of Tenant (including, without limitation, electrical and plumbing systems servicing the Premises) in good condition, promptly making all necessary repairs and replacements, whether ordinary or extraordinary, with materials and workmanship of the same character, kind and quality as the original (including, but not limited to, repair

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and replacement of all fixtures installed by Tenant, water heaters serving the Premises, windows, glass and plate glass, doors, exterior stairs, skylights, if any, any special office entries, interior walls and finish work, floors and floor coverings, heating and air conditioning systems serving the Premises, electrical systems and fixtures, sprinkler systems, dock boards, truck doors, dock bumpers, plumbing work and fixtures, and performance of regular removal of trash and debris). Tenant as part of its obligations hereunder shall keep the Premises in a clean and sanitary condition. Tenant will, as far as possible keep all such parts of the Premises from falling temporarily out of repair, and upon termination of this Lease in any way Tenant will yield up the Premises to Landlord in good condition and repair, loss by fire or other casualty excepted (but not excepting any damage to glass). Subject to the waiver of subrogation provided in Section 12, Tenant shall, at its own cost and expense, repair any damage to the Premises or the Building resulting from and/or caused in whole or in part by the negligence or misconduct of Tenant, its agents, employees, contractors, invitees, or any other person entering upon the Premises as a result of Tenant’s business activities or caused by Tenant’s default hereunder.

     7.3 Except as provided in Article 22, there shall be no abatement of rent and no liability of Landlord by reason of any injury to or interference with Tenant’s business arising from the making of any repairs, alterations or improvements in or to any portion of the Building or the Premises or to fixtures, appurtenances and equipment in the Building. Tenant hereby waives any and all rights under and benefits of subsection 1 of Section 1932 and Sections 1941 and 1942 of the California Civil Code, or any similar or successor Regulations or other laws now or hereinafter in effect. Except in emergency situations as determined by Landlord, Landlord shall exercise reasonable efforts not to unreasonably interfere with the conduct of the business of Tenant in the Premises.

     7.4 Tenant shall, at its own cost and expense, enter into a regularly scheduled preventive maintenance/service contract with a maintenance contractor approved by Landlord for servicing all heating and air conditioning systems and equipment serving the Premises (and a copy thereof shall be furnished to Landlord). The service contract must include all services suggested by the equipment manufacturer in the operation/maintenance manual and must become effective within thirty (30) days of the date Tenant takes possession of the Premises. Should Tenant fail to do so, Landlord may, upon notice to Tenant, enter into such a maintenance/ service contract on behalf of Tenant or perform the work and in either case, charge Tenant the cost thereof along with a reasonable amount for Landlord’s overhead.

8. LIENS. Tenant shall keep the Premises, the Building and appurtenant land and Tenant’s leasehold interest in the Premises free from any liens arising out of any services, work or materials performed, furnished, or contracted for by Tenant, or obligations incurred by Tenant. In the event that Tenant fails, within ten (10) days following the imposition of any such lien, to either cause the same to be released of record or provide Landlord with insurance against the same issued by a major title insurance company or such other protection against the same as Landlord shall accept (such failure to constitute an Event of Default), Landlord shall have the right to cause the same to be released by such means as it shall deem proper, including payment of the claim giving rise to such lien. All such sums paid by Landlord and all expenses incurred by it in connection therewith shall be payable to it by Tenant within five (5) days after Landlord’s demand.

9. ASSIGNMENT AND SUBLETTING.

     9.1 Tenant shall not have the right to assign or pledge this Lease or to sublet the whole or any part of the Premises whether voluntarily or by operation of law, or permit the use or occupancy of the Premises by anyone other than Tenant, and shall not make, suffer or permit such assignment, subleasing or occupancy without the prior written consent of Landlord, such consent not to be unreasonably withheld, and said restrictions shall be binding upon any and all assignees of this Lease and subtenants of the Premises. In the event Tenant desires to sublet, or permit such occupancy of, the Premises, or any portion thereof, or assign this Lease, Tenant shall give written notice thereof to Landlord at least thirty (30) days prior to the proposed commencement date of such subletting or assignment, which notice shall set forth the name of the proposed subtenant or assignee, the relevant terms of any sublease or assignment and copies of financial reports and other relevant financial information of the proposed subtenant or assignee. To the extent reasonably necessary, upon written request by Tenant, Landlord shall enter into a commercially reasonable confidentiality agreement covering any confidential information that is disclosed by Tenant with respect to the financial reports and other relevant financial information of the proposed subtenant or assignee.

     9.2 Notwithstanding any assignment or subletting, permitted or otherwise, Tenant shall at all times remain directly, primarily and fully responsible and liable for the payment of the rent specified in this Lease and for compliance with all of its other obligations under the terms, provisions and covenants of this Lease. Upon the occurrence of an Event of Default, if the Premises or any part of them are then assigned or sublet, Landlord, in addition to any other remedies provided in this Lease or provided by law, may, at its option, collect directly from such assignee or subtenant all rents due and becoming due to Tenant under such assignment or sublease and apply such rent against any sums due to Landlord from

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Tenant under this Lease, and no such collection shall be construed to constitute a novation or release of Tenant from the further performance of Tenant’s obligations under this Lease.

     9.3 In addition to Landlord’s right to approve of any subtenant or assignee, Landlord shall have the option, in its sole discretion, in the event of any proposed assignment of this Lease, or with respect to a subletting, (i) for a term which is for more than 50% of the then remaining Term of this Lease (as the same may have been extended) or (ii) of 30% or more of the Premises, to terminate this Lease, or in the case of a proposed subletting of less than the entire Premises, to recapture the portion of the Premises to be sublet, as of the date the subletting or assignment is to be effective. The foregoing shall not apply to Permitted Transfers, Affiliated Parties, and any Corporate Successors (as each such term is defined in Section 9.8 below). The option shall be exercised, if at all, by Landlord giving Tenant written notice given by Landlord to Tenant within twenty (20) days following Landlord’s receipt of Tenant’s written notice as required above. However, if Tenant notifies Landlord, within five (5) days after receipt of Landlord’s termination notice, that Tenant is rescinding its proposed assignment or sublease, the termination notice shall be void and the Lease shall continue in full force and effect. If this Lease shall be terminated with respect to the entire Premises pursuant to this Section, the Term of this Lease shall end on the date stated in Tenant’s notice as the effective date of the sublease or assignment as if that date had been originally fixed in this Lease for the expiration of the Term. If Landlord recaptures under this Section only a portion of the Premises, the rent to be paid from time to time during the unexpired Term shall abate proportionately based on the proportion by which the approximate square footage of the remaining portion of the Premises shall be less than that of the Premises as of the date immediately prior to such recapture. Tenant shall, at Tenant’s own cost and expense, discharge in full any outstanding commission obligation which may be due and owing as a result of any proposed assignment or subletting, whether or not the Premises are recaptured pursuant to this Section 9.3 and rented by Landlord to the proposed tenant or any other tenant.

     9.4 In the event that Tenant sells, sublets, assigns or transfers this Lease, Tenant shall pay to Landlord as additional rent an amount equal to seventy-five percent (75%) of any Increased Rent (as defined below), less the Costs Component (as defined below), when and as such Increased Rent is received by Tenant. As used in this Section, “Increased Rent” shall mean the excess of (i) all rent and other consideration which Tenant is entitled to receive by reason of any sale, sublease, assignment or other transfer of this Lease, over (ii) the rent otherwise payable by Tenant under this Lease at such time. For purposes of the foregoing, any consideration received by Tenant in form other than cash shall be valued at its fair market value as determined by Landlord in good faith. The “Costs Component” is that amount which, if paid monthly, would fully amortize on a straight-line basis, over the entire period for which Tenant is to receive Increased Rent, the reasonable costs incurred by Tenant for legal fees, leasing commissions and tenant improvements constructed by or on behalf of Tenant and performed solely to bring about such sublease, assignment or other transfer.

     9.5 Notwithstanding any other provision hereof, it shall be considered reasonable for Landlord to withhold its consent to any assignment of this Lease or sublease of any portion of the Premises if at the time of either Tenant’s notice of the proposed assignment or sublease or the proposed commencement date thereof, there shall exist any uncured Event of Default of Tenant or matter which will become an Event of Default of Tenant with passage of time unless cured, or if the proposed assignee or sublessee is an entity: (a) with which Landlord is already in negotiation; (b) is already an occupant of the Building unless Landlord is unable to provide the amount of space required by such occupant; (c) is a governmental agency; (d) is incompatible with the character of occupancy of the Building; (e) with which the payment for the sublease or assignment is determined in whole or in part based upon its net income or profits; or (f) would subject the Premises to a use which would: (i) involve increased wear upon the Building; (ii) violate any exclusive right granted to another tenant of the Building; (iii) require any addition to or modification of the Premises or the Building in order to comply with building code or other governmental requirements; or, (iv) involve a violation of Section 1.2. Tenant expressly agrees that for the purposes of any statutory or other requirement of reasonableness on the part of Landlord, Landlord’s refusal to consent to any assignment or sublease for any of the reasons described in this Section 9.5, shall be conclusively deemed to be reasonable.

     9.6 Upon any request to assign or sublet, Tenant will pay to Landlord the Assignment/Subletting Fee plus, on demand, a sum equal to all of Landlord’s costs, including reasonable attorney’s fees, incurred in investigating, considering reviewing and documenting any proposed or purported assignment or pledge of this Lease or sublease of any of the Premises (the “Review Reimbursement” and together with the Assignment/Subletting Fee, collectively, the “Total Reimbursement”), regardless of whether Landlord shall consent to, refuse consent, or determine that Landlord’s consent is not required for, such assignment, pledge or sublease. Except as otherwise expressly provided herein, the Total Reimbursement shall not exceed $1,000.00 (the “Cap”). Any purported sale, assignment, mortgage, transfer of this Lease or subletting which does not comply with the provisions of this Article 9 shall be void. Landlord shall notify Tenant if Landlord reasonably estimates that the Total Reimbursement shall exceed the Cap and shall inform Tenant of the amount of Landlord’s reasonable estimate of the Total Reimbursement (the “Estimated Fees”). If the Estimated Fees exceed the Cap, then the Cap shall not apply and Tenant shall pay to Landlord the amount of the Total Reimbursement up to an amount not to exceed one hundred twenty percent (120%) of the amount of the Estimated Fees.

