Wave Systems 10K 2009 Annual report

Wave Systems (WAVX) Inactive 10-K2009 FY Annual report

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PART IV

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K


ý		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2009
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 0-24752

Wave Systems Corp.
(Exact name of registrant as specified in its charter)


Delaware (State or other jurisdiction of incorporation or organization)		13-3477246 (I.R.S. Employer Identification No.)
480 Pleasant Street Lee, Massachusetts (Address of principal executive offices)		01238 (Zip Code)

413-243-1600
(Registrant's telephone number, including area code)

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

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

Class A Common Stock, $.01 par value
(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 ý

Indicate 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 ý

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 ý NO o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter), during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES o NO ý

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "accelerated filer", "large accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one).


Large accelerated filer o		Accelerated filer o		Non-accelerated filer o (Do not check if a smaller reporting company)		Smaller reporting company ý

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). YES o NO ý

The aggregate market value of the shares of Common Stock of the registrant held by non-affiliates based on the closing price (as reported by NASDAQ) of such common stock on the last business day of the registrant's most recently completed second fiscal quarter (June 30, 2009) was approximately $73 million. (For purposes of this calculation, the market value of a share of Class B Common Stock was assumed to be the same as a share of Class A Common Stock, into which it is convertible.)

As of March 12, 2010, there were 78,459,621 shares of the registrant's Class A Common Stock and 38,232 shares of the registrant's Class B Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE:

Portions of our definitive Proxy Statement for the 2010 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2010, have been incorporated by reference into Part III of this annual report.

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EXCEPT FOR HISTORICAL INFORMATION CONTAINED HEREIN, THIS FORM 10-K CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF THE U.S. SECURITIES LITIGATION REFORM ACT OF 1995. THESE STATEMENTS INVOLVE KNOWN AND UNKNOWN RISKS AND UNCERTAINTIES THAT MAY CAUSE WAVE'S ACTUAL RESULTS OR OUTCOMES TO BE MATERIALLY DIFFERENT FROM THOSE ANTICIPATED AND DISCUSSED HEREIN. FURTHER, WAVE OPERATES IN AN INDUSTRY SECTOR WHERE SECURITIES VALUES MAY BE VOLATILE AND MAY BE INFLUENCED BY REGULATORY AND OTHER FACTORS BEYOND WAVE'S CONTROL. IMPORTANT FACTORS THAT WAVE BELIEVES MIGHT CAUSE SUCH DIFFERENCES ARE DISCUSSED IN THE CAUTIONARY STATEMENTS ACCOMPANYING THE FORWARD-LOOKING STATEMENTS AND IN THE RISK FACTORS DETAILED IN PART I, ITEM 1 OF THIS FORM 10-K. IN ASSESSING FORWARD-LOOKING STATEMENTS CONTAINED HEREIN, READERS ARE URGED TO READ CAREFULLY ALL RISK FACTORS AND CAUTIONARY STATEMENTS CONTAINED IN THIS FORM 10-K.

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PART I			2
	Item 1.	Business	2
	Item 1A.	Risk Factors	14
	Item 1B.	Unresolved Staff Comments	21
	Item 2.	Properties	21
	Item 3.	Legal Proceedings	21
	Item 4.	Removed and Reserved	21
PART II			22
	Item 5.	Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	22
	Item 6.	Selected Financial Data	26
	Item 7.	Management's Discussion and Analysis of Financial Condition and Results of Operations	27
	Item 7A.	Quantitative and Qualitative Disclosures about Market Risk	46
	Item 8.	Financial Statements and Supplementary Data	46
	Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	46
	Item 9A.	Controls and Procedures	46
	Item 9B.	Other Information	47
PART III			48
	Item 10.	Directors, Executive Officers and Corporate Governance	48
	Item 11.	Executive Compensation	48
	Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	48
	Item 13.	Certain Relationships and Related Transactions, and Director Independence	48
	Item 14.	Principal Accounting Fees and Services	48
PART IV			49
	Item 15.	Exhibits and Financial Statement Schedules	49

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PART I

Item 1. Business

General

Reference to "Wave", "we", "us", "our" or "the Company" refer to Wave Systems Corp. Wave was incorporated in Delaware under the name Indata Corp. on August 12, 1988. We changed our name to Cryptologics International, Inc. on December 4, 1989. We changed our name again to Wave Systems Corp. on January 22, 1993. Our principal executive offices are located at 480 Pleasant Street, Lee, Massachusetts 01238 and our telephone number is (413) 243-1600.

Wave develops, produces and markets products for hardware-based digital security, including security applications and services that are complementary to and work with the specifications of the Trusted Computing Group, www.trustedcomputinggroup.org ("TCG"), an industry standards organization comprised of computer and device manufacturers, software vendors and other computing products manufacturers. Specifications developed by the TCG are designed to address a broad range of current and evolving digital security issues. These issues include: identity protection, data security, digital signatures, electronic transaction integrity, platform trustworthiness, network security and regulatory compliance.

Since 2008, we have held a permanent seat on the TCG Board of Directors (the "TCG Board"), joining permanent members AMD, Fujitsu, HP, IBM, Infineon, Intel, Lenovo, Microsoft, Sun and Seagate Technology. Wave has also elevated its membership status to the highest level of TCG "Promoter." Permanent members of the TCG Board provide guidance to the organization's work groups in the creation of the specifications to protect PCs and other computing devices from attacks and to help prevent data loss and theft. Wave's enhanced membership status allows it to take a more active role in helping to develop, define and promote hardware-enabled trusted computing security technologies, including related hardware building blocks and software interfaces. Wave is eligible to serve on and chair the TCG Board, Work Groups and Special Committees; is able to submit revisions and addendum proposals for specifications with design guides; and may review and comment on design guides prior to their adoption.

One of the current TCG specifications recommends a hardware-based trusted computing platform, which is a platform that uses a semiconductor device, known as a Trusted Platform Module ("TPM") that contains protected storage and performs protected activities, including platform authentication, protected cryptographic processes and capabilities allowing for the attestation of the state of the platform which provides the first level of trust for the computing platform (a "Trusted Platform"). The TPM is a hardware chip that is separate from the platform's main CPU(s) that enables secure protection of files and other digital secrets, and performs critical security functions such as generating, storing and protecting "cryptographic keys," which are secret codes used to decipher encrypted or coded data. While TPMs provide the anchor for hardware security, known as the "root of trust", trust is achieved by integrating the TPM within a carefully architected trust infrastructure and supporting the TPM with essential operational and lifecycle services, such as key management and credential authentication.

Prior to the formation of the TCG, Wave developed its pioneering EMBASSY® (EMBeddedApplicationSecuritySYstem) Trust System. The EMBASSY Trust System is a combination of client hardware consisting of the EMBASSY 2100 security chip (the "EMBASSY chip"), and software consisting of the Trust Assurance Network ("TAN"), a back-office infrastructure that manages its security functions. As the market for TPM-enabled products has developed with computing devices being shipped in volume by leaders in the PC industry, Wave has enabled the development work on the EMBASSY Trust System to support security hardware based on the TCG specifications, by repurposing these product assets. Wave has since developed a set of applications known as the EMBASSY Trust

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Suite, EMBASSY Trust Server products, middleware and software tools to work with various other chip manufacturers' TCG-enabled TPMs that are now available. Wave's products are unique in the fact that they support cross platform interoperability for the currently available TPM chips from Nuvoton Technology Corporation, Atmel, Broadcom, Infineon Technologies AG, and ST Microelectronics and have been verified for usage on TPM platforms shipped by Dell, Acer, Intel, Lenovo, HP, NEC and Fujitsu.

Wave's operations to date have consisted primarily of product development, performance under contract to develop products and marketing and sales to personal computer ("PC") and semi-conductor chip ("Chip") original equipment manufacturers ("OEMs"), resellers, and enterprises. Wave has been successful in signing distribution and reseller contracts with Intel, Nuvoton, ST Microelectronics, Dell Products LP ("Dell"), Acer and Broadcom. In November 2009 Wave entered into a reseller agreement with Hewlett-Packard Company ("HP") that permits HP to distribute and sell Wave's software products through HP sales channels. In December 2008, Wave completed an amendment to its software license agreement with its largest OEM customer, Dell. Under the new arrangement, the per-unit royalties that Wave receives for each OEM PC model shipping with Wave's EMBASSY Trust Suite software were increased by at least 100% per unit, retroactive to November 1, 2008.

Due to the early stage nature of its market category, Wave is unable to predict with a high enough level of certainty whether enough revenue will be generated in calendar 2010 to fund its cash flow requirements. Given the uncertainty with respect to Wave's revenue forecast for 2010, Wave may be required to raise additional capital through either equity or debt financing in order to adequately fund its capital requirements for the year ending December 31, 2010. As of December 31, 2009, we had approximately $1.9 million of cash on hand and negative working capital of approximately $2.0 million. Considering our current cash balance and Wave's projected operating cash requirements, we project that we have enough liquid assets to continue operating through December 31, 2010. Due to our current cash position, our capital needs over the next year and beyond, the fact that we may require additional financing and uncertainty as to whether we will achieve our sales forecast for our products and services, substantial doubt exists with respect to our ability to continue as a going concern.

Formation of the Trusted Computing Group and introduction of TCG Compliant Products

The TCG was formed in April 2003 by the Promoting Founders—AMD, HP, IBM, Intel, and Microsoft. Wave Systems was initially invited to join the founding group as a Contributing Member. Since 2008, Wave has held a permanent seat on the TCG Board. The TCG has significantly expanded the industry participation in security hardware standards and now includes industry leaders offering additional platforms such as storage devices, cell phones, PDAs and consumer electronics. Since 2005, the rate of adoption of TPMs continued to grow with the availability of TPM-equipped PCs and servers from additional PC OEMs including Acer, Dell, HP and Lenovo. The overall number of TPM-equipped PC models being offered from the OEMs shipping with TPMs, combined with the increased number of OEMs that have introduced TPM-equipped models, has continued to accelerate the rate at which TPMs are being shipped by the PC industry. Within the TCG there are TCG Working Groups that are developing specifications to extend TCG technologies to other devices such as storage devices, network products, servers, peripherals and mobile devices.

The offering of products using TCG specifications to the PC market is an important development in the creation of the market for hardware-based computer security. Wave is continuing to execute its strategy to leverage its EMBASSY Trust System in an effort to become a leading developer of software, applications and services for this market. Wave is providing solutions in the market that are designed to work with many commercially available products using TCG specifications.

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Products and Services

Although Wave's revenue has grown considerably in 2009 versus prior years, Wave's revenue in 2009 of approximately $18,890,000 was still less than its operating expenses, which were approximately $22,216,000. For the years ended December 31, 2009, 2008, and 2007, Wave incurred losses to common shareholders of approximately $3,346,000, $21,206,000 and $19,952,000 respectively. At December 31, 2009, we had an accumulated deficit of approximately $348,036,000. There can be no assurance that we will ever be successful in achieving significant commercial acceptance of our products and services.

Client-side Applications

EMBASSY Trust Suite

The current version of the EMBASSY Trust Suite consists of a set of applications and services that is designed to bring functionality and user value to TPM-enabled products. Designed to make the TPM easy for users to set up and use, the EMBASSY Trust Suite includes the EMBASSY Security Center (the "ESC"), Trusted Drive Manager ("TDM"), Document Manager ("DM"), Private Information Manager ("PIM") and Key Transfer Manager ("KTM").

The ESC enables the user to set up and configure the TPM platform. In addition to the basic function of making the TPM operational, the ESC is designed to enable the user to manage extended TPM-based security settings and policies, including strong authentication, Windows logon preferences to add biometrics and streamlined password policy management. In January 2009, the TCG published storage specifications for another major trusted hardware component, the self-encrypting drive or SED. The ESC software contains advanced lifecycle management tools for the SED. Trusted Drive Manager is the software utilized for managing SEDs. SEDs are designed to provide advanced data protection technology and they differ from software-based full disk encryption in that encryption takes place in hardware, in a manner designed to provide a more robust security without slowing processing speeds. Because the drives are factory-installed, the systems can be configured such that encryption is "always on," for the protection of proprietary information. SEDs from Seagate (DriveTrustTM technology) and Samsung, which earlier this year unveiled the first solid-state SED using flash memory, come bundled with Wave's client software EMBASSY® Trusted Drive Manager, for pre-boot authentication and initialization of the drive. During 2009 Wave worked with other disk drive OEMs such as Toshiba, Fujitsu, and Hitachi to develop support for their self-encrypting drives which are based on the new TCG storage specifications. Enterprises can also select Wave's EMBASSY® Remote Administration Server for the centralized administration and management of the drives, which are designed to provide detailed event logs for compliance reporting.

Data protection is also addressed by the DM, which is offered to provide document encryption, decryption and client- side storage of documents. The DM works with Microsoft Windows and Microsoft Office to secure documents against unauthorized users and hackers. Wave's software is Windows 7 and Vista ready, building upon the operating systems data protection feature sets, providing full-featured EMBASSY solutions for data protection and strong authentication.

Password management can be a security challenge due to the increasing number of passwords required and the tendency of users to select easily guessed passwords. To help address these password issues, PIM uses the TPM to securely store and manage user information such as user names, passwords, credit card numbers and other personal information. It retrieves login information to efficiently fill in applications, web forms and web login information.

Backup and recovery of keys used for logon, signing, and protection of data can be an essential requirement for deployment of TPM-based systems. KTM is an archive application for the cryptographic keys that is designed to provide a simple, yet full-featured, method to securely archive, restore and transfer keys, having the property of being migratable, that are secured by the TPM.

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Additionally, Wave has developed TPM Wizards as part of the EMBASSY Trust Suite, which can allow users to setup and use the TPM for securing 802.11x wireless networks, the Windows Encrypting File System and encrypted email.

Wave plans to continue to develop and enhance the current products being developed within this product group and to develop new applications and services as the trusted computing market continues to evolve. Current planned development costs for this product group are expected to be approximately $3.5 million for the year ending December 31, 2010.

Middleware and Tools

TCG-Enabled Toolkit

The Wave TCG-Enabled Toolkit is a compilation of software designed to assist application developers writing new applications or modifying existing ones to function on TCG-compliant platforms. Wave provides two versions of the Toolkit, Discovery and Commercial, which can enable developers to leverage basic and enhanced TCG services such as integrated key lifecycle management, including key escrow and key recovery. The Discovery Toolkit offers application developers a license for internal evaluation only whereas the Commercial Toolkit is a license for external redistribution.

Wave TCG-Enabled Cryptographic Service Provider ("CSP")

Wave offers a TCG-enabled CSP, which can allow software developers to utilize the enhanced security of a TCG standards-based platform, facilitating a common user experience independent of the platform. It is also designed to enable applications to utilize functionality available on TCG-compliant platforms directly through the Microsoft cryptographic application programming interface without requiring user knowledge of any specific TCG software stack layer.

Current planned development costs for this product group are expected to be approximately $4.3 million for the year ending December 31, 2010.

EMBASSY Trust Server Applications

EMBASSY Key Management Server ("EKMS")

EKMS is a server application that is designed to provide corporate-level backup and transition of the TPM keys, a process known as key migration. Key migration using EKMS is designed to help prevent the risk of serious data loss in the event that a TPM, hard drive or motherboard becomes corrupted, or a user leaves the organization. For instance, an organization may require access to a former employee's encrypted data or TPM-secured keys for business continuity or disaster recovery purposes. EKMS enables enterprise-level key protection services while ensuring proper archive procedures and recovery capabilities.

EMBASSY Authentication Server ("EAS")

EAS is offered to provide centralized management, provisioning and enforcement of multifactor domain access policies. With EAS, authentication policies can be based on TPM credentials, Smart Card credentials, user passwords and fingerprint templates. With EAS, authentication policies can be provisioned and managed from the domain controller. EAS has an integrated biometric template capability with support for a variety of third-party vendors.

EMBASSY Remote Administration Server ("ERAS")

ERAS is a server product that is offered to provide centralized management and auditing of TPMs and SEDs. ERAS is designed to give IT administrators the ability to deploy and remotely

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manage SED and TPM systems, including initialization, pre-boot authentication management, recovery, and repurposing of TPMs and SEDs. ERAS is designed to provide auditing capabilities that aid in compliance management by allowing for validation of TPM and SED security settings and to allow IT administrators to assess the risk of whether a lost or compromised PC is adequately secure. ERAS is designed to facilitate enterprise adoption of TPM and SED technology as it provides IT administrators with tools to utilize the security of these devices while reducing deployment and management costs. The latest version of EMBASSY Trust Suite, including TDM, incorporates support for Seagate's Momentus FDE 7200-RPM SED and Samsung's SEDs (standard and solid-state versions)—both shipping on Dell's E-Series notebook PCs. In December 2008, Wave and Fujitsu Computer Products of America, Inc. showcased their SED solution at the Network World IT Roadmap Conference & Expo in San Francisco. Fujitsu's 2.5-inch High Definition Drive was the first technology that met the Opal Security Subsystem Class (SSC) specification—an industry standard issued by the TCG. The SSC specification gives vendors an industry standard for developing SEDs that secure data. Wave's products currently support SED offerings from Fujitsu, Toshiba, Samsung, Hitachi, Seagate and others based on Opal SED specifications.

Current planned development costs for this product are expected to be approximately $1.6 million for the year ending December 31, 2010.

Electronic/Digital Signature and Electronic Document Management

eSign Transaction Management Suite

Our eSign Transaction Management Suite, also known as eTMS ("eTMS"), originally consisted of four core products: SmartIdentity, SmartSignature, SmartSAFE and SmartConnect. SmartSignature Version 3.0 is a digital signature application that can connect signers and institutions—banks, insurance companies, enterprises, etc.—through a digital signature process. Wave's SmartSignature Server 4.02.02, a server-side electronic signature application, enables individuals to electronically sign and store virtually any format of document, while connected to a server, as opposed to the signing taking place on the client PC. Wave's SmartSigning Rooms Version 2.03 was designed to enhance the functionality of SmartSAFE, enabling an organization to offer signers a secure virtual environment to review, annotate and electronically sign documents. An enhancement to eTMS known as SmartClose has been designed to allow for mortgage closing documents to be signed and notarized in a secure environment. The electronic note is then registered through the Mortgage Electronic Registry System, a system for electronically tracking mortgage ownership and servicing rights. SmartClose also offers lenders protection against borrowers claiming not to have understood their debt obligation by requiring the borrower to electronically sign and initial key line items while providing audit capabilities for the entire transaction. SmartClose has been designed to allow a lender to originate, sign, track, access, store and transfer electronic mortgages. SmartSAFE is the core component of eTMS that provides the record retention of these electronically signed documents. SmartSAFE meets the requirements of Federal Rule 901 which requires that the user demonstrate that electronic documents offered as evidence in a legal proceeding are authentic.

To increase the security associated with identity protection and digital signing credentials, Wave's SmartSignature is designed for the support of TPMs. SmartSAFE Version 5.0.3h is a web-based document management application where signed documents are archived and tracked. SmartSAFE was designed to provide an easy to use environment where a client institution can view, manage, store and transfer sensitive signed and unsigned documents. These products can allow a document to be executed, verified, accepted and filed in minutes at a lower cost compared to many traditional paper-based documentation methods. SmartIdentity is an optional service to verify a signer's identity through strong authentication methods, including issuing encrypted digital certificates based on public key infrastructure technology. Wave plans to continue to allocate resources toward marketing and sales to promote these products.

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Wave's eTMS, in addition to supporting TPMs, is also being independently marketed in the insurance, mortgage, banking, government and other markets, offering digital and electronic signature solutions that are designed to comply with the Electronic Signatures in Global and National Commerce Act ("ESIGN") and Uniform Electronic Transaction Act ("UETA"). Through direct and reseller channels, many organizations have used eTMS functionality to automate paper processes. Some of the flagship organizations that are currently utilizing eTMS include: Ellie Mae, ala mode, DocuTech, SigniaDocs, Xerox Mortgage Services and Insurance Administrative Solutions. Wave has focused on digital signature applications that can make effective use of the stronger security features provided by trusted computing platforms.

Current planned development costs for this product are expected to be approximately $350,000 for the year ending December 31, 2010.

Broadband Media Distribution Services

Markets and Business Strategy

Our Market

Software has traditionally secured critical information on networks and PCs and allowed for user access to various applications. However, virus attacks and breaches of security have in many cases demonstrated that software, on its own, is not always capable of completely securing a network or platform. Because of these security concerns, we believe that there is a need in the computer industry for the development and deployment of a more robust and reliable security infrastructure including new security hardware in devices to guard against these persistent security risks. The TCG was formed to develop, define and promote open industry standard specifications for embedded hardware-enabled trusted computing and security technologies, including secure hardware and software interfaces across multiple platforms, peripherals and devices. The underlying premise of the creation of a Trusted Platform that meets the TCG specification is that only when a platform is secured by hardware, in effect creating a root of trust and a security environment which can be authenticated within the computer itself, will the information stored on the platform be adequately secure. Wave is seeking to become a software, application and services leader in hardware-based digital security and e-commerce products markets. We believe Wave has been a pioneer in developing hardware-based computer security systems and that we are distinctively positioned to take advantage of our unique knowledge, significant technology assets and trusted computing intellectual properties.

Hardware-based trusted computing solutions can involve a new approach to conducting business and exchanging information using computer systems. We believe that these solutions will require traditional software-based security to be augmented with next generation hardware-based security and an enhanced support infrastructure. Intensive marketing and sales efforts have been, and will continue to be, necessary, in order to generate demand for products using Wave's technology and to ensure that Wave's solution is accepted in this emerging market. Our objective is to make our EMBASSY branded

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products and services the preferred applications and infrastructure for Trusted Platforms. We believe that the key components in achieving this goal include:

Capitalizing on Information Security Industry Trends

We believe that security remains one of the top industry priorities across multiple segments of the user and product value chains. Wave believes that a key differentiator of its EMBASSY Trust Suite is that it is interoperable across all of the currently available TPM-enabled Windows platforms, as well as supporting all shipping SEDs from multiple vendors, and provides for ease of use. Key industry initiatives and security specifications that will require the addition of trusted hardware are moving forward in a number of platforms. The issuance of TCG's Opal self-encrypting drive industry specification standard for developing SEDs is one example of this. The Opal security subsystem storage specification gives developers a "blueprint" for developing SEDs. In addition to our work with Seagate and Samsung, Wave is working with Fujitsu, Toshiba, Hitachi and others to develop Opal-compliant SED solutions. Other past platforms requiring the addition of trusted hardware include Microsoft's Windows 7 and Vista operating systems, Intel's LaGrande/vPro secure computing program, and AMD's Secure Execution Mode. Similar programs are under consideration in network devices and mobile devices such as PDAs and cell phones and consumer electronics devices.

Wave has designed its products with features and functionality that we believe may uniquely position us to capitalize on information security industry issues and trends. Wave believes that the following could be important issues and trends for our strategic objectives:

•: Requirements to authenticate the identity of both platforms and users for access to protected resources and information
•: Need to protect sensitive information on mobile PCs which may be stolen or lost
•: Need to comply with consumer laws and state and federal legislation requiring identity theft protection
•: User managed security features
•: Major privacy concerns
•: Rapid development of new e-commerce business and distribution models
•: Lack of adequate security for e-commerce and vulnerability to attacks
•: Convergence of consumer electronics and PCs
•: Legal status of digital identities and digital signatures, including development of next generation web services which require digital signature solutions
•: Increased focus on security and privacy by government entities
•: Rampant piracy of digital goods including music, video, software and the need for digital goods providers to securely distribute their content and prevent theft

Wave plans to continue to pursue strategic relationships with hardware manufacturers, independent software vendors, systems integrators and companies involved in the development of commerce in electronic content and services to achieve broad market acceptance of its products as a platform for security solutions and commerce performed in user devices.

Pursuing Strategic Marketing and Distribution Alliances

We intend to expand Wave's strategic alliances with key partners that could distribute our products in enterprise, government and eventually consumer markets, and to build upon our alliances with such

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industry leaders as Intel, Dell, Acer, HP, Lenovo, NEC and others in the PC industry. In addition, we are engaged in strategic activities with semi-conductor manufacturers Broadcom, ST Microelectronics, Nuvoton, Atmel and Infineon Technologies to support and/or deploy EMBASSY applications with their TPMs designed to the TCG specifications. TCG has expanded its scope to include networking systems, trusted peripherals, data storage devices, mobile wireless products and consumer electronics devices. Wave expects additional secure storage devices and data protection alternatives to be introduced in 2010 and thereafter and believes that its trusted computing offerings can provide significant value in these new markets and on these platforms and thus, is working to establish relationships with key partners in each of these markets.

Enhancing Our Current Product Offerings and Products in Development

We intend to continue to develop and extend our existing product offerings to include features and functionality to meet customer requirements and market demand. Planned development efforts that enhance or utilize existing technologies include building upon and enhancing our EMBASSY Trust Suite and eTMS applications.

Client and server solutions supporting both the operations and life cycle management of Trusted Platforms is a major focus area for Wave. New products that Wave is planning on developing over the ensuing period will consist primarily of new TCG client and server software services and enabling tools that will expand upon its portfolio of TCG trusted computing applications and services in the following areas:

•: Cross-platform interoperability: TCG hardware is provided by multiple suppliers and supporting software is offered by multiple vendors. In order to assist applications from independent software vendors to work with any of these multiple combinations of products, Wave is developing TCG specific toolkits that provide for interoperability across platforms. Wave plans to continue to expand the functions available to systems integrators ("SIs"), independent software vendors ("ISVs") and independent hardware vendors ("IHVs") within these enabling toolkits in an effort to make it easier to bring new applications to Trusted Platforms.
•: Client applications: Wave's EMBASSY Trust Suite provides important end user PC applications such as EMBASSY Security Center, Trusted Drive Manager, Document Manager, Private Information Manager and Key Transfer Manager. Wave plans to continue to add new client applications and enhance the current applications with advanced functions to exploit the strong security of the TCG platforms.
•: Server applications: Trusted devices require a number of life cycle management products to address the set up, registration, operations and systems management requirements of the platforms. Wave's current server and life cycle management products consist of the EKMS, EAS and ERAS. Wave plans to enhance these products with future versions and to expand these products to offer additional trust services.

At Digital ID World in September 2009 Wave released and demonstrated a beta version of id.wave.com, its new identity service for strong authentication and single-sign on to Web services and applications in the Cloud. This service takes advantage of the TPM security chip to secure users' authentication identities with keys held in the TPM. Also, during the 2009 Intel Developers Forum, Wave demonstrated remote, out-of-band management of self-encrypting drives using Intel® vPro™ Technology with Wave's EMBASSY® client and server software. The solution allows a secure network unlock of the drives automatically by an administrator, regardless of whether the PC is powered on and independent of the PC's operating system. Wave believes that these development efforts will likely be significant and Wave intends to expend a substantial portion of its research and development resources towards these enhancements as well as significant marketing and corporate development funds to introduce the products and build market demand. As a result, our continued research and development

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efforts will require substantial capital resources, which may necessitate the need for further funding so that Wave may ultimately be able to capitalize on the emerging market opportunities for its products and services.

Marketing, Sales and Customers

Because Wave's products involve a new approach to conducting business and exchanging information using computer systems, we believe market acceptance of these products will require that traditional software-based security be enhanced and/or replaced with next generation products designed using the TCG and related specifications. Intensive marketing and sales efforts have been and will continue to be necessary in order to increase recognition of and generate demand for products using Wave's technology and to ensure that Wave's solutions are accepted in this emerging market. Our current primary focus is on closing business with chip OEMs, PC OEMs, enterprise customers and systems integrators. Wave has also undertaken steps to develop and establish reseller channels for our products.

Wave's business model targets revenues from various sources: licensing of our technology including EMBASSY Trust Suite client applications; tools and enabling software; and client/server-based trusted software solutions for the lifecycle management of keys and authentication of Trusted Platforms.

Wave has identified six key markets where we believe our products could provide unique benefits:

•: PCs—TCG's standards-based specifications for trusted hardware is leading a growing number of PC OEMs toward increased deployment of TPM hardware. The current focus for both TCG and Wave is on business PC platforms, but Wave plans to extend these platforms to consumer PCs over time. Wave anticipates providing enabling tools to SIs, ISVs, and IHVs in order to take advantage of the new trusted computing features of these platforms.
•: Secure Storage Devices and Data Protection Devices—Based on significant industry requirements for data protection solutions and as the TCG-based specifications are released for trusted drives, Wave anticipates expanding its range of support for new products from IHVs and platform OEMs.
•: Network Products and Mobile Devices—As TCG-based specifications are released and product deployment develops, Wave plans to extend its products to support these new trusted computing platforms and marketing to the associated OEMs, SI, ISVs, IHVs, and service providers for these devices.
•: Banking and Finance—In addition to our European initiatives to be a leader in delivering solutions that are designed to comply with European standards, we are cultivating interest and support from financial institutions for utilizing TCG-compliant platforms.
•: Government and Enterprise—Wave believes the market for electronic security systems in governmental units and large business enterprises is growing and that this market represents a key opportunity for Wave's TCG-compliant offerings.
•: Medical and Healthcare—Major government initiatives and investments associated with Health Information Technology are aimed at creating a nationwide electronic medical infrastructure, which would require high levels of security to protect unauthorized access to patient information and improved data security for storage of sensitive records. Wave believes that its security solutions may play a role as these initiatives and investments are developed.

Directly and through our partners, Wave is actively targeting opportunities in these markets as we believe our products provide a wide range of security and trust capabilities not offered in any other single solution.

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Wave's sales for the year ended December 31, 2009 consisted primarily of licensing its software applications, engineering and support services. Of the total revenue realized for the years ended December 31, 2009, 2008 and 2007, 100% was derived from Wave's EMBASSY computer security products and services. Customers from which Wave derived revenue in 2009 in excess of 10% or total revenues that would have a material adverse effect on Wave's business if Wave were to lose such customers are as follows:

Customer		Product or Service Sold		Percentage of Total Revenue for the year ended December 31, 2009

Dell		Software Licensing			81	%

Wave's business plan will continue to depend heavily on a small number of OEM customers, partners and prospective customers, the loss of, or lack of substantial future revenues from any of whom, may have a material adverse effect on our business plan going forward. In 2009, Wave worked to expand its presence as a security solutions provider marketing to small, medium and large business enterprises and will continue to actively market its products and services to these enterprises in concert with its OEM customer base. In late December 2009 Wave received a series of significant license and maintenance orders for its ERAS software from a U.S.-based automotive company. The orders were received by Wave through an OEM partner and totaled approximately $5.7 million, including approximately $1.9 million for software licenses and annual maintenance delivered and invoiced at the end of 2009. On average, the orders account for tens of thousands of new licenses per year for each of the next three years, along with maintenance orders for each of the next five years. The remaining orders are cancelable by the customer.

Segment Reporting

Information required by this item is incorporated herein by reference to "Segment Information" in Note 16 of the Notes to Consolidated Financial Statements.

Financial Information about Geographic Areas

Information required by this item is incorporated herein by reference to "Segment Information" in Note 16 of the Notes to Consolidated Financial Statements.

