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Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549



FORM 10-K



ý

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended December 31, 2010oro

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period
from                to


Commission File Number 0-24752

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

Delaware(State or other jurisdiction of
incorporation or organization)

13-3477246(I.R.S. Employer
Identification No.)480 Pleasant Street
Lee, Massachusetts(Address of principal executive offices)

01238(Zip Code)


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

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

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

Class A Common Stock, $.01 par value(Title of Class)

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

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
YES o    NO ý

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the
past 90 days. YES ý    NO o

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

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

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

Large accelerated filer o

Accelerated filer ý

Non-accelerated filer o (Do not check if a
smaller reporting company)

Smaller reporting company o


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

The aggregate market value of the shares of Common Stock of the registrant held by non-affiliates based on the closing price (as reported by NASDAQ)
of such common stock on the last business day of the registrant's most recently completed second fiscal quarter (June 30, 2010) was approximately $260 million. (For purposes of this
calculation, the market value of a share of Class B Common Stock was assumed to be the same as a share of Class A Common Stock, into which it is convertible.)

As
of March 9, 2011, there were 82,307,004 shares of the registrant's Class A Common Stock and 35,556 shares of the registrant's Class B Common Stock outstanding.

DOCUMENTS
INCORPORATED BY REFERENCE:

Portions
of our definitive Proxy Statement for the 2011 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2011, have been
incorporated by reference into Part III of this annual report.



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

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Table of Contents



PART I


2Item 1.

Business


2Item 1A.

Risk Factors


14Item 1B.

Unresolved Staff Comments


21Item 2.

Properties


21Item 3.

Legal Proceedings


21Item 4.

Removed and Reserved


21PART II


22Item 5.

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


22Item 6.

Selected Financial Data


24Item 7.

Management's Discussion and Analysis of Financial Condition and Results of Operations


25Item 7A.

Quantitative and Qualitative Disclosures about Market Risk


44Item 8.

Financial Statements and Supplementary Data


44Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure


44Item 9A.

Controls and Procedures


44Item 9B.

Other Information


45PART III


46Item 10.

Directors, Executive Officers and Corporate Governance


46Item 11.

Executive Compensation


46Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters


46Item 13.

Certain Relationships and Related Transactions, and Director Independence


46Item 14.

Principal Accounting Fees and Services


46PART IV


47Item 15.

Exhibits and Financial Statement Schedules


47


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PART I

Item 1.    Business

General

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

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

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

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

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

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

Wave's
operations to-date have consisted primarily of product development, performance under contract to develop products and marketing and sales to personal computer ("PC") and
semi-conductor chip ("Chip") original equipment manufacturers ("OEMs"), resellers, and enterprises. Wave has been successful in signing distribution and reseller contracts with Intel,
Nuvoton, ST Microelectronics, Dell Products LP ("Dell"), Acer, ASUS and Broadcom. In February 2010, Wave entered into a reseller agreement with Universal Scientific Industrial ("USI") that
permits USI to distribute a custom version of Wave's software on specified ASUS notebook platforms worldwide. In November 2009, Wave entered into a reseller agreement with Hewlett-Packard Company
("HP") that permits HP to distribute and sell Wave's software products through HP sales channels. In December 2008, Wave completed an amendment to its software license agreement with its largest OEM
customer, Dell. The per-unit royalties that Wave receives for each Dell PC model shipping with Wave's EMBASSY Trust Suite software were increased by at least 100% per unit retroactive to
November 1, 2008.

Due
to the early stage nature of its market category Wave is unable to predict with a high enough level of certainty whether enough revenue will be generated in calendar 2011 to fund its
cash flow requirements. Given the uncertainty with respect to Wave's revenue forecast for 2011, Wave may be required to raise additional capital through either equity or debt financing in order to
adequately fund its capital requirements for the year ending December 31, 2011. As of December 31, 2010, we had approximately $3.6 million of cash on hand and positive working
capital of approximately $2.6 million. Considering our current cash balance and Wave's projected operating cash requirements, we project that we have enough liquid assets to continue operating
through December 31, 2011. Due to our current cash position, our capital needs over the next year and beyond, the fact that we may require additional financing and uncertainty as to whether we
will achieve our sales forecast for our products and services, substantial doubt exists with respect to our ability to continue as a going concern.

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

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

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

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Products and Services

Although Wave's revenue has grown considerably in 2010 versus prior years, Wave's revenue in 2010 of approximately $26,051,000 was
still less than its operating expenses which were approximately $30,158,000. For the years ended December 31, 2010, 2009, and 2008, Wave incurred losses to common shareholders of approximately
$4,123,000, $3,346,000 and $21,206,000 respectively. At December 31, 2010, we had an accumulated deficit of approximately $352,159,000. There can be no assurance that we will ever be successful
in achieving significant commercial acceptance of our products and services.

Client-side Applications

EMBASSY Trust Suite

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

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

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

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

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

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

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Wave
plans to continue to develop and enhance the current products being developed within this product group and to develop new applications and services as the trusted computing market
continues to evolve. Current planned development costs for this product group are expected to be approximately $4.1 million for the year ending December 31, 2011.

Middleware and Tools

TCG-Enabled Toolkit

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

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

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

Current
planned development costs for this product group are expected to be approximately $4.4 million for the year ending December 31, 2011.

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.
EKMS may assist an organization that requires access to a former employee's encrypted data or TPM-secured keys for business continuity or disaster recovery purposes. EKMS enables
enterprise-level key protection services while ensuring proper archive procedures and recovery capabilities.

EMBASSY Authentication Server ("EAS")

EAS is offered to provide centralized management, provisioning and enforcement of multifactor domain access policies. With EAS,
authentication policies can be based on TPM credentials, smart card credentials, user passwords and fingerprint templates. With EAS, authentication policies can be provisioned and managed from the
domain controller. EAS also has an integrated biometric template capability.

EMBASSY Remote Administration Server ("ERAS")

ERAS is a server product that is offered to provide centralized management and auditing of TPMs and SEDs. ERAS is designed to
give IT administrators the ability to deploy and remotely manage SED and TPM systems, including initialization, pre-boot authentication management, recovery and repurposing of
TPMs and SEDs. ERAS is designed to provide auditing capabilities that aid in compliance management by allowing for validation of TPM and SED security settings and to allow IT administrators to
assess the risk of whether a lost or compromised PC is adequately secure. ERAS is

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designed
to facilitate enterprise adoption of TPM and SED technology as it provides IT administrators with tools to utilize the security of these devices while reducing deployment and management
costs. The latest version of EMBASSY Trust Suite, including TDM, incorporates support for Seagate's Momentus FDE 7200-RPM SED and Samsung's SEDs (standard and solid-state
versions)both shipping on Dell's E-Series notebook PCs. This version also supports Fujitsu's 2.5-inch High Definition Drivetechnology based upon the
Opal Security Subsystem Class (SSC) specificationan industry standard issued by the TCG. The SSC specification gives vendors an industry standard for developing SEDs that secure data.
Wave's products currently support Opal compliant SED offerings from Fujitsu, Toshiba, Samsung, Hitachi and Seagate.

Current
planned development costs for this product are expected to be approximately $2.4 million for the year ending December 31, 2011.

Electronic/Digital Signature and Electronic Document Management

eSign Transaction Management Suite

Our SmartSAFE Bundle, previously known as eSign Transaction Management Suite or eTMS, originally consisted of four core products:
SmartIdentity, SmartSignature, SmartSAFE and SmartConnect. SmartIdentity is an optional service to verify a signer's identity through strong authentication methods, including issuing encrypted digital
certificates based on public key infrastructure technology. SmartSignature is a digital signature application that can connect signers and institutionsbanks, insurance companies,
enterprises, etc.through a digital signature process. Wave's SignatureServer 5.04, 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. SmartSAFE is a core component of the SmartSAFE Bundle that
provides record retention of the electronically signed documents. SmartSAFE Version 5.04 is a web-based document management application where signed documents are archived and
tracked. SmartSAFE was designed to provide an environment where a client institution can view, manage, store and transfer sensitive signed and unsigned documents. SmartSAFE meets the requirements of
Federal Rule 901 which requires that the user demonstrate that electronic documents offered as evidence in a legal proceeding are authentic. Wave's SigningRoom Version 2.04 was designed
to enhance the functionality of SmartSAFE, enabling an organization to offer signers a secure virtual environment to review, annotate and electronically sign documents. SmartConnect is a core
component of the SmartSAFE Bundle that offers a web service that can retrieve signing and transactional data for viewing and/or for use in populating other systems such as CRM and other workflow
applications. An enhancement to the SmartSAFE Bundle known as SmartClose has been designed to allow for mortgage closing documents to be signed and notarized in a secure environment. The electronic
note is then registered through the Mortgage Electronic Registry System, a system for electronically tracking mortgage ownership and servicing rights. SmartClose also offers lenders protection against
borrowers claiming not to have understood their debt obligation by requiring the borrower to electronically sign and initial key line items while providing audit capabilities for the entire
transaction. SmartClose has been designed to allow a lender to originate, sign, track, access, store and transfer electronic mortgages. Wave plans to continue to allocate resources toward marketing
and sales to promote these products.

Wave's
SmartSAFE Bundle is being independently marketed to insurance, mortgage, banking and governmental institutions, offering digital and electronic signature solutions that are
designed to comply with the Electronic Signatures in Global and National Commerce Act ("ESIGN") and Uniform Electronic Transaction Act ("UETA"). Some of the flagship organizations that are currently
utilizing the SmartSAFE Bundle include: Bank of NY Mellon, Mortgage Cadence, Medallion Analytics, Ellie Mae, ala mode, DocuTech, SigniaDocs, Xerox Mortgage Services and Insurance Administrative
Solutions.

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Current
planned development costs for this product are expected to be approximately $600,000 for the year ending December 31, 2011.

Broadband Media Distribution Services

Wave offered broadband content distribution products and services through Wavexpress and its TVTonic consumer media service, which was
a joint venture between Wave and Sarnoff Corporation. On September 23, 2008, Wave, Sarnoff Corporation and Wavexpress entered into a Restructuring Agreement and an Amended and Restated
Stockholder Agreement whereby, among other things, the parties agreed to terminate the Joint Venture Agreement between the parties, dated October 15, 1999. As of December 31, 2010, Wave
owned 97.3% of Wavexpress, while Sarnoff owned 1.7% (on a fully diluted basis). Wavexpress has suspended its TVTonic consumer media service and is exploring opportunities to sell or license its
technology to third parties that may provide "download and play" services.

Markets and Business Strategy

Our Market

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

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



We believe that security remains one of the top industry priorities across multiple segments of the user and product value chains. Wave
believes that a key differentiator of its EMBASSY Trust Suite is that it is interoperable across all of the currently available TPM-enabled Windows platforms while supporting all shipping
DriveTrust and Opal-compliant SEDs from multiple vendors. Key industry initiatives and security specifications that will require the addition of trusted hardware are moving forward in a
number of platforms. The issuance of TCG's Opal self-encrypting drive industry

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specification
standard for developing SEDs is one example of this. The Opal security subsystem storage specification gives developers a "blueprint" for developing SEDs. In addition to our work with
Seagate and Samsung, Wave has worked with Fujitsu, Toshiba and Hitachi to develop Opal-compliant SED solutions. Similar programs are under consideration in network devices and mobile
devices such as SmartPhones, cell phones, and other consumer electronics devices.

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



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



We intend to expand Wave's strategic alliances with key partners that could distribute our products in enterprise, government and
consumer markets and to build upon our alliances with such industry leaders as Intel, Dell, Acer, HP, Lenovo, ASUS and others in the PC industry. In addition, we are engaged in strategic activities
with semi-conductor manufacturers Broadcom, ST Microelectronics, Nuvoton, Atmel and Infineon Technologies to support and/or deploy EMBASSY applications with their TPMs designed to
the TCG specifications. TCG has expanded its scope to include networking systems, trusted peripherals, data storage devices, mobile wireless products and consumer electronics devices. Wave expects
additional secure storage devices and data protection alternatives to be introduced in 2011 and thereafter and believes that its trusted computing offerings can provide significant value on these
platforms in these new markets. Wave is working to establish relationships with key partners in each of these markets.

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

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



Wave
believes that development efforts will likely be significant and Wave intends to expend a substantial portion of its research and development resources towards product enhancements
and outlay significant marketing and corporate development funds to introduce new products and build market demand. As a result, our continued research and development efforts will require substantial
capital resources which may necessitate the need for further funding so that Wave may ultimately be able to capitalize on the emerging market opportunities for its products and services.

Marketing, Sales and Customers

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

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

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



Directly
and through our partners, Wave is actively targeting opportunities in these markets as we believe our products provide a wide range of security and trust capabilities.

Wave's
sales for the year ended December 31, 2010, consisted primarily of licensing its software applications, engineering and support services. Of the total revenue realized for
the years ended December 31, 2010, 2009 and 2008, 100% was derived from Wave's EMBASSY computer security products and services. Customers from which Wave derived revenue in 2010 in excess of
10% of total revenues that would have a material adverse effect on Wave's business if Wave were to lose such customers are as follows:

Customer

Product or Service Sold

Percentage of Total
Revenue for the year
ended December 31, 2010Dell

Software Licensing

80%


Wave's
business plan will continue to depend heavily on a small number of PC OEM customers, partners and prospective customers, the loss of, or lack of substantial future revenues from
any of whom, may have a material adverse effect on our business plan going forward. In 2010, Wave continued to expand its presence as a security solutions provider marketing to small, medium and large
business enterprises and will continue to actively market its products and services to these enterprises in concert with its PC OEM customer base. In late December 2010, Wave received a series of
significant license and maintenance orders for its ERAS software from a U.S.-based automotive company. The orders were received by Wave through its PC OEM partners and totaled approximately
$5.2 million. The orders increase the total value of the automaker's software orders to $10.9 million, $6.7 million of

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which
will be recorded as revenue over the next 12 months, $1.9 million of which was recorded as revenue in 2010 and $2.3 million of which is expected to be recognized as revenue
in 2012 through 2014. Initial orders for software licenses and maintenance totaling $5.7 million were received by Wave in December 2009, $1.9 million of which was recorded as revenue on
a pro rata basis principally throughout 2010. At the automaker's request, in late December 2010, Wave fulfilled $8.1 million of the expanded orders, consisting of $6.7 million in license
fees and $1.4 million in maintenance fees for 2012 through 2014. Consistent with Wave's revenue recognition policies, approximately $6.7 million of license revenue will be recognized
over a 365-day period from the date of invoice and $1.4 million in maintenance is expected to be recorded ratably over 2012 through 2014. The remaining $972,000 in maintenance
orders are expected to be billed and recorded also during 2012 through 2014. The maintenance portion of the orders, totaling $2.3 million, is cancelable up until December 1, 2011, upon
30 days notice to Wave.

Segment Reporting

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

Financial Information about Geographic Areas

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

Competition

We operate in the information security market, a highly competitive and fragmented environment that is characterized by rapidly
evolving technology. Many of our competitors and potential competitors have substantially greater financial, technical and marketing resources than we do. Also, many current and potential competitors
have greater name recognition and more extensive customer bases to leverage, allowing these competitors to gain market share or product acceptance to our detriment. In addition, the rate of market
acceptance of trusted computing solutions is still in the formative and early stages despite the substantial increase in distribution of the technology. The markets for our products are developing
and, while the TCG specifications have provided the basis for the industry to move forward, significant standards work efforts need to be accomplished in order for the system supporting trusted
computing to move forward. Wave's potential competitors include security solutions providers such as RSA Security, Inc. (a division of EMC), Symantec, Computer Associates,
Verisign, Inc., Entrust, Inc., Utimaco (acquired by Sophos), SafeNet and major systems integrators such as IBM, HP and EDS. In addition, Wave competes with other client security
applications companies that are developing trusted computer applications including Softex, Phoenix, Infineon and Microsoft. The competitive factors defining these evolving markets include product
features, compatibility, standards compliance, quality and reliability, ease of use, performance, customer service and support, distribution and price. Wave believes its products meet the requirements
to be successful viable products in these markets. The features of Wave's products that should allow it to compete favorably through product differentiation include: cross-platform interoperable
solutions; easy-to-use features; and leading-edge trusted client/server infrastructure solutions. In addition, Wave continues to offer digital signature products which can be
enhanced when combined with trusted computing platforms and features.

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

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

International Market

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

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

Proprietary Rights and Licenses and Intellectual Property

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

Wave
has been issued twelve (12) United States patents, of which one (1) has expired, relating to encryption and our proprietary EMBASSY and Wave Commerce technology. Wave
has purchased two (2) additional patents in May 2010, bringing our total to thirteen (13) active US patents. We have three (3) patents pending before the United States
Patent Office. In addition, we have three (3) foreign patents. Our patents are material to protecting some of our technology.

As
noted above, in May 2010, Wave acquired two U.S. patents pertaining to security subsystems for storage devices. The patents describe certain elements of core technology underlying
SEDs. The purchase price was $1.1 million in cash. These patents (U.S. patents #7,036,020 and #7,426,747) were acquired by Wave from a company owned by Robert Thibadeau, Ph.D., a noted computer
security

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expert
who joined Wave in February 2010, as Senior Vice President and Chief Scientist. The patents were issued in 2006 and 2008 and are valid until 2021.

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

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

Research and Development

Wave's products incorporate encryption/decryption, client and server software applications and other technologies in which we have made
a substantial investment in research and development. We will likely be required to continue to make substantial investments in the design of information security applications and services, including
the EMBASSY Trust Suite, EMBASSY Server applications and eTMS products. For the years ended December 31, 2010, 2009 and 2008, we spent approximately $10.3 million, $7.8 million
and $11.7 million, respectively, on research and development activities. Planned development expenditures for the year ended December 31, 2011, are expected to be approximately
$11.5 million.

Employees

As of December 31, 2010, we employed one hundred and twenty-nine (129) full-time employees,
seventy (70) of whom were involved in sales, marketing and administration and fifty-nine (59) of whom were involved in research and development. As of December 31,
2010, we retained the services of four (4) full-time consultants. We believe our employee relations are satisfactory.

Available Information

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

The public may read and copy any materials the Company files with the SEC at the SEC's Public Reference Room at 100 F Street, N.E., Washington, DC 20549.
Information on the operation of the Public Reference Room may be obtained by calling the SEC at
1-800-SEC-0330. The SEC also maintains an Internet site that contains reports, proxies and information statements, and other information regarding issuers that file
electronically with the SEC at http://www.sec.gov.

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Item 1A.    Risk Factors

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

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



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

We have experienced significant losses and negative cash flow from operations since our inception. We have not realized a net operating
profit in any quarter since we began our operations. Wave's revenue in 2010 was less than operating expenses as our products have not yet attained widespread commercial acceptance. This is due in part
to the early stage nature of the digital security industry in which we operate. As of December 31, 2010, we had an accumulated deficit of approximately $352.2 million and positive
working capital of approximately $2.6 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.



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

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

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

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

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

We expect that a small number of customers will continue to account for a large portion of our revenues for the foreseeable future. We
have one customer that accounted for approximately 80% of our revenue for the year ended December 31, 2010. If our relationship with any of our significant customers were disrupted we could
lose a significant portion of our anticipated revenues which may have a material adverse effect on our results of operations.

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



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

Sales to a relatively small number of OEM customers, as opposed to direct retail sales to end customers, comprise a large portion of
our revenues. For example, we have one customer that accounted for approximately 80% of our revenue for the year ended December 31, 2010. Our ability to make sales to OEM customers depends on
our ability to compete on price, delivery and quality. The timing and volume of these sales depend upon the sales levels and shipping schedules for the products into which our OEM customers
incorporate our products. Thus, even if we develop a successful component, our sales will not increase unless the product into which our component is incorporated is successful. If our OEM customers
decide not to incorporate our products as components of their products or fail to sell a sufficient quantity of products incorporating our components or if the OEM customers' sales timing and volume
fluctuate, it may lead to a reduction in our sales and have a material adverse effect on our results of operations.

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

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

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

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

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

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

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

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

We believe platforms adopting integrated hardware security into the PC will become a significant standard feature in the overall PC
marketplace. However, our technologies have not been accepted as industry standards. Standards for trusted computing are still evolving. To be successful we must obtain acceptance of our technologies
as industry standards, modify our products and services to meet whatever industry standards ultimately develop and/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 upon, among other things, our ability to improve our products, develop and introduce new products and services that keep pace
with technological developments, maintain our products compatibility with changing computer system platforms, respond to evolving customer requirements and achieve market acceptance on a timely and
cost effective basis. If we do not identify, develop, manufacture, market and support new products and deploy new services effectively and timely our business will not grow, our financial results will
suffer and we may not have the ability to remain in business.

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

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

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

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

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

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PGP
(acquired by Symantec), Credant, SafeBoot (acquired by McAfee), SafeNet, WinMagic, Secude (acquired by SAP) and GuardianEdge (acquired by Symantec) and major systems integrators such as IBM, HP
and EDS. In addition, Wave competes with other client security applications companies that are developing trusted computing applications including Softex Incorporated, Phoenix
Technologies Ltd., Infineon Technologies AG and Microsoft.

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

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

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

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

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

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

We believe that our future success depends upon the continued service of our key technical and management personnel and on our ability
to attract and retain highly skilled technical, management, sales and marketing personnel. Our industry is characterized by a high level of employee mobility and aggressive recruiting of skilled
personnel. Competition for these employees can be intense. 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. 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.