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     9.7 If Tenant is a corporation, limited liability company, partnership or trust, any transfer or transfers of or change or changes within any twelve (12) month period in the number of the outstanding voting shares of the corporation or limited liability company, the general partnership interests in the partnership or the identity of the persons or entities controlling the activities of such partnership or trust resulting in the persons or entities owning or controlling a majority of such shares, partnership interests or activities of such partnership or trust at the beginning of such period no longer having such ownership or control shall be regarded as equivalent to an assignment of this Lease to the persons or entities acquiring such ownership or control and shall be subject to all the provisions of this Article 9 to the same extent and for all intents and purposes as though such an assignment; provided, however, to the extent Tenant is a corporation, the foregoing shall not apply to a single transfer (or series of related transfers that are part of the same general transaction and which proximately occur) of all or substantially all of the capital stock of Tenant to one recipient (whether an individual or an entity) so long as there is no diminution of the Tenant’s tangible net worth as a result thereof.

     9.8 So long as Tenant is not entering into the Permitted Transfer (as defined herein) for the purpose of avoiding or otherwise circumventing the remaining terms of this Article 9, Tenant may assign its entire interest under this Lease, without the consent of Landlord, to (i) an affiliate, subsidiary, or parent of Tenant, or a corporation, partnership or other legal entity wholly owned by Tenant (collectively, an “Affiliated Party”), or (ii) a successor to Tenant by purchase, merger, consolidation or reorganization (a “Corporate Successor”), provided that all of the following conditions are satisfied (each such transfer a “Permitted Transfer”): (1) Tenant is not in default under this Lease; (2) the Permitted Use does not allow the Premises to be used for retail purposes; (3) Tenant shall give Landlord written notice at least fifteen (15) days prior to the effective date of the proposed Permitted Transfer; provided, however, that to the extent that Tenant is prohibited by any applicable law, rule, regulation, ordinance of code from providing the foregoing notice, Tenant shall provide notice to Landlord as soon as is reasonably possible but in no event later than two (2) business days following the effective date of any such Permitted Transfer; (4) with respect to a proposed Permitted Transfer to an Affiliated Party, the proposed transferee has a tangible net worth, financial standing and financial resources, as evidenced by current financial statements satisfactory to Landlord and certified by an independent certified public accountant, prepared in accordance with generally accepted accounting principles that are consistently applied, reasonably sufficient, taking into account all expected obligations of the transferee with respect to the proposed transfer and all of its other contingent and noncontingent obligations, to service when due the obligations of the transferee with respect to the proposed Permitted Transfer; and (5) with respect to a purchase, merger, consolidation or reorganization or any Permitted Transfer which results in Tenant ceasing to exist as a separate legal entity, (a) Tenant’s successor shall own all or substantially all of the assets of Tenant, and (b) Tenant’s successor shall have a tangible net worth which is at least equal to Ten Million Dollars ($10,000,000.00) as evidenced by current financial statements satisfactory to Landlord and certified by an independent certified public accountant, prepared in accordance with generally accepted accounting principles that are consistently applied. Tenant’s notice to Landlord shall include information and documentation showing that each of the above conditions has been satisfied. If requested by Landlord, Tenant’s successor shall sign a commercially reasonable form of assumption agreement. As used herein, (A) “parent” shall mean a company which owns a majority of Tenant’s voting equity; (B) “subsidiary” shall mean an entity wholly owned by Tenant or at least fifty-one percent (51%) of whose voting equity is owned by Tenant; and (C) “affiliate” shall mean an entity controlled, controlling or under common control with Tenant. Notwithstanding the foregoing, if any parent, affiliate or subsidiary to which this Lease has been assigned or transferred subsequently sells or transfers its voting equity or its interest under this Lease other than to another parent, subsidiary or affiliate of the original Tenant named hereunder, such sale or transfer shall be deemed to be a transfer requiring the consent of Landlord hereunder.

10. INDEMNIFICATION. None of the Landlord Entities shall be liable and Tenant hereby waives all claims against them for any damage to any property or any injury to any person in or about the Premises or the Building by or from any cause whatsoever (including without limiting the foregoing, rain or water leakage of any character from the roof, windows, walls, basement, pipes, plumbing works or appliances, the Building not being in good condition or repair, gas, fire, oil, electricity or theft), except to the extent caused by or arising from the active negligence or willful misconduct of Landlord or its agents, employees or contractors or a breach of this Lease by Landlord. Tenant shall protect, indemnify and hold the Landlord Entities harmless from and against any and all loss, claims, liability or costs (including court costs and attorney’s fees) incurred by reason of (a) any damage to any property (including but not limited to property of any Landlord Entity) or any injury (including but not limited to death) to any person occurring in, on or about the Premises or the Building to the extent that such injury or damage shall be caused by or arise from any actual or alleged act, neglect, fault, or omission by or of Tenant or any Tenant Entity to meet any standards imposed by any duty with respect to the injury or damage; (b) the conduct or management of any work or thing whatsoever done by the Tenant in or about the Premises or from transactions of the Tenant concerning the Premises; (c) Tenant’s failure to comply with any and all Regulations applicable to the condition or use of the Premises or its occupancy; or (d) any breach or default on the part of Tenant in the performance of any covenant or agreement on the part of the Tenant to be performed pursuant to this Lease. The provisions of this Article shall survive the termination of this Lease with respect to any claims or liability accruing prior to such termination.

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11. INSURANCE.

     11.1 Tenant shall keep in force throughout the Term: (a) a Commercial General Liability insurance policy or policies to protect the Landlord Entities against any liability to the public or to any invitee of Tenant or a Landlord Entity incidental to the use of or resulting from any accident occurring in or upon the Premises with a limit of not less than $1,000,000 per occurrence and not less than $2,000,000 in the annual aggregate, or such larger amount as Landlord may prudently require from time to time so long as such larger amounts are typically carried by similar commercial tenants in similar buildings and in the same geographic area in which the Building is located, covering bodily injury and property damage liability and $1,000,000 products/completed operations aggregate; (b) Business Auto Liability covering owned, non-owned and hired vehicles with a limit of not less than $1,000,000 per accident; (c) Worker’s Compensation Insurance with limits as required by statute and Employers Liability with limits of $500,000 each accident, $500,000 disease policy limit, $500,000 disease—each employee; (d) All Risk or Special Form coverage protecting Tenant against loss of or damage to Tenant’s alterations, additions, improvements, carpeting, floor coverings, panelings, decorations, fixtures, inventory and other business personal property situated in or about the Premises to the full replacement value of the property so insured; and, (e) Business Interruption Insurance with limit of liability representing loss of at least approximately six (6) months of income.

     11.2 The aforesaid policies shall (a) be provided at Tenant’s expense; (b) name the Landlord Entities as additional insureds (General Liability) and loss payee (Property—Special Form); (c) be issued by an insurance company with a minimum Best’s rating of “A-:VII” during the Term; and (d) provide that said insurance shall not be canceled unless thirty (30) days prior written notice (ten days for non-payment of premium) shall have been given to Landlord; a certificate of Liability insurance on ACORD Form 25 and a certificate of Property insurance on ACORD Form 27 shall be delivered to Landlord by Tenant upon the Commencement Date and at least thirty (30) days prior to each renewal of said insurance.

     11.3 Whenever Tenant shall undertake any alterations, additions or improvements in, to or about the Premises (“Work”) the aforesaid insurance protection must extend to and include injuries to persons and damage to property arising in connection with such Work, without limitation including liability under any applicable structural work act, and such other insurance as Landlord shall require; and the policies of or certificates evidencing such insurance must be delivered to Landlord prior to the commencement of any such Work.

     11.4 Landlord shall keep in force throughout the Term Commercial General Liability Insurance and All Risk or Special Form coverage insuring the Landlord and the Building, in such amounts and with such deductibles as Landlord determines from time to time in accordance with sound and reasonable risk management principles. The cost of all such insurance is included in Expenses.

12. WAIVER OF SUBROGATION. Notwithstanding anything in this Lease to the contrary, Landlord and Tenant hereby waive, and shall cause their respective insurance carriers to waive, any and all rights of recovery, claim, action or causes of action against the other and their respective trustees, principals, beneficiaries, partners, officers, directors, agents, and employees, by subrogation, to the extent the same is insured against (or is required to be insured against under the terms hereof) for any loss or damage that may occur to Landlord or Tenant or any party claiming by, through or under Landlord or Tenant, as the case may be, with respect to Tenant’s personal property, the Premises, the Building, the project of which the Building is a part, any additions or improvements to the Premises, the Building or the project of which the Building is a part, or any contents thereof, including all rights of recovery, claims, actions or causes of action arising out of the negligence of Landlord or any parties related to or comprising Landlord or the negligence of Tenant or parties related to or comprising Tenant, which loss or damage is (or would have been, had the insurance required by this Lease been carried and as if the All Risk or Special Form coverage insuring the Landlord and the Building and required to be carried by Landlord pursuant to Paragraph 12 above is carried at full replacement value) covered by property damage insurance.

13. SERVICES AND UTILITIES. Tenant shall pay for all water, gas, heat, light, power, telephone, sewer, sprinkler system charges and other utilities and services used on or from the Premises, together with any taxes, penalties, and surcharges or the like pertaining thereto and any maintenance charges for utilities. Tenant shall furnish all electric light bulbs, tubes and ballasts, battery packs for emergency lighting and fire extinguishers. If any such services are not separately metered to Tenant, Tenant shall pay such proportion of all charges jointly metered with other premises as determined by Landlord, in its sole discretion, to be reasonable. Any such charges paid by Landlord and assessed against Tenant shall be immediately payable to Landlord on demand and shall be additional rent hereunder. Tenant will not, without the written consent of Landlord, contract with a utility provider to service the Premises with any utility, including, but not limited to, telecommunications, electricity, water, sewer or gas, which is not previously providing such service to other tenants in the Building; provided that Landlord shall not unreasonably withhold its consent to a telecommunications provider if the telecommunication services affect only the Premises and if any agreement between Tenant and such telecommunications provider is terminable at will (and which agreement Tenant hereby agrees to terminate if reasonably requested by Landlord). Landlord shall have no obligations to such telecommunications provider or any other party either in connection with Tenant’s agreement with such telecommunications

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provider or otherwise. Landlord shall in no event be liable for any interruption or failure of utility services on or to the Premises. Notwithstanding the foregoing, if Tenant is prevented from using, and does not use, all or part of the Premises (the “Affected Area”) as a result of a Essential Services Interruption Event as defined below, and the remaining portions of the Premises are not reasonably sufficient to allow Tenant to conduct its business in the Premises and if this Essential Services Interruption Event continues for three (3) consecutive business days after Landlord’s receipt of notice from Tenant of the Essential Services Interruption Event (the “Eligibility Period”), the Rent payable under this Lease shall be abated after the expiration of the Eligibility Period for such time that Tenant continues to be prevented from using, and does not use, the Affected Area in the proportion that the rentable area of the Affected Area bears to the total rentable area of the Premises. If, however, Tenant reoccupies any portion of the Premises during this period, the Rent allocable to this reoccupied portion (based on the proportion that the rentable area of the reoccupied portion of the Premises bears to the total rentable area of the Premises) shall be payable by Tenant from the date on which Tenant reoccupies this portion of the Premises. An “Essential Services Interruption Event” shall mean the failure of or interruption in essential services required to be supplied by Landlord to the Premises during ordinary business hours of generally recognized business days which occurs solely as a result of Landlord’s active negligence or willful misconduct. In the event of a stoppage or interruption of services, Landlord shall diligently attempt to resume such services as promptly as practicable.