Competition

Wave EMBASSY Digital Security Products

We operate in the information security market, a highly competitive and fragmented environment that is characterized by rapidly evolving technology. Many of our competitors and potential competitors have substantially greater financial, technical and marketing resources than us. Also, many current and potential competitors have greater name recognition and more extensive customer bases to leverage, allowing these competitors to gain market share or product acceptance to our detriment. In addition, the rate of market acceptance of trusted computing solutions is still in the formative and early stages, despite the substantial increase in distribution of the technology. The markets for our products are developing and, while the TCG specifications have provided the basis for the industry to move forward, significant standards work efforts need to be accomplished in order for the system supporting trusted computing to move forward. Wave's potential competitors include security solutions providers such as RSA Security, Inc. (a division of EMC), Symantec, Computer Associates, Verisign, Inc., Entrust, Inc., Utimaco (acquired by Sophos), SafeNet and major systems integrators such as IBM, HP and EDS. In addition, Wave competes with other client security applications companies that are developing trusted computer applications including Softex, Phoenix, Infineon and Microsoft. The competitive factors defining these evolving markets include product features, compatibility, standards compliance, quality

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and reliability, ease of use, performance, customer service and support, distribution and price. Wave believes its products meet the requirements to be successful viable products in these markets. The features of Wave's products that should allow it to compete favorably through product differentiation include: cross-platform, interoperable solutions; easy-to-use features; and leading edge trusted client/server infrastructure solutions. In addition, Wave continues to offer digital signature products, which can be enhanced when combined with trusted computing platforms and features.

In the market for data protection products there are well established software companies which provide software-based full disk encryption products and supporting infrastructure, including PointSec (acquired by Checkpoint), Utimaco (acquired by Sophos), Credant, PGP, SafeBoot (acquired by McAfee), Secude, WinMagic, GuardianEdge and others. As the market for hardware-based full disk encryption products evolves, these companies have begun to provide support for the new trusted drives, similar to Wave's products which support these products today.

One of the market challenges facing Wave is the establishment of a newly defined market category within the overall information security market for trusted computing software and services that includes a more complex business model for adoption. While the TCG specifications define a very complex and comprehensive cryptographic system that require significant skills and resources, the market for security solutions that are as complex as those developed by Wave is in a formative stage of development. As a result, commercialization of these technologies has been slow to develop. It is also possible for other competitors to develop similar offerings to compete with our products or for new technologies to emerge that could replace existing technology that our products rely on, thereby making our products non-competitive or obsolete. We can offer no assurances that Wave's products will become industry standards or become widely accepted by the marketplace.

International Market

Most of our software products are controlled under various United States export control laws and regulations and may require export licenses for certain exports of the products and components outside of the United States and Canada. With respect to our EMBASSY Trust Suite and EMBASSY Trust Server software applications, we have applied for and received export classifications that allow us to export our products, without a license and with no restrictions, to any country throughout the world with the exception of Cuba, Iran, Iraq, Libya, North Korea, Sudan and Syria.

We believe the export classifications that we have received for our software products allow us to sell our products internationally in an effective, competitively advantageous manner. Enhancements to existing products may, and new products will, be subject to reviews by the Bureau of Export Administration to determine what export classification they will receive. Some of our partners demand that our products be allowed to be exported without restrictions and/or reporting requirements. Current export regulations have, in part, allowed us to receive the desired classification without undue cost or effort. However, the export regulations may be modified at any time. Modifications to the export regulations could prevent us from exporting our existing and future products in an unrestricted manner without a license, as we are currently allowed for the products that we've received classification, or make it more difficult to receive the desired classification. If export regulations were to be modified in such a way, we may be put at a competitive disadvantage with respect to selling our products internationally.

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Proprietary Rights and Licenses and Intellectual Property

Our success depends, in part, on our ability to enjoy or obtain protection for our products and technologies under United States and foreign patent laws, copyright laws and other intellectual property laws, to preserve our trade secrets and to operate without infringing the proprietary rights of other parties. Any issued patent owned or licensed by us may not, however, afford adequate protection to us and may be challenged, invalidated, infringed upon or circumvented. Furthermore, you should understand that our activities may infringe upon patents owned by others.

Wave has been issued twelve (12) United States patents relating to encryption and to our proprietary EMBASSY and Wave Commerce technology. We also have seven (7) patents pending before the United States Patent Office. In addition, we have two (2) foreign patents and twenty-nine (29) pending foreign patent applications. Our patents are material to protecting some of our technology.

We rely on trade secrets and proprietary know-how, which we protect, in part, by confidentiality agreements with our employees and contract partners. However, we caution you that our confidentiality agreements may be breached and we may not have adequate remedies if such a breach occurs. Furthermore, we can provide no assurance that our trade secrets will not otherwise become known or be independently discovered by competitors.

We also rely on copyright law to prevent the unauthorized duplication of our software and hardware products. We have and will continue to protect our software and our copyright interest therein through agreements with our consultants. We can provide no assurance that copyright laws will adequately protect our technology.

Research and Development

Wave's products incorporate encryption/decryption, client and server software applications and other technologies in which we have made a substantial investment in research and development. We will likely be required to continue to make substantial investments in the design of information security applications and services, including the EMBASSY Trust Suite, EMBASSY Server applications and eTMS products. For the years ended December 31, 2009, 2008 and 2007, we spent approximately $7.8 million, $11.7 million and $10.6 million, respectively, on research and development activities. Planned development expenditures for the year ended December 31, 2010 are expected to be approximately $9.8 million.

Employees

As of December 31, 2009, we employed one hundred and two (102) full-time employees, fifty-seven (57) of whom were involved in sales, marketing and administration and forty-five (45) of whom were involved in research and development. As of December 31, 2009, we retained the services of three (3) full-time consultants. We believe our employee relations are satisfactory.

Available Information

Wave makes available, free of charge on its website by means of a link to www.nasdaq.com, its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act. Reports may be viewed and obtained on the Company's website, www.wave.com, or by calling Investor Relations at (212) 835-8500.

The public may read and copy any materials the Company files with the SEC at the SEC's Public Reference Room at 100 F Street, N.E., Washington, DC 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. The SEC also

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maintains an Internet site that contains reports, proxies and information statements, and other information regarding issuers that file electronically with the SEC at http://www.sec.gov.

Item 1A. Risk Factors

Our business, financial condition and results of operation may be adversely affected by the unprecedented economic and market conditions.

The current global economic downturn could significantly and adversely affect our business, financial condition and results of operation in various ways. The decline in economic conditions has negatively impacted the demand for our products and services and our ability to conduct our business, thereby reducing our revenues and earnings. In addition, the economic downturn has negatively impacted, and/or may negatively impact, among other things:

•: our continued growth and development of our business;
•: our liquidity;
•: our ability to raise capital and obtain financing; and
•: the price of our common stock.

We have a history of net losses and expect net losses will continue. If we continue to operate at a loss, our business will not be financially viable.

We have experienced significant losses and negative cash flow from operations since our inception. We have not realized a net operating profit in any quarter since we began our operations. Wave's revenue in 2009 was less than operating expenses as our products have not yet attained widespread commercial acceptance. This is due in part to the early stage nature of the digital security industry in which we operate. As of December 31, 2009, we had an accumulated deficit of approximately $348.0 million and negative working capital of approximately $2.0 million. Given the lack of widespread adoption of the technology for our products and services, there is little basis for evaluating the financial viability of our business and our long-term prospects. You should consider our prospects in light of the risks, expenses and difficulties that companies in their early stage of development encounter, particularly companies in new and rapidly evolving markets, such as digital security and online commerce.

To achieve profitability we must, among other things:

•: Continue to convince chip, personal computer motherboard, personal computer and computer peripheral manufacturers to license and distribute our products and services and/or make them available to their customers through their sales channels;
•: Convince computer end users and enterprise computer users to purchase our upgrade software and server products for trusted computing:
•: Convince consumers to choose to order, purchase and accept products using our products and services;
•: Continue to maintain the necessary resources, especially talented software programmers;
•: Continue to develop relationships with personal computer manufacturers, computer chip manufacturers and computer systems integrators to facilitate and to maximize acceptance of our products and services; and
•: Generate substantial revenue, complete one or more commercial or strategic transactions or raise additional capital to support our operations until we can generate sufficient revenues and cash flows.

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If we do not succeed in these objectives, we will not generate revenues; hence, our business will not be sustainable.

We may be unable to raise or generate the additional financing or cash flow which will be necessary to continue as a going concern for the next twelve months.

Since we began our operations, we have incurred net losses and experienced significant negative cash flow from operations. This is due to the early stage nature of market development for our products and services and the digital security industry as a whole. Wave expects to continue to incur substantial additional expenses associated with continued research and development and business development activities that will be necessary to commercialize our technology. We may be unable to raise or generate the additional financing or cash flow which will be necessary to continue as a going concern for the next twelve months.

In addition to our efforts to generate revenue sufficient to fund our operations, or complete one or more commercial or strategic transactions, Wave may evaluate additional financing options to generate additional capital in order to continue as a going concern, to capitalize on business opportunities and market conditions and to insure the continued development of our technology, products and services. We do not know if additional financing will be available or that, if available, it will be available on favorable terms. If we issue additional shares of our stock, our stockholders' ownership will be diluted and the shares issued may have rights, preferences or privileges senior to those of our common stock. In addition, if we pursue debt financing we may be required to pay interest costs. The failure to generate sufficient cash flow to fund our forecasted expenditures would require us to reduce our cash burn rate, which would in turn impede our ability to achieve our business objectives. Even if we are successful in raising additional capital, uncertainty with respect to Wave's viability will continue until we are successful in achieving our objectives. Furthermore, although we may be successful at achieving our business objectives, a positive cash flow from operations may not ultimately be realized unless we are able to sell our products and services at a profit. Given the early stage nature of the markets for our products and services, considerable uncertainty exists as to whether or not Wave's business model is viable. If we are not successful in generating sufficient cash flow or obtaining additional funding, we may be unable to continue our operations, develop or enhance our products, take advantage of future opportunities, respond to competitive pressures or continue as a going concern.

A single customer accounts for a significant portion of our revenues and, therefore, the loss of that customer may have a material adverse effect on our results of operations.

We expect that a small number of customers will continue to account for a large portion of our revenues for the foreseeable future. We have one customer that accounted for approximately 81% of our revenue for the year ended December 31, 2009. If our relationship with any of our significant customers were disrupted, we could lose a significant portion of our anticipated revenues which may have a material adverse effect on our results of operations.

Factors that could influence our relationships with our customers include, among other things:

•: our ability to sell our products at prices that are competitive with our competitors;
•: our ability to maintain features and quality standards for our products sufficient to meet the expectations of our customers; and
•: our ability to produce and deliver a sufficient quantity of our products in a timely manner to meet our customers' requirements.

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If our OEM customers fail to purchase our components or to sell sufficient quantities of their products incorporating our components, or if our OEM customers' sales timing and volume fluctuates, it may have a material adverse effect on our results of operations.

Sales to a relatively small number of OEM customers, as opposed to direct retail sales to end customers, comprise a large portion of our revenues. For example, we have one customer that accounted for approximately 81% of our revenue for the year ended December 31, 2009. Our ability to make sales to OEM customers depends on our ability to compete on price, delivery and quality. The timing and volume of these sales depend upon the sales levels and shipping schedules for the products into which our OEM customers incorporate our products. Thus, even if we develop a successful component, our sales will not increase unless the product into which our component is incorporated is successful. If our OEM customers decide not to incorporate our products as components of their products, or fail to sell a sufficient quantity of products incorporating our components, or if the OEM customers' sales timing and volume fluctuate, it may lead to a reduction in our sales and have a material adverse effect on our results of operations.

Our market is in the early stage of development so we are unable to accurately ascertain the size and growth potential for revenue in such a market.

The market for our products and services is still developing and is continually evolving. As a result, substantial uncertainty exists with respect to the size of the market for these products and the level of capital that will be required to meet the evolving technical requirements of the marketplace.

Wave's business model relies on an assumed market of tens of millions of units shipping with built-in security hardware and for Wave to be successful selling its upgraded version of client and server software products to the users of such units. Because this market remains in the early stage of development, there is significant uncertainty with respect to the validity of the future size of the market. If the market for computer systems that utilize our products and services does not grow to the extent necessary for us to realize our business plan, we may not be successful.

As this early stage market develops and evolves, significant capital will likely be required to fund the resources needed to meet the changing technological demands of the marketplace. There is uncertainty with respect to the level of capital that may be required to meet these changing technological demands. If the amount of capital resources needed exceeds our ability to obtain such capital, we may not be a viable enterprise.

Wave is not established in the industry so we may not be accepted as a supplier or service provider to the market.

Wave's offering represents a highly complex architecture designed to solve many of the security issues currently present with computer systems, such as identity theft, fraudulent transactions, virus attacks, unauthorized access to restricted networks and other security problems that users of computer systems generally encounter. We are uncertain as to whether the marketplace will accept our solution to these security problems. We will not be successful if the market does not accept the value proposition that we perceive to be present in our products and services.

Although Wave has expended considerable resources in developing technology and products that utilize our technology and in business development activities in an attempt to drive the development of the hardware security market, we do not have a track record as a substantial supplier or service provider to consumers of computer systems. Therefore, uncertainty remains as to whether we will be accepted as a supplier to the enterprise and consumer markets, which will likely be necessary for us to be a successful commercial enterprise.

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Our products have not been accepted as industry standards, which may slow their sales growth.

We believe platforms adopting integrated hardware security into the PC will become a significant standard feature in the overall PC marketplace. However, our technologies have not been accepted as industry standards. Standards for trusted computing are still evolving. To be successful, we must obtain acceptance of our technologies as industry standards, modify our products and services to meet whatever industry standards ultimately develop, or adapt our products to be complementary to whatever these standards become. If we fail to do any of these, we will not be successful in commercializing our technology; and therefore, we will not generate sales to fund our operations and develop into a self-sustaining, profitable business.

If we do not keep up with technological changes, our product development and business growth will suffer.

Because the market in which we operate is characterized by rapidly changing technology, changes in customer requirements, frequent new products, service introductions and enhancements, and emerging industry standards, our success will depend, among other things, upon our ability to improve our products, develop and introduce new products and services that keep pace with technological developments, remain compatible with changing computer system platforms, respond to evolving customer requirements and achieve market acceptance on a timely and cost effective basis. If we do not identify, develop, manufacture, market and support new products and deploy new services effectively and timely, our business will not grow, our financial results will suffer, and we may not have the ability to remain in business.

We are subject to risks relating to potential security breaches of our software products.

Although we have implemented in our products various security mechanisms, our products and services may nevertheless be vulnerable to break-ins, piracy and similar disruptive problems caused by Internet users. Any of these disruptions would harm our business. Advances in computer capabilities, new discoveries in the field of security, or other developments may result in a compromise or breach of the technology we use to protect products and information in electronic form. Computer break-ins and other disruptions would jeopardize the security of information stored in and transmitted through the computer systems of users of our products, which may result in significant liability to us and may also deter potential customers.

A party who is able to circumvent our security measures could misappropriate proprietary electronic content or cause interruptions in our operations and those of our strategic partners. We may be required to expend significant capital and other resources to protect against security breaches or to alleviate problems caused by breaches. Our attempts to implement contracts that limit our liability to our customers, including liability arising from a failure of security features contained in our products and services, may not be enforceable. We currently do not have product liability insurance to protect against these risks.

Competition and competing technologies may render some or all of our products non-competitive or obsolete.

An increasing number of market entrants have introduced or are developing products and services that compete with Wave's. Our competitors may be able to develop products and services that are more attractive to customers than our products and services. Many of our competitors and potential competitors have substantially greater financial, technical and marketing resources than we have. Also, many current and potential competitors have greater name recognition and larger customer bases that could be leveraged to enable them to gain market share or product acceptance to our detriment. Wave's potential competitors include security solutions providers such as RSA Security, Inc. (a division

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of EMC), Symantec, Computer Associates, Verisign, Inc., Entrust, Inc., Utimaco (acquired by Sophos), SafeNet, WinMagic, Secude and GuardianEdge and major systems integrators such as IBM, HP and EDS. In addition, Wave competes with other client security applications companies that are developing trusted computing applications, including Softex Incorporated, Phoenix Technologies Ltd., Infineon Technologies AG and Microsoft.

Other companies have developed or are developing technologies that are, or may become, the basis for competitive products in the field of security and electronic content distribution. Some of those technologies may have an approach or means of processing that is entirely different from ours. Existing or new competitors may develop products that are superior to ours or that otherwise achieve greater market acceptance than ours. Due to Wave's early stage, and lower relative name recognition compared to many of our competitors and potential competitors, our competitive position in the marketplace is vulnerable.

We have a high dependence on relationships with strategic partners that must continue or our ability to successfully produce and market our products will be impaired.

Due in large part to Wave's early stage and lower name recognition, we depend upon strategic partners such as large, well established personal computer and semiconductor manufacturers and computer systems' integrators to adopt our products and services within the Trusted Computing marketplace. These companies may choose not to use our products and could develop or market products or technologies that compete directly with us. We cannot predict whether these third parties will commit the resources necessary to achieve broad-based commercial acceptance of our technology. Any delay in the use of our technology by these partners could impede or prohibit the commercial acceptance of our products. Although we have established some binding commitments from some of our strategic partners, there can be no assurance that we will be able to enter into additional definitive agreements or that the terms of such agreements will be satisfactory. It will be necessary for Wave to expand upon our current business relationships with our partners, or form new ones, in order to sell more products and services for Wave to become a viable, self-sufficient enterprise.

Product defects or development delays may limit our ability to sell our products.

We may experience delays in the development of our new products and services and the added features and functionality to our existing products and services that our customers and prospective customers are demanding. If we are unable to successfully develop products that contain the features and functionality being demanded by these customers and prospective customers in a timely manner, we may lose business to our competitors. In addition, despite testing by us and potential customers, it is possible that our products may nevertheless contain defects. Development delays or defects could have a material adverse effect on our business if such defects and delays result in our inability to meet the market's demand.

If we lose our key personnel, or fail to attract and retain additional personnel, we will be unable to continue to develop our products and technology.

We believe that our future success depends upon the continued service of our key technical and management personnel and on our ability to attract and retain highly skilled technical, management, sales and marketing personnel. Our industry is characterized by a high level of employee mobility and aggressive recruiting of skilled personnel. There can be no assurance that our current employees will continue to work for us or that we will be able to hire any additional personnel necessary for our growth. Our future success also depends on our continuing ability to identify, hire, train and retain other highly qualified technical and managerial personnel. Competition for these employees can be intense. We may not be able to attract, assimilate or retain qualified technical and managerial

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personnel in the future, and the failure of us to do so would have a material adverse effect on our business.

We have a limited ability to protect our intellectual property rights and others could infringe on or misappropriate our proprietary rights.

Our success depends, in part, on our ability to enjoy or obtain protection for our products and technologies under United States and foreign patent laws, copyright laws and other intellectual property laws and to preserve our trade secrets. We cannot assure you that any patent owned or licensed by us will provide us with adequate protection or will not be challenged, invalidated, infringed or circumvented.

We rely on trade secrets and proprietary know-how, which we protect, in part, by confidentiality agreements with our employees and contract partners. However, our confidentiality agreements may be breached, and we may not have adequate remedies for these breaches. Our trade secrets may also otherwise become known or be independently discovered by competitors. We also rely on intellectual property laws to prevent the unauthorized duplication of our software and hardware products. While we have and will continue to protect our software and our patented technology, intellectual property laws may not adequately protect our technology. We have registered trademark and service mark registrations with the United States Patent and Trademark Office for the marks WaveMeter and WaveNet, EMBASSY, Second Shift (the Wave juggler logo), WaveDirect and Charity Wave. Wave intends to apply for additional name and logo marks in the United States and foreign jurisdictions, as appropriate, but we cannot assure you that federal registration of any of these trademarks will be granted.

Regulation of international transactions may limit our ability to sell our products in foreign markets.

Enhancements to existing products may, and new products will be subject to reviews by the Bureau of Export Administration to determine what export classification they will receive. Some of our partners demand that our products be allowed to be exported without restrictions and/or reporting requirements. Current export regulations have, in part, allowed us to receive the desired classification without undue cost or effort. However, the export regulations may be modified at any time. Currently, we are allowed to export the products for which we've received classification, in an unrestricted manner without a license. However, modifications to the export regulations could prevent us from exporting our existing and future products in an unrestricted manner without a license. Such modifications could also make it more difficult to receive the desired classification. If export regulations were to be modified in such a way, we may be put at a competitive disadvantage with respect to selling our products internationally.

In addition, import and export regulations of encryption/decryption technology vary from country to country. We may be subject to different statutory or regulatory controls in different foreign jurisdictions, and as such, our technology may not be permitted in these foreign jurisdictions. Violations of foreign regulations or regulation of international transactions could prevent us from being able to sell our products in international markets. Our success depends in large part to having access to international markets. A violation of foreign regulations could limit our access to such markets and have a negative effect on our results of operations.

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Our stock price is volatile.

The price of our Class A Common Stock has been and likely will continue to be subject to wide fluctuations in response to a number of events and factors, such as:

•: quarterly variations in operating results;
•: announcements of technological innovations, new products, acquisitions, capital commitments or strategic alliances by us or our competitors;
•: the operating and stock price performance of other companies that investors may deem comparable to us; and
•: news reports relating to trends in our markets.

In addition, the stock market in general, and the market prices for technology-related companies in particular, have experienced significant price and volume fluctuations. These broad market fluctuations may adversely affect the market price of our Class A Common Stock or any of our other securities for which a market develops, regardless of our operating performance. Securities class action litigation has often been instituted against companies that have experienced periods of volatility in the market price for their securities. It is possible that we could become the target of litigation of this kind that would require substantial management attention and expense. The diversion of management's attention and capital resources could have a material adverse affect on our business. In addition, any negative publicity or perceived negative publicity of any such litigation could have an adverse impact on our business.

We may be subject to conflicts of interest that could adversely slow our corporate governance process.

Our current Board of Directors does not include any representatives of our strategic partners. However, our Board of Directors has included in the past, and may include in the future, representatives of our strategic partners. It is possible that those corporations may be competing against us, or each other, directly or indirectly. A director who also represents another company may voluntarily abstain from voting on matters where there could be conflicts of interest. Even if such a director does abstain, his presence on the Board could affect the process or the results of the Board's deliberations. We have adopted no policies or procedures to reduce or avoid such conflicts. If such conflicts of interest arise, they may have a materially adverse effect on our business.

Governmental regulation may slow our growth and decrease our profitability.

There are currently few laws or regulations that apply directly to the Internet. Because our business is dependent in significant respect on the Internet, the adoption of new local, state, national or international laws or regulations may decrease the growth of Internet usage or the acceptance of Internet commerce, which could, in turn, decrease the demand for our products and services and increase our costs or otherwise have a material adverse effect on our business.

Tax authorities in a number of states are currently reviewing the appropriate tax treatment of companies engaged in Internet commerce. New state tax regulations may subject us to additional state sales, use and income taxes.

If we make any acquisitions, we will incur a variety of costs and may never realize the anticipated benefits.

If appropriate opportunities become available, we may attempt to acquire businesses, technologies, services or products that we believe are a strategic fit with our business. If we do undertake any transaction of this sort, the process of integrating an acquired business, technology, service or product may result in operating difficulties and expenditures and may absorb significant management attention

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that would otherwise be available for ongoing development of our business. Moreover, we may never realize the anticipated benefits of any acquisition. Future acquisitions could result in potentially dilutive issuances of equity securities, the incurrence of debt, contingent liabilities and/or amortization expenses related to certain intangible assets and increased operating expenses, which could adversely affect our results of operations and financial condition.

If our common stock ceases to be listed for trading on the NASDAQ Capital Market, it may harm our stock price and make it more difficult to sell shares.

Our common stock is listed on the NASDAQ Capital Market. In order to maintain our NASDAQ listing, NASDAQ Marketplace Rule 4450(b)(4) requires that the bid price for our common stock not fall below $1.00 per share for a period of 30 consecutive trading days. Because of the volatility in our common stock price, there can be no assurance that we will be able to maintain compliance with this requirement. If our minimum bid price remains below $1.00 for 30 consecutive trading days, under the current NASDAQ Capital Market rules, we will have a period of 180 days to attain compliance by meeting the minimum bid price requirement for 10 consecutive days during the compliance period. In the event that we do not regain compliance during such 180 day period, we would be entitled to an additional 180 day compliance period if we meet the other initial listing requirements of the NASDAQ Capital Market at the end of such initial 180 day period. If our common stock ceases to be listed for trading on the NASDAQ Capital Market, we expect that our common stock would be traded on the NASD's Over-the-Counter Bulletin Board (OTC-BB). The level of trading activity of our common stock may decline if it is no longer listed on the NASDAQ Capital Market. As such, if our common stock ceases to be listed for trading on the NASDAQ Capital Market for any reason, it may harm our stock price, increase the volatility of our stock price and make it more difficult to sell your shares of our common stock.

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

Summarized below is a listing of properties leased by Wave. Our principal research and development activities are conducted at the Princeton and Cupertino facilities. We believe our office facilities are suitable and adequate for our business as it is presently conducted.

Facility		Annualized Lease Cost		Lease Expires

Lee, MA	13,473	$	144,545	Jan. 2011
Princeton, NJ	4,924		68,320	Dec. 2014
Cupertino, CA	14,573		528,953	Feb. 2013
Orvault, France	250		13,563	Feb. 2012

Item 3. Legal Proceedings

None.

Item 4. Removed and Reserved

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PART II

Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

On July 24, 2006, our Board of Directors approved a reverse stock split of our common stock at a ratio of one-for-three, causing each three outstanding shares of Class A common stock and Class B common stock to convert automatically into one share of Class A common stock or Class B common stock, respectively. The par value of Class A common stock and Class B common stock remains $0.01 per share. The reverse split became effective at the close of business on July 25, 2006. In lieu of fractional shares, stockholders received a cash payment based on an average trading price of the Class A common stock prior to the effectiveness of the reverse split. Except as otherwise noted, all references to common share and per common share amounts (including warrant shares, shares reserved for issuance and applicable exercise prices) for all periods presented have been retroactively restated to reflect this reverse split.

Market Information & Dividends

The Class A Common Stock trades on the NASDAQ Capital Market under the symbol "WAVX". The following table sets forth, for the periods indicated, the high and low sales prices per share for the Class A Common Stock. There is no established trading market for our Class B Common Stock.

	High

Year Ended December 31, 2009
First Quarter	$	.98	.38
Second Quarter		1.25	.49
Third Quarter		1.12	.80
Fourth Quarter		1.48	.82
Year Ended December 31, 2008
First Quarter	$	1.80	.97
Second Quarter		1.59	.64
Third Quarter		.94	.33
Fourth Quarter		.60	.20

As of March 8, 2010, there were approximately 18,600 holders of our Class A Common Stock. As of such date, there were 13 holders of our Class B Common Stock.

On March 15, 2010 the last sale price reported on the NASDAQ Capital Market for the Class A Common Stock was $3.37.

We have never declared, nor paid, cash dividends on our Class A Common Stock. We currently anticipate that we will retain all future earnings, if any, to fund the development and growth of our business and do not anticipate paying cash dividends on our Class A Common Stock in the foreseeable future.

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Performance Graph

The following line graph compares the Company's cumulative total return to stockholders with the cumulative total return of the NASDAQ Market Value Index and the Computer Related Services SIC Code Index from December 31, 2004 through December 31, 2009. These comparisons assume the investment of $100 on December 31, 2004 and the reinvestment of dividends. The stock performance on the graph is not necessarily indicative of future stock price performance.

Wave Systems Corp.
Comparison of Cumulative Total Return to Stockholders
December 31, 2004 through December 31, 2009

COMPARISON OF 5-YEAR CUMULATIVE TOTAL RETURN AMONG WAVE SYSTEMS CORP.,
NASDAQ MARKET INDEX AND SIC CODE INDEX

ASSUMES $100 INVESTED ON JAN. 01, 2005
ASSUMES DIVIDEND REINVESTED
FISCAL YEAR ENDING DEC. 31, 2009

Comparison of cumulative total return of one or more companies, peer groups, industry indexes, and/or broad markets

Company/Index/Market	2004		2005		2006		2007		2008		2009

Wave Systems Corporation	$	100.00	$	59.44	$	73.72	$	42.25	$	10.78	$	41.38
NASDAQ Market Index	$	100.00	$	102.20	$	112.68	$	124.57	$	74.71	$	108.56
SIC Code Index	$	100.00	$	108.45	$	145.05	$	181.42	$	118.13	$	138.65

The current composition of SIC Code 7379—Computer Related Services, NEC—is as follows:
Acxiom Corporation
Adept Technology, Inc.
Advanced Techno Grp Ltd
Agilysys, Inc.

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Allscripts-Misys Healthcare Solutions Inc
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ubroadcast, inc.

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Uni Core Holdings Corporation
Verizon Communications Inc.
Xplore Technologies Corporation
Zix Corporation


Source:		Morningstar, Inc. 22 West Washington Chicago, IL 60602 Phone: (312) 384-4055 Fax: (312) 244-8014

Securities Authorized for Issuance Under Equity Compensation Plans

The following pertains to Wave's equity compensation plans as of December 31, 2009:

Plan Category			Weighted- average exercise price of outstanding options, warrants and rights (b)

Equity compensation plans approved by security holders		9,116,319	$	4.12	5,148,454
Equity compensation plans not approved by security holders		865,356		.69	—

	Total Company plans	9,981,675	$	3.82	5,148,454
Wavexpress equity compensation plans not approved by security holders		556,263	$	1.23	1,915,960

Wave equity compensation plans approved by security holders are comprised of 3,866,273 shares of the 1994 Employee Stock Option Plan, 726,902 shares of the 1994 Non-Employee Directors Stock Option Plan and 555,279 shares of the 2004 Employee Stock Purchase Plan.

Wave equity compensation plans not approved by security holders are comprised of the following:

Pursuant to placement agency agreements that Wave entered into with Securities Research Associates ("SRA"), in connection with several sales of Class A Common Stock offerings, Wave issued warrants to purchase 845,568 shares of Class A Common Stock at prices ranging from $0.28 to $1.33 per share. No additional warrants are required to be granted pursuant to the placement agency agreements. These warrants are currently exercisable and expire February 11, 2011 through April 8, 2012.

In connection with an agreement that Wave entered into with an outside sales representative, in 2003 Wave issued warrants to purchase 14,788 shares of Class A Common Stock at prices ranging from $2.85 to $4.35 per share, pursuant to an individual compensation plan with the sales representative. No additional warrants are required to be granted pursuant to the individual compensation plan for the sales representative. These warrants are currently exercisable and expire January 1, 2013 through April 30, 2013.

In connection with an agreement that Wave entered into with an outside sales representative, in 2007 Wave issued a warrant to purchase 5,000 shares of Class A Common Stock at an exercise price of $1.99 per share, pursuant to an individual compensation plan with the sales representative. No additional warrants are required to be granted pursuant to the individual compensation plan for the sales representative. This warrant is currently exercisable and expires on August 7, 2012.

Wavexpress issued equity compensation to certain of its employees pursuant to the Wavexpress 1999 Stock Incentive Plan.

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Item 6. Selected Financial Data

The selected historical consolidated financial data presented below as of December 31, 2009 and 2008 and for the years ended December 31, 2009, 2008, and 2007 are derived from our audited Consolidated Financial Statements contained in Item 8 of this report. The historical consolidated financial data as of December 31, 2007, 2006, and 2005 and for the years ended December 31, 2006 and 2005 are derived from our audited Consolidated Financial Statements, which are not included in this report. This information should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the audited consolidated financial statements and related notes in Part IV, Item 15(a) of this Annual Report on Form 10-K.

