This Quarterly Report on Form 10-Q contains forward-looking statements for purposes of the safe harbor provisions under Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. For example, statements, other than statements of historical facts regarding our strategy, future operations, financial position, projected results, estimated revenues or losses, projected costs, prospects, plans, market trends, competition and objectives of management constitute forward-looking statements. In some cases, you can identify forward-looking statements by terms such as "will," "believe," "could," "should," "would," "may," "anticipate," "intend," "plan," "estimate," "expect," "project" or the negative of these terms or other similar expressions. Although we believe that our expectations reflected in or suggested by the forward-looking statements that we make in this Quarterly Report on Form 10-Q are reasonable, we cannot guarantee future results, performance or achievements. You should not place undue reliance on these forward-looking statements. All forward-looking statements speak only as of the date of this Quarterly Report on Form 10-Q. While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our expectations change, whether as a result of new information, future events or otherwise. We also caution you that such forward-looking statements are subject to risks, uncertainties and other factors, not all of which are known to us or within our control, and that actual events or results may differ materially from those indicated by these forward-looking statements. We disclose some of the important factors that could cause our actual results to differ materially from our expectations under "Part II - Item 1A, Risk Factors" and elsewhere in this Quarterly Report on Form 10-Q. These cautionary statements qualify all of the forward-looking statements included in this Quarterly Report on Form 10-Q that are attributable to us or persons acting on our behalf.
The following information should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto set forth in Part I - Item 1 of this Quarterly Report on Form 10-Q. We also urge readers to review and consider our disclosures describing various factors that could affect our business, including the disclosures under the headings "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Risk Factors" and the audited financial statements and notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2008.
The terms "SCM," the "Company," "we" and "us" refer to SCM Microsystems, Inc. and its subsidiaries, unless otherwise specified. Overview
Highlights of the Second Quarter, Ending June 30, 2009:
• We completed our acquisition of Hirsch Electronics Corp. ("Hirsch") on April 30, 2009, and consolidated it as a wholly-owned subsidiary. Financial results for the current quarter therefore include two months of results related to the Hirsch acquisition (May 1 through June 30, 2009).

• Net revenue rose to $11.0 million, a substantial increase compared to the same quarter a year earlier due primarily to new revenue from the Hirsch subsidiary.

• Organic growth in our main Security and Identity Solutions business included record sales in Asia (excluding Japan) and higher sales of smart card reader products in the U.S. Organic growth excludes the sales of the acquired Hirsch business.

• Our gross profit margin increased in the second quarter, due primarily to an improved product mix as a result of the Hirsch acquisition.

• On a continuing basis, SCM overall posted an after-tax loss of $(0.6) million compared to a loss of $(2.0) million in the prior-year quarter. The loss in the current period includes transaction expenses related to the Hirsch acquisition, offset by a $1.7 million tax benefit related to the accounting for taxes following the Hirsch acquisition. Our net loss for the quarter was $(0.5) million.

• Cash and cash equivalents at the end of the quarter were $5.3 million, after substantial net cash outflows associated with the Hirsch acquisition.

