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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, 2008oro

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:

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


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 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 the
definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

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, 2008) was approximately $57 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 11, 2009, there were 63,437,968 shares of the registrant's Class A Common Stock and 38,232 shares of the registrant's Class B Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE:

Portions of our definitive Proxy Statement for the 2009 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before
April 30, 2009, 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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PagePART I

2Item 1.

Business

2Item 1A.

Risk Factors

14Item 1B.

Unresolved Staff Comments

22Item 2.

Properties

22Item 3.

Legal Proceedings

22Item 4.

Submission of Matters to a Vote of Security Holders

22PART II

23Item 5.

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

23Item 6.

Selected Financial Data

25Item 7.

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

27Item 7A.

Quantitative and Qualitative Disclosures about Market Risk

45Item 8.

Financial Statements and Supplementary Data

45Item 9.

Changes in and Disagreements with Accountant on Accounting and Financial Disclosure

45Item 9A.

Controls and Procedures

45Item 9B.

Other Information

46PART III

47Item 10.

Directors and Executive Officers and Corporate Governance of the Registrant

47Item 11.

Executive Compensation

47Item 12.

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

47Item 13.

Certain Relationships and Related Transactions, and Director Independence

47Item 14.

Principal Accountant Fees and Services

47PART IV

48Item 15.

Exhibits and Financial Statement Schedules

48


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PART I

Item 1.    Business

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.

In
2008, we accepted an invitation from the TCG to assume a permanent seat on its Board of Directors (the "TCG Board"), joining permanent members AMD, Fujitsu, HP, IBM, Infineon, Intel,
Lenovo, Microsoft, Sun and Seagate Technology. Wave also agreed to elevate 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 now eligible to serve on and chair the TCG Board, Work Groups and Special Committees; is able to submit revisions and addendum proposals for specifications with design guides; and
may review and comment on design guides prior to their adoption.

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

Prior
to the formation of the TCG, Wave developed its pioneering EMBASSY® (EMBedded ApplicationSecuritySYstem) Trust System. The EMBASSY
Trust System is a combination of client hardware consisting of the EMBASSY 2100 security chip (the "EMBASSY chip"); and software consisting of the Trust Assurance Network ("TAN"), a
back-office infrastructure that manages its security functions. As the market for TPM-enabled products has developed with computing devices being shipped in volume by leaders
in the PC industry, Wave has enabled the development work on the EMBASSY Trust System to support security hardware based on the TCG specifications, by repurposing these product assets. Wave has since
developed a set of applications known as the EMBASSY Trust Suite, EMBASSY Trust Server products, middleware and software tools to work with various other chip manufacturers' TCG-enabled
TPMs that are now available. Wave's products are unique in the fact that

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they
support cross platform interoperability for the currently available TPM chips from Nuvoton Technology Corporation (formerly Winbond Electronics Corporation), Atmel, Broadcom, Infineon
Technologies AG, and ST Microelectronics and have been verified for usage on TPM platforms shipped by Dell, Acer, Intel, Lenovo, HP, NEC and Fujitsu.

In
2007, Wave introduced software to support the Seagate Momentus 5400.2 FDE (Full Disc Encryption) drive for hardware protection of data. Wave's products supporting FDE drives include
the EMBASSY Trusted Drive Manager (ETDM) and the EMBASSY Remote Administration Server (ERAS). The ETDM was developed in partnership with Seagate. During 2007, we announced a licensing agreement with
Seagate for bundling and joint marketing of a Seagate version of the EMBASSY Trust Suite with Seagate FDE drives in certain distribution channels. Also during 2007, Wave and Seagate announced that
their data protection solution was being offered by Dell, ASI, and NEC Europe. In November 2008, Wave announced the availability of enhanced versions of EMBASSY Trust Suite, including ETDM, which
incorporate support for the new Seagate Momentus FDE 7200-RPM and FDE.3 5400-RPM self-encrypting drives shipping on Dell's new E-Series notebook PCs,
and available as an installable option on laptops for other PC original equipment manufacturers ("OEMs"). The drives provide enhanced protection against theft of data on lost or stolen computers and
assist organizations to comply with consumer protection laws and state and federal legislation requiring data and identity theft protection.

Wave's
operations to date have consisted primarily of product development, performance under contract to develop products and marketing and initial sales to personal computer ("PC") and
semi-conductor chip ("Chip") OEMs, resellers, and enterprises. In addition, Wave has signed distribution contracts for its products with a number of OEMs that have resulted in a
marked increase in revenues for the years ended December 31, 2008 and 2007 versus prior years.

Wave
has been successful in signing distribution contracts with Intel, Nuvoton (formerly Winbond), ST Microelectronics, Dell Products LP, Gateway/MPC and Broadcom. In early
November 2008, certain Intel Desktop Boards began shipping with an OEM version of EMBASSY Trust Suite. The Desktop Boards include Intel's integrated Trusted Platform Module ("iTPM"), which acts as a
tamper-resistant storage vault for user credentials, providing improved data protection and strong multi-factor authentication for network access. In mid-October 2008, Wave completed a
license agreement with Acer,
Wave's eighth OEM partner and the world's third-largest PC vendor, to bundle Wave EMBASSY® software with Acer's new Veriton 670 business PCs. The motherboards on the Acer
desktops feature an iTPM. Shipments in Europe and Asia began during the fourth quarter of 2008. U.S. shipments are to begin in early 2009. In December 2008, Wave completed an amendment to its software
license agreement with its largest OEM customer, Dell Products LP. Under the new arrangement, the per-unit royalties that Wave receives for each OEM PC model shipping with Wave's
EMBASSY Trust Suite software were increased by at least 100% per unit, retroactive to November 1, 2008.

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 2009 to fund
its cash flow requirements. Given the uncertainty with respect to Wave's revenue forecast for 2009, it is likely that Wave will 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, 2009. As of December 31, 2008, we had negative working capital of approximately
$6.3 million. 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 its Class A
common stock, par value $.01 per share, to such purchasers for an aggregate purchase price of $431,750. These shares were priced at $0.55 per share. Wave also agreed to issue warrants to the
purchasers 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. Securities Research Associates, Inc.
("SRA") entered into a placement agency agreement with Wave in which they agreed

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to
act as placement agent in connection with this offering. Wave agreed to pay SRA a fee equal to 6.0% of the gross proceeds of this offering. 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. Considering our current cash balance (including the net proceeds from our March 13, 2009 financing described above) and Wave's projected operating cash
requirements, we anticipate that we will need a minimum of approximately $4.6 million of additional cash to satisfy our current forecasted cash flow requirements for the year ending
December 31, 2009. Due to our current cash position, our capital needs over the next year and beyond, the fact that we will 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. During 2008, Wave accepted an invitation from the TCG to assume a permanent seat on its Board of Directors. The TCG has significantly
expanded the industry participation in security hardware standards and now includes industry leaders offering additional platforms such as storage devices, cell phones, PDAs and consumer electronics.
Since 2005, the rate of adoption of TPMs continued to grow with the availability of TPM-equipped PCs and servers from additional PC OEMs including Acer, Dell, Gateway/MPC and
Lenovo. The overall number of TPM-equipped PC models being offered from the OEMs shipping with TPMs, combined with the increased number of OEMs that have introduced
TPM-equipped models, has continued to accelerate the rate at which TPMs are being shipped by the PC industry. Within the TCG there are TCG Working Groups that are developing
specifications to extend TCG technologies to other devices such as storage devices, network products, servers, peripherals and mobile devices.

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

Products and Services

Although Wave's revenue has grown considerably in 2008 versus prior years, Wave's revenue in 2008 of approximately $8,810,000 was
significantly below operating expenses, which were approximately $29,349,000. For the years ended December 31, 2008, 2007, and 2006, Wave incurred losses to common shareholders of approximately
$21,206,000, $19,952,000 and $18,785,000 respectively. At December 31, 2008, we had an accumulated deficit of approximately $344,721,000. There can be no assurance that we will ever be
successful in achieving commercial acceptance of our products and services.

Client-side Applications



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

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(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, 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. Wave previously announced
in March 2007, a version of the ESC software that supports Seagate's Momentus 5400 FDE.2 hard drive (the "Seagate Trusted Drives"). Wave's EMBASSY Trust Suite software for TPM and key management also
supports Seagate Trusted Drives.

Data
Protection is addressed by the DM, which provides document encryption, decryption and client-side storage of documents. The DM, which works with Microsoft Windows, and Microsoft
Office, secures documents against unauthorized users and hackers. Wave's software is Windows Vista ready and builds upon the operating system's data protection feature set, providing
full-featured EMBASSY solutions for data protection and strong authentication.

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

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

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

Wave
plans to continue to develop and enhance the current products being developed within this product group and to develop new applications and services as the trusted computing market
continues to evolve. Current planned development costs for this product group are expected to be approximately $3.5 million for the year ending December 31, 2009.

Middleware and Tools



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



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

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Current
planned development costs for this product group are expected to be approximately $4.3 million for the year ending December 31, 2009.

EMBASSY Trust Server Applications



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



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



ERAS is a server product that provides centralized management and auditing of Trusted Platform Modules ("TPM") and Seagate Trusted
Drives ("Trusted Drive"). ERAS is designed to give IT administrators the ability to deploy and remotely manage Trusted Drives and TPM systems. It provides for initialization, pre-boot
authentication management, recovery, and repurposing of TPMs and Trusted Drives. ERAS is designed to provide auditing capabilities that aid in compliance management by allowing for validation
of TPM and Trusted Drive security settings, thus allowing IT administrators to assess the risk of whether a lost or compromised PC is adequately secure. ERAS is designed to facilitate enterprise
adoption of TPM and Trusted Drive technology as it provides IT administrators with tools to utilize the security of these devices while reducing deployment and management costs. During November 2008,
Wave announced the availability of enhanced versions of EMBASSY Trust Suite, including TDM, which incorporate support for the new Seagate Momentus FDE 7200-RPM and 5400.3-RPM
self-encrypting drives shipping on Dell's new E-Series notebook PCs. In December 2008, Wave and Fujitsu Computer Products of America, Inc. showcased their
self-encrypting drive solution at the Network World IT Roadmap Conference & Expo in San Francisco. Fujitsu's 2.5-inch High Definition Drive is the first technology that
will meet the Opal Security Subsystem Class (SSC) specificationan industry standard recently issued by the TCG. The SSC gives vendors an industry standard for developing
self-encrypting drives that secure data. During 2008, Wave has worked with Fujitsu, Toshiba, Samsung and Hitachi to develop Opal-compliant FDE solutions, in addition to its
currently shipping Seagate Trusted Drives.

Current
planned development costs for this product are expected to be approximately $1.6 million for the year ending December 31, 2009.

Digital Signature and Electronic Document Management

Our eSign Transaction Management Suite, also known as eTMS ("eTMS"), originally consisted of four core products: SmartIdentity,
SmartSignature, SmartSAFE and SmartConnect. SmartSignature Version 3.0 is a digital signature application that connects signers and institutionsbanks, insurance companies, enterprises,
etc.through a legally binding digital signature. Wave's SmartSignature Server,

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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. During the fourth quarter of 2007, Wave launched SmartSigning Rooms Version 1.0, which enhances the functionality of the SmartSAFE to enable an organization to
offer signers a secure virtual environment to review, annotate and electronically sign documents. During October 2008, Wave announced enhancements to its electronic signature and vaulting software.
With the latest enhancements to eTMS, closing documents can be signed and notarized in a secure environment and the note then registered through the Mortgage Electronic Registry System, the industry
endorsed system for electronically tracking mortgage ownership and servicing rights. Additionally, eTMS has added an optional SmartClose module which offers lenders protection against borrowers
claiming not to have understood their debt obligation. Lenders can now require electronic initialing on key line itemsa critical feature for refuting borrower calls to nullify the loan.
The module also offers electronic notarization through the integration of the World Wide Notary's DigiSign application with SmartSafe. The SmartClose module provides critical functionality to enable
true e-Mortgages.

To
increase the security associated with identity protection and digital signing credentials, Wave's SmartSignature is currently enabled for the support of TPMs. SmartSAFE Version
4.0 is a web-based document management application where signed documents are archived and tracked. SmartSAFE provides an easy to use environment where a client institution can view,
manage, store and transfer sensitive signed and unsigned documents. SmartSAFE also supports archival and management of unsigned documents in virtually any format. These products allow a document to be
executed, verified, accepted and filed in minutes at a lower cost compared to traditional paper-based documentation methods. SmartSignature Version 3.0 and SmartSAFE Version 4.0 have been completed
and Wave commercially released these products in the first quarter of 2007. SmartIdentity, an optional service to verify a signer's identity through strong authentication methods, including issuing
encrypted digital certificates based on public key infrastructure technology, was completed and released in January of 2003. Wave will continue to allocate resources toward marketing and sales to
promote these products.

Wave's
eTMS, in addition to supporting TPMs, is also being independently marketed in the insurance, mortgage, banking, government and other markets which are seeking digital and
electronic signature solutions that are compliant with the Electronic Signatures in Global and National Commerce Act ("ESIGN") and Uniform Electronic Transaction Act ("UETA"). Through direct and
reseller channels,
over 3,000 organizations have used eTMS functionality to automate paper processes. Some of the flagship organizations that are currently utilizing eTMS include: Ellie Mae, Realtime Solutions Group,
Heritage Union, DocuTech, Remark, American Community Life Insurance Company, Trust Company of America, SigniaDocs, Xerox Mortgage Services and others. Wave has focused on digital signature
applications that can make effective use of the stronger security features provided by trusted computing platforms.

Current
planned development costs for this product are expected to be approximately $350,000 for the year ending December 31, 2009.

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, 2008, Wave
owned 97.2% of Wavexpress, while Sarnoff owned 1.7% (on a fully diluted basis).

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

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provide
"download and play" services. A small staff remains in place at Wavexpress in order to support efforts to license or sell the Wavexpress technology to third parties.

Markets and Business Strategy

Our Market

Software has traditionally secured critical information on networks and PCs and allowed for user access to various applications.
However, virus attacks and breaches of security have proven that software, on its own, is not capable of completely securing a network or platform. Because of these persistent security concerns, we
believe that there is now a recognized need in the computer industry for the development and deployment of a more robust and reliable security infrastructure including new security hardware in devices
to guard against these persistent security risks. The TCG was formed to develop, define and promote open industry standard specifications for embedded hardware-enabled trusted computing and security
technologies, including secure hardware and software interfaces across multiple platforms, peripherals and devices. The underlying premise of the creation of a Trusted Platform that meets the TCG
specification is that only when a platform is secured by hardware, in effect creating 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. Because Wave has been a pioneer in developing hardware-based computer security systems, we believe we are distinctively positioned to take advantage of our unique knowledge, significant
technology assets and trusted computing intellectual properties.

Hardware-based
trusted computing solutions 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. Key components in achieving this goal include:

Capitalizing on Information Security Industry Trends

We believe that security remains one of the top industry priorities across multiple segments of the user and product value chains. Wave
believes that a key differentiator of its EMBASSY Trust Suite is that it is interoperable across all of the currently available TPM-enabled Windows platforms and provides for ease of use.
Key industry initiatives and security specifications that will require the addition of trusted hardware are moving forward in a number of platforms. One example is availability of the new Seagate
Momentus FDE 7200-RPM and 5400.3-RPM self-encrypting drives that are powered by Seagate Secure technology, a Seagate security platform that couples strong, fully
automated hardware-based full-disk encryption with Wave's client (TDM) and server-based (ERAS) software applications to deliver centralized provisioning and management, strong
pre-boot user authentication and other data and identity theft protection capabilities.
Also, in 2008, TCG announced a new industry standard for developing self-encrypting drives that secure data. The Opal security subsystem storage specification gives developers a
"blueprint" for developing self-encrypting drives. In addition to our work with Seagate, Wave is working with Fujitsu, Toshiba, Samsung and Hitachi on developing Opal-compliant
FDE solutions. Other past platforms requiring the addition of trusted hardware include Microsoft's Windows Vista operating system, Intel's LaGrande secure computing program, and AMD's Secure Execution
Mode ("SEM"). Similar programs are under consideration in network devices, and mobile devices such as PDAs and cell phones and consumer electronics devices.

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Wave
has designed its products with features and functionality that we believe uniquely positions 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
will continue to pursue strategic relationships with hardware manufacturers, independent software vendors, systems integrators and companies involved in the development of commerce
in electronic content and services to achieve broad market acceptance of its products as a platform for security solutions and commerce performed in user devices.

Pursue Strategic Marketing and Distribution Alliances

We intend to expand Wave's strategic alliances with key partners that could distribute our products in enterprise, government and
eventually consumer markets, and to build upon our alliances with such industry leaders as Intel, Dell, Acer, HP, IBM, Lenovo, NEC and others in the PC industry. In addition, we are engaged in
strategic activities with
semi-conductor manufacturers Broadcom, ST Microelectronics, Nuvoton (formerly Winbond), 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, similar to the Seagate FDE drives, to be introduced in 2009 and thereafter and that these products could be
supported by our trusted drive solutions. Wave believes its trusted computing offerings can provide significant value in these new markets and on these platforms and thus, is working to establish
relationships with key partners in each of these markets.