		Consolidated Statement of Operations Data

		2009			2008			2007			2006			2005
Net Revenues		$	18,888,879		$	8,809,815		$	6,306,960		$	3,116,381		$	1,018,464

Operating expenses:
	Cost of sales		1,397,891			824,181			811,970			983,671			726,853
	Selling, general and administrative		12,992,715			16,375,372			15,222,896			12,598,389			11,560,039
	Research and development		7,825,058			11,702,776			10,557,937			8,486,368			6,937,618
	Write-off of intangible and other impaired assets		—			447,128			—			—			—

Total operating expenses			22,215,664			29,349,457			26,592,803			22,068,428			19,224,510

Operating loss			(3,326,785	)		(20,539,642	)		(20,285,843	)		(18,952,047	)		(18,206,046	)

Other income (expense):
	Gain on decrease in value of warrant liability		—			—			—			2,794			490,334
	Gain on sale of marketable securities		—			—			—			—			80,971
	Net interest and other income (expense)		(19,466	)		(9,572	)		334,292			163,980			72,279

Total other income (expense)			(19,466	)		(9,572	)		334,292			166,774			643,584

Net loss			(3,346,251	)		(20,549,214	)		(19,951,551	)		(18,785,273	)		(17,562,462	)
Accretion of non-cash beneficial conversion feature on convertible preferred stock			—			(657,000	)		—			—			—

Net loss attributable to common stockholders		$	(3,346,251	)	$	(21,206,214	)	$	(19,951,551	)	$	(18,785,273	)	$	(17,562,462	)

Weighted average number of common shares outstanding during the period			68,526,572			55,379,118			46,660,794			36,735,059			27,726,221
Loss per common share-basic and diluted		$	(0.05	)	$	(0.38	)	$	(0.43	)	$	(0.51	)	$	(0.63	)

Cash dividends declared per common share			-0-			-0-			-0-			-0-			-0-

	Consolidated Balance Sheet Data

	2009			2008			2007		2006		2005
Working capital	$	(2,046,998	)	$	(6,322,057	)	$	1,676,412	$	5,369,273	$	(1,112,413	)
Total assets		6,327,925			3,429,774			6,037,856		9,359,677		3,429,765
Long-term liabilities		183,505			245,362			—		—		2,794
Total liabilities		8,187,880			9,448,777			3,542,345		3,439,408		3,595,574
Total stockholders' equity (deficit)	$	(1,859,955	)	$	(6,019,003	)	$	2,495,511	$	5,920,269	$	(165,809	)

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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

Wave's management has focused its activities and resources on the continued development and marketing of the TCG-compliant software products known as the EMBASSY Trust Suite and EMBASSY Trust Server Applications. As the market for TPM-enabled products has developed, with computing devices full-disk encrypted drives being shipped in volume by leaders in the PC industry, Wave has developed its products to support security hardware, based on the TCG specifications, including the Opal security subsystem storage specification for developing self-encrypting drives ("SEDs"). Wave's products are unique because they are designed to support cross platform interoperability for the currently available TPM chips from Nuvoton, Broadcom, Atmel, Infineon and ST Microsystems, and have been certified and/or approved for usage on TPM-based platforms shipped by Dell, Intel, Acer, Fujitsu, Hitachi, Toshiba, Samsung, Lenovo, NEC and HP.

Wave is devoting its resources to capitalize on the opportunities, and overcome the specific challenges, presented by this developing market as it continues to pursue a strategy of educating the marketplace on the benefits that trusted computing has to offer, while continuing to develop the basic software applications designed to enable this emerging technology. The market trends and opportunities on which management focused the company's activities during the year ended December 31, 2009 included the following:

•: The need for organizations of all sizes to comply with consumer laws and state and federal legislation requiring data and identity theft protection—Wave is working with Fujitsu, Toshiba, Samsung, Hitachi and Micron Technology on developing Opal-compliant SED solutions that utilize our client (TDM) and server-based (ERAS) software applications to address this need. Dell offers SEDs from Seagate (DriveTrust^TM technology) and Samsung, which in early 2009 introduced a solid-state SED using flash memory. Both the Seagate and Samsung SEDs are currently offered by Dell bundled with Wave's client TDM software for pre-boot authentication and initialization of the drive. Enterprises also have the option of selecting Wave's ERAS application for the centralized administration and management of the drives.
•: Emergence of TPM-enabled PCs being sold into the marketplace—this emergence is complementary to Wave's business model, which largely relies upon providing services for Trusted Platforms rather than selling the hardware itself. According to Gartner, Inc., an industry analyst, worldwide PC unit shipments will grow 19.7% to 366.1 million units in 2010 and spending on all PCs is expected to increase 12.2% to $245 billion. Gartner, Inc. expects that unit growth will be robust over the next few years as enterprise replacements rise in the recovery from the global recession.
•: Increased alignment of business and security strategies—these strategies are becoming more closely aligned due to the increasing rate of significant high profile and costly security breaches and the risks associated with such breaches.
•: Lack of in-house security expertise for many enterprises—Wave plans to seek to capitalize on its expertise as awareness of TPM-enabled solutions increases.
•: Adoption of TPM software by Microsoft for certain compliance standards—in itsWindows Vista Logo Program for Systems, Microsoft has required TPM version 1.2 in its operating system hardware requirements specification for logo compliance for "Gold" level business PCs.
•: Emergence of additional trusted PC components in the marketplace—the development and sale of components such as the Seagate and Samsung SEDs represent additional opportunities for Wave's products to support and integrate these devices with the TPM elements in the PC.

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•: Issuance of specifications by the U.S. Department of Defense requiring TPM-enabled devices for data security—in 2008 the U.S. Army, in their Consolidated Buy-2 (CB2) Desktop and Notebook minimum specifications for Army customers as published by the Army Small Computer Program, requires desktop and laptop personal computers to be equipped with a TPM. In 2009 the U.S. Army listed self-encrypting drives on its consolidated buy program for orders of desktop and notebook computers.

In pursuing these opportunities, we recognize many significant challenges that must be overcome, including:

•: Tight enterprise IT budgets—overall economic conditions and industry specific data appear to indicate that, while enterprise security should be a priority, it will be challenged by tight budgets.
•: Long sales cycle due to continued lack of support for enterprise spending on security solutions—information security continues to be viewed as an IT issue rather than a business issue.
•: Need for education regarding the use of TPMs—the marketplace continues to need to be educated regarding the advantages of utilizing hardware-based trusted platforms as a security solution.
•: Limited availability of capital resources—Wave has financed the development of its business, in large part, by issuing new equity (SeeLiquidity and Capital Resources section for a detailed discussion of financing activities during 2009).
•: Competitive marketplace—our business is in a highly competitive market that includes competitors and potential competitors having substantially greater name recognition, customer bases, and financial, technical, and marketing resources than we do.
•: General economic conditions—the current economic downturn has had, and may continue to have, an adverse effect on the volume of shipments by our OEM partners of products equipped with our software and general demand for our products.

As more PC and chip OEMs have begun introducing their Trusted Platform offerings, management has focused on entering into licensing contracts pursuant to which such OEMs license our applications and distribute them as part of their offerings, paying Wave a royalty for each unit shipped. Wave currently has signed such bundling agreements with eight separate OEM partners. Revenue recognized on these contracts for the years ended December 31, 2009 and 2008 was approximately $16,487,000 and $8,284,000, respectively.

Management is also focused on developing the client and server-side applications and tools that will enable enterprises to manage an IT infrastructure that relies on products built using TCG specifications. Wave is devoting a significant portion of its research and development budget to address this opportunity, as we believe that this will be a key ingredient for enterprises in successfully implementing a Trusted Platform solution.

Management is focusing on opportunities for its eTMS product suite to provide digital signing and document management solutions to the financial services and other vertical markets in which there is an identifiable value proposition in implementing these solutions. During 2009 we entered into contracts for the eTMS product suite with enterprises from the insurance and financial services sectors. We continue to pursue additional opportunities for the eTMS product line.

Operating Expense Trends

Selling, general and administrative expenses ("SG&A") decreased from 2008 to 2009 as a result of various cost savings initiatives in the sales, marketing and business development and support activities during 2009, net of allocated non-cash, share-based compensation expenses incurred during 2009 and

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2008 in accordance with ASC 718. For the years ended December 31, 2009, 2008 and 2007, we have incurred approximately $13.0 million, $16.8 million and $15.2 million, in SG&A expenses, respectively. In accordance with ASC 718, non-cash, share-based compensation expenses allocated to SG&A for the years ended December 31, 2009, 2008 and 2007 were approximately $1.1 million, $1.3 million and $1.2 million, respectively.

The activities supported by these expenditures include business development, sales, marketing (including product management), corporate communications and public relations, information technology and management information systems, human resources, accounting, executive management, corporate governance and general administrative functions.

Given the early stage nature of the markets for products that use our technology, we have expended and plan to continue to expend considerable resources in the sales, marketing, business development and support activities referred to above that will be necessary for us to be successful in developing saleable products and markets for our technology. As a result, we expect overall sales and marketing expenditures, as well as, overall research and development expenditures to increase, as compared with 2009. (SeeLiquidity and Capital Resources)

The following discussion related to the consolidated financial statements of Wave should be read in conjunction with the financial statements appearing in Item 8.

Critical Accounting Policies

Wave's discussion and analysis of its financial condition and results of operations are based on the Company's consolidated financial statements, which have been prepared in accordance with United States generally accepted accounting principles. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported revenues and expenses during the reporting periods. On an ongoing basis, management evaluates its estimates and judgments, including those related to depreciation and amortization, revenue recognition, accounts receivable reserves, valuation of long-lived and intangible assets, software development, contingencies and share based compensation. Management bases its estimates 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 value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

The following accounting policies are deemed critical to the understanding of the consolidated financial statements included under Item 8—Financial Statements and Supplementary Data.

Revenue Recognition—Wave's business model targets revenues from various sources, including the licensing of EMBASSY Trust Suite, eTMS software products and development contracts. Some of our sales arrangements include multiple-elements, and/or require significant modification or customization of our software.

Wave recognizes revenue pursuant to generally accepted accounting principles or GAAP, in accordance with Accounting Standards Codification, or ASC, Topic 985-605,"Software Revenue Recognition", or ASC 985-605 as amended. Generally, Wave recognizes revenue when it is realized or realizable and earned. Wave considers revenue realized or realizable and earned when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectability is reasonably assured. Wave reduces revenue for estimated customer returns, rotations and sales rebates when such amounts can be estimated. When these amounts cannot be estimated Wave defers revenue until the product is sold to the end-user. Revenue from software license agreements that have significant customizations and modification of the software product is deferred and recognized in

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a manner that approximates the percentage of completion method. In addition to the aforementioned general policy, the following are the specific revenue recognition policies for each major category of revenue.

LICENSES

Revenue from delivered elements of one-time charge licensed software is recognized at the inception of the license term, provided Wave has vendor-specific objective evidence of the fair value of each undelivered element for arrangements that contain multiple elements. Revenue is deferred for undelivered elements for these arrangements. Revenue is also deferred for the entire arrangement if vendor-specific objective evidence does not exist for each undelivered contract element. Examples of undelivered elements in which the timing of delivery is uncertain include contractual elements that give customers rights to any future upgrades at no additional charge or future maintenance that is provided within the overall price. The revenue that is deferred for any contract element is recognized when all of the revenue recognition criteria have been met for that element.

Prepaid royalty fees received pursuant to distribution software licenses with OEMs in which Wave earns a royalty, based upon units shipped by the OEM to end customers, are deferred when received, and recognized as revenue as units are shipped by the OEM.

SERVICES

Revenue from time and material service contracts is recognized as the services are provided. Revenue from fixed price, long-term service or development contracts is recognized over the contract term based on the percentage of services that are provided during the period compared with the total estimated services to be provided over the entire contract. Losses on fixed price contracts are recognized during the period in which the loss first becomes apparent. Payment terms vary by contract.

Cost of sales—licensing includes foreign tax withholdings, customer support and share-based compensation expense in accordance with ASC 718. In order to enhance the comparability of its results of operations with other security software providers in the industry, Wave has reclassified cost of sales to a component of operating expenses. As a result, a gross profit analysis is not presented.

We account for share-based payment awards in accordance with the provisions of FASB ASC 718, "Compensation—Stock Compensation" (formerly SFAS No. 123 (revised 2004),Share-Based Payment), which requires us to recognize compensation expense for all share-based payment awards made to employees and directors including employee stock options and employee stock purchases related to the Employee Stock Purchase Plan ("employee stock purchases").

Stock-based compensation expense recognized is based on the value of the portion of stock-based payment awards that is ultimately expected to vest and has been reduced for estimated forfeitures. We value stock-based payment awards at grant date using the Black-Scholes option-pricing model ("Black-Scholes model"). Our determination of fair value of stock-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, our expected stock price volatility over the term of the awards and actual and projected employee stock option exercise behaviors.

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Results of Operations

Comparison of the years ended December 31, 2009 and 2008

Wave had net revenues of $18,888,879 and $8,809,815 for the years ended December 31, 2009, and 2008, respectively. The increase in revenue was due primarily to an increase in licensing revenues. Licensing revenues increased by $9,321,467 during the year as compared to 2008. This increase in licensing revenue was due to higher per-unit royalty rates earned during the year ended December 31, 2009 as compared to 2008, primarily related to an amendment of Wave's software license agreement with Dell that was executed in December 2008, and was retroactive to November 1, 2008. Pursuant to the amendment, the per-unit royalties that Wave receives for each Dell PC model shipping with Wave's EMBASSY Trust Suite software increased by at least 100% per unit. The amendment provides that this increase in per-unit royalty may be cancelled prospectively by Dell or Wave upon 30 days notice. Services revenue, consisting primarily of non-recurring government time and materials contracts, increased by $757,597 during the year, due primarily to revenue earned from a $748,640 contract awarded by the United States Department of Defense. In October 2009 Wave was awarded an additional $1,600,000 fixed-price modification to this contract. The term of the project, as modified, is expected to be approximately seventeen months. Under the contract, Wave provides consulting services in connection with a study to evaluate the implementation of trusted computing solutions for the United States government.

The table below sets forth the components that make up net revenues for the year ended December 31, 2009 and 2008:

	2009		2008		Increase

Licensing	$	18,013,043	$	8,691,576	$	9,321,467	107	%
Services		875,836		118,239		757,597	641	%

Total Net Revenues	$	18,888,879	$	8,809,815	$	10,079,064	114	%

Cost of sales—licensing, which consists primarily of foreign tax withholdings, customer support and share-based compensation expense in accordance with ASC 718, was $876,723, for the year ended December 31, 2009, compared to $736,429 for the same period in 2008. The increase in cost of sales-licensing was due to higher foreign taxes withheld during the year ended December 31, 2009 versus the prior period offset partially by lower customer support costs. The increase in net revenues noted above did not materially impact cost of sales as the increase was due primarily to higher per-unit royalty rates earned during 2009 as compared to 2008. Cost of sales—services, which consists primarily of non-recurring government time and materials costs, was $521,168, for the year ended December 31, 2009, compared to $87,752 for the same period in 2008. The change in cost of sales—services was due to an increase in non-recurring government time and materials costs in connection with a contract with the United States Department of Defense during year ended December 31, 2009 versus the prior year. In order to enhance the comparability of its results of operations with other security software providers in the industry, Wave presents cost of sales as a component of operating expenses. As a result, a gross profit analysis is not presented.

SG&A expenses for the year ended December 31, 2009, were $12,992,715, as compared to $16,375,372 for the comparable period of 2008, a decrease of approximately 21%. SG&A expenses decreased from 2008 to 2009 as a result of various cost savings initiatives in the sales, marketing and business development and support activities during 2009. In accordance with ASC 718, non-cash, share-based compensation expense allocated to SG&A was approximately $985,000 at Wave and $83,000 at Wavexpress for the year ended December 31, 2009 as compared to approximately $1,202,000 for Wave and $107,000 for Wavexpress for the year ended December 31, 2008. Other notable decreases in SG&A expenses for the year ended December 31, 2009 as compared to 2008 include (i) a decrease of approximately $1,351,000 in professional fees, primarily resulting from the suspension of Wavexpress'

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TVTonic consumer media service on December 1, 2008, (ii) a decrease of approximately $291,000 in travel expenses, (iii) a decrease of approximately $256,000 in public relations expenditures, (iv) a decrease of approximately $461,000 in telephone expenses, (v) a decrease of approximately $222,000 in rent and utility expenses and (vi) a decrease of approximately $144,000 in conference and trade show expenditures. Included in the SG&A expenses listed above are Wavexpress' selling, general and administrative expenses, which were $437,339 and $2,117,913 for the years ended December 31, 2009 and 2008, respectively. The decrease in such expenses reflects the suspension of Wavexpress' TVTonic consumer media service as of December 1, 2008.

The activities supported by SG&A expenses include business development, sales, marketing (including product development and product management), corporate communications and public relations, information technology and management information systems, human resources, accounting, executive management, corporate governance and general administrative functions. Given the early stage nature of the markets for products that use our technology, we have expended and plan to continue to expend considerable resources, in the sales, marketing, business development and support activities referred to above that will be necessary for us to be successful in developing products and markets for our technology. We expect SG&A expenses to increase in the near future reflecting our increased activities supported by SG&A expenses. Actual SG&A expenditures may vary depending upon the future business needs of Wave.

Research and development expenses for the year ended December 31, 2009, were $7,825,058, as compared to $11,702,776 for the comparable period of 2008, a decrease of 33% resulting from various cost savings initiatives in our engineering activities during 2009. This decrease was primarily attributable to decreased salaries, fringe and benefit expenditures of approximately $3,196,000, associated with headcount reductions, as compared to the year ended December 31, 2008. In addition, product development costs, consisting of language translation charges, decreased approximately $193,000 and professional fees, consisting primarily of consulting fees, decreased approximately $230,000 during the year ended December 31, 2009 versus 2008. In accordance with ASC 718, non-cash, share-based compensation expense allocated to R&D was approximately $543,000 at Wave and $64,000 at Wavexpress for the year ended December 31, 2009 as compared to approximately $661,000 for Wave and $106,000 for Wavexpress for the year ended December 31, 2008. Wavexpress' research and development expenditures included in the above were $193,683 and $1,564,698 for the years ended December 31, 2009 and 2008, respectively. The decrease of approximately 88% was due primarily to a decrease in salaries and fringe benefit expenditures reflecting the suspension of Wavexpress' TVTonic consumer media service as of December 1, 2008.

Operating expenses for the year ended December 31, 2008 include an impairment charge for the write-off of impaired assets, consisting primarily of computer equipment, of approximately $447,000 incurred as a result of the suspension of Wavexpress' TVTonic consumer media service as of December 1, 2008.

Interest income for the year ended December 31, 2009, was $1,918 as compared to $26,134 for the comparable period of 2008. The decrease in interest income is primarily attributable to lower average balances in Wave's money market accounts for the year ended December 31, 2009, compared with the same period in 2008.

Interest expense for the year ended December 31, 2009 was $21,384 as compared to $35,706 for the comparable period of 2008. Interest expense is primarily attributable to interest incurred on a capital lease obligation for equipment acquired for the expansion of the Wavexpress broadband infrastructure in 2008.

Due to the reasons set forth above, our net loss for the year ended December 31, 2009 was $3,346,251 as compared to $20,549,214 for year ended December 31, 2008.

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Comparison of the years ended December 31, 2008 and 2007

Wave had revenues of $8,809,815 and $6,306,960 for the years ended December 31, 2008 and 2007, respectively. Licensing revenues increased by $2,468,089 in 2008, due primarily to a higher volume of shipments of Wave's OEM customer products, in particular by Dell, for which Wave receives royalty income. The increase also reflected an amendment of our software license agreement with Dell pursuant to which, retroactive to November 1, 2008, the per-unit royalties that Wave receives for each Dell PC model with Wave's EMBASSY Trust Suite software increased by at least 100% per unit for development work performed by Wave. The amendment provides that this increase in per unit royalty may be cancelled prospectively by Dell or Wave upon 30 days notice. Services revenue increased by $34,766 in 2008 due to an increase in non-recurring government time-and-materials contracts.

The table below sets forth the components that comprise our revenue for the year ended December 31, 2008 and 2007:

	2008		2007		Increase

Licensing	$	8,691,576	$	6,223,487	$	2,468,089	40	%
Services		118,239		83,473		34,766	42	%

Total Net Revenues	$	8,809,815	$	6,306,960	$	2,502,855	40	%

Cost of sales, consisting primarily of customer support, share-based compensation expense in accordance with ASC 718 and the amortization of software development costs, was $824,181 for the year ended December 31, 2008, compared to $811,970 for the same period in 2007. The change in costs of sales was due to an increase in customer support costs in connection with the increased license revenue during the year ended December 31, 2008 versus the prior year offset by a decrease in the amortization of software development costs.

SG&A expenses for the year ended December 31, 2008 were $16,375,372, as compared to $15,222,896 for the comparable period in 2007. This increase of approximately 8% was due mainly to an increase in salaries and related benefits totaling approximately $331,000, associated with salary rate increases and headcount additions to accommodate additional sales, marketing, business development and support activities, which exceeded those during the year ended December 31, 2007. In accordance with ASC 718, non-cash, share-based compensation expense allocated to SG&A was approximately $1,202,000 at Wave and $107,000 at Wavexpress for the year ended December 31, 2008 as compared to approximately $1,125,000 for Wave and $105,000 for Wavexpress for the year ended December 31, 2007. In addition, telephone expenses increased approximately $462,000 over the prior year due to significantly higher bandwidth charges incurred as a result of expanding the broadband infrastructure in order to broadcast the 2008 Olympics. Also, professional fees, primarily consulting fees, increased approximately $299,000 and additional conference and trade show expenses of approximately $141,000 were incurred during the year ended December 31, 2008 versus the prior year. Included in the SG&A expenses listed above are Wavexpress' selling, general and administrative expenses, which were $2,117,913 and $1,492,373 for the years ended December 31, 2008, and 2007, respectively. This 42% increase was due primarily to an increase in telephone expenses of approximately $408,000 over the prior year for the higher bandwidth charges discussed above.

Research and development expenses for the year ended December 31, 2008 were $11,702,776, as compared to $10,557,937 for the comparable period in 2007. This increase of approximately 11% was primarily attributable to increased salaries, fringe and benefit expenditures of approximately $922,000 associated with salary rate increases and headcount additions to accommodate additional research and development efforts that were undertaken after December 31, 2007. In addition, product development expenses, primarily language translation costs, increased approximately $165,000 during 2008 as compared to 2007. For the year ended December 31, 2008, in accordance with ASC 718, non-cash, share-based compensation expense allocated to R&D was approximately $661,000 at Wave and

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$106,000 at Wavexpress as compared to approximately $634,000 for Wave and $85,000 for Wavexpress for the year ended December 31, 2007. Wavexpress' research and development expenditures included in the above figures were $1,564,698 and $1,416,832 for the years ended December 31, 2008 and 2007, respectively, for an increase of approximately 10%. The increase in Wavexpress R&D expense was due primarily to an increase in salaries and related benefits as discussed above.

Interest income for the year ended December 31, 2008 was $26,134 as compared to $334,292 for the comparable period in 2007. The decrease in interest income is primarily attributable to lower average balances in Wave's money market accounts for the year ended December 31, 2008 as compared with the same period in 2007.

Interest expense for the year ended December 31, 2008 was $35,706 as compared to $0 for the comparable period in 2007. The increase is attributable to interest incurred on the new capital lease obligation for equipment acquired for the expansion of the Wavexpress broadband infrastructure during the year ended December 31, 2008.

Due to the reasons set forth above, our net loss for the year ended December 31, 2008 was $20,549,214 as compared to $19,951,551 for year ended December 31, 2007.

Liquidity and Capital Resources

Wave has incurred substantial operating losses since its inception, and as of December 31, 2009, has an accumulated deficit of $348,036,115. We may also incur an operating loss for the fiscal year of 2010. As of December 31, 2009, we had negative working capital of $2,046,998.

Sources and Uses of Cash

At December 31, 2009, we had $1,900,014 in cash and cash equivalents versus $951,563 as of December 31, 2008, resulting in a net increase in cash of $948,451 for the year ended December 31, 2009. The table below shows the year-to-year comparison of the significant elements of cash used in or provided by operating, investing and financing activities and a reconciliation of each year's operating results reported in the statement of operations to the total increase (decrease) in cash for the years ended December 31, 2009, 2008 and 2007.

As shown below, the total net change in cash over the last three years has fluctuated significantly from a net cash decrease for the year ended December 31, 2007 of $4,251,964 to a net cash decrease for the year ended December 31, 2008 of $2,762,467 to a net cash increase for the year ended December 31, 2009 of $948,451.

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Consolidated Statement of Cash Flow Data

	For the years ended December 31,

	2009			2008			2007
Cash flows from operating activities:
Net loss	$	(3,346,251	)	$	(20,549,214	)	$	(19,951,551	)

Compensation associated with issuance of stock options		1,724,874			2,105,941			1,969,271
Depreciation and amortization		259,210			395,253			355,884
Impairment of Wavexpress property and equipment		—			447,128			—

Total adjustments to reconcile net loss to cash used in operating activities		1,984,084			2,948,322			2,325,155

Increase in prepaid expenses, receivables and other assets		(2,120,903	)		(428,457	)		(667,355	)
Increase (decrease) in deferred revenue		2,016,817			1,195,019			(115,034	)
Increase (decrease) in accounts payable and accrued expenses		(3,214,177	)		4,402,514			217,971

Changes in assets and liabilities		(3,318,263	)		5,169,076			(564,418	)

Net cash used in operating activities		(4,680,430	)		(12,431,816	)		(18,190,814	)

Cash flows from investing activities:
Acquisition of property and equipment		(88,007	)		(232,512	)		(618,672	)

Net cash used in investing activities		(88,007	)		(232,512	)		(618,672	)

Cash flows from financing activities:
Payments on capital lease obligation		(63,537	)		(26,898	)		—
Net proceeds from sale of preferred stock		—			2,688,372			—
Net proceeds from sale of common stock		5,494,780			7,011,013			14,229,331
Proceeds from employee options under stock plans		260,285			229,428			328,432
Payment in lieu of fractional shares in reverse stock split		—			(54	)		(241	)
Proceeds from the exercise of warrants		102,800			—			—
Payment of dividends on preferred stock		(77,440	)		—			—

Net cash provided by financing activities		5,716,888			9,901,861			14,557,522

Net increase (decrease) increase in cash	$	948,451		$	(2,762,467	)	$	(4,251,964	)

Supplemental cash flow information:
Non-cash financing activities:
Conversion of 8% Series K Preferred stock into Class A Common Stock	$	45,600		$	—		$	—

Conversion of Series J Preferred stock into Class A Common Stock	$	9,100		$	—		$	—

Conversion of 8% Series I Preferred stock into Class A Common Stock	$	22,000		$	—		$	—

Capital lease obligation for capital expenditures	$	—		$	335,797		$	—

Cash paid during the year for:
Interest	$	21,384		$	10,415		$	—

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Cash used in operations

The amount of cash used in operations decreased to $4,680,430 for the year ended December 31, 2009 from $12,431,816 used for the year ended December 31, 2008, which decreased from $18,190,814 used for the year ended December 31, 2007. As shown above, the fluctuations in cash used in operations were the result of the changes in the net losses in each of the three years ended December 31, 2009, as discussed in detail in the previousResults of Operations section, adjusted for non-cash items of the net losses such as non-cash share-based compensation and changes to assets and liabilities for net cash outlays and/or receipts, which, under generally accepted accounting principles, are not reported in the Statement of Operations.

Adjustments to reconcile net loss to cash used in operating activities

These amounts represent items reported in Wave's Consolidated Statement of Operations that do not represent an outlay or receipt of cash in the year that they are reported under generally accepted accounting principles. These items in the aggregate make up a significant portion of the differences between Wave's reported net loss year over year compared to the differences in the amount of cash used by Wave's operations over each of the periods. These items resulted in a net add-back to our net loss of $1,984,084 for the year ended December 31, 2009 versus $2,948,322 for the year ended December 31, 2008 and $2,325,155 for the year ended December 31, 2007. The individual items that make up these adjustments are listed in the table above and described in greater detail in theResults of Operations sections above. In addition, changes in asset and liability accounts, as shown above, represent additional sources or uses of cash in each of the three years. Accordingly, the overall net loss decreased by $17,202,963 (to $3,346,251 from $20,549,214) for the year ended December 31, 2009 versus the year ended December 31, 2008, and cash used in operating activities decreased by $7,751,385 (to $4,680,431 from $12,431,816). In comparing the year ended December 31, 2008 to 2007, the overall net loss increased by $597,663 (to $20,549,214 from $19,951,551) for the year ended December 31, 2008 versus the year ended December 31, 2007, while cash used in operating activities decreased by $5,758,998 (to $12,431,816 from $18,190,814).

Cash flows from investing activities

As displayed in the table above, cash used in investing activities consisted of funds used to acquire capital assets totaling $88,007, $232,512 and $618,672 for the years ended December 31, 2009, 2008 and 2007, respectively. Wave expects to continue to acquire fixed assets primarily to replace computer equipment to be used internally. These expenditures are expected to continue at approximately the same level as the 2009 expenditures. As a result of lower capital expenditures, net cash used for investing activities decreased by $144,505 for the year ended December 31, 2009 versus the year ended December 31, 2008 and decreased by $386,160 for the year ended December 31, 2008 versus the year ended December 31, 2007.

Cash flows from financing activities

Because Wave did not have sufficient cash on hand, nor did it generate sufficient revenues to fund the amount of cash used for operations and acquisition of capital assets for the years ended December 31, 2009, 2008 and 2007, we needed to finance much of our operations through the sale of newly issued equity securities as described below.

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Proceeds from issuance of newly issued equity securities

Sales of preferred stock

On December 24, 2008, Wave entered into subscription agreements, pursuant to which Wave sold and issued 456 shares of newly designated 8% Series K Preferred Stock, par value $.01 per share ("Series K Preferred Stock"), to certain purchasers for an aggregate purchase price of $1,276,800. These shares were priced at $2,800 per share. Each purchaser was also issued a warrant to purchase up to 2,500 shares of Class A common stock for each share of Series K Preferred Stock purchased at an exercise price of $0.28 per share. Wave entered into a placement agency agreement with Security Research Associates, Inc. ("SRA") in which they acted as placement agent in connection with this offering. Wave paid SRA a fee equal to 6.0% of the gross proceeds of this offering. Additionally, Wave issued a warrant to SRA to purchase up to 273,600 shares of Class A Common Stock at an exercise price of $0.28 per share. All of the warrants issued in connection with this offering expire in December 2011. Wave realized net proceeds of approximately $1,175,000 after deducting the placement agent fees of $76,608 and additional legal and other fees associated with the issuance of these securities which totaled approximately $25,000.

Each share of Series K Preferred Stock issued in connection with this offering was convertible into 10,000 shares of Class A Common Stock at the election of the holder thereof at any time or automatically on the date on which the average closing price per share of Wave common stock for the 15 consecutive trading day period then ended equaled or exceeded $0.70. On February 5, 2009, all of the shares issued in connection with this offering automatically converted into Class A Common Stock as the average of the closing bid prices for the fifteen-day trading period ending February 5, 2009 was $0.706, exceeding the bid price target of $0.70 per share. The shares subscribed to on December 24, 2008 were offered and issued pursuant to a shelf registration statement on Form S-3, which was filed by Wave on April 18, 2008 and declared effective by the Commission on June 23, 2008.