Narrative Summary of the 2009 Second Quarter During the second quarter, we completed our acquisition of Hirsch and consolidated it as a wholly-owned subsidiary. The acquisition closed on April 30, 2009. Financial results for SCM for the quarter therefore include two months of results from our Hirsch Electronics subsidiary. As expected, this acquisition substantially increased our net revenue, which came in 68% higher than in the second quarter of 2008. Focused business development programs enabled us to achieve growth in existing businesses as well. While overall sales excluding Hirsch were down slightly year on year, sales of smart card reader products rose 12%, with record sales in Asia (excluding Japan) and higher sales in the U.S. offsetting declines in Europe and Japan.
The Hirsch acquisition had a strong influence on other financial results for the quarter as well. Our overall gross margin rose to 51% from 43% in the prior-year quarter, as our revenue mix improved due to inclusion of higher-margin products from the Hirsch subsidiary. At the same time, operating expenses were 45% higher than in the second quarter a year earlier, primarily due to the inclusion of operating expenses for Hirsch, as well as $0.5 million in transaction expenses related to the acquisition. Aside from the Hirsch and transaction-related expenses, operating expenses decreased both sequentially and year over year across all major categories. We also recorded a tax benefit of $1.7 million in the second quarter related to the release of a valuation allowance on deferred tax assets following the Hirsch acquisition. As a result, we posted an after-tax loss of $(0.6) million from continuing operations in the second quarter, compared to a loss of $(2.0) million in the prior-year period.
Our net loss for the quarter was $(0.5) million, compared to $(1.5) million in the prior-year period, which benefited from $0.5 million in gains on sales of discontinued operations. Cash and cash equivalents were $5.3 million at the end of the quarter, significantly lower than in the prior-year period due in part to a $14.2 million cash payment for Hirsch, partly offset by $3.3 million in cash acquired.
We achieved significant progress in integrating the Hirsch acquisition during the second quarter, with a particular focus on sales and marketing activities so as to maintain our momentum with regard to acquiring new customers and establishing new products in target markets. We have also nearly completed the move of our U.S. headquarters to Hirsch's headquarters in Santa Ana, California. Company Background
SCM Microsystems, Inc. is a global provider of security and identity solutions for secure access, secure identity and secure exchange. For organizations and individuals that need to secure their digital assets, electronic transactions and facilities, SCM provides solutions that cut costs and reduce risk and liabilities. Instead of providing only a piece of the puzzle, our offerings are broad and integrated, enabling complete solutions that allow customers to turn to a single source to meet all their security and identity management challenges. We were incorporated in 1996 under the laws of the state of Delaware.
SCM's products are installed in every major industry segment and around the world. Our solutions are especially sought after in market segments requiring a higher-than-average level of security effectiveness, such as government, public utilities and other critical infrastructure, data centers, healthcare, education, communications, finance, transportation and manufacturing, as well as by security-conscious individuals. Our distribution partners and customers include top-tier computer manufacturers, OEMs, smart card manufacturers, security application providers, distributors, system integrators, specialized resellers and VARs, financial institutions, enterprises and government agencies.
We sell our security and identity solutions in two primary market segments:
Security and Identity Solutions (formerly called "Secure Authentication") and Digital Media and Connectivity.

• For the Security and Identity Solutions market, we offer a broad range of contact, contactless and mobile smart card reader technology, access control products and digital identity and transaction platforms, as well as systems that integrate physical access control, secure data storage and transmission, digital certificates, biometrics and digital video. Our solutions are used in a wide variety of industries for security, identity, contactless payment, e-health and electronic government services. We also offer a range of smart card-based productivity solutions, which include readers and software, for small and medium-size businesses under our CHIPDRIVE® brand.

• For the Digital Media and Connectivity market, we offer commercial digital media readers that are used in digital photo kiosks to transfer digital content to and from various flash media.