Enhancing Our Current Product Offerings and Products in Development

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

Client
and server solutions supporting both the operations and life cycle management of Trusted Platforms is a major focus area for Wave. New products that Wave is planning on developing
over the

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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:



These
development efforts will likely be significant and Wave intends to expend a substantial portion of its research and development resources towards these enhancements as well as
significant marketing and corporate development funds to introduce the products and build market demand. As a result, our continued research and development efforts will require substantial capital
resources, which will likely 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. Wave
announced product enhancements in 2008, primarily for its server-based and eTMS products, and continues to develop new client and server-based products and product enhancements, which are planned to
be introduced in 2009. For example: At the Intel Developer Forum (IDF), in August 2008, Wave demonstrated a data theft protection solution showcasing pre-production management and data
protection capabilities for platforms with Intel Anti-Theft Technologyadvanced, integrated hardware-based security technologyusing Wave's ERAS and TDM software.
Also at IDF, Wave demonstrated how enterprises can strengthen and simplify their existing wireless and virtual private network security by harnessing the built-in technology on platforms
featuring Intel vPro technology. The demonstration illustrated how enterprises can reduce expenses related to tokens, smart cards or complex authentication schemes by deploying PC platforms with Intel
vPro technology, in connection with Wave's EMBASSY software.

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 a reseller channel for our products.

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

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



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

Wave's
sales for the year ended December 31, 2008 consisted primarily of licensing its software applications, engineering and support services. Of the total revenue realized for
the years ended December 31, 2008 and 2007, 100% was derived from Wave's EMBASSY computer security products and services. For the year ended December 31, 2006, 99% was derived from
Wave's EMBASSY computer security products and services and 1% was from Wavexpress' broadband media distribution segment. Customers from which Wave derived revenue in 2008 in excess of 10% or total
revenues that would have a material adverse effect on Wave's business if Wave were to lose such customers are as follows:

Customer

Product or Service Sold

Percentage of Total
Revenue for the year
ended December 31, 2008Dell, Inc.

Software Licensing


80
%


Wave's
business plan, will continue to depend heavily on a small number of OEM customers, partners and prospective customers, the loss of, or lack of substantial future revenues from any
of whom, may have a material adverse effect on our business plan going forward. These are expected to include Dell, Inc., Broadcom and others. However, in 2008, Wave worked to expand its
presence as a

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security
solutions provider marketing to small, medium and large business enterprises and will continue to aggressively market its products and services to these enterprises in concert with its OEM
customer base.

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 us. Also, many current and potential competitors have greater name recognition and more extensive
customer bases to leverage, allowing these competitors to gain market share or product acceptance to our detriment. In addition, the rate of market acceptance of trusted computing solutions is still
in the formative and early stages, despite the substantial increase in distribution of the technology. The markets for our products are developing and, while the TCG specifications have provided the
basis for the industry to move forward, there remains significant standards work efforts in order for the eco-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 have leading solutions with its digital signature products, especially when combined with trusted computing platforms and
features.

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

One
of the market challenges facing Wave is the establishment of a newly defined market category within the overall information security market for trusted computing software and
services that includes a more complex business model for adoption. While the TCG specifications define a very complex and comprehensive cryptographic system that require significant skills and
resources, the market for security solutions that are as complex as those developed by Wave is in a formative stage of development. As a result, commercialization of these technologies has been slow
to develop. It is also possible for other competitors to develop similar offerings to compete with our products or new technologies may emerge

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that
could replace existing technology that our products rely on, thereby making our products non-competitive or obsolete. We can offer no assurances that Wave's products will become
industry standards or become widely accepted by the marketplace.

International Market

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

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

Proprietary Rights and Licenses and Intellectual Property

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

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

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

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

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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, eTMS products, and broadband media distribution products. For the years ended December 31, 2008, 2007 and 2006, we spent approximately
$11.7 million, $10.6 million and $8.5 million, respectively, on research and development ("R&D") activities. Planned development expenditures for the year ended
December 31, 2009 are expected to be approximately $9.5 million.

Employees

As of December 31, 2008, we employed ninety (90) full-time employees, forty-five (45) of
whom were involved in sales, marketing and administration and forty-five (45) of whom were involved in research and development (including six (6) employed by Wavexpress,
three (3) of whom were in sales, marketing and administration and three (3) of whom were involved in research and development). As of December 31, 2008, we retained the services
of three (3) full-time consultants. We believe our employee relations are satisfactory.

Available Information

Wave makes available, free of charge on its website by means of a link towww.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 athttp://www.sec.gov.

Item 1A.    Risk Factors

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

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



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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 2008 was significantly below 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, 2008, we had an accumulated deficit of approximately $344.7 million and
negative working capital of approximately $6.3 million. Given the lack of widespread adoption of the technology for our products and services, there is little basis for evaluating the financial
viability of our business and our long-term prospects. You should consider our prospects in light of the risks, expenses and difficulties that companies in their early stage of development
encounter, particularly companies in new and rapidly evolving markets, such as digital security and online commerce.

To
achieve profitability we must, among other things:



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

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

Since we began our operations, we have incurred net losses and experienced significant negative cash flow from operations. This is due
to the early stage nature of market development for our products and services and the digital security industry as a whole. Wave expects to continue to incur substantial additional expenses associated
with continued research and development and business development activities that will be necessary to commercialize our technology. This will likely result in significant losses for the foreseeable
future. Considering our current cash balance, which includes the net proceeds received from the financing transaction completed on March 13, 2009, and Wave's projected operating cash
requirements, we anticipate that our existing capital resources will be adequate to satisfy our cash flow requirements through April 2009. In order to fund our business beyond April 2009, it will be
necessary for us to generate substantial revenue, complete one or more commercial or strategic transactions or raise additional capital. Wave is uncertain as to the availability of financing from
other sources to fund any cash deficiencies. Even if we are successful in raising additional capital, uncertainty with respect to Wave's viability will continue until we are successful in achieving
our objectives. Furthermore, although we may be successful at achieving our business

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objectives,
a positive cash flow from operations may not ultimately be realized unless we are able to sell our products and services at a profit. Given the early stage nature of the markets for our
products and services, considerable uncertainty exists as to whether or not Wave's business model is viable.

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

Based upon our current expense forecast, assuming current revenue levels, we estimate that our current available capital (including
capital raised in the March 2009 financing) is sufficient to fund Wave through April 2009. In addition to our efforts to begin to generate revenue sufficient to fund our operations, or complete one or
more commercial or strategic transactions, Wave is evaluating additional financing options to generate additional capital in order to continue as a going concern, to capitalize on business
opportunities and to insure the continued development of our technology, products and services. Wave is also evaluating and considering cost reduction measures that may be taken in order to reduce our
operating expenses in an efficient manner, however, we may not be successful in identifying and implementing those measures. We estimate, based upon our current forecasts, we will need to realize no
less than $4,600,000 from a combination of revenue growth, expense reductions, commercial or strategic transactions and/or additional financings, to continue as a going concern for the twelve-months
ending December 31, 2009.

We
do not know if additional financing will be available or that, if available, it will be available on favorable terms. If we issue additional shares of our stock, our stockholders'
ownership will be diluted, or the shares issued may have rights, preferences or privileges senior to those of our common stock. In addition, if we pursue debt financing we may be required to pay
interest costs. The failure to generate sufficient cash flow to fund our forecasted expenditures would require us to reduce our operating expenses in a manner that could impede our ability to achieve
our business objectives. Furthermore, if we are not successful in generating sufficient cash flow or obtaining additional funding, we will be unable to continue our operations, develop or enhance our
products, take advantage of future opportunities, respond to competitive pressures and continue as a going concern.

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

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

Wave's
business model relies on an assumed market of tens of millions of units shipping with built-in security hardware and for Wave to be successful selling its upgraded
version of client and server software products to these users. 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.

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

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

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

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

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

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

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

We are subject to risks relating 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

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

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

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

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

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

We may experience delays in the development of our new products and services and the added features and functionality to our existing
products and services that our customers and prospective customers are demanding. If we are unable to successfully develop products that contain the features and functionality being demanded by these
customers and prospective customers in a timely manner, we may lose business to our competitors. In addition, despite testing by us and potential customers, it is

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possible
that our products may nevertheless contain defects. Development delays or defects could have a material adverse effect on our business if such defects and delays result in our inability to
meet the market's demand.

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

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

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

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

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

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

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

We
believe the export classifications that we have received for our software products allow us to sell our products internationally in an effective, competitively advantageous manner.
Enhancements to existing products may, and new products will be subject to reviews by the BXA to determine what

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

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

Our stock price is volatile.

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



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

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

Our 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.

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Governmental regulation may slow our growth and decrease our profitability.

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

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

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

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

We may be unable to remain listed on The NASDAQ Capital Market.

On July 17, 2008, the Company received notification from the Listing Qualifications division of The NASDAQ Stock Market
indicating that the Company's Class A common stock is subject to potential delisting from The NASDAQ Global Market because the market value of the Company's common stock was below
$50 million for 10 consecutive business days, and, therefore, did not meet the requirement set forth in NASDAQ Marketplace Rule 4450(b)(1)(A) (the "Market Value Rule"). This notice was
the subject of the Company's filing on Form 8-K filed on July 17, 2008.

Thereafter,
on August 12, 2008, the Company received an additional notification from the Listing Qualifications division of The NASDAQ Stock Market indicating that the Company's
Class A common stock is subject to potential delisting from The NASDAQ Global Market because for the prior 30 consecutive business days, the bid price of the Company's Class A common
stock closed below the minimum $1.00 per share requirement for continued inclusion under NASDAQ Marketplace Rule 4450 (the "Bid Price Rule"). This notice was the subject of the Company's filing
on Form 8-K filed on August 12, 2008.

In
accordance with NASDAQ Marketplace Rule 4450(e)(4), the Company was provided a period of 30 calendar days, or until August 18, 2008, to regain compliance with the Market
Value Rule, and, in accordance with NASDAQ Marketplace Rule 4450(e)(2), the Company was provided 180 calendar days, or until February 9, 2009, to regain compliance with the Bid Price
Rule.

On
August 19, 2008, the Company received notification from The NASDAQ Stock Market indicating that the Company failed to regain compliance with the Market Value Rule for continued
inclusion on The NASDAQ Global Market. Under the NASDAQ rules, Wave requested an appeal hearing before the Listings Qualifications Panel (the "Panel"). The hearing was held on October 23, 2008.
On December 8, 2008, Wave was notified by the Panel that it had determined that the shares of the Company's Class A common stock would be transferred from the NASDAQ Global Market to the
NASDAQ Capital Market, effective at the open of the trading session on Wednesday, December 10,

21

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Table of Contents

2008.
Our common stock will continue to trade under the ticker symbol "WAVX". On February 9, 2009, the Company received notification from the NASDAQ Stock Market confirming that the market
value of the company's Class A common stock has been above $35 million for ten consecutive trading days, in
compliance with the rules governing continued listing on the NASDAQ Capital Market. We note that we are not required to meet the Bid Price Rule by February 17, 2009. On December 19,
2008, the NASDAQ Stock Market suspended enforcement of the Bid Price Rule and the running of related compliance periods until April 20, 2009. Accordingly, the remainder of the Initial
Compliance Period begins to run again on April 20, 2009 and ends on or about August 14, 2009 (the "Extended Compliance Period"). If the Company does not regain compliance with the Bid
Price Rule by the end of the Extended Compliance Period, the Company may be subject to delisting or may be entitled to another 180 day period if we meet all of the other initial listing
requirements of the NASDAQ Capital Market at the end of the Extended Compliance 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 "Pink Sheets" or the NASD's
Over-the-Counter Bulletin Board (OTC-BB). The level of trading activity of our common stock may decline if it is no longer listed on NASDAQ Capital Market and this
may harm our stock price, increase the volatility of our stock price and make it more difficult to sell 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. Our broadband media distribution services, offered through Wavexpress, were conducted primarily at the New York facility. We believe our office facilities are
suitable and adequate for our business as it is presently conducted.

Facility

Sq. Ft.

Annual Lease Cost

Lease ExpiresLee, MA


13,473

$
149,122


Aug. 2010Princeton, NJ


5,000


171,623


Dec. 2009Cupertino, CA


14,573


524,408


Feb. 2013New York, NY


2,100


105,000


Oct. 2009Orvault, France


1,000


67,260


Sept. 2010


Item 3.    Legal Proceedings

None.

Item 4.    Submission of Matters to a Vote of Security Holders

None.

22

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Table of Contents

PART II

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

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



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

High

LowYear Ended December 31, 2008First Quarter

$
1.80


.97Second Quarter


1.59


.64Third Quarter


.94


.33Fourth Quarter


.60


.20Year Ended December 31, 2007First Quarter

$
3.49


2.25Second Quarter


2.98


1.80Third Quarter


2.11


1.45Fourth Quarter


1.90


1.21


As
of March 8, 2009, there were approximately 20,500 holders of our Class A Common Stock. As of such date, there were 13 holders of our Class B Common Stock.

On
March 13, 2009 the last sale price reported on the NASDAQ Capital Market for the Class A Common Stock was $0.525.

We
have never declared nor paid any cash dividends on our Class A common stock. Other than accrued dividends required to be paid in respect of the Series I and
Series K Convertible Preferred Stock of the Company, par value of $0.01 per share, 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 any cash dividends on our Class A common stock in the foreseeable future.



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, 2003 through December 31, 2008. These comparisons assume the investment of $100 on
December 31, 2003 and the reinvestment of dividends. The stock performance on the graph is not necessarily indicative of future stock price performance.

23

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Table of Contents

Wave Systems Corp.  Comparison of Cumulative Total Return to Stockholders  December 31, 2003 through December 31, 2008

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

GRAPHIC

ASSUMED
$100 INVESTED ON JAN. 1, 2004
ASSUMES DIVIDEND REINVESTED
FISCAL YEAR ENDED DEC. 31, 2008

Wave Systems

Peer Group
(SIC Code 7379)

NASDAQ Market12/31/03

$
100.00

$
100.00

$
100.0012/31/04

$
69.76

$
104.86

$
108.4112/31/05

$
41.46

$
113.72

$
110.7912/31/06

$
51.42

$
152.10

$
122.1612/31/07

$
29.47

$
190.24

$
134.2912/31/08

$
7.52

$
123.87

$
79.25


24

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Table of Contents



The following pertains to Wave's equity compensation plans as of December 31, 2008:

Plan Category

Number of
securities to be
issued upon
exercise of
outstanding
options, warrants
and rights
(a)

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

Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding
securities reflected in
column (a))
(c)Equity compensation plans approved by security holders


6,550,258

$
6.22


3,970,837Wave equity compensation plans not approved by security holders


41,455


3.01


-Total Company plans


6,591,713

$
6.20


3,970,837Wavexpress equity compensation plans not approved by security holders


624,663

$
1.23


1,847,560


Wave
equity compensation plans approved by security holders are comprised of 25,910 shares of the N*ABLE Technologies Incorporated 1997 Equity Incentive Plan, 2,900,611 shares of the
1994 Employee Stock Option Plan, 211,620 shares of the 1996 Performance Stock Option Plan, 742,904 shares of the 1994 Non-Employee Directors Stock Option Plan and 89,792 shares of the 2004
Employee Stock Purchase Plan.

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

In
connection with an agreement that the Company entered into with nClose, Inc., an outside software development firm, on January 2, 2004 the Company issued a warrant to
purchase 10,000 shares of Class A Common Stock at an exercise price of $3.00 per share, pursuant to an individual compensation plan with nClose. Also, in connection with the same agreement, on
April 30, 2004 an additional warrant was issued to nClose, Inc. to purchase 11,667 shares of Class A Common Stock at an exercise price of $3.00 per share. The warrants are
currently exercisable and expire on January 2, 2009 and April 30, 2009, respectively. No additional warrants are required to be granted pursuant to the individual compensation plan for
nClose.

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

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

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

Item 6.    Selected Financial Data

The selected historical consolidated financial data presented below for the years ended December 31, 2008, 2007, 2006, 2005 and
2004 have been derived from our consolidated financial

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Table of Contents

statements.
The following financial data should be read in conjunction with Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the 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

2008

2007

2006

2005

2004Net Revenues

$
8,809,815

$
6,306,960

$
3,116,381

$
1,018,464

$
209,311Operating expenses:Cost of sales


824,181


811,970


983,671


726,853


151,704Selling, general and administrative


16,375,372


15,222,896


12,598,389


11,560,039


12,255,427Research and development


11,702,776


10,557,937


8,486,368


6,937,618


6,852,754Write-off of intangible and other impaired assets


447,128











301,366Total operating expenses


29,349,457


26,592,803


22,068,428


19,224,510


19,561,251Operating loss


(20,539,642
)

(20,285,843
)

(18,952,047
)

(18,206,046
)

(19,351,940
)Other income (expense):Gain on decrease in value of warrant liability








2,794


490,334


498,723Gain on sale of marketable securities











80,971


4,330,248Net interest and other income (expense)


(9,572
)

334,292


163,980


72,279


24,931Total other income (expense)


(9,572
)

334,292


166,774


643,584


4,853,902Net loss


(20,549,214
)

(19,951,551
)

(18,785,273
)

(17,562,462
)

(14,498,038
)Accretion of non-cash beneficial conversion feature on convertible preferred stock


(657,000
)










Net loss attributable to common stockholders

$
(21,206,214
)
$
(19,951,551
)
$
(18,785,273
)
$
(17,562,462
)
$
(14,498,038
)Weighted average number of common shares outstanding during the period


55,379,118


46,660,794


36,735,059


27,726,221


23,013,554Loss per common share-basic and diluted

$
(0.38
)
$
(0.43
)
$
(0.51
)
$
(0.63
)
$
(0.63
)Cash dividends declared per common share


-0-


-0-


-0-


-0-


-0-


Consolidated Balance Sheet Data

2008

2007

2006

2005

2004Working capital

$
(6,322,057
)
$
1,676,412

$
5,369,273

$
(1,112,413
)
$
3,549,095Total assets


3,429,774


6,037,856


9,359,677


3,429,765


8,454,582Long-term liabilities


245,362








2,794


493,128Total liabilities


9,448,777


3,542,345


3,439,408


3,595,574


3,744,382Total stockholders' equity (deficit)

$
(6,019,003
)
$
2,495,511

$
5,920,269

$
(165,809
)
$
4,710,200


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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 developed, with computing devices full-disk
encrypted drives being shipped in volume by leaders in the PC industry, Wave has developed its products to support security hardware, based on the TCG specifications, including the newly issued Opal
security subsystem storage specification for developing self-encrypting drives. Wave's products are unique because they support cross platform interoperability for the currently available
TPM chips from Nuvoton (formerly Winbond), Broadcom, Atmel, Infineon and ST Microsystems, and have been certified and/or approved for usage on TPM-based platforms shipped by Dell, Intel,
Acer, Fujitsu, Lenovo, NEC and HP.