14. HOLDING OVER. Tenant shall pay Landlord for each day Tenant retains possession of the Premises or part of them after termination of this Lease by lapse of time or otherwise at the rate (“Holdover Rate”) which shall be One Hundred Fifty Percent (150%) of the greater of (a) the amount of the Annual Rent for the last period prior to the date of such termination plus Tenant’s Proportionate Share of Expenses and Taxes under Article 4; and (b) the then market rental value of the Premises as determined by Landlord assuming a new lease of the Premises of the then usual duration and other terms, in either case, prorated on a daily basis, and also pay all damages sustained by Landlord by reason of such retention. If Landlord gives notice to Tenant of Landlord’s election to such effect, such holding over shall constitute renewal of this Lease for a period from month to month or one (1) year, whichever shall be specified in such notice, in either case at the Holdover Rate, but if the Landlord does not so elect, no such renewal shall result notwithstanding acceptance by Landlord of any sums due hereunder after such termination; and instead, a tenancy at sufferance at the Holdover Rate shall be deemed to have been created. In any event, no provision of this Article 14 shall be deemed to waive Landlord’s right of reentry or any other right under this Lease or at law.

15. SUBORDINATION. Without the necessity of any additional document being executed by Tenant for the purpose of effecting a subordination, this Lease shall be subject and subordinate at all times to ground or underlying leases and to the lien of any mortgages or deeds of trust now or hereafter placed on, against or affecting the Building, Landlord’s interest or estate in the Building, or any ground or underlying lease; provided, however, that if the lessor, mortgagee, trustee, or holder of any such mortgage or deed of trust elects to have Tenant’s interest in this Lease be superior to any such instrument, then, by notice to Tenant, this Lease shall be deemed superior, whether this Lease was executed before or after said instrument. Notwithstanding the foregoing, Tenant covenants and agrees to execute and deliver within ten (10) days of Landlord’s request such further instruments evidencing such subordination or superiority of this Lease as may be required by Landlord.

16. RULES AND REGULATIONS. Tenant shall faithfully observe and comply with all the rules and regulations as set forth in Exhibit D to this Lease and all reasonable and non-discriminatory modifications of and additions to them from time to time put into effect by Landlord, provided that any such modification and/or additions shall not materially increase Tenant’s obligations or decrease Tenant’s rights or parking ratio as provided in this Lease. Landlord shall not be responsible to Tenant for the non-performance by any other tenant or occupant of the Building of any such rules and regulations. If there is a conflict between this Lease and any rules and regulations enacted after the date of this Lease, the terms of this Lease shall control. The rules and regulations shall be generally applicable, and generally applied in the same manner, to all tenants of the Building.

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17. REENTRY BY LANDLORD.

     17.1 Landlord reserves and shall at all times have the right to re-enter the Premises to inspect the same, to show said Premises to prospective purchasers or mortgagees, and to alter, improve or repair the Premises and any portion of the Building, and, during the last nine (9) months of the Term, to show said Premises to prospective tenants, without abatement of rent, and may for that purpose erect, use and maintain scaffolding, pipes, conduits and other necessary structures and open any wall, ceiling or floor in and through the Building and Premises where reasonably required by the character of the work to be performed, provided entrance to the Premises shall not be blocked thereby, and further provided that the business of Tenant shall not be interfered with unreasonably. Except in emergencies, Landlord shall provide Tenant with reasonable prior notice of entry into the Premises, which may be given orally. During any entry by Landlord to the Premises as provided herein, Landlord shall comply with all reasonable security measures pertaining to the Premises and of which Tenant has provided reasonable advance written notice to Landlord. Landlord shall have the right at any time to change the arrangement and/or locations of entrances, or passageways, doors and doorways, and corridors, windows, elevators, stairs, toilets or other public parts of the Building and to change the name, number or designation by which the Building is commonly known. Landlord shall use reasonable efforts to give Tenant at least sixty (60) days prior notice with respect to a change in the Building’s street address that will prohibit Tenant from receiving mail at its current address, and if Landlord fails to provide Tenant with such prior notice, Landlord shall reimburse Tenant for the cost of replacing all business stationery and business cards on hand (not to exceed a two (2) month supply) at the effective date of such change. Landlord shall provide to Tenant at least thirty (30) days prior notice before any change is made to the name, number or designation by which the Building is commonly known. In the event that Landlord damages any portion of any wall or wall covering, ceiling, or floor or floor covering within the Premises, Landlord shall repair or replace the damaged portion to match the original as nearly as commercially reasonable but shall not be required to repair or replace more than the portion actually damaged. Tenant hereby waives any claim for damages for any injury or inconvenience to or interference with Tenant’s business, any loss of occupancy or quiet enjoyment of the Premises, and any other loss occasioned by any action of Landlord authorized by this Article 17; provided, however, that Tenant shall not be entitled to receive any consequential, special or indirect damages based upon a claim that Landlord violated the terms and conditions of this Section 17.1. Instead, any such claim of Tenant shall be limited to the foreseeable, direct and actual damages incurred by Tenant.

     17.2 For each of the aforesaid purposes, Landlord shall at all times have and retain a key with which to unlock all of the doors in the Premises, excluding Tenant’s vaults and safes or special security areas (designated in advance), and Landlord shall have the right to use any and all means which Landlord may deem proper to open said doors in an emergency to obtain entry to any portion of the Premises. As to any portion to which access cannot be had by means of a key or keys in Landlord’s possession, Landlord is authorized to gain access by such means as Landlord shall elect and the cost of repairing any damage occurring in doing so shall be borne by Tenant and paid to Landlord within five (5) days of Landlord’s written demand.

18. DEFAULT.

     18.1 Except as otherwise provided in Article 20, the following events shall be deemed to be Events of Default under this Lease:

          18.1.1 Tenant shall fail to pay when due any sum of money becoming due to be paid to Landlord under this Lease, whether such sum be any installment of the rent reserved by this Lease, any other amount treated as additional rent under this Lease, or any other payment or reimbursement to Landlord required by this Lease, whether or not treated as additional rent under this Lease, and such failure shall continue for a period of five (5) days after written notice that such payment was not made when due, but if any such notice shall be given, more than two (2) times in such twelve (12) month period commencing with the date of such notice, the failure to pay within five (5) days after due any additional sum of money becoming due to be paid to Landlord under this Lease the third (3rd) time during such period shall be an Event of Default, without notice. So long as a notice delivered to Tenant pursuant to this Section 18.1.1 is in compliance with California Code of Civil Procedure Section 1161 or any successor statute, such notice shall concurrently satisfy the statutory requirement as well as the notice requirement of this Lease described in this Section 18.1.1.

          18.1.2 Tenant shall fail to comply with any term, provision or covenant of this Lease which is not provided for in another Section of this Article and shall not cure such failure within thirty (30) days (forthwith, if the failure involves a hazardous condition) after written notice of such failure to Tenant provided, however, that such failure shall not be an event of default if such failure could not reasonably be cured during such thirty (30) day period, Tenant has commenced the cure within such thirty (30) day period and thereafter is diligently pursuing such cure to completion, but the total aggregate cure period shall not exceed ninety (90) days.

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          18.1.3 Tenant shall fail to vacate the Premises immediately upon termination of this Lease, by lapse of time or otherwise, or upon termination of Tenant’s right to possession only.

          18.1.4 Tenant shall become insolvent, admit in writing its inability to pay its debts generally as they become due, file a petition in bankruptcy or a petition to take advantage of any insolvency statute, make an assignment for the benefit of creditors, make a transfer in fraud of creditors, apply for or consent to the appointment of a receiver of itself or of the whole or any substantial part of its property, or file a petition or answer seeking reorganization or arrangement under the federal bankruptcy laws, as now in effect or hereafter amended, or any other applicable law or statute of the United States or any state thereof.

          18.1.5 A court of competent jurisdiction shall enter an order, judgment or decree adjudicating Tenant bankrupt, or appointing a receiver of Tenant, or of the whole or any substantial part of its property, without the consent of Tenant, or approving a petition filed against Tenant seeking reorganization or arrangement of Tenant under the bankruptcy laws of the United States, as now in effect or hereafter amended, or any state thereof, and such order, judgment or decree shall not be vacated or set aside or stayed within sixty (60) days from the date of entry thereof.

19. REMEDIES.

     19.1 Upon the occurrence of any Event or Events of Default under this Lease, whether enumerated in Article 18 or not, Landlord shall have the option to pursue any one or more of the following remedies without any notice (except as expressly prescribed herein) or demand whatsoever (and without limiting the generality of the foregoing, Tenant hereby specifically waives notice and demand for payment of rent (except to the extent required herein) or other obligations and waives any and all other notices or demand requirements imposed by applicable law):

          19.1.1 Terminate this Lease and Tenant’s right to possession of the Premises and recover from Tenant an award of damages equal to the sum of the following:

               19.1.1.1 The Worth at the Time of Award of the unpaid rent which had been earned at the time of termination;

               19.1.1.2 The Worth at the Time of Award of the amount by which the unpaid rent which would have been earned after termination until the time of award exceeds the amount of such rent loss that Tenant affirmatively proves could have been reasonably avoided;

               19.1.1.3 The Worth at the Time of Award of the amount by which the unpaid rent for the balance of the Term after the time of award exceeds the amount of such rent loss that Tenant affirmatively proves could be reasonably avoided;

               19.1.1.4 Any other amount necessary to compensate Landlord for all the detriment either proximately caused by Tenant’s failure to perform Tenant’s obligations under this Lease or which in the ordinary course of things would be likely to result therefrom; and

               19.1.1.5 All such other amounts in addition to or in lieu of the foregoing as may be permitted from time to time under applicable law.