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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 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. However, intellectual property laws may not adequately protect our technology. We have
registered various trademark and service mark registrations with the United States Patent and Trademark Office. Wave may apply for additional name and logo marks in the United States and foreign
jurisdictions in the future but we cannot assure you that 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,
North Korea, Sudan and Syria.

Any
new product offerings will be subject to review by the Bureau of Export Administration to determine what export classification they will receive. Enhancements to existing products
may be subject to review by the Bureau of Export Administration to determine their export classification. 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 have 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 difficult to receive the desired classification. If
export regulations were to be modified in such a way, we may be put at a competitive disadvantage with respect to selling our products internationally.

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

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Our stock price is volatile.

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



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 and any of our other securities for
which a market develops regardless of our operating performance. Securities class action litigation has often been instituted against companies that have experienced periods of volatility in the
market price for their securities. It is possible that we could become the target of litigation of this kind that would require substantial management attention and expense. The diversion of
management's attention and capital resources could have a material adverse affect on our business. In addition, any negative publicity or perceived negative publicity of any such litigation could have
an adverse impact on our business.

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

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

Governmental regulation may slow our growth and decrease our profitability.

There are relatively 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
decrease the demand for our products and services and increase our costs or otherwise have a material adverse effect on our business.

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

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

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

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

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

Our common stock is listed on the NASDAQ Capital Market. In order to maintain our NASDAQ listing NASDAQ Marketplace
Rule 5550(a)(2) requires that the bid price for our common stock not fall below $1.00 per share for a period of 30 consecutive trading days. Because of the volatility in our common stock price
there can be no assurance that we will be able to maintain compliance with this requirement. If our minimum bid price remains below $1.00 for 30 consecutive trading days, under the current NASDAQ
Capital Market rules, we will have a period of 180 days to attain compliance by meeting the minimum bid price requirement for 10 consecutive days during the compliance period. In the event that
we do not regain compliance during such 180 day period we would be entitled to an additional 180 day compliance period if we meet the other initial listing requirements of the NASDAQ
Capital Market at the end of such initial 180 day period. If our common stock ceases to be listed for trading on the NASDAQ Capital Market we expect that our common stock would be traded on the
Over-the-Counter Bulletin Board (OTC-BB). The level of trading activity of our common stock may decline if it is no longer listed on the NASDAQ Capital Market. If
our common stock ceases to be listed for trading on the NASDAQ Capital Market for any reason it may harm our stock price, increase the volatility of our stock price and make it more difficult to sell
your shares of our common stock.

Item 1B.    Unresolved Staff Comments

None.

Item 2.    Properties

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

Facility

Sq. Ft.

Approximate
Annualized
Lease Cost

Lease ExpiresLee, MA


13,473

$
154,331


MonthlyPrinceton, NJ


4,924


99,072


Dec. 2014Cupertino, CA


14,573


521,934


Feb. 2013Orvault, France


250


13,563


Feb. 2012


Item 3.    Legal Proceedings

None.

Item 4.    Removed and Reserved

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PART II

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

Market Information & Dividends

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

High

LowYear Ended December 31, 2010First Quarter

$
4.75


1.41Second Quarter


4.20


2.20Third Quarter


3.35


1.76Fourth Quarter


4.64


2.15Year Ended December 31, 2009First Quarter

$
.98


.38Second Quarter


1.25


.49Third Quarter


1.12


.80Fourth Quarter


1.48


.82


As
of March 4, 2011, there were approximately 21,500 holders of our Class A Common Stock. As of such date, there were 12 holders of our Class B Common Stock.

On
March 14, 2011, the last sale price reported on the NASDAQ Capital Market for the Class A Common Stock was $3.48.

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

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Performance Graph

The following line graph compares the Company's cumulative total return to stockholders with the cumulative total return of the NASDAQ
Market Value Index and the Computer Related Services SIC Code Index from December 31, 2005 through December 31, 2010. These comparisons assume the investment of $100 on
December 31, 2005 and the reinvestment of dividends. The stock performance on the graph is not necessarily indicative of future stock price performance.

Wave Systems Corp.  Comparison of Cumulative Total Return to Stockholders  December 31, 2005 through December 31, 2010

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*Among Wave Systems Inc, the NASDAQ Composite Index  and SIC Code Index

GRAPHIC

---

Wave Systems

Peer Group
(SIC Code 7379)

NASDAQ Market12/31/05

$
100.00

$
100.00

$
100.0012/31/06

$
124.02

$
112.99

$
111.7412/31/07

$
71.08

$
95.24

$
124.6712/31/08

$
18.14

$
37.85

$
73.7712/31/09

$
69.61

$
58.41

$
107.1212/31/10

$
193.14

$
77.05

$
125.93


23

---



Table of Contents

Item 6.    Selected Financial Data

The selected historical consolidated financial data presented below as of December 31, 2010 and 2009 and for the years ended
December 31, 2010, 2009 and 2008 are derived from our audited Consolidated Financial Statements contained in Item 8 of this report. The historical consolidated data as of
December 31, 2008, 2007 and 2006 and for the years ended December 31, 2007 and 2006 are derived from our audited Consolidated Financial Statements, which are not included in this report.
This information should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the audited consolidated financial statements and
related notes in Part IV, Item 15(a) of this Annual Report on Form 10-K.

Consolidated Statement of Operations Data

2010

2009

2008

2007

2006Net Revenues

$
26,050,792

$
18,888,879

$
8,809,815

$
6,306,960

$
3,116,381Operating expenses:Cost of net revenues


1,776,818


1,397,891


824,181


811,970


983,671Selling, general and administrative


18,092,489


12,992,715


16,375,372


15,222,896


12,598,389Research and development


10,288,460


7,825,058


11,702,776


10,557,937


8,486,368Write-off of intangible and other impaired assets








447,128





Total operating expenses


30,157,767


22,215,664


29,349,457


26,592,803


22,068,428Operating loss


(4,106,975
)

(3,326,785
)

(20,539,642
)

(20,285,843
)

(18,952,047
)Other income (expense):Gain on decrease in value of warrant liability














2,794Net interest and other income (expense)


(15,842
)

(19,466
)

(9,572
)

334,292


163,980Total other income (expense)


(15,842
)

(19,466
)

(9,572
)

334,292


166,774Net loss


(4,122,817
)

(3,346,251
)

(20,549,214
)

(19,951,551
)

(18,785,273
)Accretion of non-cash beneficial conversion feature on convertible preferred stock








(657,000
)




Net loss attributable to common stockholders

$
(4,122,817
)
$
(3,346,251
)
$
(21,206,214
)
$
(19,951,551
)
$
(18,785,273
)Weighted average number of common shares outstanding during the period


79,924,475


68,526,572


55,379,118


46,660,794


36,735,059Loss per common share-basic and diluted

$
(0.05
)
$
(0.05
)
$
(0.38
)
$
(0.43
)
$
(0.51
)Cash dividends declared per common share


-0-


-0-


-0-


-0-


-0-


Consolidated Balance Sheet Data

2010

2009

2008

2007

2006Working capital

$
1,238,456

$
(2,046,998
)
$
(6,322,057
)
$
1,676,412

$
5,369,273Total assets


17,083,883


6,327,925


3,429,774


6,037,856


9,359,677Long-term liabilities


116,734


183,505


245,362





Total liabilities


14,387,112


8,187,880


9,448,777


3,542,345


3,439,408Total stockholders' equity (deficit)

$
2,696,771

$
(1,859,955
)
$
(6,019,003
)
$
2,495,511

$
5,920,269


24

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Table of Contents

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

Overview

Wave's management has focused its activities and resources on the continued development and marketing of the TCG-compliant
software products known as the EMBASSY Trust Suite and EMBASSY Trust Server Applications. As the market for TPM-enabled products has evolved, Wave has developed its products to support
security hardware based on the TCG specifications. Wave's products are designed to support cross platform interoperability for the currently available TPM chips from Nuvoton, Broadcom, Atmel, Infineon
and
ST Microsystems which appear on TPM-based platforms shipped by Dell, Intel, Acer, Fujitsu, Hitachi, Toshiba, Samsung, Lenovo, ASUS and HP.

Wave
is devoting its resources to capitalize on the opportunities, and overcome the specific challenges, presented by this developing market as it continues to pursue a strategy of
educating the marketplace on the benefits that trusted computing has to offer while continuing to develop the basic software applications designed to enable this emerging technology. The market trends
and opportunities on which management focused the Company's activities during the year ended December 31, 2010, included the following:



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



25

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Management
has focused on entering into licensing contracts pursuant to which PC and chip OEMs license our applications and distribute them as part of their offerings while paying
Wave a royalty for each unit shipped. Revenue earned on these licensing contracts for the years ended December 31, 2010 and 2009 was approximately $19,980,000 and $16,487,000, respectively.

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

Management
is also focused on pursuing opportunities for its eTMS product suite. The eTMS product suite provides digital signing and document management solutions to the financial
services and other vertical markets in which there is an identifiable value proposition in implementing these solutions.

Operating Expense Trends

Selling, general and administrative expenses ("SG&A") increased from 2009 to 2010 as a result of headcount additions in support of our
additional sales, marketing and business development and support activities during 2010, net of allocated share-based compensation expenses incurred during 2010 and 2009. For the years ended
December 31, 2010, 2009 and 2008, we have incurred approximately $18.1 million, $13.0 million and $16.8 million, in SG&A expenses, respectively. Share-based compensation
expenses allocated to SG&A for the years ended December 31, 2010, 2009 and 2008 were approximately $1.9 million, $1.1 million and $1.3 million, respectively.

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

Given
the early stage nature of the markets for products that use our technology we have expended, and plan to continue to expend, considerable resources in the sales, marketing,
business development and support activities referred to above that will be necessary for us to be successful in developing saleable products and markets for our technology. As a result, we expect
overall sales and marketing expenditures, as well as, overall research and development expenditures to increase as compared with 2010 (SeeLiquidity and Capital
Resources).

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

26

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Table of Contents

Critical Accounting Policies

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

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

Revenue RecognitionWave's business model targets revenues primarily from the licensing of its EMBASSY Trust Suite and eTMS software products and
development contracts. These sales arrangements may include multiple-elements and/or require significant modification or customization of our software.

Wave
recognizes revenue when it is realized or realizable and earned. Wave considers revenue realized or realizable and earned when persuasive evidence of an arrangement exists, delivery
has occurred, the sales price is fixed or determinable and collectability is reasonably assured. Wave reduces revenue, if applicable, 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. In addition to the aforementioned general policy the
following are the specific revenue recognition policies for each major category of revenue:



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 ("VSOE") 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 delivered elements if VSOE 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.

Cost
of net revenueslicensing includes foreign tax withholdings, customer support personnel costs and share-based compensation expense.



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 using the percentage of completion method. Wave measures the percentage of completion by reference to the proportion of contract
hours incurred for work performed to date to the estimated total contract hours

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Table of Contents

expected
to be incurred. Losses on fixed price contracts are recognized during the period in which the loss first becomes apparent. Payment terms vary by contract.

Cost
of net revenuesservices includes non-recurring government time and materials costs incurred in connection with a contract with the United States Department
of Defense and share-based compensation expense.

In
order to enhance the comparability of its results of operations with other security software providers in the industry Wave has classified cost of net revenues to a component of
operating expenses. As a result, a gross profit analysis is not presented.

Share-based CompensationWe recognize compensation expense for all share-based payment awards made to employees and directors including employee stock
options and employee stock purchases related to the Employee Stock Purchase Plan. Share-based compensation expense recognized is based on the value of the portion of share-based payment award that is
ultimately expected to vest and has been reduced for estimated forfeitures. We value share-based payment awards at grant date using an option-pricing model. Our determination of the fair value of the
share-based payment award on the date of grant using the option-pricing model is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These
variables include, but are not limited to, our expected stock price volatility over the term of the award and actual and projected employee stock option exercise behaviors.

Results of Operations

Comparison of the years ended December 31, 2010 and 2009

Wave had net revenues of $26,050,792 and $18,888,879 for the years ended December 31, 2010 and 2009, respectively. The increase
in net revenues was due primarily to an increase in licensing revenues. Licensing revenues increased by $6,722,986 during 2010 as compared to 2009. This increase in licensing revenues was due
primarily to (i) an increase in revenue recognized on our license upgrade sales due in large part to the recognition of approximately $1,901,000 in revenue on an order received in late December
2009 through an OEM partner on behalf of its customer, a U.S.-based global automaker and (ii) higher per-unit royalty rates earned during 2010 as compared to 2009 as a majority of
the TPMs shipped during 2010 were bundled with Wave's latest version of its EMBASSY Trust Suite softwareETS 3.0. Per Wave's software license agreement with Dell, and as a result of
added product enhancements, ETS 3.0 earns a higher per-unit royalty rate than the previous version of ETS. Services revenue, consisting
primarily of non-recurring government contracts, increased by $438,927 during 2010 as compared to 2009. Services revenue earned during 2009 included $781,677 from a time and materials
contract awarded by the United States Department of Defense. In October 2009 Wave was awarded an additional $1,600,000 fixed-price modification to this contract, of which $1,314,763 of revenue was
recognized during 2010. The project, as modified, was completed during February 2011. Under the contract, Wave provided consulting services in connection with a study to evaluate the implementation of
trusted computing solutions for the United States government.

The
table below sets forth the components that make up net revenues for the year ended December 31, 2010 and 2009:

2010

2009

Increase

% ChangeLicensing

$
24,736,029

$
18,013,043

$
6,722,986


37
%Services


1,314,763


875,836


438,927


50
%Total Net Revenues

$
26,050,792

$
18,888,879

$
7,161,913


38
%


Cost
of net revenueslicensing, which consists primarily of foreign tax withholdings, customer support personnel costs and share-based compensation expense, was $1,177,114
for the year ended

28

---



Table of Contents

December 31,
2010 as compared to $876,723 for 2009. The increase in cost of net revenueslicensing was due to (i) headcount additions in support of our customer support
activities and (ii) an increase in foreign tax withholdings in connection with the increased license revenue earned during 2010 versus 2009. The increase in net revenues noted above did not
materially impact cost of net revenueslicensing as the increase was due primarily to higher per-unit royalty rates earned during 2010 as compared to 2009. Cost of net
revenuesservices, which consists primarily of non-recurring government time and materials costs, was $599,704, for the year ended December 31, 2010 as compared to
$521,168
in 2009. In order to enhance the comparability of its results of operations with other security software providers in the industry, Wave presents cost of net revenues as a component of operating
expenses. As a result, a gross profit analysis is not presented.

SG&A
expenses for the year ended December 31, 2010 were $18,092,489, as compared to $12,992,715 in 2009, an increase of approximately 39%. The increase in SG&A expenses during the
year ended December 31, 2010 was due primarily to (i) an increase in salaries and related benefits totaling approximately $2,693,000, (ii) an increase of approximately $866,000 in
share-based compensation, (iii) an increase of approximately $534,000 in travel expenses, supporting Wave's growing customer base, (iv) an increase of approximately $256,000 in
professional services expenses, consisting primarily of recruitment and regularly occurring legal fees, and (v) an increase of approximately $553,000 in trade show and marketing expenses, in
each case as compared to 2009. Share-based compensation expense allocated to SG&A was approximately $1,931,000 for the year ended December 31, 2010 as compared to approximately $1,068,000 in
2009.

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

Research
and development expenses ("R&D") for the year ended December 31, 2010 were $10,288,460, as compared to $7,825,058 in 2009, an increase of approximately 31%. This increase
was primarily attributable to increased salaries, fringe and benefit expenditures of approximately $1,594,000, supporting Wave's OEM relationships, as compared to 2009. Also, professional fees,
consisting primarily of outsourced engineering fees, increased approximately $609,000 for the year ended December 31, 2010 versus 2009. Share-based compensation expense allocated to R&D was
approximately $807,000 for the year ended December 31, 2010, as compared to approximately $607,000 in 2009.

Interest
income for the year ended December 31, 2010 was $830 as compared to $1,918 in 2009. Interest expense for the year ended December 31, 2010 was $16,672 as compared
to $21,384 in 2009. Interest expense is primarily attributable to interest incurred on a capital lease obligation for equipment acquired for the expansion of the Wavexpress broadband infrastructure in
2008.

Due
to the reasons set forth above, our net loss for the year ended December 31, 2010 was $4,122,817 as compared to $3,346,251 for year ended December 31, 2009.

Comparison of the years ended December 31, 2009 and 2008

Wave had net revenues of $18,888,879 and $8,809,815 for the years ended December 31, 2009 and 2008, respectively. The increase
in net revenues was due primarily to an increase in licensing revenues.

29

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Table of Contents

Licensing
revenues increased by $9,321,467 during 2009 as compared to 2008. This increase in licensing revenue was due to higher per-unit royalty rates earned during 2009 as compared to
2008, primarily related to an amendment of Wave's software license agreement with Dell that was executed in December 2008 and was retroactive to November 1, 2008. Pursuant to the amendment, the
per-unit royalties that Wave receives for each Dell PC model shipping with Wave's EMBASSY Trust Suite software increased by at least 100% per unit. The amendment provides that this
increase in per-unit royalty may be cancelled prospectively by Dell or Wave upon 30 days notice. Services revenue, consisting primarily of non-recurring government time
and materials contracts, increased by $757,597 during 2009 as compared to 2008, due primarily to revenue earned from a $748,640 contract awarded by the United States Department of Defense. Under the
contract, Wave provided consulting services in connection with a study to evaluate the implementation of trusted computing solutions for the United States government.

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

2009

2008

Increase

% ChangeLicensing

$
18,013,043

$
8,691,576

$
9,321,467


107
%Services


875,836


118,239


757,597


641
%Total Net Revenues

$
18,888,879

$
8,809,815

$
10,079,064


114
%


Cost
of net revenueslicensing, which consists primarily of foreign tax withholdings, customer support personnel costs and share-based compensation expense, was $876,723, for
the year ended December 31, 2009 as compared to $736,429 for the same period in 2008. The increase in cost of net revenueslicensing was due to higher foreign taxes withheld during
the year ended December 31, 2009 versus the prior period offset partially by lower customer support personnel costs. The increase in net revenues noted above did not materially impact cost of
net revenueslicensing as the increase was due primarily to higher per-unit royalty rates earned during 2009 as compared to 2008. Cost of net revenuesservices,
which consists primarily of non-recurring government time and materials costs, was $521,168, for the year ended December 31, 2009 as compared to $87,752 for the same period in 2008.
The change in cost of net revenuesservices was due to an increase in non-recurring government time and materials costs in connection with a contract with the United States
Department of Defense during the year ended December 31, 2009 versus the prior year.

SG&A
expenses for the year ended December 31, 2009, were $12,992,715, as compared to $16,375,372 for the comparable period of 2008, a decrease of approximately 21%. SG&A expenses
decreased from 2008 to 2009 as a result of various cost savings initiatives in the sales, marketing and business development and support activities during 2009. Share-based compensation expense
allocated to SG&A was approximately $985,000 at Wave and $83,000 at Wavexpress for the year ended December 31, 2009 as compared to approximately $1,202,000 for Wave and $107,000 for Wavexpress
for the year ended December 31, 2008. Other notable decreases in SG&A expenses for the year ended December 31, 2009 as compared to 2008 included (i) a decrease of approximately
$1,351,000 in professional fees, primarily resulting from the suspension of Wavexpress' TVTonic consumer media service on December 1, 2008, (ii) a decrease of approximately $291,000 in
travel expenses, (iii) a decrease of approximately $256,000 in public relations expenditures, (iv) a decrease of approximately $461,000 in telephone expenses, (v) a decrease of
approximately $222,000 in rent and utility expenses and (vi) a decrease of approximately $144,000 in conference and trade show expenditures. Included in the SG&A expenses listed above are
Wavexpress' selling, general and administrative expenses, which were $437,339 and $2,117,913 for the years ended December 31, 2009 and 2008, respectively. The decrease in such expenses reflects
the suspension of Wavexpress' TVTonic consumer media service as of December 1, 2008.

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Table of Contents

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

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

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

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

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

Liquidity and Capital Resources

Wave has incurred substantial operating losses since its inception and, as of December 31, 2010, has an accumulated deficit of
$352,158,932. We may also incur an operating loss for the fiscal year of 2011. As of December 31, 2010, we had positive working capital of $2,588,456.

Sources and Uses of Cash

At December 31, 2010 we had $3,595,076 in cash and cash equivalents versus $1,900,014 as of December 31, 2009, resulting
in a net increase in cash of $1,695,062 for the year ended December 31, 2010. The table below shows the year-to-year comparison of the significant elements of cash used
in or provided by operating, investing and financing activities and a reconciliation of each year's operating results reported in the statement of operations to the total increase (decrease) in cash
for the years ended December 31, 2010, 2009 and 2008. The overall net loss increased by $776,566 (to $4,122,817 from $3,346,251) for the year ended December 31, 2010 versus the year
ended December 31, 2009, and cash used in operating activities decreased by $2,199,760 (to $2,480,670 from $4,680,430). In comparing the year ended December 31, 2009 to 2008, the overall
net loss decreased by $17,202,963 (to $3,346,251 from $20,549,214), while cash used in operating activities decreased by $7,751,385 (to $4,680,430 from $12,431,816).

31

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Table of Contents

As shown below, the total net change in cash over the last three years has fluctuated significantly from a net cash decrease for the year ended
December 31, 2008 of $2,762,467 to a net cash increase for the year ended December 31, 2009 of $948,451 to a net cash increase for the year ended December 31, 2010 of $1,695,062.