Wave
is devoting its resources to capitalize on the opportunities, and overcome the specific challenges, presented by this developing market as it continues to pursue a strategy of
educating the marketplace on the benefits that trusted computing has to offer, while continuing to develop the basic software applications designed to enable this emerging technology. The market
trends and opportunities on which management focused the company's activities during the year ended December 31, 2008 included the following:



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Table of Contents



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



As
more PC and chip OEMs have begun introducing their Trusted Platform offerings, management has focused on entering into licensing contracts pursuant to which the OEM licenses
our applications and distributes them as part of their offering, paying Wave a royalty for each unit shipped. Wave currently has signed such bundling agreements with eight separate OEM partners.
Revenue recognized on these contracts for the years ended December 31, 2008 and 2007 was approximately $8,284,000 and $5,971,000, respectively.

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

Management
is focusing on opportunities for its eTMS product suite to provide digital signing and document management solutions to the financial services and other vertical markets in
which there is a clear and identifiable value proposition in implementing these solutions. Although we have met significant implementation challenges and long sales cycles with this effort, we have
entered into contracts with Xerox Mortgage Services and SigniaDocs in the eMortgage services sector during 2008. We continue to pursue additional opportunities for the eTMS product line.



Selling, general and administrative expenses ("SG&A") increased from 2007 to 2008 as a result of expending considerable resources in
the sales, marketing and business development and support activities during 2008, net of allocated non-cash, share-based compensation expenses incurred during 2008 and 2007 in accordance
with SFAS 123(R). For the years ended December 31, 2008, 2007 and 2006, we have incurred approximately $16.8 million, $15.2 million and $12.6 million, in SG&A
expenses, respectively. Non-cash, share-based compensation expenses allocated to SG&A for the years

28

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Table of Contents

ended
December 31, 2008, 2007 and 2006 were approximately $2.1 million, $1.2 million and $1.1 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 will continue to expend considerable resources in the sales, marketing, business
development and support activities referred to above that will be necessary for us to be successful in developing saleable products and markets for our technology. However, as a result of the cost
savings initiatives begun during the last quarter of 2008 and the suspension of Wavexpress' TVTonic consumer media service, we expect overall sales and marketing expenditures, as well as, overall
research and development expenditures to decrease, as compared with 2008. (SeeLiquidity and Capital Resources)

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

Critical Accounting Policies

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

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

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

Wave
follows the provisions of AICPA Statement of Position (SOP) 97-2,Software Revenue Recognitionas amended by
SOP 98-9, Modification of SOP 97-2,Software Revenue Recognition, with Respect to Certain Transactions. Generally,
Wave recognizes revenue when it is realized or realizable and earned. Wave considers revenue realized or realizable and earned when persuasive evidence of an arrangement exists, delivery has occurred,
the sales price is fixed or determinable and collectability is reasonably assured. Wave reduces revenue for estimated customer returns, rotations and sales rebates when such amounts can be estimated.
When these amounts cannot be estimated, Wave defers revenue until the product is sold to the end-user. Revenue from software license agreements that have significant customizations and
modification of the software product is deferred and recognized in a manner that approximates the percentage of completion method. In addition to the aforementioned general policy, the following are
the specific revenue recognition policies for each major category of revenue.

29

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Table of Contents



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

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



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

Cost of saleslicensing includes customer support, share-based compensation expense in accordance with FAS 123(R) and amortization of software
and development costs. In order to enhance the comparability of its results of operations with other security software providers in the industry, Wave has reclassified cost of sales to a component of
operating expenses. As a result, a gross profit analysis will not be presented.

Share-based CompensationOn January 1, 2006, Wave adopted Statement of Financial Accounting Standards No. 123 (R),
"Share-Based Payment," ("SFAS No. 123(R)"), which requires the
measurement and recognition of compensation expense for all stock-based payment awards made to employees and directors including employee stock options and employee stock purchases based on estimated
fair values. In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107 ("SAB 107") relating to SFAS No. 123(R). The Company has applied the
provisions of SAB 107 in its adoption of SFAS No. 123(R).

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

Wave
adopted SFAS No. 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006. In
accordance with the modified prospective transition method, Wave's consolidated financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS
No. 123(R).

30

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Results of Operations



Wave had revenues of $8,809,815 and $6,306,960 for the years ended December 31, 2008, and 2007, respectively. Licensing revenues
increased by $2,468,089, due primarily to higher volume of shipments of Wave's OEM customer products, primarily as a result of its OEM relationship with Dell, for which Wave receives royalty income.
The increase was also due in part to an
amendment of its software license agreement with Dell. Retroactive to November 1, 2008, the per-unit royalties that Wave receives for each OEM PC model shipping with Wave's EMBASSY
Trust Suite software were increased by at least 100% per unit in recognition of prior development work performed by Wave. The amendment states that this increase in per unit royalty could be cancelled
prospectively by Dell or Wave upon 30 days notice.

Services
revenue increased by $34,766 due to an increase in non-recurring government time-and-materials contracts.

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

2008

2007

Increase/
(Decrease)

% ChangeLicensing

$
8,691,576

$
6,223,487

$
2,468,089


40
%Services


118,239


83,473


34,766


42
%Total Net Revenues

$
8,809,815

$
6,306,960

$
2,502,855


40
%


Cost
of sales, consisting primarily of customer support, share-based compensation expense in accordance with SFAS 123(R) and the amortization of software development costs, was
$824,181, for the year ended December 31, 2008, compared to $811,970 for the same period in 2007. The change in costs of sales was due to an increase in customer support costs in connection
with the increased license revenue during the year ended December 31, 2008 versus the prior year offset by a decrease in the amortization of software development costs. In order to enhance the
comparability of its results of operations with other security software providers in the industry, Wave has reclassified cost of sales to a component of operating expenses. As a result, a gross profit
analysis will not be presented.

SG&A
expenses for the year ended December 31, 2008, were $16,375,372 as compared to $15,222,896 for the comparable period of 2007, an increase of approximately 8%. The increase
was due mainly to an increase in salaries and related benefits totaling approximately $331,000, associated with salary rate increases and headcount additions to accommodate additional sales,
marketing, business development and support activities, which exceeded those during the year ended December 31, 2007. Non-cash, share-based compensation expense was approximately
$1,202,000 at Wave and $107,000 at Wavexpress, in accordance with SFAS 123(R). This expense totaled approximately $1,125,000 for Wave and $105,000 for Wavexpress for the year ended
December 31, 2007. In addition, telephone expenses increased approximately $462,000 over the prior year due to significantly higher bandwidth charges incurred as a result of expanding the
broadband infrastructure in order to broadcast the 2008 Olympics. Also, professional feesprimarily consulting feesincreased approximately $299,000 and additional conference
and trade show expenses of approximately $141,000 were incurred during the year ended December 31, 2008 versus the prior year 2007. Included in the SG&A expenses listed above are Wavexpress'
selling, general and administrative expenses, which were $2,117,913 and $1,492,373 for the years ended December 31, 2008, and 2007, respectively. This 42% increase was due primarily to an
increase in telephone expenses of approximately $408,000 over the prior year for the higher bandwidth charges noted above.

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Table of Contents

The activities supported by SG&A expenses include business development, sales, marketing (including product development and product management), corporate
communications and public relations, information technology and management information systems, human resources, accounting, executive management, corporate governance and general administrative
functions. Given the early stage nature of the markets for products that use our technology, we have expended and will continue to expend considerable resources, in the sales, marketing, business
development and support activities referred to above that will be necessary for us to be successful in developing products and markets for our technology. We expect SG&A expenses to decrease in the
near future reflecting our cost cutting initiatives undertaken during the last quarter of 2008 and the suspension of Wavexpress' TVTonic consumer media service. Actual SG&A expenditures may vary
depending upon the future business needs of Wave.

Research
and development expenses for the year ended December 31, 2008, were $11,702,776, as compared to $10,557,937 for the comparable period of 2007, an increase of 11%. This
increase was primarily attributable to increased salaries, fringe and benefit expenditures of approximately $922,000 associated with salary rate increases and headcount additions to accommodate
additional research and development efforts that were undertaken since December 31, 2007. In addition, product development expensesprimarily language translation
costsincreased approximately $165,000 during 2008 versus 2007. For the year ended December 31, 2008, non-cash, share-based compensation expense was approximately
$661,000 at Wave and $106,000 at Wavexpress, in accordance with SFAS 123(R). This expense totaled approximately $634,000 for Wave and $85,000 for Wavexpress for the year ended
December 31, 2007. Wavexpress' research and development expenditures included in the above were $1,564,698 and $1,416,832 for the years ended December 31, 2008, and 2007, respectively,
for an increase of approximately 10%. The increase in Wavexpress R&D expense was due
primarily to an increase in salaries and related benefits as noted above. We expect research and development expenses to decrease in the near future reflecting our cost cutting initiatives undertaken
during the last quarter of 2008 and the suspension of Wavexpress' TVTonic consumer media service. Actual research and development expenditures may vary depending upon the future business needs of
Wave.

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.

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

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

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



Wave had revenues of $6,306,960 and $3,116,381 for the years ended December 31, 2007, and 2006, respectively. Licensing revenues
increased by $3,551,326, due to higher volume of shipments of Wave's OEM customer products, primarily as a result of its OEM relationship with Dell, for which Wave receives royalty income. Services
revenue decreased by $360,747 due to a decrease in non-recurring government time-and-materials contracts.

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The
table below sets forth the components that make up the revenue for the year ended December 31, 2007 and 2006:

2007

2006

Increase/
(Decrease)

% ChangeLicensing

$
6,223,487

$
2,672,161

$
3,551,326


132
%Services


83,473


444,220


(360,747
)

(81
)%Total Net Revenues

$
6,306,960

$
3,116,381

$
3,190,579


102
%


Cost
of sales for the year ended December 31, 2007, was $811,970, compared with $983,671 for the same period in 2006. The change in cost of sales was due to a decrease in
amortization expense as most capitalized software became fully amortized, offset by higher customer support costs in connection with the increased license revenue during the year ended
December 31, 2007 versus the prior year.

SG&A
expenses for the year ended December 31, 2007, were $15,222,896, as compared to $12,598,389 for the comparable period of 2006, an increase of approximately 21%. The increase
was due mainly to an increase in salaries and related benefits totaling approximately $1,169,000, associated with salary rate increases and headcount additions to accommodate additional sales,
marketing, business development and support activities, which exceeded those during the year ended December 31, 2006. Non-cash, share-based compensation expense was approximately
$1,125,000 at Wave and $105,000 at Wavexpress, in accordance with SFAS 123(R). This expense totaled approximately $953,000 for Wave and $103,000 for Wavexpress for the year ended
December 31, 2006. In addition, to accommodate additional sales, marketing, business development and support activities, professional feesprimarily consulting
feesincreased approximately $527,000 and additional travel expenses of approximately $306,000 were incurred during the year ended December 31, 2007 versus the comparable period of
2006. Included in the SG&A expenses listed above are Wavexpress' selling, general and administrative expenses, which were $1,492,373 and $1,059,405 for the years ended December 31, 2007, and
2006, respectively. This 41% increase was due to primarily to an increase in professional fee expenditures of approximately $333,000.

Research
and development expenses for the year ended December 31, 2007, were $10,557,937, as compared to $8,486,368 for the comparable period of 2006, an increase of 24%. This
increase was
primarily attributable to increased salaries, fringe and benefit expenditures of approximately $1,538,000 associated with salary rate increases and headcount additions to accommodate additional
research and development efforts that were undertaken since December 31, 2006. In addition, non-cash, share-based compensation expense was approximately $634,000 at Wave and $85,000
at Wavexpress, in accordance with SFAS 123(R). This expense totaled approximately $408,000 for Wave and $66,000 for Wavexpress for the year ended December 31, 2006. Wavexpress' research
and development expenditures included in the above were $1,416,832 and $1,343,748 for the years ended December 31, 2007, and 2006, respectively, for an increase of 5%. The increase in
Wavexpress R&D expense was due primarily to the increase in salaries and related benefits noted above and an increase in rent expenditures offset by a decrease in product development costs.

Interest
income for the year ended December 31, 2007, was $334,292 as compared to $163,980 for the comparable period of 2006. The increase in interest income is primarily
attributable to higher average balances of Wave's money market accounts and higher rates of return for the year ended December 31, 2007, compared with the same period in 2006.

Due
to the reasons set forth above, our net loss for the year ended December 31, 2007 was $19,951,551 as compared to $18,785,273 for year ended December 31, 2006.

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Liquidity and Capital Resources

Wave has incurred substantial operating losses since its inception, and as of December 31, 2008, has an accumulated deficit of
$344,689,864. We also expect Wave will incur an operating loss for the calendar year of 2009. As of December 31, 2008, we had negative working capital of $6,322,056.



At December 31, 2008, we had $951,563 in cash and cash equivalents versus $3,714,030 as of December 31, 2007, resulting
in a net decrease in cash of $2,762,467 for the year ended December 31, 2008. 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 decrease in cash in the years ended December 31, 2008 and 2007 and to the total increase in cash in the year ended December 31, 2006.

As
shown below, the total net change in cash over the last three years has fluctuated significantly from a net cash increase for the year ended December 31, 2006 of $5,959,972 to
a net cash decrease for the year ended December 31, 2007 of $4,251,964 to a net cash decrease for the year ended December 31, 2008 of $2,762,467.

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Consolidated Statement of Cash Flow Data

For the years ended December 31,2008

2007

2006Cash flows from operating activities:Net loss

$
(20,549,214
)
$
(19,951,551
)
$
(18,785,273
)Compensation associated with issuance of stock options


2,105,941


1,969,271


1,556,042Gain on decrease in value of warrant liability








(2,794
)Depreciation and amortization


395,253


355,884


663,033Impairment of Wavexpress property and equipment


447,128





Total adjustments to reconcile net loss to cash used in operating activities


2,948,322


2,325,155


2,216,281Proceeds from liquidation of other assets








63,973Increase in prepaid expenses, receivables and other assets


(428,457
)

(667,355
)

(368,342
)Increase (decrease) in deferred revenue


1,195,019


(115,034
)

(99,571
)Increase (decrease) in accounts payable and accrued expenses


4,402,514


217,971


(53,801
)Changes in assets and liabilities


5,169,076


(564,418
)

(457,741
)Net cash used in operating activities


(12,431,816
)

(18,190,814
)

(17,026,733
)Cash flows from investing activities:Acquisition of property and equipment


(232,512
)

(618,672
)

(328,604
)Net cash used in investing activities


(232,512
)

(618,672
)

(328,604
)Cash flows from financing activities:Payments on capital lease obligation


(26,898
)




Net proceeds from sale of preferred stock


2,688,372





Net proceeds from sale of common stock


7,011,013


14,229,331


22,428,249Proceeds from employee options under stock plans


229,428


328,432


287,834Payment in lieu of fractional shares in reverse stock split


(54
)

(241
)

(774
)Proceeds from the exercise of warrants








600,000Net cash provided by financing activities


9,901,861


14,557,522


23,315,309Net (decrease) increase in cash

$
(2,762,467
)
$
(4,251,964
)
$
5,959,972Supplemental cash flow information:Non-cash financing activities:Capital lease obligation for capital expenditures

$
335,797

$


$
Cash paid during the year for:Interest

$
10,415

$


$





The amount of cash used in operations decreased to $12,431,816 for the year ended December 31, 2008 from $18,190,814 used for
the year ended December 31, 2007, which increased from $17,026,733 used for the year ended December 31, 2006. 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, 2008, 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.

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These amounts represent items reported in Wave's Consolidated Statement of Operations, that do not represent an outlay or receipt of
cash in the year that they are reported, under generally accepted accounting principles. These items in the aggregate make up a significant portion of the differences between Wave's reported net loss
year over year, versus the differences in the amount of cash used by Wave's operations over each of the periods. These items resulted in a net add-back to net loss of $2,948,322 for the
year ended December 31, 2008 versus $2,325,155 for the year ended December 31, 2007 and $2,216,281 for the year ended December 31, 2006. The individual items that make up these
adjustments are listed in the table above and described in greater detail in theResults of OperationsandOther Income and
Expensesections above. In addition, changes in asset and liability accounts, as shown above, represent additional sources or uses of cash in each of the three years.
Accordingly, the overall net loss increased by $597,663 (to $20,549,214 from $19,951,551) for the year ended December 31, 2008 versus the year ended December 31, 2007, and cash used in
operating activities decreased by $5,758,999 (to $12,431,816 from $18,190,814). In comparing the year ended December 31, 2007 to 2006, the overall net loss increased by $1,166,278 (to
$19,951,551 from $18,785,273) for the year ended December 31, 2007 versus the year ended December 31, 2006, while cash used in operating activities increased by $1,164,081 (to
$18,190,814 from $17,026,733).