The “Worth at the Time of Award” of the amounts referred to in parts 19.1.1.1 and 19.1.1.2 above, shall be computed by allowing interest at the lesser of a per annum rate equal to: (i) the greatest per annum rate of interest permitted from time to time under applicable law, or (ii) the Prime Rate plus 5%. For purposes hereof, the “Prime Rate” shall be the per annum interest rate publicly announced as its prime or base rate by a federally insured bank selected by Landlord in the State of California. The “Worth at the Time of Award” of the amount referred to in part 19.1.1.3, above, shall be computed by discounting such amount at the discount rate of the Federal Reserve Bank of San Francisco at the time of award plus 1%;

          19.1.2 Employ the remedy described in California Civil Code § 1951.4 (Landlord may continue this Lease in effect after Tenant’s breach and abandonment and recover rent as it becomes due, if Tenant has the right to sublet or assign, subject only to reasonable limitations); or

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          19.1.3 Notwithstanding Landlord’s exercise of the remedy described in California Civil Code § 1951.4 in respect of an Event or Events of Default, at such time thereafter as Landlord may elect in writing, to terminate this Lease and Tenant’s right to possession of the Premises and recover an award of damages as provided above in Section 19.1.1.

     19.2 The subsequent acceptance of rent hereunder by Landlord shall not be deemed to be a waiver of any preceding breach by Tenant of any term, covenant or condition of this Lease, other than the failure of Tenant to pay the particular rent so accepted, regardless of Landlord’s knowledge of such preceding breach at the time of acceptance of such rent. No waiver by Landlord of any breach hereof shall be effective unless such waiver is in writing and signed by Landlord.

     19.3 TENANT HEREBY WAIVES ANY AND ALL RIGHTS CONFERRED BY SECTION 3275 OF THE CIVIL CODE OF CALIFORNIA AND BY SECTIONS 1174 (c) AND 1179 OF THE CODE OF CIVIL PROCEDURE OF CALIFORNIA AND ANY AND ALL OTHER REGULATIONS AND RULES OF LAW FROM TIME TO TIME IN EFFECT DURING THE TERM PROVIDING THAT TENANT SHALL HAVE ANY RIGHT TO REDEEM, REINSTATE OR RESTORE THIS LEASE FOLLOWING ITS TERMINATION BY REASON OF TENANT’S BREACH. TENANT ALSO HEREBY WAIVES, TO THE FULLEST EXTENT PERMITTED BY LAW, THE RIGHT TO TRIAL BY JURY IN ANY LITIGATION ARISING OUT OF OR RELATING TO THIS LEASE.

     19.4 No right or remedy herein conferred upon or reserved to Landlord is intended to be exclusive of any other right or remedy, and each and every right and remedy shall be cumulative and in addition to any other right or remedy given hereunder or now or hereafter existing by agreement, applicable law or in equity. In addition to other remedies provided in this Lease, Landlord shall be entitled, to the extent permitted by applicable law, to injunctive relief, or to a decree compelling performance of any of the covenants, agreements, conditions or provisions of this Lease, or to any other remedy allowed to Landlord at law or in equity. Forbearance by Landlord to enforce one or more of the remedies herein provided upon an Event of Default shall not be deemed or construed to constitute a waiver of such Event of Default.

     19.5 This Article 19 shall be enforceable to the maximum extent such enforcement is not prohibited by applicable law, and the unenforceability of any portion thereof shall not thereby render unenforceable any other portion..

     19.6 If more than one (1) Event of Default occurs during the Term or any renewal thereof, Tenant’s renewal options, expansion options, purchase options and rights of first offer and/or refusal, if any are provided for in this Lease, shall be null and void.

     19.7 If, on account of any breach or default by Tenant in Tenant’s obligations under the terms and conditions of this Lease, it shall become necessary or appropriate for Landlord to employ or consult with an attorney or collection agency concerning or to enforce or defend any of Landlord’s rights or remedies arising under this Lease or to collect any sums due from Tenant, Tenant agrees to pay all costs and fees so incurred by Landlord, including, without limitation, reasonable attorneys’ fees and costs. TENANT EXPRESSLY WAIVES ANY RIGHT TO SERVICE OF ANY NOTICE REQUIRED BY ANY PRESENT OR FUTURE LAW OR ORDINANCE APPLICABLE TO LANDLORDS OR TENANTS BUT NOT REQUIRED BY THE TERMS OF THIS LEASE.

     19.8 Upon the occurrence of an Event of Default, Landlord may (but shall not be obligated to) cure such default at Tenant’s sole expense. Without limiting the generality of the foregoing, Landlord may, at Landlord’s option, enter into and upon the Premises if Landlord determines in its sole discretion that Tenant is not acting within a commercially reasonable time to maintain, repair or replace anything for which Tenant is responsible under this Lease or to otherwise effect compliance with its obligations under this Lease and correct the same, without being deemed in any manner guilty of trespass, eviction or forcible entry and detainer and without incurring any liability for any damage or interruption of Tenant’s business resulting therefrom and Tenant agrees to reimburse Landlord within five (5) days of Landlord’s demand as additional rent, for any expenses which Landlord may incur in thus effecting compliance with Tenant’s obligations under this Lease, plus interest from the date of expenditure by Landlord at the Wall Street Journal prime rate.

20. TENANT’S BANKRUPTCY OR INSOLVENCY.

     20.1 If at any time and for so long as Tenant shall be subjected to the provisions of the United States Bankruptcy Code or other law of the United States or any state thereof for the protection of debtors as in effect at such time (each a “Debtor’s Law”):

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          20.1.1 Tenant, Tenant as debtor-in-possession, and any trustee or receiver of Tenant’s assets (each a “Tenant’s Representative”) shall have no greater right to assume or assign this Lease or any interest in this Lease, or to sublease any of the Premises than accorded to Tenant in Article 9, except to the extent Landlord shall be required to permit such assumption, assignment or sublease by the provisions of such Debtor’s Law. Without limitation of the generality of the foregoing, any right of any Tenant’s Representative to assume or assign this Lease or to sublease any of the Premises shall be subject to the conditions that:

               20.1.1.1 Such Debtor’s Law shall provide to Tenant’s Representative a right of assumption of this Lease which Tenant’s Representative shall have timely exercised and Tenant’s Representative shall have fully cured any default of Tenant under this Lease.

               20.1.1.2 Tenant’s Representative or the proposed assignee, as the case shall be, shall have deposited with Landlord as security for the timely payment of rent an amount equal to the larger of: (a) three (3) months’ rent and other monetary charges accruing under this Lease; and (b) any sum specified in Article 5; and shall have provided Landlord with adequate other assurance of the future performance of the obligations of the Tenant under this Lease. Without limitation, such assurances shall include, at least, in the case of assumption of this Lease, demonstration to the satisfaction of the Landlord that Tenant’s Representative has and will continue to have sufficient unencumbered assets after the payment of all secured obligations and administrative expenses to assure Landlord that Tenant’s Representative will have sufficient funds to fulfill the obligations of Tenant under this Lease; and, in the case of assignment, submission of current financial statements of the proposed assignee, audited by an independent certified public accountant reasonably acceptable to Landlord and showing a net worth and working capital in amounts determined by Landlord to be sufficient to assure the future performance by such assignee of all of the Tenant’s obligations under this Lease.

               20.1.1.3 The assumption or any contemplated assignment of this Lease or subleasing any part of the Premises, as shall be the case, will not breach any provision in any other lease, mortgage, financing agreement or other agreement by which Landlord is bound.

               20.1.1.4 Landlord shall have, or would have had absent the Debtor’s Law, no right under Article 9 to refuse consent to the proposed assignment or sublease by reason of the identity or nature of the proposed assignee or sublessee or the proposed use of the Premises concerned.

21. QUIET ENJOYMENT. Landlord represents and warrants that it has full right and authority to enter into this Lease and that Tenant, while paying the rental and performing its other covenants and agreements contained in this Lease within applicable notice and cure periods, shall peaceably and quietly have, hold and enjoy the Premises for the Term without hindrance or molestation from Landlord subject to the terms and provisions of this Lease. Landlord shall not be liable for any interference or disturbance by other tenants or third persons, nor shall Tenant be released from any of the obligations of this Lease because of such interference or disturbance.

22. CASUALTY.

     22.1 In the event the Premises or the Building are damaged by fire or other cause and in Landlord’s reasonable estimation such damage can be materially restored within one hundred eighty (180) days, Landlord shall forthwith repair the same and this Lease shall remain in full force and effect, except that Tenant shall be entitled to a proportionate abatement in rent from the date of such damage. Such abatement of rent shall be made in proportion to the extent to which the damage and the making of such repairs shall interfere with the Permitted Use and occupancy by Tenant of the Premises from time to time. Within forty-five (45) days from the date of such damage, Landlord shall notify Tenant, in writing, of Landlord’s reasonable estimation of the length of time within which material restoration can be made, and Landlord’s determination shall be binding on Tenant. For purposes of this Lease, the Building or Premises shall be deemed “materially restored” if they are in a substantially similar condition as of the date of this Lease, reasonable wear and tear excepted, and provided that Landlord shall have no obligation to restore and/or replace the Improvements or any alterations or other improvements made to the Premises.

     22.2 If such repairs cannot, in Landlord’s reasonable estimation, be made within one hundred eighty (180) days, Landlord and Tenant shall each have the option of giving the other, at any time within ninety (90) days after such damage, notice terminating this Lease as of the date of such damage. In the event of the giving of such notice, this Lease shall expire and all interest of the Tenant in the Premises shall terminate as of the date of such damage as if such date had been originally fixed in this Lease for the expiration of the Term. In the event that neither Landlord nor Tenant exercises its option to terminate this Lease, then Landlord shall repair or restore such damage, this Lease continuing in full force and effect, and the

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rent hereunder shall be proportionately abated as provided in Section 22.1. Landlord shall not in bad faith terminate this Lease pursuant to the terms of this Section 22.2 solely for the purpose of replacing Tenant with a successor tenant.

     22.3 Landlord shall not be required to repair or replace any damage or loss by or from fire or other cause to any panelings, decorations, partitions, additions, railings, ceilings, floor coverings, office fixtures or any other property or improvements installed on the Premises by, or belonging to, Tenant. Any insurance which may be carried by Landlord or Tenant against loss or damage to the Building or Premises shall be for the sole benefit of the party carrying such insurance and under its sole control.