On October 30, 2008, Wave entered into subscription agreements, pursuant to which Wave sold and issued 111 shares of newly designated Series J Convertible Preferred Stock ("Series J Preferred Stock"), par value $.01 per share, plus warrants to purchase up to 2,220,000 shares of Class A common stock to certain purchasers for an aggregate purchase price of $721,500. Purchasers paid an amount equal to $6,500 per share of preferred stock and the corresponding warrants. This is based on a $4,000 per share liquidation value for each share of preferred stock plus an additional $0.125 for each share of common stock issuable upon exercise of the corresponding warrants. For each share of preferred stock purchased, the purchaser received a warrant to purchase 20,000 shares of common stock at an exercise price equal to $0.40. These warrants expire in October 2013. Each share of preferred stock was convertible into 10,000 shares of common stock at the election of the holder thereof at any time or automatically on the date on which the average closing price per share of Wave common stock for the 15 consecutive trading day period then ended equaled or exceeded $1.00. On June 9, 2009, all of the remaining outstanding shares issued in connection with this offering automatically converted into Class A Common Stock as the average of the closing bid prices for the fifteen-day trading period ending June 9, 2009 was $1.001, exceeding the bid price target of $1.00 per share. SRA entered into a placement agency agreement with Wave in which they acted as placement agent in connection with the offering. Wave paid SRA a fee equal to 6.0% of the gross proceeds of this offering. Wave also issued a warrant to SRA to purchase up to 66,600 shares of Class A Common Stock at an exercise price of $0.40 per share. This warrant expires in October 2011. Wave realized net proceeds of approximately $653,000 after deducting the placement agent fees of $43,290 and additional legal and other fees associated with the issuance of these securities which totaled approximately $25,000. The shares subscribed to on October 30, 2008 were offered and issued pursuant to a shelf registration statement on Form S-3, which was filed by Wave on April 18, 2008 and declared effective by the Commission on June 23, 2008.

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On September 11, 2008, Wave entered into subscription agreements, pursuant to which Wave sold and issued 172 shares of newly designated 8% Series I Preferred Stock, par value $.01 per share ("Series I Preferred Stock"), to certain purchasers for an aggregate purchase price of $756,800. These shares were priced at $4,400 per share. SRA entered into a placement agency agreement with Wave in which they acted as placement agent in connection with this offering. Wave paid SRA a fee equal to 6.0% of the gross proceeds of this offering. Additionally, Wave issued a warrant to SRA to purchase up to 103,200 shares of Class A common stock at an exercise price of $0.50 per share. This warrant expires in September 2011. Wave realized net proceeds of approximately $679,000 after deducting the placement agent fees of $45,408 and additional legal and other fees associated with the issuance of these securities which totaled approximately $33,000. On September 29, 2008, Wave entered into subscription agreements, pursuant to which Wave sold and issued 48 shares of Series I Preferred Stock, to certain purchasers for an aggregate purchase price of $211,200. These shares were priced at $4,400 per share. Wave realized net proceeds of approximately $181,000 after deducting legal and other fees associated with the issuance of these securities which totaled approximately $30,000.

Each share of Series I Preferred Stock issued in connection with these two offerings was convertible into 10,000 shares of Class A Common Stock at the election of the holder thereof at any time or automatically on the date on which the average closing price per share of Wave common stock for the 15 consecutive trading day period then ended equaled or exceeded $1.10. On November 20, 2009, all of the shares issued in connection with these offerings automatically converted into Class A Common Stock as the average of the closing bid prices for the fifteen-day trading period ending November 20, 2009 was $1.110, exceeding the bid price target of $1.10 per share. Dividends accrued at 8% per annum, payable every six months in either cash or in shares of Wave common stock (at the Company's election) at a rate equal to $0.44 per share of Wave common stock. Wave paid dividends of $77,440 in cash during 2009. The shares subscribed to on September 29, 2008 and September 11, 2008 were offered and issued pursuant to a shelf registration statement on Form S-3, which was filed by Wave on April 18, 2008 and declared effective by the Commission on June 23, 2008.

Sales of common stock

On July 21, 2009 Wave entered into subscription agreements with certain purchasers pursuant to which Wave agreed to sell and issue 1,791,738 shares of Class A Common Stock, par value $.01 per share, for an aggregate purchase price of $1,648,400. These shares were priced at $0.92 per share. Roth Capital Partners ("Roth") entered into a placement agency agreement with Wave in which Roth agreed to act as placement agent in connection with the offering. Wave agreed to pay Roth a fee equal to 8.0% of the gross proceeds of this offering. Wave also agreed to issue warrants to the subscribers to purchase up to 895,868 shares of Class A Common Stock at an exercise price of $1.155 per share. These warrants expire in January 2015. Wave realized net proceeds of approximately $1,489,000 after deducting the placement agent fees of $131,872 and additional legal and other fees associated with the issuance of these securities which totaled approximately $27,000. The shares sold on July 21, 2009 were offered and issued pursuant to a shelf registration statement on Form S-3, which was filed by Wave on April 18, 2008 and declared effective by the Commission on June 23, 2008.

On July 16, 2009, Wave entered into subscription agreements with certain purchasers pursuant to which Wave agreed to sell and issue 3,448,042 shares of Class A Common Stock, par value $.01 per share, for an aggregate purchase price of $3,172,199. These shares were priced at $0.92 per share. Roth entered into a placement agency agreement with Wave in which Roth agreed to act as placement agent in connection with the offering. Wave agreed to pay Roth a fee equal to 8.0% of the gross proceeds of this offering. Wave also agreed to issue warrants to the subscribers to purchase up to 1,724,024 shares of Class A Common Stock at an exercise price of $1.155 per share. These warrants expire in January 2015. Wave realized net proceeds of approximately $2,687,000 after deducting the placement agent fees of $253,776 and additional legal and other fees associated with the issuance of these securities which

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totaled approximately $231,000. The shares sold on July 16, 2009 were offered and issued pursuant to a shelf registration statement on Form S-3, which was filed by Wave on April 18, 2008 and declared effective by the Commission on June 23, 2008.

On April 8, 2009, Wave entered into subscription agreements with certain purchasers pursuant to which Wave agreed to sell and issue 1,881,136 shares of Class A Common Stock, par value $.01 per share, for an aggregate purchase price of $1,034,625. These shares were priced at $0.55 per share. SRA entered into a placement agency agreement with Wave in which they agreed to act as placement agent in connection with the offering. Wave agreed to pay SRA a fee equal to 6.0% of the gross proceeds of this offering. Wave also agreed to issue warrants to the subscribers to purchase up to 940,568 shares of Class A Common Stock at an exercise price of $0.55 per share. These warrants expire in April 2012. Additionally, Wave agreed to issue a warrant to SRA to purchase up to 112,868 shares of Class A Common Stock at an exercise price of $0.55 per share. This warrant expires in April 2012. Wave realized net proceeds of approximately $942,500 after deducting the placement agent fees of $62,077 and additional legal and other fees associated with the issuance of these securities which totaled approximately $30,000. The shares sold on April 8, 2009 were offered and issued pursuant to a shelf registration statement on Form S-3, which was filed by Wave on April 18, 2008 and declared effective by the Commission on June 23, 2008.

On March 13, 2009, Wave entered into subscription agreements with certain purchasers pursuant to which Wave agreed to sell and issue 785,000 shares of Class A Common Stock, par value $.01 per share, for an aggregate purchase price of $431,750. These shares were priced at $0.55 per share. SRA entered into a placement agency agreement with Wave in which they agreed to act as placement agent in connection with the offering. Wave agreed to pay SRA a fee equal to 6.0% of the gross proceeds of this offering. Wave also agreed to issue warrants to the subscribers to purchase up to 392,500 shares of Class A Common Stock at an exercise price of $0.55 per share. These warrants expire in March 2012. Additionally, Wave agreed to issue a warrant to SRA to purchase up to 47,100 shares of Class A Common Stock at an exercise price of $0.55 per share. This warrant expires in March 2012. Wave realized net proceeds of approximately $376,000 after deducting the placement agent fees of $25,905 and additional legal and other fees associated with the issuance of these securities which totaled approximately $30,000. The shares sold on March 13, 2009 were offered and issued pursuant to a shelf registration statement on Form S-3, which was filed by Wave on April 18, 2008 and declared effective by the Commission on June 23, 2008.

On August 11, 2008, Wave entered into subscription agreements pursuant to which Wave sold and issued 1,368,333 shares of Class A Common Stock, par value $.01 per share, to certain purchasers for an aggregate purchase price of $821,000. These shares were priced at $0.60 per share. SRA entered into a placement agency agreement with Wave in which they acted as placement agent in connection with the offering. Wave paid SRA a fee equal to 6.0% of the gross proceeds of this offering. Wave also issued warrants to the purchasers to purchase up to 342,083 shares of Class A Common Stock at an exercise price of $0.65 per share. These warrants expire in August 2011. Wave also issued a warrant to SRA to purchase up to 82,100 shares of Class A Common Stock at an exercise price of $0.65 per share. This warrant expires in August 2011. Wave realized net proceeds of approximately $742,000 after deducting the placement agent fees of $49,260 and additional legal and other fees associated with the issuance of these securities which totaled approximately $30,000. The shares subscribed to on August 11, 2008 were offered and issued pursuant to a shelf registration statement on Form S-3, which was filed by Wave on April 18, 2008 and declared effective by the Commission on June 23, 2008.

On June 30, 2008, Wave entered into subscription agreements pursuant to which Wave agreed to sell and issue 1,880,500 shares of Class A Common Stock, par value $.01 per share, to certain purchasers for an aggregate purchase price of $1,598,425. These shares were priced at $0.85 per share. SRA entered into a placement agency agreement with Wave in which they agreed to act as placement agent in connection with the offering. Wave agreed to pay SRA a fee equal to 6.0% of the gross

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proceeds of this offering. Wave also agreed to issue warrants to the subscribers to purchase up to 470,125 shares of Class A Common Stock at an exercise price of $0.90 per share. These warrants expire in June 2011. Additionally, Wave agreed to issue a warrant to SRA to purchase up to 112,830 shares of Class A Common Stock at an exercise price of $0.90 per share. This warrant expires in June 2011. Wave realized net proceeds, in early July, of approximately $1,467,000 after deducting the placement agent fees of $95,906 and additional legal and other fees associated with the issuance of these securities which totaled approximately $36,000. The shares subscribed to on June 30, 2008 were issued in early July and offered and issued pursuant to a shelf registration statement on Form S-3, which was filed by Wave on March 20, 2007 and declared effective by the Commission on April 27, 2007.

On May 23, 2008, Wave entered into subscription agreements pursuant to which Wave agreed to sell and issue 2,151,250 shares of Class A Common Stock, par value $.01 per share, to certain purchasers for an aggregate purchase price of $1,721,000. These shares were priced at $0.80 per share. SRA entered into a placement agency agreement with Wave in which they agreed to act as placement agent in connection with the offering. Wave agreed to pay SRA a fee equal to 6.0% of the gross proceeds of this offering. Wave also agreed to issue warrants to the subscribers to purchase up to 537,812 shares of Class A Common Stock at an exercise price of $0.85 per share. These warrants expire in May 2011. Additionally, Wave agreed to issue a warrant to SRA to purchase up to 129,075 shares of Class A Common Stock at an exercise price of $0.85 per share. This warrant expires in November 2009. Wave realized net proceeds of approximately $1,583,000 after deducting the placement agent fees of $103,260 and additional legal and other fees associated with the issuance of these securities which totaled approximately $31,000. The shares sold on May 23, 2008 were offered and issued pursuant to a shelf registration statement on Form S-3, which was filed by Wave on March 20, 2007 and declared effective by the Commission on April 27, 2007.

On February 29, 2008, Wave entered into subscription agreements pursuant to which Wave agreed to sell and issue 3,173,500 shares of Class A Common Stock, par value $.01 per share, to certain purchasers for an aggregate purchase price of $3,490,850. These shares were priced at $1.10 per share. SRA entered into a placement agency agreement with Wave in which they agreed to act as placement agent in connection with the offering. Wave agreed to pay SRA a fee equal to 6.0% of the gross proceeds of this offering. Wave also agreed to issue warrants to the subscribers to purchase up to 952,050 shares of Class A Common Stock at an exercise price of $1.15 per share. These warrants expire in February 2013. Additionally, Wave agreed to issue a warrant to SRA to purchase up to 190,410 shares of Class A Common Stock at an exercise price of $1.33 per share. This warrant expires on February 28, 2010. Wave realized net proceeds of approximately $3,220,000 after deducting the placement agent fees of $209,451 and additional legal and other fees associated with the issuance of these securities which totaled approximately $61,000. The shares sold on February 29, 2008 were offered and issued pursuant to a shelf registration statement on Form S-3, which was filed by Wave on March 20, 2007 and declared effective by the Commission on April 27, 2007.

On May 24, 2007, Wave entered into subscription agreements pursuant to which Wave agreed to sell and issue 7,317,073 shares of Class A Common Stock, par value $0.01 per share, to certain purchasers for an aggregate purchase price of $15,000,000. These shares were priced at $2.05 per share. SRA entered into a placement agency agreement with Wave in which they agreed to act as placement agent in connection with the offering. Wave agreed to pay SRA a fee equal to 5.0% of the gross proceeds of this offering. Wave also agreed to issue a warrant to SRA to purchase up to 365,853 shares of Class A Common Stock at an exercise price of $2.58 per share. The warrant expires on May 24, 2009. Wave realized net proceeds of $14,229,331 after deducting the placement agent fees of $750,000 and additional legal and other fees associated with the issuance of these securities which totaled $20,669. The shares sold on May 24, 2007 were offered and issued pursuant to a shelf registration statement, which was filed by Wave on March 20, 2007 and declared effective by the Commission on April 27, 2007.

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Exercise of warrants to purchase Class A Common Stock

On November 20, 2009, Wave received gross proceeds of $45,000 in connection with the issuance of 50,000 shares of Class A Common Stock upon the exercise of a warrant that was granted to an investor as part of Wave's June 30, 2008 financing. The warrant issued to this investor was exercised in full for 50,000 shares of Class A Common Stock at an exercise price of $0.90 per share.

On August 12, 2009, Wave received gross proceeds of $2,800 in connection with the issuance of 10,000 shares of Class A Common Stock upon the exercise of a warrant that was granted to an investor as part of Wave's December 24, 2008 financing. The warrant issued to this investor was exercised in full for 10,000 shares of Class A Common Stock at an exercise price of $0.28 per share.

On July 21, 2009, Wave received gross proceeds of $55,000 in connection with the issuance of 100,000 shares of Class A Common Stock upon the exercise of warrants that were granted to an investor as part of Wave's March 13, 2009 and April 8, 2009 financings. The warrant issued to the investor in connection with the March 13, 2009 financing was exercised in full for 87,500 shares of Class A Common Stock at an exercise price of $0.55 per share. The warrant issued to the investor in connection with the April 8, 2009 financing was exercised in full for 12,500 shares of Class A Common Stock at an exercise price of $0.55 per share.

Exercise of employee stock options

On December 1, 2009, Wave issued 152,135 shares of Class A Common Stock to Wave employees for $1.037 per share, pursuant to the Wave 2004 Employee Stock Purchase Plan. Wave received proceeds of $157,763 from the issuance of these shares.

On June 1, 2009, Wave issued 365,498 shares of Class A Common Stock to Wave employees for $0.28 per share pursuant to the Wave 2004 Employee Stock Purchase Plan. Wave received proceeds of $102,522 from the issuance of these shares.

On December 1, 2008, Wave issued 150,201 shares of Class A Common Stock to Wave and Wavexpress employees for $0.28 per share pursuant to the Wave 2004 Employee Stock Purchase Plan. Wave received proceeds of $42,131 from the issuance of these shares.

On June 1, 2008, Wave issued 209,857 shares of Class A Common Stock to Wave and Wavexpress employees for $0.89 per share pursuant to the Wave 2004 Employee Stock Purchase Plan. Wave received proceeds of $187,297 from the issuance of these shares.

During 2007, an employee exercised stock options resulting in the issuance of 3,315 shares of Class A Common Stock for proceeds of $8,055 at a price of $2.43 per share.

On December 1, 2007, Wave issued 127,420 shares of Class A Common Stock to Wave and Wavexpress employees for $1.20 per share pursuant to the Wave 2004 Employee Stock Purchase Plan. Wave received proceeds of $152,712 from the issuance of these shares.

On June 1, 2007, Wave issued 91,746 shares of Class A Common Stock to Wave and Wavexpress employees for $1.83 per share pursuant to the Wave 2004 Employee Stock Purchase Plan. Wave received proceeds of $167,665 from the issuance of these shares.

Summary analysis of historical cash flows and future outlook

It is evident from the table above that Wave's use of cash to fund operations has fluctuated significantly over the three-year period presented. The detailed discussion of this trend is presented in the analysis of the results of operations above. In addition, Wave needed to raise a significant amount of additional funds primarily from issuing new shares of preferred and common stock as detailed in the above discussion of cash flows from financing activities.

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Liquidity requirements and future sources of capital

Wave estimates that its total expenditures to fund operations for the year ending December 31, 2010 will be approximately $23,000,000, including research and development, acquisition of capital assets, sales and marketing, general corporate expenses and overhead.

Sources of capital may include the following:

•: cash on hand of $1,900,014 as of December 31, 2009
•: cash generated from sales and licensing of products
•: additional financings

Given Wave's capital requirements for the year ending December 31, 2010 as indicated above, our cash balance as of December 31, 2009, and the uncertainty as to whether we will generate sufficient revenue, Wave may be required to raise additional capital to continue to fund its operations. We may obtain additional funding as needed from further sales of newly issued shares of Class A Common Stock, including the sale of Class A Common Stock under the remaining availability of our $25,000,000 shelf registration statement that we filed on April 18, 2008 and was declared effective by the Commission on June 23, 2008. Approximately $9,500,000 in gross proceeds is available under the April 18, 2008 shelf registration statement, which may be utilized for future financings. We can provide no assurances as to whether, if necessary, we will be successful in raising the capital that may be needed to continue as a going concern.

Revenue outlook

Wave receives revenue from licensing its EMBASSY Trust Suite software through distribution arrangements with OEM partners as described below. In addition, Wave received revenues from software development and other services. Total cash received from all revenue sources in 2009 was approximately $18,513,000 versus approximately $9,410,000 for 2008. This increase in total cash received was due to higher per-unit royalty rates earned in 2009 as compared to 2008, primarily related to an amendment of Wave's software license agreement with Dell that was executed in December 2008, and was retroactive to November 1, 2008. The amendment provides that this increase in per-unit royalty may be cancelled prospectively by Dell or Wave upon 30 days notice.

On October 23, 2009, Wave executed a $1,600,000 modification to a previously awarded contract by the United States Department of Defense. Under the terms of the modification, Wave will continue to provide consulting services in connection with a study to evaluate the implementation of trusted computing solutions for the government. The term of the project is expected to be approximately seventeen months. Also, on November 13, 2009, Wave and Hewlett-Packard Company ("HP") entered into a reseller agreement that permits HP to distribute and sell Wave's software products through HP channels. Initial sales under this agreement began in early 2010.

In mid-October 2008, Wave completed a license agreement with Acer, Wave's eighth OEM partner and the world's second-largest PC vendor, to bundle Wave EMBASSY® software with Acer's Veriton™ 670 business PCs. Wave is paid a per unit royalty fee for each Acer shipment which includes Wave's software. Shipments in Europe and Asia began during the fourth quarter of 2008 and U.S. shipments began in early 2009.

Wave also continues to work with all of its partners and customers to introduce and promote its existing software products and new software products which are under development, in an effort to expand the market for TPM-based secure computing and thereby increase its market share and revenues. However, it should be noted that because of the early stage of Wave's market and other factors, a high level of uncertainty exists with respect to the ability to forecast future revenues. Although there has been a substantial increase in the volume of shipments of TPM-equipped PCs and

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self-encrypting drives, which our business model depends upon, this remains a new and developing category within the computer security market, and the ultimate size of this market and the timeframe for its development are unknown and difficult to predict.

Wave's OEM distribution agreements began to generate royalty revenue in the second quarter of 2006. The aggregate amount of royalty revenue from these arrangements was a significant contributor to Wave's revenue growth to date. Revenue from these contracts in future years may also be material. We expect to continue to generate cash flow from these agreements as long as the agreements remain in effect and our software continues to ship with these products. In December 2008, Wave completed an amendment to its software license agreement with its largest OEM customer, Dell Products LP. Under the new arrangement, the per-unit royalties that Wave receives for each OEM PC model shipping with Wave's EMBASSY Trust Suite software were increased by at least 100% per unit, retroactive to November 1, 2008. This increase in per unit royalty may be cancelled prospectively by Dell or Wave upon 30 days notice.

The OEM distribution agreements referred to above have given rise to separate software upgrade contracts with the end users of the products distributed by the OEMs. The contracts, referred to by us as license upgrade agreements, include a software license and a maintenance agreement. The contracts are separately negotiated with end users and are not associated with our OEM distribution agreements. Sales from the license upgrade agreements began in the latter part of the third quarter of fiscal year 2007. The sales consist of licensed use of Wave's EMBASSY Trust Suite of products, primarily Wave's EMBASSY Security Center paired with our ERAS server product. In late December 2009, Wave invoiced and delivered a $1.9 million order for software licenses and annual maintenance received through an OEM partner. This order is part of a larger $5.7 million group of orders received through the OEM partner on behalf of its customer, a U.S.-based global automaker. On average, the orders account for tens of thousands of new software licenses per year for each of the next three years, along with maintenance orders for each of the next five years. However, the remaining orders are cancelable by the customer. Given that Wave is in the early stages of its software upgrade and maintenance business and consistent with the Company's revenue recognition policies, Wave has not yet established vendor-specific objective evidence of the fair value of each undelivered element for its software and services. Accordingly, Wave's upgrade sales are being recorded as deferred revenue and then recognized generally over a 365-day period. Deferred revenue increased $2,016,817 (to $3,500,861 from $1,484,044) at December 31, 2009 versus 2008 and increased $1,195,019 (to $1,484,044 from $289,025) at December 31, 2008 versus 2007. Wave recognized approximately $1,332,000 and $311,000 of license upgrade revenue during 2009 and 2008, respectively. Wave recorded modest initial revenues from the sale of license upgrade packages during 2007.

Known trends and uncertainties affecting future cash flows

Because Wave may not have sufficient cash to fund operations for the year ending December 31, 2010, and there is uncertainty as to whether Wave will generate sufficient revenues to fund its operations over this time period, Wave has been, and may continue to be, actively engaged in financing activities in order to generate additional funding to cover its operating costs for the year ending December 31, 2010.

We may be required to sell additional shares of common stock or preferred stock, obtain debt financing or engage in a combination of these financing alternatives, to raise additional capital to continue to fund our operations for the year ending December 31, 2010. The availability and amount of any such financings are unknown at this time. Wave may also be required to reduce expenses, which may significantly impede its ability to meet its sales, marketing and development objectives. Based upon the available cash currently on hand, if we meet our current revenue and expenditure forecast for the year ending December 31, 2010 (both of which are uncertain), we would have enough liquid assets to continue operating through December 31, 2010. The foregoing is based on maintaining current revenue

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levels for both Dell and non-Dell revenues for the year ending December 31, 2010. Dell revenue increased during 2009 primarily as a result of an amendment signed in December 2008 where the per-unit royalties that Wave receives for each Dell PC model with Wave's EMBASSY Trust Suite software were increased by at least 100% per unit, retroactive to November 1, 2008. The increase in per unit royalty may be cancelled prospectively by Dell or Wave upon 30 days notice. While the foregoing assumes current shipment volumes at the increased per-unit royalty rate throughout 2010 our contract with Dell contains no guaranteed minimum royalties or minimum shipment volume requirements.

Other uncertainties that may impact the future business outlook

Because the information security services market and the TCG hardware security category in particular are in early stages of development, customer requirements may change or new competitive pressures can emerge which could require a shift in product development and/or market strategy. Should such shifts occur, they may require development, marketing and sales strategies to re-start or expand, which would likely increase operating costs and require additional capital. Such shifts have occurred several times throughout Wave's history, requiring significant changes in strategy and business plan.

Furthermore, the achievement of sufficient revenue is dependent upon continued significant expenditures, which will likely be required for research and development and sales and marketing to increase market awareness for our products. Therefore, if Wave is not able to begin to generate significant revenues by December 31, 2010 to cover its operating costs, it will need to generate capital from other sources, including raising funds through the issuance of additional common stock, preferred stock and/or debt to fund its operations beyond December 31, 2010.

The challenges presented by the current economic downturn may have a negative impact on the volume of shipments by our OEM partners of products equipped with our software and general demand for our products.

Commitments

Wave has a capitalized lease obligation for computer equipment due July 2013 of $245,362 and $308,899 as of December 31, 2009 and 2008, respectively. The interest rate is 7.7% per annum. This lease obligation is collateralized by the related assets with a net book value of $-0- as of December 31, 2009 reflecting an impairment charge recorded during 2008 due to the suspension of Wavexpress' TVTonic consumer media services as of December 1, 2008.

Wave has no significant long-term contractual obligations other than with respect to the capitalized lease obligation described above and operating leases for its facilities, which are all listed below:

		Within one year		Years two and three		Years four and five		Thereafter		Total

Capital lease commitment		$	61,857	$	138,846	$	44,659	$	—	$	245,362
Operating lease commitments			755,381		1,273,094		289,162		—		2,317,637

	Total commitments	$	817,238	$	1,411,940	$	333,821	$	—	$	2,562,999

Net operating loss carryforwards

As of December 31, 2009, Wave had available net operating and capital loss carryforwards for Federal income tax purposes of approximately $286.3 million, which expire beginning in 2010 through 2029. Because of the "change in ownership" provisions of the Tax Reform Act of 1986, our net operating and capital loss carryforwards may be subject to an annual limitation on the utilization of

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these carryforwards against taxable income in future periods if a cumulative change in ownership of more than 50 percent of Wave occurs within any three-year period. We have made no determination concerning whether there have been such cumulative changes in ownership or the impact on the utilization of the loss carryforwards if such changes have occurred. However, in considering Section 382 of the Internal Revenue Code, we believe that it is likely that such a change in ownership occurred prior to or following the completion of our initial public offering in September 1994 and, potentially, in periods following. As a result, all of the utilization of our net operating losses is likely to be subject to annual limitations.

Going Concern Opinion

Wave's consolidated financial statements as of December 31, 2009 have been prepared under the assumption that we will continue as a going concern. Wave's independent registered public accounting firm has issued a report dated March 16, 2010, that includes an explanatory paragraph referring to our significant operating losses and substantial doubt about our ability to continue as a going concern. (See Note 2 to Wave's consolidated financial statements.)

Recent Accounting Pronouncements

In September 2009, the FASB reached a consensus on Accounting Standards Update, or ASU 2009-13, Revenue Recognition (Topic 605)—Multiple-Deliverable Revenue Arrangements, or ASU 2009-13 and ASU 2009-14, Software (Topic 985)—Certain Revenue Arrangements That Include Software Elements, or ASU 2009-14. ASU 2009-13 modifies the requirements that must be met for an entity to recognize revenue from the sale of a delivered item that is part of a multiple-element arrangement when other items have not yet been delivered. ASU 2009-13 eliminates the requirement that all undelivered elements must have either: i) VSOE or ii) third-party evidence, or TPE, before an entity can recognize the portion of an overall arrangement consideration that is attributable to items that already have been delivered. In the absence of VSOE or TPE of the standalone selling price for one or more delivered or undelivered elements in a multiple-element arrangement, entities will be required to estimate the selling prices of those elements. Overall arrangement consideration will be allocated to each element (both delivered and undelivered items) based on their relative selling prices, regardless of whether those selling prices are evidenced by VSOE or TPE or are based on the entity's estimated selling price. The residual method of allocating arrangement consideration has been eliminated. ASU 2009-14 modifies the software revenue recognition guidance to exclude from its scope tangible products that contain both software and non-software components that function together to deliver a product's essential functionality. These new updates are effective for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Early adoption is permitted. We are currently evaluating the impact that the adoption of these ASUs will have on our consolidated financial statements.

In May 2009, the FASB issued FASB ASC 855, Subsequent Events ("ASC 855") (formerly referenced as SFAS No. 165, Subsequent Events), which provides guidance to establish general standards of accounting for and disclosures of events that occur after the balance sheet date but before financial statements are issued. ASC 855 is effective for interim and annual periods ending after June 15, 2009. The adoption of ASC 855 did not have an impact on our financial position or results of operations. We evaluated all events or transactions that occurred after December 31, 2009 up through March 16, 2010, the date our financials were issued. During this period, we did not have any material recognizable subsequent events.

In April 2009, the FASB issued ASC 825-10-65, Interim Disclosures about Fair Value of Financial Instruments (formerly referenced as FSP FAS 107-1 and APB Opinion No. 28-1), which requires disclosures about fair value of financial instruments for interim reporting periods as well as in annual financial statements. This ASC, which became effective for the Company on July 1, 2009, did not

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impact the consolidated financial results of the Company as the requirements are disclosure-only in nature.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

The exposure to market risk associated with interest rate-sensitive instruments is not material. Wave's cash and cash equivalents consist primarily of money market funds that meet high credit quality standards and the amount of credit exposure to any one issue is limited.

Item 8. Financial Statements and Supplementary Data

The consolidated financial statements, the notes thereto, and the independent auditors' report thereon are presented beginning at page F-1 of this Form 10-K and are hereby incorporated by reference into this Item 8. The quarterly financial information required by this Item 8 is included in the Notes to Consolidated Financial Statements.

Item 9. Changes in and Disagreements with Accountant on Accounting and Financial Disclosure

None.

Item 9A. Controls and Procedures

Evaluation of disclosure controls and procedures

As of the end of the period covered by this Annual Report on Form 10-K, an evaluation was carried out under the supervision and with the participation of Wave's management, including our Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"), of the effectiveness of Wave's disclosure and control procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Based on that evaluation, our CEO and CFO concluded that Wave's disclosure controls and procedures were effective as of December 31, 2009 to provide reasonable assurance that the information required to be disclosed by Wave in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC's rules and forms and that such information is accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.

Management's annual report on internal control over financial reporting

Wave's management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) promulgated under the Exchange Act. Wave's internal control system was designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.

Wave's management assessed the effectiveness of our internal control over financial reporting as of December 31, 2009 based on the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in "Internal Control Integrated Framework". Based on this assessment, Wave's management concluded that, as of December 31, 2009, our internal control over financial reporting is effective based on those criteria.

The independent registered public accounting firm that audited the Company's consolidated financial statements included in Item 8 of this Annual Report on Form 10-K has issued an opinion on the effectiveness of the Company's internal control over financial reporting.

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Changes in internal controls

There have been no changes in Wave's internal control over financial reporting that occurred during Wave's fourth fiscal quarter that have materially affected, or are reasonably likely to affect, Wave's internal control over financial reporting.

Item 9B. Other Information

Not Applicable.

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PART III

Item 10. Directors, Executive Officers and Corporate Governance of the Registrant

Information concerning Wave's directors, executive officers, promoters and control persons will appear in Wave's Proxy Statement for the 2010 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2010, under the caption "Election of Directors." Such information is incorporated herein by reference.