As displayed in the table above, cash used in investing activities consisted of funds used to acquire capital assets totaling $232,512,
$618,672 and $328,604 for the years ended December 31, 2008, 2007 and 2006, respectively. Wave expects to continue to acquire fixed assets primarily to replace computer equipment to be used
internally. These expenditures are expected to continue at approximately the same level as the 2008 expenditures. Net cash used for investing activities decreased by $386,160 as a result of lower
capital expenditures, for the year ended December 31, 2008 versus the year ended December 31, 2007 and increased by $290,068 for the year ended December 31, 2007 versus the year
ended December 31, 2006 as a result of higher capital expenditures.



Because Wave did not have sufficient cash on hand, nor did it generate sufficient revenues to fund the amount of cash used for
operations and acquisition of capital assets for the years ended December 31, 2008, 2007 and 2006, we needed to finance much of our operations through the sale of newly issued equity securities
as described below.



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 ("Series K Preferred Stock"), to certain purchasers for an aggregate purchase price of $1,276,800. These shares were priced at
$2,800 per share. Each purchaser was also issued a warrant to purchase up to 2,500 shares of Class A common stock for each share of Series K Preferred Stock purchased at an exercise
price of $0.28 per share. Wave entered into a placement agency agreement with Security Research Associates, Inc. ("SRA") in which they acted as placement agent in connection with this offering.
Wave paid SRA a fee equal to 6.0% of the gross proceeds of this offering. Additionally, Wave issued a warrant to SRA to purchase up to 273,600 shares of Class A common stock at an exercise
price of $0.28 per share. All of the warrants issued in connection with this offering expire in December 2011. Wave realized net proceeds of approximately $1,175,000 after deducting the placement
agent fees of

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$76,608
and additional legal and other fees associated with the issuance of these securities which totaled approximately $25,000.

Each
share of Series K Preferred Stock issued in connection with this offering was convertible into 10,000 shares of Class A common stock at the election of the holder
thereof at any time or automatically on the date on which the average closing price per share of Wave common stock for the 15 consecutive trading day period then ended equals or exceeds $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,
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 is 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 equals or exceeds $1.00. On
liquidation/dissolution, the Series J Preferred Stock will rank senior to the common stock, to 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 J Preferred Stock. 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.

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.

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Each
share of Series I Preferred Stock issued in connection with these two offerings is 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 $1.10. On
liquidation/dissolution, the Series I Preferred Stock will rank 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 will accrue 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. 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.



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. Securities Research
Associates, Inc. ("SRA") entered into a placement agency agreement with Wave in which they acted as placement agent in connection with the offering. Wave paid SRA a fee equal to 6.0% of the
gross proceeds of this offering. Wave also issued warrants to the purchasers to purchase up to 342,083 shares of Class A common stock at an exercise price of $0.65 per share. These warrants
expire in August 2011. Wave also issued a warrant to SRA to purchase up to 82,100 shares of Class A common stock at an exercise price of $0.65 per share. This warrant expires in August 2011.
Wave realized net proceeds of approximately $742,000 after deducting the placement agent fees of $49,260 and additional legal and other fees associated with the issuance of these securities which
totaled approximately $30,000. The shares subscribed to on August 11, 2008 were offered and issued pursuant to a shelf registration statement on Form S-3 which was filed by
Wave on April 18, 2008 and declared effective by the Commission on June 23, 2008.

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

On
May 23, 2008, Wave entered into subscription agreements, pursuant to which Wave agreed to sell and issue 2,151,250 shares of Class A Common Stock, par value $.01 per
share, to certain purchasers for an aggregate purchase price of $1,721,000. These shares were priced at $0.80 per share. SRA entered into a placement agency agreement with Wave in which they agreed to
act as placement agent in connection with the offering. Wave agreed to pay SRA a fee equal to 6.0% of the gross proceeds of this offering. Wave also agreed to issue warrants to the subscribers to
purchase up to 537,812 shares of Class A common stock at an exercise price of $0.85 per share. These warrants expire in May 2011. Additionally, Wave agreed to issue a warrant to SRA to purchase
up to 129,075 shares of

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Class A
common stock at an exercise price of $0.85 per share. This warrant expires in November 2009. Wave realized net proceeds of approximately $1,583,000 after deducting the placement agent
fees of $103,260 and additional legal and other fees associated with the issuance of these securities which totaled approximately $31,000. The shares sold on May 23, 2008 were offered and
issued pursuant to a shelf registration statement on Form S-3 which was filed by Wave on March 20, 2007 and declared effective by the Commission on April 27, 2007.

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

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

On
October 30, 2006, Wave entered into subscription agreements, pursuant to which Wave agreed to sell and issue 3,517,230 shares of Class A Common Stock, par value $0.01
per share, to certain purchasers for an aggregate purchase price of $9,602,038. These shares were priced at $2.73 per share. Securities Research Associates, Inc. ("SRA") entered into a
placement agency agreement with Wave in which they agreed to act as placement agent in connection with the offering. Wave agreed to pay SRA a fee equal to 5.0% of the gross proceeds of this offering.
Wave also agreed to issue a warrant to SRA to purchase up to 175,861 shares of Class A common stock at an exercise price of $2.73 per share. The warrant expired unexercised on
November 30, 2007. Wave realized net proceeds of $9,101,224 after deducting the placement agent fees of $484,000 and additional legal and other fees associated with the issuance of these
securities which totaled $16,814. The shares sold on October 30, 2006 were offered and issued pursuant to a shelf registration statement which was filed by Wave on December 16, 2005 and
declared effective by the Commission on January 13, 2006.

On
August 4, 2006, Wave entered into subscription agreements, pursuant to which Wave agreed to sell and issue 2,336,752 shares of Class A Common Stock, par value $.01 per
share, to certain purchasers for an aggregate purchase price of $4,790,342. These shares were priced at $2.05 per share. Securities Research Associates, Inc. ("SRA") entered into a placement
agency agreement with Wave in which they agreed to act as placement agent in connection with the offering. Wave agreed to pay SRA

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a
fee equal to 5.0% of the gross proceeds of this offering. Wave also agreed to issue a warrant to SRA to purchase up to 116,837 shares of Class A common stock at an exercise price of $2.05 per
share. The warrant expired unexercised on September 3, 2007. Wave realized net proceeds of $4,528,376 after deducting the placement agent fees of $239,517 and additional legal and other fees
associated with the issuance of these securities which totaled $22,449. The shares sold on August 4, 2006 were offered and issued pursuant to a shelf registration statement which was filed by
Wave on December 16, 2005 and declared effective by the Commission on January 13, 2006.

On
May 3, 2006, Wave entered into subscription agreements, pursuant to which Wave agreed to sell and issue 2,012,500 shares of Class A Common Stock to certain purchasers
for an aggregate purchase price of $4,830,000. The shares were priced at $2.40 per share. SRA entered into a placement agency agreement with Wave in which they agreed to act as placement agent in
connection with the offering. Wave agreed to pay SRA a fee equal to 5.0% of the gross proceeds of this offering. Wave also agreed to issue a warrant to SRA to purchase up to 100,625 shares of
Class A common stock at an exercise price of $2.40. The warrant expired unexercised on June 3, 2007. Wave realized net proceeds of $4,548,439 after deducting the placement agent fees of
$241,500 and additional legal and other fees associated with the issuance of these securities of $40,061. The shares sold on May 3, 2006 were offered and issued pursuant to a shelf registration
statement which was filed by Wave on December 16, 2005 and declared effective by the Commission on January 13, 2006.

On
February 15, 2006, Wave entered into a securities purchase agreement, pursuant to which Wave agreed to sell and issue 2,782,866 shares of Class A Common Stock for $1.605
per share, to certain purchasers for an aggregate purchase price of $4,466,500. The purchasers were also granted warrants (the "Warrants") to purchase up to 516,956 shares of Class A common
stock at an exercise price of $2.16. The Warrants were exercisable for a period of six months following the date of issuance. All unexercised warrants granted in connection with the
February 15, 2006 securities purchase agreement expired on August 16, 2006. The placement agent, JPC Capital Partners, Inc. (formerly Corpfin, Inc.) (the "Placement
Agent"), had 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 the Placement Agent a fee equal to
4.0% of the gross proceeds of this offering. Wave realized net proceeds of $4,250,212 after deducting the placement agent fees of $216,289 and additional legal and other fees associated with the
issuance of these securities. The shares sold on February 15, 2006 were offered and issued pursuant to a shelf registration statement which was filed by Wave on December 16, 2005 and
declared effective by the Commission on January 13, 2006.



On May 8, 2006, Wave received gross proceeds of $625,000 less placement agent fees of $25,000 for net proceeds of $600,000, in
connection with the issuance of 276,620 shares of Class A Common Stock upon the exercise of two warrants that were granted to an investor as part of Wave's December 5, 2005 financing and
February 15, 2006 financing. The warrant issued to this investor in connection with the December 5, 2005 financing was exercised in full for 114,583 shares of Class A Common Stock
at an exercise price of $2.40 per share. The warrant issued to the investor in connection with the February 15, 2006 financing was exercised in full for 162,037 shares of Class A Common
Stock at an exercise price of $2.16 per share.



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 sale of these shares.

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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 sale of these shares.

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

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

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

On
December 1, 2006 Wave issued 62,269 shares of Class A Common Stock to Wave and Wavexpress employees for $2.01 per share, pursuant to the Wave 2004 Employee Stock
Purchase Plan. Wave received proceeds of $125,441, from the sale of these shares.

On
June 1, 2006 Wave issued 82,706 shares of Class A Common Stock to Wave and Wavexpress employees for $1.96 per share, pursuant to the Wave 2004 Employee Stock Purchase
Plan. Wave received proceeds of $162,393, from the sale of these shares.



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



Wave estimates that its total expenditures to fund operations for the year ending December 31, 2009 will be approximately
$22,000,000, including research and development, acquisition of capital assets, sales and marketing, general corporate expenses and overhead.

Expected
sources of capital include the following:



Given
Wave's capital requirements for the year ending December 31, 2009 as indicated above, and our cash balance as of December 31, 2008, Wave will be required to raise
additional capital to continue to fund its operations. On March 13, 2009, Wave entered into subscription agreements, pursuant to which Wave agreed to sell and issue 785,000 shares of
Class A Common Stock, par value $0.01 per share, to certain purchasers for an aggregate purchase price of $431,750. These shares were priced at $0.55 per share. 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. The warrants expire March 2012. Securities Research
Associates, Inc. ("SRA") entered into a placement agency agreement with Wave in which they agreed to act as placement agent in connection with the offering. Wave agreed to pay SRA a fee equal
to 6.0% of the gross proceeds of this offering. Wave also agreed to issue 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. The
warrant expires in March 2012. Wave realized net proceeds of approximately $376,000 after deducting

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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.

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 declared effective by the Commission on June 23, 2008. Approximately
$19,600,000 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 we will
be successful in raising the needed capital to continue as a going concern.



Wave receives revenue from licensing its EMBASSY Trust Suite software through distribution arrangements with OEM partners as described
below. In addition, Wave received revenues from software development and other services. Total cash received from all revenue sources in 2008 was approximately $9,410,000 versus approximately
$5,666,000 for 2007.

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

Wave
also continues to work with all of its partners and customers to introduce and promote its existing software products and new software products which are under development, in an
effort to expand the market for TPM-based secure computing and thereby increase its market share and revenues. However, it should be noted that because of the early stage of Wave's market
and other factors, a high level of uncertainty exists with respect to the ability to forecast future revenues. Although there has been a substantial increase in the volume of shipments of TPM chips
(TPM hardware security that meets the TCG industry standard), 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
license and distribution agreements began to generate royalty revenue in the second quarter of 2006. The aggregate amount of royalty revenue from these arrangements was a
significant contributor to Wave's revenue growth during 2007 and 2008. Revenue from these contracts in future years may also be material. We expect to continue to generate cash flow from these
agreements as long as the agreements remain in effect and our software continues to ship with these products. In December 2008, Wave completed an amendment to its software license agreement with its
largest OEM customer, Dell Products LP. Under the new arrangement, the per-unit royalties that Wave receives for each OEM PC model shipping with Wave's EMBASSY Trust Suite software
were increased by at least 100% per unit, retroactive to November 1, 2008. This increase in per unit royalty may be cancelled prospectively by Dell or Wave upon 30 days notice.

We
continued to experience license upgrade activity during 2008 as enterprise customers began to purchase the packages offered in connection with these distribution agreements. Billings
for license upgrades amounted to approximately $960,000 for the year ended December 31, 2008. Given that Wave is in the early stages of its software upgrade and maintenance business and
consistent with the Company's revenue recognition policies, Wave has not yet established vendor-specific objective evidence of the fair value of each undelivered element for its software and services.
Accordingly, Wave's upgrade sales are being recorded as deferred revenue and then recognized generally over a 365-day period.

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Wave
recognized approximately $311,000 of license upgrade revenue during 2008. Wave recorded modest initial revenues from the sale of license upgrade packages during 2007.



Because Wave does not have sufficient cash to fund operations for the year ending December 31, 2009, and there is uncertainty as
to whether Wave will generate sufficient revenues to fund its operations over this time period, Wave has been, and will continue to be, actively engaged in financing activities in order to generate
additional funding to cover its operating costs for
the year ending December 31, 2009. These activities have included the sale of 785,000 shares of common stock at $0.55 per share (and warrants to purchase up to 439,600 shares of common stock at
an exercise price of $0.55 per share) for gross proceeds of $431,750 on March 13, 2009.

We
will be required to sell additional shares of common stock, preferred stock, obtain debt financing or engage in a combination of these financing alternatives, to raise additional
capital to continue to fund our operations for the year ending December 31, 2009. The availability and amount of any such financings are unknown at this time. Wave may also be required to
reduce expenses which may significantly impede its ability to meet its sales, marketing and development objectives. Given the available cash currently on hand, including the net proceeds from the
March 13, 2009 financing described above, and our revenue and expenditure forecast for the year ending December 31, 2009, we estimate that we will need at least $4,600,000 in additional
cash, in order to continue as a going concern for the next twelve months ending December 31, 2009. The foregoing is based on maintaining current revenue levels for non-Dell sales
and increasing Dell revenues for the year ending December 31, 2009 as a result of the amendment signed in December 2008 where the per-unit royalties that Wave receives for each OEM
PC model shipping with Wave's EMBASSY Trust Suite software were increased by at least 100% per unit, retroactive to November 1, 2008. This increase in per unit royalty may be cancelled
prospectively by Dell or Wave upon 30 days notice. While the foregoing assumes current shipment volumes at the increased per-unit royalty rate throughout 2009 our contract with Dell
contains no guaranteed minimum royalties or minimum shipment volume requirements.



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, requiring 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, 2009 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, 2009.

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.

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Wave has a capitalized lease obligation for computer equipment due July 2013 of $308,899 and $-0- as of December 31,
2008 and 2007, 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, 2008
reflecting an impairment charge due to the suspension of Wavexpress' TVTonic consumer media services.

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

$
63,537

$
128,628

$
116,734

$


$
308,899Operating lease commitments


1,038,893


1,137,072


624,226





2,800,191Total commitments

$
1,102,430

$
1,265,700

$
740,960

$


$
3,109,090




As of December 31, 2008, Wave had available net operating and capital loss carryforwards for Federal income tax purposes of
approximately $278.0 million, which expire beginning in 2009 through 2028. 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.



Wave's consolidated financial statements as of December 31, 2008 have been prepared under the assumption that we will continue
as a going concern. Wave's independent registered public accounting firm, KPMG LLP, has issued a report dated March 16, 2009, 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 June 2008, FASB ratified EITF Issue No. 08-4,Transition Guidance for Conforming Changes
to Issue No. 98-5("EITF No. 08-4"). Per EITF No. 08-4, conforming changes made to EITF Issue
No. 98-5, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios, that result from EITF Issue
No. 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments, and SFAS No. 150,Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity, shall be effective for us beginning after January 1, 2009. The potential impact of the adoption of this
standard is not expected to be material to Wave's consolidated financial statements.

In
May 2008, the FASB issued SFAS No. 162,"The Hierarchy of Generally Accepted Accounting Principles,"("SFAS No. 162").
SFAS No. 162 identifies the sources of accounting principles and the

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framework
for selecting the principles used in the preparation of financial statements. SFAS No. 162 is effective for the Company as of November 15, 2008. The implementation of this
standard did not have a material impact on Wave's consolidated financial statements.

In
January 2008, Wave adopted SFAS No. 159,The Fair Value Option for Financial Assets and Financial Liabilities("SFAS
No. 159"). SFAS No. 159 expands the scope of what entities may carry at fair value by offering an irrevocable option to record many types of financial assets and liabilities at fair
value. Period-to-period changes in fair value are recorded in an entity's income statement. Wave has not elected the fair value option for eligible items.

In
September 2006, the FASB issued SFAS No. 157,Fair Value Measurements("SFAS No. 147"). SFAS 157 provides guidance
for using fair value to measure assets and liabilities. The standard establishes a common definition for fair value to be applied to U.S. GAAP requiring the use of fair value, establishes a
framework for measuring fair value and expands required disclosures about such fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007; however,
FASB Staff Position FAS 157-2,Effective Date of FASB Statement No. 157, delayed the effective date of SFAS 157 for
most nonfinancial assets and nonfinancial liabilities until fiscal years beginning after November 15, 2008. The implementation of SFAS 157 for financial assets and financial liabilities,
effective January 1, 2008, did not have a material impact on Wave's consolidated financial statements. The potential impact of the adoption of SFAS No. 157 for nonfinancial assets and
nonfinancial liabilities is not expected to be material to Wave's consolidated financial statements. See Note 15 for additional fair value disclosures.

