Wave Systems 10Q 2007 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2007

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

For the transition period from to

Commission File Number 0-24752

Wave Systems Corp.

(Exact name of registrant as specified in its charter)

Delaware		13-3477246
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

480 Pleasant Street Lee, Massachusetts 01238 (Address of principal executive offices) (Zip code)

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No o

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

Large accelerated filer o

Accelerated filer x

Non-accelerated filer o

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

Yes o No x

The number of shares outstanding of each of the issuer’s classes of common stock as of November 2, 2007: 49,616,907 shares of Class A Common Stock and 38,232 shares of Class B Common Stock.

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Consolidated Balance Sheets

(Unaudited)

	September 30,			December 31,
	2007			2006
Assets
Current assets:
Cash and cash equivalents	$	7,754,204		$	7,965,994
Accounts receivable, net of allowance for doubtful accounts of $41,032 and $40,547 at September 30, 2007 and December 31, 2006, respectively	1,353,069			635,852
Prepaid expenses	453,123			206,835
Total current assets	9,560,396			8,808,681
Property and equipment, net	604,908			419,724
Other assets	134,301			131,272
Total Assets	10,299,605			9,359,677

Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable and accrued expenses	2,818,040			3,035,349
Deferred revenue	477,852			404,059
Total current liabilities	3,295,892			3,439,408

Stockholders’ Equity:
Common stock, $.01 par value. Authorized 150,000,000 shares as Class A; 49,616,907 shares issued and outstanding in 2007 and 42,203,773 in 2006	496,169			422,038
Common stock, $.01 par value. Authorized 13,000,000 shares as Class B; 38,232 shares issued and outstanding in 2007 and 39,232 in 2006	382			392
Capital in excess of par value	324,703,255			309,029,938
Accumulated deficit	(318,196,093		)	(303,532,099		)
Total Stockholders’ Equity	7,003,713			5,920,269
Total Liabilities and Stockholders’ Equity	$	10,299,605		$	9,359,677

See accompanying notes to unaudited consolidated financial statements.

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Consolidated Statements of Operations

(Unaudited)

	Three months ended						Nine months ended
	September 30, 2007			September 30, 2006			September 30, 2007			September 30, 2006
Net revenues:
Licensing	$	1,716,878		$	826,946		$	4,353,815		$	1,817,993
Services	17,371			19,334			77,826			431,846
Total net revenues	1,734,249			846,280			4,431,641			2,249,839
Cost of sales:
Licensing	199,104			197,406			558,669			493,021
Services	11,184			5,679			21,393			280,883
Total cost of sales	210,288			202,985			580,062			773,904
Gross profit	1,523,961			643,295			3,851,579			1,475,935
Operating expenses:
Selling, general, and administrative	3,707,498			2,998,236			11,093,101			9,400,495
Research and development	2,724,857			2,163,201			7,687,312			6,175,701
Total operating expenses	6,432,355			5,161,437			18,780,413			15,576,196
Operating loss	(4,908,394		)	(4,518,142		)	(14,928,834		)	(14,100,261		)
Other income:
Interest income	130,694			30,872			264,840			79,183
Other	-0-			-0-			-0-			2,794
Total other income	130,694			30,872			264,840			81,977
Net loss	$	(4,777,700	)	$	(4,487,270	)	$	(14,663,994	)	$	(14,018,284	)
Loss per common share — basic and diluted	$	(0.10	)	$	(0.12	)	$	(0.32	)	$	(0.40	)
Weighted average number of common shares outstanding during the period	49,736,556			37,800,037			45,636,775			35,279,324

See accompanying notes to unaudited consolidated financial statements.

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Unaudited)

	Nine Months ended
	September 30,			September 30,
	2007			2006
Cash flows from operating activities:
Net loss	$	(14,663,994	)	$	(14,018,284	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization	241,050			501,530
Compensation associated with issuance of stock options	1,342,627			1,141,775
Other	-0-			(2,794		)
Changes in assets and liabilities:
Increase in accounts receivable	(717,217		)	(338,178		)
Increase in prepaid expenses	(246,288		)	(39,856		)
(Increase) decrease in other assets	(3,029		)	61,938
Decrease in accounts payable and accrued expenses	(217,309		)	(83,586		)
Increase in deferred revenue	73,793			53,566
Net cash used in operating activities	(14,190,367		)	(12,723,889		)

Cash flows from investing activity:
Acquisition of property and equipment	(426,234		)	(242,103		)
Net cash used in investing activities	(426,234		)	(242,103		)

Cash flows from financing activity:
Net proceeds from issuance of common stock	14,404,811			14,088,643
Net cash provided by financing activities	14,404,811			14,088,643

Net (decrease) increase in cash and cash equivalents	(211,790		)	1,122,651

Cash and cash equivalents at beginning of period	7,965,994			2,006,022

Cash and cash equivalents at end of period	$	7,754,204		$	3,128,673

See accompanying notes to unaudited consolidated financial statements.

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity and Comprehensive Income (Loss)

(Unaudited)

	Class A Common Stock			Class B Common Stock					Capital in Excess		Accumulated
	Shares	Amount		Shares		Amount			of Par Value		Deficit			Total
Balance at December 31, 2006	42,203,773	$	422,038	39,232		$	392		$	309,029,938	$	(303,532,099	)	$	5,920,269

Net loss and comprehensive loss	—	—		—		—			—		(14,663,994		)	(14,663,994		)

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, net of issuance costs of $770,669	7,317,073	73,171		—		—			14,156,160		—			14,229,331

Issuance of Class A Common Stock pursuant to the Wave Employee Stock Purchase Plan at $1.8275 per share	91,746	917		—		—			166,749		—			167,666

Exchange of Class B Common Stock for Class A Common Stock	1,000	10		(1,000	)	(10		)	—		—			—

Cash paid for fractional shares						(241		)						(241		)

Stock-based compensation	—	—		—		—			1,342,627		—			1,342,627

Balance at September 30, 2007	49,616,907	$	496,169	38,232		$	382		$	324,703,255	$	(318,196,093	)	$	7,003,713

See accompanying notes to unaudited consolidated financial statements.

WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements

September 30, 2007 and 2006

In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the financial position of Wave Systems Corp. as of September 30, 2007 and December 31, 2006, its results of operations for the three-month and nine-month periods ended September 30, 2007 and 2006, and cash flows for the nine-month periods ended September 30, 2007 and 2006. Such financial statements have been prepared in accordance with the applicable regulations of the Securities and Exchange Commission (the Commission”).

Certain information and footnote disclosures normally included in financial statements prepared in accordance with U. S. generally accepted accounting principles have been omitted. It is suggested that these consolidated financial statements be read in conjunction with Wave’s audited financial statements and notes thereto for the year ended December 31, 2006, included in its Form 10-K filed on March 16, 2007. The results of operations for the three-month and nine-month periods ended September 30, 2007 are not necessarily indicative of the operating results for the full year or any future periods.

The consolidated financial statements of Wave include the financial statements of Wave Systems Corp., Wave Systems Holdings, Inc., a wholly owned subsidiary, and Wavexpress, Inc., a joint venture between Wave and Sarnoff Corporation. All significant inter-company transactions have been eliminated.

1. Liquidity

The accompanying consolidated financial statements have been prepared assuming that Wave will continue as a going concern. Wave has substantial operating losses since its inception, and as of September 30, 2007, has an accumulated deficit of $318,196,093. We also expect Wave will incur an operating loss for the calendar year 2007. As of September 30, 2007, Wave had working capital of $6,264,504.

Wave has begun market introduction of its security and broadband media distribution software products and has signed initial distribution contracts for these applications. However, due to the early stage nature of this market, it is unlikely that Wave will generate sufficient revenue to cover all of its cash flow needs to fund its operating requirements for the twelve months ending September 30, 2008.

Because Wave does not have sufficient cash to fund operations for the twelve months ending September 30, 2008, and because of the uncertainty as to whether Wave will generate sufficient revenues to fund its operations over this time period, Wave has been, and will likely continue to be, actively engaged in financing activities in order to generate additional funding to cover its operating costs for the

twelve months ending September 30, 2008. These activities have included the filing of a $25,000,000 S-3 shelf registration with the Commission on March 20, 2007, which was declared effective on April 27, 2007; and the sale of 7,317,073 shares of common stock at $2.05 per share for gross proceeds of $15,000,000 in an initial round of financing under this shelf registration on May 24, 2007, for which Wave received approximately $14,229,000 in net proceeds. In connection with that financing, Wave also agreed to issue a warrant to the placement agent (as part of the fees paid to the placement agent) that will allow the placement agent to acquire 365,853 shares of Wave Class A common stock for $2.58 per share. The warrant expires on May 24, 2009.

As a result, we will 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 our operations for the twelve months ending September 30, 2008.

Considering our current cash balance, we project that we have enough liquid assets to continue operating into April 2008. We estimate we will need a minimum of approximately $4,700,000 of additional cash, over and above forecasted revenue growth, from a combination of additional revenue growth and additional financings, to fund operating expenses and capital expenditures for the twelve months ending September 30, 2008.

If Wave is not successful in raising the needed capital referred to above, or is not successful in executing its business plan, we could be forced to cease operations or merge with another company. No assurance can be provided that any of these initiatives will be successful. Due to our current cash position, our capital needs over the next year and beyond, the fact that we have not at this time secured enough financing to fund our operations through September 30, 2008 and beyond, and the 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.

2. Loss per Share

Basic net loss per common share has been calculated based upon the weighted-average number of shares of common stock outstanding during the period. 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 three-month and nine-month periods ended September 30, 2007, were approximately 2,600 shares and 168,000 shares, respectively, versus 2,000 shares and 60,000 shares for the three-month and nine-month periods ended September 30, 2006, respectively. Employee stock options and other stock warrants to purchase a weighted average of approximately 7,096,000 and 6,239,000 shares were outstanding for the three-month and nine-month periods ended September 30, 2007, respectively versus 5,583,000 and 5,632,000 shares of the three-month and nine-month periods ended September 30, 2006, respectively, but would not have been 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.

3. Wavexpress

In April 1999, Wave joined with Sarnoff Corporation to form Wavexpress. Wavexpress develops secure broadband media distribution software products, infrastructure and content services. On October 15, 1999, Wave and Sarnoff signed a Joint Venture Agreement, which formally established Wavexpress. Under this 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.

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 September 30, 2007, Wave has funded Wavexpress with approximately $42,178,000 in cash, plus approximately $19,896,000 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 September 30, 2007, Wave owned 69% of Wavexpress, while Sarnoff and its affiliates owned 25.6%. 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’ net losses included in Wave’s consolidated financial statements were approximately $771,000 and $540,000 for the three-month periods ended September 30, 2007 and September 30, 2006, respectively, and approximately $2,072,000 and $1,735,000 for the nine-month periods ended September 30, 2007 and September 30, 2006, respectively.

4. Recent Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. In February 2007, the FASB issued SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial assets and financial liabilities at fair value. Both SFAS 157 and SFAS 159 are effective for fiscal years beginning after November 15, 2007. Wave is currently assessing the impact that the adoption of SFAS 157 and SFAS 159 will have on its financial statements.

5. Share-based Compensation

Wave recognized $542,717 and $381,171 of share-based compensation during the three-months ended September 30, 2007 and 2006, respectively, and $1,342,627 and $1,141,775 for the nine-month periods ended September 30, 2007 and 2006, respectively. During the three-month period ended September 30, 2007, Wave granted 1,419,400 stock options at a weighted-average estimated fair value of $1.46. During the three-month period ended September 30, 2006, Wave granted 42,684 stock options at a weighted-average estimated fair value of $1.38.

The following table summarizes the effect of share based compensation in Wave’s statement of operations, for the three-month and nine-month periods ended September 30, 2007 and 2006:

	Three months ended September 30,				Nine months ended September 30,
	2007		2006		2007		2006
Cost of sales	$	6,244	$	3,578	$	11,731	$	22,656

Selling, general and administrative	325,999		246,333		871,211		777,726

Research and development	210,474		131,260		459,685		341,393

Total	$	542,717	$	381,171	$	1,342,627	$	1,141,775

6. Income Taxes

There is no provision for income taxes because Wave has incurred operating losses since inception. Effective January 1, 2007, Wave adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement 109” (“FIN 48”), which 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 FIN 48 did not result in a cumulative adjustment to Wave’s accumulated deficit. Wave classifies any interest and penalties related to income taxes as components of the income tax provision.