Consolidated Statement of Cash Flow Data

For the years ended December 31,2010

2009

2008Cash flows from operating activities:Net loss

$
(4,122,817
)
$
(3,346,251
)
$
(20,549,214
)Compensation associated with issuance of stock options


2,813,816


1,724,874


2,105,941Depreciation and amortization


404,795


259,210


395,253Impairment of Wavexpress property and equipment








447,128Total adjustments to reconcile net loss to cash used in operating activities


3,218,611


1,984,084


2,948,322Increase in prepaid expenses, receivables and other assets


(7,837,553
)

(2,120,903
)

(428,457
)Increase in deferred revenue


6,303,168


2,016,817


1,195,019Increase (decrease) in accounts payable and accrued expenses


(42,079
)

(3,214,177
)

4,402,514Changes in assets and liabilities


(1,576,464
)

(3,318,263
)

5,169,076Net cash used in operating activities


(2,480,670
)

(4,680,430
)

(12,431,816
)Cash flows from investing activities:Acquisition of property and equipment


(528,138
)

(88,007
)

(232,512
)Acquisition of intangibles


(1,100,000
)




Net cash used in investing activities


(1,628,138
)

(88,007
)

(232,512
)Cash flows from financing activities:Payments on capital lease obligation


(61,857
)

(63,537
)

(26,898
)Net proceeds from sale of preferred stock








2,688,372Net proceeds from sale of common stock





5,494,780


7,011,013Proceeds from employee options under stock plans


601,807


260,285


229,428Proceeds from employee stock option exercises


1,284,629





Payment in lieu of fractional shares in reverse stock split








(54
)Proceeds from the exercise of warrants


3,979,291


102,800


Payment of dividends on preferred stock





(77,440
)

Net cash provided by financing activities


5,803,870


5,716,888


9,901,861Net increase (decrease) increase in cash

$
1,695,062

$
948,451

$
(2,762,467
)Supplemental cash flow information:Non-cash financing activities:Conversion of 8% Series K Preferred stock into Class A Common Stock

$


$
45,600

$
Conversion of Series J Preferred stock into Class A Common Stock

$


$
9,100

$
Conversion of 8% Series I Preferred stock into Class A Common Stock

$


$
22,000

$
Capital lease obligation for capital expenditures

$


$


$
335,797Cash paid during the year for:Interest

$
16,672

$
21,384

$
10,415


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Adjustments to reconcile net loss to cash used in operating activities

Adjustments to reconcile net loss to cash used in operating activities are items reported in Wave's Consolidated Statement of
Operations that do not require an outlay or receipt of cash in the year that they are reported under generally accepted accounting principles. Compensation associated with the issuance of stock
options and depreciation and amortization make up a significant portion of the differences between Wave's reported net loss year over year compared to the differences in the amount of cash used by
Wave's operations over each of the periods. During 2008 Wave recorded an impairment charge for Wavexpress property and equipment as a result of the suspension of their TVTonic consumer media service
on December 1, 2008. These items resulted in a net reduction in the amount of cash used in operating activities of $3,218,611 for the year ended December 31, 2010 versus $1,984,084 for
the year ended December 31, 2009 and $2,948,322 for the year ended December 31, 2008. The individual items that make up these adjustments are listed in the table above and described in
greater detail in theResults of Operationssections.

Cash used in operations

The amount of cash used in operations decreased to $2,480,670 for the year ended December 31, 2010 from $4,680,430 used for the
year ended December 31, 2009, which decreased from $12,431,816 used for the year ended December 31, 2008. As shown above, the fluctuations in cash used in operations were the result of
the changes in the net losses in each of the three years ended December 31, 2010, as discussed in detail in the previousResults of Operationssection, adjusted for non-cash items of the net losses such as non-cash share-based compensation and changes to assets and liabilities for net cash outlays and/or receipts,
which, under generally accepted accounting principles, are not reported in the Statement of Operations.

Our
largest source of operating cash flow is cash collections from our customers. Cash collections from customers amounted to $24,343,140, $18,512,712 and $9,410,271 for the years ended
December 31, 2010, 2009 and 2008, respectively. Our primary uses of cash in operations are for personnel related expenditures and other general operating expenses.

Comparison of the years ended December 31, 2010 and 2009

Net cash used in operating activities decreased primarily due to an increase in cash received from customers resulting from an increase
in net revenues in 2010 as compared to 2009. This decrease was offset by an increase in cash payments for personnel related expenditures, primarily resulting from a higher average headcount during
2010 as compared to 2009, and an increase in payments to consultants, primarily for outsourced engineering services. The decrease in net cash used in operations was also offset by an increase in cash
payments to suppliers, primarily as a result of increased tradeshow and marketing activities during 2010 as compared to 2009. The increase in prepaid expenses, receivables and other assets was
primarily due to the fulfillment of $8.1 million of orders invoiced and delivered in late December 2010. Wave received $5.2 million in additional license and maintenance orders through
its PC OEM partners on behalf of a U.S.-based automotive company. The orders increased the total value of the automaker's software orders to $10.9 million, $6.7 million of which will be
recorded as revenue over the next 12 months, $1.9 million of which was recorded as revenue in 2010 and $2.3 million of which is expected to be recognized as revenue in 2012
through 2014. As of December 31, 2010 we have not established VSOE for the fair value of each undelivered element for our software and maintenance services. Accordingly, our license and
maintenance sales are recorded as deferred revenue and then recognized generally over a 365-day period. As a result, the increase in deferred revenue was due primarily to the order
referred to above.

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Comparison of the years ended December 31, 2009 and 2008

Net cash used in operating activities decreased due to an increase in cash received from customers resulting from an increase in net
revenues in 2009 as compared to 2008. Additionally, the decrease in net cash used in operating activities was attributable to a decrease in cash payments for personnel related expenditures, primarily
resulting from a lower average headcount during 2009 as compared to 2008, and a decrease in cash payments to suppliers during 2009, primarily as a result of the suspension of Wavexpress' TVTonic
consumer media service on December 1, 2008. The increase in prepaid expenses, receivables and other assets was primarily due to a $1.9 million order invoiced and delivered in late
December 2009 for software licenses and annual maintenance that Wave received through a PC OEM partner on behalf of a U.S.-based automotive company. As noted above, we have not established VSOE for
the fair value of each undelivered element for our software and maintenance services. Accordingly, our license and maintenance sales are recorded as deferred revenue and then recognized generally over
a 365-day period. As a result, the increase in deferred revenue was due primarily to the order received in late December 2009.

Cash flows from investing activities

Cash used in investing activities consisted of funds used to acquire capital assets totaling $528,138, $88,007 and $232,512 for the
years ended December 31, 2010, 2009 and 2008, respectively, and amortizable intangible assets totaling $1,100,000, $-0- and $-0- for the years
ended December 31, 2010, 2009 and 2008, respectively. Wave expects to continue to acquire capital assets primarily to replace computer equipment to be used internally. These expenditures are
expected to continue at approximately the same level as the 2010 expenditures. In May 2010 Wave acquired two U.S. patents pertaining to security subsystems for storage devices. The patents describe
certain elements of core technology underlying SEDs. The purchase price was $1.1 million in cash. These patents (U.S. patents #7,036,020 and #7,426,747) were acquired by Wave from a company
owned by Robert Thibadeau, Ph.D., a noted computer security expert who joined Wave in February 2010 as Senior Vice President and Chief Scientist. The patents were issued in 2006 and 2008 and
are valid until 2021. As a result of higher capital expenditures, net cash used in investing activities increased by $1,540,131 for the year ended December 31, 2010 versus the year ended
December 31, 2009. Lower capital expenditures resulted in a decrease in net cash used in investing activities of $144,505 for the year ended December 31, 2009 versus the year ended
December 31, 2008.

Cash flows from financing activities

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

Proceeds from issuance of newly issued equity securities

Sales of preferred stock

On December 24, 2008, Wave entered into subscription agreements, pursuant to which Wave sold and issued 456 shares of newly
designated 8% Series K Preferred Stock, par value $.01 per share ("Series K Preferred Stock"), to certain purchasers for an aggregate purchase price of $1,276,800. These shares were
priced at $2,800 per share. Each purchaser was also issued a warrant to purchase up to 2,500 shares of Class A common stock for each share of Series K Preferred Stock purchased at an
exercise price of $0.28 per share. Wave entered into a placement agency agreement with Security Research Associates, Inc. ("SRA") in which they acted as placement agent in connection with this
offering. Wave paid SRA a fee equal to 6.0% of the gross proceeds of this offering. Additionally, Wave

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issued
a warrant to SRA to purchase up to 273,600 shares of Class A Common Stock at an exercise price of $0.28 per share. All of the warrants issued in connection with this offering expire in
December 2011. Wave realized net proceeds of approximately $1,175,000 after deducting the placement agent fees of $76,608 and additional legal and other fees associated with the issuance of these
securities which totaled approximately $25,000. During 2010 and 2009, Wave received gross proceeds of $45,500 and $2,800, respectively, in connection with the issuance of 162,500 and 10,000 shares,
respectively, of Class A Common Stock upon the exercise of warrants that were granted to investors as part of this financing. Also, during 2010 and 2009, 231,945 and 17,361 shares,
respectively, of Class A Common Stock were issued to SRA upon the partial cashless exercise of a warrant that was granted to SRA as part of this financing.

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

On
October 30, 2008, Wave entered into subscription agreements, pursuant to which Wave sold and issued 111 shares of newly designated Series J Convertible Preferred Stock
("Series J Preferred Stock"), par value $.01 per share, plus warrants to purchase up to 2,220,000 shares of Class A common stock to certain purchasers for an aggregate purchase price of
$721,500. Purchasers paid an amount equal to $6,500 per share of preferred stock and the corresponding warrants. This is based on a $4,000 per share liquidation value for each share of preferred stock
plus an additional $0.125 for each share of common stock issuable upon exercise of the corresponding warrants. For each share of preferred stock purchased, the purchaser received a warrant to purchase
20,000 shares of common stock at an exercise price equal to $0.40. These warrants expire in October 2013. Each share of preferred stock was convertible into 10,000 shares of common stock at the
election of the holder thereof at any time or automatically on the date on which the average closing price per share of Wave common stock for the 15 consecutive trading day period then ended equaled
or exceeded $1.00. On June 9, 2009, all of the remaining outstanding shares issued in connection with this offering automatically converted into Class A Common Stock as the average of
the closing bid prices for the fifteen-day trading period ending June 9, 2009 was $1.001, exceeding the bid price target of $1.00 per share. SRA entered into a placement agency
agreement with Wave in which they acted as placement agent in connection with the offering. Wave paid SRA a fee equal to 6.0% of the gross proceeds of this offering. Wave also issued a warrant to SRA
to purchase up to 66,600 shares of Class A Common Stock at an exercise price of $0.40 per share. This warrant expires in October 2011. Wave realized net proceeds of approximately $653,000 after
deducting the placement agent fees of $43,290 and additional legal and other fees associated with the issuance of these securities which totaled approximately $25,000. The shares subscribed to on
October 30, 2008 were offered and issued pursuant to a shelf registration statement on Form S-3, which was filed by Wave on April 18, 2008 and declared effective by
the Commission on June 23, 2008. During 2010, Wave received gross proceeds of $149,000, in connection with the issuance of 372,500 shares of Class A Common Stock upon the exercise of
warrants that were granted to investors as part of this financing. Also, 29,020 shares of Class A Common Stock were issued to SRA during 2010 upon the partial cashless exercise of a warrant
that was granted to SRA as part of this financing.

On
September 11, 2008, Wave entered into subscription agreements, pursuant to which Wave sold and issued 172 shares of newly designated 8% Series I Preferred Stock, par
value $.01 per share

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("Series I
Preferred Stock"), to certain purchasers for an aggregate purchase price of $756,800. These shares were priced at $4,400 per share. SRA entered into a placement agency agreement with
Wave in
which they acted as placement agent in connection with this offering. Wave paid SRA a fee equal to 6.0% of the gross proceeds of this offering. Additionally, Wave issued a warrant to SRA to purchase
up to 103,200 shares of Class A common stock at an exercise price of $0.50 per share. This warrant was to expire in September 2011. Wave realized net proceeds of approximately $679,000 after
deducting the placement agent fees of $45,408 and additional legal and other fees associated with the issuance of these securities which totaled approximately $33,000. During 2010, 79,877 shares of
Class A Common Stock were issued to SRA upon the complete and cashless exercise of the warrant that was granted to SRA as part of this financing. On September 29, 2008, Wave entered into
subscription agreements, pursuant to which Wave sold and issued 48 shares of Series I Preferred Stock, to certain purchasers for an aggregate purchase price of $211,200. These shares were
priced at $4,400 per share. Wave realized net proceeds of approximately $181,000 after deducting legal and other fees associated with the issuance of these securities which totaled approximately
$30,000.

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

Sales of common stock

On July 21, 2009 Wave entered into subscription agreements with certain purchasers pursuant to which Wave agreed to sell and
issue 1,791,738 shares of Class A Common Stock, par value $.01 per share, for an aggregate purchase price of $1,648,400. These shares were priced at $0.92 per share. Roth Capital Partners
("Roth") entered into a placement agency agreement with Wave in which Roth agreed to act as placement agent in connection with the offering. Wave agreed to pay Roth a fee equal to 8.0% of the gross
proceeds of this offering. Wave also agreed to issue warrants to the subscribers to purchase up to 895,868 shares of Class A Common Stock at an exercise price of $1.155 per share. These
warrants expire in January 2015. Wave realized net proceeds of approximately $1,489,000 after deducting the placement agent fees of $131,872 and additional legal and other fees associated with the
issuance of these securities which totaled approximately $27,000. The shares sold on July 21, 2009 were offered and issued pursuant to a shelf registration statement on
Form S-3, which was filed by Wave on April 18, 2008 and declared effective by the Commission on June 23, 2008. During 2010, Wave received gross proceeds of $494,265,
in connection with the issuance of 427,935 shares of Class A Common Stock upon the exercise of warrants that were granted to investors as part of this financing.

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

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2015.
Wave realized net proceeds of approximately $2,687,000 after deducting the placement agent fees of $253,776 and additional legal and other fees associated with the issuance of these securities
which totaled approximately $231,000. The shares sold on July 16, 2009 were offered and issued pursuant to a shelf registration statement on Form S-3, which was filed by Wave
on April 18, 2008 and declared effective by the Commission on June 23, 2008. During 2010, Wave received gross proceeds of $1,352,231, in connection with the issuance of 1,170,763 shares
of Class A Common Stock upon the exercise of warrants that were granted to investors as part of this financing.

On
April 8, 2009, Wave entered into subscription agreements with certain purchasers pursuant to which Wave agreed to sell and issue 1,881,136 shares of Class A Common
Stock, par value $.01 per share, for an aggregate purchase price of $1,034,625. These shares were priced at $0.55 per share. SRA entered into a placement agency agreement with Wave in which they
agreed to act as placement agent in connection with the offering. Wave agreed to pay SRA a fee equal to 6.0% of the gross proceeds of this offering. Wave also agreed to issue warrants to the
subscribers to purchase up to 940,568 shares of Class A Common Stock at an exercise price of $0.55 per share. These warrants expire in April 2012. Additionally, Wave agreed to issue a warrant
to SRA to purchase up to 112,868 shares of Class A Common Stock at an exercise price of $0.55 per share. This warrant expires in April 2012. Wave realized net proceeds of approximately $942,500
after deducting the placement agent fees of $62,077 and additional legal and other fees associated with the issuance of these securities which totaled approximately $30,000. The shares sold on
April 8, 2009 were offered and issued pursuant to a shelf registration statement on Form S-3, which was filed by Wave on April 18, 2008 and declared effective by the
Commission on June 23, 2008. During 2010, Wave received gross proceeds of $234,375, in connection with the issuance of 426,136 shares of Class A Common Stock upon the exercise of
warrants that were granted to investors as part of this financing. Also, 34,560 shares of Class A Common Stock were issued to SRA during 2010 upon the partial cashless exercise of a warrant
that was granted to SRA as part of this financing.

On
March 13, 2009, Wave entered into subscription agreements with certain purchasers pursuant to which Wave agreed to sell and issue 785,000 shares of Class A Common Stock,
par value $.01 per share, for an aggregate purchase price of $431,750. These shares were priced at $0.55 per share. SRA entered into a placement agency agreement with Wave in which they agreed to act
as placement agent in connection with the offering. Wave agreed to pay SRA a fee equal to 6.0% of the gross proceeds of this offering. Wave also agreed to issue warrants to the subscribers to purchase
up to 392,500 shares of Class A Common Stock at an exercise price of $0.55 per share. These warrants expire in March 2012. Additionally, Wave agreed to issue a warrant to SRA to purchase up to
47,100 shares of Class A Common Stock at an exercise price of $0.55 per share. This warrant expires in March 2012. Wave realized net proceeds of approximately $376,000 after deducting the
placement agent fees of $25,905 and additional legal and other fees associated with the issuance of these securities which totaled
approximately $30,000. The shares sold on March 13, 2009 were offered and issued pursuant to a shelf registration statement on Form S-3, which was filed by Wave on
April 18, 2008 and declared effective by the Commission on June 23, 2008. During 2010, Wave received gross proceeds of $90,750, in connection with the issuance of 165,000 shares of
Class A Common Stock upon the exercise of warrants that were granted to investors as part of this financing. Also, 3,144 shares of Class A Common Stock were issued to SRA during 2010
upon the partial cashless exercise of a warrant that was granted to SRA as part of this financing.

On
August 11, 2008, Wave entered into subscription agreements pursuant to which Wave sold and issued 1,368,333 shares of Class A Common Stock, par value $.01 per share, to
certain purchasers for an aggregate purchase price of $821,000. These shares were priced at $0.60 per share. SRA entered into a placement agency agreement with Wave in which they acted as placement
agent in connection with the offering. Wave paid SRA a fee equal to 6.0% of the gross proceeds of this offering. Wave also issued warrants to the purchasers to purchase up to 342,083 shares of
Class A Common Stock at an

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exercise
price of $0.65 per share. These warrants expire in August 2011. Wave also issued a warrant to SRA to purchase up to 82,100 shares of Class A Common Stock at an exercise price of $0.65
per share. This warrant expires in August 2011. Wave realized net proceeds of approximately $742,000 after deducting the placement agent fees of $49,260 and additional legal and other fees associated
with the issuance of these securities which totaled approximately $30,000. The shares subscribed to on August 11, 2008 were offered and issued pursuant to a shelf registration statement on
Form S-3, which was filed by Wave on April 18, 2008 and declared effective by the Commission on June 23, 2008. During 2010, Wave received gross proceeds of $222,354,
in connection with the issuance of 342,083 shares of Class A Common Stock upon the exercise of warrants that were granted to investors as part of this financing. Also, during 2010 and 2009,
53,456 and 3,659 shares, respectively, of Class A Common Stock were issued to SRA upon the partial cashless exercise of a warrant that was granted to SRA as part of this financing.

On
June 30, 2008, Wave entered into subscription agreements pursuant to which Wave agreed to sell and issue 1,880,500 shares of Class A Common Stock, par value $.01 per
share, to certain purchasers for an aggregate purchase price of $1,598,425. These shares were priced at $0.85 per share. SRA entered into a placement agency agreement with Wave in which they agreed to
act as placement agent in connection with the offering. Wave agreed to pay SRA a fee equal to 6.0% of the gross proceeds of this offering. Wave also agreed to issue warrants to the subscribers to
purchase up to 470,125 shares of Class A Common Stock at an exercise price of $0.90 per share. These warrants expire in June 2011. Additionally, Wave agreed to issue a warrant to SRA to
purchase up to 112,830 shares of Class A Common Stock at an exercise price of $0.90 per share. This warrant was to expire in June 2011. Wave realized net proceeds, in early July, of
approximately $1,467,000 after deducting the placement agent fees of $95,906 and additional legal and other fees associated with the issuance of these securities which totaled approximately $36,000.
The shares subscribed to on June 30, 2008 were issued in early July and offered and issued pursuant to a shelf registration statement on Form S-3, which was filed by Wave on
March 20, 2007 and declared effective by the Commission on April 27, 2007. During 2010 and 2009, Wave received gross proceeds of $302,162 and $45,000, respectively, in connection with
the issuance of 335,736 and 50,000 shares, respectively, of Class A Common Stock upon the exercise of warrants that were granted to investors as part of this financing. Also, during 2009,
30,178 shares of Class A Common Stock were issued to SRA upon the complete and cashless exercise of the warrant that was granted to SRA as part of this financing.

On
May 23, 2008, Wave entered into subscription agreements pursuant to which Wave agreed to sell and issue 2,151,250 shares of Class A Common Stock, par value $.01 per
share, to certain purchasers for an aggregate purchase price of $1,721,000. These shares were priced at $0.80 per share. SRA entered into a placement agency agreement with Wave in which they agreed to
act as placement agent in connection with the offering. Wave agreed to pay SRA a fee equal to 6.0% of the gross proceeds of this offering. Wave also agreed to issue warrants to the subscribers to
purchase up to 537,812 shares of Class A Common Stock at an exercise price of $0.85 per share. These warrants expire in May 2011. Additionally, Wave agreed to issue a warrant to SRA to purchase
up to 129,075 shares of Class A Common Stock at an exercise price of $0.85 per share. This warrant was to expire in November 2009. Wave realized net proceeds of approximately $1,583,000 after
deducting the placement agent fees of $103,260 and additional legal and other fees associated with the issuance of these securities which totaled approximately $31,000. The shares sold on
May 23, 2008 were offered and issued pursuant to a shelf registration statement on Form S-3, which was filed by Wave on March 20, 2007 and declared effective by the
Commission on April 27, 2007. During 2010, Wave received gross proceeds of $183,547, in connection with the issuance of 215,938 shares of Class A Common Stock upon the exercise of
warrants that were granted to investors as part of this financing. Also, during 2009, 28,339 shares of Class A Common Stock were issued to SRA upon the complete and cashless exercise of the
warrant that was granted to SRA as part of this financing.