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



Our CEO and CFO have evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2008. Based on
their evaluation, our CEO and CFO have concluded, as of the date of such evaluation, that our disclosure controls and procedures are effective.



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. Wave's management assessed the effectiveness of its internal control

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over
financial reporting as of December 31, 2008. There has been no change in our internal controls over financial reporting that occurred during the quarter ended December 31, 2008 that
has materially affected, or is reasonably likely to materially affect, Wave's internal controls over financial reporting. In making its assessment, Wave's management used 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, 2008,
its internal control over financial reporting is effective based on those criteria. The independent registered public accounting firm that audited the Company's consolidated financial statements
included elsewhere in this Annual Report on Form 10-K has issued an opinion on the effectiveness of the Company's internal control over financial reporting.

Dated:
March 16, 2009

WAVE
SYSTEMS CORP.

By:

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

By:

/s/ GERARD T. FEENEY Name:  Gerard T. Feeney
Title:Senior Vice President of Finance and
            Administration, Chief Financial Officer




There have been no changes in Wave's internal controls 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 and 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 2009 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2009, 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 2009 Annual Meeting of Stockholders, to be filed
pursuant to
Regulation 14A on or before April 30, 2009, under the caption "Compliance with Section 16(a) of the Exchange Act." Such information is incorporated herein by reference.

Information
concerning Wave's Audit Committee will appear in Wave's Proxy Statement for the 2009 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or
before April 30, 2009, under the caption "The Board of Directors and its Committees". Such information is incorporated herein by reference.

Wave's
Board of Directors has adopted a code of ethics that applies to its Chief Executive Officer and Chief Financial Officer (the "Code of Ethics"). The Code of Ethics has been posted
on Wave's Internet website atwww.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 atwww.wave.com.

Item 11.    Executive Compensation

Information regarding executive compensation will appear in Wave's Proxy Statement for the 2009 Annual Meeting of Stockholders, to be
filed pursuant to Regulation 14A on or before April 30, 2009, under the caption "Executive Compensation." Such information is incorporated herein by reference.

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

Information regarding security ownership of certain beneficial owners and management and related stockholder matters will appear in
Wave's Proxy Statement for the 2009 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2009, under the caption "Security Ownership of Certain
Beneficial Owners and Management." Such information is incorporated herein by reference.

Item 13.    Certain Relationships and Related Transactions, and Director Independence

Information regarding certain relationships and related transactions and director independence will appear in Wave's Proxy Statement
for the 2009 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2009, under the caption "Certain Relationships and Related Transactions." Such
information is incorporated herein by reference.

Item 14.    Principal Accountant Fees and Services

Information regarding Wave's principal accountant's fees will appear in Wave's Proxy Statement for the 2009 Annual Meeting of
Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2009, under the caption "Certain Relationships and Related Transactions." Such information is incorporated
herein by reference.

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PART IV

Item 15.    Exhibits and Financial Statement Schedules

Page(s)Report of Independent Registered Public Accounting Firm

F-1Consolidated Balance Sheets as of December 31, 2008 and 2007

F-3Consolidated Statements of Operations for each of the years ended December 31, 2008, 2007 and
2006

F-4Consolidated Statements of Stockholders' Equity (Deficiency) and Comprehensive Income (Loss) for each of the
years ended December 31, 2008, 2007 and 2006

F-5Consolidated Statements of Cash Flows for each of the years ended December 31, 2008, 2007 and
2006

F-7Notes to Consolidated Financial Statements

F-8




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

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

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| |        |   |   |  |                                                                                                                                                                                                                                                                             
| | ------ | - | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | 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)                                                                                                   
| | 4.22   | * |  |  | Certificate of Designations of Series K Convertible Preferred Stock of Wave as filed with the Delaware Secretary of State on December 29, 2008 (incorporated by reference to Exhibit 3.1 of Wave's Current
Report on Form 8-K, filed on December 29, 2008, File No. 0-24752)
| | 4.23   | * |  |  | Form of Warrant issued to Purchasers (incorporated by reference to Exhibit 4.1 of Wave's Current Report on Form 8-K, filed December 29, 2008, File # 0-24752)                                                                                                               
| | 4.24   | * |  |  | Form of Warrant issued to Private Placement Agent (incorporated by reference to Exhibit 4.2 of Wave's Current Report on Form 8-K, filed December 29, 2008, File # 0-24752)                                                                                                  
| | 10.1  | * |  |  | Wave Systems Corp. 2004 Employee Stock Purchase Plan (incorporated by reference to Exhibit 4.1 of Wave's Form S-8 Registration Statement, filed on May 24, 2005)                                                                                                            
| | 10.2   | * |  |  | Form of Subscription Agreement dated as of October 30, 2006 among Purchasers and Wave (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed on October 31, 2006,
File # 0-24752)                                                           
| | 10.3   | * |  |  | Form of Subscription Agreement dated as of August 4, 2006 among Purchasers and Wave (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed on August 8, 2006,
File # 0-24752)                                                               
| | 10.4   | * |  |  | Form of Subscription Agreement dated as of May 3, 2006 among Purchasers and Wave (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed on May 8, 2006,
File # 0-24752)                                                                     
| | 10.5   | * |  |  | Reserved                                                                                                                                                                                                                                                                    
| | 10.6   | * |  |  | Securities Purchase Agreement dated as of December 5, 2005 among Purchasers and Wave (includes form of warrant) (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed on
December 7, 2005, File # 0-24752)                                 
| | 10.7   | * |  |  | Securities Purchase Agreement dated as of August 5, 2005 among Purchasers and Wave (includes form of warrant) (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed on
August 8, 2005, File # 0-24752)                                     
| | 10.8   | * |  |  | Securities Purchase Agreement dated as of March 15, 2005 among Purchasers and Wave (includes form of warrant) (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed on
March 17, 2005, File # 0-24752)                                     
| | 10.9  | * |  |  | Wave's Amended and Restated 1994 Stock Option Plan (incorporated by reference to Wave's Notice of Annual Meeting of Stockholders on Schedule 14A filed on April 18, 2007,as amended by the Schedule 14A
filed on May 7, 2007)                                               
| | 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)                                                       

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| |        |   |   |  |                                                                                                                                                                                                                                                                                                     
| | ------ | - | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | 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)        
| | 10.21  | * |  |  | GlobalWave Group plc Notice of Extraordinary General Meeting dated June 20, 2002 (Incorporated herein by referenced to Exhibit 10.4 of Wave's Quarterly Report on Form 10-Q/A for the quarter ended
September 30, 2002, filed on March 19, 2003, File #0-24752)                                     
| | 10.22  | * |  |  | Joint Venture Agreement dated October 15, 1999 between Wave, Wavexpress and Sarnoff. (incorporated by reference to Exhibit 10.20 of Wave's Annual Report on Form 10-K/A, filed on June 27, 2003,
File #0-24752)                                                                                     
| | 10.23  | * |  |  | Stockholder Agreement dated October 15, 1999 between Wave, Wavexpress and Sarnoff. (incorporated by reference to Exhibit 10.21 of Wave's Annual Report on Form 10-K/A, filed on June 27, 2003,
File #0-24752)                                                                                       

51

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Table of Contents

| |       |   |   |  |                                                                                                                                                                                                                                             
| | ----- | - | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | 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)                                                                                         
| | 10.36 | * |  |  | Placement Agency Agreement, dated as of May 23, 2008, by and between Wave and Security Research Associates, Inc. (incorporated by reference to Exhibit 10.2 of Wave's Current Report on Form 8-K,
filed May 27, 2008, File # 0-24752)       
| | 10.37 | * |  |  | Form of Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed July 1, 2008, File # 0-24752)                                                                                         
| | 10.38 | * |  |  | Placement Agency Agreement, dated as of June 30, 2008, by and between Wave and Security Research Associates, Inc. (incorporated by reference to Exhibit 10.2 of Wave's Current Report on Form 8-K,
filed July 1, 2008, File # 0-24752)      
| | 10.39 | * |  |  | Form of Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed August 12, 2008, File # 0-24752)                                                                                      

52

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Table of Contents

| |       |   |   |  |                                                                                                                                                                                                                                                                                    
| | ----- | - | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | 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)                                   
| | 21.1  | * |  |  | Subsidiaries of Registrant (incorporated by reference to Exhibit 10.12 of Wave's Annual Report on Form 10-K, filed on April 1, 2002, File #0-24752)                                                                                                                                
| | 23.1  |   |  |  | Consent of Independent Registered Public Accounting FirmKPMG LLP                                                                                                                                                                                                                  
| | 31.1  |   |  |  | Section 302 Certification by Steven K. Sprague, President and Chief Executive Officer                                                                                                                                                                                              
| | 31.2  |   |  |  | Section 302 Certification by Gerard T. Feeney, Chief Financial Officer                                                                                                                                                                                                             
| | 32.1  |   |  |  | Section 906 Certification                                                                                                                                                                                                                                                          
| | 99.1  | * |  |  | Form of Series H Convertible Preferred Stock Purchase Agreement, dated as of April 30, 2003 (the "First Purchase Agreement"), by and among Wave and the purchasers of the Series H Convertible Preferred
Stock (Incorporated by reference to Wave's Form 8-K filed on May 5, 2003).

53

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Table of Contents

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

54

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Table of Contents

| |       |   |   |  |                                                                                                                                                                                                                       
| | ----- | - | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | 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)    

---

55

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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 16, 2009

WAVE SYSTEMS CORP.By:

/s/ STEVEN K SPRAGUE Name:  Steven K Sprague
Title: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

March 16, 2009/s/ JOHN E. BAGALAY, JR. John E. Bagalay, Jr.

Chairman

March 16, 2009/s/ GEORGE GILDER George Gilder

Director

March 16, 2009/s/ JOHN E. MCCONNAUGHY, JR. John E. McConnaughy, Jr.

Director

March 16, 2009/s/ NOLAN BUSHNELL Nolan Bushnell

Director

March 16, 2009/s/ GERARD T. FEENEY Gerard T. Feeney

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

March 16, 2009


56

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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, 2008 and 2007, and the related consolidated statements of
operations, stockholders' equity (deficiency) and comprehensive income (loss), and cash flows for each of the years in the three-year period ended December 31, 2008. We have also
audited Wave System Corp.'s internal control over financial reporting as of December 31, 2008, based on criteria established inInternal ControlIntegrated
Frameworkissued 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 accompanyingManagement'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, 2008 and 2007, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2008, 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, 2008, based on criteria established in

F-1

---



Table of Contents

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

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

/s/
KPMG LLP

Boston,
Massachusetts
March 16, 2009

F-2

---





Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES        Consolidated Balance Sheets        December 31, 2008 and 2007

2008

2007AssetsCurrent assets:Cash and cash equivalents

$
951,563

$
3,714,030Accounts receivable, net of allowance for doubtful accounts of $16,364 and $-0- at December 31, 2008 and 2007, respectively


1,701,829


1,165,385Prepaid expenses


227,967


339,342Total current assets


2,881,359


5,218,757Property and equipment, net


408,440


682,512Other assets


139,975


136,587Total Assets


3,429,774


6,037,856Liabilities and Stockholders' Equity (Deficit)Current liabilities:Accounts payable and accrued expenses


7,655,834


3,253,320Current portion of capital lease payable


63,537


Deferred revenue


1,484,044


289,025Total current liabilities


9,203,415


3,542,345Long-term portion of capital lease payable


245,362


Total liabilities


9,448,777


3,542,345Stockholders' Equity (Deficit):8% Series I Convertible Preferred stock, $.01 par value. 220 shares issued and outstanding (liquidation preference of $968,000) in 2008 and -0- in
2007


2


Series J Convertible Preferred stock, $.01 par value. 91 shares issued and outstanding (liquidation preference of $364,000) in 2008 and -0- in
2007


1


8% Series K Convertible Preferred stock, $.01 par value. 456 shares issued and outstanding (liquidation preference of $1,276,800) in 2008 and -0- in
2007


5


Common Stock, $.01 par value. Authorized 150,000,000 shares as Class A; 58,877,968 shares issued and outstanding in 2008 and 49,744,327 in
2007


588,780


497,443Common Stock, $.01 par value. Authorized 13,000,000 shares as Class B; 38,232 shares issued and outstanding in 2008 and 2007


382


382Capital in excess of par value


338,081,691


325,481,336Accumulated deficit


(344,689,864
)

(323,483,650
)Total Stockholders' Equity (Deficit)


(6,019,003
)

2,495,511Total Liabilities and Stockholders' Equity (Deficit)

$
3,429,774

$
6,037,856


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, 2008, 2007, 2006

2008

2007

2006Net revenues:Licensing

$
8,691,576

$
6,223,487

$
2,672,161Services


118,239


83,473


444,220Total net revenues


8,809,815


6,306,960


3,116,381Operating expenses:Cost of saleslicensing


736,429


781,675


700,766Cost of salesservices


87,752


30,295


282,905Selling, general and administrative


16,375,372


15,222,896


12,598,389Research and development


11,702,776


10,557,937


8,486,368Write-off of impaired assets


447,128





Total operating expenses


29,349,457


26,592,803


22,068,428Operating loss


(20,539,642
)

(20,285,843
)

(18,952,047
)Other income (expense):Net interest income (expense)


(9,572
)

334,292


163,980Other income








2,794Total other income (expense)


(9,572
)

334,292


166,774Net loss


(20,549,214
)

(19,951,551
)

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


(657,000
)




Net loss attributable to common stockholders


(21,206,214
)

(19,951,551
)

(18,785,273
)Loss per common sharebasic and diluted

$
(0.38
)
$
(0.43
)
$
(0.51
)Weighted average number of common shares outstanding during the year


55,379,118


46,660,794


36,735,059


See
accompanying notes to consolidated financial statements.

F-4

---



Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity (Deficiency) And Comprehensive Income (Loss)

8% Series I
Convertible
Preferred Stock

Series J
Convertible
Preferred Stock

8% Series K
Convertible
Preferred Stock

Class A
Common Stock

Class B
Common 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, 2005




$





$





$



31,113,918

$
311,139


58,575

$
586

$
284,269,292

$
(284,746,826
)
$


$
(165,809
)Net loss



































(18,785,273
)




(18,785,273
)Issuance of Class A Common Stock at $1.605 per share, less issuance cost of $216,291




















2,782,866


27,829








4,222,383








4,250,212Issuance of Class A Common Stock at $2.40 per share, less issuance cost of $281,561




















2,012,500


20,125








4,528,314








4,548,439Issuance of Class A Common Stock at $2.05 per share, less issuance cost of $261,968




















2,336,752


23,367








4,505,007








4,528,374Issuance of Class A Common Stock at $2.73 per share, less issuance cost of $500,814




















3,517,230


35,172








9,066,052








9,101,224Shares of Class A Common Stock Issued pursuant to the Wave Employee Stock Purchase Plan at $1.9635 per share




















82,706


827








161,566








162,393Shares of Class A Common Stock Issued pursuant to the Wave Employee Stock Purchase Plan at $2.0145 per share




















62,269


623








124,818








125,441Warrants Exercised at $2.16 per share, less issuance cost of $14,000




















162,037


1,620








334,380








336,000Warrants Exercised at $2.40 per share, less issuance cost of $11,000




















114,583


1,146








262,854








264,000Cash paid for fraction shares in reverse stock split




















(431
)

(4
)







(770
)







(774
)Stock based compensation
































1,556,042








1,556,042Exchange of Class B Common Stock for Class A Common Stock




















19,343


194


(19,343
)

(194
)










Balance as of December 31, 2006




$





$





$



42,203,773

$
422,038


39,232

$
392

$
309,029,938

$
(303,532,099
)
$


$
5,920,269Net loss



































(19,951,551
)




(19,951,551
)Employee Stock Options Exercised at $2.43 per share




















3,315


33








8,022








8,055Issuance of Class A Common Stock at $2.05 per share, less issuance cost of $770,669




















7,317,073


73,171








14,156,160








14,229,331Shares of Class A Common Stock Issued pursuant to the Wave Employee Stock Purchase Plan at $1.8275 per share




















91,746


917








166,748








167,665Shares of Class A Common Stock Issued pursuant to the Wave Employee Stock Purchase Plan at $1.1985 per share




















127,420


1,274








151,438








152,712


F-5

---



Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity (Deficiency) And Comprehensive Income (Loss) (Continued)

8% Series I
Convertible
Preferred Stock

Series J
Convertible
Preferred Stock

8% Series K
Convertible
Preferred Stock

Class A
Common Stock

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

Accumulated
DeficitShares

Amount

Shares

Amount

Shares

Amount

Shares

Amount

Shares

Amount

TotalExchange of Class B Common Stock for Class A Common Stock




















1,000


10


(1,000
)

(10
)










Cash paid for fractional shares exchanged
































(241
)







(241
)Stock-based compensation
































1,969,271








1,969,271Balance 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








15,984Series 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
)


See accompanying notes to consolidated financial statements.