As of January 1, 2007, Wave had no gross unrecognized tax benefits. There have been no significant changes during the nine-months ended September 30, 2007.

As of December 31, 2006, Wave had approximately $268.2 million of federal and state net operating loss carryforward (“NOL”), which can be used to offset future federal and state income tax liabilities prior to expiration on various dates through 2026.

Utilization of NOL carryforwards may be subject to substantial annual limitation due to ownership changes that have occurred previously or that could occur in the future as provided by Section 382 of the Internal Revenue Code of 1986 and similar state provisions. These ownership changes may limit the amount of NOL carryforward that can be utilized annually to offset future taxable income. In general, an ownership change, as defined in Section 382, results from transactions which increase the ownership of certain 5% or greater shareholders or public groups in the stock of a corporation by more than 50 percentage points over a three-year period. Since the Company’s formation, the Company has raised capital through the issuance of capital stock on several occasions which, combined with the purchasing shareholders’ subsequent disposition of those shares, may have resulted in a change of control, as defined in Section 382, or could result in a change of control in the future upon subsequent disposition. Due to the significant complexity and cost, Wave has not completed a study to determine whether a change of control has occurred or whether there have been multiple changes of control since the Company’s formation. If Wave has experienced a change of control at any time since formation, or if Wave experiences a change of control in the future, utilization of our NOL and R&D credit carryforwards would be subject to an annual limitation under Section 382. Any limitation may result in expiration of all or a portion of the NOL carryforward before utilization. Until a study is completed and any limitation known, no amounts are being presented as an uncertain tax position under FIN 48.

Wave’s federal tax returns for 2003 through 2006 and tax returns in certain states for 2000 through 2006 remain subject to examination by taxing authorities. Preceding years also remain open to examination by U.S. federal and state revenue authorities to the extent of future utilization of net operating losses “(NOLs”) generated in each preceding year.

7. Segment Reporting

Wave’s products include the Wave EMBASSY^® digital security products and services and Wavexpress broadband media distribution products and services. These products and services constitute Wave’s reportable segments under Statement of Financial Accounting Standards No. 131 “Disclosures about Segments of an Enterprise and Related Information”. Net losses for reportable segments exclude interest and gain (loss) on change in value of warrant liability. These items are not reported by segment since they are

excluded from the measurement of segment performance reviewed by Wave’s chief operating decision maker.

The following sets forth reportable segment data:

	Three months ended September 30,						Nine months ended September 30,
	2007			2006			2007			2006
Operating Revenues:
EMBASSY® digital security products and services	$	1,734,249		$	841,404		$	4,431,641		$	2,224,969
Wavexpress broadband media distribution products and services	—			4,876			—			24,870
Total Operating Revenues	1,734,249			846,280			4,431,641			2,249,839
Net Loss:
EMBASSY® digital security products and services	(4,137,050		)	(3,977,721		)	(12,856,951		)	(12,365,523		)
Wavexpress broadband media distribution	(771,344		)	(540,421		)	(2,071,883		)	(1,734,738		)
Total Segments Net Loss	(4,908,394		)	(4,518,142		)	(14,928,834		)	(14,100,261		)
Interest income	130,694			30,872			264,840			79.183
Other	—			—			—			2,794
Net Loss	(4,777,700		)	(4,487,270		)	(14,663,994		)	(14,018,284		)
Depreciation and Amortization Expense:
EMBASSY® digital security products and services	84,461			144,458			223,980			401,522
Wavexpress broadband media distribution	10,049			33,568			17,070			100,008
Total Depreciation and Amortization Expense	94,510			178,026			241,050			501,530
Capital Expenditures:
EMBASSY® digital security products and services	139,709			59,911			341,226			202,978
Wavexpress broadband media distribution	54,098			3,763			85,008			39,125
Total Capital Expenditures	$	193,807		$	63,674		$	426,234		$	242,103

	September 30,		December 31,
	2007		2006
Assets:
EMBASSY^® Trusted Client Platform and services	$	10,137,259	$	9,262,942
Wavexpress Data Broadcasting	162,346		96,735
Total Assets	$	10,299,605	$	9,359,677

The following table details Wave’s sales by geographic area for the three and nine-month periods ended September 30, 2007 and 2006. Geographic area is based on the location of where the products were shipped or services rendered.

	United States of America			Europe			Asia			Total
Three months ended September 30, 2007:
EMBASSY® digital security products and services	$	1,633,037		$	64,625		$	36,587		$	1,734,249
Wavexpress broadband media distribution products and services	—			—			—			—
Total	1,633,037			64,625			36,587			1,734,249
% of Total Revenue	94		%	4		%	2		%	100		%

Three months ended September 30, 2006:
EMBASSY® digital security products and services	609,183			198,201			34,020			841,404
Wavexpress broadband media distribution products and services	4,876			—			—			4,876
Total	614,059			198,201			34,020			846,280
% of Total Revenue	73		%	23		%	4		%	100		%

Nine months ended September 30, 2007:
EMBASSY® digital security products and services	$	4,180,823		$	164,764		$	86,054		$	4,431,641
Wavexpress broadband media distribution products and services	—			—			—			—
Total	4,180,823			164,764			86,054			4,431,641
% of Total Revenue	94		%	4		%	2		%	100		%

Nine months ended September 30, 2006:
EMBASSY® digital security products and services	1,449,248			628,799			146,922			2,224,969
Wavexpress broadband media distribution products and services	24,870			—			—			24,870
Total	1,474,118			628,799			146,922			2,249,839
% of Total Revenue	66		%	28		%	6		%	100		%

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

Customers, by segment, from which Wave derived revenue in excess of 10% for the three and nine-month periods ended September 30^th are as follows:

		Three months ended September 30,						Nine months ended September 30,
		2007			2006			2007			2006
Customer	Segment	Revenue						Revenue

Dell, Inc.	EMBASSY®	$	1,279,395		$	437,577		$	3,229,932		$	628,899
ST Microelectronics	EMBASSY®	64,625			198,200			151,654			628,798
Broadcom	EMBASSY®	218,314			101,551			481,057			206,238
US Government	EMBASSY®	—			—			—			291,737
Total		$	1,562,334		$	737,328		$	3,862,643		$	1,755,672
% of Total Revenue		90		%	87		%	87		%	78		%

8. Issuance of Common Stock

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 $.01 per share, to certain purchasers for an aggregate purchase price of $15,000,000. These shares were priced at $2.05 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 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. 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 on Form S-3 which was filed by Wave on March 20, 2007 and declared effective by the Commission on April 27, 2007.