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On
February 29, 2008, Wave entered into subscription agreements pursuant to which Wave agreed to sell and issue 3,173,500 shares of Class A Common Stock, par value $.01 per
share, to certain purchasers for an aggregate purchase price of $3,490,850. These shares were priced at $1.10 per share. SRA entered into a placement agency agreement with Wave in which they agreed to
act as placement agent in connection with the offering. Wave agreed to pay SRA a fee equal to 6.0% of the gross proceeds of this offering. Wave also agreed to issue warrants to the subscribers to
purchase up to 952,050 shares of Class A Common Stock at an exercise price of $1.15 per share. These warrants expire in February 2013. Additionally, Wave agreed to issue a warrant to SRA to
purchase up to 190,410 shares of Class A Common Stock at an exercise price of $1.33 per share. This warrant expired, unexercised, on February 28, 2010. Wave realized net proceeds of
approximately $3,220,000 after deducting the placement agent fees of $209,451 and additional legal and other fees associated with the issuance of these securities which totaled approximately $61,000.
The shares sold on February 29, 2008 were offered and issued pursuant to a shelf registration statement on Form S-3, which was filed by Wave on March 20, 2007 and
declared effective by the Commission on April 27, 2007. During 2010, Wave received gross proceeds of $905,108, in connection with the issuance of 787,050 shares of Class A Common Stock
upon the exercise of warrants that were granted to investors as part of this financing.

Exercise of warrants to purchase Class A Common Stock

During 2010, Wave received gross proceeds of $3,979,291 in connection with the issuance of 4,405,641 shares of Class A Common
Stock upon the exercise of warrants that were granted to investors as part of Wave's 2009 and 2008 financings noted above. The warrants were exercised at exercise prices ranging from $0.28-$1.155 per
share.

During
2010, 432,002 shares of Class A Common Stock were issued to SRA upon the cashless exercises of warrants that were granted to SRA in its capacity as placement agent as part
of Wave's 2009 and 2008 financings noted above.

During
2009, Wave received gross proceeds of $102,800 in connection with the issuance of 160,000 shares of Class A Common Stock upon the exercise of warrants that were granted to
investors as part of Wave's 2009 and 2008 financings noted above. The warrants were exercised at exercise prices ranging from $0.28-$0.90 per share.

During
2009, 79,537 shares of Class A Common Stock were issued to SRA upon the cashless exercises of warrants that were granted to SRA in its capacity as placement agent as part
of Wave's 2009 and 2008 financings noted above.

Exercise of employee stock options

During 2010, Wave received gross proceeds of $1,284,629 in connection with the issuance of 888,445 shares of Class A Common
Stock upon the exercise of employee stock options. The employee stock options were exercised at exercise prices ranging from $0.50-$3.00 per share.

On
December 1, 2010, Wave issued 151,729 shares of Class A Common Stock to Wave employees for $2.244 per share, pursuant to the Wave 2004 Employee Stock Purchase Plan. Wave
received proceeds of $340,480 from the issuance of these shares.

On
June 1, 2010, Wave issued 240,190 shares of Class A Common Stock to Wave employees for $1.088 per share pursuant to the Wave 2004 Employee Stock Purchase Plan. Wave
received proceeds of $261,327 from the issuance of these shares.

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

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

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

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

Summary analysis of historical cash flows and future outlook

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

Liquidity requirements and future sources of capital

Wave estimates that its total expenditures to fund operations for the year ending December 31, 2011 will be approximately
$28,275,000, including research and development, acquisition of capital assets, sales and marketing, general corporate expenses and overhead.

Sources
of capital may include the following:



Given
Wave's capital requirements for the year ending December 31, 2011 as indicated above, our cash balance as of December 31, 2010, and the uncertainty as to whether we
will generate sufficient revenue, Wave may be required to raise additional capital to continue to fund its operations. We may obtain additional funding as needed from further sales of newly issued
shares of Class A Common Stock, including the sale of Class A Common Stock under the remaining availability of our $25,000,000 shelf registration statement that we filed on
April 18, 2008 and was declared effective by the Commission on June 23, 2008. Approximately $9,500,000 in gross proceeds is available under the April 18, 2008 shelf registration
statement, which may be utilized for future financings. We can provide no assurances as to whether, if necessary, we will be successful in raising the capital that may be needed to continue as a going
concern.

Revenue outlook

Wave receives revenue from licensing its EMBASSY Trust Suite software through distribution arrangements with its OEM partners. In
addition, Wave received revenues from software development and other services. Total cash received from all revenue sources in 2010 was approximately $24,343,000 versus approximately $18,513,000 in
2009. This increase in total cash received was primarily a result of higher per-unit royalty rates earned in 2010 as compared to 2009, as a majority of the TPMs shipped during 2010
were bundled with Wave's latest version of its EMBASSY Trust Suite softwareETS 3.0. Per Wave's software license agreement with Dell, as amended in late 2008, and as a result of
added product enhancements, ETS 3.0 earns a higher per-unit royalty rate than the previous version of ETS.

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In
February 2010 Wave entered into a reseller agreement with Universal Scientific Industrial ("USI") that permits USI to distribute a customized version of Wave's EMBASSY Trust Suite on
specific ASUS notebook platforms. Also, in November 2009, Wave and HP entered into a reseller agreement that permits HP to distribute and sell Wave's software products through HP channels. Initial
sales under this agreement began in early 2010.

Wave
also continues to work with all of its partners and customers to introduce and promote its existing software products and new software products which are under development, in an
effort to expand the market for TPM-based secure computing and thereby increase its market share and revenues. However, it should be noted that because of the early stage of Wave's market
and other factors, a high level of uncertainty exists with respect to the ability to forecast future revenues. Although there has been a substantial increase in the volume of shipments of
TPM-equipped PCs and self-encrypting drives, which our business model depends upon, this remains a new and developing category within the computer security market and the
ultimate size of this market and the timeframe for its development are unknown and difficult to predict.

Wave's
OEM distribution agreements began to generate royalty revenue during 2006. The aggregate amount of royalty revenue from these arrangements has been a significant contributor to
Wave's revenue growth to date. Revenue from these contracts in future years may also be material. We expect to continue to generate cash flow from these agreements as long as the agreements remain in
effect and our software continues to ship with these products.

The
OEM distribution agreements referred to above have given rise to separate software upgrade contracts with the end users of the products distributed by the OEMs. The contracts,
referred to by us as license upgrade agreements, include a software license and a maintenance agreement. The contracts are separately negotiated with end users and are not associated with our OEM
distribution agreements. Sales from the license upgrade agreements began in the latter part of the third quarter of fiscal year 2007. The sales consist of licensed use of Wave's EMBASSY Trust Suite of
products, primarily Wave's EMBASSY Security Center paired with our ERAS server product. In late December 2010 Wave received a series of significant license and maintenance orders for its ERAS software
from a U.S.-based automotive company. The orders were received by Wave through its PC OEM partners and totaled approximately $5.2 million. The orders increase the total value of the automaker's
software orders to $10.9 million, $6.7 million of which will be recorded as revenue over the next 12 months, $1.9 million of which was recorded as revenue in 2010 and
$2.3 million of which is expected to be recognized as revenue in 2012 through 2014. Initial orders for software licenses and maintenance totaling $5.7 million were received by Wave in
December 2009, $1.9 million of which was recorded as revenue on a pro rata basis principally throughout 2010. At the automaker's request, in late December 2010 Wave fulfilled
$8.1 million of the expanded orders, consisting of $6.7 million in license fees and $1.4 million in maintenance fees for 2012 through 2014. Consistent with Wave's current revenue
recognition policies, approximately $6.7 million of license revenue will be recognized over a 365-day period from the date of invoice and $1.4 million in maintenance is
expected to be recorded ratably over 2012 through 2014. The remaining $972,000 in maintenance orders are expected to be billed and recorded also during 2012 through 2014. The maintenance portion of
the orders, totaling $2.3 million, is cancelable up until December 1, 2011 upon 30 days notice to Wave.

As
of December 31, 2010, we have not established VSOE for the fair value of each undelivered element for our software and maintenance services. Accordingly, our license and
maintenance sales are recorded as deferred revenue and then recognized generally over a 365-day period. Deferred revenue increased $6,303,168 (to $9,804,029 from $3,500,861) at
December 31, 2010 versus 2009 and increased $2,016,817 (to $3,500,861 from $1,484,044) at December 31, 2009 versus 2008. Wave recognized approximately $4,284,000, $1,397,000 and $369,000
of license upgrade revenue during 2010, 2009 and 2008, respectively.

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Known trends and uncertainties affecting future cash flows

Because Wave may not have sufficient cash to fund operations for the year ending December 31, 2011, and there is uncertainty as
to whether Wave will generate sufficient revenues to fund its operations over this time period, Wave has been, and may continue to be, actively engaged in financing activities in order to generate
additional funding to cover its operating costs for the year ending December 31, 2011.

We
may be required to sell additional shares of common stock or preferred stock, obtain debt financing or engage in a combination of these financing alternatives, to raise additional
capital to continue to fund our operations for the year ending December 31, 2011. The availability and amount of any such financings are unknown at this time. Wave may also be required to
reduce expenses, which may significantly impede its ability to meet its sales, marketing and development objectives. Based upon the available cash currently on hand, if we meet our current revenue and
expenditure forecast for the year ending December 31, 2011 (both of which are uncertain), we would have enough liquid assets to continue operating through December 31, 2011. The
foregoing is based on maintaining current revenue levels for both Dell and non-Dell revenues for the year ending December 31, 2011. Dell revenue increased during 2010 and 2009
primarily as a result of an amendment signed in December 2008 where the per-unit royalties that Wave receives for each Dell PC model with Wave's EMBASSY Trust Suite software were increased
by at least 100% per unit, retroactive to November 1, 2008. The increase in per unit royalty may be cancelled prospectively by Dell or Wave upon 30 days notice. While the foregoing
assumes current shipment volumes at the increased per-unit royalty rate throughout 2011, our contract with Dell contains no guaranteed minimum royalties or minimum shipment volume
requirements.

Other uncertainties that may impact the future business outlook

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

Furthermore,
the achievement of sufficient revenue is dependent upon continued significant expenditures, which will likely be required for research and development and sales and
marketing to increase market awareness for our products. Therefore, if Wave is not able to begin to generate significant revenues by December 31, 2011 to cover its operating costs, it will need
to generate capital from other sources, including raising funds through the issuance of additional common stock, preferred stock and/or debt to fund its operations beyond December 31, 2011.

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

Commitments

Wave has a capitalized lease obligation for computer equipment due July 2013 of $183,505 and $245,362 as of December 31, 2010
and 2009, respectively. The interest rate is 7.7% per annum. This lease obligation is collateralized by the related assets with a net book value of $-0- as of December 31, 2010
reflecting an impairment charge recorded during 2008 due to the suspension of Wavexpress' TVTonic consumer media services as of December 1, 2008.

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Table of Contents

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

Within one
year

Years two
and three

Years four
and five

Thereafter

TotalCapital lease commitment

$
66,771

$
116,734

$


$


$
183,505Operating lease commitments


629,365


820,985


100,942





1,551,292Total commitments

$
696,136

$
937,719

$
100,942

$


$
1,734,797


Net operating loss carryforwards

As of December 31, 2010, Wave had available net operating and capital loss carryforwards for Federal income tax purposes of
approximately $277.0 million, which expire beginning in 2011 through 2030. 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 is likely to be subject to annual limitations.

Going Concern Opinion

Wave's consolidated financial statements as of December 31, 2010 have been prepared under the assumption that we will continue
as a going concern. Wave's independent registered public accounting firm has issued a report dated March 15, 2011, that includes an explanatory paragraph referring to our significant operating
losses and substantial doubt about our ability to continue as a going concern (See Note 2 to Wave's consolidated financial statements).

Recent Accounting Pronouncements

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

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Table of Contents

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

Item 7A.    Quantitative and Qualitative Disclosures about Market Risk

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

Item 8.    Financial Statements and Supplementary Data

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

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

None.

Item 9A.    Controls and Procedures

Evaluation of disclosure controls and procedures

As of the end of the period covered by this Annual Report on Form 10-K, an evaluation was carried out under the
supervision and with the participation of Wave's management, including our Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"), of the effectiveness of Wave's disclosure and control
procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Based on that evaluation, our CEO and CFO concluded that Wave's
disclosure controls and procedures were effective as of December 31, 2010 to ensure that the information required to be disclosed by Wave in the reports that we file or submit under the
Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms and to ensure that information required to be disclosed by Wave in the
reports that it files or submits under the Exchange Act is
accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.

Management's annual report on internal control over financial reporting

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

Wave's
management assessed the effectiveness of our internal control over financial reporting as of December 31, 2010 based on the criteria set forth by the Committee of
Sponsoring Organizations of the Treadway Commission in "Internal Control Integrated Framework". Based on this assessment, Wave's management concluded that, as of December 31, 2010, our internal
control over financial reporting is effective based on those criteria.

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

Changes in internal controls

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

Item 9B.    Other Information

Not Applicable.

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PART III

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

Information concerning Wave's directors, executive officers, promoters and control persons will appear in Wave's Proxy Statement for
the 2011 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2011, under the caption "Election of Directors." Such information is incorporated
herein by reference.

Information
concerning compliance with Section 16(a) of the Securities Exchange Act will appear in Wave's Proxy Statement for the 2011 Annual Meeting of Stockholders, to be filed
pursuant to
Regulation 14A on or before April 30, 2011, under the caption "Section 16(a) Beneficial Ownership Reporting Compliance." Such information is incorporated herein by reference.

Information
concerning Wave's Audit Committee will appear in Wave's Proxy Statement for the 2011 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or
before April 30, 2011, under the caption "Corporate GovernanceAudit Committee." Such information is incorporated herein by reference.

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

Item 11.    Executive Compensation

Information regarding executive compensation will appear in Wave's Proxy Statement for the 2011 Annual Meeting of Stockholders, to be
filed pursuant to Regulation 14A on or before April 30, 2011, under the captions "Executive Compensation", "Compensation Committee Report" and "Compensation Committee Interlocks and
Insider Participation." Such information is incorporated herein by reference.

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

Information regarding security ownership of certain beneficial owners and management and related stockholder matters will appear in
Wave's Proxy Statement for the 2011 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2011, under the captions "Security Ownership of Certain
Beneficial Owners and Management" and "Equity Compensation Plan Information." Such information is incorporated herein by reference.

Item 13.    Certain Relationships and Related Transactions and Director Independence

Information regarding certain relationships and related transactions and director independence will appear in Wave's Proxy Statement
for the 2011 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2011, under the captions "Certain Relationships and Related Transactions" and
"Director Independence." Such information is incorporated herein by reference.

Item 14.    Principal Accounting Fees and Services

Information regarding Wave's principal accountant's fees will appear in Wave's Proxy Statement for the 2011 Annual Meeting of
Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2011, under the caption "Ratification of Independent Registered Public Accounting Firm." Such information is
incorporated herein by reference.

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PART IV

Item 15.    Exhibits and Financial Statement Schedules

(a)
(1)    Financial Statements:



Page(s)Report of Independent Registered Public Accounting Firm


F-1Consolidated Balance Sheets as of December 31, 2010 and 2009


F-3Consolidated Statements of Operations for each of the years ended December 31, 2010, 2009 and 2008


F-4Consolidated Statements of Stockholders' Equity (Deficit) and Comprehensive Income (Loss) for each of the years ended
December 31, 2010, 2009 and 2008


F-5Consolidated Statements of Cash Flows for each of the years ended December 31, 2010, 2009 and 2008


F-9Notes to Consolidated Financial Statements


F-10


(a)
(2)    Financial Statement Schedules:

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

(a)
(3)    Exhibits:

Exhibit No.



Description of Exhibit3.1
*



Restated Certificate of Incorporation of Wave, as amended (incorporated by reference to Exhibit 3.1 of Wave's Quarterly Report on Form 10-Q, filed on August 9, 2006, File No. 0-24752)3.2
*



Bylaws of Wave (incorporated by reference to Exhibit 3.2 of Wave's Registration Statement on Form S-1, File No. 33-75286)4.1
*



Form of Stock Certificate of Class A Common Stock (incorporated by reference to Exhibit 4.1 of Wave's Registration Statement on Form S-1, File No. 33-75286)4.2
*



Form of Representative's Warrant Agreement, including the form of Representative's Warrant (incorporated by reference to Exhibit 4.2 of Wave's Registration Statement on Form S-1, File
No. 33-75286).4.3
*



Certificate of Designation of Series B Preferred Stock of Wave as filed with the Delaware Secretary of State on May 24, 1996 (incorporated by reference to Exhibit 3.1 of Wave's Current
Report on Form 8-K, filed on June 6, 1996, File No. 0-24752)4.4
*



Certificate of Designation of Series C Convertible Preferred Stock as filed with the Delaware Secretary of State on December 27, 1996 (incorporated by reference to Exhibit 3.1 of Wave's
Current Report on Form 8-K, filed on January 8, 1997, File No. 0-24752)4.5
*



Certificate of Designation of Series D Convertible Preferred Stock as filed with the Delaware Secretary of State on December 27, 1996 (incorporated by reference to Exhibit 3.1 of Wave's
Current Report on Form 8-K, filed on June 3, 1997, File No. 0-24752)4.6
*



Certificate of Designation of Series F Convertible Preferred Stock of Wave as filed with the Delaware Secretary of State on October 9, 1997 (incorporated by reference to Exhibit 3.1 of
Wave's Current Report on Form 8-K, filed on October 15, 1997, File No. 0-24752)


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Table of Contents

Exhibit No.



Description of Exhibit4.7
*



Certificate of Designation of Series G Convertible Preferred Stock of Wave as filed with the Delaware Secretary of State on March 5, 1998 (incorporated by reference to Exhibit 3.1 of Wave's
Current Report on Form 8-K, filed on March 19, 1998, File No. 0-24752)4.8
*



Certificate of Designation of Series H Convertible Preferred Stock of Wave as filed with the Delaware Secretary of State on April 30, 2003 (incorporated by reference to Exhibit 4.1 of Wave's
Current Report on Form 8-K, filed on May 5, 2003, File No. 0-24752)4.9
*



Form of Warrant issued to Purchasers (incorporated by reference to Exhibit 4.1 of Wave's Current Report on Form 8-K, filed March 3, 2008, File # 0-24752)4.10
*



Form of Warrant issued to Private Placement Agent (incorporated by reference to Exhibit 4.2 of Wave's Current Report on Form 8-K, filed March 3, 2008, File # 0-24752)4.11
*



Form of Warrant issued to Purchasers (incorporated by reference to Exhibit 4.1 of Wave's Current Report on Form 8-K, filed May 27, 2008, File # 0-24752)4.12
*



Form of Warrant issued to Private Placement Agent (incorporated by reference to Exhibit 4.2 of Wave's Current Report on Form 8-K, filed May 27, 2008, File # 0-24752)4.13
*



Form of Warrant issued to Purchasers (incorporated by reference to Exhibit 4.1 of Wave's Current Report on Form 8-K, filed July 1, 2008, File # 0-24752)4.14
*



Form of Warrant issued to Private Placement Agent (incorporated by reference to Exhibit 4.2 of Wave's Current Report on Form 8-K, filed July 1, 2008, File # 0-24752)4.15
*



Form of Warrant issued to Purchasers (incorporated by reference to Exhibit 4.1 of Wave's Current Report on Form 8-K, filed August 12, 2008, File # 0-24752)4.16
*



Form of Warrant issued to Private Placement Agent (incorporated by reference to Exhibit 4.2 of Wave's Current Report on Form 8-K, filed August 12, 2008, File # 0-24752)4.17
*



Certificate of Designations of Series I Convertible Preferred Stock of Wave as filed with the Delaware Secretary of State on September 12, 2008 (incorporated by reference to Exhibit 3.1 of
Wave's Current Report on Form 8-K, filed on September 15, 2008, File No. 0-24752)4.18
*



Form of Warrant issued to Private Placement Agent (incorporated by reference to Exhibit 4.1 of Wave's Current Report on Form 8-K, filed September 15, 2008, File # 0-24752)4.19
*



Certificate of Designations of Series J Convertible Preferred Stock of Wave as filed with the Delaware Secretary of State on October 30, 2008 (incorporated by reference to Exhibit 3.1 of
Wave's Current Report on Form 8-K, filed on October 31, 2008, File No. 0-24752)4.20
*



Form of Warrant issued to Purchasers (incorporated by reference to Exhibit 4.1 of Wave's Current Report on Form 8-K, filed October 31, 2008, File # 0-24752)4.21
*



Form of Warrant issued to Private Placement Agent (incorporated by reference to Exhibit 4.2 of Wave's Current Report on Form 8-K, filed October 31, 2008, File # 0-24752)


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Table of Contents

Exhibit No.