     22.4 In the event that Landlord should fail to complete such repairs and material restoration within ninety (90) days after the date estimated by Landlord therefor as extended by this Section 22.4, Tenant may at its option and as its sole remedy terminate this Lease by delivering written notice to Landlord, within fifteen (15) days after the expiration of said period of time, whereupon this Lease shall end on the date of such notice or such later date fixed in such notice as if the date of such notice was the date originally fixed in this Lease for the expiration of the Term; provided, however, that if construction is delayed because of changes, deletions or additions in construction requested by Tenant, strikes, lockouts, casualties, Acts of God, war, material or labor shortages, government regulation or control or other causes beyond the reasonable control of Landlord, the period for restoration, repair or rebuilding shall be extended for the amount of time Landlord is so delayed.

     22.5 Notwithstanding anything to the contrary contained in this Article: (a) Landlord shall not have any obligation whatsoever to repair, reconstruct, or restore the Premises when the damages resulting from any casualty covered by the provisions of this Article 22 occur during the last twelve (12) months of the Term or any extension thereof, but if Landlord determines not to repair such damages Landlord shall notify Tenant and if such damages shall render any material portion of the Premises untenantable Tenant shall have the right to terminate this Lease by notice to Landlord within fifteen (15) days after receipt of Landlord’s notice; and (b) in the event the holder of any indebtedness secured by a mortgage or deed of trust covering the Premises or Building requires that any insurance proceeds be applied to such indebtedness, then Landlord shall have the right to terminate this Lease by delivering written notice of termination to Tenant within fifteen (15) days after such requirement is made by any such holder, whereupon this Lease shall end on the date of such damage as if the date of such damage were the date originally fixed in this Lease for the expiration of the Term.

     22.6 In the event of any damage or destruction to the Building or Premises by any peril covered by the provisions of this Article 22, it shall be Tenant’s responsibility to properly secure the Premises and upon notice from Landlord to remove forthwith, at its sole cost and expense, such portion of all of the property belonging to Tenant or its licensees from such portion or all of the Building or Premises as Landlord shall request.

     22.7 Tenant hereby waives any and all rights under and benefits of Sections 1932(2) and 1933(4) of the California Civil Code, or any similar or successor Regulations or other laws now or hereinafter in effect.

23. EMINENT DOMAIN. If all or any substantial part of the Premises shall be taken or appropriated by any public or quasi-public authority under the power of eminent domain, or conveyance in lieu of such appropriation, either party to this Lease shall have the right, at its option, of giving the other, at any time within thirty (30) days after such taking, notice terminating this Lease, except that Tenant may only terminate this Lease by reason of taking or appropriation, if such taking or appropriation shall be so substantial as to materially interfere with Tenant’s use and occupancy of the Premises. If neither party to this Lease shall so elect to terminate this Lease, the rental thereafter to be paid shall be adjusted on a fair and equitable basis under the circumstances and based upon the proportion of the Premises so taken. In addition to the rights of Landlord above, if any substantial part of the Building shall be taken or appropriated by any public or quasi-public authority under the power of eminent domain or conveyance in lieu thereof, and regardless of whether the Premises or any part thereof are so taken or appropriated, Landlord shall have the right, at its sole option, to terminate this Lease. Landlord shall be entitled to any and all income, rent, award, or any interest whatsoever in or upon any such sum, which may be paid or made in connection with any such public or quasi-public use or purpose, and Tenant hereby assigns to Landlord any interest it may have in or claim to all or any part of such sums, other than any separate award which may be made with respect to Tenant’s trade fixtures, moving expenses and the value of leasehold improvements to the extent paid for solely by Tenant (except for those alterations approved by Landlord and which will become the property of Landlord upon the expiration or termination of this Lease); Tenant shall make no claim for the value of any unexpired Term. Tenant hereby waives any and all rights under and benefits of Section 1265.130 of the California Code of Civil Procedure, or any similar or successor Regulations or other laws now or hereinafter in effect.

24. SALE BY LANDLORD. In event of a sale or conveyance by Landlord of the Building, the same shall operate to release Landlord from any future liability upon any of the covenants or conditions, expressed or implied, contained in this

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Lease in favor of Tenant and in such event Tenant agrees to look solely to the responsibility of the successor in interest of Landlord in and to this Lease. In the event of a sale, such successor-in-interest shall assume in writing Landlord’s obligations under this Lease. Except as set forth in this Article 24, this Lease shall not be affected by any such sale and Tenant agrees to attorn to the purchaser or assignee. If any security has been given by Tenant to secure the faithful performance of any of the covenants of this Lease, Landlord shall transfer or deliver said security, as such, to Landlord’s successor in interest and thereupon Landlord shall be discharged from any further liability with regard to said security.

25. ESTOPPEL CERTIFICATES. Within ten (10) days following any written request which Landlord may make from time to time, Tenant shall execute and deliver to Landlord or mortgagee or prospective mortgagee a sworn statement certifying: (a) the date of commencement of this Lease; (b) the fact that this Lease is unmodified and in full force and effect (or, if there have been modifications to this Lease, that this lease is in full force and effect, as modified, and stating the date and nature of such modifications); (c) the date to which the rent and other sums payable under this Lease have been paid; (d) the fact that there are no current defaults under this Lease by either Tenant or, to Tenant’s actual knowledge, Landlord, except as specified in Tenant’s statement; and (e) such other matters as may be reasonably requested by Landlord. Landlord and Tenant intend that any statement delivered pursuant to this Article 25 may be relied upon by any mortgagee, beneficiary or purchaser, and Tenant shall be liable for all loss, cost or expense resulting from the failure of any sale or funding of any loan caused by any material misstatement contained in such estoppel certificate. Tenant irrevocably agrees that if Tenant fails to execute and deliver such certificate within such ten (10) day period, such certificate as prepared by Landlord shall be deemed executed by Tenant and accordingly shall be fully binding on Tenant. The parties agree that Tenant’s obligation to furnish such estoppel certificates in a timely fashion is a material inducement for Landlord’s execution of this Lease, and shall be an Event of Default (without any cure period that might be provided under this Lease) if Tenant fails to fully comply or makes any material misstatement in any such certificate.

26. SURRENDER OF PREMISES.

     26.1 Landlord shall arrange to meet Tenant for two (2) joint inspections of the Premises, the first to occur at least ten (10) days (but no more than sixty (60) days) before the last day of the Term, and the second to occur not later than five (5) days after Tenant has vacated the Premises. In the event of Landlord’s failure to arrange such joint inspections or Tenant’s failure to participate in either such inspection, Landlord’s inspection at or after Tenant’s vacating the Premises shall be conclusively deemed correct for purposes of determining Tenant’s responsibility for repairs and restoration.

     26.2 All alterations, additions, and improvements in, on, or to the Premises made or installed by or for Tenant, including, without limitation, carpeting (collectively, “Alterations”), shall be and remain the property of Tenant during the Term. Upon the expiration or sooner termination of the Term, all Alterations shall become a part of the realty and shall belong to Landlord without compensation, and title shall pass to Landlord under this Lease as by a bill of sale. At the end of the Term or any renewal of the Term or other sooner termination of this Lease, Tenant will peaceably deliver up to Landlord possession of the Premises, together with all Alterations by whomsoever made, in the same conditions received or first installed, broom clean and free of all debris, excepting only ordinary wear and tear and damage by fire or other casualty. Notwithstanding the foregoing, and subject to the terms of Article 6 of this Lease, if Landlord elects by notice given to Tenant at least ten (10) days prior to expiration of the Term, Tenant shall, at Tenant’s sole cost, remove any Alterations, including carpeting, so designated by Landlord’s notice, and repair any damage caused by such removal. Further, nothing contained in this Section 26.2 shall increase Tenant’s obligation to remediate or remove Hazardous Materials as the same is expressly provided in this Lease. Tenant must, at Tenant’s sole cost, remove upon termination of this Lease, any and all of Tenant’s furniture, furnishings, movable partitions of less than full height from floor to ceiling and other trade fixtures and personal property (collectively, “Personalty”). The Personalty shall be and remain the property of Tenant during the Term. Personalty not so removed shall be deemed abandoned by the Tenant and title to the same shall thereupon pass to Landlord under this Lease as by a bill of sale, but Tenant shall remain responsible for the cost of removal and disposal of such Personalty, as well as any damage caused by such removal. If Tenant fails to remove such alterations or Tenant’s trade fixtures or furniture or the Personalty, Landlord may keep and use them or remove any of them and cause them to be stored or sold in accordance with applicable law, at Tenant’s sole expense.

     26.3 All obligations of Tenant under this Lease not fully performed as of the expiration or earlier termination of the Term shall survive the expiration or earlier termination of the Term To the extent Tenant has failed to do the same, upon the expiration or earlier termination of the Term, Tenant shall pay to Landlord the amount, as reasonably estimated by Landlord, necessary to repair and restore the Premises as provided in this Lease and/or to discharge Tenant’s obligation for unpaid amounts due or to become due to Landlord. All such amounts shall be used and held by Landlord for payment of such obligations of Tenant, with Tenant being liable for any additional costs upon demand by Landlord, or with any excess to be promptly returned to Tenant after all such obligations have been determined and satisfied. Any otherwise unused Security Deposit shall be credited against the amount payable by Tenant under this Lease.

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27. NOTICES. Any notice or document required or permitted to be delivered under this Lease shall be addressed to the intended recipient, by fully prepaid registered or certified United States Mail return receipt requested, or by reputable independent contract delivery service furnishing a written record of attempted or actual delivery, and shall be deemed to be delivered when tendered for delivery to the addressee at its address set forth on the Reference Pages, or at such other address as it has then last specified by written notice delivered in accordance with this Article 27, or if to Tenant at either its aforesaid address or its last known registered office or home of a general partner or individual owner, whether or not actually accepted or received by the addressee. Any such notice or document may also be personally delivered if a receipt is signed by and received from, the individual, if any, named in Tenant’s Notice Address.