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

CERTAIN FORWARD-LOOKING INFORMATION:

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements include, but are not limited to, statements regarding contingencies, future prospects, liquidity and capital expenditures herein under “Part I Financial Information—Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Actual results could differ materially from those projected in the forward-looking statements as a result of the risk factors set forth below and detailed in our other filings with the Commission during the past 12 months.

Overview

Our Business

Wave Systems Corp. 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 body. 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.

The current TCG specification recommends a hardware-based trusted computing platform, which is a platform that uses a semiconductor device, known as a Trusted Platform Module (“TPM”) that performs protected activities, including protected storage, platform authentication, protected cryptographic processes and attestable state capabilities to provide 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.

Management has focused on entering into licensing contracts to which the OEM licenses our applications and distributes them as part of their offering, paying Wave a royalty for each unit shipped. Wave currently has signed such bundling agreements with seven separate OEM partners. Revenue recognized on these contracts for the three-month periods ended September 30, 2007 and 2006 was approximately $1,723,000 and $825,000, respectively. For the nine-month periods ended September 30, 2007 and 2006, revenue recognized on these contracts amounted to approximately $4,278,000 and $1,780,000, respectively.

Management is focused on opportunities for its eSign Transaction Management Suite, also known as eTMS (“eTMS”), to provide digital signing and document management solutions to the financial services and other vertical markets in which there is a clear and identifiable value proposition in implementing these

solutions. Although we have met significant implementation challenges and long sales cycles with this effort, we have entered into contracts with a la mode, inc. and Ellie Mae, Inc. in the real estate industry and with Efficient Forms, LLC and Realtime Solutions Group, LLC in the financial services sector. We continue to pursue additional opportunities for the eTMS product line.

Wavexpress is focused on building a sustainable revenue stream by establishing partnerships with branded content providers to provide primarily advertising supported video entertainment services. Wavexpress’ TVTonic service offers hundreds of video feeds, a significant number of which are signed to revenue sharing agreements for ad placements. The service is designed to support any video channel distributed via RSS. RSS is the standard format for blogs and podcasts and is being increasingly used for open video distribution on the Internet. TVTonic is promoted by Microsoft with all installations of their Media Center software. Media Center is standard with Microsoft Vista Premium and Vista Ultimate, as well as XP Media Center Edition. In addition, Wavexpress is extending its technology so that its subscriber management system can leverage the added security of a TPM and is preparing back-office systems for standalone deployment into enterprise installations. Management plans to devote ongoing development resources toward enhancing the TVTonic client software and services.

Our Products

Client-side Applications

The EMBASSY Trust Suite

The current version of the EMBASSY Trust Suite is a set of applications and services that are designed to bring functionality and user value to TPM-equipped 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”), Document Manager Vault (“Vault”), Private Information Manager (“PIM”), SmartSignature and Key Transfer Manager (“KTM”).

The ESC enables the user to set up and configure the TPM platform. Wave has also developed the Trusted Drive Manager functions for ESC to support the Seagate Full Disc Encryption drives.

Data Protection is addressed by the Vault, which provides document encryption, decryption and client side storage of documents. The Vault, which works with Microsoft Windows and Microsoft Office, secures documents against unauthorized users and hackers.

Password management is a security challenge due to the increasing number of passwords required and the tendency of users to select easily guessed passwords. To help improve 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 is 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 fully featured method to securely archive, restore and transfer keys having migratable properties that are secured by the TPM.

SmartSignature is a digital signing application that utilizes the signing keys generated by the TPM.

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

In March 2007, Wave announced that a new version of the ESC software now supports Seagate’s Momentus 5400 FDE.2 hard drive, the latest generation of Seagate’s FDE drives (the “Seagate Trusted Drives”). Wave’s support for the Seagate Trusted Drives will also utilize its EMBASSY Trust Suite software for TPM and key management.

Wave plans to continue to develop and enhance the current products being developed within this product group and will 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 $3.3 million for the twelve-month period ending September 30, 2008.

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 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 allows software developers to utilize the enhanced security of a TCG standards-based platform, facilitating a common user experience independent of the platform. It also enables 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 $4.6 million for the twelve-month period ending September 30, 2008.

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 provides centralized management, provisioning and enforcement of multifactor domain access policies. With EAS, authentication policies can be based on TPM credentials, SmartCard 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 3^rd-party vendors.

EMBASSY Remote Administration Server (“ERAS”)

ERAS is a server product that provides centralized management and auditing of Trusted Platform Modules (“TPM”) and Seagate Trusted Hard Drives (“Trusted Drive”). ERAS is designed to give IT administrators the ability to deploy and remotely manage Trusted Drives and TPM systems. ERAS will also provide the ability to remotely manage newly available Trusted Drives. It provides for initialization, pre-boot authentication management, recovery, and repurposing of TPMs and Trusted Drives. ERAS is designed to provide auditing capabilities that aid in compliance management by allowing for validation of TPM and Trusted Drive security settings, thus allowing 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 Trusted Drive technology as it provides IT administrators with tools to utilize the security of these devices while reducing deployment and management costs.

Current planned development costs for this product are expected to be approximately $1.6 million for the twelve-month period ending September 30, 2008.

Digital Signature and Electronic Document Management

On October 4, 2001, Wave acquired the digital signature and electronic document management technology, SmartSignature and SmartSAFE, from SignOnLine, Inc. (“SignOnLine”), a California-based company. This group of products initially made up our eSign Transaction Management Suite, also known as eTMS (“eTMS”), which consisted of four core products: SmartIdentity, SmartSignature, SmartSAFE and SmartConnect. SmartSignature Version 3.0 is a digital signature application that connects signers and institutions – banks, insurance companies, enterprises, etc. – through a legally binding digital signature. Wave’s SmartSignature Server, 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.