F-6

---





Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES        Consolidated Statements of Cash Flows        Years ended December 31, 2008, 2007, 2006

2008

2007

2006Cash flows from operating activities:Net loss

$
(20,549,214
)
$
(19,951,551
)
$
(18,785,273
)Adjustments to reconcile net loss to net cash used inoperating activities:Depreciation and amortization


395,253


355,884


663,033Impairment of property and equipment


447,128





Gain on decrease in value of warrant liability








(2,794
)Compensation associated with issuance of stock options


2,105,941


1,969,271


1,556,042Changes in assets and liabilities:Increase (decrease) in deferred revenue


1,195,019


(115,034
)

(99,571
)Increase in accounts receivable


(536,444
)

(529,533
)

(301,193
)(Increase) decrease in prepaid expenses


111,375


(132,507
)

(67,149
)(Increase) decrease in other assets


(3,388
)

(5,315
)

63,973Increase (decrease) in accounts payable and accrued expenses


4,402,514


217,971


(53,801
)Net cash used in operating activities


(12,431,816
)

(18,190,814
)

(17,026,733
)Cash flows from investing activities:Acquisition of property and equipment


(232,512
)

(618,672
)

(328,604
)Net cash used in investing activities


(232,512
)

(618,672
)

(328,604
)Cash flows from financing activities:Payments on capital lease obligation


(26,898
)




Net proceeds from issuance of preferred stock


2,688,372





Net proceeds from issuance of common stock


7,011,013


14,229,331


22,428,249Proceeds from employee options under stock plans


229,428


328,432


287,834Proceeds from exercise of warrants








600,000Payment in lieu of fractional shares in reverse stock split


(54
)

(241
)

(774
)Net cash provided by financing activities


9,901,861


14,557,522


23,315,309Net (decrease) increase in cash and cash equivalents


(2,762,467
)

(4,251,964
)

5,959,972Cash and cash equivalents at beginning of year


3,714,030


7,965,994


2,006,022Cash and cash equivalents at end of year

$
951,563

$
3,714,030

$
7,965,994Supplemental cash flow information:Non-cash financing activities:Capital lease obligation on property and equipment

$
335,797

$


$
Cash paid during the year for:Interest

$
10,415

$


$



See
accompanying notes to consolidated financial statements.

F-7

---





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, 2008, has an accumulated deficit of $344,689,864. Wave is expected to incur an operating loss for the calendar year of 2009. As of December 31, 2008,
Wave had negative working capital of $6,322,056.

Wave
has begun market introduction of its security and broadband media distribution software products and has signed initial distribution contracts for these applications. However, due
to the early stage nature of this market, it is unlikely that Wave will generate sufficient revenue to cover all of its cash flow needs to fund its operating requirements for the year ending
December 31, 2009.

Because
Wave does not have sufficient cash to fund operations for the year ending December 31, 2009; and given the uncertainties described above with respect to Wave's revenue
outlook for 2009, Wave has been and will continue to be actively engaged in financing activities in order to generate additional funding to cover its operating costs for the year ending
December 31, 2009. 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 2008 (See footnotes 7 and 8). Also, 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 its Class A common stock, par value $.01 per share, to
such purchasers for an aggregate purchase price of $431,750. These shares were priced at $0.55 per share. Securities Research Associates, Inc. ("SRA") entered into a placement agency agreement
with Wave in which they agreed to act as placement agent in connection with this 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 purchasers to purchase up to 392,500 shares of Class A common stock at an exercise price of $0.55 per share. 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. All of the warrants issued in connection with this offering expire 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.
There remains approximately $19,600,000 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
will be required to sell additional shares of common stock, preferred stock, obtain debt financing or engage in a combination of these financing alternatives, to raise additional
capital to continue to fund its operations for the twelve months ending December 31, 2009.

F-8

---



Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(2) Liquidity (Continued)

Considering
current cash balances, Wave projects that it has enough liquid assets to continue operating through April 2009. Wave estimates a need of a minimum of $4,600,000 of additional
cash from a combination of revenue growth and additional financings, to fund operating expenses and capital expenditures for the year ending December 31, 2009.

If
Wave is not successful in raising the needed capital referred to above, or is not successful in executing its business plan, 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, the fact that it has not at this time secured enough financing to fund operations through
December 31, 2009 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.

(3) Significant Accounting Policies



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



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, accounting for joint ventures, software development, contingencies and share based compensation.
Actual results could differ from those estimates.



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



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



Included
in accounts receivable at December 31, 2008 and 2007 are amounts unbilled totaling $239,799 and $327,988, respectively.

F-9

---



Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(3) Significant Accounting Policies (Continued)

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 $16,364 and $-0- at December 31, 2008 and 2007,
respectively.



Sales
to Wave's largest customer in 2008, 2007 and 2006, Dell, Inc., were approximately 80%, 71% and 35% of revenue, respectively. Accounts receivable at December 31, 2008,
2007 and 2006 included receivables from Dell, Inc. of $1,054,368, $652,572 and $272,825, respectively.



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.



Effective
January 1, 2007, Wave adopted FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxesand interpretation of
FASB Statement 109" ("FIN 48"), which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax
position taken, or expected to be taken, in a tax return, and provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosures and transition. The
adoption of FIN 48 did not result in a cumulative adjustment to Wave's accumulated earnings. Wave classifies any interest and penalties related to income taxes as components of the income tax
provision.

Wave
accounts for income taxes under the asset and liability method. As such, deferred tax assets and liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred
tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. At December 31, 2008 and 2007, 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.



On
January 1, 2006, Wave adopted Statement of Financial Accounting Standards No. 123 (R), "Share-Based Payment," ("SFAS
No. 123(R)"), using the modified prospective transition method. SFAS No. 123(R) requires the measurement and recognition of compensation expense for all stock-based payment awards made
to employees and directors including employee stock options and employee stock purchases based on estimated fair values. In March 2005, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 107 ("SAB 107") relating to SFAS No. 123(R). The Company has applied the provisions of SAB 107 in its adoption of SFAS No. 123(R).

F-10

---



Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(3) Significant Accounting Policies (Continued)

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



Research
and development costs are expensed as incurred. Software development costs are accounted for pursuant to Statement of Financial Accounting Standards No. 86
"Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed" which requires software development costs for products that
have achieved commercial marketability to be capitalized subsequent to the establishment of a product's technological feasibility and prior to general release of the product. Wave did not capitalize
any software development costs for 2008 or 2007 since all products in development have not had sufficient testing to determine commercial viability or acceptance by a particular customer such that
they could be categorized as technologically feasible. Amortization of capitalized software costs for the years ended December 31, 2008, 2007 and 2006 was $-0-, $69,733
and $382,287, respectively.



Basic
net loss per common share has been calculated by dividing the net loss attributable to common stockholders by the weighted average number of shares of common stock outstanding
during the period. The net loss attributable to common stockholders is calculated by adding the accretion of the beneficial conversion feature on convertible preferred stock to the net loss. Diluted
net loss per share is also computed using the weighted average number of common shares and excludes dilutive potential common shares outstanding, as their effect is anti-dilutive. Dilutive
potential common shares consist primarily of employee stock options, convertible preferred stock 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, 2008, 2007 and 2006 were approximately 546,000 shares, 175,000 shares and 121,000 shares, respectively. Employee stock
options, convertible preferred stock and other stock warrants to purchase approximately 10,238,000, 6,446,000 and 5,577,000 shares were outstanding for the years ended December 31, 2008, 2007
and 2006 respectively, but are not included in the computation of diluted loss per share because their exercise price was greater than the average share price of Wave's
common shares and, therefore, their effect would have been anti-dilutive.



Wave
reviews the valuation of long-lived assets, including property and equipment and capitalized software, under the provisions of SFAS
No. 144,"Accounting for the Impairment or Disposal of Long-Lived Assets"("SFAS No. 144") and SFAS No.86, "Accounting for the Costs of Computer Software to Be Sold,
Leased, or Otherwise Marketed"("SFAS No. 86"), respectively. Wave is required to
assess

F-11

---



Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(3) Significant Accounting Policies (Continued)

the
recoverability of long-lived assets and capitalized software development costs whenever events and circumstances indicate that the carrying value may not be recoverable. Factors
considered important that could trigger an impairment review include the following:



In
accordance with SFAS No. 144, 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, they evaluate whether the carrying amount of the asset exceeds the sum of the undiscounted cash flows expected to result from the use and eventual
disposition of that asset. If such a circumstance exists, Wave would measure an impairment loss to the extent the carrying amount of the particular long-lived asset or group exceeds its
fair value. Wave would determine the fair value based on a projected discounted cash flow method using a discount rate determined by management to be commensurate with the risk inherent in their
current business model. In accordance with SFAS No. 86, 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.



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

Wave
follows the provisions of AICPA Statement of Position (SOP) 97-2,Software Revenue Recognitionas amended by
SOP 98-9, Modification of SOP 97-2,Software Revenue Recognition, with Respect to Certain Transactions. Generally,
Wave recognizes revenue when it is realized or realizable and earned. Wave considers revenue realized or realizable and earned when persuasive evidence of an arrangement exists, delivery has occurred,
the sales price is fixed or determinable and collectability is reasonably assured. Wave reduces revenue for estimated customer returns, rotations and sales rebates when such amounts can be estimated.
When these amounts cannot be estimated Wave defers revenue until the product is sold to the end-user. Revenue from software license agreements that have significant customizations and
modification of the software product is deferred and recognized in a manner that approximates the percentage of completion method. In addition to the aforementioned general policy, the following are
the specific revenue recognition policies for each major category of revenue.

LICENSES

Revenue from delivered elements of one-time charge licensed software is recognized at the inception of the license term,
provided Wave has vendor-specific objective evidence of the fair value of

F-12

---



Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(3) Significant Accounting Policies (Continued)

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

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

SERVICES

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

Cost
of saleslicensing includes customer support, share-based compensation expense in accordance with FAS 123(R) and amortization of software and development costs.
In order to enhance the comparability of its results of operations with other security software providers in the industry, Wave has reclassified cost of sales to a component of operating expenses. As
a result, a gross profit analysis will not be presented.



Wave
follows the FASB's Emerging Issues Task Force pronouncement No. 00-19 ("EITF 00-19") to account for derivative financial instruments indexed
to, and settled in our own stock. These would include financial instruments such as options or warrants to purchase Wave stock, but does not include employee stock options.
EITF 00-19 requires that freestanding financial instruments of this nature be classified as an asset or liability at fair value, in the event that the contract underlying any such
financial instruments includes a net cash settlement provision. In addition, EITF 00-19 requires any such asset or liability to be marked to market at the end of each period, with
any resulting difference in fair value to be recorded as income or loss, through the company's statement of operations, depending upon whether the difference results in a gain or loss.



In
June 2008, FASB ratified EITF Issue No. 08-4,Transition Guidance for Conforming Changes to Issue
No. 98-5("EITF No. 08-4"). Per EITF No. 08-4, conforming changes made to EITF Issue No. 98-5,
Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios, that result from EITF Issue No. 00-27, Application of Issue
No. 98-5 to Certain Convertible Instruments, and SFAS No. 150,Accounting for Certain Financial Instruments with Characteristics of both Liabilities
and Equity, shall be effective for us beginning after January 1, 2009. The potential impact of the adoption of this standard is not expected to be material to Wave's
consolidated financial statements.

F-13

---



Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(3) Significant Accounting Policies (Continued)

In May 2008, the FASB issued SFAS No. 162, "The Hierarchy of Generally Accepted Accounting Principles," ("SFAS No. 162").
SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements. SFAS No. 162 is effective for
the Company as of November 15, 2008. The implementation of this standard did not have a material impact on Wave's consolidated financial statements.

In
January 2008, Wave adopted SFAS No. 159,The Fair Value Option for Financial Assets and Financial Liabilities(SFAS
No. 159). SFAS No. 159 expands the scope of what entities may carry at fair value by offering an irrevocable option to record many types of financial assets and liabilities at fair
value. Period-to-period changes in fair value are recorded in an entity's income statement. Wave has not elected the fair value option for eligible items.



In
September 2006, the FASB issued SFAS No. 157,Fair Value Measurements(SFAS No. 157). SFAS 157 provides guidance
for using fair value to measure assets and liabilities. The standard establishes a common definition for fair value to be applied to U.S. GAAP requiring the use of fair value, establishes a
framework for measuring fair value and expands required disclosures about such fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007; however,
FASB Staff Position FAS 157-2,Effective Date of FASB Statement No. 157,delayed the effective date of SFAS 157 for
most nonfinancial assets and nonfinancial liabilities until fiscal years beginning after November 15, 2008. The implementation of SFAS 157 for financial assets and financial liabilities,
effective January 1, 2008, did not have a material impact on Wave's consolidated financial statements. The impact of the adoption of SFAS 157 for nonfinancial assets and nonfinancial
liabilities is not expected to be material to Wave's consolidated financial statements. See Note 15 for additional fair value disclosures.

(4) Related Party Transactions

In March 2003, Mr. Peter Sprague, who is the former Chairman of Wave, was appointed Chairman and Chief Executive Officer of Wavexpress. Mr. Sprague was paid $129,000 for
each of the years ended December 31, 2008, 2007 and 2006, respectively in salary as an officer of Wavexpress. Mr. Peter Sprague is the father of Wave's President and Chief Executive
Officer, Steven Sprague.

On
August 1, 1997, Michael Sprague became an employee of Wave and was paid a salary of $175,000, $187,500 and $150,000 for the years ended December 31, 2008, 2007 and 2006,
respectively. In addition, lease payments were made to Michael Sprague in the amount of $48,750 for the year ended December 31, 2006. These payments were for property occupied by Wavexpress and
owned by Michael Sprague. This lease agreement was in effect for the period of April 15, 2006 through October 31, 2006. Michael Sprague is the brother of Steven Sprague and the son of
Wave's former Chairman, Peter Sprague.

F-14

---



Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(5) Property and Equipment

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

2008

2007Computer equipment

$
2,521,987

$
3,806,573Furniture, fixtures and improvements


218,151


298,843Computer software


2,429,955


2,529,6735,170,093


6,635,089Less: Accumulated depreciation and amortization


4,761,653


5,952,577Total

$
408,440

$
682,512


Computer
software includes $1,812,631 and $1,864,256 of capitalized software development costs pursuant to SFAS 86 as of December 31, 2008 and 2007, respectively.
Capitalized software pursuant to SFAS 86 is amortized over a three-year life using the straight-line method, once the product is ready to bring to market. Capitalized
software is fully amortized at December 31, 2008.

Depreciation
and amortization expense on property and equipment amounted to approximately $395,000, $356,000 and $663,000 for the years ended December 31, 2008, 2007, 2006,
respectively.

(6) Accounts Payable and Accrued Expenses

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

2008

2007Accounts payable

$
4,513,954

$
747,737Accrued consulting and professional fees


589,202


405,289Accrued payroll and related costs


1,945,735


1,433,417State & local taxes payable


225,798


296,784Accrued software licenses


162,500


162,500Other accrued expenses


218,645


207,593Total accounts payable and accrued expenses

$
7,655,834

$
3,253,320


(7) Preferred Stock

Wave has authorized the issuance of 2,000 shares of convertible preferred stock having a par value of $.01 per share. At December 31, 2008, a total of 767 shares of convertible
preferred stock are 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.



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

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(7) Preferred Stock (Continued)

agreement
with Security Research Associates, Inc. ("SRA") in which they acted as placement agent in connection with this offering. Wave paid SRA a fee equal to 6.0% of the gross proceeds of
this offering. Additionally, Wave issued a warrant to SRA to purchase up to 273,600 shares of Class A common stock at an exercise price of $0.28 per share. All of the warrants issued in
connection with this offering expire in December 2011. Wave realized net cash proceeds of approximately $1,175,192 after deducting the placement agent fees of $76,608 and additional legal and other
fees associated with the issuance of these securities which totaled approximately $25,000.

On
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 are 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. 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 is 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 is 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:

Class A common shares if converted


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 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.

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(7) Preferred Stock (Continued)

In
connection with the issuance of the Series K Securities, a beneficial conversion feature arises from the fact that the holders of the Series K Preferred Stock are able
to acquire common stock of the Company at an effective conversion price that is less than the fair value as of the issuance date of December 24, 2008. Wave recorded a beneficial conversion
feature discount of $501,600 in the quarter ended December 31, 2008, which 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. 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 the Financial
Accounting Standards Board's Emerging Issues Task Force ("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
%


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




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 Security Research Associates, Inc. ("SRA") in which they

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(7) Preferred Stock (Continued)

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.

On
liquidation/dissolution, the Series J Preferred Stock will rank 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 is $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 is 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 is convertible into 1,110,000 shares of
Wave's Class A common stock at a conversion price of $0.65 per share. The excess of the proceeds of the Series J Preferred Stock over the estimated aggregate fair value of the
Series J Preferred Stock upon conversion has been calculated as follows:

Class A common shares if converted


1,111,000Closing 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, which 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. 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 the Financial

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(7) Preferred Stock (Continued)

Accounting
Standards Board's Emerging Issues Task Force ("EITF") 98-5 and EITF 00-27 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
%


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




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

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(7) Preferred Stock (Continued)

Each share of Series I Preferred Stock issued in connection with these two offerings is 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 $1.10. On
liquidation/dissolution, the Series I Preferred Stock will rank 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 will accrue 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. Dividend expense in connection with converted Series I Preferred Stock for year ended
December 31, 2008 totaled $22,929. The shares subscribed to on September 29, 2008 and September 11, 2008 were offered and issued pursuant to a shelf registration statement on
Form S-3 which was filed by Wave on April 18, 2008 and declared effective by the Commission on June 23, 2008.

(8) Common Stock

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

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

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(8) Common Stock (Continued)

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. The shares sold on May 23, 2008 were
offered and issued pursuant to a shelf registration statement on Form S-3 which was filed by Wave on March 20, 2007 and declared effective by the Commission on
April 27, 2007.