Description of Exhibit4.22
*



Certificate of Designations of Series K Convertible Preferred Stock of Wave as filed with the Delaware Secretary of State on December 29, 2008 (incorporated by reference to Exhibit 3.1 of
Wave's Current Report on Form 8-K, filed on December 29, 2008, File No. 0-24752)4.23
*



Form of Warrant issued to Purchasers (incorporated by reference to Exhibit 4.1 of Wave's Current Report on Form 8-K, filed December 29, 2008, File # 0-24752)4.24
*



Form of Warrant issued to Private Placement Agent (incorporated by reference to Exhibit 4.2 of Wave's Current Report on Form 8-K, filed December 29, 2008, File # 0-24752)4.25
*



Form of Warrant issued to Purchasers (incorporated by reference to Exhibit 4.1 of Wave's Current Report on Form 8-K, filed March 16, 2009, File # 0-24752).4.26
*



Form of Warrant issued to Private Placement Agent (incorporated by reference to Exhibit 4.2 of Wave's Current Report on Form 8-K, filed March 16, 2009, File # 0-24752).4.27
*



Form of Warrant issued to Purchasers (incorporated by reference to Exhibit 4.1 of Wave's Current Report on Form 8-K, filed April 9, 2009, File # 0-24752).4.28
*



Form of Warrant issued to Private Placement Agent (incorporated by reference to Exhibit 4.2 of Wave's Current Report on Form 8-K, filed April 9, 2009, File # 0-24752).4.29
*



Form of Warrant issued to Purchasers (incorporated by reference to Exhibit 4.1 of Wave's Current Report on Form 8-K, filed July 17, 2009, File # 0-24752).4.30
*



Form of Warrant issued to Purchasers (incorporated by reference to Exhibit 4.1 of Wave's Current Report on Form 8-K, filed July 22, 2009, File # 0-24752).10.1
*



Wave Systems Corp. 2004 Employee Stock Purchase Plan (incorporated by reference to Exhibit 4.1 of Wave's Form S-8 Registration Statement, filed on May 24,2005)10.2
*



Form of Subscription Agreement dated as of October 30, 2006 among Purchasers and Wave (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed on
October 31, 2006, File # 0-24752)10.3
*



Form of Subscription Agreement dated as of August 4, 2006 among Purchasers and Wave (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed on August 8,
2006, File # 0-24752)10.4
*



Form of Subscription Agreement dated as of May 3, 2006 among Purchasers and Wave (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed on May 8, 2006,
File # 0-24752)10.5
*



Reserved10.6
*



Securities Purchase Agreement dated as of December 5, 2005 among Purchasers and Wave (includes form of warrant) (incorporated by reference to Exhibit 10.1 of Wave's Current Report on
Form 8-K, filed on December 7, 2005, File # 0-24752)10.7
*



Securities Purchase Agreement dated as of August 5, 2005 among Purchasers and Wave (includes form of warrant) (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K,
filed on August 8, 2005, File # 0-24752)


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Exhibit No.



Description of Exhibit10.8
*



Securities Purchase Agreement dated as of March 15, 2005 among Purchasers and Wave (includes form of warrant) (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K,
filed on March 17, 2005, File # 0-24752)10.9
*



Wave's Amended and Restated 1994 Stock Option Plan (incorporated by reference to Exhibit 1 of Wave's Proxy Statement (DEF 14A) filed on April 30, 2009)10.10
*



Wave Non-Employee Directors Stock Option Plan (incorporated by reference to Wave's Notice of Annual Meeting of Stockholders on Schedule 14A filed on April 18, 2007, as amended by
Schedule 14A filed on May 7, 2007)10.11
*



Wave 1996 Performance Stock Option Plan (incorporated by reference to Exhibit 10.12 of Wave's Annual Report on Form 10-K, filed on April 1, 2002, File #0-24752)10.12
*



Employment Contract, dated June 8, 1998, between Gerard T. Feeney and Wave (incorporated by reference to Exhibit 10.18 of Wave's Annual Report on Form 10-K, filed on April 1, 1999, File
No. 0-24752).10.13
*



Employment Contract, dated November 10, 1998, between Steven Sprague and Wave (incorporated by reference to Exhibit 10.19 of Wave's Annual Report on Form 10-K, filed on April 1, 1999,
File No. 0-24752).10.14
*



Asset Purchase Agreement dated August 13, 2000, by and among Wave and Indigo Networks, LLC (incorporated by reference to Exhibit 99.1 of Wave's Current Report on Form 8-K, filed on
September 15, 2000, File #0-24752)10.15
*



Office Building Lease dated October 20, 2002 between Stevens Creek Investors, LLC and Wave (incorporated by reference to Exhibit 10.13 of Wave's Annual Report on Form 10-K, filed on
March 31, 2003, File #0-24752)10.16
*



Form of Asset Purchase Agreement dated October 4, 2001, by and between Wave and SignOnLine (incorporated by reference to Exhibit 10.15 of Wave's Annual Report on Form 10-K, filed on
April 1, 2002, File #0-24752)10.17
*



First Amendment to Asset Purchase Agreement dated October 4, 2001, by and between Wave and SignOnLine (incorporated by reference to Exhibit 10.16 of Wave's Annual Report on Form 10-K, filed
on April 1, 2002, File #0-24752)10.18
*



Termination Agreement and Mutual Release between Wave Systems Corp. and SSP Solutions, Inc. date September 30, 2002 (Incorporated herein by referenced to Exhibit 10.1 of Wave's Quarterly
Report on Form 10-Q for the quarter ended September 30, 2002, filed on November 14, 2002, File #0-24752)10.19
*



Subordinated Convertible Promissory Note between Wave Systems Corp. and SSP Solutions, Inc. dated September 30, 2002 (Incorporated herein by referenced to Exhibit 10.2 of Wave's Quarterly
Report on Form 10-Q for the quarter ended September 30, 2002, filed on November 14, 2002, File #0-24752)10.20
*



Share Purchase Agreement between Redwave plc, GlobalWave Group plc and Wave Systems Corp. dated June 19, 2002 (Incorporated herein by referenced to Exhibit 10.3 of Wave's Quarterly
Report on Form 10-Q/A for the quarter ended September 30, 2002, filed on March 19, 2003, File #0-24752)


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Exhibit No.



Description of Exhibit10.21
*



GlobalWave Group plc Notice of Extraordinary General Meeting dated June 20, 2002 (Incorporated herein by referenced to Exhibit 10.4 of Wave's Quarterly Report on Form 10-Q/A for the
quarter ended September 30, 2002, filed on March 19, 2003, File #0-24752)10.22
*



Joint Venture Agreement dated October 15, 1999 between Wave, Wavexpress and Sarnoff. (incorporated by reference to Exhibit 10.20 of Wave's Annual Report on Form 10-K/A, filed on June 27,
 2003, File #0-24752)10.23
*



Stockholder Agreement dated October 15, 1999 between Wave, Wavexpress and Sarnoff. (incorporated by reference to Exhibit 10.21 of Wave's Annual Report on Form 10-K/A, filed on June 27,
2003, File #0-24752)10.24
*



Securities Purchase Agreement dated as of July 30, 2004 among Purchasers and Wave (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed on August 3,
2004, File #0-24752)10.25
*



Additional Investment Right to Purchase 3,529,412 Shares of Common Stock of Wave Systems Corp. (incorporated by reference to Exhibit 10.2 of Wave's Current Report on Form 8-K, filed on
August 3, 2004, File #0-24752)10.26
*



Series A Common Stock Purchase Warrant to Purchase 3,529,412 Shares of Class A Common Stock of Wave Systems Corp. (incorporated by reference to Exhibit 10.3 of Wave's Current Report on
Form 8-K, filed on August 3, 2004, File #0-24752)10.27
*



Series B Common Stock Purchase Warrant to Purchase 882,353 Shares of Class A Common Stock of Wave Systems Corp. (incorporated by reference to Exhibit 10.4 of Wave's Current Report on
Form 8-K, filed on August 3, 2004, File # 0-24752)10.28
*



Placement Agency Agreement between Corpfin Inc. and Wave (incorporated by reference to Exhibit 10.5 of Wave's Current Report on Form 8-K, filed on August 3, 2004,
File # 0-24752)10.29
*



Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed on May 5, 2006, File #0-24752)10.30
*



Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed on August 8, 2006, File #0-24752)10.31
*



Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed on October 31, 2006, File #0-24752)10.32
*



Form of Subscription Agreement (incorporated by reference to Exhibit 99.1 of Wave's Current Report on Form 8-K, filed May 25, 2007, File # 0-24752)10.33
*



Form of Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed March 3, 2008, File # 0-24752)10.34
*



Placement Agency Agreement, dated as of February 29, 2008, by and between Wave and Security Research Associates, Inc. (incorporated by reference to Exhibit 10.2 of Wave's Current Report on
Form 8-K, filed March 3, 2008, File # 0-24752)10.35
*



Form of Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed May 27, 2008, File # 0-24752)


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Exhibit No.



Description of Exhibit10.36
*



Placement Agency Agreement, dated as of May 23, 2008, by and between Wave and Security Research Associates, Inc. (incorporated by reference to Exhibit 10.2 of Wave's Current Report on
Form 8-K, filed May 27, 2008, File # 0-24752)10.37
*



Form of Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed July 1, 2008, File # 0-24752)10.38
*



Placement Agency Agreement, dated as of June 30, 2008, by and between Wave and Security Research Associates, Inc. (incorporated by reference to Exhibit 10.2 of Wave's Current Report on
Form 8-K, filed July 1, 2008, File # 0-24752)10.39
*



Form of Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed August 12, 2008, File # 0-24752)10.40
*



Placement Agency Agreement, dated as of August 11, 2008, by and between Wave and Security Research Associates, Inc. (incorporated by reference to Exhibit 10.2 of Wave's Current Report on
Form 8-K, filed August 12, 2008, File # 0-24752)10.41
*



Form of Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed September 15, 2008, File # 0-24752)10.42
*



Placement Agency Agreement, dated as of September 11, 2008, by and between Wave and Security Research Associates, Inc. (incorporated by reference to Exhibit 10.2 of Wave's Current Report on
Form 8-K, filed September 15, 2008, File # 0-24752)10.43
*



Restructuring Agreement dated September 23, 2008 by and among Wave, Wavexpress and Sarnoff Corporation (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed
September 24, 2008, File # 0-24752)10.44
*



Amended and Restated Stockholder Agreement, dated September 23, 2008 between Wave and Sarnoff Corporation (incorporated by reference to Exhibit 10.2 of Wave's Current Report on Form 8-K,
filed September 24, 2008, File # 0-24752)10.45
*



Form of Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed September 30, 2008, File # 0-24752)10.46
*



Form of Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed October 31, 2008, File # 0-24752)10.47
*



Placement Agency Agreement, dated as of October 29, 2008, by and between Wave and Security Research Associates, Inc. (incorporated by reference to Exhibit 10.2 of Wave's Current Report on
Form 8-K, filed October 31, 2008, File # 0-24752)10.48
*



Form of Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed December 29, 2008, File # 0-24752)10.49
*



Placement Agency Agreement, dated as of December 24, 2008, by and between Wave and Security Research Associates, Inc. (incorporated by reference to Exhibit 10.2 of Wave's Current Report on
Form 8-K, filed December 29, 2008, File # 0-24752)10.50
*



Form of Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed March 16, 2009, File # 0-24752).10.51
*



Placement Agency Agreement, dated as of March 13, 2009, by and between Wave and Security Research Associates, Inc. (incorporated by reference to Exhibit 10.2 of Wave's Current Report on
Form 8-K, filed March 16, 2009, File # 0-24752).


52

---



Table of Contents

Exhibit No.



Description of Exhibit10.52
*



Form of Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed April 9, 2009, File # 0-24752).10.53
*



Placement Agency Agreement, dated as of April 8, 2009, by and between Wave and Security Research Associates, Inc. (incorporated by reference to Exhibit 10.2 of Wave's Current Report on
Form 8-K, filed April 9, 2009, File # 0-24752).10.54
*



Form of Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed July 17, 2009, File # 0-24752).10.55
*



Placement Agency Agreement, dated as of July 16, 2009, by and between Wave and Roth Capital Partners, LLC (incorporated by reference to Exhibit 10.2 of Wave's Current Report on Form 8-K,
 filed July 17, 2009, File # 0-24752).10.56
*



Form of Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed July 22, 2009, File # 0-24752).10.57
*



Placement Agency Agreement, dated as of July 21, 2009, by and between Wave and Roth Capital Partners, LLC (incorporated by reference to Exhibit 10.2 of Wave's Current Report on Form 8-K,
 filed July 22, 2009, File # 0-24752).21.1
*



Subsidiaries of Registrant (incorporated by reference to Exhibit 10.12 of Wave's Annual Report on Form 10-K, filed on April 1, 2002, File #0-24752)23.1




Consent of Independent Registered Public Accounting FirmKPMG LLP31.1




Section 302 Certification by Steven K. Sprague, President and Chief Executive Officer31.2




Section 302 Certification by Gerard T. Feeney, Chief Financial Officer32.1




Section 906 Certification99.1
*



Form of Series H Convertible Preferred Stock Purchase Agreement, dated as of April 30, 2003 (the "First Purchase Agreement"), by and among Wave and the purchasers of the Series H Convertible
Preferred Stock (Incorporated by reference to Wave's Form 8-K filed on May 5, 2003).99.2
*



Form of Series H Convertible Preferred Stock Purchase Agreement, dated as of April 30, 2003 (the "Second Purchase Agreement"), by and between Wave and an individual purchaser (Incorporated by
reference to Wave's Form 8-K filed on May 5, 2003).99.5
*



Form of Warrant issued by Wave pursuant to the Second Purchase Agreement to the individual purchaser, dated as of April 30, 2003 (Incorporated by reference to Wave's Form 8-K filed on May 5,
2003).99.6
*



Form of Warrant issued by Wave to the placement agent and sub-placement agents, dated as of April 30, 2003 (Incorporated by reference to Wave's Form S-3 filed on May 14, 2003 (Registration
No. 333-99469)).99.7
*



Letter Amendment to First Purchase Agreement and Second Purchase Agreement effected on August 11, 2003 (Incorporated by reference to Wave's Form 8-K filed on August 12, 2003).99.8
*



Form of Letter Agreement to the Series H Convertible Preferred Stock Purchase Agreements dated September 4, 2003, effected on September 15, 2003 (Incorporated by reference to Wave's
Form 8-K filed on September 16, 2003).


53

---



Table of Contents

Exhibit No.



Description of Exhibit99.9
*



Form of Waiver to the Series H Preferred Stock Purchase Agreements dated September 4, 2003, effected on September 15, 2003 (Incorporated by reference to Wave's Form 8-K filed on
September 16, 2003).99.10
*



Securities Purchase Agreement, dated as of November 18, 2003, by and among Wave and purchasers of the Class A common stock. (Incorporated by reference to Wave's registration statement filed on
Form S-3/A filed on February 12, 2004. (Registration No. 333-112017.))99.11
*



Form of Warrant issued by Wave to each of the purchasers of the Class A Common Stock and the placement agents, dated as of November 18, 2003 with the schedule of holders attached thereto.
(Incorporated by reference to Wave's Form 8-K/A filed on February 13, 2004).99.12
*



Registration Rights Agreement by and among Wave and the purchasers of the Class A Common Stock, dated as of November 18, 2003. (Incorporated by reference to Wave's Form 8-K/A filed on
February 13, 2004).99.13
*



Demand Note, dated March 26, 2001 between Gerard T. Feeney and Wave (incorporated by reference to Exhibit 99.1 of Wave's Annual Report on Form 10-K, filed on April 1, 2002,
File #0-24752)99.14
*



Demand Note, dated February 27, 2001 between Peter J. Sprague and Wave (incorporated by reference to Exhibit 99.2 of Wave's Annual Report on Form 10-K, filed on April 1, 2002,
File #0-24752)99.15
*



Demand Note, dated July 25, 2001 between Peter J. Sprague and Wave (incorporated by reference to Exhibit 99.3 of Wave's Annual Report on Form 10-K, filed on April 1, 2002,
File #0-24752)99.16
*



Demand Note, dated September 5, 2001 between Peter J. Sprague and Wave (incorporated by reference to Exhibit 99.4 of Wave's Annual Report on Form 10-K, filed on April 1, 2002,
File #0-24752)99.17
*



Allonge to Demand Promissory Note, dated March 26, 2002 between Gerard T. Feeney and Wave (incorporated by reference to Exhibit 99.6 of Wave's Annual Report on Form 10-K/A, filed on
June 30, 2003, File #0-24752)99.18
*



Allonge to Demand Promissory Note, dated February 27, 2002 between Peter J. Sprague and Wave (incorporated by reference to Exhibit 99.7 of Wave's Annual Report on Form 10-K/A, filed on
June 30, 2003, File #0-24752)99.19
*



Allonge to Demand Promissory Note, dated July 25, 2002 between Peter J. Sprague and Wave (incorporated by reference to Exhibit 99.8 of Wave's Annual Report on Form 10-K/A, filed on
June 30, 2003, File #0-24752)


*Incorporated
herein by reference+Confidential
treatment has been granted as to portions of this exhibit.Management
contract or compensatory plan.


(b)    Reports
on Form 8-K

54

---





Table of Contents

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this
report to be signed on its behalf by the undersigned, thereunto duly authorized.

Dated:
March 15, 2011

WAVE SYSTEMS CORP.By:

/s/ STEVEN K SPRAGUEName:

Steven K. SpragueTitle:

President and Chief Executive Officer


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

Signature

Title

Date/s/ STEVEN K. SPRAGUE Steven K. Sprague

President, Chief Executive Officer and Director (Principal Executive Officer)

March 15, 2011/s/ JOHN E. BAGALAY, JR. John E. Bagalay, Jr.

Chairman

March 15, 2011/s/ GEORGE GILDER George Gilder

Director

March 15, 2011/s/ JOHN E. MCCONNAUGHY, JR. John E. McConnaughy, Jr.

Director

March 15, 2011/s/ NOLAN BUSHNELL Nolan Bushnell

Director

March 15, 2011/s/ GERARD T. FEENEY Gerard T. Feeney

Senior Vice President, Finance and Administration, Chief Financial Officer and Secretary (Principal Financial and Accounting Officer and Duly Authorized Officer of the Registrant)

March 15, 2011


55

---



Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The
Board of Directors and Stockholders 
Wave Systems Corp.:

We
have audited the accompanying consolidated balance sheets of Wave Systems Corp. and subsidiaries as of December 31, 2010 and 2009, and the related consolidated statements of
operations, stockholders' equity (deficit) and comprehensive income (loss), and cash flows for each of the years in the three-year period ended December 31, 2010. We have also
audited Wave System Corp.'s internal control over financial reporting as of December 31, 2010, based on criteria established in Internal ControlIntegrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO). Wave System Corp.'s management is responsible for these consolidated financial statements, for maintaining effective internal
control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Annual Report on Internal Control
Over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on Wave Systems Corp.'s internal control over financial reporting based
on our audits.

We
conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material
respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting
principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an
understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control
based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our
opinions.

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

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

In
our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Wave Systems Corp. and subsidiaries as of
December 31, 2010 and 2009, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2010, in conformity with
U.S. generally accepted accounting principles. Also in our opinion, Wave Systems Corp. maintained, in all material respects, effective internal control over financial reporting as of
December 31, 2010, based on criteria established in

F-1

---



Table of Contents

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

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

/s/
KPMG LLP

Boston,
Massachusetts
March 15, 2011

F-2

---



Table of Contents



WAVE SYSTEMS CORP. AND SUBSIDIARIES

Consolidated Balance Sheets

December 31, 2010 and 2009

2010

2009AssetsCurrent assets:Cash and cash equivalents

$
3,595,076

$
1,900,014Accounts receivable, net of allowance for doubtful accounts of $-0- at December 31, 2010 and 2009, respectively


11,594,549


3,850,020Prepaid expenses


319,209


207,343Total current assets


15,508,834


5,957,377Property and equipment, net


507,247


237,237Amortizable intangible assets, net


953,333


Other assets


114,469


133,311Total Assets


17,083,883


6,327,925Liabilities and Stockholders' Equity (Deficit)Current liabilities:Accounts payable and accrued expenses


4,399,579


4,441,657Current portion of capital lease payable


66,770


61,857Deferred revenue


8,454,029


3,500,861Total current liabilities


12,920,378


8,004,375Long-term portion of capital lease payable


116,734


183,505Long-term deferred revenue


1,350,000


Total liabilities


14,387,112


8,187,880Stockholders' Equity (Deficit):Common Stock, $.01 par value. Authorized 150,000,000 shares as Class A; 81,331,737 shares issued and outstanding in 2010 and 75,211,054 in
2009


813,317


752,110Common Stock, $.01 par value. Authorized 13,000,000 shares as Class B; 35,556 shares issued and outstanding in 2010 and 38,232 in 2009


355


382Capital in excess of par value


354,042,031


345,423,668Accumulated deficit


(352,158,932
)

(348,036,115
)Total Stockholders' Equity (Deficit)


2,696,771


(1,859,955
)Total Liabilities and Stockholders' Equity (Deficit)

$
17,083,883

$
6,327,925


See
accompanying notes to consolidated financial statements.