To increase the security associated with identity protection and digital signing credentials, Wave’s SmartSignature is currently enabled for the support of TPMs. SmartSAFE Version 3.0 is a web-based document management application where signed documents are archived and tracked. SmartSAFE provides an easy to use environment where a client institution can view, manage, store and transfer sensitive signed and unsigned documents. SmartSAFE also supports the archival and management of unsigned documents in virtually any format. These products allow a document to be executed, verified, accepted and filed in minutes at a lower cost compared to traditional paper-based documentation methods. SmartSignature Version 3.0 and SmartSAFE Version 3.0 have been completed and Wave commercially released these products in the first quarter of 2003. SmartIdentity, an optional service to verify a signer’s identity through strong authentication methods, including issuing encrypted digital certificates based on public key infrastructure technology, was completed and released in January of 2003. Wave will continue to allocate resources toward marketing and sales to promote these products.

Wave’s eTMS, in addition to being part of the EMBASSY Trust Suite applications and supporting TPMs, is also being independently marketed in the insurance, mortgage, finance, government and other markets which are seeking digital and electronic signature solutions that are compliant with the Electronic Signatures in Global and National Commerce Act (“ESIGN”). During March 2007, the eTMS’ SmartSignature Server product was licensed to Ellie Mae, Inc. (“Ellie Mae”), a provider of software and services for the mortgage industry, for integration into Ellie Mae’s electronically-signed mortgage document solution. Also in March 2007, the eTMS’ SmartSignature Server product was licensed to Realtime Solutions Group, LLC, a provider of software and services for the insurance industry. Wave’s eTMS’ SmartSignature Server product is also licensed to a la mode, Inc., a leading provider of desktop, mobile, and Web tools for the real estate and mortgage industries, to provide digital signature solutions for their XSites product line. In addition, Wave has a signed licensing agreement with Efficient Forms, LLC, a leading provider of interview-based electronic forms creation, to offer a comprehensive managed-service solution for electronic forms and electronic signatures. 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 $389,000 for the twelve-month period ending September 30, 2008.

Broadband Media Distribution Services

Wave offers broadband content distribution products and services through Wavexpress, a joint venture between Wave and Sarnoff Corporation. The joint venture was established on October 15, 1999. Under the 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, former Chairman of Wave, Steven Sprague, Chief Executive Officer of Wave, certain members of the Board of Directors of Wave and certain Wave employees.

Wavexpress has developed a vertically integrated suite of products designed to enable the optimum broadband distribution of digital programming. The current product offering combines industry standard syndication protocols with proprietary back-end software to create an end-to-end content syndication and monetization platform. This system is offered to content providers looking to deliver high-quality broadband media services using either Wavexpress’ distribution facility or on their own, through Really Simple Syndication (“RSS”). RSS is the standard format for blogs and podcasts and is being increasingly used for open video distribution on the Internet. Content providers connect through the Wavexpress client

and backend software to generate advertising revenue or subscription fees for premium services. Wavexpress’ business model intends to derive revenue either from direct fees charged to content providers for the use of Wavexpress software and facilities, or from a share of advertising proceeds collected. Wavexpress proprietary client software is integrated and promoted through Microsoft’s XP Media Center Edition operating system, as well as the Vista Premium and Vista Ultimate operating systems which began shipping in January 2007. It is also available through Microsoft’s Internet Explorer web browser.

We believe Wavexpress’ products deliver value to content providers by bringing a traditional advertising sales model to the emerging market for cached, syndicated, high-quality video content. By leveraging an open standard, RSS, Wavexpress believes it is in a position to work with any content provider – large or small. Wavexpress’ investment in proprietary backend and distribution technology creates opportunities to differentiate and capitalize on this rapidly growing segment of the content industry.

Planned futures development expenditures are expected to approximate $1.6 million for the twelve-month period ending September 30, 2008.

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 proven that software, on its own, is not capable of completely securing a network or platform. Because of these persistent security concerns, there is now a recognized 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 root of trust and an authenticatable security environment 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. Because Wave has been a pioneer in developing hardware-based computer security systems, it is distinctively positioned to take advantage of its unique knowledge, significant technology assets and trusted computing intellectual properties.

Because hardware-based trusted computing involves a new approach to conducting business and exchanging information using computer systems, it will require that traditional software-based security 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. The 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 a reseller channel for our products. Our objective is to make our EMBASSY branded products and services the preferred applications and infrastructure for Trusted Platforms.

R&D

Wave has realized minimal operating revenues since its inception. At September 30, 2007, Wave had an accumulated deficit of approximately $318.2 million. Wave has made a substantial investment in research and development, including approximately $2.7 million and $7.7 million for the three and nine-month periods ended September 30, 2007, respectively. Wave will continue to make substantial investments in its products and technology. For the years ended December 31, 2006, 2005 and 2004, Wave spent approximately $8.5 million, $6.9 million and $6.9 million respectively, on research and development activities.

Critical Accounting Policies

Wave’s discussion and analysis of its financial condition and results of operations are based on its consolidated financial statements. 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 revenue recognition, accounts receivable reserves, valuation of long-lived and intangible assets, accounting for joint ventures, software development and stock-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 1 - Financial Information:

Research and Development and Software Development Costs - Research and development costs are expensed as incurred. Software development costs are accounted for pursuant to SFAS No. 86 “Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed” (“SFAS No. 86”). SFAS No. 86 specifies that costs incurred internally in creating a computer software product should be charged to expense when incurred as research and development costs until technological feasibility is established for the product. Once technological feasibility is established and the product has achieved commercial marketability, all development costs should be capitalized until the product is available for general release to customers. We consider technological feasibility to be established upon completion of a detail program design or in the absence of a detail program design, upon completion of a working model of the software, as defined in SFAS No. 86. Judgment is required in determining when the technological feasibility of a product is established, if the product has achieved commercial marketability and in estimating the life of the product for which the capitalized costs will be amortized.

Revenue Recognition – Wave’s business model targets revenues from various sources including: licensing of EMBASSY Trust Suite, Wavexpress’ broadband media distribution and 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 follows the provisions of statement of position “SOP” 97-2, Software Revenue Recognition as amended by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, with Respect to Certain Transactions. 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 collectibility 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 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.

PRODUCTS-SOFTWARE

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.