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

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

On
October 30, 2006, Wave entered into subscription agreements, pursuant to which Wave agreed to sell and issue 3,517,230 shares of Class A Common Stock, par value $.01 per
share, to certain purchasers for an aggregate purchase price of $9,602,038. These shares were priced at $2.73 per share. Securities Research Associates, Inc. ("SRA") entered into a placement
agency agreement with Wave in which they agreed to act as placement agent in connection with the offering. Wave agreed to pay SRA a fee equal to 5.0% of the gross proceeds of this offering. Wave also
agreed to issue a warrant to SRA

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(8) Common Stock (Continued)

to
purchase up to 175,861 shares of Class A common stock at an exercise price of $2.73. The warrant expired unexercised on November 30, 2007. Wave realized net proceeds of $9,101,224
after deducting the placement agent fees of $484,000 and additional legal and other fees associated with the issuance of the securities which totaled $16,814. The shares sold on October 30,
2006 were offered and issued pursuant to a shelf registration statement which was filed by Wave on December 16, 2005 and declared effective by the Commission on January 13, 2006.

On
August 4, 2006, Wave entered into subscription agreements, pursuant to which Wave agreed to sell and issue 2,336,752 shares of Class A Common Stock, par value $.01 per
share, to certain purchasers for an aggregate purchase price of $4,790,342. These shares were priced at $2.05 per share. Securities Research Associates, Inc. ("SRA") entered into a placement
agency agreement with Wave in which they agreed to act as placement agent in connection with the offering. Wave agreed to pay SRA a fee equal to 5.0% of the gross proceeds of this offering. Wave also
agreed to issue a warrant to SRA to purchase up to 116,837 shares of Class A common stock at an exercise price of $2.05. The warrant expired unexercised on September 3, 2007. Wave
realized net proceeds of $4,528,374 after deducting the placement agent fees of $239,517 and additional legal and other fees associated with the issuance of these securities which totaled $22,451. The
shares sold on August 4, 2006 were offered and issued pursuant to a shelf registration statement which was filed by Wave on December 16, 2005 and declared effective by the Commission on
January 13, 2006.

On
May 8, 2006, Wave received gross proceeds of $625,000 less placement agent fees of $25,000 for net proceeds of $600,000, in connection with the issuance of 276,620 shares of
Class A Common Stock upon the exercise of two warrants that were granted to an investor as part of Wave's December 5, 2005 financing and February 15, 2006 financing. The warrant
issued to this investor in connection with the December 5, 2005 financing was exercised in full for 114,583 shares of Class A Common Stock at an exercise price of $2.40 per share. The
warrant issued to the investor in connection with the February 15, 2006 financing was exercised in full for 162,037 shares of Class A Common Stock at an exercise price of $2.16 per
share. The shares sold on May 8, 2006 were offered and issued pursuant to a shelf registration statement which was filed by Wave on December 16, 2005 and declared effective by the
Commission on January 13, 2006.

On
May 3, 2006, Wave entered into subscription agreements, pursuant to which Wave agreed to sell and issue 2,012,500 shares of Class A Common Stock to certain purchasers
for an aggregate purchase price of $4,830,000. The shares were priced at $2.40 per share. SRA entered into a placement agency agreement with Wave in which they agreed to act as placement agent in
connection with the offering. Wave agreed to pay SRA a fee equal to 5.0% of the gross proceeds of this offering. Wave also agreed to issue a warrant to SRA to purchase up to 100,625 shares of
Class A common stock at an exercise price of $2.40. The warrant expired unexercised on June 3, 2007. Wave realized net proceeds of $4,548,439 after deducting the placement agent fees of
$241,500 and additional legal and other fees associated with the issuance of these securities, which were $40,061. The shares sold on May 3, 2006 were offered and issued pursuant to a shelf
registration statement which was filed by Wave on December 16, 2005 and declared effective by the Commission on January 13, 2006.

On
February 15, 2006, Wave entered into a securities purchase agreement, pursuant to which Wave agreed to sell and issue 2,782,866 shares of Class A Common Stock for $1.605
per share, to certain purchasers for an aggregate purchase price of $4,466,500. The purchasers were also granted warrants (the "Warrants") to purchase up to 516,956 shares of Class A common
stock at an exercise price of $2.16. The Warrants were exercisable for a period of six months following the date of issuance.

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(8) Common Stock (Continued)

Warrants
to purchase 162,037 shares were exercised on May 8, 2006, as described above. The remaining warrants to purchase 354,919 shares expired unexercised on August 16, 2006. Each
Warrant was subject to cancellation if the closing bid price of Wave's common stock exceeded $2.58 for 10 out of 20 consecutive trading days and the Warrant had not been exercised by the close of
business on the trading day after the 10th trading day on which the closing bid price exceeded $2.58. The placement agent, JPC Capital Partners, Inc. (formerly Corpfin, Inc.) (the
"Placement Agent") had 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 the Placement Agent a fee
equal to 4.0% of the gross proceeds of this offering. Wave realized net proceeds of $4,250,212 after deducting the placement agent fees of $216,291 and additional legal and other fees associated with
the issuance of these securities. The shares sold on February 15, 2006 were offered and issued pursuant to a shelf registration statement which was filed by Wave on December 16, 2005 and
declared effective by the Commission on January 13, 2006.

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 sale 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 sale of these shares.

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

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

On
December 1, 2006 Wave issued 62,269 shares of Class A Common Stock to Wave and Wavexpress employees for $2.01 per share, pursuant to the Wave 2004 Employee Stock
Purchase Plan. Wave received proceeds of $125,441, from the sale of these shares.

On
June 1, 2006 Wave issued 82,706 shares of Class A Common Stock to Wave and Wavexpress employees for $1.96 per share, pursuant to the Wave 2004 Employee Stock Purchase
Plan. Wave received proceeds of $162,393, from the sale of these shares.

(9) Share-based Compensation

In January 1994, Wave adopted the 1994 Employee Stock Option Plan (the "1994 Plan"). The total number of shares of Class A Common Stock reserved for issuance under the 1994 Plan,
as amended is 10,500,000 shares. The 1994 Plan Expires on July 1, 2014. In September 1996, Wave adopted the 1996 Performance Stock Option Plan (the "1996 Plan"). The number of shares of
Class A Common Stock subject to the 1996 Plan was 266,666. Under 1994 and 1996 Plans, 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 plans 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,

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(9) Share-based Compensation (Continued)

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 1,000,000 shares of Wave's 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 Common Stock. Offering periods commence on
May 1st and December 1st and are for a period of six months. The purchase price under the Purchase Plan is 85% of the lesser of the market price on the beginning or the
ending of the offering period.

On
January 1, 2006, Wave adopted Statement of Financial Accounting Standards No. 123(R), "Share-Based Payment," ("SFAS
No. 123(R)"), which requires the measurement and recognition of compensation expense for all stock-based payment awards made to employees and directors including employee stock options and
employee stock purchases based on estimated fair values. In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107 ("SAB 107") relating to SFAS
No. 123(R). The Company has applied the provisions of SAB 107 in its adoption of SFAS No. 123(R).

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

Wave
adopted SFAS No. 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006. In
accordance with the modified prospective transition method, Wave's consolidated financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS
No. 123(R). Stock-based compensation expense recognized under SFAS No. 123(R) for the years ended December 31, 2008, 2007 and 2006 was $2,105,941, $1,969,271 and $1,556,042,
respectively. SFAS 123(R) requires that the classification of the cost of share based compensation, in the statement of operations, is consistent with the nature of the services being rendered
in exchange for the share based payment.

F-24

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(9) Share-based Compensation (Continued)

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

2008

2007Cost of Sales

$
28,896

$
19,247Selling, General & Administrative


1,309,729


1,230,392Research & Development


767,316


719,632Total

$
2,105,941

$
1,969,271


Wave
uses the Black-Scholes-Merton option pricing model to value stock options. The Black-Scholes-Merton model requires the use of employee exercise behavior data and the use of a number
of assumptions including volatility of the company's stock price, the weighted-average risk-free interest rate and the weighted-average expected term of the options. As Wave does not pay
dividends on it Class A common stock, the dividend rate variable in the Black-Scholes-Merton model is zero. The following values for the indicated variables were used to value options granted
during the years ended December 31:

2008

2007Stock 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


2.34%3.33%


0.44%1.99%


3.49%5.07%


3.28%4.98%Risk-free Ratewt. avg.


2.81%


1.34%


4.66%


4.88%Expected Volatilityrange


83.7%97.9%


44.8%69.2%


92.2%95.0%


44.9%71.3%Expected Volatilitywt. avg.


97.38%


54.97%


93.93%


58.35%Dividend Yield


0%


0%


0%


0%


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

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

The
expected term of employee stock options represents the weighted average period that the stock options are expected to remain outstanding. For Wave's stock option plans, it is based
upon an analysis of the historical behavior of option holders during the period from January 1, 2003 to December 31, 2008. Management believes historical data is representative of future
exercise behavior. For Wave's Employee Stock Purchase Plan, the expected term of six months, is the length of each purchase period, pursuant to the plan.

As
stock-based compensation expense recognized in the consolidated statement of operations pursuant to SFAS No. 123(R) is based on awards ultimately expected to vest, expense for
grants beginning upon adoption of SFAS No. 123(R) on January 1, 2006 is reduced for estimated forfeitures. The estimated forfeiture rate used in the calculation of share-based
compensation expense was approximately 19% for the years ended December 31, 2008 and 2007. The estimated forfeiture rates

F-25

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(9) Share-based Compensation (Continued)

used
in the calculation of share-based compensation expense ranged from approximately 18% to 19% for the year ended December 31, 2006. SFAS No. 123(R) requires forfeitures to be
estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures are estimated based on historical experience.

A
summary of option activity for all Wave option plans through December 31, 2007 follows:

2008

2007

2006Number of
Shares

Weighted
Average
Exercise
Price

Number of
Shares

Weighted
Average
Exercise
Price

Number of
Shares

Weighted
Average
Exercise
PriceBalance at beginning of year


6,916,478

$
6.80


4,825,928

$
8.97


4,122,870

$
11.46Granted


932,300


1.67


2,313,667


2.15


1,048,517


1.91Forfeited


(507,127
)

2.00


(127,913
)

2.31


(114,025
)

2.83Expired


(813,355
)

8.42


(91,889
)

10.25


(231,434
)

24.51Exercised








(3,315
)

2.43


Balance at end of year


6,528,296


6.24


6,916,478


6.80


4,825,928


8.97Exercisable at end of year


4,311,378

$
8.44


3,936,647

$
10.33


3,329,847

$
11.94Additional shares available for grant at end of year


3,970,837





3,933,187





1,930,265


The
weighted average grant date fair value of options granted during the years ended December 31, 2008, 2007 and 2006 was $1.24, $1.59 and $1.46, respectively.

The
weighted average remaining contractual term for options outstanding and options exercisable at December 31, 2008 were 5.8 and 5.0 years, respectively.

As
of December 31, 2008, unrecognized stock-based compensation related to stock options was approximately $1,202,000. At December 31, 2008, the weighted average period this
cost is expected to be expensed is 1.8 years. The total fair value of shares that vested during the years ended December 31, 2008, 2007 and 2006 was approximately $1,988,000, $1,561,000
and $1,788,000, respectively.

As
of December 31, 2008, the intrinsic value of outstanding, vested and currently exercisable share options was $-0-.

F-26

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(9) Share-based Compensation (Continued)

The
following table summarizes information about stock options outstanding under the Wave stock options plans as of December 31, 2008:

Options OutstandingOptions ExercisableWeighted
Average
Remaining
Contractual
LifeExercise Price Range

Number
Outstanding

Weighted
Average
Exercise
Price

Number
Exercisable

Weighted
Average
Exercise
Price$0.25$2.00


2,778,916


7.7

$
1.85


1,074,170

$
1.90$2.01$3.00


1,476,915


6.4


2.54


964,743


2.61$3.01$4.25


371,166


5.7


3.26


371,166


3.26$4.26$5.50


538,952


4.4


4.97


538,952


4.97$5.51$10.00


356,422


3.1


6.24


356,422


6.24$10.01$22.50


528,174


1.6


12.55


528,174


12.55$22.51$112.50


477,751


1.1


39.99


477,751


39.996,528,296


5.8

$
6.24


4,311,378

$
8.44




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 2008, 2007 and 2006 is as follows:

2008

2007

2006Number of
Shares

Weighted
Average
Exercise
Price

Number of
Shares

Weighted
Average
Exercise
Price

Number of
Shares

Weighted
Average
Exercise
PriceBalance at Beginning of year


624,663

$
1.23


637,163

$
1.23


691,896

$
1.23Granted

















Canceled








(12,500
)

1.20


(54,733
)

1.20Balance at end of year


624,663


1.23


624,663


1.23


637,163


1.23Exercisable at end of year


624,663

$
1.23


624,663

$
1.23


633,830

$
1.23Additional shares available for grant at end of year


1,847,560





1,847,560





1,835,060


No
options were granted under the Wavexpress stock option plan during the years ended December 31, 2008, 2007 and 2006.

F-27

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(9) Share-based Compensation (Continued)

The following table summarizes information about Wavexpress' stock options outstanding at December 31, 2008:

Options OutstandingWeighted
Average
Remaining
Contractual Life
(in years)



Options ExercisableExercise Price

Number
Outstanding

Weighted
Average
Exercise Price

Number
Exercisable

Weighted
Average
Exercise Price$1.20


616,466


3.1

$
1.20


616,466

$
1.20$3.00$4.50


8,197


1.6


3.37


8,197


3.37$1.20$4.50


624,663


3.1

$
1.23


624,663

$
1.23




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 Common Stock.
Offering periods commence on May 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 22%, 34% and 37% of eligible employees participated in the Purchase Plan for the years ended December 31, 2008, 2007
and 2006, respectively. For the year ended December 31, 2008
employees purchased 360,058 shares of Wave Class A Common Stock at an average share price of $0.64 per share, for an aggregate of $229,428 in proceeds to Wave. For the year ended
December 31, 2007 employees purchased 219,166 shares of Wave Class A Common Stock at an average share price of $1.46 per share, for an aggregate of $328,432 in proceeds to Wave. For the
year ended December 31, 2006 employees purchased 144,975 shares of Wave Class A Common Stock at an average share price of $1.99 per share, for an aggregate of $287,834 in proceeds to
Wave.

(10) Warrants

On December 24, 2008, Wave issued warrants to investors to purchase up to 1,140,000 shares of Class A common stock pursuant to which Wave sold and issued 456 shares of 8%
Series K Convertible Preferred Stock, par value $.01 per share for an aggregate purchase price of $1,276,800. The warrants are exercisable at an exercise price of $0.28 per share and expire on
December 24, 2011. If exercised in full, the investor warrants granted in connection with this financing may generate up to an additional $319,200, at the exercise price. Wave also issued to a
placement agent warrants to purchase up to 273,600 shares of Class A common stock, in connection with a securities purchase agreement. The warrants are exercisable at an exercise price of $0.28
per share and expire on December 24, 2011. If exercised in full, the warrants granted to the placement agent may generate up to an additional $76,608, at the exercise price. All of the warrants
granted in connection with the December 24, 2008 financing remain outstanding as of December 31, 2008.

F-28

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(10) Warrants (Continued)

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

On
September 11, 2008, Wave issued to a placement agent warrants to purchase up to 103,200 shares of Class A common stock, in connection with a securities purchase
agreement, pursuant to which Wave sold and issued 172 shares of 8% Series I Preferred Stock, par value $.01 per share for an aggregate purchase price of $756,800. The warrants are exercisable
at an exercise price of $0.50 per share and expire on September 11, 2011. If exercised in full, the warrants granted in connection with this financing may generate up to an additional $51,600,
at the exercise price. All of the warrants granted in connection with the September 11, 2008 securities purchase agreement remain outstanding as of December 31, 2008.

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

On
June 30, 2008, Wave issued warrants to investors to purchase up to 470,125 shares of Class A common stock pursuant to which Wave sold and issued 1,880,500 shares of
Class A common stock, par value $.01 per share for an aggregate purchase price of $1,598,425. The warrants are exercisable at an exercise price of $0.90 per share and expire on June 30,
2011. If exercised in full, the investor warrants granted in connection with this financing may generate up to an additional $423,113, at the exercise price. Wave also issued to a placement agent
warrants to purchase up to 112,830 shares of Class A common stock, in connection with a securities purchase agreement. The warrants are exercisable at an exercise price of $0.90 per share and
expire on December 31, 2009. If exercised in full, the warrants granted to the placement agent may generate up to an additional $101,547, at the exercise price. All of the warrants granted in
connection with the June 30, 2008 financing remain outstanding as of December 31, 2008.

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

F-29

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(10) Warrants (Continued)

value
$.01 per share for an aggregate purchase price of $1,721,000. The warrants are exercisable at an exercise price of $0.85 per share and expire on May 23, 2011. If exercised in full, the
investor warrants granted in connection with this financing may generate up to an additional $457,140, at the exercise price. Wave also issued to a placement agent warrants to purchase up to 129,075
shares of Class A common stock, in connection with a securities purchase agreement. The warrants are exercisable at an exercise price of $0.85 per share and expire on November 23, 2009.
If exercised in full, the warrants granted to the placement agent may generate up to an additional $109,714, at the exercise price. All of the warrants granted in connection with the May 23,
2008 financing remain outstanding as of December 31, 2008.

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

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

On
May 24, 2007, Wave issued to a placement agent warrants to purchase up to 365,853 shares of Class A Common Stock, in connection with a securities purchase agreement,
pursuant to which Wave sold and issued 7,317,073 shares of Class A Common Stock, par value $.01 per share for an aggregate purchase price of $15,000,000. The warrants are exercisable at an
exercise price of $2.58 per share and expire on May 24, 2009. If exercised in full, the warrants granted in connection with this financing may generate up to an additional $943,901, at the
exercise price. The warrants may also be exercised on a cashless basis. All of the warrants granted in connection with the May 24, 2007 securities purchase agreement remain outstanding as of
December 31, 2008.