F-3

---



Table of Contents



WAVE SYSTEMS CORP. AND SUBSIDIARIES

Consolidated Statements of Operations

Years ended December 31, 2010, 2009, 2008

2010

2009

2008Net revenues:Licensing

$
24,736,029

$
18,013,043

$
8,691,576Services


1,314,763


875,836


118,239Total net revenues


26,050,792


18,888,879


8,809,815Operating expenses:Cost of net revenueslicensing


1,177,114


876,723


736,429Cost of net revenueservices


599,704


521,168


87,752Selling, general and administrative


18,092,489


12,992,715


16,375,372Research and development


10,288,460


7,825,058


11,702,776Impairment of property and equipment








447,128Total operating expenses


30,157,767


22,215,664


29,349,457Operating loss


(4,106,975
)

(3,326,785
)

(20,539,642
)Other income (expense):Net interest expense


(15,842
)

(19,466
)

(9,572
)Net loss


(4,122,817
)

(3,346,251
)

(20,549,214
)Accretion of non-cash beneficial conversion feature on Series J and Series K convertible preferred stock








(657,000
)Net loss attributable to common stockholders


(4,122,817
)

(3,346,251
)

(21,206,214
)Loss per common sharebasic and diluted

$
(0.05
)
$
(0.05
)
$
(0.38
)Weighted average number of common shares outstanding during the year


79,924,475


68,526,572


55,379,118


See
accompanying notes to consolidated financial statements.

F-4

---



Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

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

8% Series I
Convertible
Preferred Stock

Series J
Convertible
Preferred Stock

8% Series K
Convertible
Preferred Stock

Class A
Common Stock

Class B
Common StockAccumulated
Other
Comprehensive
IncomeCapital in
Excess of Par
Value

Accumulated
DeficitShares

Amount

Shares

Amount

Shares

Amount

Shares

Amount

Shares

Amount

TotalBalance as of December 31, 2007




$





$





$



49,744,327

$
497,443


38,232

$
382

$
325,481,336

$
(323,483,650
)
$


$
2,495,511Net loss



































(20,549,214
)




(20,549,214
)Issuance of Class A Common Stock at $1.10 per share, less issuance cost of $270,959




















3,173,500


31,735








3,188,156








3,219,891Issuance of Class A Common Stock at $0.80 per share, less issuance cost of $138,180




















2,151,250


21,513








1,561,307








1,582,820Shares of Class A Common Stock Issued pursuant to the Wave Employee Stock Purchase Plan at $0.8925 per share




















209,857


2,098








185,199








187,297Issuance of Class A Common Stock at $0.85 per share, less issuance cost of $131,793




















1,880,500


18,805








1,447,827








1,466,632Issuance of Class A Common Stock at $0.60 per share, less issuance cost of $79,330




















1,368,333


13,684








727,986








741,670Issuance of 8% Series I Preferred Stock at $4,400 per share, less issuance cost of $78,030


172


2


























678,768








678,770Issuance of 8% Series I Preferred Stock at $4,400 per share, less issuance cost of $30,000


48





























181,200








181,200Issuance of Series J Preferred Stock at $6,500 per share, less issuance cost of $68,290








111


1




















214,528








214,529Issuance of warrants to purchase Class A common stock in connection with the issuance of Series J Preferred Stock
































422,697








422,697Issuance of warrants to purchase Class A common stock to placement agent for services in connection with the Series J financing
transaction
































15,984








15,984


See accompanying notes to consolidated financial statements.

F-5

---



Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

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

8% Series I
Convertible
Preferred Stock

Series J
Convertible
Preferred Stock

8% Series K
Convertible
Preferred Stock

Class A
Common Stock

Class B
Common StockAccumulated
Other
Comprehensive
IncomeCapital in
Excess of Par
Value

Accumulated
DeficitShares

Amount

Shares

Amount

Shares

Amount

Shares

Amount

Shares

Amount

TotalSeries J Preferred Stock Beneficial Conversion Feature
































155,400


(155,400
)




Conversion of Series J Preferred Stock for Class A Common Stock








(20
)










200,000


2,000








(2,000
)







Shares of Class A Common Stock Issued pursuant to the Wave Employee Stock Purchase Plan at $0.2805 per share




















150,201


1,502








40,629








42,131Issuance of 8% Series K Preferred Stock at $2,800 per share, less issuance cost of $101,608














456


5














941,602








941,607Issuance of warrants to purchase Class A common stock in connection with the issuance of Series K Preferred Stock
































173,393








173,393Issuance of warrants to purchase Class A common stock to placement agent for services in connection with the Series K financing
transaction
































60,192








60,192Series K Preferred Stock Beneficial Conversion Feature
































501,600


(501,600
)




Cash paid for fraction shares in reverse stock split
































(54
)







(54
)Stock based compensation
































2,105,941








2,105,941Balance as of December 31, 2008


220

$
2


91

$
1


456

$
5


58,877,968

$
588,780


38,232

$
382

$
338,081,691

$
(344,689,864
)
$


$
(6,019,003
)Net loss



































(3,346,251
)




(3,346,251
)Conversion of 8% Series K Preferred Stock for Class A Common Stock














(456
)

(5
)

4,560,000


45,600








(45,595
)










See accompanying notes to consolidated financial statements.

F-6

---



Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

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

8% Series I
Convertible
Preferred Stock

Series J
Convertible
Preferred Stock

8% Series K
Convertible
Preferred Stock

Class A
Common Stock

Class B
Common StockAccumulated
Other
Comprehensive
IncomeCapital in
Excess of Par
Value

Accumulated
DeficitShares

Amount

Shares

Amount

Shares

Amount

Shares

Amount

Shares

Amount

TotalIssuance of Class A Common Stock at $0.55 per share, less issuance cost of $55,904




















785,000


7,850








367,995








375,845Issuance of Class A Common Stock at $0.55 per share, less issuance cost of $92,077




















1,881,136


18,811








923,736








942,547Conversion of Series J Preferred Stock for Class A Common Stock








(91
)

(1
)







910,000


9,100








(9,099
)







Issuance of Class A Common Stock at $0.92 per share, less issuance cost of $484,960




















3,448,042


34,480








2,652,759








2,687,239Issuance of Class A Common Stock at $0.92 per share, less issuance cost of $159,250




















1,791,738


17,917








1,471,232








1,489,149Warrants exercised at $0.28 per share




















10,000


100








2,700








2,800Warrants exercised at $0.55 per share




















100,000


1000








54,000








55,000Cashless exercise of warrants at $0.28 per share




















17,361


174








(174
)







Cashless exercise of warrants at $0.65 per share




















3,659


37








(37
)







Cashless exercise of warrants at $0.85 per share




















28,339


283








(283
)







Cashless exercise of warrants at $0.90 per share




















30,178


302








(302
)







Shares of Class A Common Stock Issued pursuant to the Wave Employee Stock Purchase Plan at $0.28 per share




















365,498


3,655








98,867








102,522Warrants exercised at $0.90 per share




















50,000


500








44,500








45,000


See accompanying notes to consolidated financial statements.

F-7

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

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

8% Series I
Convertible
Preferred Stock

Series J
Convertible
Preferred Stock

8% Series K
Convertible
Preferred Stock

Class A
Common Stock

Class B
Common StockAccumulated
Other
Comprehensive
IncomeCapital in
Excess of Par
Value

Accumulated
DeficitShares

Amount

Shares

Amount

Shares

Amount

Shares

Amount

Shares

Amount

TotalConversion of 8% Series I Preferred Stock for Class A Common Stock


(220
)

(2
)













2,200,000


22,000








(21,998
)







Shares of Class A Common Stock Issued pursuant to the Wave Employee Stock Purchase Plan at $1.037 per share




















152,135


1,521








156,242








157,763Cash dividends paid on 8% Series I Preferred Stock
































(77,440
)







(77,440
)Stock based compensation
































1,724,874








1,724,874Balance as of December 31, 2009




$





$





$



75,211,054

$
752,110


38,232

$
382

$
345,423,668

$
(348,036,115
)
$


$
(1,859,955
)Net loss



































(4,122,817
)




(4,122,817
)Warrants exercised at $0.28 - $1.155 per share




















4,405,641


44,056








3,935,235








3,979,291Employee stock options exercised at $0.50 - $3.00 per share




















888,445


8,885








1,275,744








1,284,629Cashless exercise of warrants at $0.28 - $0.65 per share




















432,002


4,320








(4,320
)







Shares of Class A Common Stock Issued pursuant to the Wave Employee Stock Purchase Plan at $1.088 per share




















240,190


2,402








258,925








261,327Shares of Class A Common Stock Issued pursuant to the Wave Employee Stock Purchase Plan at $2.244 per share




















151,729


1,517








338,963








340,480Exchange of Class B Common Stock for Class A Common Stock




















2,676


27


(2,676
)

(27
)










Stock based compensation
































2,813,816








2,738,816Balance as of December 31, 2010




$





$





$



81,331,737

$
813,317


35,556

$
355

$
354,042,031

$
(352,158,932
)
$


$
2,696,771


See accompanying notes to consolidated financial statements.

F-8

---



Table of Contents



WAVE SYSTEMS CORP. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

Years ended December 31, 2010, 2009, 2008

2010

2009

2008Cash flows from operating activities:Net loss

$
(4,122,817
)
$
(3,346,251
)
$
(20,549,214
)Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization


404,795


259,210


395,253Impairment of property and equipment








447,128Compensation associated with issuance of stock options


2,813,816


1,724,874


2,105,941Changes in assets and liabilities:Increase in deferred revenue


6,303,168


2,016,817


1,195,019Increase in accounts receivable


(7,744,529
)

(2,148,191
)

(536,444
)(Increase) decrease in prepaid expenses


(111,866
)

20,624


111,375(Increase) decrease in other assets


18,842


6,664


(3,388
)Increase (decrease) in accounts payable and accrued expenses


(42,079
)

(3,214,177
)

4,402,514Net cash used in operating activities


(2,480,670
)

(4,680,430
)

(12,431,816
)Cash flows from investing activities:Acquisition of property and equipment


(528,138
)

(88,007
)

(232,512
)Acquisition of intangible assets


(1,100,000
)




Net cash used in investing activities


(1,628,138
)

(88,007
)

(232,512
)Cash flows from financing activities:Payments on capital lease obligation


(61,857
)

(63,537
)

(26,898
)Net proceeds from issuance of preferred stock








2,688,372Net proceeds from issuance of common stock





5,494,780


7,011,013Proceeds from employee options under stock plans


601,807


260,285


229,428Proceeds from employee stock option exercises


1,284,629





Proceeds from exercise of warrants


3,979,291


102,800


Payment of dividends on preferred stock





(77,440
)

Payment in lieu of fractional shares in reverse stock split








(54
)Net cash provided by financing activities


5,803,870


5,716,888


9,901,861Net increase (decrease) in cash and cash equivalents


1,695,062


948,451


(2,762,467
)Cash and cash equivalents at beginning of year


1,900,014


951,563


3,714,030Cash and cash equivalents at end of year

$
3,595,076

$
1,900,014

$
951,563Supplemental cash flow information:Non-cash financing activities:Conversion of 8% Series K Preferred Stock into Class A Common Stock

$


$
45,600

$
Conversion of Series J Preferred Stock into Class A Common Stock

$


$
9,100

$
Conversion of 8% Series I Preferred Stock into Class A Common Stock

$


$
22,000

$
Capital lease obligation on property and equipment

$


$


$
335,797Cash paid during the year for:Interest

$
16,672

$
21,384

$
10,415


See accompanying notes to consolidated financial statements.

F-9

---



Table of Contents



WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(1) Business of the Company

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

(2) Liquidity

The accompanying consolidated financial statements have been prepared assuming that Wave will continue as a going concern. Wave has incurred substantial operating losses since its
inception, and as of December 31, 2010, has an accumulated deficit of $352,158,932. Wave may incur an operating loss for the calendar year of 2011. As of December 31, 2010, Wave had
positive working capital of $2,588,456.

Wave
has begun market introduction of its security and other software products and has signed initial distribution contracts for these applications. However, due to the early stage
nature of this market, Wave may not generate sufficient revenue to cover all of its cash flow needs to fund its operating requirements for the year ending December 31, 2011.

Because
Wave may not have sufficient cash to fund operations for the year ending December 31, 2011; and given the uncertainties described above with respect to Wave's revenue
outlook for 2011, Wave has been and may continue to be actively engaged in financing activities in order to generate additional funding to cover its operating costs for the year ending
December 31, 2011. These activities included the filing of a $25,000,000 S-3 shelf registration with the SEC on April 18, 2008, which was declared effective on
June 23, 2008; and the subsequent sales of shares of preferred and common stock pursuant to this shelf registration statement during 2009 and 2008 (See notes 8 and 9). There remains
approximately $9,500,000 in gross proceeds available under the April 18, 2008 shelf registration statement, which may be used for future financings although there can be no assurances that
future financings will be attainable.

Wave
may be required to sell additional shares of common stock, preferred stock, obtain debt financing or engage in a combination of these financing alternatives, to raise additional
capital to continue to fund its operations for the twelve months ending December 31, 2011. If Wave is not successful in executing its business plan, it may be required to sell additional shares
of common stock, preferred stock, obtain debt financing or engage in a combination of these financing alternatives or it could be forced to reduce expenses which may significantly impede its ability
to meet its sales, marketing and development objectives, cease operations or merge with another company. No assurance can be
provided that any of these initiatives will be successful. Due to its current cash position, capital needs over the next year and beyond, and the uncertainty as to whether it will achieve its sales
forecast for its products and services, substantial doubt exists with respect to Wave's ability to continue as a going concern.

F-10

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(3) Significant Accounting Policies

(a)   Basis of Consolidation

The consolidated financial statements include the financial statements of Wave, Wave Systems Holdings, Inc., a wholly owned subsidiary and
Wavexpress, Inc. a majority-owned subsidiary (see note 12). All significant intercompany accounts and transactions have been eliminated in consolidation.

(b)   Use of Estimates

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

(c)   Cash and Cash Equivalents

Wave considers all highly liquid instruments with an original or remaining maturity of three months or less to be cash equivalents. Substantially all cash and
cash equivalents are on deposit with two major financial institutions.

(d)   Accounts Receivable and Allowance For Doubtful Accounts

Included in accounts receivable at December 31, 2010 and 2009 are unbilled amounts totaling $6,250 and $73,120, respectively.

The
determination of the allowance for doubtful accounts is based on management's estimate of uncollectible accounts receivable. Management records specific reserves for receivable
balances that are considered high risk due to known facts regarding the customer. Allowance for doubtful accounts amounted to $-0- at December 31, 2010 and 2009.

(e)   Concentrations of Credit Risks

Sales to Wave's largest customer in 2010, 2009 and 2008, Dell, Inc., were approximately 80%, 81% and 80% of revenue, respectively. Accounts receivable at
December 31, 2010, 2009 and 2008 included receivables from Dell, Inc. and it affiliates of $7,240,452, $3,317,548 and $1,054,368, respectively.

(f)    Property and Equipment

Property and equipment, including purchased computer software, are stated at cost less accumulated depreciation and amortization. Depreciation and amortization
are computed using the straight-line method over the estimated useful lives of the assets which range from between three to five years. Amortization of leasehold improvements is computed
using the shorter of the useful life or remaining lease term which range from between three and fifteen years.

(g)   Income Taxes

Wave classifies any interest and penalties related to income taxes as components of the income tax provision. Wave accounts for income taxes under the asset and
liability method. As such, deferred tax

F-11

---



Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(3) Significant Accounting Policies (Continued)

assets
and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their
respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the
enactment date. At December 31, 2010 and 2009, a full valuation allowance has been recorded against the gross deferred tax asset since management believes that, after considering all the
available objective evidence, both positive and negative, historical and prospective, with greater weight given to historical evidence, it is more likely than not that these assets will not be
realized.

(h)   Share-based Payments

Wave recognizes compensation expense for all share-based payment awards made to employees and directors including employee stock options and employee stock
purchases related to the Employee Stock Purchase Plan. Stock-based compensation expense recognized is based on the value of the portion of stock-based payment awards that is ultimately expected to
vest and has been reduced for estimated forfeitures. Wave determines the fair value of stock-based payment awards on the date of grant using an option-pricing model that is affected by Wave's stock
price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to Wave's expected stock price volatility over the term of the
awards and actual and projected employee stock option exercise behaviors.

(i)    Research and Development and Software Development Costs

Research and development costs are expensed as incurred. Such costs related to software development are included in research and development expense until the
point that technological feasibility is reached, which for our software products, is generally shortly before the products are released. Once
technological feasibility is reached, such costs are capitalized and amortized to cost of revenue over the estimated lives of the products.

(j)    Loss Per Share

Basic net loss per common share has been calculated by dividing the net loss attributable to common stockholders by the weighted average number of shares of
common stock outstanding during the period. The net loss attributable to common stockholders is calculated by adding the accretion of the beneficial conversion feature on convertible preferred stock
to the net loss. Diluted net loss per share is also computed using the weighted average number of common shares and includes dilutive potential common shares outstanding. Dilutive potential common
shares consist primarily of employee stock options and stock warrants. Diluted net loss per share is equal to basic net loss per share and is therefore not presented separately in the financial
statements. The weighted average number of potential common shares that would have been included in diluted loss per share had their effect not been anti-dilutive for each of the years
ended December 31, 2010, 2009 and 2008 were approximately 8,512,000 shares, 2,961,000 shares and 546,000 shares, respectively. Employee stock options and other stock warrants to purchase
approximately 7,846,000, 17,575,000 and 10,238,000 shares were outstanding for the years ended December 31, 2010, 2009 and 2008 respectively, but are not included in the

F-12

---



Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(3) Significant Accounting Policies (Continued)

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.

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

Wave reviews the valuation of long-lived assets, including property and equipment, amortizable intangible assets and capitalized software, whenever
events and circumstances indicate that the carrying value may not be recoverable. Factors considered important that could trigger an impairment review include the following:



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

(l)    Revenue Recognition

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

Wave
recognizes revenue when it is realized or realizable and earned. Wave considers revenue realized or realizable and earned when persuasive evidence of an arrangement exists, delivery
has occurred, the sales price is fixed or determinable and collectability is reasonably assured. In addition to the aforementioned general policy, the following are the specific revenue recognition
policies for each major category of revenue.

LICENSES

Revenue
from delivered elements of one-time charge licensed software is recognized at the inception of the license term, provided Wave has
vendor-specific objective evidence of the fair value of each undelivered element, for arrangements that contain multiple elements. Revenue is deferred for

F-13

---



Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(3) Significant Accounting Policies (Continued)

undelivered
elements for these arrangements. Revenue is also deferred for the delivered elements, 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 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.

Cost
of net revenueslicensing includes customer support personnel costs, foreign tax withholdings and share-based compensation expense.

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 using the percentage of completion method. The Company measures the percentage of completion by reference to the proportion of contract hours incurred for work
performed to date to the estimated total contract hours expected to be incurred. Losses on fixed price contracts are recognized during the period in which the loss first becomes apparent. Payment
terms vary by contract.

(m)  Accounting for Warrants Containing Cash Settlement Provisions

All warrants issued by the Company are required to be settled in the Company's common stock, and are not eligible for net cash settlement. Therefore, the fair
value of the instruments are accounted for as equity. The instruments will remain classified in equity, provided they continue to meet the conditions of an equity instrument, and subsequent changes in
the fair value of the instruments will not be recognized as long as the instruments remain in equity.

(n)   Recent Accounting Pronouncements

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

F-14

---



Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(3) Significant Accounting Policies (Continued)

entered
into or materially modified in fiscal years beginning on or after June 15, 2010. These new updates did not materially impact our consolidated financial statements.

(4) Related Party Transactions

In March 2003, Mr. Peter Sprague, who is the former Chairman of Wave, was appointed Chairman and
Chief Executive Officer of Wavexpress. On January 1, 2010, Mr. Sprague became an employee of Wave and was paid a salary of $129,000. Mr. Sprague was paid $129,000 in salary for
each of the years ended December 31, 2009 and 2008, respectively, as an officer of Wavexpress. Mr. Peter Sprague is the father of Wave's President and Chief Executive Officer, Steven
Sprague.

On
August 1, 1997, Michael Sprague became an employee of Wave and was paid a salary of $182,000, $175,000 and $175,000 for the years ended December 31, 2010, 2009 and 2008,
respectively. Michael Sprague is the brother of Steven Sprague and the son of Wave's former Chairman, Peter Sprague.

(5) Property and Equipment

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

2010

2009Computer equipment

$
2,951,890

$
2,588,084Furniture, fixtures and improvements


239,660


218,151Computer software


2,589,624


2,446,8015,781,174


5,253,036Less: Accumulated depreciation and amortization


(5,273,927
)

(5,015,799
)Total

$
507,247

$
237,237


Depreciation
and amortization expense on property and equipment amounted to approximately $258,000, $259,000 and $395,000 for the years ended December 31, 2010, 2009 and 2008,
respectively.

F-15

---



Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(6) Amortizable Intangible Assets

Wave's amortizable intangible assets consist of two patents acquired on May 7, 2010 for $1,100,000. These patents were acquired by Wave from a company owned by Robert Thibadeau,
Ph. D., a noted computer security expert who joined Wave in February 2010 as Senior Vice President and Chief Scientist. The patents were issued in 2006 and 2008 and are valid until 2021. Both patents
concern the methods and systems for promoting security in a computer employing attached storage devices. The patents are being amortized on a straight-line basis over 5 years based
upon their estimated useful life. Amortization expense on amortizable intangible assets amounted to approximately
$147,000, $-0- and $-0- for the years ended December 31, 2010, 2009 and 2008, respectively.