SCM's shares are traded on the NASDAQ exchange in the U.S. (symbol: SCMM) and the Frankfurt Prime Standard exchange in Germany (symbol: SMY). Recent Trends and Strategies for Growth
We have adopted a multi-pronged strategy for growth that includes efforts to expand and diversify our customer base, fully capture emerging market opportunities and accelerate long-term growth. A primary component of our strategy is the development of a range of new contactless and near field communication (NFC) infrastructure products to enable fast growing contactless applications and services for the electronic transaction market (including payment and ticketing), government and enterprise customers. Additionally, we are developing and implementing programs to market our existing product offerings into new distribution channels and new geographic regions. The worldwide recession has slowed our progress in penetrating new markets; however, we continue to have a high level of activity to develop new customers.
An additional component of our growth strategy is to actively seek merger and acquisition opportunities to expand our business, reinforce our market position in targeted areas and fully leverage our strengths and opportunities, such as the acquisition of Hirsch, which was completed during the second quarter of 2009. We believe our acquisition of Hirsch supports our growth strategy, as it nearly doubles our revenues, diversifies our customer base and positions our company to better address the growing market demand for solutions that address both IT security and physical access, a trend referred to in the security industry as "convergence." As the demand for the convergence of IT and physical security is most pronounced in the U.S. government sector, we believe our acquisition of Hirsch strengthens our position in this market as it allows us to offer a full range of logical (i.e., computer) and physical access solutions, systems and services.
To ensure appropriate resources for our contactless and expansion strategies, we have strengthened our management team with the addition of marketing, engineering and product management professionals from the contactless industry to execute our contactless product roadmap, including the hiring of our CEO, Felix Marx, in October 2007. Additionally, as a result of our acquisition of Hirsch, we have added a fourth member to our executive team. Lawrence Midland, who, as President of Hirsch, brings significant expertise in the security and identity solutions market to SCM. We believe the expanded expertise of our management team strengthens our ability to anticipate and respond to market trends both in the traditional smart card industry and in the emerging market for contactless and converged solutions.
Additionally, we have adopted a more active approach to partnering with other companies that can provide complementary resources and strengths. For example, in April 2008, we began working with TranZfinity, Inc. ("TranZfinity"), a provider of e-payment transactions solutions, to develop our @MAXX® family of contactless readers and to provide application services for those readers. On October 1, 2008, we entered into a Stock Purchase Agreement with TranZfinity, pursuant to which we purchased 10 million shares of TranZfinity common stock, or 33.7% of TranZfinity's outstanding shares (16.67% on a fully diluted basis), for an aggregate purchase price of $2.5 million. The transaction closed on October 2, 2008. We also entered into a Stockholders Agreement with TranZfinity and certain other stockholders of TranZfinity, which sets forth certain rights and privileges of SCM and the other stockholders of TranZfinity, including rights and privileges with respect to the composition of TranZfinity's board of directors.
On April 30, 2009, we completed our acquisition of Hirsch, a private California corporation that manufactures and sells physical access control and other security management systems. Following the acquisition, Hirsch became a Delaware limited liability company and wholly-owned subsidiary of SCM. In exchange for all of the outstanding capital stock of Hirsch, we paid approximately $14.2 million in cash, issued approximately 9.4 million shares of SCM common stock and issued approximately 4.7 million warrants to purchase SCM common stock as consideration in connection with the Hirsch acquisition. Further details of the acquisition are described in Note 2 of this Quarterly Report on Form 10-Q. Following the