28. TAXES PAYABLE BY TENANT. In addition to rent and other charges to be paid by Tenant under this Lease, Tenant shall reimburse to Landlord, upon demand, any and all taxes payable by Landlord (other than net income taxes) whether or not now customary or within the contemplation of the parties to this Lease: (a) upon or measured by the Tenant’s gross receipts or payroll or the value of Tenant’s equipment, furniture, fixtures and other personal property of Tenant or leasehold improvements, alterations or additions located in the Premises; or (b) upon this transaction or any document to which Tenant is a party creating or transferring any interest of Tenant in this Lease or the Premises. If due to a future change in the method of taxation, any franchise, income or profit or other tax shall be levied in substitution in whole or in part or in lieu of any tax which would otherwise constitute a part of Taxes under this Lease, such franchise, income, profit or other tax shall be deemed to be a part of Taxes for the purposes of this Lease. In addition to the foregoing, Tenant agrees to pay, before delinquency, any and all taxes levied or assessed against Tenant and which become payable during the term hereof upon Tenant’s equipment, furniture, fixtures and other personal property of Tenant located in the Premises. In addition to and wholly apart from Tenant’s obligation to pay Tenant’s Proportionate Share of Expenses and Taxes, Tenant shall be responsible for and shall pay prior to delinquency any taxes or governmental service fees, possessory interest taxes, fees or charges in lieu of any such taxes, capital levies, or other charges imposed upon, levied with respect to or assessed against its fixtures or Personalty, on the value of any alterations or other improvements within the Premises, and on Tenant’s interest pursuant to this Lease, or any increase in any of the foregoing based on such alterations and/or improvements.

29. RELOCATION OF TENANT. Intentionally Omitted

30. DEFINED TERMS AND HEADINGS. The Article headings shown in this Lease are for convenience of reference and shall in no way define, increase, limit or describe the scope or intent of any provision of this Lease. Any indemnification or insurance of Landlord shall apply to and inure to the benefit of all the following “Landlord Entities”, being Landlord, Landlord’s investment manager, and the trustees, boards of directors, officers, general partners, beneficiaries, stockholders, employees and agents of each of them. Any option granted to Landlord shall also include or be exercisable by Landlord’s trustee, beneficiary, agents and employees, as the case may be. In any case where this Lease is signed by more than one person, the obligations under this Lease shall be joint and several. The terms “Tenant” and “Landlord” or any pronoun used in place thereof shall indicate and include the masculine or feminine, the singular or plural number, individuals, firms or corporations, and their and each of their respective successors, executors, administrators and permitted assigns, according to the context hereof. The term “rentable area” shall mean the rentable area of the Premises or the Building as calculated by the Landlord on the basis of the plans and specifications of the Building including a proportionate share of any common areas. Tenant hereby accepts and agrees to be bound by the figures for the rentable square footage of the Premises and Tenant’s Proportionate Share shown on the Reference Pages; however, Landlord may adjust either or both figures if there is manifest error, addition or subtraction to the Building or any business park or complex of which the Building is a part, remeasurement or other circumstance reasonably justifying adjustment. The term “Building” refers to the structure in which the Premises are located and the common areas (parking lots, sidewalks, landscaping, etc.) appurtenant thereto. If the Building is part of a larger complex of structures, the term “Building” may include the entire complex, where appropriate (such as shared Expenses or Taxes) and subject to Landlord’s reasonable discretion.

31. TENANT’S AUTHORITY.

     31.1 If Tenant signs as a corporation, partnership, trust or other legal entity each of the persons executing this Lease on behalf of Tenant represents and warrants that Tenant has been and is qualified to do business in the state in which the Building is located, that the entity has full right and authority to enter into this Lease, and that all persons signing on behalf of the entity were authorized to do so by appropriate actions. Tenant agrees to deliver to Landlord, simultaneously with the delivery of this Lease, a corporate resolution, proof of due authorization by partners, opinion of counsel or other appropriate documentation reasonably acceptable to Landlord evidencing the due authorization of Tenant to enter into this Lease.

     31.2 Tenant hereby represents and warrants that neither Tenant, nor any persons or entities holding any legal or beneficial interest whatsoever in Tenant, are (i) the target of any sanctions program that is established by Executive Order of

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the President or published by the Office of Foreign Assets Control, U.S. Department of the Treasury (“OFAC”); (ii) designated by the President or OFAC pursuant to the Trading with the Enemy Act, 50 U.S.C. App. § 5, the International Emergency Economic Powers Act, 50 U.S.C. §§ 1701-06, the Patriot Act, Public Law 107-56, Executive Order 13224 (September 23, 2001) or any Executive Order of the President issued pursuant to such statutes; or (iii) named on the following list that is published by OFAC: “List of Specially Designated Nationals and Blocked Persons.” If the foregoing representation is untrue at any time during the Term, an Event of Default will be deemed to have occurred, without the necessity of notice to Tenant.

32. FINANCIAL STATEMENTS AND CREDIT REPORTS. At Landlord’s request, Tenant shall deliver to Landlord a copy, certified by an officer of Tenant as being a true and correct copy, of Tenant’s most recent audited financial statement, or, if unaudited, certified by Tenant’s chief financial officer as being true, complete and correct in all material respects. Tenant hereby authorizes Landlord to obtain one or more credit reports on Tenant at any time, and shall execute such further authorizations as Landlord may reasonably require in order to obtain a credit report. The foregoing shall not apply to the extent Tenant is a publicly traded entity on the “over-the-counter” market or any recognized national or international securities exchange and, accordingly, Tenant’s audited financial statements are available to the public.

33. COMMISSIONS. Each of the parties represents and warrants to the other that it has not dealt with any broker or finder in connection with this Lease. Tenant shall indemnify and hold Landlord and its employees and affiliates harmless from all claims of any brokers claiming to have represented Tenant in connection with this Lease. Landlord agrees to indemnify and hold Tenant and its employees and affiliates harmless from all claims of any brokers claiming to have represented Landlord in connection with this Lease.

34. TIME AND APPLICABLE LAW. Time is of the essence of this Lease and all of its provisions. This Lease shall in all respects be governed by the laws of the state in which the Building is located.

35. SUCCESSORS AND ASSIGNS. Subject to the provisions of Article 9, the terms, covenants and conditions contained in this Lease shall be binding upon and inure to the benefit of the heirs, successors, executors, administrators and assigns of the parties to this Lease.

36. ENTIRE AGREEMENT. This Lease, together with its exhibits, contains all agreements of the parties to this Lease and supersedes any previous negotiations. There have been no representations made by the Landlord or any of its representatives or understandings made between the parties other than those set forth in this Lease and its exhibits. This Lease may not be modified except by a written instrument duly executed by the parties to this Lease.

37. EXAMINATION NOT OPTION. Submission of this Lease shall not be deemed to be a reservation of the Premises. Landlord shall not be bound by this Lease until it has received a copy of this Lease duly executed by Tenant and has delivered to Tenant a copy of this Lease duly executed by Landlord, and until such delivery Landlord reserves the right to exhibit and lease the Premises to other prospective tenants. Notwithstanding anything contained in this Lease to the contrary, Landlord may withhold delivery of possession of the Premises from Tenant until such time as Tenant has paid to Landlord any security deposit required by Article 5, the first month’s rent as set forth in Article 3 and any sum owed pursuant to this Lease.

38. RECORDATION. Tenant shall not record or register this Lease or a short form memorandum hereof without the prior written consent of Landlord, and then shall pay all charges and taxes incident such recording or registration.

39. SIGNAGE. Tenant shall not place, install, affix, paint or maintain any signs, notices, graphics or banners whatsoever or any window decor which is visible in or from public view or corridors, the common areas or the exterior of the Premises or the Building, in or on any exterior window or window fronting upon any common areas or service area or upon any truck doors or man doors without Landlord’s prior written approval which Landlord shall have the right to withhold in its absolute and sole discretion; provided that Tenant’s name shall be included in any Building-standard door and directory signage, if any, in accordance with Landlord’s Building signage program, including without limitation, payment by Tenant of any fee charged by Landlord for maintaining such signage, which fee shall constitute additional rent hereunder. Any installation of signs, notices, graphics or banners on or about the Premises approved by Landlord shall be subject to any applicable Regulations and to any signage specifications for the Building and other reasonable requirements imposed by Landlord. Tenant shall remove all such signs or graphics by the expiration or any earlier termination of this Lease. Such installations and removals shall be made in such manner as to avoid injury to or defacement of the Premises and the Building and any other improvements contained therein, and Tenant shall repair any injury or defacement including without limitation discoloration caused by such installation or removal.

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40. OPTION TO RENEW.

     40.1 Provided this Lease is in full force and effect and Tenant is not in default under any of the other terms and conditions of this Lease at the time of notification or commencement, Tenant shall have one (1) option to renew (the “Renewal Option”) this Lease for a term of one (1) year (the “Renewal Term”), for the portion of the Premises being leased by Tenant as of the date the Renewal Term is to commence, on the same terms and conditions set forth in this Lease, except as modified by the terms, covenants and conditions as set forth below:

          40.1.1 If Tenant elects to exercise the Renewal Option, then Tenant shall provide Landlord with written notice no earlier than the date which is two hundred seventy (270) days prior to the expiration of the Term of this Lease but no later than the date which is one hundred twenty (120) days prior to the expiration of the Term of this Lease. If Tenant fails to provide such notice, Tenant shall have no further or additional right to extend or renew the Term of this Lease.

          40.1.2 The Annual Rent and Monthly Installment of Rent in effect at the expiration of the Term of this Lease shall be increased to reflect the current fair market rental for comparable space in the Building and in other similar buildings in the same rental market as of the date the Renewal Term is to commence, taking into account the specific provisions of this Lease which will remain constant. Landlord shall advise Tenant of the new Annual Rent and Monthly Installment of Rent for the Premises no later than thirty (30) days after receipt of Tenant’s written request therefor. Said request shall be made no earlier than thirty (30) days prior to the first date on which Tenant may exercise its Renewal Option under this Article 40. Said notification of the new Annual Rent may include a provision for its escalation to provide for a change in fair market rental between the time of notification and the commencement of the Renewal Term. In no event shall the Annual Rent and Monthly Installment of Rent for the Renewal Term be less than the Annual Rent and Monthly Installment of Rent in the preceding period.

          40.1.3 This Renewal Option is not transferable; the parties hereto acknowledge and agree that they intend that the aforesaid option to renew this Lease shall be “personal” to Tenant as set forth above and that in no event will any assignee or sublessee have any rights to exercise the aforesaid option to renew.

          40.1.4 If the Renewal Option is validly exercised or if Tenant fails to validly exercise the Renewal Option, Tenant shall have no further right to extend the term of this Lease.

          40.1.5 Notwithstanding anything herein to the contrary, the Renewal Option is subject and subordinate to the expansion rights (whether such rights are designated as a right of first offer, right of first refusal, expansion option or otherwise) of any tenant of the Building existing on the date hereof.