(7) Accounts Payable and Accrued Expenses

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

2010

2009Accounts payable

$
1,095,530

$
1,382,511Accrued payroll and related costs


2,658,370


2,190,037Accrued consulting and professional fees


196,239


321,939State & local taxes payable


108,987


186,468Other accrued expenses


340,453


360,702Total accounts payable and accrued expenses

$
4,399,579

$
4,441,657


(8) Preferred Stock

Wave has authorized the issuance of 2,000 shares of convertible preferred stock having a par value of $.01 per share. At December 31, 2010 and 2009, -0-
shares of convertible preferred stock are issued and outstanding. At December 31, 2008, a total of 767 shares of convertible preferred stock were issued and outstanding220 shares
of 8% Series I Convertible Preferred Stock, 91 shares of Series J Convertible Preferred Stock and 456 shares of 8% Series K Convertible Preferred Stock.

(a)   Series K Preferred Stock

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

F-16

---



Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(8) Preferred Stock (Continued)

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

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

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

Shares of converted Class A Common Stock


4,560,000Closing price on December 24, 2008

$
0.35Aggregate fair value upon conversion

$
1,596,000Gross proceeds of Series K Preferred Stock


1,276,800Excess fair value upon conversion

$
319,200


As
part of the transaction, Wave issued to the investors and SRA warrants to purchase shares of Class A Common Stock, with an initial exercise price of $0.28 per share and a three
(3) year life (the "Series K Warrants" and, together with Series K Preferred Stock, the "Series K Securities"). The Series K Warrants are exercisable for a total of
1,413,600 shares of Class A Common Stock beginning

F-17

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(8) Preferred Stock (Continued)

on
the date of initial issuance. If exercised in full, the Series K Warrants would generate proceeds of up to an additional $395,808, at the exercise price.

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

Expected Life in years


3Interest rate


1.1
%Volatility


89.2
%Dividend yield


0
%


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

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

Gross offering proceeds

$
1,276,800Fees and commissions deducted from proceeds


(101,608
)Fair value of warrants issued to SRA


(60,192
)Net Series K Preferred Stock after all fees


1,115,000Additional discounts:Series K Warrants


(173,393
)Beneficial Conversion Feature (BCF)


(501,600
)Total additional discounts


(674,993
)Net Series K Preferred Stock after allocations


440,007Accretion of discount related to BCF


501,600Preferred Stock balance as of December 31, 2008

$
941,607


F-18

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(8) Preferred Stock (Continued)

(b)   Series J Preferred Stock

On October 30, 2008, Wave entered into subscription agreements, pursuant to which Wave sold and issued 111 shares of newly designated Series J
Convertible Preferred Stock, par value $.01 ("Series J Preferred Stock"), to certain purchasers for an aggregate purchase price of $721,500. These shares were priced at $6,500 per share. Each
share of Series J Preferred Stock also included a warrant to purchase up to 20,000 shares of Class A Common Stock for each share of Series J Preferred Stock purchased at an
exercise price of $0.40 per share. The warrants expire in October 2013. Wave entered into a placement agency agreement with SRA in which they acted as placement agent in connection with this offering.
Wave paid SRA a fee equal to 6.0% of the gross proceeds of this offering. Additionally, Wave issued a warrant to SRA to purchase up to 66,600 shares of Class A Common Stock at an exercise price
of $0.40 per share. The warrant expires in October 2011. Wave realized net cash proceeds of approximately $653,210 after deducting the placement agent fees of $43,290 and additional legal and other
fees associated with the issuance of these securities which totaled approximately $25,000.

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

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

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

F-19

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(8) Preferred Stock (Continued)

$0.65
per share. The excess of the proceeds of the Series J Preferred Stock over the estimated aggregate fair value of the Series J Preferred Stock upon conversion has been calculated as
follows:

Shares of converted Class A Common Stock


1,110,000Closing price on October 30, 2008

$
0.41Aggregate fair value upon conversion

$
455,100Gross proceeds of Series J Preferred Stock


721,500Excess gross proceeds upon conversion

$
(266,400
)


As
part of the transaction, Wave issued to the investors and SRA warrants to purchase shares of Class A Common Stock, with an initial exercise price of $0.40 per share. The
investor warrants have a five (5) year life and the SRA warrants have a three (3) year life (the "Series J Warrants" and, together with Series J Preferred Stock, the
"Series J Securities"). The Series J Warrants are exercisable for a total of 2,286,600 shares of Class A Common Stock beginning on the date of issuance. If exercised in full, the
Series J Warrants would generate proceeds of up to an additional $914,640, at the exercise price.

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

Expected Life in years (investor/SRA)

5/3Interest rate (investor/SRA)

2.8%/1.8%Volatility

89.2%Dividend yield

0%


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

F-20

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(8) Preferred Stock (Continued)

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

Gross offering proceeds

$
721,500Fees and commissions deducted from proceeds


(68,290
)Fair value of warrants issued to SRA


(15,984
)Net Series J Preferred Stock after all fees


637,226Additional discounts:Series J Warrants


(422,697
)Beneficial Conversion Feature (BCF)


(155,400
)Total additional discounts


(578,097
)Net Series J Preferred Stock after allocations


59,129Accretion of discount related to BCF


155,400Preferred Stock balance as of December 31, 2008

$
214,529


(c)   Series I Preferred Stock

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

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

On
liquidation/dissolution, the Series I Preferred Stock would have ranked senior to the common stock and to any other series of preferred stock that may hereafter be designated
by the board of directors as junior to the Series I Preferred Stock. Dividends accrued at 8% per annum, payable every six months in either cash or in shares of Wave common stock (at the
Company's election) at a rate

F-21

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(8) Preferred Stock (Continued)

equal
to $0.44 per share of Wave common stock. Wave paid $77,440 of dividends in cash during the year ended December 31, 2009. Dividend expense in connection with converted Series I
Preferred Stock for year ended December 31, 2008 totaled $22,929. The shares subscribed to on September 29, 2008 and September 11, 2008 were offered and issued pursuant to a shelf
registration statement on Form S-3, which was filed by Wave on April 18, 2008 and declared effective by the Commission on June 23, 2008.

(9) Common Stock

During 2010, Wave received gross proceeds of $3,979,291 in connection with the issuance of 4,405,641 shares of Class A Common Stock upon the exercise of warrants that were granted
to investors as part of Wave's 2009 and 2008 financings. The warrants were exercised at exercise prices ranging from $0.28 - $1.155 per share. Additionally, 432,002 shares of
Class A Common Stock were issued to SRA upon the partial cashless exercise of warrants that were granted to SRA in its capacity as placement agent as part of Wave's 2009 and 2008 financings
(See Note 11).

During
2009, Wave received gross proceeds of $102,800 in connection with the issuance of 160,000 shares of Class A Common Stock upon the exercise of warrants that were granted to
investors as part of Wave's 2009 and 2008 financings. The warrants were exercised at exercise prices ranging from $0.28 - $0.90 per share. Additionally, 79,537 shares of Class A
Common Stock were issued to SRA upon the partial cashless exercise of warrants that were granted to SRA in its capacity as placement agent as part of Wave's 2009 and 2008 financings (See
Note 11).

On
July 21, 2009 Wave entered into subscription agreements with certain purchasers, pursuant to which Wave agreed to sell and issue 1,791,738 shares of Class A Common
Stock, par value $.01 per share, for an aggregate purchase price of $1,648,400. These shares were priced at $0.92 per share. Roth Capital Partners ("Roth") entered into a placement agency agreement
with Wave in which Roth agreed to act as placement agent in connection with the offering. Wave agreed to pay Roth a fee equal to 8.0% of the gross proceeds of this offering. Wave also agreed to issue
warrants to the subscribers to purchase up to 895,868 shares of Class A common stock at an exercise price of $1.155 per share. These warrants expire in January 2015. Wave realized net proceeds
of approximately $1,489,000 after deducting the placement agent fees of $131,872 and additional legal and other fees associated with the issuance of these securities which totaled approximately
$27,000. The shares sold on July 21, 2009 were offered and issued pursuant to a shelf registration statement on Form S-3, which was filed by Wave on April 18, 2008 and
declared effective by the Commission on June 23, 2008. On July 16, 2009, Wave entered into subscription agreements with certain purchasers, pursuant to which Wave agreed to sell and
issue 3,448,042 shares of Class A Common Stock, par value $.01 per share, for an aggregate purchase price of $3,172,199. These shares were priced at $0.92 per share. Roth entered into a
placement agency agreement with Wave in which Roth agreed to act as placement agent in connection with the offering. Wave agreed to pay Roth a fee equal to 8.0% of the gross proceeds of this offering.
Wave also agreed to issue warrants to the subscribers to purchase up to 1,724,024 shares of Class A
common stock at an exercise price of $1.155 per share. These warrants expire in January 2015. Wave realized net proceeds of approximately $2,687,000 after deducting the placement agent fees of
$253,776 and additional legal and other fees associated with the issuance of these securities which totaled approximately $231,000. The shares sold on July 16, 2009 were offered and issued
pursuant to a shelf registration statement on Form S-3, which was filed by Wave on April 18, 2008 and declared effective by the Commission on June 23, 2008.

F-22

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(9) Common Stock (Continued)

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

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

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

On
June 30, 2008, Wave entered into subscription agreements, pursuant to which Wave agreed to sell and issue 1,880,500 shares of Class A Common Stock, par value $.01 per
share, to certain purchasers for an aggregate purchase price of $1,598,425. These shares were priced at $0.85 per share.

F-23

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(9) Common Stock (Continued)

SRA
entered into a placement agency agreement with Wave in which they agreed to act as placement agent in connection with the offering. Wave agreed to pay SRA a fee equal to 6.0% of the gross proceeds
of this offering. Wave also agreed to issue warrants to the subscribers to purchase up to 470,125 shares of Class A Common Stock at an exercise price of $0.90 per share. These warrants expire
in June 2011. Additionally, Wave agreed to issue a warrant to SRA to purchase up to 112,830 shares of Class A Common Stock at an exercise price of $0.90 per share. This warrant expires in June
2011. Wave realized net proceeds, in early July, of approximately $1,467,000 after deducting the placement agent fees of $95,906 and additional legal and other fees associated with the issuance of
these securities which totaled approximately $36,000. The shares subscribed to on June 30, 2008 were issued in early July and offered and issued pursuant to a shelf registration statement on
Form S-3, which was filed by Wave on April 18, 2008 and declared effective by the Commission on June 23, 2008.

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

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

On
December 1, 2010, Wave issued 151,729 shares of Class A Common Stock to Wave employees for $2.244 per share, pursuant to the Wave 2004 Employee Stock Purchase Plan. Wave
received proceeds of $340,480 from the issuance of these shares.

F-24

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(9) Common Stock (Continued)

On
June 1, 2010, Wave issued 240,190 shares of Class A Common Stock to Wave employees for $1.088 per share pursuant to the Wave 2004 Employee Stock Purchase Plan. Wave
received proceeds of $261,327 from the issuance of these shares.

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

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

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

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

(10) Share-based Compensation

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

In
November 2004 Wave adopted the 2004 Employee Stock Purchase Plan (the "Purchase Plan") pursuant to which a total of 3,000,000 shares of Wave's Class A Common Stock may be sold
to eligible employees at a 15% discount from the market value of the shares. The Purchase Plan was approved by a vote of Wave's shareholders. Under the terms of the Purchase Plan, employees may elect
to have withheld up to 15% of their base earnings to purchase these shares during each offering period, up to a maximum of $25,000 in market value of Wave's Class A Common Stock. Offering
periods commence on June 1st and December 1st and are for a period of six months. The purchase price under the Purchase Plan is 85% of the lesser of the market price on the
beginning or the ending of the offering period.

F-25

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(10) Share-based Compensation (Continued)

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

ASC
718 requires companies to estimate the fair value of stock-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is
ultimately expected to vest is recognized as expense over the requisite service periods in the Company's consolidated statement of operations.

Stock-based
compensation expense recognized for the years ended December 31, 2010, 2009 and 2008 was $2,813,816, $1,724,874 and $2,105,941, respectively. The classification of the
cost of share based compensation, in the statement of operations, is consistent with the nature of the services being rendered in exchange for the share based payment.

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

2010

2009

2008Cost of Sales

$
75,876

$
49,038

$
28,896Selling, General & Administrative


1,930,529


1,068,314


1,309,729Research & Development


807,411


607,522


767,316Total

$
2,813,816

$
1,724,874

$
2,105,941


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

2010

2009Stock Option
Plans

Stock Purchase
Plan

Stock Option
Plans

Stock Purchase
PlanExpected Term (in years)


5 Years


6 Months


5 Years


6 MonthsRisk-free Raterange


1.25% - 2.75
%

0.20% - 0.23
%

1.75% - 2.75
%

0.15% - 0.29
%Risk-free Ratewt. avg.


2.43
%

0.22
%

1.83
%

0.25
%Expected Volatilityrange


77.0% - 82.9
%

75.2% - 88.7
%

75.2% - 78.1
%

52.2% - 67.7
%Expected Volatilitywt. avg.


77.85
%

83.49
%

75.52
%

63.18
%Dividend Yield


0
%

0
%

0
%

0
%


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

F-26

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(10) Share-based Compensation (Continued)

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

The
expected term of employee stock options represents the weighted average period that the stock options are expected to remain outstanding. For Wave's stock option plans, it is based
upon an analysis of the historical behavior of option holders during the period from January 1, 2000 to December 31, 2010. Management believes historical data is representative of future
exercise behavior. For Wave's Employee Stock Purchase Plan, the expected term of six months, is the length of each purchase period, pursuant to the plan.

As
stock-based compensation expense recognized in the consolidated statement of operations pursuant to ASC 718 is based on awards ultimately expected to vest, stock-based
compensation expense reduced for estimated forfeitures. ASC 718 requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures
differ from those estimates. Forfeitures are estimated based on historical experience.

A
summary of option activity for all Wave option plans through December 31, 2010 follows:

2010

2009

2008Number of
Shares

Weighted
Average
Exercise
Price

Number of
Shares

Weighted
Average
Exercise
Price

Number of
Shares

Weighted
Average
Exercise
PriceBalance at beginning of year


9,077,477

$
4.13


6,528,296

$
6.24


6,916,478

$
6.80Granted


2,457,050


2.18


3,242,900


0.82


932,300


1.67Forfeited


(199,449
)

1.48


(105,654
)

1.27


(507,127
)

2.00Expired


(404,301
)

38.15


(588,065
)

9.74


(813,355
)

8.42Exercised


(888,445
)

1.45








Balance at end of year


10,042,332


2.47


9,077,477


4.13


6,528,296


6.24Exercisable at end of year


5,521,762

$
3.23


4,907,817

$
6.70


4,311,378

$
8.44Additional shares available for grant at end of year


2,739,875





4,593,175





3,970,837


The
weighted average grant date fair value of options granted during the years ended December 31, 2010, 2009 and 2008 was $1.39, $0.51 and $1.24, respectively.

The
weighted average remaining contractual term for options outstanding and options exercisable at December 31, 2010 were 6.6 and 5.0 years, respectively.

As
of December 31, 2010, unrecognized stock-based compensation related to stock options was approximately $1,668,000. At December 31, 2010, the weighted average period this
cost is expected to be expensed is 2.1 years. The total fair value of shares that vested during the years ended December 31, 2010, 2009 and 2008 was approximately $1,861,000, $1,682,000
and $1,988,000, respectively.

As
of December 31, 2010, the intrinsic value of outstanding, vested and currently exercisable share options was approximately $6,789,000.

F-27

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(10) Share-based Compensation (Continued)

The following table summarizes information about stock options outstanding under the Wave stock options plans as of December 31, 2010:

Options Outstanding

Options ExercisableExercise Price Range

Number
Outstanding

Weighted
Average
Remaining
Contractual
Life

Weighted
Average
Exercise
Price

Number
Exercisable

Weighted
Average
Exercise
Price$0.25 - $0.75


143,666


8.0

$
0.66


81,160

$
0.67$0.76 - $1.00


2,534,027


8.1


0.82


676,080


0.83$1.01 - $2.00


4,018,233


7.6


1.90


1,865,066


1.88$2.01 - $2.50


1,088,026


6.1


2.39


949,426


2.41$2.51 - $3.00


417,567


4.2


2.89


324,867


2.98$3.01 - $5.00


789,878


5.5


3.64


574,228


3.64$5.01 - $10.00


674,104


2.1


5.65


674,104


5.65$10.01 - $15.00


376,831


.1


12.10


376,831


12.1010,042,332


6.6

$
2.47


5,521,762

$
3.23


1999 Wavexpress Stock Incentive Plan

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

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

Stock
option activity during 2010, 2009 and 2008 is as follows:

2010

2009

2008Number of
Shares

Weighted
Average
Exercise
Price

Number of
Shares

Weighted
Average
Exercise
Price

Number of
Shares

Weighted
Average
Exercise
PriceBalance at Beginning of year


556,263

$
1.23


624,663

$
1.23


624,663

$
1.23Granted

















Canceled


(21,530
)

2.65


(68,400
)

1.20





Balance at end of year


534,733


1.20


556,263


1.23


624,663


1.23Exercisable at end of year


534,733

$
1.20


556,263

$
1.23


624,663

$
1.23Additional shares available for grant at end of year


1,937,490





1,915,960





1,847,560


F-28

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(10) Share-based Compensation (Continued)

No
options were granted under the Wavexpress stock option plan during the years ended December 31, 2010, 2009 and 2008.

The
following table summarizes information about Wavexpress' stock options outstanding at December 31, 2010:

Options Outstanding

Options ExercisableExercise Price

Number
Outstanding

Weighted
Average
Remaining
Contractual Life
(in years)

Weighted
Average
Exercise
Price

Number
Exercisable

Weighted
Average
Exercise
Price$1.20


534,733


1.3

$
1.20


534,733

$
1.20


Employee Stock Purchase Plan

In November 2004, the Board of Directors adopted the Wave Systems Corp. 2004 Employee Stock Purchase sold to eligible employees at a
15% discount from the market value of the shares. The Purchase Plan was ratified by a shareholder vote at Wave's 2005 annual shareholder meeting on May 23, 2005. Under the terms of the Purchase
Plan, employees may elect to have withheld, up to 15% of their base earnings to purchase these shares during each offering period, up to a maximum of $25,000 in market value of Wave's Class A
Common Stock. Offering periods
commence on June 1st and December 1st and are for a period of six months. The purchase price under the Purchase Plan is 85% of the lesser of the market price on the
beginning or the ending of the offering period. Approximately 50%, 30% and 22% of eligible employees participated in the Purchase Plan for the years ended December 31, 2010, 2009 and 2008,
respectively. For the year ended December 31, 2010 employees purchased 391,919 shares of Wave Class A Common Stock at an average share price of $1.54 per share, for an aggregate of
$601,807 in proceeds to Wave. For the year ended December 31, 2009 employees purchased 517,633 shares of Wave Class A Common Stock at an average share price of $0.50 per share, for an
aggregate of $260,285 in proceeds to Wave. For the year ended December 31, 2008 employees purchased 360,058 shares of Wave Class A Common Stock at an average share price of $0.64 per
share, for an aggregate of $229,428 in proceeds to Wave.

(11) Warrants

On July 21, 2009, Wave issued warrants to investors to purchase up to 895,868 shares of Class A Common Stock pursuant to which Wave sold and issued 1,791,738 shares of
Class A Common Stock, par value $.01 per share for an aggregate purchase price of $1,648,400. The warrants are exercisable at an exercise price of $1.155 per share and expire on
January 21, 2015. If exercised in full, the investor warrants granted in connection with this financing may generate up to an additional $1,034,728, at the exercise price. During 2010, Wave
received gross proceeds of $494,265, in connection with the issuance of 427,935 shares of Class A Common Stock upon the exercise of warrants that were granted to investors as part of this
financing.

On
July 16, 2009, Wave issued warrants to investors to purchase up to 1,724,024 shares of Class A Common Stock pursuant to which Wave sold and issued 3,448,042 shares of
Class A Common Stock, par value $.01 per share for an aggregate purchase price of $3,172,199. The warrants are exercisable at an exercise price of $1.155 per share and expire on
January 16, 2015. If exercised in full, the investor

F-29

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(11) Warrants (Continued)

warrants
granted in connection with this financing may generate up to an additional $1,991,248, at the exercise price. During 2010, Wave received gross proceeds of $1,352,231, in connection with the
issuance of 1,170,763 shares of Class A Common Stock upon the exercise of warrants that were granted to investors as part of this financing.

On
April 8, 2009, Wave issued warrants to investors to purchase up to 940,568 shares of Class A Common Stock pursuant to which Wave sold and issued 1,881,136 shares of
Class A Common Stock, par value $.01 per share for an aggregate purchase price of $1,034,625. The warrants are exercisable at an exercise price of $0.55 per share and expire on April 8,
2012. If exercised in full, the investor warrants granted in connection with this financing may generate up to an additional $517,312, at the exercise price. Wave also issued to a placement agent
warrants to purchase up to 112,868 shares of Class A Common Stock, in connection with a securities purchase agreement. The warrants are exercisable at an exercise price of $0.55 per share and
expire on April 8, 2012. If exercised in full, the warrants granted to the placement agent may generate up to an additional $62,077, at the exercise price. During 2010 and 2009, Wave received
gross proceeds of $234,375 and $6,875, respectively, in connection with the issuance of 426,136 and 12,500 shares, respectively, of Class A Common Stock upon the exercise of warrants that were
granted to investors as part of this financing. Also, 34,560 shares of Class A Common Stock were issued to SRA during 2010 upon the partial cashless exercise of the warrants that were granted
to SRA as part of this financing.