acquisition, former Hirsch shareholders beneficially own approximately 37% of the shares of SCM common stock outstanding. As mentioned above, Lawrence Midland, a former Hirsch director and current President of Hirsch, joined SCM's Board of Directors and became an Executive Vice President of SCM. Douglas Morgan, a former director of Hirsch, also joined the Board of Directors of SCM.
As a result of our April 30, 2009 acquisition of Hirsch, two months of Hirsch operating results are included in our consolidated results in the second quarter of 2009, and Hirsch operating results will continue to be included in our consolidated results going forward.
Trends in our Business
Sales Trends
The current global recession and economic uncertainty has created a broader cautionary environment for us and for our customers and has resulted in decreased or delayed orders for our products in several geographic markets, most particularly Japan (which we report within our results for Asia), Europe and the U.S. We believe sales to some markets will continue to be constricted until the global economic environment strengthens, end user demand increases and the lending environment for capital purchases improves. Despite the continued sluggishness of security and identity programs in the U.S., Japan and Europe in the second quarter of 2009, revenue increased 68% compared to the second quarter of 2008, as a result of our strategic growth initiatives, including our acquisition of Hirsch and investments made in key markets and regions.
We believe that our acquisition of Hirsch has strengthened our performance across multiple financial metrics, our ability to capture new and existing sales opportunities and our overall business profile. With only two months of Hirsch operating results included in the second quarter, sales doubled in our Security and Identity Solutions business and overall gross profit margin increased by eight percentage points. The integration of Hirsch and SCM is proceeding as planned: sales and marketing cross training has begun; integrated finance systems, including reporting processes, are in place or in process; and we have nearly completed the move of our U.S. headquarters to Hirsch's Santa Ana, California headquarters and the subsequent closure of our Fremont, California facility.
In the U.S. government market, sales of our smart card reader products for PC and network access by military and federal employees has been an important component of our overall revenue composition. In recent periods, project and budget delays in the U.S. government sector and the rapid shift towards lower cost embedded chips rather than external smart card readers by laptop and keyboard manufacturers servicing the U.S. government sector have constricted our sales in this market. The U.S. government sector is also an important market for our Hirsch business, but Hirsch's sales model is more focused on the provision of integrated systems, rather than point solutions, and is generally less susceptible to variability from project delays and other factors. In the 2009 second quarter, sales from the Hirsch business were up both sequentially and year over year, and a significant percentage of Hirsch sales related to projects at federal government agencies. We believe that our acquisition of Hirsch creates a substantially more stable and consistent revenue profile for SCM in the U.S. government sector, given Hirsch's sales model. We believe that Hirsch's ability to offer complete systems and professional services complements and strengthens SCM's position and provides significant new opportunities for incremental revenue growth.
In Europe, over the next several quarters we believe our most significant revenue opportunity comes from the new electronic health card program in Germany. Deployment of electronic health insurance cards to Germany's 82 million citizens began in 2008 and the German government began distribution of card reader terminals for the program in April 2009. During the second quarter of 2009, we continued to ship eHealth terminals for desktop environments and recorded our first sales of mobile terminals. Our government-certified eHealth terminals are used in hospitals, pharmacies, physicians' offices, nursing homes and elsewhere to authenticate individual health card holders, allow them access to healthcare services and manage medical records and insurance information. Based on the current pace of the German government's deployment of technology in the German electronic health card program, we anticipate an opportunity for SCM to sell higher volumes of eHealth terminals towards the end of 2009 and through the first half of 2010.
Apart from this program, the weak economic environment in Europe continues to constrict sales to both established and new customers. In general, smart-card based security projects in all sectors are experiencing delays or are limited in scale. At the same time, sales development activities we initiated 12 to 18 months ago as part of our strategy to broaden our market and geographic penetration are resulting in higher customer engagement than in past periods. During the second quarter of 2009 we also sold our first products based on the core technology used in our eHealth terminals for applications other than electronic healthcare.

In Japan, the weak economic environment also continued to constrict sales. Outside Japan, our efforts to develop additional distribution channels and penetrate new geographic markets in Asia appear to be demonstrating success. Over the past year, we have added sales resources and applied a more systematic and focused approach to sales in countries such as China, India, Korea, Malaysia, the Philippines and Thailand. During the second quarter of 2009, sales in Asia increased significantly year over year and came from an expanded base of customers in a larger number of countries than in past periods. In particular, we added new customers, new distribution channels and significantly increased our sales of both smart card chips and readers in the Asian PC OEM market, which targets OEM customers that manufacture components and equipment for global consumer brand companies. We expect that our expanded channel and customer base in Asia will continue to generate a higher level of sales going forward.
In our continuing operations, we may experience significant variations in demand for our products quarter to quarter. This is particularly true for our smart card reader products, a significant portion of which are currently sold for 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. Further, this business is typically subject to seasonality based on governmental budget cycles, with lowest sales in the first quarter and highest sales in the fourth quarter of each year. Additionally, we are dependent on a small number of customers in our Security and Identity Solutions business overall for a significant portion of our revenues.
Sales of our Digital Media and Connectivity products are less subject to variability based on market or project demands than sales in our Security and Identity Solutions business; however, we are dependent on a very small number of customers in this product segment, which can result in fluctuations in sales levels from one period to another. During the second quarter of 2009, the timing of customer orders was not favorable, in part due to the transition to a new product, and revenues were lower than anticipated. Gross Profit Margin Trends
Our acquisition of Hirsch has resulted in a significant increase in our gross profit margin, as Hirsch's sales typically yield margins that are several percentage points higher than sales of our smart card reader products. We expect that our gross profit margin will continue to benefit from this more favorable mix going forward. Additionally, we have implemented ongoing cost reduction programs to address pricing pressure in our business and these programs have generally resulted in ongoing improvements to our product margins. We believe we should be able to offset ongoing pricing pressure and material cost increases with continual improvements in our supply chain systems. Operating Expense Trends
Our operating expenses in the second quarter of 2009 reflect the addition of two months of expenses for the Hirsch business, as well as approximately $0.5 million in transaction costs. Aside from incremental Hirsch expenses, operating expenses decreased both sequentially and year over year across all major categories. During 2008, we increased research and development investment in order to develop card reader terminals for the electronic health card program in Germany and new products for the contactless market, and the majority of this work has now been completed. Similarly, Hirsch also increased its engineering investment over the last several quarters to develop its next generation of controllers, and we expect that our research and development expenses will decrease from current levels once the development of these controllers is completed. As part of our growth strategy, we have also made significant investments to build up sales resources and create business development programs both in our traditional markets and also in the contactless market, particularly in Asia and Latin America. We believe that we have sufficient resources in place to address our market opportunities, including new opportunities with Hirsch, and that sales and marketing expenses will remain relatively steady going forward. Over the last three quarters, acquisition related costs have driven increases in general and administrative expense. Going forward, we will continue to closely manage our expenses, particularly general and administrative.