Royalty fees received pursuant to distribution software licenses with OEMs in which wave earns a royalty, are recognized as revenue as units are shipped by the OEM to end customers.

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.

Share-based Compensation - On January 1, 2006, Wave adopted Statement of Financial Accounting Standards No. 123 (R), “Share-Based Payment,” (“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 Staff Accounting Bulletin No. 107 (“SAB 107”) relating to SFAS No. 123(R). The Company has applied the provisions of SAB 107 in its adoption of SFAS No. 123(R).

SFAS No. 123(R) 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. SFAS No. 123(R) supersedes Wave’s previous accounting under the provisions of SFAS No. 123, “Accounting for Stock-Based Compensation.” As permitted by 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” 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 SFAS No. 123(R) 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 SFAS No. 123(R). Stock-based compensation expense recognized under SFAS No. 123(R) for the three and nine-month periods ended September 30, 2007 was $542,717 and $1,342,627, respectively, versus $381,171 and $1,141,775 for the three and nine-month periods ended September 30, 2006, respectively.

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 rate and the weighted average expected term of the options. Since Wave does not pay dividends, the dividend rate variable in the Black-Scholes-Merton model is zero.

Results of Operations

Three Months Ended September 30, 2007 and 2006

Wave had revenues of $1,734,249 and $846,280 for the three months ended September 30, 2007 and 2006, respectively. The increase was due primarily to licensing revenues, which increased by $889,932 during the quarter. This increase was due to a higher volume of shipments of Wave’s OEM customer

products, primarily as a result of its OEM relationship with Dell, for which Wave receives royalty income. Service revenue consists primarily of non-recurring government time and materials contracts.

The table below sets forth the components that make up the revenue for the quarters ended September 30:

	2007		2006		Increase/ (Decrease)			% Change
Licensing	$	1,716,878	$	826,946	$	889,932		108	%
Services	17,371		19,334		(1,963		)	(10	)%
Total Net Revenues	$	1,734,249	$	846,280	$	887,969		105	%

Cost of sales for the three months ended September 30, 2007, was $210,288 compared with $202,985 for the same period in 2006. The change in costs of sales was due to a decrease in amortization expense as most capitalized software became fully amortized offset by higher customer support costs in connection with the increased license revenue during the September 30, 2007 quarter versus the prior year quarter.

For the reasons noted above, gross profit for the three-months ended September 30, 2007 and 2006 was $1,523,961 and $643,295, respectively. Wave’s gross profit percentage was 87.9% for the quarter ended September 30, 2007 as compared to 76.0% for the same period in 2006.

Selling, general and administrative (“SG&A) expenses for the three months ended September 30, 2007, were $3,707,498 as compared to $2,998,236 for the comparable period of 2006, an increase of approximately 24%. The increase was due mainly to an increase in salaries and related benefits totaling approximately $381,000, associated with salary rate increases and headcount additions to accommodate additional sales, marketing, business development and support activities, which exceeded those in the three months ended September 30, 2006. In addition, professional fees increased approximately $104,000 and additional travel expenses of approximately $32,000 were incurred in the quarter ended September 30, 2007 versus the comparable period of 2006. Also, stock option expense increased approximately $80,000 for the quarter ended September 30, 2007 versus the comparable period of 2006 due mainly to a company-wide option grant in early August 2007. Included in the SG&A expenses listed above are Wavexpress’ selling, general and administrative expenses, which were $381,807 and $224,334 for the quarters ended September 30, 2007, and 2006, respectively. This increase was due primarily to an increase of approximately $95,000 in professional fee expenditures during the quarter ended September 30, 2007 versus the comparable period of 2006.

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 will 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.

Research and development expenses for the three months ended September 30, 2007, were $2,724,857 as compared to $2,163,201 for the comparable period of 2006, an increase of 26%. This increase was primarily attributable to increased salaries, fringe and benefit expenditures of approximately $359,000 at Wave and approximately $69,000 at Wavexpress, associated with salary rate increases and headcount additions to accommodate additional research and development efforts, which exceed those in the three months ended September 30, 2006. In addition, rent and other facilities-related costs increased approximately $37,000 during the quarter ended September 30, 2007 versus the comparable period of 2006. Additional office space was leased to accommodate our research and development efforts. Also, stock option expense increased approximately $79,000 for the quarter ended September 30, 2007 versus the comparable period of 2006 due mainly to a company-wide option grant in early August 2007. Wavexpress’

research and development expenditures included in the above were approximately $389,537 and $324,916 for the quarters ended September 30, 2007, and 2006, respectively.

Interest income for the three months ended September 30, 2007, was $130,694 as compared to $30,872 for the comparable period of 2006. The increase in interest income is due to higher average balances of Wave’s money market accounts and higher rates of return for the quarter ended September 30, 2007 compared with the same period in 2006.

Due to the reasons set forth above, our net loss to common stockholders for the three months ended September 30, 2007, was $4,777,700 as compared to $4,487,270 for the comparable period of 2006.

Nine Months Ended September 30, 2007 and 2006

Wave had revenues of $4,431,641 and $2,249,839 for the nine-month period ended September 30, 2007, and 2006, respectively. The increase was due primarily to licensing revenues, which increased by $2,535,822 during the nine-month period. This increase was due to a higher volume of shipments of Wave’s OEM customer products, primarily as a result of its OEM relationship with Dell, for which Wave receives royalty income. Service revenue consists primarily of non-recurring government time and materials contracts.

The table below sets forth the components that make up the revenue for the six-month period ended September 30:

	2007		2006		Increase/ (Decrease)			% Change
Licensing	$	4,353,815	$	1,817,993	$	2,535,822		139	%
Services	77,826		431,846		(354,020		)	(82	)%

Total Net Revenues	$	4,431,641	$	2,249,839	$	2,181,802		97	%

Cost of sales for the nine-month period ended September 30, 2007, was $580,062, compared with $773,904 for the same period in 2006. The decrease in costs of sales was due to a decrease in the associated costs of the non-recurring government time and materials contracts noted above. Additionally, amortization expense decreased as most capitalized software became fully amortized. These decreases were partially offset by higher customer support costs in connection with the increased license revenue during the nine-month period ended September 30, 2007 versus the comparable period of 2006.