On
October 30, 2006, Wave issued to a placement agent warrants to purchase up to 175,861 shares of Class A Common Stock, in connection with a securities purchase agreement,
pursuant to which Wave sold and issued 3,517,230 shares of Class A Common Stock, par value $.01 per share for an aggregate purchase price of $9,602,038. The warrants were exercisable at an
exercise price of $2.73 per share and expired unexercised on November 30, 2007.

On
August 4, 2006, Wave issued to a placement agent warrants to purchase up to 116,837 shares of Class A Common Stock, in connection with a securities purchase agreement,
pursuant to which Wave sold and issued 2,336,752 shares of Class A Common Stock, par value $.01 per share for an aggregate purchase price of $4,790,342. The warrants were exercisable at an
exercise price of $2.05 per share and expired unexercised on September 3, 2007.

F-30

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(10) Warrants (Continued)

On
May 3, 2006, Wave issued to a placement agent warrants to purchase up to 100,625 shares of Class A Common Stock, in connection with a securities purchase agreement,
pursuant to which Wave sold and issued 2,012,500 shares of Class A Common Stock, par value $.01 per share for an aggregate purchase price of $4,830,000. The warrants were exercisable at an
exercise price of $2.40 per share and expired unexercised on June 3, 2007.

On
February 15, 2006, Wave granted warrants to purchase up to 516,956 shares of Class A common stock at an exercise price of $2.16 in connection with a financing competed
as of that date (See Footnote 7Common Stock). The warrants were exercisable for a period of six months following the date of issuance. On May 8, 2006, warrants to purchase 162,037
shares were exercised on May 8, 2006, at the exercise price of $2.16 per share. Wave received net proceeds of $336,000, after deducting placement agent fees of $14,000, for the exercise of
these warrants. The remaining warrants to purchase 354,919 shares expired unexercised on August 16, 2006.

On
December 5, 2005, Wave granted warrants to purchase up to 364,583 shares of Class A Common Stock, in connection with a securities purchase agreement. The warrants were
exercisable at an exercise price of $2.40 per share and were set to expire on June 5, 2006. Any shares of Class A Common Stock issuable upon exercise of these warrants were to be
drawn-down off of a shelf registration statement. On May 8, 2006, an investor exercised a warrant issued by Wave to that investor in connection with Wave's December 5, 2005
financing. The warrant was exercised in full for 114,583 shares of Wave Class A Common Stock, at its exercise price of $2.40 per share. Wave received $264,000 from the exercise of this warrant
after subtracting the 4% placement agent fee. The remaining warrants expired unexercised on June 5, 2006.

On
July 30, 2004, Wave granted warrants to purchase up to 1,470,588 shares of Class A Common Stock, in connection with a securities purchase agreement that Wave entered
into with certain purchasers as of that date. The warrants granted in this transaction were made up of two different series, Series A and Series B. The Series A warrants were
exercisable for up to 1,176,471 shares of Class A Common Stock at an exercise price of $3.45 per share. The Series A warrants were exercisable from January 30, 2005, until
August 1, 2005. The Series B warrants were exercisable for up to 294,118 shares of Class A Common Stock at an exercise price of $3.90 per share. The Series B warrants were
exercisable from July 30, 2005, until January 30, 2006. Any shares of Class A Common Stock issuable upon exercise of the Series A warrants and Series B warrants were
also to be drawn-down off of a shelf registration statement. The Series A and Series B warrants issued in this transaction carried a subsequent equity clause that required
Wave to adjust the initial exercise price, pro-rata, for any subsequent equity sales that were made at a lower price than the initial exercise price. As a result several sales of common
stock subsequent to the July 30, 2004 securities purchase agreement, the exercise prices of the Series A and Series B warrants were adjusted to $3.39 and $3.60, respectively, in
accordance with the formula pursuant to the warrant agreements. On August 1, 2005 a Series A Warrant holder exercised a portion of the Series A Warrant for a total of 666,667
shares at an exercise price of $3.39 per share, for aggregate gross proceeds of $2,260,000, less placement agent fees of $90,400, for net proceeds of $2,169,600. The remaining warrants for 509,804
expired on August 1, 2005. All of the Series B Warrants granted in connection with the July 30, 2004 securities purchase agreement expired unexercised on January 30, 2006.

In
connection with an agreement that Wave entered into with an outside software development consultant, on January 2, 2004, Wave issued warrants to purchase 10,000 shares of
Class A Common

F-31

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(10) Warrants (Continued)

Stock
at a price of $3.00 per share, pursuant to an individual compensation plan with the consultant. Also, in connection with the same agreement, on April 30, 2004 an additional warrant was
issued to the consultant to purchase 11,667 shares of Class A Common Stock at an exercise price of $3.00 per share. The fair market value of these warrants was approximately $81,000 and was
recorded as consultant expense in 2004. 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 2, 2009 through April 30, 2009.

On
November 18, 2003, Wave granted warrants to purchase 310,436 shares of Class A Common Stock at an exercise price of $7.86 per share in connection with a private
placement to a group of accredited investors. The warrants had a three year term. In addition, in connection with the transaction, Wave granted additional warrants to purchase 53,865 shares of
Class A Common Stock as commissions to placement agents in connection with the private placement. The warrants granted to the placement agents are also exercisable at a price of $7.86 per share
and had a 3 year life as well. All of the warrants granted in connection with the November 18, 2003 private placement expired unexercised in November 2006.

On
April 30, 2003, Wave granted the Series H Warrants to purchase shares of Class A Common Stock, with an initial exercise price of $3.39 per share and a five
(5) year life. Initially, the Series H Warrants were exercisable for a total of 1,202,852 shares of Class A Common Stock on the trading day following
the date of Wave's 2003 annual meeting of stockholders. During September 2003 the terms of the Series H Purchase Agreement and other documents governing the Series H Stock and the
Series H Warrants were modified. As of December 31, 2003, 877,438 shares of Class A Common Stock were issued in connection with the exercise of Series H Warrants for net
proceeds of $2,565,167. Series H Warrants to acquire 21,930 shares of Class A Common Stock expired unexercised in April 2008.

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

In
connection with a software development agreement that Wave entered into with Archon Technologies, Inc. ("Archon"), Wave issued to Archon a warrant to purchase 16,667 shares of
Wave Class A Common Stock at $10.44 per share. The warrant became exercisable on November 9, 2002, and expired unexercised on November 9, 2007.

F-32

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(10) Warrants (Continued)

A
summary of warrants outstanding at December 31, 2008, follows:

Warrants OutstandingWeighted
Average
Remaining
Contractual Life
(in years)



Warrants ExercisableExercise Price

Number of
Shares

Weighted
Average
Exercise Price

Number of
Shares

Weighted
Average
Exercise Price$0.25$0.50


3,803,400


4.1

$
0.36


3,803,400

$
0.36$0.51$1.00


1,674,025


2.2

$
0.82


1,674,025

$
0.82$1.01$2.00


1,147,460


3.7

$
1.18


1,147,460

$
1.18$2.01$4.35


402,308


0.5

$
2.63


402,308

$
2.637,027,193


3.3

$
0.73


7,027,193

$
0.73


(11) Wavexpress

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

On
December 1, 2008, Wavexpress announced that it had suspended its TVTonic consumer media service and was exploring opportunities to sell or license its technology to third
parties that may provide "download and play" services. As of December 31, 2008, the New York, NY facility is closed. The engineering staff has been terminated. A small engineering and
management staff will remain in place at the Cupertino, CA office in order to support efforts to license or sell the Wavexpress technology to third parties. An impairment charge of $447,128 was
recorded to reflect the write-off of impaired assets, consisting primarily of computer equipment, including equipment collateralizing a capital lease obligation (see note 12). This
impairment charge has been presented in the Wavexpress broadband media distribution products and services segment (see note 16).

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, 2008, Wave has funded Wavexpress with approximately
$45,643,000 in cash, plus approximately $25,857,000 in accrued interest. Such amounts include approximately $9,500,000 that automatically converted into 1,826,571 additional shares of Wavexpress at an
average conversion price of $5.20 per share. These amounts are eliminated in consolidation.

F-33

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(11) Wavexpress (Continued)

As
of December 31, 2008, Wave owned 97.2% of Wavexpress, while Sarnoff owned 1.7% (on a fully diluted basis). None of the minority shareholders have provided, or are obligated to
provide, funding to Wavexpress. Accordingly, the financial statements of Wavexpress have been included in the consolidated financial statements of Wave for all periods presented herein. In addition,
Wave has not recorded a minority interest in Wavexpress in the consolidated financial statements and therefore has reflected 100% of Wavexpress' balance sheet and operating results in its consolidated
financial statements. Wavexpress has incurred net operating losses of $4.1 million, $2.9 million and $2.4 million, for the years ended December 31, 2008, 2007 and 2006,
respectively.

(12) Commitments and Contingencies



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. Wave's broadband media distribution services, offered through Wavexpress, are conducted primarily at the
New York facility. 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.

Location

Annual
Lease Cost

Lease Expiration
DateLee, MA

$
149,122


Aug. 2010Princeton, NJ


171,623


Dec. 2009Cupertino, CA


524,408


Feb. 2013Orvault, France


67,260


Sep. 2010New York, NY(1)


126,480


Oct. 2009Total

$
1,038,893






Future
minimum lease payments under non-cancelable operating leases (with initial or remaining lease terms in excess of one year) as of December 31, 2008 are as
follows:

2009

$
1,038,8932010


614,8262011


522,2462012


534,487Thereafter


89,739Total minimum lease payments

$
2,800,191


Rent
expense for the years ended December 31, 2008, 2007, 2006 amounted to approximately $1,134,000, $916,000 and $790,000, respectively.

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(12) Commitments and Contingencies (Continued)



Wave has a capitalized lease obligation for computer equipment due July 2013 of $308,899 and $-0- as of December 31,
2008 and 2007, 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, 2008
reflecting an impairment charge due to the suspension of Wavexpress' TVTonic consumer media services (see note 11).

Future
minimum lease payments under this non-cancelable capital lease as of December 31, 2008 are as follows:

2009

$
84,9212010


78,5292011


78,5292012


78,529Thereafter


45,808Total minimum lease payments


366,316Less: Amount representing interest


(57,417
)Balance at December 31, 2008

$
308,899




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

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

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

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

(13) Income Taxes

The Company did not provide for any income tax expense or (benefit) for the years ending December 31, 2008, 2007 and 2006.

F-35

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(13) Income Taxes (Continued)

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:

2008

2007

2006Statutory tax rate


34
%

34
%

34
%Stock-based compensation on ISO's


(3
)

(3
)

(3
)Beneficial conversion feature on preferred stock


(1
)

(0
)

(0
)Change in valuation allowance


(30
)

(31
)

(31
)Total



%


%


%


The
tax effects of temporary differences that give rise to the deferred tax asset at December 31, 2008 and 2007 are as follows:

2008

2007Deferred tax assets:Net operating and capital loss carryforwards

$
105,624,154

$
105,680,000Accrued expenses


940,000


425,000Intangibles


365,000


446,000Reserves


945,000


945,000Depreciation


458,000


467,000Total gross deferred tax assets


108,332,154


107,963,000Less valuation allowance


(108,332,154
)

(107,963,000
)Net deferred tax asset

$


$



The
valuation allowance increased by approximately $0.4 million and $7.8 million, during the years ended December 31, 2008 and 2007, 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 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 $108,332,000 as of
December 31, 2008. Subsequently reported tax benefits relating to the valuation allowance for deferred tax assets as of December 31, 2008 will be allocated as follows: $107,591,000 to
continuing operations and $741,000 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 $278.0 million, which expire beginning in 2009 through 2028. Wave also has capital loss carryforwards
for tax return purposes of approximately $7.5 million, which expire in 2009 and 2010. 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.

F-36

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(13) Income Taxes (Continued)

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

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

Gross
Unrecognized
Tax BenefitsBalance at January 1, 2008

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


1,925,167Balance at December 31, 2008

$
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
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 2005, 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, 2009. As described above, utilization of the
Company's loss carryforwards may be limited pursuant to Section 382 of the Internal Revenue Code. Any limitation may result in expiration of a portion of the net operating and capital loss
carryforwards before utilization. Until a study is completed and any limitation known, no amounts are being presented as an uncertain tax position under FIN 48.

(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 2008, 2007 or 2006.

(15) Disclosures about the Fair Value of Financial Instruments



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

As
of December 31, 2008, 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 $641,000 at December 31, 2008) within cash and cash equivalents on the consolidated balance
sheet

F-37

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

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

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

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

(16) Segment Reporting

Wave's products include the Wave EMBASSY® digital security products and services ("EMBASSY®") and Wavexpress broadband media distribution products and services.
These products and services constitute Wave's reportable segments under Statement of Financial Accounting Statement 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 Operating Decision Maker.

The
following sets forth reportable segment data:

For the years ended December 31,2008

2007

2006Operating Revenues:EMBASSY® digital security products and services

$
8,809,815

$
6,306,960

$
3,086,637Wavexpress broadband media distribution products and services








29,744Total Operating Revenues


8,809,815


6,306,960


3,116,381Net Loss:EMBASSY® digital security products and services


(16,409,060
)

(17,401,966
)

(16,562,112
)Wavexpress broadband media distribution products and services


(4,130,582
)

(2,883,877
)

(2,389,935
)Total Segments Net Loss


(20,539,642
)

(20,285,843
)

(18,952,047
)Net interest income (expense)


(9,572
)

334,292


163,980Other income








2,794Net Loss

$
(20,549,214
)
$
(19,951,551
)
$
(18,785,273
)Depreciation and Amortization Expense:EMBASSY® digital security products and services


309,642


317,311


547,712Wavexpress broadband media distribution products and services


85,611


38,573


115,321Total Depreciation and Amortization Expense

$
395,253

$
355,884

$
663,033Capital Expenditures:EMBASSY® digital security products and services


132,789


500,042


275,834Wavexpress broadband media distribution products and services


99,723


118,630


52,770Total Capital Expenditures

$
232,512

$
618,672

$
328,604


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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(16) Segment Reporting (Continued)



As ofDecember 31,
2008

December 31,
2007

December 31,
2006Assets:EMBASSY® digital security products and services


3,367,690


5,915,158


9,262,942Wavexpress broadband media distribution products and services


62,084


122,698


96,735Total Assets

$
3,429,774

$
6,037,856

$
9,359,677


The
following table details Wave's sales by geographic area for the years ended December 31, 2008, 2007 and 2006. Geographic area is based on the location of where the products
were shipped or services rendered.

United States
of America

Europe

Asia

Total2008EMBASSY® 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
%2007EMBASSY® digital security products and services

$
5,947,111

$
225,444

$
134,405

$
6,306,960Wavexpress broadband media distribution products and services











Total


5,947,111


225,444


134,405


6,306,960% of Total


94
%

4
%

2
%

100
%2006EMBASSY® digital security products and services


2,102,959


792,744


190,934


3,086,637Wavexpress broadband media distribution products and services


29,744








29,744Total


2,132,703


792,744


190,934


3,116,381% of Total


68
%

26
%

6
%

100
%


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

F-39

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(16) Segment Reporting (Continued)

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

2008

2007

2006Customer

Segment

RevenueDell, Inc.

EMBASSY®

$
7,048,920

$
4,483,053

$
1,094,041ST Microelectronics

EMBASSY®








774,695Broadcom

EMBASSY®





682,129


335,899US Government

EMBASSY®








319,877Total



$
7,048,920

$
5,165,182

$
2,524,512% of Total Revenue




80
%

81
%

81
%


(17) Selected Quarterly Financial Data (unaudited)

Quarter-endedDecember 31,
2008

September 30,
2008

June 30,
2008

March 31,
2008Revenues

$
3,290,736

$
1,834,707

$
1,985,293

$
1,699,079Loss from operations


(3,269,102
)

(5,598,310
)

(5,643,265
)

(6,028,965
)Net loss


(3,294,539
)

(5,604,732
)

(5,639,895
)

(6,010,048
)Net loss attributable to common stockholders


(3,951,539
)

(5,604,732
)

(5,639,895
)

(6,010,048
)Net loss per common share

$
(0.07
)
$
(0.10
)
$
(0.10
)
$
(0.12
)




Quarter-endedDecember 31,
2007

September 30,
2007

June 30,
2007

March 31,
2007Revenues

$
1,875,319

$
1,734,249

$
1,410,351

$
1,287,041Loss from operations


(5,357,009
)

(4,908,394
)

(4,911,873
)

(5,108,567
)Net loss


(5,287,557
)

(4,777,700
)

(4,840,734
)

(5,045,560
)Net loss attributable to common stockholders


(5,287,557
)

(4,777,700
)

(4,840,734
)

(5,045,560
)Net loss per common share

$
(0.11
)
$
(0.10
)
$
(0.10
)
$
(0.12
)


(18) Subsequent Events

On February 5, 2009, all 456 shares issued in connection with 8% Series K Convertible Preferred Stock ("Series K Preferred Stock") December 24, 2008 offering
automatically converted into 4,560,000 shares
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 equals or exceeds $0.70.

On
March 13, 2009, Wave entered into subscription agreements, pursuant to which Wave agreed to sell and issue 785,000 shares of Class A common stock, par value $.01 per
share, to certain purchasers for an aggregate purchase price of $431,750. These shares were priced at $0.55 per share. Securities Research Associates, Inc. ("SRA") entered into a placement
agency agreement with Wave in which they agreed to act as placement agent in connection with the offering. Wave agreed to pay SRA a fee equal

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(18) Subsequent Events (Continued)

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 2013. 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 2013. 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.

F-41

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