Information concerning compliance with Section 16(a) of the Securities Exchange Act will appear in Wave's Proxy Statement for the 2010 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2010, under the caption "Compliance with Section 16(a) of the Exchange Act." Such information is incorporated herein by reference.

Information concerning Wave's Audit Committee will appear in Wave's Proxy Statement for the 2010 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2010, under the caption "The Board of Directors and its Committees." Such information is incorporated herein by reference.

Wave's Board of Directors has adopted a code of ethics that applies to its Chief Executive Officer and Chief Financial Officer (the "Code of Ethics"). The Code of Ethics has been posted on Wave's Internet website at www.wave.com. Wave intends to satisfy the disclosure requirements under Item 10 of Form 8-K regarding an amendment to, or waiver from, a provision of the Code of Ethics that relates to a substantive amendment or material departure from a provision of the Code of Ethics by posting such information on its internet website at www.wave.com.

Item 11. Executive Compensation

Information regarding executive compensation will appear in Wave's Proxy Statement for the 2010 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2010, under the caption "Executive Compensation." Such information is incorporated herein by reference.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

Information regarding security ownership of certain beneficial owners and management and related stockholder matters will appear in Wave's Proxy Statement for the 2010 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2010, under the caption "Security Ownership of Certain Beneficial Owners and Management." Such information is incorporated herein by reference.

Item 13. Certain Relationships and Related Transactions and Director Independence

Information regarding certain relationships and related transactions and director independence will appear in Wave's Proxy Statement for the 2010 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2010, under the caption "Certain Relationships and Related Transactions." Such information is incorporated herein by reference.

Item 14. Principal Accounting Fees and Services

Information regarding Wave's principal accountant's fees will appear in Wave's Proxy Statement for the 2010 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2010, under the caption "Certain Relationships and Related Transactions." Such information is incorporated herein by reference.

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PART IV

Item 15. Exhibits and Financial Statement Schedules

(a)(1) Financial Statements:

		Page(s)

Report of Independent Registered Public Accounting Firm			F-1
Consolidated Balance Sheets as of December 31, 2009 and 2008			F-3
Consolidated Statements of Operations for each of the years ended December 31, 2009, 2008 and 2007			F-4
Consolidated Statements of Stockholders' Equity (Deficiency) and Comprehensive Income (Loss) for each of the years ended December 31, 2009, 2008 and 2007			F-5
Consolidated Statements of Cash Flows for each of the years ended December 31, 2009, 2008 and 2007			F-8
Notes to Consolidated Financial Statements			F-9

(a)(2) Financial Statement Schedules:

All schedules have been omitted since they are either not required or not applicable.

(a)(3) Exhibits:

			Description of Exhibit

3.1	*	—	Restated Certificate of Incorporation of Wave, as amended (incorporated by reference to Exhibit 3.1 of Wave's Quarterly Report on Form 10-Q, filed on August 9, 2006, File No. 0-24752)
3.2	*	—	Bylaws of Wave (incorporated by reference to Exhibit 3.2 of Wave's Registration Statement on Form S-1, File No. 33-75286)
4.1	*	—	Form of Stock Certificate of Class A Common Stock (incorporated by reference to Exhibit 4.1 of Wave's Registration Statement on Form S-1, File No. 33-75286)
4.2	*	—	Form of Representative's Warrant Agreement, including the form of Representative's Warrant (incorporated by reference to Exhibit 4.2 of Wave's Registration Statement on Form S-1, File No. 33-75286).
4.3	*	—	Certificate of Designation of Series B Preferred Stock of Wave as filed with the Delaware Secretary of State on May 24, 1996 (incorporated by reference to Exhibit 3.1 of Wave's Current Report on Form 8-K, filed on June 6, 1996, File No. 0-24752)
4.4	*	—	Certificate of Designation of Series C Convertible Preferred Stock as filed with the Delaware Secretary of State on December 27, 1996 (incorporated by reference to Exhibit 3.1 of Wave's Current Report on Form 8-K, filed on January 8, 1997, File No. 0-24752)
4.5	*	—	Certificate of Designation of Series D Convertible Preferred Stock as filed with the Delaware Secretary of State on December 27, 1996 (incorporated by reference to Exhibit 3.1 of Wave's Current Report on Form 8-K, filed on June 3, 1997, File No. 0-24752)
4.6	*	—	Certificate of Designation of Series F Convertible Preferred Stock of Wave as filed with the Delaware Secretary of State on October 9, 1997 (incorporated by reference to Exhibit 3.1 of Wave's Current Report on Form 8-K, filed on October 15, 1997, File No. 0-24752)

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			Description of Exhibit

4.7	*	—	Certificate of Designation of Series G Convertible Preferred Stock of Wave as filed with the Delaware Secretary of State on March 5, 1998 (incorporated by reference to Exhibit 3.1 of Wave's Current Report on Form 8-K, filed on March 19, 1998, File No. 0-24752)
4.8	*	—	Certificate of Designation of Series H Convertible Preferred Stock of Wave as filed with the Delaware Secretary of State on April 30, 2003 (incorporated by reference to Exhibit 4.1 of Wave's Current Report on Form 8-K, filed on May 5, 2003, File No. 0-24752)
4.9	*	—	Form of Warrant issued to Purchasers (incorporated by reference to Exhibit 4.1 of Wave's Current Report on Form 8-K, filed March 3, 2008, File # 0-24752)
4.10	*	—	Form of Warrant issued to Private Placement Agent (incorporated by reference to Exhibit 4.2 of Wave's Current Report on Form 8-K, filed March 3, 2008, File # 0-24752)
4.11	*	—	Form of Warrant issued to Purchasers (incorporated by reference to Exhibit 4.1 of Wave's Current Report on Form 8-K, filed May 27, 2008, File # 0-24752)
4.12	*	—	Form of Warrant issued to Private Placement Agent (incorporated by reference to Exhibit 4.2 of Wave's Current Report on Form 8-K, filed May 27, 2008, File # 0-24752)
4.13	*	—	Form of Warrant issued to Purchasers (incorporated by reference to Exhibit 4.1 of Wave's Current Report on Form 8-K, filed July 1, 2008, File # 0-24752)
4.14	*	—	Form of Warrant issued to Private Placement Agent (incorporated by reference to Exhibit 4.2 of Wave's Current Report on Form 8-K, filed July 1, 2008, File # 0-24752)
4.15	*	—	Form of Warrant issued to Purchasers (incorporated by reference to Exhibit 4.1 of Wave's Current Report on Form 8-K, filed August 12, 2008, File # 0-24752)
4.16	*	—	Form of Warrant issued to Private Placement Agent (incorporated by reference to Exhibit 4.2 of Wave's Current Report on Form 8-K, filed August 12, 2008, File # 0-24752)
4.17	*	—	Certificate of Designations of Series I Convertible Preferred Stock of Wave as filed with the Delaware Secretary of State on September 12, 2008 (incorporated by reference to Exhibit 3.1 of Wave's Current Report on Form 8-K, filed on September 15, 2008, File No. 0-24752)
4.18	*	—	Form of Warrant issued to Private Placement Agent (incorporated by reference to Exhibit 4.1 of Wave's Current Report on Form 8-K, filed September 15, 2008, File # 0-24752)
4.19	*	—	Certificate of Designations of Series J Convertible Preferred Stock of Wave as filed with the Delaware Secretary of State on October 30, 2008 (incorporated by reference to Exhibit 3.1 of Wave's Current Report on Form 8-K, filed on October 31, 2008, File No. 0-24752)
4.20	*	—	Form of Warrant issued to Purchasers (incorporated by reference to Exhibit 4.1 of Wave's Current Report on Form 8-K, filed October 31, 2008, File # 0-24752)
4.21	*	—	Form of Warrant issued to Private Placement Agent (incorporated by reference to Exhibit 4.2 of Wave's Current Report on Form 8-K, filed October 31, 2008, File # 0-24752)

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			Description of Exhibit

4.22	*	—	Certificate of Designations of Series K Convertible Preferred Stock of Wave as filed with the Delaware Secretary of State on December 29, 2008 (incorporated by reference to Exhibit 3.1 of Wave's Current Report on Form 8-K, filed on December 29, 2008, File No. 0-24752)
4.23	*	—	Form of Warrant issued to Purchasers (incorporated by reference to Exhibit 4.1 of Wave's Current Report on Form 8-K, filed December 29, 2008, File # 0-24752)
4.24	*	—	Form of Warrant issued to Private Placement Agent (incorporated by reference to Exhibit 4.2 of Wave's Current Report on Form 8-K, filed December 29, 2008, File # 0-24752)
4.25	*	—	Form of Warrant issued to Purchasers (incorporated by reference to Exhibit 4.1 of Wave's Current Report on Form 8-K, filed March 16, 2009, File # 0-24752).
4.26	*	—	Form of Warrant issued to Private Placement Agent (incorporated by reference to Exhibit 4.2 of Wave's Current Report on Form 8-K, filed March 16, 2009, File # 0-24752).
4.27	*	—	Form of Warrant issued to Purchasers (incorporated by reference to Exhibit 4.1 of Wave's Current Report on Form 8-K, filed April 9, 2009, File # 0-24752).
4.28	*	—	Form of Warrant issued to Private Placement Agent (incorporated by reference to Exhibit 4.2 of Wave's Current Report on Form 8-K, filed April 9, 2009, File # 0-24752).
4.29	*	—	Form of Warrant issued to Purchasers (incorporated by reference to Exhibit 4.1 of Wave's Current Report on Form 8-K, filed July 17, 2009, File # 0-24752).
4.30	*	—	Form of Warrant issued to Purchasers (incorporated by reference to Exhibit 4.1 of Wave's Current Report on Form 8-K, filed July 22, 2009, File # 0-24752).
†10.1	*	—	Wave Systems Corp. 2004 Employee Stock Purchase Plan (incorporated by reference to Exhibit 4.1 of Wave's Form S-8 Registration Statement, filed on May 24,2005)
10.2	*	—	Form of Subscription Agreement dated as of October 30, 2006 among Purchasers and Wave (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed on October 31, 2006, File # 0-24752)
10.3	*	—	Form of Subscription Agreement dated as of August 4, 2006 among Purchasers and Wave (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed on August 8, 2006, File # 0-24752)
10.4	*	—	Form of Subscription Agreement dated as of May 3, 2006 among Purchasers and Wave (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed on May 8, 2006, File # 0-24752)
10.5	*	—	Reserved
10.6	*	—	Securities Purchase Agreement dated as of December 5, 2005 among Purchasers and Wave (includes form of warrant) (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed on December 7, 2005, File # 0-24752)
10.7	*	—	Securities Purchase Agreement dated as of August 5, 2005 among Purchasers and Wave (includes form of warrant) (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed on August 8, 2005, File # 0-24752)

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			Description of Exhibit

10.8	*	—	Securities Purchase Agreement dated as of March 15, 2005 among Purchasers and Wave (includes form of warrant) (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed on March 17, 2005, File # 0-24752)
†10.9	*	—	Wave's Amended and Restated 1994 Stock Option Plan (incorporated by reference to Exhibit 1 of Wave's Proxy Statement (DEF 14A) filed on April 30, 2009)
†10.10	*	—	Wave Non-Employee Directors Stock Option Plan (incorporated by reference to Wave's Notice of Annual Meeting of Stockholders on Schedule 14A filed on April 18, 2007, as amended by Schedule 14A filed on May 7, 2007)
†10.11	*	—	Wave 1996 Performance Stock Option Plan (incorporated by reference to Exhibit 10.12 of Wave's Annual Report on Form 10-K, filed on April 1, 2002, File #0-24752)
†10.12	*	—	Employment Contract, dated June 8, 1998, between Gerard T. Feeney and Wave (incorporated by reference to Exhibit 10.18 of Wave's Annual Report on Form 10-K, filed on April 1, 1999, File No. 0-24752).
†10.13	*	—	Employment Contract, dated November 10, 1998, between Steven Sprague and Wave (incorporated by reference to Exhibit 10.19 of Wave's Annual Report on Form 10-K, filed on April 1, 1999, File No. 0-24752).
10.14	*	—	Asset Purchase Agreement dated August 13, 2000, by and among Wave and Indigo Networks, LLC (incorporated by reference to Exhibit 99.1 of Wave's Current Report on Form 8-K, filed on September 15, 2000, File #0-24752)
10.15	*	—	Office Building Lease dated October 20, 2002 between Stevens Creek Investors, LLC and Wave (incorporated by reference to Exhibit 10.13 of Wave's Annual Report on Form 10-K, filed on March 31, 2003, File #0-24752)
10.16	*	—	Form of Asset Purchase Agreement dated October 4, 2001, by and between Wave and SignOnLine (incorporated by reference to Exhibit 10.15 of Wave's Annual Report on Form 10-K, filed on April 1, 2002, File #0-24752)
10.17	*	—	First Amendment to Asset Purchase Agreement dated October 4, 2001, by and between Wave and SignOnLine (incorporated by reference to Exhibit 10.16 of Wave's Annual Report on Form 10-K, filed on April 1, 2002, File #0-24752)
10.18	*	—	Termination Agreement and Mutual Release between Wave Systems Corp. and SSP Solutions, Inc. date September 30, 2002 (Incorporated herein by referenced to Exhibit 10.1 of Wave's Quarterly Report on Form 10-Q for the quarter ended September 30, 2002, filed on November 14, 2002, File #0-24752)
10.19	*	—	Subordinated Convertible Promissory Note between Wave Systems Corp. and SSP Solutions, Inc. dated September 30, 2002 (Incorporated herein by referenced to Exhibit 10.2 of Wave's Quarterly Report on Form 10-Q for the quarter ended September 30, 2002, filed on November 14, 2002, File #0-24752)
10.20	*	—	Share Purchase Agreement between Redwave plc, GlobalWave Group plc and Wave Systems Corp. dated June 19, 2002 (Incorporated herein by referenced to Exhibit 10.3 of Wave's Quarterly Report on Form 10-Q/A for the quarter ended September 30, 2002, filed on March 19, 2003, File #0-24752)

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			Description of Exhibit

10.21	*	—	GlobalWave Group plc Notice of Extraordinary General Meeting dated June 20, 2002 (Incorporated herein by referenced to Exhibit 10.4 of Wave's Quarterly Report on Form 10-Q/A for the quarter ended September 30, 2002, filed on March 19, 2003, File #0-24752)
10.22	*	—	Joint Venture Agreement dated October 15, 1999 between Wave, Wavexpress and Sarnoff. (incorporated by reference to Exhibit 10.20 of Wave's Annual Report on Form 10-K/A, filed on June 27, 2003, File #0-24752)
10.23	*	—	Stockholder Agreement dated October 15, 1999 between Wave, Wavexpress and Sarnoff. (incorporated by reference to Exhibit 10.21 of Wave's Annual Report on Form 10-K/A, filed on June 27, 2003, File #0-24752)
10.24	*	—	Securities Purchase Agreement dated as of July 30, 2004 among Purchasers and Wave (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed on August 3, 2004, File #0-24752)
10.25	*	—	Additional Investment Right to Purchase 3,529,412 Shares of Common Stock of Wave Systems Corp. (incorporated by reference to Exhibit 10.2 of Wave's Current Report on Form 8-K, filed on August 3, 2004, File #0-24752)
10.26	*	—	Series A Common Stock Purchase Warrant to Purchase 3,529,412 Shares of Class A Common Stock of Wave Systems Corp. (incorporated by reference to Exhibit 10.3 of Wave's Current Report on Form 8-K, filed on August 3, 2004, File #0-24752)
10.27	*	—	Series B Common Stock Purchase Warrant to Purchase 882,353 Shares of Class A Common Stock of Wave Systems Corp. (incorporated by reference to Exhibit 10.4 of Wave's Current Report on Form 8-K, filed on August 3, 2004, File # 0-24752)
10.28	*	—	Placement Agency Agreement between Corpfin Inc. and Wave (incorporated by reference to Exhibit 10.5 of Wave's Current Report on Form 8-K, filed on August 3, 2004, File # 0-24752)
10.29	*	—	Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed on May 5, 2006, File #0-24752)
10.30	*	—	Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed on August 8, 2006, File #0-24752)
10.31	*	—	Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed on October 31, 2006, File #0-24752)
10.32	*	—	Form of Subscription Agreement (incorporated by reference to Exhibit 99.1 of Wave's Current Report on Form 8-K, filed May 25, 2007, File # 0-24752)
10.33	*	—	Form of Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed March 3, 2008, File # 0-24752)
10.34	*	—	Placement Agency Agreement, dated as of February 29, 2008, by and between Wave and Security Research Associates, Inc. (incorporated by reference to Exhibit 10.2 of Wave's Current Report on Form 8-K, filed March 3, 2008, File # 0-24752)
10.35	*	—	Form of Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed May 27, 2008, File # 0-24752)

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			Description of Exhibit

10.36	*	—	Placement Agency Agreement, dated as of May 23, 2008, by and between Wave and Security Research Associates, Inc. (incorporated by reference to Exhibit 10.2 of Wave's Current Report on Form 8-K, filed May 27, 2008, File # 0-24752)
10.37	*	—	Form of Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed July 1, 2008, File # 0-24752)
10.38	*	—	Placement Agency Agreement, dated as of June 30, 2008, by and between Wave and Security Research Associates, Inc. (incorporated by reference to Exhibit 10.2 of Wave's Current Report on Form 8-K, filed July 1, 2008, File # 0-24752)
10.39	*	—	Form of Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed August 12, 2008, File # 0-24752)
10.40	*	—	Placement Agency Agreement, dated as of August 11, 2008, by and between Wave and Security Research Associates, Inc. (incorporated by reference to Exhibit 10.2 of Wave's Current Report on Form 8-K, filed August 12, 2008, File # 0-24752)
10.41	*	—	Form of Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed September 15, 2008, File # 0-24752)
10.42	*	—	Placement Agency Agreement, dated as of September 11, 2008, by and between Wave and Security Research Associates, Inc. (incorporated by reference to Exhibit 10.2 of Wave's Current Report on Form 8-K, filed September 15, 2008, File # 0-24752)
10.43	*	—	Restructuring Agreement dated September 23, 2008 by and among Wave, Wavexpress and Sarnoff Corporation (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed September 24, 2008, File # 0-24752)
10.44	*	—	Amended and Restated Stockholder Agreement, dated September 23, 2008 between Wave and Sarnoff Corporation (incorporated by reference to Exhibit 10.2 of Wave's Current Report on Form 8-K, filed September 24, 2008, File # 0-24752)
10.45	*	—	Form of Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed September 30, 2008, File # 0-24752)
10.46	*	—	Form of Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed October 31, 2008, File # 0-24752)
10.47	*	—	Placement Agency Agreement, dated as of October 29, 2008, by and between Wave and Security Research Associates, Inc. (incorporated by reference to Exhibit 10.2 of Wave's Current Report on Form 8-K, filed October 31, 2008, File # 0-24752)
10.48	*	—	Form of Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed December 29, 2008, File # 0-24752)
10.49	*	—	Placement Agency Agreement, dated as of December 24, 2008, by and between Wave and Security Research Associates, Inc. (incorporated by reference to Exhibit 10.2 of Wave's Current Report on Form 8-K, filed December 29, 2008, File # 0-24752)
10.50	*	—	Form of Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed March 16, 2009, File # 0-24752).
10.51	*	—	Placement Agency Agreement, dated as of March 13, 2009, by and between Wave and Security Research Associates, Inc. (incorporated by reference to Exhibit 10.2 of Wave's Current Report on Form 8-K, filed March 16, 2009, File # 0-24752).

Table of Contents

			Description of Exhibit

10.52	*	—	Form of Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed April 9, 2009, File # 0-24752).
10.53	*	—	Placement Agency Agreement, dated as of April 8, 2009, by and between Wave and Security Research Associates, Inc. (incorporated by reference to Exhibit 10.2 of Wave's Current Report on Form 8-K, filed April 9, 2009, File # 0-24752).
10.54	*	—	Form of Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed July 17, 2009, File # 0-24752).
10.55	*	—	Placement Agency Agreement, dated as of July 16, 2009, by and between Wave and Roth Capital Partners, LLC (incorporated by reference to Exhibit 10.2 of Wave's Current Report on Form 8-K, filed July 17, 2009, File # 0-24752).
10.56	*	—	Form of Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed July 22, 2009, File # 0-24752).
10.57	*	—	Placement Agency Agreement, dated as of July 21, 2009, by and between Wave and Roth Capital Partners, LLC (incorporated by reference to Exhibit 10.2 of Wave's Current Report on Form 8-K, filed July 22, 2009, File # 0-24752).
21.1	*	—	Subsidiaries of Registrant (incorporated by reference to Exhibit 10.12 of Wave's Annual Report on Form 10-K, filed on April 1, 2002, File #0-24752)
23.1		—	Consent of Independent Registered Public Accounting Firm—KPMG LLP
31.1		—	Section 302 Certification by Steven K. Sprague, President and Chief Executive Officer
31.2		—	Section 302 Certification by Gerard T. Feeney, Chief Financial Officer
32.1		—	Section 906 Certification
99.1	*	—	Form of Series H Convertible Preferred Stock Purchase Agreement, dated as of April 30, 2003 (the "First Purchase Agreement"), by and among Wave and the purchasers of the Series H Convertible Preferred Stock (Incorporated by reference to Wave's Form 8-K filed on May 5, 2003).
99.2	*	—	Form of Series H Convertible Preferred Stock Purchase Agreement, dated as of April 30, 2003 (the "Second Purchase Agreement"), by and between Wave and an individual purchaser (Incorporated by reference to Wave's Form 8-K filed on May 5, 2003).
99.5	*	—	Form of Warrant issued by Wave pursuant to the Second Purchase Agreement to the individual purchaser, dated as of April 30, 2003 (Incorporated by reference to Wave's Form 8-K filed on May 5, 2003).
99.6	*	—	Form of Warrant issued by Wave to the placement agent and sub-placement agents, dated as of April 30, 2003 (Incorporated by reference to Wave's Form S-3 filed on May 14, 2003 (Registration No. 333-99469)).
99.7	*	—	Letter Amendment to First Purchase Agreement and Second Purchase Agreement effected on August 11, 2003 (Incorporated by reference to Wave's Form 8-K filed on August 12, 2003).
99.8	*	—	Form of Letter Agreement to the Series H Convertible Preferred Stock Purchase Agreements dated September 4, 2003, effected on September 15, 2003 (Incorporated by reference to Wave's Form 8-K filed on September 16, 2003).

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			Description of Exhibit

99.9	*	—	Form of Waiver to the Series H Preferred Stock Purchase Agreements dated September 4, 2003, effected on September 15, 2003 (Incorporated by reference to Wave's Form 8-K filed on September 16, 2003).
99.10	*	—	Securities Purchase Agreement, dated as of November 18, 2003, by and among Wave and purchasers of the Class A common stock. (Incorporated by reference to Wave's registration statement filed on Form S-3/A filed on February 12, 2004. (Registration No. 333-112017.))
99.11	*	—	Form of Warrant issued by Wave to each of the purchasers of the Class A Common Stock and the placement agents, dated as of November 18, 2003 with the schedule of holders attached thereto. (Incorporated by reference to Wave's Form 8-K/A filed on February 13, 2004).
99.12	*	—	Registration Rights Agreement by and among Wave and the purchasers of the Class A Common Stock, dated as of November 18, 2003. (Incorporated by reference to Wave's Form 8-K/A filed on February 13, 2004).
99.13	*	—	Demand Note, dated March 26, 2001 between Gerard T. Feeney and Wave (incorporated by reference to Exhibit 99.1 of Wave's Annual Report on Form 10-K, filed on April 1, 2002, File #0-24752)
99.14	*	—	Demand Note, dated February 27, 2001 between Peter J. Sprague and Wave (incorporated by reference to Exhibit 99.2 of Wave's Annual Report on Form 10-K, filed on April 1, 2002, File #0-24752)
99.15	*	—	Demand Note, dated July 25, 2001 between Peter J. Sprague and Wave (incorporated by reference to Exhibit 99.3 of Wave's Annual Report on Form 10-K, filed on April 1, 2002, File #0-24752)
99.16	*	—	Demand Note, dated September 5, 2001 between Peter J. Sprague and Wave (incorporated by reference to Exhibit 99.4 of Wave's Annual Report on Form 10-K, filed on April 1, 2002, File #0-24752)
99.17	*	—	Allonge to Demand Promissory Note, dated March 26, 2002 between Gerard T. Feeney and Wave (incorporated by reference to Exhibit 99.6 of Wave's Annual Report on Form 10-K/A, filed on June 30, 2003, File #0-24752)
99.18	*	—	Allonge to Demand Promissory Note, dated February 27, 2002 between Peter J. Sprague and Wave (incorporated by reference to Exhibit 99.7 of Wave's Annual Report on Form 10-K/A, filed on June 30, 2003, File #0-24752)
99.19	*	—	Allonge to Demand Promissory Note, dated July 25, 2002 between Peter J. Sprague and Wave (incorporated by reference to Exhibit 99.8 of Wave's Annual Report on Form 10-K/A, filed on June 30, 2003, File #0-24752)

*: Incorporated herein by reference
+: Confidential treatment has been granted as to portions of this exhibit.
†: Management contract or compensatory plan.
(b): Reports on Form 8-K

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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.

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

Signature	Title	Date


/s/ STEVEN K. SPRAGUE Steven K. Sprague	President, Chief Executive Officer and Director	March 16, 2010
/s/ JOHN E. BAGALAY, JR. John E. Bagalay, Jr.	Chairman	March 16, 2010
/s/ GEORGE GILDER George Gilder	Director	March 16, 2010
/s/ JOHN E. MCCONNAUGHY, JR. John E. McConnaughy, Jr.	Director	March 16, 2010
/s/ NOLAN BUSHNELL Nolan Bushnell	Director	March 16, 2010
/s/ GERARD T. FEENEY Gerard T. Feeney	Senior Vice President, Finance and Administration, Chief Financial Officer and Secretary (Principal Financial Officer and Duly Authorized Officer of the Registrant)	March 16, 2010

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders
Wave Systems Corp.:

We have audited the accompanying consolidated balance sheets of Wave Systems Corp. and subsidiaries as of December 31, 2009 and 2008, and the related consolidated statements of operations, stockholders' equity (deficiency) and comprehensive income (loss), and cash flows for each of the years in the three-year period ended December 31, 2009. We have also audited Wave System Corp.'s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Wave System Corp.'s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on Wave Systems Corp.'s internal control over financial reporting 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 audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Wave Systems Corp. and subsidiaries as of December 31, 2009 and 2008, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2009, in conformity with U.S. generally accepted accounting principles. Also in our opinion, Wave Systems Corp. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on criteria established in

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Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

The accompanying consolidated financial statements have been prepared assuming that Wave Systems Corp. will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, Wave Systems Corp. has suffered recurring losses from operations and has an accumulated deficit that raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

/s/ KPMG LLP

Boston, Massachusetts
March 16, 2010

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Consolidated Balance Sheets

December 31, 2009 and 2008

			2009			2008

Assets
Current assets:
	Cash and cash equivalents		$	1,900,014		$	951,563
	Accounts receivable, net of allowance for doubtful accounts of $-0- and $16,364 at December 31, 2009 and 2008, respectively			3,850,020			1,701,829
	Prepaid expenses			207,343			227,967

		Total current assets		5,957,377			2,881,359
	Property and equipment, net			237,237			408,440
	Other assets			133,311			139,975

Total Assets				6,327,925			3,429,774

Liabilities and Stockholders' Equity (Deficit)
Current liabilities:
	Accounts payable and accrued expenses			4,441,657			7,655,834
	Current portion of capital lease payable			61,857			63,537
	Deferred revenue			3,500,861			1,484,044

		Total current liabilities		8,004,375			9,203,415
	Long-term portion of capital lease payable			183,505			245,362

		Total liabilities		8,187,880			9,448,777

Stockholders' Equity (Deficit):
8% Series I Convertible Preferred stock, $.01 par value. -0- shares issued and outstanding (liquidation preference of $-0-) in 2009 and 220 shares issued and outstanding (liquidation preference of $968,000) in 2008				—			2
Series J Convertible Preferred stock, $.01 par value. -0- shares issued and outstanding (liquidation preference of $-0-) in 2009 and 91 shares issued and outstanding (liquidation preference of $364,000) in 2008				—			1
8% Series K Convertible Preferred stock, $.01 par value. -0- shares issued and outstanding (liquidation preference of $-0-) in 2009 and 456 shares issued and outstanding (liquidation preference of $1,276,800) in 2008				—			5
Common Stock, $.01 par value. Authorized 150,000,000 shares as Class A; 75,211,054 shares issued and outstanding in 2009 and 58,877,968 in 2008				752,110			588,780
Common Stock, $.01 par value. Authorized 13,000,000 shares as Class B; 38,232 shares issued and outstanding in 2009 and 2008				382			382
Capital in excess of par value				345,423,668			338,081,691
Accumulated deficit				(348,036,115	)		(344,689,864	)

		Total Stockholders' Equity (Deficit)		(1,859,955	)		(6,019,003	)

Total Liabilities and Stockholders' Equity (Deficit)			$	6,327,925		$	3,429,774

See accompanying notes to consolidated financial statements.

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Consolidated Statements of Operations

Years ended December 31, 2009, 2008, 2007

		2009			2008			2007

Net revenues:
Licensing		$	18,013,043		$	8,691,576		$	6,223,487
Services			875,836			118,239			83,473

	Total net revenues		18,888,879			8,809,815			6,306,960

Operating expenses:
	Cost of sales—licensing		876,723			736,429			781,675
	Cost of sales—services		521,168			87,752			30,295
	Selling, general and administrative		12,992,715			16,375,372			15,222,896
	Research and development		7,825,058			11,702,776			10,557,937
	Write-off of impaired assets		—			447,128			—

	Total operating expenses		22,215,664			29,349,457			26,592,803
	Operating loss		(3,326,785	)		(20,539,642	)		(20,285,843	)
Other income (expense):
	Net interest income (expense)		(19,466	)		(9,572	)		334,292
	Net loss		(3,346,251	)		(20,549,214	)		(19,951,551	)
	Accretion of non-cash beneficial conversion feature on Series J and Series K convertible preferred stock		—			(657,000	)		—

	Net loss attributable to common stockholders		(3,346,251	)		(21,206,214	)		(19,951,551	)

	Loss per common share—basic and diluted	$	(0.05	)	$	(0.38	)	$	(0.43	)

	Weighted average number of common shares outstanding during the year		68,526,572			55,379,118			46,660,794

See accompanying notes to consolidated financial statements.

