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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, 2009oro

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


Commission File Number 0-24752

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

Delaware(State or other jurisdiction of
incorporation or organization)

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

01238(Zip Code)


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

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

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

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

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

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

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

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

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

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

Large accelerated filer o

Accelerated filer o

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

Smaller reporting company ý


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

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

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

DOCUMENTS
INCORPORATED BY REFERENCE:

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



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

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Table of Contents



PART I

2Item 1.

Business

2Item 1A.

Risk Factors

14Item 1B.

Unresolved Staff Comments

21Item 2.

Properties

21Item 3.

Legal Proceedings

21Item 4.

Removed and Reserved

21PART II

22Item 5.

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

22Item 6.

Selected Financial Data

26Item 7.

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

27Item 7A.

Quantitative and Qualitative Disclosures about Market Risk

46Item 8.

Financial Statements and Supplementary Data

46Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure

46Item 9A.

Controls and Procedures

46Item 9B.

Other Information

47PART III

48Item 10.

Directors, Executive Officers and Corporate Governance

48Item 11.

Executive Compensation

48Item 12.

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

48Item 13.

Certain Relationships and Related Transactions, and Director
Independence

48Item 14.

Principal Accounting Fees and Services

48PART IV

49Item 15.

Exhibits and Financial Statement Schedules

49


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PART I

Item 1.    Business

General

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

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

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

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

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

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

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

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

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

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

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

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Products and Services

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

Client-side Applications



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

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

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

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

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

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

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

Middleware and Tools



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



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

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

EMBASSY Trust Server Applications



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



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

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

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

Electronic/Digital Signature and Electronic Document Management



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

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

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

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

Broadband Media Distribution Services

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, 2009, Wave
owned 97.3% 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 provide "download and play" services.

Markets and Business Strategy

Our Market

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

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

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



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

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



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



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

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



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

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



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

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

Marketing, Sales and Customers

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

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

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



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

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

Customer

Product or Service Sold

Percentage of Total
Revenue for the year
ended December 31, 2009Dell

Software Licensing


81
%


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

Segment Reporting

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

Financial Information about Geographic Areas

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

Competition



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

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

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

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

International Market

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

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

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Proprietary Rights and Licenses and Intellectual Property

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

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

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

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

Research and Development

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

Employees

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

Available Information

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

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

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

Item 1A.    Risk Factors

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

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



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

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

To
achieve profitability we must, among other things:



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

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

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

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

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

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

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



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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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.

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

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

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Our stock price is volatile.

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



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

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

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

Governmental regulation may slow our growth and decrease our profitability.

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

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

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

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

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

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

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

Item 1B.    Unresolved Staff Comments

None.

Item 2.    Properties

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

Facility

Sq. Ft.

Annualized
Lease Cost

Lease ExpiresLee, MA


13,473

$
144,545

Jan. 2011Princeton, NJ


4,924


68,320

Dec. 2014Cupertino, CA


14,573


528,953

Feb. 2013Orvault, France


250


13,563

Feb. 2012


Item 3.    Legal Proceedings

None.