For the reasons noted above, gross profit for the nine-month period ended September 30, 2007 and 2006 was $3,851,579 and $1,475,935, respectively. Wave’s gross profit percentage was 86.9% for the nine-months ended September 30, 2007 as compared to 65.6% for the same period in 2006.

SG&A expenses for the nine months ended September 30, 2007, were $11,093,101, as compared to $9,400,495 for the comparable period of 2006, an increase of approximately 18%. The increase was due mainly to an increase in salaries and related benefits totaling approximately $936,000, associated with salary rate increases and headcount additions to accommodate additional sales, marketing, business development and support activities, which exceeded those in the nine months ended September 30, 2006. In addition, professional fees - primarily consulting fees - increased approximately $304,000 and additional travel expenses of approximately $218,000 were incurred during the nine-month period ended September 30, 2007 versus the comparable period of 2006. Included in the SG&A expenses listed above are Wavexpress’ selling, general and administrative expenses, which were $1,027,258 and $822,217 for the nine-month period ended September 30, 2007 and 2006, respectively. This 25% increase was due primarily to an increase in professional fee expenditures of approximately $261,000 offset by a decrease in rent and other facilities-related costs.

Research and development expenses for the nine months ended September 30, 2007, were $7,687,312, as compared to $6,175,701 for the comparable period of 2006, an increase of 24%. This increase was primarily attributable to increased salaries, fringe and benefit expenditures of approximately $939,000 at Wave and approximately $186,000 at Wavexpress, associated with salary rate increases and headcount additions to accommodate additional research and development efforts, which exceed those in the nine months ended September 30, 2006. In addition, professional fees, consisting of computer programming consultants, increased approximately $44,000 in support of additional research and development efforts and rent and other facilities-related costs increased approximately $133,000 during the nine months ended September 30, 2007 versus the comparable period of 2006. As noted above, additional office space was leased to accommodate our research and development efforts. Wavexpress’ research and development expenditures included in the above were $1,044,625 and $920,865 for the nine months ended September 30, 2007, and 2006, respectively, for an increase of approximately 13%, due to the increase in salaries, fringe and benefit expenditures noted above offset by a decrease in product development costs of approximately $90,000.

Interest income for the nine months ended September 30, 2007, was $264,840 as compared to $79,183 for the comparable period of 2006. The increase in interest income is primarily attributable to higher average balances of Wave’s money market accounts and higher rates of return for the nine months ended September 30, 2007 compared with the same period in 2006.

Due to the reasons set forth above, our net loss to common stockholders for the nine months ended September 30, 2007, was $14,663,994 as compared to $14,018,254 for the comparable period of 2006.

Liquidity and Capital Resources

Wave has experienced net losses and negative cash flow from its operations since its inception, and, as of September 30, 2007, had an accumulated deficit of $318,196,093. Total stockholders’ equity as of September 30, 2007, was $7,003,713. Wave has financed its operations through September 30, 2007, principally through the issuance of Class A and B Common Stock and various series of preferred stock.

Sources and uses of cash

As of September 30, 2007, Wave had $7,754,204 in cash and cash equivalents. As of December 31, 2006, Wave had $7,965,994 in cash and cash equivalents. The decrease in cash and cash equivalents of $211,790, resulted from $14,190,367 used in operating activities, $426,234 used in investing activities for the acquisition of capital assets offset by $14,404,811 generated through financing activities, from the sale of 7,412,134 shares of Class A Common Stock, including 91,746 shares sold pursuant to Wave’s Employee Stock Purchase Plan and 3,315 shares sold as a result of an employee stock option exercise. At September 30, 2007, Wave had positive working capital of $6,264,504.

Liquidity requirements and future sources of capital

Wave estimates that its total expenditures to fund operations for the twelve months ending September 30, 2008, will be approximately $25,200,000, including research and development, acquisition of capital assets, sales and marketing, general corporate expenses and overhead.

Expected sources of cash include the following:

• cash on hand of $7,754,204 as of September 30, 2007

• cash from sales and licensing of products

Given Wave’s capital requirements for the twelve-month period ending September 30, 2008, as indicated above, and Wave’s cash on hand as of September 30, 2007, Wave will be required to raise additional capital to fund its operations.

Wave may obtain additional funding from further sales of newly issued shares of Class A Common Stock including the sale of Class A Common Stock under the shelf registration statement that we filed on March 20, 2007 that the Securities and Exchange Commission declared effective on April 27, 2007. There are $10,000,000 in gross proceeds available under the March 20, 2007 shelf registration statement, which may be utilized for future financings. We can provide no assurances as to whether we will be successful in raising the needed capital to continue as a going concern.

Revenue outlook

Wave receives revenue from licensing its EMBASSY Trust Suite software through distribution arrangements with its OEM partners. In addition, Wave received revenues from software development and other services. Total cash received from all revenue sources for the nine months ended September 30, 2007, was approximately $3,787,000 versus approximately $1,912,000 for the comparable period of 2006.

In March of 2007, Wave signed a distribution agreement with Seagate Technology LLC (“Seagate”) that permits Seagate to distribute Wave’s management software on Seagate’s Momentus 5400 Full Disc Encryption hard drive (“FDE.2”). Wave is being paid a per unit royalty fee for each Seagate shipment which includes Wave’s software. Shipments began in late July 2007. We are working with Seagate to market our products in an effort to drive volume of shipments of their TPM-equipped FDE.2 hard drives. However, we have no reliable basis to predict how many of Seagate’s TPM-equipped FDE.2 hard drives will be purchased or what the resultant revenue to Wave might be from this program. There are no minimum royalty or shipped quantity requirements in this agreement.

Wave works 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 chips, TPM hardware security that meets the TCG industry standard, which our business model depends upon, is still a new, 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.

Other than the recently signed agreement with Seagate, our license and distribution agreements began to generate royalty revenue in the second quarter of 2006. The aggregate amount of royalty revenue from these arrangements for 2007 and future years may be material. We expect to continue to generate cash flow from these arrangements as long as the agreements remain in effect and our software continues to ship with these products. Enterprise customers are beginning to express interest in the upgrade packages offered in connection with these distribution agreements.