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Consolidated Statements of Stockholders' Equity (Deficiency) And Comprehensive Income (Loss)

	8% Series I Convertible Preferred Stock				Series J Convertible Preferred Stock				8% Series K Convertible Preferred Stock				Class A Common Stock				Class B Common Stock

																													Accumulated Other Comprehensive Income
																							Capital in Excess of Par Value			Accumulated Deficit
	Shares		Amount		Shares		Amount		Shares		Amount		Shares		Amount		Shares			Amount			Capital in Excess of Par Value			Accumulated Deficit					Total
Balance as of December 31, 2006		—	$	—		—	$	—		—	$	—		42,203,773	$	422,038		39,232		$	392		$	309,029,938		$	(303,532,099	)	$	—	$	5,920,269
Net loss		—		—		—		—		—		—		—		—		—			—			—			(19,951,551	)		—		(19,951,551	)
Employee Stock Options Exercised at $2.43 per share		—		—		—		—		—		—		3,315		33		—			—			8,022			—			—		8,055
Issuance of Class A Common Stock at $2.05 per share, less issuance cost of $770,669		—		—		—		—		—		—		7,317,073		73,171		—			—			14,156,160			—			—		14,229,331
Shares of Class A Common Stock Issued pursuant to the Wave Employee Stock Purchase Plan at $1.8275 per share		—		—		—		—		—		—		91,746		917		—			—			166,748			—			—		167,665
Shares of Class A Common Stock Issued pursuant to the Wave Employee Stock Purchase Plan at $1.1985 per share		—		—		—		—		—		—		127,420		1,274		—			—			151,438			—			—		152,712
Cash paid for fraction shares exchanged		—		—		—		—		—		—		—		—		—			—			(241	)		—			—		(241	)
Stock based compensation		—		—		—		—		—		—		—		—		—			—			1,969,271			—			—		1,969,271
Exchange of Class B Common Stock for Class A Common Stock		—		—		—		—		—		—		1,000		10		(1,000	)		(10	)		—			—			—		—

Balance as of December 31, 2007		—	$	—		—	$	—		—	$	—		49,744,327	$	497,443		38,232		$	382		$	325,481,336		$	(323,483,650	)	$	—	$	2,495,511
Net loss		—		—		—		—		—		—		—		—		—			—			—			(20,549,214	)		—		(20,549,214	)
Issuance of Class A Common Stock at $1.10 per share, less issuance cost of $270,959		—		—		—		—		—		—		3,173,500		31,735		—			—			3,188,156			—			—		3,219,891
Issuance of Class A Common Stock at $0.80 per share, less issuance cost of $138,180		—		—		—		—		—		—		2,151,250		21,513		—			—			1,561,307			—			—		1,582,820
Shares of Class A Common Stock Issued pursuant to the Wave Employee Stock Purchase Plan at $0.8925 per share		—		—		—		—		—		—		209,857		2,098		—			—			185,199			—			—		187,297
Issuance of Class A Common Stock at $0.85 per share, less issuance cost of $131,793		—		—		—		—		—		—		1,880,500		18,805		—			—			1,447,827			—			—		1,466,632
Issuance of Class A Common Stock at $0.60 per share, less issuance cost of $79,330		—		—		—		—		—		—		1,368,333		13,684		—			—			727,986			—			—		741,670
Issuance of 8% Series I Preferred Stock at $4,400 per share, less issuance cost of $78,030		172		2		—		—		—		—		—		—		—			—			678,768			—			—		678,770
Issuance of 8% Series I Preferred Stock at $4,400 per share, less issuance cost of $30,000		48		—		—		—		—		—		—		—		—			—			181,200			—			—		181,200

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Consolidated Statements of Stockholders' Equity (Deficiency) And Comprehensive Income (Loss) (Continued)

	8% Series I Convertible Preferred Stock				Series J Convertible Preferred Stock					8% Series K Convertible Preferred Stock				Class A Common Stock				Class B Common Stock

																												Accumulated Other Comprehensive Income
																						Capital in Excess of Par Value			Accumulated Deficit
	Shares		Amount		Shares			Amount		Shares		Amount		Shares		Amount		Shares		Amount		Capital in Excess of Par Value			Accumulated Deficit					Total
Issuance of Series J Preferred Stock at $6,500 per share, less issuance cost of $68,290		—		—		111			1		—		—		—		—		—		—		214,528			—			—		214,529
Issuance of warrants to purchase Class A common stock in connection with the issuance of Series J Preferred Stock		—		—		—			—		—		—		—		—		—		—		422,697			—			—		422,697
Issuance of warrants to purchase Class A common stock to placement agent for services in connection with the Series J financing transaction		—		—		—			—		—		—		—		—		—		—		15,984			—			—		15,984
Series J Preferred Stock Beneficial Conversion Feature		—		—		—			—		—		—		—		—		—		—		155,400			(155,400	)		—		—
Conversion of Series J Preferred Stock for Class A Common Stock		—		—		(20	)		—		—		—		200,000		2,000		—		—		(2,000	)		—			—		—
Shares of Class A Common Stock Issued pursuant to the Wave Employee Stock Purchase Plan at $0.2805 per share		—		—		—			—		—		—		150,201		1,502		—		—		40,629			—			—		42,131
Issuance of 8% Series K Preferred Stock at $2,800 per share, less issuance cost of $101,608		—		—		—			—		456		5		—		—		—		—		941,602			—			—		941,607
Issuance of warrants to purchase Class A common stock in connection with the issuance of Series K Preferred Stock		—		—		—			—		—		—		—		—		—		—		173,393			—			—		173,393
Issuance of warrants to purchase Class A common stock to placement agent for services in connection with the Series K financing transaction		—		—		—			—		—		—		—		—		—		—		60,192			—			—		60,192
Series K Preferred Stock Beneficial Conversion Feature		—		—		—			—		—		—		—		—		—		—		501,600			(501,600	)		—		—
Cash paid for fraction shares in reverse stock split		—		—		—			—		—		—		—		—		—		—		(54	)		—			—		(54	)
Stock based compensation		—		—		—			—		—		—		—		—		—		—		2,105,941			—			—		2,105,941

Balance as of December 31, 2008		220	$	2		91		$	1		456	$	5		58,877,968	$	588,780		38,232	$	382	$	338,081,691		$	(344,689,864	)	$	—	$	(6,019,003	)
Net loss		—		—		—			—		—		—		—		—		—		—		—			(3,346,251	)		—		(3,346,251	)

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Consolidated Statements of Stockholders' Equity (Deficiency) And Comprehensive Income (Loss) (Continued)

	8% Series I Convertible Preferred Stock						Series J Convertible Preferred Stock						8% Series K Convertible Preferred Stock						Class A Common Stock				Class B Common Stock

																																	Accumulated Other Comprehensive Income
																											Capital in Excess of Par Value			Accumulated Deficit
	Shares			Amount			Shares			Amount			Shares			Amount			Shares		Amount		Shares		Amount		Capital in Excess of Par Value			Accumulated Deficit					Total
Conversion of 8% Series K Preferred Stock for Class A Common Stock		—			—			—			—			(456	)		(5	)		4,560,000		45,600		—		—		(45,595	)		—			—		—
Issuance of Class A Common Stock at $0.55 per share, less issuance cost of $55,904		—			—			—			—			—			—			785,000		7,850		—		—		367,995			—			—		375,845
Issuance of Class A Common Stock at $0.55 per share, less issuance cost of $92,077		—			—			—			—			—			—			1,881,136		18,811		—		—		923,736			—			—		942,547
Conversion of Series J Preferred Stock for Class A Common Stock		—			—			(91	)		(1	)		—			—			910,000		9,100		—		—		(9,099	)		—			—		—
Issuance of Class A Common Stock at $0.92 per share, less issuance cost of $484,960		—			—			—			—			—			—			3,448,042		34,480		—		—		2,652,759			—			—		2,687,239
Issuance of Class A Common Stock at $0.92 per share, less issuance cost of $159,250		—			—			—			—			—			—			1,791,738		17,917		—		—		1,471,232			—			—		1,489,149
Warrants exercised at $0.55 per share		—			—			—			—			—			—			100,000		1,000		—		—		54,000			—			—		55,000
Warrants exercised at $0.28 per share		—			—			—			—			—			—			10,000		100		—		—		2,700			—			—		2,800
Cashless exercise of warrants at $0.28 per share		—			—			—			—			—			—			17,361		174		—		—		(174	)		—			—		—
Cashless exercise of warrants at $0.65 per share		—			—			—			—			—			—			3,659		37		—		—		(37	)		—			—		—
Cashless exercise of warrants at $0.85 per share		—			—			—			—			—			—			28,339		283		—		—		(283	)		—			—		—
Cashless exercise of warrants at $0.90 per share		—			—			—			—			—			—			30,178		302		—		—		(302	)		—			—		—
Shares of Class A Common Stock Issued pursuant to the Wave Employee Stock Purchase Plan at $0.28 per share		—			—			—			—			—			—			365,498		3,655		—		—		98,867			—			—		102,522
Warrants exercised at $0.90 per share		—			—			—			—			—			—			50,000		500		—		—		44,500			—			—		45,000
Conversion of 8% Series I Preferred Stock for Class A Common Stock		(220	)		(2	)		—			—			—			—			2,200,000		22,000		—		—		(21,998	)		—			—		—
Shares of Class A Common Stock Issued pursuant to the Wave Employee Stock Purchase Plan at $1.037 per share		—			—			—			—			—			—			152,135		1,521		—		—		156,242			—			—		157,763
Cash dividends paid on 8% Series I Preferred Stock		—			—			—			—			—			—			—		—		—		—		(77,440	)		—			—		(77,440	)
Stock based compensation		—			—			—			—			—			—			—		—		—		—		1,724,874			—			—		1,724,874

Balance as of December 31, 2009		—		$	—			—		$	—			—		$	—			75,211,054	$	752,110		38,232	$	382	$	345,423,668		$	(348,036,115	)	$	—	$	(1,859,955	)

See accompanying notes to consolidated financial statements.

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

Years ended December 31, 2009, 2008, 2007

			2009			2008			2007

Cash flows from operating activities:
Net loss			$	(3,346,251	)	$	(20,549,214	)	$	(19,951,551	)
Adjustments to reconcile net loss to net cash used in operating activities:
	Depreciation and amortization			259,210			395,253			355,884
	Impairment of property and equipment			—			447,128			—
	Compensation associated with issuance of stock options			1,724,874			2,105,941			1,969,271
Changes in assets and liabilities:
	Increase (decrease) in deferred revenue			2,016,817			1,195,019			(115,034	)
	Increase in accounts receivable			(2,148,191	)		(536,444	)		(529,533	)
	(Increase) decrease in prepaid expenses			20,624			111,375			(132,507	)
	(Increase) decrease in other assets			6,664			(3,388	)		(5,315	)
	Increase (decrease) in accounts payable and accrued expenses			(3,214,177	)		4,402,514			217,971

	Net cash used in operating activities			(4,680,430	)		(12,431,816	)		(18,190,814	)

Cash flows from investing activities:
	Acquisition of property and equipment			(88,007	)		(232,512	)		(618,672	)

	Net cash used in investing activities			(88,007	)		(232,512	)		(618,672	)

Cash flows from financing activities:
	Payments on capital lease obligation			(63,537	)		(26,898	)		—
	Net proceeds from issuance of preferred stock			—			2,688,372			—
	Net proceeds from issuance of common stock			5,494,780			7,011,013			14,229,331
	Proceeds from employee options under stock plans			260,285			229,428			328,432
	Proceeds from exercise of warrants			102,800			—			—
	Payment of dividends on preferred stock			(77,440	)		—			—
	Payment in lieu of fractional shares in reverse stock split			—			(54	)		(241	)

	Net cash provided by financing activities			5,716,888			9,901,861			14,557,522

Net increase (decrease) in cash and cash equivalents				948,451			(2,762,467	)		(4,251,964	)
Cash and cash equivalents at beginning of year				951,563			3,714,030			7,965,994

Cash and cash equivalents at end of year			$	1,900,014		$	951,563		$	3,714,030

Supplemental cash flow information:
	Non-cash financing activities:
	Conversion of 8% Series K Preferred Stock into Class A Common Stock		$	45,600		$	—		$	—

	Conversion of Series J Preferred Stock into Class A Common Stock		$	9,100		$	—		$	—

	Conversion of 8% Series I Preferred Stock into Class A Common Stock		$	22,000		$	—		$	—

	Capital lease obligation on property and equipment		$	—		$	335,797		$	—

	Cash paid during the year for:
		Interest	$	21,384		$	10,415		$	—

See accompanying notes to consolidated financial statements.

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(1) Business of the Company

Wave Systems Corp. ("Wave" or "the Company") develops, produces and markets products for hardware-based digital security including security applications and services that are complementary to and compliant with the specifications of the Trusted Computing Group, www.trustedcomputinggroup.org ("TCG"). Specifications developed by the TCG are designed to address a broad range of current and evolving digital security issues facing the industry. These issues include the following: identity protection, data security, digital signatures, electronic transaction integrity, platform trustworthiness, network security, and regulatory compliance. Wave's products are designed to solve many of these digital security issues.

(2) Liquidity

The accompanying consolidated financial statements have been prepared assuming that Wave will continue as a going concern. Wave has incurred substantial operating losses since its inception, and as of December 31, 2009, has an accumulated deficit of $348,036,115. Wave may incur an operating loss for the calendar year of 2010. As of December 31, 2009, Wave had negative working capital of $2,046,998.

Wave has begun market introduction of its security and other software products and has signed initial distribution contracts for these applications. However, due to the early stage nature of this market, Wave may not generate sufficient revenue to cover all of its cash flow needs to fund its operating requirements for the year ending December 31, 2010.

Because Wave may not have sufficient cash to fund operations for the year ending December 31, 2010; and given the uncertainties described above with respect to Wave's revenue outlook for 2010, Wave has been and may continue to be actively engaged in financing activities in order to generate additional funding to cover its operating costs for the year ending December 31, 2010. These activities included the filing of a $25,000,000 S-3 shelf registration with the SEC on April 18, 2008, which was declared effective on June 23, 2008; and the subsequent sales of shares of preferred and common stock pursuant to this shelf registration statement during 2009 (See footnotes 7 and 8). There remains approximately $9,500,000 in gross proceeds available under the April 18, 2008 shelf registration statement, which may be used for future financings although there can be no assurances that future financings will be attainable.

Wave may be required to sell additional shares of common stock, preferred stock, obtain debt financing or engage in a combination of these financing alternatives, to raise additional capital to continue to fund its operations for the twelve months ending December 31, 2010. Based upon the available cash currently on hand, if Wave meets its current revenue and expenditure forecast for the year ending December 31, 2010 (both of which are uncertain), Wave would have enough liquid assets to continue operating through December 31, 2010.

If Wave is not successful in executing its business plan, it may be required to sell additional shares of common stock, preferred stock, obtain debt financing or engage in a combination of these financing alternatives or it could be forced to reduce expenses which may significantly impede its ability to meet its sales, marketing and development objectives, cease operations or merge with another company. No assurance can be provided that any of these initiatives will be successful. Due to its current cash position, capital needs over the next year and beyond, and the uncertainty as to whether it will achieve its sales forecast for its products and services, substantial doubt exists with respect to Wave's ability to continue as a going concern.

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(3) Significant Accounting Policies

(a) Basis of Consolidation

The consolidated financial statements include the financial statements of Wave, Wave Systems Holdings, Inc., a wholly owned subsidiary and Wavexpress, Inc. a majority-owned subsidiary (see note 11). All significant intercompany accounts and transactions have been eliminated in consolidation.

(b) Use of Estimates

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect amounts reported in the Consolidated Financial Statements and accompanying notes. Estimates are used for, but not limited to, depreciation and amortization, revenue recognition, accounts receivable reserves, valuation of long-lived and intangible assets, software development, contingencies and share based compensation. Actual results could differ from those estimates.

(c) Method of Accounting for Joint Ventures

Wave accounts for its investments in joint ventures using the equity method of accounting when its ownership interest in the joint venture is less than fifty percent and it is determined that Wave has the ability to exercise significant influence over the joint venture's operating and financial policies. The financial statements of joint ventures in which Wave owns greater than a fifty percent interest are consolidated with Wave's financial statements (see note 11).

(d) Cash and Cash Equivalents

Wave considers all highly liquid instruments with an original or remaining maturity of three months or less to be cash equivalents. Substantially all cash and cash equivalents are custodial with one major financial institution.

(e) Accounts Receivable and Allowance For Doubtful Accounts

Included in accounts receivable at December 31, 2009 and 2008 are amounts unbilled totaling $73,120 and $239,799, respectively.

The determination of the allowance for doubtful accounts is based on management's estimate of uncollectible accounts receivable. Management records specific reserves for receivable balances that are considered high risk due to known facts regarding the customer. Allowance for doubtful accounts amounted to $-0- and $16,364 at December 31, 2009 and 2008, respectively.

(f) Concentrations of Credit Risks

Sales to Wave's largest customer in 2009, 2008 and 2007, Dell, Inc., were approximately 81%, 80%, and 71% of revenue, respectively. Accounts receivable at December 31, 2009, 2008 and 2007 included receivables from Dell, Inc. and it affiliates of $3,317,548, $1,054,368 and $652,572, respectively.

(g) Property and Equipment

Property and equipment, including purchased computer software, are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed using the

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(3) Significant Accounting Policies (Continued)

straight-line method over the estimated useful lives of the assets which range from between three to five years. Amortization of leasehold improvements is computed using the shorter of the useful life or remaining lease term.

(h) Income Taxes

Effective January 1, 2007, Wave adopted ASC 740, "Accounting for Uncertainty in Income Taxes", formerly FASB Interpretation No. 48. The ASC 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, and provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosures and transition. The adoption of ASC 740 did not result in a cumulative adjustment to Wave's accumulated earnings. Wave classifies any interest and penalties related to income taxes as components of the income tax provision.

Wave accounts for income taxes under the asset and liability method. As such, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. At December 31, 2009 and 2008, a full valuation allowance has been recorded against the gross deferred tax asset since management believes that, after considering all the available objective evidence, both positive and negative, historical and prospective, with greater weight given to historical evidence, it is more likely than not that these assets will not be realized.

(i) Share-based Payments

Stock-based compensation expense recognized is based on the value of the portion of stock-based payment awards that is ultimately expected to vest and has been reduced for estimated forfeitures. We value stock-based payment awards at grant date using the Black-Scholes option-pricing model ("Black-Scholes model"). Our determination of fair value of stock-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to our expected stock price volatility over the term of the awards and actual and projected employee stock option exercise behaviors.

(j) Research and Development and Software Development Costs

Research and development costs are expensed as incurred. Software development costs are accounted for pursuant to ASC 985-20,"Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed" which requires software development costs for products that have

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(3) Significant Accounting Policies (Continued)

achieved commercial marketability to be capitalized subsequent to the establishment of a product's technological feasibility and prior to general release of the product. Wave did not capitalize any software development costs for 2009 or 2008 since all products in development have not had sufficient testing to determine commercial viability or acceptance by a particular customer such that they could be categorized as technologically feasible. Amortization of capitalized software costs for the years ended December 31, 2009, 2008 and 2007 was $-0-, $-0- and $69,733, respectively.

(k) Loss Per Share

Basic net loss per common share has been calculated by dividing the net loss attributable to common stockholders by the weighted average number of shares of common stock outstanding during the period. The net loss attributable to common stockholders is calculated by adding the accretion of the beneficial conversion feature on convertible preferred stock to the net loss. Diluted net loss per share is also computed using the weighted average number of common shares and excludes dilutive potential common shares outstanding, as their effect is anti-dilutive. Dilutive potential common shares consist primarily of employee stock options and stock warrants. Diluted net loss per share is equal to basic net loss per share and is therefore not presented separately in the financial statements. The weighted average number of potential common shares that would have been included in diluted loss per share had their effect not been anti-dilutive for each of the years ended December 31, 2009, 2008 and 2007 were approximately 2,961,000 shares, 546,000 shares and 175,000 shares, respectively. Employee stock options and other stock warrants to purchase approximately 17,575,000, 10,238,000 and 6,446,000 shares were outstanding for the years ended December 31, 2009, 2008 and 2007 respectively, but are not included in the computation of diluted loss per share because their exercise price was greater than the average share price of Wave's common shares and, therefore, their effect would have been anti-dilutive.

(l) Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of

Wave reviews the valuation of long-lived assets, including property and equipment and capitalized software, under the provisions of Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASU") 360,"Property, Plant and Equipment" (formerly Statement of Financial Accounting Standards (SFAS) No. 144,"Accounting for the Impairment or Disposal of Long-Lived Assets", and ASC 985-20,"Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed,", respectively. Wave is required to assess the recoverability of long-lived assets and capitalized software development costs whenever events and circumstances indicate that the carrying value may not be recoverable. Factors considered important that could trigger an impairment review include the following:

•: significant underperformance relative to expected historical or projected future operating results;
•: significant changes in the manner of use of the acquired assets or the strategy of the overall business;
•: significant negative industry or economic trends; and
•: significant decline in the stock price for a sustained period.

In accordance with ASU 360, when Wave determines that the carrying value of applicable long-lived assets may not be recoverable based upon the existence of one or more of the above

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(3) Significant Accounting Policies (Continued)

indicators of impairment, they evaluate whether the carrying amount of the asset exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of that asset. If such a circumstance exists, Wave would measure an impairment loss to the extent the carrying amount of the particular long-lived asset or group exceeds its fair value. Wave would determine the fair value based on a projected discounted cash flow method using a discount rate determined by management to be commensurate with the risk inherent in their current business model. In accordance with ASC 985-20, when Wave determines that the carrying value of capitalized software development costs may not be recoverable, they evaluate whether the unamortized cost exceeds the expected future net realizable value of the products. If the unamortized costs exceed the expected future net realizable value of the products, the excess amount is written off. Changes in judgments on any of these factors could impact the value of the asset being evaluated.

(m) Revenue Recognition

Wave's business model targets revenues from various sources including: licensing of EMBASSY Trust Suite, eTMS software products and development contracts. Many of these sales arrangements include multiple-elements, and/or required significant modification or customization of Wave's software.

Wave recognizes revenue pursuant to generally accepted accounting principles or GAAP, in accordance with Accounting Standards Codification, or ASC, Topic 985-605, Software Revenue Recognition, or ASC 985-605 as amended. Generally, Wave recognizes revenue when it is realized or realizable and earned. Wave considers revenue realized or realizable and earned when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectability is reasonably assured. Wave reduces revenue for estimated customer returns, rotations and sales rebates, as applicable, when such amounts can be estimated. When these amounts cannot be estimated Wave defers revenue until the product is sold to the end-user. Revenue from software license agreements that have significant customizations and modification of the software product is deferred and recognized in a manner that approximates the percentage of completion method. In addition to the aforementioned general policy, the following are the specific revenue recognition policies for each major category of revenue.

LICENSES

Revenue from delivered elements of one-time charge licensed software is recognized at the inception of the license term, provided Wave has vendor-specific objective evidence of the fair value of each undelivered element, for arrangements that contain multiple elements. Revenue is deferred for undelivered elements for these arrangements. Revenue is also deferred for the entire arrangement, if vendor-specific objective evidence does not exist for each undelivered contract element. Examples of undelivered elements in which the timing of delivery is uncertain include contractual elements that give customers rights to any future upgrades at no additional charge or future maintenance that is provided within the overall price. The revenue that is deferred for any contract element is recognized when all of the revenue recognition criteria have been met for that element.

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(3) Significant Accounting Policies (Continued)

SERVICES

Cost of sales—licensing includes customer support, share-based compensation expense in accordance with ASC 718 and amortization of software and development costs. In order to enhance the comparability of its results of operations with other security software providers in the industry, Wave has reclassified cost of sales to a component of operating expenses. As a result, a gross profit analysis is not presented.

(n) Accounting for Warrants Containing Cash Settlement Provisions

Wave follows the guidance under ASC 480-10, formerly EITF 00-19, to account for derivative financial instruments indexed to, and settled in our own stock. These would include financial instruments such as options or warrants to purchase Wave stock, but does not include employee stock options. ASC 480-10 requires that freestanding financial instruments of this nature be classified as an asset or liability at fair value, in the event that the contract underlying any such financial instruments includes a net cash settlement provision. In addition, ASC 480-10 requires any such asset or liability to be marked to market at the end of each period, with any resulting difference in fair value to be recorded as income or loss, through the company's statement of operations, depending upon whether the difference results in a gain or loss.

(o) Recent Accounting Pronouncements

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(3) Significant Accounting Policies (Continued)

is permitted. We are currently evaluating the impact that the adoption of these ASUs will have on our consolidated financial statements.

In May 2009, the FASB issued FASB ASC 855, Subsequent Events ("ASC 855") (formerly referenced as SFAS No. 165, Subsequent Events), which establishes the period after the balance sheet date during which management shall evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements; the circumstances under which an entity shall recognize events or transactions occurring after the balance sheet date in its financial statements; and the disclosures that an entity shall make about events or transactions that occurred after the balance sheet date. The pronouncement was effective for the company's second quarter 2009, and did not have an impact on our financial position or results of operations. We evaluated all events or transactions that occurred after December 31, 2009 up through March 16, 2010, the date our financials were issued. During this period, we did not have any material recognizable subsequent events.

(4) Related Party Transactions

In March 2003, Mr. Peter Sprague, who is the former Chairman of Wave, was appointed Chairman and Chief Executive Officer of Wavexpress. Mr. Sprague was paid $129,000 for each of the years ended December 31, 2009, 2008 and 2007, respectively in salary as an officer of Wavexpress. Mr. Peter Sprague is the father of Wave's President and Chief Executive Officer, Steven Sprague.

On August 1, 1997, Michael Sprague became an employee of Wave and was paid a salary of $175,000, $175,000 and $187,500 for the years ended December 31, 2009, 2008 and 2007, respectively. Michael Sprague is the brother of Steven Sprague and the son of Wave's former Chairman, Peter Sprague.

(5) Property and Equipment

Property and equipment as of December 31 consisted of the following:

		2009		2008

Computer equipment		$	2,588,084	$	2,521,987
Furniture, fixtures and improvements			218,151		218,151
Computer software			2,446,801		2,429,955

			5,253,036		5,170,093
Less: Accumulated depreciation and amortization			5,015,799		4,761,653

	Total	$	237,237	$	408,440

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(5) Property and Equipment (Continued)

Depreciation and amortization expense on property and equipment amounted to approximately $259,000, $395,000 and $356,000 for the years ended December 31, 2009, 2008, 2007, respectively.

(6) Accounts Payable and Accrued Expenses

Accounts payable and accrued expenses as of December 31 consisted of the following:

	2009		2008

Accounts payable	$	1,382,511	$	4,513,954
Accrued payroll and related costs		2,190,037		1,945,735
Accrued consulting and professional fees		321,939		589,202
State & local taxes payable		186,468		225,798
Other accrued expenses		360,702		381,145

Total accounts payable and accrued expenses	$	4,441,657	$	7,655,834

(7) Preferred Stock

Wave has authorized the issuance of 2,000 shares of convertible preferred stock having a par value of $.01 per share. At December 31, 2009 -0- shares of convertible preferred stock are issued and outstanding. At December 31, 2008, a total of 767 shares of convertible preferred stock were issued and outstanding—220 shares of 8% Series I Convertible Preferred Stock, 91 shares of Series J Convertible Preferred Stock and 456 shares of 8% Series K Convertible Preferred Stock.

(a) Series K Preferred Stock

On December 24, 2008, Wave entered into subscription agreements, pursuant to which Wave sold and issued 456 shares of newly designated 8% Series K Convertible Preferred Stock, par value $.01 ("Series K Preferred Stock"), to certain purchasers for an aggregate purchase price of $1,276,800. These shares were priced at $2,800 per share. Each share of Series K Preferred Stock also included a warrant to purchase up to 2,500 shares of Class A Common Stock for each share of Series K Preferred Stock purchased at an exercise price of $0.28 per share. Wave entered into a placement agency agreement with Security Research Associates, Inc. ("SRA") in which they acted as placement agent in connection with this offering. Wave paid SRA a fee equal to 6.0% of the gross proceeds of this offering. Additionally, Wave issued a warrant to SRA to purchase up to 273,600 shares of Class A Common Stock at an exercise price of $0.28 per share. All of the warrants issued in connection with this offering expire in December 2011. Wave realized net cash proceeds of approximately $1,175,192 after deducting the placement agent fees of $76,608 and additional legal and other fees associated with the issuance of these securities which totaled approximately $25,000.

On February 5, 2009, all 456 shares of the Series K Preferred Stock automatically converted into 4,560,000 shares of Class A Common Stock, as the average of the closing bid prices for the fifteen-day trading period ending February 5, 2009 was $0.706, exceeding the bid price target of $0.70 per share. Each share of Series K Preferred Stock issued in connection with the offering was convertible into 10,000 shares of Class A Common Stock at the election of the holder thereof at any time or automatically on the date on which the average closing price per share of Wave common stock for the 15 consecutive trading day period then ended equaled or exceeded $0.70.

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(7) Preferred Stock (Continued)

On liquidation/dissolution, the Series K Preferred Stock would have ranked (a) pari passu with the Series J Convertible Preferred Stock of the Company and with any other series of preferred stock that may hereafter be designated by the board of directors as pari passu with the Series K Preferred Stock and (b) senior to the common stock and the Series I Convertible Preferred Stock of the Company and to any other series of preferred stock that may hereafter be designated by the board of directors as junior to the Series K Preferred Stock. The Series K Preferred Stock would have ranked junior on liquidation/dissolution to any series of preferred stock that may hereafter be designated by the board of directors as senior to the Series K Preferred Stock. The liquidation value of each share of Series K Preferred Stock would have been $2,800, plus all accrued dividends thereon. Dividends on the Series K Preferred Stock accrued on the initial liquidation preference amount of each share at an annual rate of 8%. Dividends were payable every six months out of any assets legally available to pay dividends when declared by Wave, or upon liquidation or conversion of the Series K Preferred Stock. Accrued dividends in connection with Series K Preferred Stock for the year ended December 31, 2008 were not material and were cancelled upon the automatic conversion of the Series K Preferred Stock on February 5, 2009. The shares subscribed to on December 24, 2008 were offered and issued pursuant to a shelf registration statement on Form S-3, which was filed by Wave on April 18, 2008 and declared effective by the Commission on June 23, 2008.

Pursuant to the Series K Convertible Preferred Stock Purchase Agreement (the "Series K Purchase Agreement"), each share of the Series K Preferred Stock issued in connection with this offering was convertible into 10,000 shares of Class A Common Stock at the election of the holder thereof at any time or automatically on the date on which the average closing price per share of Wave common stock for the 15 consecutive trading day period then ended equals or exceeds $0.70. The Series K Preferred Stock was convertible into 4,560,000 shares of Wave's Class A Common Stock at a conversion price of $0.28 per share. The excess of the estimated aggregate fair value of the Series K Preferred Stock upon conversion over the proceeds of the Series K Preferred Stock has been calculated as follows:


Shares of converted Class A Common Stock		4,560,000
Closing price on December 24, 2008	$	0.35

Aggregate fair value upon conversion	$	1,596,000
Gross proceeds of Series K Preferred Stock		1,276,800

Excess fair value upon conversion	$	319,200

As part of the transaction, Wave issued to the investors and SRA warrants to purchase shares of Class A Common Stock, with an initial exercise price of $0.28 per share and a three (3) year life (the "Series K Warrants" and, together with Series K Preferred Stock, the "Series K Securities"). The Series K Warrants are exercisable for a total of 1,413,600 shares of Class A Common Stock beginning on the date of initial issuance. If exercised in full, the Series K Warrants would generate proceeds of up to an additional $395,808, at the exercise price. On August 12, 2009, Wave received gross proceeds of $2,800, in connection with the issuance of 10,000 shares of Class A Common Stock upon the exercise of a warrant that was granted to an investor as part of this financing. Additionally, 17,361 shares of Class A Common Stock were issued to the placement agent during 2009 upon the cashless exercise of a warrant that was granted to the placement agent as part of this financing.