Item 4.    Removed and Reserved

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PART II

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

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

Market Information & Dividends

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

High

LowYear Ended December 31, 2009First Quarter

$
.98


.38Second Quarter


1.25


.49Third Quarter


1.12


.80Fourth Quarter


1.48


.82Year Ended December 31, 2008First Quarter

$
1.80


.97Second Quarter


1.59


.64Third Quarter


.94


.33Fourth Quarter


.60


.20


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

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

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

22

---



Table of Contents

Performance Graph

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

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

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

GRAPHIC

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

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

Company/Index/Market

2004

2005

2006

2007

2008

2009Wave Systems Corporation

$
100.00

$
59.44

$
73.72

$
42.25

$
10.78

$
41.38NASDAQ Market Index

$
100.00

$
102.20

$
112.68

$
124.57

$
74.71

$
108.56SIC Code Index

$
100.00

$
108.45

$
145.05

$
181.42

$
118.13

$
138.65


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

23

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Table of Contents

Allscripts-Misys
Healthcare Solutions Inc
Analysts International
Answers Corporation
AsiaInfo Holdings, Inc.
Aspyra, Inc.
Assure Data, Incorporated
Atlas Technology Group, Inc.
Attunity, Ltd.
Austin Chalk Oil and Gas, Ltd.
Avenue Exchange Corp.
Avistar Communications Corporation
Belzberg Technologies
Blackbaud, Inc.
Blue Coat Systems, Inc.
China Digital Media Corporation
Cimatron Ltd.
CompuMed, Inc.
Computer Horizons Corp.
Data Storage Corp.
Digital Angel Corporation
Dun & Bradstreet Corporation
Edgewater Technology, Inc.
Formula Systems (1985), Ltd. ADR
General Dynamics
Henry Jack & Associates Inc
hereUare, Inc.
Hewlett-Packard Company
IHS, Inc. A
IncrediMail, Ltd.
Inova Technology, Inc.
IOWorldMedia, Inc.
Juniper Networks, Inc.
MDI, Inc.
Navisite, Inc.
Netplex Group, Inc.
Northcore Technologies, Inc.
One Bio Corporation
Open Text Corporation
PICO Holdings, Inc.
QSGI, Inc.
Rackspace Hosting Inc
Roomlinx, Inc
Roomlinx, Inc Pref Share
Sap AG ADR
Scientific Games Corporation
SIN Holdings Incorporated
SXC Health Solutions Corporation
TechTeam Global, Inc.
Telecom Italia Media Spa AZ
Trintech Group PLC ADR
ubroadcast, inc.

24

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Table of Contents

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

Source:

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


Securities Authorized for Issuance Under Equity Compensation Plans

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

Plan Category

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


9,116,319

$
4.12


5,148,454Equity compensation plans not approved by security holders


865,356


.69


Total Company plans


9,981,675

$
3.82


5,148,454Wavexpress equity compensation plans not approved by security holders


556,263

$
1.23


1,915,960


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

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

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

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

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

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

25

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Table of Contents

Item 6.    Selected Financial Data

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

Consolidated Statement of Operations Data2009

2008

2007

2006

2005Net Revenues

$
18,888,879

$
8,809,815

$
6,306,960

$
3,116,381

$
1,018,464Operating expenses:Cost of sales


1,397,891


824,181


811,970


983,671


726,853Selling, general and administrative


12,992,715


16,375,372


15,222,896


12,598,389


11,560,039Research and development


7,825,058


11,702,776


10,557,937


8,486,368


6,937,618Write-off of intangible and other impaired assets





447,128








Total operating expenses


22,215,664


29,349,457


26,592,803


22,068,428


19,224,510Operating loss


(3,326,785
)

(20,539,642
)

(20,285,843
)

(18,952,047
)

(18,206,046
)Other income (expense):Gain on decrease in value of warrant liability











2,794


490,334Gain on sale of marketable securities














80,971Net interest and other income (expense)


(19,466
)

(9,572
)

334,292


163,980


72,279Total other income (expense)


(19,466
)

(9,572
)

334,292


166,774


643,584Net loss


(3,346,251
)

(20,549,214
)

(19,951,551
)

(18,785,273
)

(17,562,462
)Accretion of non-cash beneficial conversion feature on convertible preferred stock





(657,000
)







Net loss attributable to common stockholders

$
(3,346,251
)
$
(21,206,214
)
$
(19,951,551
)
$
(18,785,273
)
$
(17,562,462
)Weighted average number of common shares outstanding during the period


68,526,572


55,379,118


46,660,794


36,735,059


27,726,221Loss per common share-basic and diluted

$
(0.05
)
$
(0.38
)
$
(0.43
)
$
(0.51
)
$
(0.63
)Cash dividends declared per common share


-0-


-0-


-0-


-0-


-0-


Consolidated Balance Sheet Data2009

2008

2007

2006

2005Working capital

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

$
5,369,273

$
(1,112,413
)Total assets


6,327,925


3,429,774


6,037,856


9,359,677


3,429,765Long-term liabilities


183,505


245,362








2,794Total liabilities


8,187,880


9,448,777


3,542,345


3,439,408


3,595,574Total stockholders' equity (deficit)

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

$
5,920,269

$
(165,809
)


26

---



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 Opal security
subsystem storage specification for developing self-encrypting drives ("SEDs"). Wave's products are unique because they are designed to support cross platform interoperability for the
currently available TPM chips from Nuvoton, Broadcom, Atmel, Infineon and ST Microsystems, and have been certified and/or approved for usage on TPM-based platforms shipped by Dell, Intel,
Acer, Fujitsu, Hitachi, Toshiba, Samsung, Lenovo, NEC and HP.