Results of Operations
   The comparability of our operating results in the three and six months ended
June 30, 2009, compared with the same periods of 2008, is primarily impacted by
our acquisition of Hirsch on April 30, 2009, as the 2009 periods presented
include two months of operating results from the acquired Hirsch business.
   Net Revenue. Summary information by business segment for the three and six
months ended June 30, 2009 and 2008 is as follows (in thousands):

                                                                 % change                                             % change
                                  Three months ended             period to              Six months ended              period to
                                       June 30,                   period                    June 30,                   period
                                2009              2008                               2009              2008
Security and Identity
Solutions
Revenue                      $  10,028          $ 4,878              106 %        $ 13,971          $  9,885               41 %
Gross profit                     5,251            2,276                              6,929             4,423
Gross profit %                      52 %             47 %                               50 %              45 %

Digital Media and
Connectivity
Revenue                      $     933          $ 1,642              (43 )%       $  2,145          $  3,099              (31 )%
Gross profit                       320              547                                755             1,083
Gross profit %                      34 %             33 %                               35 %              35 %

Total:
Revenue                      $  10,961          $ 6,520               68 %        $ 16,116          $ 12,984               24 %
Gross profit                     5,571            2,823                              7,684             5,506
Gross profit %                      51 %             43 %                               48 %              42 %

Net revenue for the second quarter of 2009 was $11.0 million, up 68% from $6.5 million for the same period of 2008. The increase in second quarter revenue year over year was primarily the result of incremental revenues from the acquired Hirsch business. Excluding Hirsch, revenues were down slightly, reflecting higher demand for our smart card reader products, offset by decreased sales of Digital Media and Connectivity products. For the first six months of 2009, net revenue was $16.1 million, up 24% from revenue of $13.0 million for the first six months of 2008. The increase in revenue for the first six months of 2009 compared with the prior year period resulted from incremental revenues from our acquisition of Hirsch in the second quarter of 2009, partially offset by lower sales of our smart card reader and Digital Media and Connectivity products.
Following our acquisition of Hirsch, revenue in our Security and Identity Solutions business principally consists of sales of smart card readers, related chip technology and access control products that are primarily used in security programs where smart cards and/or personal identification ("PIN") codes are employed to authenticate the identity of people in order to control access to computers or computer networks; borders; buildings and other facilities; and services, such as health care. Additionally, this business includes sales of digital identity and transaction platforms, as well as systems that integrate physical access control, secure data storage and transmission, digital certificates, biometrics and digital video. Also included in this business segment are our CHIPDRIVE software and reader solutions, which provide electronic timecard and other productivity applications for small and medium enterprises and are primarily sold in Europe. The majority of revenue in our . . .