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(7) Preferred Stock (Continued)

In connection with the issuance of the Series K Securities, a beneficial conversion feature arises from the fact that the holders of the Series K Preferred Stock are able to acquire common stock of the Company at an effective conversion price that is less than the fair value as of the issuance date of December 24, 2008. Wave recorded a beneficial conversion feature discount of $501,600 in the quarter ended December 31, 2008. In addition, $233,585 was allocated to the Series K Warrants as an additional discount to the Series K Preferred Stock. After allocating $101,608 of commissions and fees on the Series K Preferred Stock, the remaining gross proceeds of $440,007 were allocated to the preferred stock. Wave followed ASC 505-10, formerly EITF 98-5 and EITF 00-27, in determining the beneficial conversion feature, whereby the proceeds were first allocated to the Series K Preferred Stock and the Series K warrants on a relative fair value basis. Wave utilized the Black-Scholes-Merton option pricing model to calculate the fair value of the Series K Warrants with the following assumptions:


Expected Life in years	3
Interest rate	1.1	%
Volatility	89.2	%
Dividend yield	0	%

The fair value of the Series K Preferred Stock was calculated as the number of shares of Class A Common Stock that the Series K Preferred Stock is convertible into, multiplied by the closing price of Wave's Class A Common Stock on NASDAQ on the closing date of this financing. The value of the beneficial conversion feature was calculated by multiplying the number of shares of Class A Common Stock that the Series K Preferred Stock was convertible into by the intrinsic value per share. The beneficial conversion feature discount was accreted on the closing date of the financing, as the Series K Preferred Stock was immediately convertible at the election of the holder thereof at any time.

As of December 31, 2008, the balance of the Series K Preferred Stock, net of all discounts, consisted of the following:


Gross offering proceeds	$	1,276,800
Fees and commissions deducted from proceeds		(101,608	)
Fair value of warrants issued to SRA		(60,192	)

Net Series K Preferred Stock after all fees		1,115,000

Additional discounts:
Series K Warrants		(173,393	)
Beneficial Conversion Feature (BCF)		(501,600	)

Total additional discounts		(674,993	)

Net Series K Preferred Stock after allocations		440,007

Accretion of discount related to BCF		501,600

Preferred Stock balance as of December 31, 2008	$	941,607

(b) Series J Preferred Stock

On October 30, 2008, Wave entered into subscription agreements, pursuant to which Wave sold and issued 111 shares of newly designated Series J Convertible Preferred Stock, par value $.01

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(7) Preferred Stock (Continued)

("Series J Preferred Stock"), to certain purchasers for an aggregate purchase price of $721,500. These shares were priced at $6,500 per share. Each share of Series J Preferred Stock also included a warrant to purchase up to 20,000 shares of Class A Common Stock for each share of Series J Preferred Stock purchased at an exercise price of $0.40 per share. The warrants expire in October 2013. Wave entered into a placement agency agreement with Security Research Associates, Inc. ("SRA") in which they acted as placement agent in connection with this offering. Wave paid SRA a fee equal to 6.0% of the gross proceeds of this offering. Additionally, Wave issued a warrant to SRA to purchase up to 66,600 shares of Class A Common Stock at an exercise price of $0.40 per share. The warrant expires in October 2011. Wave realized net cash proceeds of approximately $653,210 after deducting the placement agent fees of $43,290 and additional legal and other fees associated with the issuance of these securities which totaled approximately $25,000.

Prior to the automatic conversion on June 9, 2009, certain purchasers elected to convert 12 shares of the Series J Preferred Stock into 120,000 shares of Class A Common Stock. On June 9, 2009, all 79 remaining outstanding shares of the Series J Preferred Stock automatically converted into 790,000 shares of Class A Common Stock, as the average of the closing bid prices for the fifteen-day trading period ending June 9, 2009 was $1.001, exceeding the bid price target of $1.00 per share. Each share of Series J Preferred Stock issued in connection with the offering was convertible into 10,000 shares of Class A Common Stock at the election of the holder thereof at any time or automatically on the date on which the average closing price per share of Wave common stock for the 15 consecutive trading day period then ended equaled or exceeded $1.00.

On liquidation/dissolution, the Series J Preferred Stock would have ranked senior to the common stock, to the Series I Convertible Preferred Stock and to any other series of preferred stock that may hereafter be designated by the board of directors as junior to the Series J Preferred Stock. The liquidation value of each share of Series J Preferred Stock was $4,000. The shares subscribed to on October 30, 2008 were offered and issued pursuant to a shelf registration statement on Form S-3, which was filed by Wave on April 18, 2008 and declared effective by the Commission on June 23, 2008.

Pursuant to the Series J Convertible Preferred Stock Purchase Agreement (the "Series J Purchase Agreement"), each share of the Series J Preferred Stock issued in connection with this offering was convertible into 10,000 shares of Class A Common Stock at the election of the holder thereof at any time or automatically on the date on which the average closing price per share of Wave common stock for the 15 consecutive trading day period then ended equals or exceeds $1.00. The Series J Preferred Stock was convertible into 1,110,000 shares of Wave's Class A Common Stock at a conversion price of $0.65 per share. The excess of the proceeds of the Series J Preferred Stock over the estimated aggregate fair value of the Series J Preferred Stock upon conversion has been calculated as follows:


Shares of converted Class A Common Stock		1,110,000
Closing price on October 30, 2008	$	0.41

Aggregate fair value upon conversion	$	455,100
Gross proceeds of Series J Preferred Stock		721,500

Excess gross proceeds upon conversion	$	(266,400	)

As part of the transaction, Wave issued to the investors and SRA warrants to purchase shares of Class A Common Stock, with an initial exercise price of $0.40 per share. The investor warrants have a

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(7) Preferred Stock (Continued)

five (5) year life and the SRA warrants have a three (3) year life (the "Series J Warrants" and, together with Series J Preferred Stock, the "Series J Securities"). The Series J Warrants are exercisable for a total of 2,286,600 shares of Class A Common Stock beginning on the date of issuance. If exercised in full, the Series J Warrants would generate proceeds of up to an additional $914,640, at the exercise price.

In connection with the issuance of the Series J Securities, a beneficial conversion feature arises from the fact that the holders of the Series J Preferred Stock are able to acquire common stock of the Company at an effective conversion price that is less than the fair value as of the issuance date of October 30, 2008. Wave recorded a beneficial conversion feature discount of $155,400 in the quarter ended December 31, 2008. In addition, $438,681 was allocated to the Series J Warrants as an additional discount to the Series J Preferred Stock. After allocating $68,290 of commissions and fees on the Series J Preferred Stock, the remaining gross proceeds of $59,129 were allocated to the preferred stock. Wave followed ASC 505-10 in determining the beneficial conversion feature, whereby the proceeds were first allocated to the Series J Preferred Stock and the Series J warrants on a relative fair value basis. Wave utilized the Black-Scholes-Merton option pricing model to calculate the fair value of the Series J Warrants with the following assumptions:


Expected Life in years (investor/SRA)		5/3
Interest rate (investor/SRA)		2.8%/1.8%
Volatility		89.2%
Dividend yield		0%

The fair value of the Series J Preferred Stock was calculated as the number of shares of Class A Common Stock that the Series J Preferred Stock is convertible into, multiplied by the closing price of Wave's Class A Common Stock on NASDAQ on the closing date of this financing. The value of the beneficial conversion feature was calculated by multiplying the number of shares of Class A Common Stock that the Series J Preferred Stock was convertible into by the intrinsic value per share. The beneficial conversion feature discount was accreted on the closing date of the financing, as the Series J Preferred Stock was immediately convertible at the election of the holder thereof at any time.

As of December 31, 2008, the balance of the Series J Preferred Stock, net of all discounts, consisted of the following:


Gross offering proceeds	$	721,500
Fees and commissions deducted from proceeds		(68,290	)
Fair value of warrants issued to SRA		(15,984	)

Net Series J Preferred Stock after all fees		637,226

Additional discounts:
Series J Warrants		(422,697	)
Beneficial Conversion Feature (BCF)		(155,400	)

Total additional discounts		(578,097	)

Net Series J Preferred Stock after allocations		59,129
Accretion of discount related to BCF		155,400

Preferred Stock balance as of December 31, 2008	$	214,529

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(7) Preferred Stock (Continued)

(c) Series I Preferred Stock

On September 11, 2008, Wave entered into subscription agreements, pursuant to which Wave sold and issued 172 shares of newly designated 8% Series I Preferred Stock, par value $.01 ("Series I Preferred Stock"), to certain purchasers for an aggregate purchase price of $756,800. These shares were priced at $4,400 per share. Security Research Associates, Inc. ("SRA") entered into a placement agency agreement with Wave in which they acted as placement agent in connection with this offering. Wave paid SRA a fee equal to 6.0% of the gross proceeds of this offering. Additionally, Wave issued a warrant to SRA to purchase up to 103,200 shares of Class A Common Stock at an exercise price of $0.50 per share. This warrant expires in September 2011. Wave realized net proceeds of approximately $679,000 after deducting the placement agent fees of $45,408 and additional legal and other fees associated with the issuance of these securities which totaled approximately $33,000. On September 29, 2008, Wave entered into subscription agreements, pursuant to which Wave sold and issued 48 shares of Series I Preferred Stock, to certain purchasers for an aggregate purchase price of $211,200. These shares were priced at $4,400 per share. Wave realized net proceeds of approximately $181,000 after deducting legal and other fees associated with the issuance of these securities which totaled approximately $30,000.

On November 20, 2009, all of the shares issued in connection with these offerings automatically converted into Class A Common Stock as the average of the closing bid prices for the fifteen-day trading period ending November 20, 2009 was $1.110, exceeding the bid price target of $1.10 per share. Each share of Series I Preferred Stock issued in connection with the offering was convertible into 10,000 shares of Class A Common Stock at the election of the holder thereof at any time or automatically on the date on which the average closing price per share of Wave common stock for the 15 consecutive trading day period then ended equaled or exceeded $1.10.

On liquidation/dissolution, the Series I Preferred Stock would have ranked senior to the common stock and to any other series of preferred stock that may hereafter be designated by the board of directors as junior to the Series I Preferred Stock. Dividends accrued at 8% per annum, payable every six months in either cash or in shares of Wave common stock (at the Company's election) at a rate equal to $0.44 per share of Wave common stock. Wave paid $77,440 of dividends in cash during the year ended December 31, 2009. Dividend expense in connection with converted Series I Preferred Stock for year ended December 31, 2008 totaled $22,929. The shares subscribed to on September 29, 2008 and September 11, 2008 were offered and issued pursuant to a shelf registration statement on Form S-3, which was filed by Wave on April 18, 2008 and declared effective by the Commission on June 23, 2008.

(8) Common Stock

On August 12, 2009, Wave received gross proceeds of $2,800, in connection with the issuance of 10,000 shares of Class A Common Stock upon the exercise of a warrant that was granted to an investor as part of the December 24, 2008 Series K Preferred Stock financing. Additionally, during 2009, 17,361 shares of Class A Common Stock were issued to the placement agent upon the partial cashless exercise of a warrant that was granted to the placement agent as part of this financing.

On July 21, 2009 Wave entered into subscription agreements with certain purchasers, pursuant to which Wave agreed to sell and issue 1,791,738 shares of Class A Common Stock, par value $.01 per share, for an aggregate purchase price of $1,648,400. These shares were priced at $0.92 per share. Roth

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(8) Common Stock (Continued)

Capital Partners ("Roth") entered into a placement agency agreement with Wave in which Roth agreed to act as placement agent in connection with the offering. Wave agreed to pay Roth a fee equal to 8.0% of the gross proceeds of this offering. Wave also agreed to issue warrants to the subscribers to purchase up to 895,868 shares of Class A common stock at an exercise price of $1.155 per share. These warrants expire in January 2015. Wave realized net proceeds of approximately $1,489,000 after deducting the placement agent fees of $131,872 and additional legal and other fees associated with the issuance of these securities which totaled approximately $27,000. The shares sold on July 21, 2009 were offered and issued pursuant to a shelf registration statement on Form S-3, which was filed by Wave on April 18, 2008 and declared effective by the Commission on June 23, 2008.

On July 16, 2009, Wave entered into subscription agreements with certain purchasers, pursuant to which Wave agreed to sell and issue 3,448,042 shares of Class A Common Stock, par value $.01 per share, for an aggregate purchase price of $3,172,199. These shares were priced at $0.92 per share. Roth entered into a placement agency agreement with Wave in which Roth agreed to act as placement agent in connection with the offering. Wave agreed to pay Roth a fee equal to 8.0% of the gross proceeds of this offering. Wave also agreed to issue warrants to the subscribers to purchase up to 1,724,024 shares of Class A common stock at an exercise price of $1.155 per share. These warrants expire in January 2015. Wave realized net proceeds of approximately $2,687,000 after deducting the placement agent fees of $253,776 and additional legal and other fees associated with the issuance of these securities which totaled approximately $231,000. The shares sold on July 16, 2009 were offered and issued pursuant to a shelf registration statement on Form S-3, which was filed by Wave on April 18, 2008 and declared effective by the Commission on June 23, 2008.

On April 8, 2009, Wave entered into subscription agreements with certain purchasers, pursuant to which Wave agreed to sell and issue 1,881,136 shares of Class A Common Stock, par value $.01 per share, for an aggregate purchase price of $1,034,625. These shares were priced at $0.55 per share. Securities Research Associates, Inc. ("SRA") entered into a placement agency agreement with Wave in which they agreed to act as placement agent in connection with the offering. Wave agreed to pay SRA a fee equal to 6.0% of the gross proceeds of this offering. Wave also agreed to issue warrants to the subscribers to purchase up to 940,568 shares of Class A Common Stock at an exercise price of $0.55 per share. These warrants expire in April 2012. Additionally, Wave agreed to issue a warrant to SRA to purchase up to 112,868 shares of Class A Common Stock at an exercise price of $0.55 per share. This warrant expires in April 2012. Wave realized net proceeds of approximately $942,500 after deducting the placement agent fees of $62,077 and additional legal and other fees associated with the issuance of these securities which totaled approximately $30,000. On July 21, 2009, Wave received gross proceeds of $6,875, in connection with the issuance of 12,500 shares of Class A Common Stock upon the exercise of a warrant that was granted to an investor as part of this financing. The shares sold on April 8, 2009 were offered and issued pursuant to a shelf registration statement on Form S-3, which was filed by Wave on April 18, 2008 and declared effective by the Commission on June 23, 2008.

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(8) Common Stock (Continued)

On March 13, 2009, Wave entered into subscription agreements with certain purchasers, pursuant to which Wave agreed to sell and issue 785,000 shares of Class A Common Stock, par value $.01 per share, for an aggregate purchase price of $431,750. These shares were priced at $0.55 per share. SRA entered into a placement agency agreement with Wave in which they agreed to act as placement agent in connection with the offering. Wave agreed to pay SRA a fee equal to 6.0% of the gross proceeds of this offering. Wave also agreed to issue warrants to the subscribers to purchase up to 392,500 shares of Class A Common Stock at an exercise price of $0.55 per share. These warrants expire in March 2012. Additionally, Wave agreed to issue a warrant to SRA to purchase up to 47,100 shares of Class A Common Stock at an exercise price of $0.55 per share. This warrant expires in March 2012. Wave realized net proceeds of approximately $376,000 after deducting the placement agent fees of $25,905 and additional legal and other fees associated with the issuance of these securities which totaled approximately $30,000. On July 21, 2009, Wave received gross proceeds of $48,125, in connection with the issuance of 87,500 shares of Class A Common Stock upon the exercise of a warrant that was granted to an investor as part of this financing. The shares sold on March 13, 2009 were offered and issued pursuant to a shelf registration statement on Form S-3, which was filed by Wave on April 18, 2008 and declared effective by the Commission on June 23, 2008.

On August 11, 2008, Wave entered into subscription agreements, pursuant to which Wave sold and issued 1,368,333 shares of Class A Common Stock, par value $.01 per share, to certain purchasers for an aggregate purchase price of $821,000. These shares were priced at $0.60 per share. SRA entered into a placement agency agreement with Wave in which they acted as placement agent in connection with the offering. Wave paid SRA a fee equal to 6.0% of the gross proceeds of this offering. Wave also issued warrants to the purchasers to purchase up to 342,083 shares of Class A Common Stock at an exercise price of $0.65 per share. These warrants expire in August 2011. Wave also issued a warrant to SRA to purchase up to 82,100 shares of Class A Common Stock at an exercise price of $0.65 per share. This warrant expires in August 2011. Wave realized net proceeds of approximately $742,000 after deducting the placement agent fees of $49,260 and additional legal and other fees associated with the issuance of these securities which totaled approximately $30,000. During 2009, 3,659 shares of Class A Common Stock were issued to the placement agent upon the cashless exercise of a warrant that was granted to the placement agent as part of this financing. The shares subscribed to on August 11, 2008 were offered and issued pursuant to a shelf registration statement on Form S-3, which was filed by Wave on April 18, 2008 and declared effective by the Commission on June 23, 2008.

On June 30, 2008, Wave entered into subscription agreements, pursuant to which Wave agreed to sell and issue 1,880,500 shares of Class A Common Stock, par value $.01 per share, to certain purchasers for an aggregate purchase price of $1,598,425. These shares were priced at $0.85 per share. SRA entered into a placement agency agreement with Wave in which they agreed to act as placement agent in connection with the offering. Wave agreed to pay SRA a fee equal to 6.0% of the gross proceeds of this offering. Wave also agreed to issue warrants to the subscribers to purchase up to 470,125 shares of Class A Common Stock at an exercise price of $0.90 per share. These warrants expire in June 2011. Additionally, Wave agreed to issue a warrant to SRA to purchase up to 112,830 shares of Class A Common Stock at an exercise price of $0.90 per share. This warrant expires in June 2011. Wave realized net proceeds, in early July, of approximately $1,467,000 after deducting the placement agent fees of $95,906 and additional legal and other fees associated with the issuance of these securities which totaled approximately $36,000. On November 20, 2009, Wave received gross proceeds of $45,000, in connection with the issuance of 50,000 shares of Class A Common Stock upon the exercise of a

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(8) Common Stock (Continued)

warrant that was granted to an investor as part of this financing. Additionally, 30,178 shares of Class A Common Stock were issued to the placement agent upon the cashless exercise of the warrant that was granted to the placement agent as part of this financing. The shares subscribed to on June 30, 2008 were issued in early July and offered and issued pursuant to a shelf registration statement on Form S-3, which was filed by Wave on April 18, 2008 and declared effective by the Commission on June 23, 2008.

On May 23, 2008, Wave entered into subscription agreements, pursuant to which Wave agreed to sell and issue 2,151,250 shares of Class A Common Stock, par value $.01 per share, to certain purchasers for an aggregate purchase price of $1,721,000. These shares were priced at $0.80 per share. SRA entered into a placement agency agreement with Wave in which they agreed to act as placement agent in connection with the offering. Wave agreed to pay SRA a fee equal to 6.0% of the gross proceeds of this offering. Wave also agreed to issue warrants to the subscribers to purchase up to 537,812 shares of Class A Common Stock at an exercise price of $0.85 per share. These warrants expire in May 2011. Additionally, Wave agreed to issue a warrant to SRA to purchase up to 129,075 shares of Class A Common Stock at an exercise price of $0.85 per share. This warrant expires in November 2009. Wave realized net proceeds of approximately $1,587,000 after deducting the placement agent fees of $103,260 and additional legal and other fees associated with the issuance of these securities which totaled approximately $31,000. During 2009, 28,339 shares of Class A Common Stock were issued to the placement agent upon the cashless exercise of a warrant that was granted to the placement agent as part of this financing. The shares sold on May 23, 2008 were offered and issued pursuant to a shelf registration statement on Form S-3, which was filed by Wave on March 20, 2007 and declared effective by the Commission on April 27, 2007.

On February 29, 2008, Wave entered into subscription agreements, pursuant to which Wave agreed to sell and issue 3,173,500 shares of Class A Common Stock, par value $.01 per share, to certain purchasers for an aggregate purchase price of $3,490,850. These shares were priced at $1.10 per share. SRA entered into a placement agency agreement with Wave in which they agreed to act as placement agent in connection with the offering. Wave agreed to pay SRA a fee equal to 6.0% of the gross proceeds of this offering. Wave also agreed to issue warrants to the subscribers to purchase up to 952,050 shares of Class A Common Stock at an exercise price of $1.15 per share. These warrants expire in February 2013. Additionally, Wave agreed to issue a warrant to SRA to purchase up to 190,410 shares of Class A Common Stock at an exercise price of $1.33 per share. This warrant expires on February 28, 2010. Wave realized net proceeds of approximately $3,220,000 after deducting the placement agent fees of $209,451 and additional legal and other fees associated with the issuance of these securities which totaled approximately $61,000. The shares sold on February 29, 2008 were offered and issued pursuant to a shelf registration statement on Form S-3, which was filed by Wave on March 20, 2007 and declared effective by the Commission on April 27, 2007.

On May 24, 2007, Wave entered into subscription agreements, pursuant to which Wave agreed to sell and issue 7,317,073 shares of Class A Common Stock, par value $0.01 per share, to certain purchasers for an aggregate purchase price of $15,000,000. These shares were priced at $2.05 per share. SRA entered into a placement agency agreement with Wave in which they agreed to act as placement agent in connection with the offering. Wave agreed to pay SRA a fee equal to 5.0% of the gross proceeds of this offering. Wave also agreed to issue a warrant to SRA to purchase up to 365,853 shares of Class A Common Stock at an exercise price of $2.58 per share. The Warrant expired on May 24, 2009. Wave realized net proceeds of approximately $14,229,331 after deducting the placement agent fees of $750,000 and additional legal and other fees associated with the issuance of these securities

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(8) Common Stock (Continued)

which totaled $20,669. The shares sold on May 24, 2007 were offered and issued pursuant to a shelf registration statement on Form S-3, which was filed by Wave on March 20, 2007 and declared effective by the Commission on April 27, 2007.

On June 1, 2009, Wave issued 365,498 shares of Class A Common Stock to Wave employees for $0.28 per share, pursuant to the Wave 2004 Employee Stock Purchase Plan. Wave received proceeds of $102,522, from the issuance of these shares.

On December 1, 2008, Wave issued 150,201 shares of Class A Common Stock to Wave and Wavexpress employees for $0.28 per share, pursuant to the Wave 2004 Employee Stock Purchase Plan. Wave received proceeds of $42,131, from the issuance of these shares.

On June 1, 2008, Wave issued 209,857 shares of Class A Common Stock to Wave and Wavexpress employees for $0.89 per share, pursuant to the Wave 2004 Employee Stock Purchase Plan. Wave received proceeds of $187,297, from the issuance of these shares.

On December 1, 2007, Wave issued 127,420 shares of Class A Common Stock to Wave and Wavexpress employees for $1.20 per share, pursuant to the Wave 2004 Employee Stock Purchase Plan. Wave received proceeds of $152,712, from the issuance of these shares.

On June 1, 2007, Wave issued 91,746 shares of Class A Common Stock to Wave and Wavexpress employees for $1.83 per share, pursuant to the Wave 2004 Employee Stock Purchase Plan. Wave received proceeds of $167,665, from the issuance of these shares.

(9) Share-based Compensation

In January 1994, Wave adopted the 1994 Employee Stock Option Plan (the "1994 Plan"). The total number of shares of Class A Common Stock reserved for issuance under the 1994 Plan, as amended is 14,000,000 shares. The 1994 Plan Expires on July 1, 2014. Under the 1994 Plan, both incentive stock options and non-qualified stock options may be granted to officers, key employees and other persons providing services to Wave. Options granted under the plan generally vest over three years and expire ten years from the date of grant. In January 1994, Wave adopted the Non-Employee Directors Stock Option Plan (the "Directors' Plan"). The total number of shares of Class A Common Stock reserved for issuance under the Directors' Plan, as amended, is 1,000,000 shares. Under the Directors' Plan, as amended, each director who is not an employee of Wave receives an initial grant of options to purchase 12,000 shares of Class A Common Stock; and an additional annual grant to purchase 10,000 shares on the day immediately following each of the dates on which an incumbent director is reelected. The options granted to non-employee directors vest on the day following the grant and expire ten years from the date of grant. Under all of Wave's stock option plans, options are granted with exercise prices that approximate fair market value at the date of grant. All of Wave's stock option plans and amendments thereto have been approved by shareholder vote.

In November 2004 Wave adopted the 2004 Employee Stock Purchase Plan (the "Purchase Plan") pursuant to which a total of 2,000,000 shares of Wave's Class A Common Stock may be sold to eligible employees at a 15% discount from the market value of the shares. The Purchase Plan was approved by

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(9) Share-based Compensation (Continued)

a vote of Wave's shareholders. Under the terms of the Purchase Plan, employees may elect to have withheld up to 15% of their base earnings to purchase these shares during each offering period, up to a maximum of $25,000 in market value of Wave's Class A Common Stock. Offering periods commence on June 1st and December 1st and are for a period of six months. The purchase price under the Purchase Plan is 85% of the lesser of the market price on the beginning or the ending of the offering period.

On January 1, 2006, Wave adopted the provisions and guidance under ASC Topic 718"Compensation—Stock Compensation" ("ASC 718"), formerly SFAS No. 123(R), which requires the measurement and recognition of compensation expense for all stock-based payment awards made to employees and directors including employee stock options and employee stock purchases based on estimated fair values. In March 2005, the Securities and Exchange Commission issued S99-4, formerly Staff Accounting Bulletin No. 107, relating to ASC 718. The Company has applied the provisions of S99-4 in its adoption of ASC 718.

ASC 718 requires companies to estimate the fair value of stock-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Company's consolidated statement of operations. ASC 718 supersedes Wave's previous accounting under the former provisions of SFAS No. 123,"Accounting for Stock-Based Compensation". As permitted by the former SFAS No. 123, Wave measured compensation cost for options granted prior to January 1, 2006, in accordance with Accounting Principles Board Opinion (APB) No. 25,"Accounting for Stock Issued to Employees" ("APB No. 25") and related interpretations. Accordingly, no accounting recognition was given to stock options granted at fair market value until they were exercised. Upon exercise, net proceeds, including tax benefits realized, were credited to equity.

Wave adopted ASC 718 using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006. In accordance with the modified prospective transition method, Wave's consolidated financial statements for prior periods have not been restated to reflect, and do not include, the impact of ASC 718. Stock-based compensation expense recognized under ASC 718 for the years ended December 31, 2009, 2008 and 2007 was $1,724,874, $2,105,941 and $1,969,271, respectively. ASC 718 requires that the classification of the cost of share based compensation, in the statement of operations, is consistent with the nature of the services being rendered in exchange for the share based payment.

The following table summarizes the effect of share based compensation in Wave's statement of operations for the years ended December 31:

	2009		2008		2007

Cost of Sales	$	49,038	$	28,896	$	19,247
Selling, General & Administrative		1,068,314		1,309,729		1,230,392
Research & Development		607,522		767,316		719,632

Total	$	1,724,874	$	2,105,941	$	1,969,271

Wave uses the Black-Scholes-Merton option pricing model to value stock options. The Black-Scholes-Merton model requires the use of employee exercise behavior data and the use of a number of assumptions including volatility of the company's stock price, the weighted-average risk-free interest

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(9) Share-based Compensation (Continued)

rate and the weighted-average expected term of the options. As Wave does not pay dividends on it Class A common stock, the dividend rate variable in the Black-Scholes-Merton model is zero. The following values for the indicated variables were used to value options granted during the years ended December 31:

	2009				2008

	Stock Option Plans		Stock Purchase Plan		Stock Option Plans		Stock Purchase Plan
Expected Term (in years)		5 Years		6 Months		5 Years		6 Months
Risk-free Rate—range		1.75% - 2.75%		0.15% - 0.29%		2.34% - 3.33%		0.44% - 1.99%
Risk-free Rate—wt. avg.		1.83%		0.25%		2.81%		1.34%
Expected Volatility—range		75.2% - 78.1%		52.2% - 67.7%		83.7% - 97.9%		44.8% - 69.2%
Expected Volatility—wt. avg.		75.52%		63.18%		97.38%		54.97%
Dividend Yield		0%		0%		0%		0%

The volatility assumptions are based on the historical weekly price data of Wave's stock over a period equivalent to the weighted average expected term of the options. Management did not identify any factors during that period which were unusual and which would distort the volatility figure if used to estimate future volatility.

The risk-free interest rate assumption is based upon the implied yield available on U.S. Treasury zero-coupon issues with a remaining term equal to the expected term of the option granted.

The expected term of employee stock options represents the weighted average period that the stock options are expected to remain outstanding. For Wave's stock option plans, it is based upon an analysis of the historical behavior of option holders during the period from January 1, 1999 to December 31, 2008. Management believes historical data is representative of future exercise behavior. For Wave's Employee Stock Purchase Plan, the expected term of six months, is the length of each purchase period, pursuant to the plan.

As stock-based compensation expense recognized in the consolidated statement of operations pursuant to ASC 718 is based on awards ultimately expected to vest, expense for grants beginning upon adoption of ASC 718 on January 1, 2006 is reduced for estimated forfeitures. The estimated forfeiture rate used in the calculation of share-based compensation expense was approximately 19% for the year ended December 31, 2009, 2008 and 2007. ASC 718 requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures are estimated based on historical experience.

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(9) Share-based Compensation (Continued)

A summary of option activity for all Wave option plans through December 31, 2009 follows:

	2009					2008					2007

	Number of Shares			Weighted Average Exercise Price		Number of Shares			Weighted Average Exercise Price		Number of Shares			Weighted Average Exercise Price
Balance at beginning of year		6,528,296		$	6.24		6,916,478		$	6.80		4,825,928		$	8.97
Granted		3,242,900			0.82		932,300			1.67		2,313,667			2.15
Forfeited		(105,654	)		1.27		(507,127	)		2.00		(127,913	)		2.31
Expired		(588,065	)		9.74		(813,355	)		8.42		(91,889	)		10.25
Exercised		—					—					(3,315	)		2.43

Balance at end of year		9,077,477			4.13		6,528,296			6.24		6,916,478			6.80

Exercisable at end of year		4,907,817		$	6.70		4,311,378		$	8.44		3,936,647		$	10.33

Additional shares available for grant at end of year		4,593,175					3,970,837					3,933,187

The weighted average grant date fair value of options granted during the years ended December 31, 2009, 2008 and 2007 was $0.51, $1.24 and $1.59, respectively.

The weighted average remaining contractual term for options outstanding and options exercisable at December 31, 2009 were 6.7 and 4.9 years, respectively.

As of December 31, 2009, unrecognized stock-based compensation related to stock options was approximately $996,000. At December 31, 2009, the weighted average period this cost is expected to be expensed is 2.0 years. The total fair value of shares that vested during the years ended December 31, 2009, 2008 and 2007 was approximately $1,682,000, $1,988,000 and $1,561,000, respectively.

As of December 31, 2009, the intrinsic value of outstanding, vested and currently exercisable share options was approximately $594,000.