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



27

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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 such
OEMs license our applications and distribute them as part of their offerings, paying Wave a royalty for each unit shipped. Wave currently has signed such bundling agreements with eight separate
OEM partners. Revenue recognized on these contracts for the years ended December 31, 2009 and 2008 was approximately $16,487,000 and $8,284,000, respectively.

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

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

Operating Expense Trends

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

28

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Table of Contents

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

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

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

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

Critical Accounting Policies

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

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

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

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

29

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Table of Contents

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.



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

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

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

30

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Table of Contents

Results of Operations

Comparison of the years ended December 31, 2009 and 2008

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

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

2009

2008

Increase

% ChangeLicensing

$
18,013,043

$
8,691,576

$
9,321,467


107
%Services


875,836


118,239


757,597


641
%Total Net Revenues

$
18,888,879

$
8,809,815

$
10,079,064


114
%


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

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

31

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Table of Contents

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

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

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

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

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

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

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

32

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Table of Contents

Comparison of the years ended December 31, 2008 and 2007

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

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

2008

2007

Increase

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

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

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

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

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

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

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

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

Liquidity and Capital Resources

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

Sources and Uses of Cash

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

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

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Consolidated Statement of Cash Flow Data

For the years ended December 31,2009

2008

2007Cash flows from operating activities:Net loss

$
(3,346,251
)
$
(20,549,214
)
$
(19,951,551
)Compensation associated with issuance of stock options


1,724,874


2,105,941


1,969,271Depreciation and amortization


259,210


395,253


355,884Impairment of Wavexpress property and equipment





447,128


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


1,984,084


2,948,322


2,325,155Increase in prepaid expenses, receivables and other assets


(2,120,903
)

(428,457
)

(667,355
)Increase (decrease) in deferred revenue


2,016,817


1,195,019


(115,034
)Increase (decrease) in accounts payable and accrued expenses


(3,214,177
)

4,402,514


217,971Changes in assets and liabilities


(3,318,263
)

5,169,076


(564,418
)Net cash used in operating activities


(4,680,430
)

(12,431,816
)

(18,190,814
)Cash flows from investing activities:Acquisition of property and equipment


(88,007
)

(232,512
)

(618,672
)Net cash used in investing activities


(88,007
)

(232,512
)

(618,672
)Cash flows from financing activities:Payments on capital lease obligation


(63,537
)

(26,898
)

Net proceeds from sale of preferred stock





2,688,372


Net proceeds from sale of common stock


5,494,780


7,011,013


14,229,331Proceeds from employee options under stock plans


260,285


229,428


328,432Payment in lieu of fractional shares in reverse stock split





(54
)

(241
)Proceeds from the exercise of warrants


102,800





Payment of dividends on preferred stock


(77,440
)




Net cash provided by financing activities


5,716,888


9,901,861


14,557,522Net increase (decrease) increase in cash

$
948,451

$
(2,762,467
)
$
(4,251,964
)Supplemental cash flow information:Non-cash financing activities:Conversion of 8% Series K Preferred stock into Class A Common Stock

$
45,600

$


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

$
9,100

$


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

$
22,000

$


$
Capital lease obligation for capital expenditures

$


$
335,797

$
Cash paid during the year for:Interest

$
21,384

$
10,415

$



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Cash used in operations

The amount of cash used in operations decreased to $4,680,430 for the year ended December 31, 2009 from $12,431,816 used for the
year ended December 31, 2008, which decreased from $18,190,814 used for the year ended December 31, 2007. As shown above, the fluctuations in cash used in operations were the result of
the changes in the net losses in each of the three years ended December 31, 2009, as discussed in detail in the previousResults of 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.