41. LIMITATION OF LANDLORD’S LIABILITY. Redress for any claim against Landlord under this Lease shall be limited to and enforceable only against and to the extent of Landlord’s interest in the Building in which the Premises is located. The obligations of Landlord under this Lease are not intended to be and shall not be personally binding on, nor shall

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any resort be had to the private properties of, any of its or its investment manager’s trustees, directors, officers, partners, beneficiaries, members, stockholders, employees, or agents, and in no case shall Landlord be liable to Tenant hereunder for any lost profits, damage to business, or any form of special, indirect or consequential damages.

IN WITNESS WHEREOF, Landlord and Tenant have executed this Lease as of the Lease Reference Date set forth in the Reference Pages of this Lease.

LANDLORD:						TENANT:
RREEF AMERICA REIT II CORP. DDD,						SCM MICROSYSTEMS, INC.,
a Maryland corporation						a Delaware corporation
By:	RREEF Management Company, a Delaware
	corporation, its Authorized Agent
By:	/s/ Stephen J. George					By:	/s/ Stephan Rohaly
Name:			Stephen J. George			Name:		Stephan Rohaly
Title:		Regional Director				Title:		Chief Financial Officer
Dated:				August 1	, 2006	Dated:		July 14	, 2006

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EXHIBIT A – FLOOR PLAN DEPICTING THE PREMISES

attached to and made a part of the Lease bearing the
Lease Reference Date of June 23, 2006 between
RREEF AMERICA REIT II CORP. DDD, a Maryland corporation, as Landlord and
SCM MICROSYSTEMS, INC., a Delaware corporation, as Tenant

Exhibit A is intended only to show the general layout of the Premises as of the beginning of the Term of the Lease. It does not in any way supersede any of Landlord’s rights set forth in Article 17 of the Lease with respect to arrangements and/or locations of public parts of the Building and changes in such arrangements and/or locations. It is not to be scaled; any measurements or distances shown should be taken as approximate.

A-1

EXHIBIT A-1 – SITE PLAN

attached to and made a part of the Lease bearing the
Lease Reference Date of June 23, 2006 between
RREEF AMERICA REIT II CORP. DDD, a Maryland corporation, as Landlord and
SCM MICROSYSTEMS, INC., a Delaware corporation, as Tenant

Exhibit A-1 is intended only to show the general location of the Building and/or the project of which the Building is a part as of the beginning of the Term of the Lease. It does not in any way supersede any of Landlord’s rights set forth in Article 17 of the Lease with respect to arrangements and/or locations of public parts of the Building and changes in such arrangements and/or locations. It is not to be scaled; any measurements or distances shown should be taken as approximate.

A-2

EXHIBIT B – INITIAL ALTERATIONS

attached to and made a part of the Lease bearing the
Lease Reference Date of June 23, 2006 between
RREEF AMERICA REIT II CORP. DDD, a Maryland corporation, as Landlord and
SCM MICROSYSTEMS, INC., a Delaware corporation, as Tenant

1. Tenant, following the delivery of the Premises by Landlord and the full and final execution and delivery of the Lease to which this Exhibit B is attached and all prepaid rental, the Security Deposit and insurance certificates required under the Lease, shall have the right to perform alterations and improvements in the Premises (the “Initial Alterations”). Notwithstanding the foregoing, Tenant and its contractors shall not have the right to perform Initial Alterations in the Premises unless and until Tenant has complied with all of the terms and conditions of Article 6 of the Lease, including, without limitation, approval by Landlord of the final plans for the Initial Alterations and the contractors to be retained by Tenant to perform such Initial Alterations. Tenant shall be responsible for all elements of the design of Tenant’s plans (including, without limitation, compliance with law, functionality of design, the structural integrity of the design, the configuration of the premises and the placement of Tenant’s furniture, appliances and equipment), and Landlord’s approval of Tenant’s plans shall in no event relieve Tenant of the responsibility for such design. Landlord’s approval of the contractors to perform the Initial Alterations shall not be unreasonably withheld. The parties agree that Landlord’s approval of the general contractor to perform the Initial Alterations shall not be considered to be unreasonably withheld if any such general contractor (a) does not have trade references reasonably acceptable to Landlord, (b) does not maintain insurance as required pursuant to the terms of the Lease, (c) does not have the ability to be bonded for the work in an amount of no less than one hundred fifty percent (150%) of the total estimated cost of the Initial Alterations, (d) does not provide current financial statements reasonably acceptable to Landlord, or (e) is not licensed as a contractor in the state/municipality in which the Premises is located. Tenant acknowledges the foregoing is not intended to be an exclusive list of the reasons why Landlord may reasonably withhold its consent to a general contractor.

2. Provided Tenant is not in default, Landlord agrees to contribute the sum of $4,154.00 (the “Allowance”) toward the cost of performing the Initial Alterations in preparation of Tenant’s occupancy of the Premises. The Allowance may only be used for the cost of preparing design and construction documents and mechanical and electrical plans for the Initial Alterations and for hard costs in connection with the Initial Alterations. The Allowance shall be paid to Tenant or, at Landlord’s option, to the order of the general contractor that performed the Initial Alterations, within thirty (30) days following receipt by Landlord of (a) receipted bills covering all labor and materials expended and used in the Initial Alterations; (b) a sworn contractor’s affidavit from the general contractor and a request to disburse from Tenant containing an approval by Tenant of the work done; (c) full and final waivers of lien; (d) as-built plans of the Initial Alterations; and (e) the certification of Tenant and its architect that the Initial Alterations have been installed in a good and workmanlike manner in accordance with the approved plans, and in accordance with applicable laws, codes and ordinances. The Allowance shall be disbursed in the amount reflected on the receipted bills meeting the requirements above. Notwithstanding anything herein to the contrary, Landlord shall not be obligated to disburse any portion of the Allowance during the continuance of an uncured default under the Lease, and Landlord’s obligation to disburse shall only resume when and if such default is cured.

3. In no event shall the Allowance be used for the purchase of equipment, furniture or other items of personal property of Tenant. If Tenant does not submit a request for payment of the entire Allowance to Landlord in accordance with the provisions contained in this Exhibit B by November 30, 2006, any unused amount shall accrue to the sole benefit of Landlord, it being understood that Tenant shall not be entitled to any credit, abatement or other concession in connection therewith. Tenant shall be responsible for all applicable state sales or use taxes, if any, payable in connection with the Initial Alterations and/or Allowance.

4. Tenant agrees to accept the Premises in its “as-is” condition and configuration, it being agreed that Landlord shall not be required to perform any work or, except as provided above with respect to the Allowance, incur any costs in connection with the construction or demolition of any improvements in the Premises.

5. This Exhibit B shall not be deemed applicable to any additional space added to the Premises at any time or from time to time, whether by any options under the Lease or otherwise, or to any portion of the original Premises or any additions to the Premises in the event of a renewal or extension of the original Term of the Lease, whether by any options under the Lease or otherwise, unless expressly so provided in the Lease or any amendment or supplement to the Lease.

B-1

EXHIBIT C – COMMENCEMENT DATE MEMORANDUM

attached to and made a part of the Lease bearing the
Lease Reference Date of June 23, 2006 between
RREEF AMERICA REIT II CORP. DDD, a Maryland corporation, as Landlord and
SCM MICROSYSTEMS, INC., a Delaware corporation, as Tenant

COMMENCEMENT DATE MEMORANDUM

     THIS MEMORANDUM, made as of ___, 20___, by and between RREEF AMERICA REIT II CORP. DDD, a Maryland corporation (“Landlord”) and SCM MICROSYSTEMS, INC., a Delaware corporation (“Tenant”).

Recitals:

A.	Landlord and Tenant are parties to that certain Lease, dated for reference June 23, 2006 (the “Lease”) for certain premises (the “Premises”) consisting of approximately 6,200 square feet at the building commonly known as 41740 Christy Street, Fremont, California.
B.	Tenant is in possession of the Premises and the Term of the Lease has commenced.
C.	Landlord and Tenant desire to enter into this Memorandum confirming the Commencement Date, the Termination Date and other matters under the Lease.

     NOW, THEREFORE, Landlord and Tenant agree as follows:

1.	The actual Commencement Date is ___.
2.	The actual Termination Date is ___.
3.	The schedule of the Annual Rent and the Monthly Installment of Rent set forth on the Reference Pages is deleted in its entirety, and the following is substituted therefor:

[insert rent schedule]

4. Capitalized terms not defined herein shall have the same meaning as set forth in the Lease.

     IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed as of the date and year first above written.

LANDLORD:		TENANT:
RREEF AMERICA REIT II CORP. DDD,		SCM MICROSYSTEMS, INC.,
a Maryland corporation		a Delaware corporation
By:	RREEF Management Company, a
	Delaware corporation, its Authorized Agent
By:		By:
Name:		Name:	DO NOT SIGN
Title:		Title:
Dated:		Dated:

C-1

EXHIBIT D – RULES AND REGULATIONS

attached to and made a part of the Lease bearing the
Lease Reference Date of June 23, 2006 between
RREEF AMERICA REIT II CORP. DDD, a Maryland corporation, as Landlord and
SCM MICROSYSTEMS, INC., a Delaware corporation, as Tenant

1. No sign, placard, picture, advertisement, name or notice (collectively referred to as “Signs”) shall be installed or displayed on any part of the outside of the Building without the prior written consent of the Landlord which consent shall be in Landlord’s sole discretion. All approved Signs shall be printed, painted, affixed or inscribed at Tenant’s expense by a person or vendor approved by Landlord and shall be removed by Tenant at Tenant’s expense upon vacating the Premises. Landlord shall have the right to remove any Sign installed or displayed in violation of this rule at Tenant’s expense and without notice.

2. If Landlord objects in writing to any curtains, blinds, shades or screens attached to or hung in or used in connection with any window or door of the Premises or Building, Tenant shall immediately discontinue such use. No awning shall be permitted on any part of the Premises. Tenant shall not place anything or allow anything to be placed against or near any glass partitions or doors or windows which may appear unsightly, in the opinion of Landlord, from outside the Premises.

3. Tenant shall not alter any lock or other access device or install a new or additional lock or access device or bolt on any door of its Premises without the prior written consent of Landlord. Tenant, upon the termination of its tenancy, shall deliver to Landlord the keys or other means of access to all doors.

4. If Tenant requires telephone, data, burglar alarm or similar service, the cost of purchasing, installing and maintaining such service shall be borne solely by Tenant. No boring or cutting for wires will be allowed without the prior written consent of Landlord. Landlord shall direct electricians as to where and how telephone, data, and electrical wires are to be introduced or installed. The location of burglar alarms, telephones, call boxes or other office equipment affixed to the Premises shall be subject to the prior written approval of Landlord.