On
March 13, 2009, Wave issued warrants to investors to purchase up to 392,500 shares of Class A Common Stock pursuant to which Wave sold and issued 785,000 shares of
Class A Common Stock, par value $.01 per share for an aggregate purchase price of $431,750. The warrants are exercisable at an exercise price of $0.55 per share and expire on March 13,
2012. If exercised in full, the investor warrants granted in connection with this financing may generate up to an additional $215,875, at the exercise price. Wave also issued to a placement agent
warrants to purchase up to 47,100 shares of Class A Common Stock, in connection with a securities purchase agreement. The warrants are exercisable at an exercise price of $0.55 per share and
expire on March 13, 2012. If exercised in full, the warrants granted to the placement agent may generate up to an additional $25,905, at the exercise price. During 2010 and 2009, Wave received
gross proceeds of $90,750 and $48,125, respectively, in connection with the issuance of 165,000 and 87,500 shares, respectively, of Class A Common Stock upon the exercise of warrants that were
granted to investors as part of this financing. Also, 3,144 shares of Class A Common Stock were issued to SRA during 2010 upon the partial cashless exercise of the warrants that were granted to
SRA as part of this financing.

On
December 24, 2008, Wave issued warrants to investors to purchase up to 1,140,000 shares of Class A Common Stock pursuant to which Wave sold and issued 456 shares of 8%
Series K Convertible Preferred Stock, par value $.01 per share for an aggregate purchase price of $1,276,800. The warrants are exercisable at an exercise price of $0.28 per share and expire on
December 24, 2011. If exercised in full, the investor warrants granted in connection with this financing may generate up to an additional $319,200, at the exercise price. Wave also issued to a
placement agent warrants to purchase up to 273,600 shares of Class A Common Stock, in connection with a securities purchase agreement. The warrants were exercisable at an exercise price of
$0.28 per share and would have expired on December 24, 2011. If exercised in full and in cash, the warrants granted to the placement agent would have generated up to an additional $76,608, at
the exercise price. During 2010 and 2009, Wave received gross proceeds of $45,500 and $2,800, respectively, in connection with the issuance of 162,500 and 10,000 shares, respectively, of
Class A Common Stock upon the exercise of warrants that were granted

F-30

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(11) Warrants (Continued)

to
investors as part of this financing. Also, during 2010 and 2009, 231,945 and 17,361 shares, respectively, of Class A Common Stock were issued to SRA upon the complete and cashless exercise
of the warrant that were granted to SRA as part of this financing.

On
October 30, 2008, Wave issued warrants to investors to purchase up to 2,220,000 shares of Class A Common Stock pursuant to which Wave sold and issued 111 shares of
Series J Convertible Preferred Stock, par value $.01 per share for an aggregate purchase price of $721,500. The warrants are exercisable at an exercise price of $0.40 per share and expire on
October 30, 2013. If exercised in full, the investor warrants granted in connection with this financing may generate up to an additional $888,000, at the exercise price. Wave also issued to a
placement agent warrants to purchase up to 66,600 shares of Class A Common Stock, in connection with a securities purchase agreement. The warrants are exercisable at an exercise price of $0.40
per share and expire on October 30, 2011. If exercised in full and in cash, the warrants granted to the placement agent may generate up to an additional $26,640, at the exercise price. During
2010, Wave received gross proceeds of $149,000, in connection with the issuance of 372,500 shares of Class A Common Stock upon the exercise of warrants that were granted to investors as part of
this financing. Also, 29,020 shares of Class A Common Stock were issued to SRA during 2010 upon the partial cashless exercise of the warrants that were granted to SRA as part of this financing.

On
September 11, 2008, Wave issued to SRA warrants to purchase up to 103,200 shares of Class A Common Stock, in connection with a securities purchase agreement, pursuant to
which Wave sold and issued 172 shares of 8% Series I Preferred Stock, par value $.01 per share for an aggregate purchase price of $756,800. The warrants were exercisable at an exercise price of
$0.50 per share and would have expired on September 11, 2011. During 2010, 79,877 shares of Class A Common Stock were issued to SRA upon the complete and cashless exercise of these
warrants. There are no remaining warrants outstanding in connection with this financing.

On
August 11, 2008, Wave issued warrants to investors to purchase up to 342,083 shares of Class A Common Stock pursuant to which Wave sold and issued 1,368,333 shares of
Class A Common Stock, par value $.01 per share for an aggregate purchase price of $821,000. The warrants are exercisable at
an exercise price of $0.65 per share and expire on August 11, 2011. If exercised in full, the investor warrants granted in connection with this financing may generate up to an additional
$222,354, at the exercise price. Wave also issued to a placement agent warrants to purchase up to 82,100 shares of Class A Common Stock, in connection with a securities purchase agreement. The
warrants were exercisable at an exercise price of $0.65 per share and would have expired on February 11, 2010. If exercised in full and in cash, the warrants granted to the placement agent
would have generated up to an additional $53,365, at the exercise price. During 2010, Wave received gross proceeds of $222,354, in connection with the issuance of 342,083 shares of Class A
Common Stock upon the exercise of warrants that were granted to investors as part of this financing. Also, during 2010 and 2009, 53,456 and 3,659 shares, respectively, of Class A Common Stock
were issued to SRA upon the complete and cashless exercise of the warrants that were granted to SRA as part of this financing.

On
June 30, 2008, Wave issued warrants to investors to purchase up to 470,125 shares of Class A Common Stock pursuant to which Wave sold and issued 1,880,500 shares of
Class A Common Stock, par value $.01 per share for an aggregate purchase price of $1,598,425. The warrants are exercisable at an exercise price of $0.90 per share and expire on June 30,
2011. If exercised in full, the investor warrants granted in connection with this financing may generate up to an additional $423,113, at the

F-31

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(11) Warrants (Continued)

exercise
price. Wave also issued to a placement agent warrants to purchase up to 112,830 shares of Class A Common Stock, in connection with a securities purchase agreement. The warrants were
exercisable at an exercise price of $0.90 per share and would have expired on December 31, 2009. If exercised in full and in cash, the warrants granted to the placement agent would have
generated up to an additional $101,547, at the exercise price. During 2010 and 2009, Wave received gross proceeds of $302,162 and $45,000, respectively, in connection with the issuance of 335,736 and
50,000 shares, respectively, of Class A Common Stock upon the exercise of warrants that were granted to investors as part of this financing. Additionally, during 2009, 30,178 shares of
Class A Common Stock were issued to SRA upon the complete and cashless exercise of the warrants that were granted to SRA as part of this financing.

On
May 23, 2008, Wave issued warrants to investors to purchase up to 537,812 shares of Class A Common Stock pursuant to which Wave sold and issued 2,151,250 shares of
Class A Common Stock, par value $.01 per share for an aggregate purchase price of $1,721,000. The warrants are exercisable at an exercise price of $0.85 per share and expire on May 23,
2011. If exercised in full, the investor warrants granted in connection with this financing may generate up to an additional $457,140, at the exercise price. Wave also issued to a placement agent
warrants to purchase up to 129,075 shares of Class A Common Stock, in connection with a securities purchase agreement. The warrants were exercisable at an exercise price of $0.85 per share and
would have expired on November 23, 2009. If exercised in full and in cash, the warrants granted to the placement agent would have generated up to an additional $109,714, at the exercise price.
During 2010, Wave received gross proceeds of $183,547, in connection with the issuance of 215,938 shares of Class A Common Stock upon the exercise of warrants that were granted to investors as
part of this financing. Also, during 2009, 28,339 shares of Class A Common Stock were issued to SRA upon the complete and cashless exercise of the warrants that were granted to SRA as part of
this financing.

On
February 29, 2008, Wave issued warrants to investors to purchase up to 952,050 shares of Class A Common Stock pursuant to which Wave sold and issued 3,173,500 shares of
Class A Common Stock, par value $.01 per share for an aggregate purchase price of $3,490,850. The warrants are exercisable at an exercise price of $1.15 per share and expire on
February 29, 2013. If exercised in full, the investor warrants granted in connection with this financing may generate up to an additional $1,094,858, at the exercise price. Wave also issued to
SRA warrants to purchase up to 190,410 shares of Class A Common Stock, in connection with a securities purchase agreement. The warrants were exercisable at an exercise price of $1.33 per share
and expired unexercised on February 29, 2010. During 2010, Wave received gross proceeds of $905,108, in connection with the issuance of 787,050 shares of Class A Common Stock upon the
exercise of warrants that were granted to investors as part of this financing.

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

In
connection with an agreement that Wave entered into with an outside sales representative, Wave issued warrants to purchase 14,788 shares of Class A Common Stock at prices
ranging from $2.85 to $4.35 per share, pursuant to an individual compensation plan with the sales representative. The fair

F-32

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(11) Warrants (Continued)

market
value of these warrants was approximately $146,000 and was recorded as consultant expense in 2003. No additional warrants are required to be granted pursuant to the individual compensation plan
for the sales representative. These warrants are currently exercisable and expire January 1, 2013 through April 30, 2013.

A
summary of warrants outstanding at December 31, 2010, follows:

Warrants
Outstanding



Warrants ExercisableExercise Price

Number of
Shares

Weighted
Average
Remaining
Contractual Life
(in years)

Weighted
Average
Exercise
Price

Number of
Shares

Weighted
Average
Exercise
Price$0.25 - $0.50


2,849,380


2.6

$
0.36


2,849,380

$
0.36$0.51 - $1.00


1,163,155


1.1

$
0.66


1,163,155

$
0.66$1.01 - $2.00


1,191,194


3.9

$
1.16


1,191,194

$
1.16$2.01 - $4.35


14,788


2.2

$
3.38


14,788

$
3.385,218,517


3.3

$
0.62


5,218,517

$
0.62


(12) Wavexpress

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

On
December 1, 2008, Wavexpress announced that it had suspended its TVTonic consumer media service and was exploring opportunities to sell or license its technology to third
parties that may provide "download and play" services. As of December 31, 2008, the New York, NY facility was closed. The engineering staff was terminated. An impairment charge of $447,128 was
recorded to reflect the write-off of impaired assets, consisting primarily of computer equipment, including equipment collateralizing a capital lease obligation (see note 13).

Wave
has funded Wavexpress through a series of convertible notes, some with attached warrants. The notes bear interest at the rate of 2% to 3% above the Prime Rate of Chase Manhattan
Bank. Generally, the notes are convertible into shares of common stock of Wavexpress at varying prices per share. Through December 31, 2010, Wave has funded Wavexpress with approximately
$47,026,000 in cash loans, which have accumulated approximately $34,174,000 in accrued interest. Such amounts include approximately $9,500,000 that has since automatically converted into 1,826,571
additional shares

F-33

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(12) Wavexpress (Continued)

of
Wavexpress at an average conversion price of $5.20 per share. These amounts are eliminated in consolidation.

As
of December 31, 2010, Wave owns 97.3% of Wavexpress, while Sarnoff owns 1.7% (on a fully diluted basis). None of the minority shareholders have provided, or are obligated to
provide, funding to Wavexpress. Accordingly, the financial statements of Wavexpress have been included in the consolidated financial statements of Wave for all periods presented herein. In addition,
Wave has not recorded a minority interest in Wavexpress in the consolidated financial statements and therefore has reflected 100% of Wavexpress' balance sheet and operating results in its consolidated
financial statements. Wavexpress has incurred net operating losses of approximately $80,000, $631,000 and $4.1 million, for the years ended December 31, 2010, 2009 and 2008,
respectively.

(13) Commitments and Contingencies

Operating Leases

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

Location

Annual
Lease
Cost

Lease
Expiration
DateLee, MA

$
154,331

MonthlyPrinceton, NJ


99,072

Dec. 2014Cupertino, CA


521,934

Feb. 2013Orvault, France


13,563

Feb. 2012Total

$
788,900


Future
minimum lease payments under non-cancelable operating leases (with initial or remaining lease terms in excess of one year) as of December 31, 2010 are as
follows:

2011

$
629,3652012


632,7662013


188,2192014


100,942Thereafter


0Total minimum lease payments

$
1,551,292


Rent
expense for the years ended December 31, 2010, 2009 and 2008 amounted to approximately $765,000, $907,000 and $1,134,000, respectively.

Capital Leases

Wave has a capitalized lease obligation for computer equipment due monthly through July 2013 of $183,504 and $245,362 as of
December 31, 2010 and 2009, respectively. The interest rate is 7.7% per annum. This lease obligation is collateralized by the related assets with a net book value of $-0- as of
December 31, 2010 reflecting an impairment charge due to the suspension of Wavexpress' TVTonic consumer media services (see note 12).

F-34

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(13) Commitments and Contingencies (Continued)

Future minimum lease payments under this non-cancelable capital lease as of December 31, 2010 are as follows:

2011

$
78,5292012


78,5292013


45,808Total minimum lease payments


202,866Less: Amount representing interest


(19,362
)Balance at December 31, 2010

$
183,504


(14) Income Taxes

The Company did not provide for any income tax expense or (benefit) for the years ending December 31, 2010, 2009 and 2008.

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

2010

2009

2008Statutory tax rate


34
%

34
%

34
%Stock-based compensation on ISO's


(8
)

(18
)

(3
)BCF on Preferred Stock


(0
)

(0
)

(1
)Change in valuation allowance


(26
)

(16
)

(30
)Total



%


%


%


The
tax effects of temporary differences that give rise to the deferred tax asset at December 31, 2010 and 2009 are as follows:

2010

2009Deferred tax assets:Net operating and capital loss carryforwards

$
96,004,000

$
99,472,000Accrued expenses


791,000


720,000Intangibles


286,000


303,000Reserves


896,000


921,000Depreciation


345,000


382,000Total gross deferred tax assets


98,322,000


101,798,000Less valuation allowance


(98,322,000
)

(101,798,000
)Net deferred tax asset

$


$



The
valuation allowance decreased by approximately $3.5 million and $6.5 million during the years ended December 31, 2010 and 2009, respectively.

Management
has concluded that it is more likely than not that Wave will not have sufficient taxable income of an appropriate character within the carryback and carryforward periods
permitted by

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(14) Income Taxes (Continued)

current
law to allow for the utilization of the deferred tax assets and, therefore, a valuation allowance has been established against the deferred tax assets of $98,322,000 as of December 31,
2010. Subsequently reported tax benefits relating to the valuation allowance for deferred tax assets as of December 31, 2010 will be allocated as follows: $96,995,000 to continuing operations
and $1,327,000 to additional paid-in capital for amounts attributable to exercise of employee stock options.

Wave
has federal and state net operating loss carryforwards of approximately $277.0 million, which expire beginning in 2011 through 2030. Pursuant to Section 382 of the
Internal Revenue Code, the annual utilization of Wave's net operating and capital loss carryforwards may be substantially limited if a cumulative change in ownership of more than 50% occurs within any
three-year period. Wave has not determined whether there have been such cumulative changes in ownership or the impact on the utilization of the loss carryforwards if such changes have
occurred. However, in considering Section 382 of the Internal Revenue Code, Wave believes that it is likely that such a change in ownership has occurred thus raising the likelihood that such
net operating and capital loss carryforwards are subject to annual limitations.

The
following table summarizes the activity related to the Company's gross unrecognized tax benefits at December 31, 2010, 2009 and 2008:

2010

2009

2008Balance at beginning of year

$
5,165,535

$
11,353,354

$
9,428,187Increases related to current tax positions


0


0


1,925,167Decreases related to prior year tax positions


(5,165,535
)

(6,187,819
)

0Balance at end of year

$
0

$
5,165,535

$
11,353,354


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

The
Company's policy is to recognize interest and penalties related to unrecognized tax benefits as a component of income tax expense. The Company files United States Federal and state
income tax returns. In general, the statute of limitations with respect to the Company's United States Federal income taxes has expired for years prior to 2006, and the relevant state statutes vary.
However, preceding years remain open to examination by United States Federal and state taxing authorities to the extent of future utilization of net operating losses and capital losses generated in
each preceding year. The Company does not anticipate that the total unrecognized tax benefits will change significantly prior to December 31, 2011. As described above, utilization of the
Company's loss carryforwards may be limited pursuant to Section 382 of the Internal Revenue Code. Any limitation may result in expiration of a portion of the net operating and capital loss
carryforwards before utilization. Until a study is completed and any limitation known, no amounts are being presented as an uncertain tax position.

F-36

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(14) Defined Contribution Plan

Wave adopted the Wave Systems Corp. 401(k) Savings and Investment Plan, a defined contribution plan, to which substantially all employees can contribute, on January 1, 1995.
Employees of Wave become eligible immediately on employment. Wave has the option to make discretionary matching contributions; no contributions were made in 2010, 2009 or 2008.

(15) Disclosures about the Fair Value of Financial Instruments

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

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

As
of December 31, 2010, Wave's financial assets that are measured at fair value on a recurring basis are comprised of overnight money market fund investments. Wave invests excess
cash from its operating cash accounts in overnight money market funds and reflects these amounts (approximately $3,446,000 at December 31, 2010) within cash and cash equivalents on the
consolidated balance sheet using quoted prices in active markets for identical assets (Level 1) at a net value of 1:1 for each dollar invested.

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

(16) Segment Reporting

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

F-37

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(16) Segment Reporting (Continued)

The
following sets forth reportable segment data:

For the years ended December 31,2010

2009

2008Operating Revenues:EMBASSY® digital security products and services


26,050,792


18,888,879


8,809,815Wavexpress broadband media distribution products and services








Total Operating Revenues

$
26,050,792

$
18,888,879

$
8,809,815Net Loss:EMBASSY® digital security products and services


(4,043,283
)

(2,695,763
)

(16,409,060
)Wavexpress broadband media distribution products and services


(63,692
)

(631,022
)

(4,130,582
)Total Segments Net Loss


(4,106,975
)

(3,326,785
)

(20,539,642
)Net interest income (expense)


(15,842
)

(19,466
)

(9,572
)Net Loss

$
(4,122,817
)
$
(3,346,251
)
$
(20,549,214
)Depreciation and Amortization Expense:EMBASSY® digital security products and services


404,795


259,210


309,642Wavexpress broadband media distribution products and services








85,611Total Depreciation and Amortization Expense

$
404,795

$
259,210

$
395,253Capital Expenditures:EMBASSY® digital security products and services


528,138


88,007


132,789Wavexpress broadband media distribution products and services








99,723Total Capital Expenditures

$
528,138

$
88,007

$
232,512




As ofDecember 31,
2010

December 31,
2009

December 31,
2008Assets:EMBASSY® digital security products and services


17,070,980


6,312,854


3,367,690Wavexpress broadband media distribution products and services


12,903


15,071


62,084Total Assets

$
17,083,883

$
6,327,925

$
3,429,774


F-38

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(16) Segment Reporting (Continued)

The following table details Wave's sales by geographic area for the years ended December 31, 2010, 2009 and 2008. Geographic area is based on the location of where the products
were shipped or services rendered.

United States
of America

Europe

Asia

Total2010EMBASSY® digital security products and services

$
25,167,998

$
72,646

$
810,148

$
26,050,792Wavexpress broadband media distribution products and services











Total

$
25,167,998

$
72,646

$
810,148

$
26,050,792% of Total


97
%

0
%

3
%

100
%2009EMBASSY® digital security products and services

$
18,350,388

$
5,440

$
533,051

$
18,888,879Wavexpress broadband media distribution products and services











Total

$
18,350,388

$
5,440

$
533,051

$
18,888,879% of Total


97
%

0
%

3
%

100
%2008EMBASSY® digital security products and services

$
8,576,635

$
57,018

$
176,162

$
8,809,815Wavexpress broadband media distribution products and services











Total

$
8,576,635

$
57,018

$
176,162

$
8,809,815% of Total


97
%

1
%

2
%

100
%


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

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

2010

2009

2008Customer

Segment

RevenueDell, Inc.

EMBASSY®

$
20,714,154

$
15,281,863

$
7,048,920% of Total Revenue




80
%

81
%

80
%


F-39

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(17) Selected Quarterly Financial Data (unaudited)

Quarter-endedDecember 31,
2010

September 30,
2010

June 30,
2010

March 31,
2010Revenues

$
7,037,238

$
6,695,452

$
6,448,674

$
5,869,428Cost of net revenues


476,813


489,204


459,141


351,660Loss from operations


(1,210,045
)

(1,174,597
)

(962,666
)

(759,667
)Net loss


(1,213,296
)

(1,178,472
)

(966,874
)

(764,175
)Net loss per common sharebasic and diluted

$
(0.01
)
$
(0.01
)
$
(0.01
)
$
(0.01
)




Quarter-endedDecember 31,
2009

September 30,
2009

June 30,
2009

March 31,
2009Revenues

$
5,213,252

$
4,843,806

$
4,797,640

$
4,034,181Cost of net revenues


358,959


303,702


387,170


348,060Loss from operations


(996,925
)

(473,706
)

(338,630
)

(1,517,524
)Net loss


(1,000,551
)

(478,716
)

(343,752
)

(1,523,232
)Net loss per common sharebasic and diluted

$
(0.01
)
$
(0.01
)
$
(0.01
)
$
(0.02
)


F-40

---