As stated previously, Wavexpress contracts with customers for its broadband media distribution services. Under these contracts, Wavexpress shares subscription and/or advertising revenue generated by the client’s website in addition to bandwidth fees. Given that this is a new type of service, it is difficult to predict the subscription levels and, therefore, the revenue that will be generated from these contracts. In addition, Wavexpress has a number of customer prospects with whom it may close business in 2007; however, it is also difficult to predict the number of contracts that it will enter into during the year. Wavexpress had no revenue during the quarter.

Known trends and uncertainties affecting future cash flows

Because Wave does not have sufficient cash to fund operations for the twelve-months ending September 30, 2008 and given the uncertainties described above with respect to Wave’s revenue outlook, Wave has been and will continue to be actively engaged in financing activities in order to generate additional funding to cover its operating costs for the twelve-months ending September 30, 2008.

Wave will 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 our

operations for the twelve-months ending September 30, 2008. 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. Given the available cash currently on hand and our expenditure forecast for the twelve-months ending September 30, 2008, we estimate that we will need to generate at least $4,700,000 from a combination of revenue growth above forecasted levels and additional financing activities, in order to continue as a going concern for the twelve-months ending September 30, 2008.

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 and new competitive pressures can emerge, which could require a shift in product development and/or market strategy. Should such shifts occur, it may require development, marketing and sales strategies to re-start or expand, which would likely increase operating costs, requiring additional capital. Such shifts have occurred several times throughout Wave’s history and have required 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 beyond September 30, 2008 to increase market awareness. Therefore, if Wave is not able to begin to generate significant revenues by September 30, 2008 to cover its operating costs, it will need to generate capital from other sources, including raising funds through issuing additional common stock, preferred stock and/or debt to fund its operations beyond September 30, 2008.

Commitments

Wave has no significant long-term contractual obligations other than with respect to operating leases for its facilities, which are listed below:

	Within one year		Years two and three		Years four and five		Thereafter		Total
Operating leases commitments	$	669,851	$	944,675	$	1,773	$	-0-	$	1,616,299

Net operating and capital loss carryforwards

As of December 31, 2006, Wave had available net operating and capital loss carryforwards for federal income tax purposes of approximately $268.2 million, which expire beginning in 2007 through 2026. 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 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 are likely to be subject to annual limitations.

Going concern opinion

The accompanying consolidated financial statements have been prepared assuming that Wave will continue as a going concern. Wave’s independent registered public accounting firm, KPMG LLP, has issued a report on Wave’s financial statements as of December 31, 2006, dated March 15, 2007, that includes an explanatory paragraph referring to our significant operating losses and substantial doubt of our ability to continue as a going concern (See also Note 1 to Wave’s consolidated financial statements).

Item 3. 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 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures.

As of the end of the period covered by this report, an evaluation was carried out under the supervision and with the participation of Wave’s management, including the 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 (the “Exchange Act”). Based on that evaluation, the CEO and CFO have concluded that Wave’s disclosure controls and procedures were effective as of September 30, 2007 to ensure that information required to be disclosed by Wave in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission rules and forms.

There has been no change in our internal controls over financial reporting that occurred during the period ended September 30, 2007 that has materially affected, or is reasonably likely to materially affect, Wave’s internal controls over financial reporting.

PART II - OTHER INFORMATION

ITEM 1. Legal Proceedings

None.

Item 1a. Risk Factors

This report contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from the results contemplated by these forward-looking statements due to certain factors, including those discussed below, and elsewhere in this quarterly report.

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 during the three-months and nine-months ended September 30, 2007 was significantly below operating expenses, as our products have not yet attained widespread commercial acceptance. This is due primarily to the early stage nature of the digital security industry in which we operate. As of September 30, 2007, we have an accumulated deficit of approximately $318.2 million and positive working capital of approximately $6.3 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.

We may not be able to fund our operations and continue as a going concern.

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. This will likely result in significant losses for the foreseeable future. Considering our current cash balance and Wave’s projected operating cash requirements, we anticipate that our existing capital resources will be adequate to satisfy our cash flow requirements into April 2008. In order to fund our business through April 2008 and beyond, it will be necessary for us to generate substantial revenue, complete one or more commercial or strategic transactions or raise additional capital. Wave is uncertain as to the availability of financing from other sources to fund any cash deficiencies. 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.

We may be unable to raise the $4,700,000 million of additional cash flow, which is necessary to continue as a going concern for the next twelve months.

Based upon our current expense forecast, we estimate that our current available capital is sufficient to fund Wave into April 2008. In addition to our efforts to begin to generate revenue sufficient to fund our

operations, or complete one or more commercial or strategic transactions, Wave is evaluating 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 estimate, based upon current forecasts, we will need to generate approximately $4,700,000 from a combination of revenue growth, commercial or strategic transactions and/or additional financings, to continue as a going concern for the twelve-months ending September 30, 2008. We expect we will be required to generate a portion of this cash through additional financings in the form of sales of securities pursuant to a shelf registration statement filed with the SEC on March 20, 2007, which was declared effective on April 27, 2007. There is $10,000,000 in gross proceeds available under this shelf registration statement, which may be utilized for future financings. 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, or 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. Furthermore, if we are not successful in generating sufficient cash flow or obtaining additional funding, we will be unable to continue our operations, develop or enhance our products, take advantage of future opportunities, respond to competitive pressures and continue as a going concern.

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. 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.

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., Symantec, Computer Associates, Verisign, Inc., Entrust, Inc., Ultimaco, 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 computing applications, including Softex, Phoenix, Infineon 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 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.

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 BXA 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.

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 additional 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 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. We currently have no commitments or agreements with respect to any material acquisitions. 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 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.

Item 6. Exhibits

(a) Exhibits

Exhibit No.		Description of Exhibit
31.1	—	Certification of the Chief Executive Officer pursuant to Rule 13a-14a, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	—	Certification of the Chief Financial Officer pursuant to Rule 13a-14a, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	—	Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18.U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

SIGNATURE

Pursuant to the requirements 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.

Dated: November 9, 2007

	WAVE SYSTEMS CORP.
	(Registrant)

	By:	/s/ Steven K. Sprague
	Name: Steven K. Sprague
	Title: President and Chief Executive Officer

	By:	/s/ Gerard T. Feeney
	Name: Gerard T. Feeney
	Title: Chief Financial Officer

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

Wave Systems (WAVX) Inactive 10-Q2007 Q3 Quarterly report

Content analysis