5. Tenant shall not place a load upon any floor of its Premises, including mezzanine area, if any, which exceeds the load per square foot that such floor was designed to carry and that is allowed by law. Heavy objects shall stand on such platforms as determined by Landlord to be necessary to properly distribute the weight. Landlord will not be responsible for loss of or damage to any such equipment or other property from any cause, and all damage done to the Building by maintaining or moving such equipment or other property shall be repaired at the expense of Tenant.

6. Tenant shall not install any radio or television antenna, satellite dish, loudspeaker or other device on the roof or exterior walls of the Building without Landlord’s prior written consent which consent shall be in Landlord’s sole discretion.

7. Tenant shall not mark, drive nails, screw or drill into the partitions, woodwork, plaster or drywall (except for pictures and general office uses) or in any way deface the Premises or any part thereof. Tenant shall not affix any floor covering to the floor of the Premises or paint or seal any floors in any manner except as approved by Landlord. Tenant shall repair any damage resulting from noncompliance with this rule.

8. No cooking shall be done or permitted on the Premises, except that Underwriters’ Laboratory approved microwave ovens or equipment for brewing coffee, tea, hot chocolate and similar beverages shall be permitted, provided that such equipment and use is in accordance with all applicable Regulations.

9. Tenant shall not use any hand trucks except those equipped with the rubber tires and side guards, and may use such other material-handling equipment as Landlord may approve. Tenant shall not bring any other vehicles of any kind into the Building. Forklifts which operate on asphalt areas shall only use tires that do not damage the asphalt.

10. Tenant shall not use the name of the Building or any photograph or other likeness of the Building in connection with or in promoting or advertising Tenant’s business except that Tenant may include the Building name in Tenant’s address. Landlord shall have the right, exercisable without notice and without liability to any tenant, to change the name and address of the Building.

11. All trash and refuse shall be contained in suitable receptacles at locations approved by Landlord. Tenant shall not place in the trash receptacles any personal trash or material that cannot be disposed of in the ordinary and customary manner of removing such trash without violation of any law or ordinance governing such disposal.

D-1

12. Tenant shall comply with all safety, fire protection and evacuation procedures and regulations established by Landlord or any governing authority.

13. Tenant assumes all responsibility for securing and protecting its Premises and its contents including keeping doors locked and other means of entry to the Premises closed.

14. Tenant shall not use any method of heating or air conditioning other than that supplied by Landlord without Landlord’s prior written consent.

15. No person shall go on the roof without Landlord’s permission.

16. Tenant shall not permit any animals, other than seeing-eye dogs, to be brought or kept in or about the Premises or any common area of the property.

17. Tenant shall not permit any motor vehicles to be washed or mechanical work or maintenance of motor vehicles to be performed on any portion of the Premises or parking lot.

18. These Rules and Regulations are in addition to, and shall not be construed to in any way modify or amend, in whole or in part, the terms, covenants, agreements and conditions of any lease of any premises in the Building. Landlord may waive any one or more of these Rules and Regulations for the benefit of any tenant or tenants, and any such waiver by Landlord shall not be construed as a waiver of such Rules and Regulations for any or all tenants.

19. Landlord reserves the right to make such other and reasonable rules and regulations as in its judgment may from time to time be needed for safety and security, for care and cleanliness of the Building and for the preservation of good order in and about the Building. Tenant agrees to abide by all such rules and regulations herein stated and any additional rules and regulations which are adopted. Tenant shall be responsible for the observance of all of the foregoing rules by Tenant’s employees, agents, clients, customers, invitees and guests.

20. Any toilet rooms, toilets, urinals, wash bowls and other apparatus shall not be used for any purpose other than that for which they were constructed and no foreign substance of any kind whatsoever shall be thrown into them. The expense of any breakage, stoppage or damage resulting from the violation of this rule shall be borne by the Tenant who, or whose employees or invitees, shall have caused it.

21. Tenant shall not permit smoking or carrying of lighted cigarettes or cigars in areas reasonably designated by Landlord or any applicable governmental agencies as non-smoking areas.

22. Any directory of the Building or project of which the Building is a part (“Project Area”), if provided, will be exclusively for the display of the name and location of tenants only and Landlord reserves the right to charge for the use thereof and to exclude any other names.

23. Canvassing, soliciting, distribution of handbills or any other written material in the Building or Project Area is prohibited and each tenant shall cooperate to prevent the same. No tenant shall solicit business from other tenants or permit the sale of any goods or merchandise in the Building or Project Area without the written consent of Landlord.

24. Any equipment belonging to Tenant which causes noise or vibration that may be transmitted to the structure of the Building or to any space therein to such a degree as to be objectionable to Landlord or to any tenants in the Building shall be placed and maintained by Tenant, at Tenant’s expense, on vibration eliminators or other devices sufficient to eliminate the noise or vibration.

25. Driveways, sidewalks, halls, passages, exits, entrances and stairways (“Access Areas”) shall not be obstructed by tenants or used by tenants for any purpose other than for ingress to and egress from their respective premises. Access areas are not for the use of the general public and Landlord shall in all cases retain the right to control and prevent access thereto by all persons whose presence, in the judgment of Landlord, shall be prejudicial to the safety, character, reputation and interests of the Building or its tenants.

26. Landlord reserves the right to designate the use of parking areas and spaces. Tenant shall not park in visitor, reserved, or unauthorized parking areas. Tenant and Tenant’s guests shall park between designated parking lines only and shall not park motor vehicles in those areas designated by Landlord for loading and unloading. Vehicles in violation of the above shall be subject to being towed at the vehicle owner’s expense. Vehicles parked overnight without prior written

D-2

consent of the Landlord shall be deemed abandoned and shall be subject to being towed at vehicle owner’s expense. Tenant will from time to time, upon the request of Landlord, supply Landlord with a list of license plate numbers of vehicles owned or operated by its employees or agents.

27. No trucks, tractors or similar vehicles can be parked anywhere other than in Tenant’s own truck dock area. Tractor-trailers which must be unhooked or parked with dolly wheels beyond the concrete loading areas must use steel plates or wood blocks under the dolly wheels to prevent damage to the asphalt paving surfaces. No parking or storing of such trailers will be permitted in the parking areas or on streets adjacent thereto.

28. During periods of loading and unloading, Tenant shall not unreasonably interfere with traffic flow and loading and unloading areas of other tenants. All products, materials or goods must be stored within the Tenant’s Premises and not in any exterior areas, including, but not limited to, exterior dock platforms, against the exterior of the Building, parking areas and driveway areas. Tenant agrees to keep the exterior of the Premises clean and free of nails, wood, pallets, packing materials, barrels and any other debris produced from their operation.

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D-3

EX-21.1

Exhibit 21.1

SCM MICROSYSTEMS INC.

SUBSIDIARIES OF THE REGISTRANT

Subsidiary Legal Name	Jurisdiction of Incorporation/Formation
United States:
SCM Microsystems (U.S.) Inc.	Delaware
Microtech International Inc.	Connecticut
Dazzle Holdings Inc. (U.S.)	Delaware
SCM (fka) Dazzle Multimedia Inc.	Delaware
Europe:
SCM Microsystems GmbH	Germany
Dazzle Europe GmbH	Germany
SCM Microsystems Group Ltd.	United Kingdom
SCM Microsystems Ltd.	United Kingdom
Asia:
SCM Microsystems (Asia) Pte. Ltd.	Singapore
SCM Microsystems (Japan) KK	Japan
SCM Microsystems (India) Private Limited	India

     All subsidiaries of the registrant are wholly owned, directly or indirectly by SCM Microsystems, and do business under their respective legal names.

EX-23.1

Exhibit 23.1

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

     We consent to the incorporation by reference in Registration Statement Nos. 333-107546, 333-100629, 333-61272, 333-51792, 333-42376, 333-73061, 333-66397, 333-45789, 333-45791 and 333-45795 on Form S-8 and in Registration Statement Nos. 333-90864, 333-62696 and 333-71915 on Form S-3 of our report dated March 20, 2007 regarding SCM Microsystems, Inc.’s consolidated financial statements and financial statement schedule appearing in this Annual Report on Form 10-K of SCM Microsystems, Inc. for the year ended December 31, 2006.

/s/ DELOITTE & TOUCHE GMBH
WIRTSCHAFTSPRÜFUNGSGESELLSCHAFT

Munich, Germany
March 20, 2007

EX-31.1

Exhibit 31.1

CERTIFICATION

I, Robert Schneider, Chief Executive Officer of SCM Microsystems, Inc., certify that:

1.	I have reviewed this annual report on Form 10-K of SCM Microsystems, Inc.;
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and 15(d)-15(f)) for the registrant and have:

a)	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b)	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
c)	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonable likely to materially affect, the registrants internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

a)	All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b)	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 19, 2007 By: /s/ ROBERT SCHNEIDER
      Robert Schneider
      Chief Executive Officer

EX-31.2

Exhibit 31.2

CERTIFICATION

I, Stephan Rohaly, Chief Financial Officer of SCM Microsystems, Inc., certify that:

1.	I have reviewed this annual report on Form 10-K of SCM Microsystems, Inc.;
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and 15(d)-15(f)) for the registrant and have:

a)	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b)	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
c)	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonable likely to materially affect, the registrants internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

a)	All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b)	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 19, 2007 By: /s/ STEPHAN ROHALY
      Stephan Rohaly
      Chief Financial Officer and
      Secretary

EX-32

Exhibit 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

     I, Robert Schneider, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Annual Report of SCM Microsystems, Inc. on Form 10-K for the fiscal year ended December 31, 2006 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Annual Report on Form 10-K fairly presents in all material respects the financial condition and results of operations of SCM Microsystems, Inc.

Dated: March 19, 2007 By:
Name:
Title: /s/ ROBERT SCHNEIDER
Robert Schneider
Chief Executive Officer

     I, Stephan Rohaly, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Annual Report of SCM Microsystems, Inc. on Form 10-K for the fiscal year ended December 31, 2006 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Annual Report on Form 10-K fairly presents in all material respects the financial condition and results of operations of SCM Microsystems, Inc.

Dated: March 19, 2007 By:
Name:
Title: /s/ STEPHAN ROHALY
Stephan Rohaly
Chief Financial Officer and Secretary

     A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to SCM Microsystems, Inc. and will be retained by SCM Microsystems, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.