The following table summarizes information about stock options outstanding under the Wave stock options plans as of December 31, 2009:

	Options Outstanding						Options Exercisable

Exercise Price Range	Number Outstanding		Weighted Average Remaining Contractual Life		Weighted Average Exercise Price		Number Exercisable		Weighted Average Exercise Price
$0.25 - $1.00		3,167,250		9.1	$	0.81		120,529	$	0.87
$1.01 - $2.00		2,540,449		7.4		1.85		1,665,231		1.88
$2.01 - $2.50		1,025,839		6.5		2.40		786,918		2.39
$2.51 - $3.00		349,517		3.5		2.97		340,717		2.98
$3.01 - $5.00		521,079		4.4		3.69		521,079		3.69
$5.01 - $10.00		677,437		3.1		5.65		677,437		5.65
$10.01 - $25.00		406,343		1.1		12.70		406,343		12.70
$25.01 - $112.50		389,563		.2		40.62		389,563		40.62

		9,077,477		6.7	$	4.13		4,907,817	$	6.70

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(9) Share-based Compensation (Continued)

1999 Wavexpress Stock Incentive Plan

In April 2000, the board of directors of Wavexpress authorized the establishment of a stock option plan. The total number of shares of Wavexpress' Class A Common Stock subject to the Plan is 2,500,000. Options terminate upon the earlier of the date of expiration of the option or upon termination of the employment relationship between Wavexpress and the optionee for any reason other than death, disability or retirement.

Employees are entitled to exercise their options on dates determined by Wavexpress' Compensation Committee of the Board of Directors. Vesting provisions for options granted generally range from immediate vesting to pro rata vesting over a three-year period.

Stock option activity during 2009, 2008 and 2007 is as follows:

	2009					2008				2007

	Number of Shares			Weighted Average Exercise Price		Number of Shares		Weighted Average Exercise Price		Number of Shares			Weighted Average Exercise Price
Balance at Beginning of year		624,663		$	1.23		624,663	$	1.23		637,163		$	1.23
Granted		—			—		—		—		—			—
Canceled		(68,400	)		—		—		—		(12,500	)		1.20

Balance at end of year		556,263			1.23		624,663		1.23		624,663			1.23

Exercisable at end of year		556,263		$	1.23		624,663	$	1.23		624,663		$	1.23

Additional shares available for grant at end of year		1,915,960					1,847,560				1,847,560

No options were granted under the Wavexpress stock option plan during the years ended December 31, 2009, 2008 and 2007.

The following table summarizes information about Wavexpress' stock options outstanding at December 31, 2009:

	Options Outstanding						Options Exercisable

Exercise Price	Number Outstanding		Weighted Average Remaining Contractual Life (in years)		Weighted Average Exercise Price		Number Exercisable		Weighted Average Exercise Price
$1.20		548,066		2.3	$	1.20		548,066	$	1.20
$3.00 - $4.50		8,197		0.6		3.37		8,197		3.37

$1.20 - $4.50		556,263		2.3	$	1.23		556,263	$	1.23

Employee Stock Purchase Plan

In November 2004, the Board of Directors adopted the Wave Systems Corp. 2004 Employee Stock Purchase sold to eligible employees at a 15% discount from the market value of the shares. The Purchase Plan was ratified by a shareholder vote at Wave's 2005 annual shareholder meeting on

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(9) Share-based Compensation (Continued)

May 23, 2005. Under the terms of the Purchase Plan, employees may elect to have withheld, up to 15% of their base earnings to purchase these shares during each offering period, up to a maximum of $25,000 in market value of Wave's Class A Common Stock. Offering periods commence on June 1st and December 1st and are for a period of six months. The purchase price under the Purchase Plan is 85% of the lesser of the market price on the beginning or the ending of the offering period. Approximately 30%, 22% and 34% of eligible employees participated in the Purchase Plan for the years ended December 31, 2009, 2008 and 2007, respectively. For the year ended December 31, 2009 employees purchased 517,633 shares of Wave Class A Common Stock at an average share price of $0.50 per share, for an aggregate of $260,285 in proceeds to Wave. For the year ended December 31, 2008 employees purchased 360,058 shares of Wave Class A Common Stock at an average share price of $0.64 per share, for an aggregate of $229,428 in proceeds to Wave. For the year ended December 31, 2007 employees purchased 219,166 shares of Wave Class A Common Stock at an average share price of $1.46 per share, for an aggregate of $328,432 in proceeds to Wave.

(10) Warrants

On July 21, 2009, Wave issued warrants to investors to purchase up to 895,868 shares of Class A Common Stock pursuant to which Wave sold and issued 1,791,738 shares of Class A Common Stock, par value $.01 per share for an aggregate purchase price of $1,648,400. The warrants are exercisable at an exercise price of $1.155 per share and expire on January 21, 2015. If exercised in full, the investor warrants granted in connection with this financing may generate up to an additional $1,034,728, at the exercise price. All of the warrants granted in connection with the July 21, 2009 financing remain outstanding as of December 31, 2009.

On July 16, 2009, Wave issued warrants to investors to purchase up to 1,724,024 shares of Class A Common Stock pursuant to which Wave sold and issued 3,448,042 shares of Class A Common Stock, par value $.01 per share for an aggregate purchase price of $3,172,199. The warrants are exercisable at an exercise price of $1.155 per share and expire on January 16, 2015. If exercised in full, the investor warrants granted in connection with this financing may generate up to an additional $1,991,248, at the exercise price. All of the warrants granted in connection with the July 21, 2009 financing remain outstanding as of December 31, 2009.

On April 8, 2009, Wave issued warrants to investors to purchase up to 940,568 shares of Class A Common Stock pursuant to which Wave sold and issued 1,881,136 shares of Class A Common Stock, par value $.01 per share for an aggregate purchase price of $1,034,625. The warrants are exercisable at an exercise price of $0.55 per share and expire on April 8, 2012. If exercised in full, the investor warrants granted in connection with this financing may generate up to an additional $517,312, at the exercise price. Wave also issued to a placement agent warrants to purchase up to 112,868 shares of Class A Common Stock, in connection with a securities purchase agreement. The warrants are exercisable at an exercise price of $0.55 per share and expire on April 8, 2012. If exercised in full, the warrants granted to the placement agent may generate up to an additional $62,077, at the exercise price. On July 21, 2009, Wave received gross proceeds of $6,875, in connection with the issuance of 12,500 shares of Class A Common Stock upon the exercise of a warrant that was granted to an investor as part of this financing. All of the remaining warrants granted in connection with the April 8, 2009 financing are outstanding as of December 31, 2009.

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(10) Warrants (Continued)

On March 13, 2009, Wave issued warrants to investors to purchase up to 392,500 shares of Class A Common Stock pursuant to which Wave sold and issued 785,000 shares of Class A Common Stock, par value $.01 per share for an aggregate purchase price of $431,750. The warrants are exercisable at an exercise price of $0.55 per share and expire on March 13, 2012. If exercised in full, the investor warrants granted in connection with this financing may generate up to an additional $215,875, at the exercise price. Wave also issued to a placement agent warrants to purchase up to 47,100 shares of Class A Common Stock, in connection with a securities purchase agreement. The warrants are exercisable at an exercise price of $0.55 per share and expire on March 13, 2012. If exercised in full, the warrants granted to the placement agent may generate up to an additional $25,905, at the exercise price. On July 21, 2009, Wave received gross proceeds of $48,125, in connection with the issuance of 87,500 shares of Class A Common Stock upon the exercise of a warrant that was granted to an investor as part of this financing. All of the remaining warrants granted in connection with the March 13 2009 financing are outstanding as of December 31, 2009.

On December 24, 2008, Wave issued warrants to investors to purchase up to 1,140,000 shares of Class A Common Stock pursuant to which Wave sold and issued 456 shares of 8% Series K Convertible Preferred Stock, par value $.01 per share for an aggregate purchase price of $1,276,800. The warrants are exercisable at an exercise price of $0.28 per share and expire on December 24, 2011. If exercised in full, the investor warrants granted in connection with this financing may generate up to an additional $319,200, at the exercise price. Wave also issued to a placement agent warrants to purchase up to 273,600 shares of Class A Common Stock, in connection with a securities purchase agreement. The warrants are exercisable at an exercise price of $0.28 per share and expire on December 24, 2011. If exercised in full, the warrants granted to the placement agent may generate up to an additional $76,608, at the exercise price. On August 12, 2009, Wave received gross proceeds of $2,800, in connection with the issuance of 10,000 shares of Class A Common Stock upon the exercise of a warrant that was granted to an investor as part of this financing. Additionally, 17,361 shares of Class A Common Stock were issued to the placement agent upon the cashless exercise of a warrant that was granted to the placement agent as part of this financing. All of the remaining warrants granted in connection with the December 24, 2008 financing are outstanding as of December 31, 2009.

On October 30, 2008, Wave issued warrants to investors to purchase up to 2,220,000 shares of Class A Common Stock pursuant to which Wave sold and issued 111 shares of Series J Convertible Preferred Stock, par value $.01 per share for an aggregate purchase price of $721,500. The warrants are exercisable at an exercise price of $0.40 per share and expire on October 30, 2013. If exercised in full, the investor warrants granted in connection with this financing may generate up to an additional $888,000, at the exercise price. Wave also issued to a placement agent warrants to purchase up to 66,600 shares of Class A Common Stock, in connection with a securities purchase agreement. The warrants are exercisable at an exercise price of $0.40 per share and expire on October 30, 2011. If exercised in full, the warrants granted to the placement agent may generate up to an additional $26,640, at the exercise price. All of the warrants granted in connection with the October 30, 2008 financing remain outstanding as of December 31, 2009.

On September 11, 2008, Wave issued to a placement agent warrants to purchase up to 103,200 shares of Class A Common Stock, in connection with a securities purchase agreement, pursuant to which Wave sold and issued 172 shares of 8% Series I Preferred Stock, par value $.01 per share for an aggregate purchase price of $756,800. The warrants are exercisable at an exercise price of $0.50 per share and expire on September 11, 2011. If exercised in full, the warrants granted in connection with

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(10) Warrants (Continued)

this financing may generate up to an additional $51,600, at the exercise price. All of the warrants granted in connection with the September 11, 2008 securities purchase agreement remain outstanding as of December 31, 2008.

On August 11, 2008, Wave issued warrants to investors to purchase up to 342,083 shares of Class A Common Stock pursuant to which Wave sold and issued 1,368,333 shares of Class A Common Stock, par value $.01 per share for an aggregate purchase price of $821,000. The warrants are exercisable at an exercise price of $0.65 per share and expire on August 11, 2011. If exercised in full, the investor warrants granted in connection with this financing may generate up to an additional $222,354, at the exercise price. Wave also issued to a placement agent warrants to purchase up to 82,100 shares of Class A Common Stock, in connection with a securities purchase agreement. The warrants are exercisable at an exercise price of $0.65 per share and expire on February 11, 2010. If exercised in full, the warrants granted to the placement agent may generate up to an additional $53,365, at the exercise price. During 2009, 3,659 shares of Class A Common Stock were issued to the placement agent upon the cashless exercise of a warrant that was granted to the placement agent as part of this financing. All of the remaining warrants granted in connection with the August 11, 2008 financing are outstanding as of December 31, 2009.

On June 30, 2008, Wave issued warrants to investors to purchase up to 470,125 shares of Class A Common Stock pursuant to which Wave sold and issued 1,880,500 shares of Class A Common Stock, par value $.01 per share for an aggregate purchase price of $1,598,425. The warrants are exercisable at an exercise price of $0.90 per share and expire on June 30, 2011. If exercised in full, the investor warrants granted in connection with this financing may generate up to an additional $423,113, at the exercise price. Wave also issued to a placement agent warrants to purchase up to 112,830 shares of Class A Common Stock, in connection with a securities purchase agreement. The warrants are exercisable at an exercise price of $0.90 per share and expire on December 31, 2009. If exercised in full, the warrants granted to the placement agent may generate up to an additional $101,547, at the exercise price. On November 20, 2009, Wave received gross proceeds of $45,000, in connection with the issuance of 50,000 shares of Class A Common Stock upon the exercise of a warrant that was granted to an investor as part of this financing. Additionally, 30,178 shares of Class A Common Stock were issued to the placement agent upon the cashless exercise of the warrant that was granted to the placement agent as part of this financing. All of the remaining warrants granted in connection with the June 30, 2008 financing are outstanding as of December 31, 2009.

On May 23, 2008, Wave issued warrants to investors to purchase up to 537,812 shares of Class A Common Stock pursuant to which Wave sold and issued 2,151,250 shares of Class A Common Stock, par value $.01 per share for an aggregate purchase price of $1,721,000. The warrants are exercisable at an exercise price of $0.85 per share and expire on May 23, 2011. If exercised in full, the investor warrants granted in connection with this financing may generate up to an additional $457,140, at the exercise price. Wave also issued to a placement agent warrants to purchase up to 129,075 shares of Class A Common Stock, in connection with a securities purchase agreement. The warrants are exercisable at an exercise price of $0.85 per share and expire on November 23, 2009. If exercised in full, the warrants granted to the placement agent may generate up to an additional $109,714, at the exercise price. During 2009, 28,339 shares of Class A Common Stock were issued to the placement agent upon the cashless exercise of a warrant that was granted to the placement agent as part of this financing. All of the remaining warrants granted in connection with the May 23, 2008 financing are outstanding as of December 31, 2009.

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(10) Warrants (Continued)

On February 29, 2008, Wave issued warrants to investors to purchase up to 952,050 shares of Class A Common Stock pursuant to which Wave sold and issued 3,173,500 shares of Class A Common Stock, par value $.01 per share for an aggregate purchase price of $3,490,850. The warrants are exercisable at an exercise price of $1.15 per share and expire on February 29, 2013. If exercised in full, the investor warrants granted in connection with this financing may generate up to an additional $1,094,858, at the exercise price. Wave also issued to a placement agent warrants to purchase up to 190,410 shares of Class A Common Stock, in connection with a securities purchase agreement. The warrants are exercisable at an exercise price of $1.33 per share and expire on February 29, 2010. If exercised in full, the warrants granted to the placement agent may generate up to an additional $253,245, at the exercise price. All of the warrants granted in connection with the February 29, 2008 financing remain outstanding as of December 31, 2009.

In connection with an agreement that Wave entered into with an outside software development consultant, on August 7, 2007, Wave issued a warrant to purchase up to 5,000 shares of Class A Common Stock at a price of $1.99 per share. The fair market value of these warrants was approximately $7,300 and was recorded as consultant expense in 2007. This warrant became exercisable on August 7, 2008 and expires August 7, 2012.

On May 24, 2007, Wave issued to a placement agent warrants to purchase up to 365,853 shares of Class A Common Stock, in connection with a securities purchase agreement, pursuant to which Wave sold and issued 7,317,073 shares of Class A Common Stock, par value $.01 per share for an aggregate purchase price of $15,000,000. The warrants were exercisable at an exercise price of $2.58 per share and expired unexercised on May 24, 2009.

In connection with an agreement that Wave entered into with an outside sales representative, Wave issued warrants to purchase 14,788 shares of Class A Common Stock at prices ranging from $2.85 to $4.35 per share, pursuant to an individual compensation plan with the sales representative. The fair market value of these warrants was approximately $146,000 and was recorded as consultant expense in 2003. No additional warrants are required to be granted pursuant to the individual compensation plan for the sales representative. These warrants are currently exercisable and expire January 1, 2013 through April 30, 2013.

A summary of warrants outstanding at December 31, 2009, follows:

	Warrants Outstanding						Warrants Exercisable

Exercise Price	Number of Shares		Weighted Average Remaining Contractual Life (in years)		Weighted Average Exercise Price		Number of Shares		Weighted Average Exercise Price
$0.25 - $0.50		3,769,928		3.0	$	0.36		3,769,928	$	0.36
$0.51 - $1.00		2,768,318		1.8	$	0.68		2,768,318	$	0.68
$1.01 - $2.00		3,767,352		4.3	$	1.16		3,767,352	$	1.16
$2.01 - $4.35		14,788		3.2	$	3.38		14,788	$	3.38

		10,320,386		3.2	$	0.74		10,320,386	$	0.74

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(11) Wavexpress

Wave offered broadband content distribution products and services through Wavexpress and its TVTonic consumer media service, which was a joint venture between Wave and Sarnoff Corporation. On September 23, 2008, Wave, Sarnoff Corporation and Wavexpress entered into a Restructuring Agreement and an Amended and Restated Stockholder Agreement whereby, among other things, the parties agreed to terminate the Joint Venture Agreement between the parties, dated October 15, 1999. Under the original joint venture agreement, Sarnoff and its affiliates received a 40% equity stake in Wavexpress. Wave received a 53% equity interest, and its affiliates, who purchased founders stock in April 1999 for a nominal amount, owned the remaining 7% of the outstanding capital stock. The affiliates of Wave include Peter Sprague, the former Chairman of Wave and Steven Sprague, the Chief Executive Officer of Wave, certain members of the Board of Directors of Wave and certain Wave employees.

On December 1, 2008, Wavexpress announced that it had suspended its TVTonic consumer media service and was exploring opportunities to sell or license its technology to third parties that may provide "download and play" services. As of December 31, 2008, the New York, NY facility was closed. The engineering staff was terminated. A small engineering and management staff remain in place at the Cupertino, CA office in order to support efforts to license or sell the Wavexpress technology to third parties. An impairment charge of $447,128 was recorded to reflect the write-off of impaired assets, consisting primarily of computer equipment, including equipment collateralizing a capital lease obligation (see note 12).

Wave has funded Wavexpress through a series of convertible notes, some with attached warrants. The notes bear interest at the rate of 2% to 3% above the Prime Rate of Chase Manhattan Bank. Generally, the notes are convertible into shares of common stock of Wavexpress at varying prices per share. Through December 31, 2009, Wave has funded Wavexpress with approximately $46,921,000 in cash, plus approximately $29,866,000 in accrued interest. Such amounts include approximately $9,500,000 that automatically converted into 1,826,571 additional shares of Wavexpress at an average conversion price of $5.20 per share. These amounts are eliminated in consolidation.

As of December 31, 2009, Wave owned 97.3% of Wavexpress, while Sarnoff owned 1.7% (on a fully diluted basis). None of the minority shareholders have provided, or are obligated to provide, funding to Wavexpress. Accordingly, the financial statements of Wavexpress have been included in the consolidated financial statements of Wave for all periods presented herein. In addition, Wave has not recorded a minority interest in Wavexpress in the consolidated financial statements and therefore has reflected 100% of Wavexpress' balance sheet and operating results in its consolidated financial statements. Wavexpress has incurred net operating losses of approximately $631,000, $4.1 million and $2.9 million, for the years ended December 31, 2009, 2008 and 2007, respectively.

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(12) Commitments and Contingencies

Operating Leases

Summarized below is a listing of properties leased by Wave pursuant to non-cancelable operating leases. Wave's principal research and development activities are conducted at the Princeton and Cupertino facilities.

Location	Annual Lease Cost		Lease Expiration Date

Lee, MA	$	144,545	Jan. 2011
Princeton, NJ		68,320	Dec. 2014
Cupertino, CA		528,953	Feb. 2013
Orvault, France		13,563	Feb. 2012

Total	$	755,381

Future minimum lease payments under non-cancelable operating leases (with initial or remaining lease terms in excess of one year) as of December 31, 2009 are as follows:


	2010	$	755,381
	2011		640,329
	2012		632,766
	2013		188,219
	Thereafter		100,942

Total minimum lease payments		$	2,317,637

Rent expense for the years ended December 31, 2009, 2008, 2007 amounted to approximately $907,000, $1,134,000 and $916,000, respectively.

Capital Leases

Wave has a capitalized lease obligation for computer equipment due July 2013 of $245,362 and $308,899 as of December 31, 2009 and 2008, respectively. The interest rate is 7.7% per annum. This lease obligation is collateralized by the related assets with a net book value of $-0- as of December 31, 2009 reflecting an impairment charge due to the suspension of Wavexpress' TVTonic consumer media services (see note 11).

Future minimum lease payments under this non-cancelable capital lease as of December 31, 2009 are as follows:


	2010	$	78,529
	2011		78,529
	2012		78,529
	2013		45,808

Total minimum lease payments			281,395
Less: Amount representing interest			(36,033	)

Balance at December 31, 2009		$	245,362

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(12) Commitments and Contingencies (Continued)

Purported Class Actions

A consolidated amended class action complaint was pending in the United States District Court for the District of Massachusetts, naming Wave, its Chief Executive Officer and its Chief Financial Officer as defendants. Brumbaugh et al. v. Wave Systems Corp. et al., Civ. No. 04-30022 (D. Mass.) (MAP).

The purported class action had been filed by alleged purchasers of Wave's Class A Common Stock during the purported class period July 31, 2003 through February 2, 2004. The complaint claimed that Wave and the named individuals violated Section 10(b) of the Securities Exchange Act of 1934 (the "1934 Act"), Rule 10(b)-5 promulgated there under and Section 20(a) of the 1934 Act by publicly disseminating materially false and misleading statements, relating to Wave's agreements with Intel and IBM. The complaint did not specify the amount of alleged damages plaintiffs sought to recover.

In January 2006, the Court granted in part and denied in part defendants' motion to dismiss. The court dismissed two but let stand seven alleged misrepresentations or omissions. This was not a finding of fault or liability, it was a decision not entirely to dismiss plaintiffs' pleading.

Without admitting liability, the defendants reached a mediated settlement in principle of all claims asserted by the plaintiffs. On January 10, 2007, the Court issued an Order and Final Judgment approving the settlement and dismissing the action with prejudice. Wave's insurer paid the plaintiffs a total of $1,750,000 in exchange for the dismissal with prejudice and release of the claims against all defendants.

(13) Income Taxes

The Company did not provide for any income tax expense or (benefit) for the years ending December 31, 2009, 2008 and 2007.

The following table summarizes the significant differences between the United States federal statutory tax rate and the Company's effective tax rate for financial statement reporting purposes:



Statutory tax rate	34	%	34	%	34	%
Stock-based compensation on ISO's	(18	)	(3	)	(3	)
BCF on Preferred Stock	(0	)	(1	)	(0	)
Change in valuation allowance	(16	)	(30	)	(31	)

Total	—	%	—	%	—	%

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(13) Income Taxes (Continued)

The tax effects of temporary differences that give rise to the deferred tax asset at December 31, 2009 and 2008 are as follows:

		2009			2008

Deferred tax assets:
	Net operating and capital loss carryforwards	$	99,472,000		$	105,624,154
	Accrued expenses		720,000			940,000
	Intangibles		303,000			365,000
	Reserves		921,000			945,000
	Depreciation		382,000			458,000

	Total gross deferred tax assets		101,798,000			108,332,154
	Less valuation allowance		(101,798,000	)		(108,332,154	)

	Net deferred tax asset	$	—		$	—

The valuation allowance decrease by approximately $6.5 million during the year ended December 31, 2009 and increased by approximately $0.4 million during the year ended December 31, 2008.

Management has concluded that it is more likely than not that Wave will not have sufficient taxable income of an appropriate character within the carryback and carryforward periods permitted by current law to allow for the utilization of the deferred tax assets and, therefore, a valuation allowance has been established against the deferred tax assets of $101,798,000 as of December 31, 2009. Subsequently reported tax benefits relating to the valuation allowance for deferred tax assets as of December 31, 2009 will be allocated as follows: $101,068,000 to continuing operations and $730,000 to additional paid-in capital for amounts attributable to exercise of employee stock options.

Wave has federal and state net operating loss carryforwards of approximately $286.3 million, which expire beginning in 2010 through 2029. Pursuant to Section 382 of the Internal Revenue Code, the annual utilization of Wave's net operating and capital loss carryforwards may be substantially limited if a cumulative change in ownership of more than 50% occurs within any three-year period. Wave has not determined whether there have been such cumulative changes in ownership or the impact on the utilization of the loss carryforwards if such changes have occurred. However, in considering Section 382 of the Internal Revenue Code, Wave believes that it is likely that such a change in ownership has occurred thus raising the likelihood that such net operating and capital loss carryforwards are subject to annual limitations.

The Company adopted the provisions of ASC 740-10, formerly FIN 48, effective January 1, 2007. The adoption did not result in an adjustment to retained earnings due to the Company's full valuation allowance against its net deferred tax asset.

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(13) Income Taxes (Continued)

The following table summarizes the activity related to the Company's gross unrecognized tax benefits:

	2009			2008		2007

Balance at beginning of year	$	11,353,354		$	9,428,187	$	7,123,302
Increases related to current year tax positions		0			1,925,167		2,304,885
Decreases related to prior year tax positions		(6,187,819	)		0		0

Balance at end of year	$	5,165,535		$	11,353,354	$	9,428,187

The unrecognized tax benefits, if recognized, would not affect the Company's effective tax rate because the Company has recorded a full valuation allowance against its net deferred tax assets. The decreases related to prior year tax positions are attributable to amendment to tax deductions previously taken on the Company's tax returns.

The Company's policy is to recognize interest and penalties related to unrecognized tax benefits as a component of income tax expense. The Company files United States Federal and state income tax returns. In general, the statute of limitations with respect to the Company's United States Federal income taxes has expired for years prior to 2006, and the relevant state statutes vary. However, preceding years remain open to examination by United States Federal and state taxing authorities to the extent of future utilization of net operating losses and capital losses generated in each preceding year. The Company does not anticipate that the total unrecognized tax benefits will change significantly prior to December 31, 2010. As described above, utilization of the Company's loss carryforwards may be limited pursuant to Section 382 of the Internal Revenue Code. Any limitation may result in expiration of a portion of the net operating and capital loss carryforwards before utilization. Until a study is completed and any limitation known, no amounts are being presented as an uncertain tax position under ASC 740-10.

(14) Defined Contribution Plan

Wave adopted the Wave Systems Corp. 401(k) Savings and Investment Plan, a defined contribution plan, to which substantially all employees can contribute, on January 1, 1995. Employees of Wave become eligible immediately on employment. Wave has the option to make discretionary matching contributions; no contributions were made in 2009, 2008 or 2007.

(15) Disclosures about the Fair Value of Financial Instruments

Cash and Cash Equivalents, Prepaid Expenses and Other Receivables, Accounts Payable and Accrued Expenses

The carrying amounts of these instruments approximate fair value because of their short maturities.

As of December 31, 2009, Wave's financial assets that are measured at fair value on a recurring basis are comprised of overnight money market fund investments. Wave invests excess cash from its operating cash accounts in overnight money market funds and reflects these amounts (approximately $1,702,000 at December 31, 2009) within cash and cash equivalents on the consolidated balance sheet

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Notes to Consolidated Financial Statements (Continued)

(15) Disclosures about the Fair Value of Financial Instruments (Continued)

using quoted prices in active markets for identical assets (Level 1) at a net value of 1:1 for each dollar invested.

Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

(16) Segment Reporting

Wave's products include the Wave EMBASSY® digital security products and services ("EMBASSY®") and Wavexpress broadband media distribution products and services. These products and services constitute Wave's reportable segments under ASC 280-10, formerly SFAS No. 131,"Disclosures about Segments of an Enterprise and Related Information". Net losses for reportable segments exclude interest income and other income. These items are not reported by segment since they are excluded from the measurement of segment performance reviewed by Wave's Chief Financial Officer.

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(16) Segment Reporting (Continued)

The following sets forth reportable segment data:

		For the years ended December 31,

		2009			2008			2007
Operating Revenues:
	EMBASSY® digital security products and services	$	18,888,879		$	8,809,815		$	6,306,960
	Wavexpress broadband media distribution products and services		—			—			—

	Total Operating Revenues		18,888,879			8,809,815			6,306,960
Net Loss:
	EMBASSY® digital security products and services		(2,695,763	)		(16,409,060	)		(17,401,966	)
	Wavexpress broadband media distribution products and services		(631,022	)		(4,130,582	)		(2,883,877	)

	Total Segments Net Loss		(3,326,785	)		(20,539,642	)		(20,285,843	)
	Net interest income (expense)		(19,466	)		(9,572	)		334,292
	Other income		—			—			—

	Net Loss	$	(3,346,251	)	$	(20,549,214	)	$	(19,951,551	)
Depreciation and Amortization Expense:
	EMBASSY® digital security products and services		259,210			309,642			317,311
	Wavexpress broadband media distribution products and services		—			85,611			38,573

	Total Depreciation and Amortization Expense	$	259,210		$	395,253		$	355,884

Capital Expenditures:
	EMBASSY® digital security products and services		88,007			132,789			500,042
	Wavexpress broadband media distribution products and services		—			99,723			118,630

	Total Capital Expenditures	$	88,007		$	232,512		$	618,672

		As of

		December 31, 2009		December 31, 2008		December 31, 2007
Assets:
	EMBASSY® digital security products and services		6,312,854		3,367,690		5,915,158
	Wavexpress broadband media distribution products and services		15,071		62,084		122,698

	Total Assets	$	6,327,925	$	3,429,774	$	6,037,856

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(16) Segment Reporting (Continued)

The following table details Wave's sales by geographic area for the years ended December 31, 2009, 2008 and 2007. Geographic area is based on the location of where the products were shipped or services rendered.

		United States of America			Europe			Asia			Total

2009
EMBASSY® digital security products and services		$	18,350,388		$	5,440		$	533,051		$	18,888,879
Wavexpress broadband media distribution products and services			—			—			—			—

	Total	$	18,350,388		$	5,440		$	533,051		$	18,888,879
	% of Total		97	%		0	%		3	%		100	%
2008
EMBASSY® digital security products and services		$	8,576,635		$	57,018		$	176,162		$	8,809,815
Wavexpress broadband media distribution products and services			—			—			—			—

	Total	$	8,576,635		$	57,018		$	176,162		$	8,809,815
	% of Total		97	%		1	%		2	%		100	%
2007
EMBASSY® digital security products and services		$	5,947,111		$	225,444		$	134,405		$	6,306,960
Wavexpress broadband media distribution products and services			—			—			—			—

	Total		5,947,111			225,444			134,405			6,306,960
% of Total			94	%		4	%		2	%		100	%

Substantially all long-lived assets of Wave Systems Corp. are located within the United States of America.

Customers, by segment, from which Wave derived revenue in excess of 10% for the years ended December 31^st are as follows:

			2009			2008			2007

Customer		Segment	Revenue
Dell, Inc.		EMBASSY®	$	15,281,863		$	7,048,920		$	4,483,053
Broadcom		EMBASSY®		—			—			682,129

	Total		$	15,281,863		$	7,048,920		$	5,165,182
% of Total Revenue				81	%		80	%		81	%

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Notes to Consolidated Financial Statements (Continued)

(17) Selected Quarterly Financial Data (unaudited)

	Quarter-ended

	December 31, 2009			September 30, 2009			June 30, 2009			March 31, 2009
Revenues	$	5,213,252		$	4,843,806		$	4,797,640		$	4,034,181
Loss from operations		(996,925	)		(473,706	)		(338,630	)		(1,517,524	)
Net loss		(1,000,551	)		(478,716	)		(343,752	)		(1,523,232	)
Net loss attributable to common shareholders		(1,000,551	)		(478,716	)		(343,752	)		(1,523,232	)
Net loss per common share	$	(0.01	)	$	(0.01	)	$	(0.01	)	$	(0.02	)

	Quarter-ended

	December 31, 2008			September 30, 2008			June 30, 2008			March 31, 2008
Revenues	$	3,290,736		$	1,834,707		$	1,985,293		$	1,699,079
Loss from operations		(3,269,102	)		(5,598,310	)		(5,643,265	)		(6,028,965	)
Net loss		(3,294,539	)		(5,604,732	)		(5,639,895	)		(6,010,048	)
Net loss attributable to common shareholders		(3,951,539	)		(5,604,732	)		(5,639,895	)		(6,010,048	)
Net loss per common share	$	(0.07	)	$	(0.10	)	$	(0.10	)	$	(0.12	)

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Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	H.S. freshman Avg

Dated: March 16, 2010

WAVE SYSTEMS CORP.

/s/ STEVEN K SPRAGUE

Steven K. Sprague

President and Chief Executive Officer