Adjustments to reconcile net loss to cash used in operating activities

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

Cash flows from investing activities

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

Cash flows from financing activities

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

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Proceeds from issuance of newly issued equity securities

Sales of preferred stock

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

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

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

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

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

Sales of common stock

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

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

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

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

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

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

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

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

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

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

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

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Exercise of warrants to purchase Class A Common Stock

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

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

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

Exercise of employee stock options

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

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

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

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

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

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

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

Summary analysis of historical cash flows and future outlook

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

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Liquidity requirements and future sources of capital

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

Sources
of capital may include the following:



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

Revenue outlook

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

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

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

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

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

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

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

Known trends and uncertainties affecting future cash flows

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

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

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

Other uncertainties that may impact the future business outlook

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

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

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

Commitments

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

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

Within one
year

Years two
and three

Years four
and five

Thereafter

TotalCapital lease commitment

$
61,857

$
138,846

$
44,659

$


$
245,362Operating lease commitments


755,381


1,273,094


289,162





2,317,637Total commitments

$
817,238

$
1,411,940

$
333,821

$


$
2,562,999


Net operating loss carryforwards

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

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

Going Concern Opinion

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

Recent Accounting Pronouncements

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

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

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

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

Item 7A.    Quantitative and Qualitative Disclosures about Market Risk

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

Item 8.    Financial Statements and Supplementary Data

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

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

None.

Item 9A.    Controls and Procedures

Evaluation of disclosure controls and procedures

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

Management's annual report on internal control over financial reporting

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

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

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

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Changes in internal controls

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

Item 9B.    Other Information

Not Applicable.

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PART III

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

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

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

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

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

Item 11.    Executive Compensation

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

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

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

Item 13.    Certain Relationships and Related Transactions and Director Independence

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

Item 14.    Principal Accounting Fees and Services

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

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Table of Contents

PART IV

Item 15.    Exhibits and Financial Statement Schedules

(a)(1)    Financial
Statements:



Page(s)Report of Independent Registered Public Accounting Firm


F-1Consolidated Balance Sheets as of December 31, 2009 and 2008


F-3Consolidated Statements of Operations for each of the years ended December 31, 2009, 2008 and
2007


F-4Consolidated Statements of Stockholders' Equity (Deficiency) and Comprehensive Income (Loss) for each of the years ended
December 31, 2009, 2008 and 2007


F-5Consolidated Statements of Cash Flows for each of the years ended December 31, 2009, 2008 and 2007


F-8Notes to Consolidated Financial Statements


F-9


(a)(2)    Financial
Statement Schedules:



(a)(3)    Exhibits:

Exhibit No.



Description of Exhibit3.1
*



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



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



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



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



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



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



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



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


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Exhibit No.



Description of Exhibit4.7
*



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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


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Table of Contents

Exhibit No.



Description of Exhibit4.22
*



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



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



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



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



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



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



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



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



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



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



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



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



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



Reserved10.6
*



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



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


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Table of Contents

Exhibit No.



Description of Exhibit10.8
*



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



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



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



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



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



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



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



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



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



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



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



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



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


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Exhibit No.



Description of Exhibit10.21
*



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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


53

---



Table of Contents

Exhibit No.



Description of Exhibit10.36
*



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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


54

---



Table of Contents

Exhibit No.



Description of Exhibit10.52
*



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



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



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



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



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



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



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




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




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




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




Section 906 Certification99.1
*



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



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



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



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



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



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


55

---



Table of Contents

Exhibit No.



Description of Exhibit99.9
*



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



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



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



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



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



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



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



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



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



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



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


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


56

---





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, 2010WAVE SYSTEMS CORP.By:

/s/ STEVEN K SPRAGUEName:

Steven K. SpragueTitle:

President and Chief Executive Officer


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

Signature

Title

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

President, Chief Executive Officer and Director

March 16, 2010/s/ JOHN E. BAGALAY, JR. John E. Bagalay, Jr.

Chairman

March 16, 2010/s/ GEORGE GILDER George Gilder

Director

March 16, 2010/s/ JOHN E. MCCONNAUGHY, JR. John E. McConnaughy, Jr.

Director

March 16, 2010/s/ NOLAN BUSHNELL Nolan Bushnell

Director

March 16, 2010/s/ GERARD T. FEENEY Gerard T. Feeney

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

March 16, 2010


57

---





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, 2009 and 2008, and the related consolidated statements of
operations, stockholders' equity (deficiency) and comprehensive income (loss), and cash flows for each of the years in the three-year period ended December 31, 2009. We have also
audited Wave System Corp.'s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal ControlIntegrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO). Wave System Corp.'s management is responsible for these consolidated financial statements, for maintaining effective internal
control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Annual Report on Internal Control
Over Financial
Reporting. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on Wave Systems Corp.'s internal control over financial reporting based on our audits.

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

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

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

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

F-1

---



Table of Contents

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

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

/s/
KPMG LLP

Boston,
Massachusetts
March 16, 2010

F-2

---





Table of Contents



WAVE SYSTEMS CORP. AND SUBSIDIARIES        Consolidated Balance Sheets        December 31, 2009 and 2008

2009

2008AssetsCurrent assets:Cash and cash equivalents

$
1,900,014

$
951,563Accounts receivable, net of allowance for doubtful accounts of $-0- and $16,364 at December 31, 2009 and 2008, respectively


3,850,020


1,701,829Prepaid expenses


207,343


227,967Total current assets


5,957,377


2,881,359Property and equipment, net


237,237


408,440Other assets


133,311


139,975Total Assets


6,327,925


3,429,774Liabilities and Stockholders' Equity (Deficit)Current liabilities:Accounts payable and accrued expenses


4,441,657


7,655,834Current portion of capital lease payable


61,857


63,537Deferred revenue


3,500,861


1,484,044Total current liabilities


8,004,375


9,203,415Long-term portion of capital lease payable


183,505


245,362Total liabilities


8,187,880


9,448,777Stockholders' Equity (Deficit):8% Series I Convertible Preferred stock, $.01 par value. -0- shares issued and outstanding (liquidation preference of $-0-) in 2009 and 220 shares
issued and outstanding (liquidation preference of $968,000) in 2008





2Series J Convertible Preferred stock, $.01 par value. -0- shares issued and outstanding (liquidation preference of $-0-) in 2009 and 91 shares issued
and outstanding (liquidation preference of $364,000) in 2008





18% Series K Convertible Preferred stock, $.01 par value. -0- shares issued and outstanding (liquidation preference of $-0-) in 2009 and 456 shares
issued and outstanding (liquidation preference of $1,276,800) in 2008





5Common Stock, $.01 par value. Authorized 150,000,000 shares as Class A; 75,211,054 shares issued and outstanding in 2009 and 58,877,968 in
2008


752,110


588,780Common Stock, $.01 par value. Authorized 13,000,000 shares as Class B; 38,232 shares issued and outstanding in 2009 and 2008


382


382Capital in excess of par value


345,423,668


338,081,691Accumulated deficit


(348,036,115
)

(344,689,864
)Total Stockholders' Equity (Deficit)


(1,859,955
)

(6,019,003
)Total Liabilities and Stockholders' Equity (Deficit)

$
6,327,925

$
3,429,774


See
accompanying notes to consolidated financial statements.

F-3

---





Table of Contents



WAVE SYSTEMS CORP. AND SUBSIDIARIES        Consolidated Statements of Operations        Years ended December 31, 2009, 2008, 2007

2009

2008

2007Net revenues:Licensing

$
18,013,043

$
8,691,576

$
6,223,487Services


875,836


118,239


83,473Total net revenues


18,888,879


8,809,815


6,306,960Operating expenses:Cost of saleslicensing


876,723


736,429


781,675Cost of salesservices


521,168


87,752


30,295Selling, general and administrative


12,992,715


16,375,372


15,222,896Research and development


7,825,058


11,702,776


10,557,937Write-off of impaired assets





447,128


Total operating expenses


22,215,664


29,349,457


26,592,803Operating loss


(3,326,785
)

(20,539,642
)

(20,285,843
)Other income (expense):Net interest income (expense)


(19,466
)

(9,572
)

334,292Net loss


(3,346,251
)

(20,549,214
)

(19,951,551
)Accretion of non-cash beneficial conversion feature on Series J and Series K convertible preferred stock





(657,000
)

Net loss attributable to common stockholders


(3,346,251
)

(21,206,214
)

(19,951,551
)Loss per common sharebasic and diluted

$
(0.05
)
$
(0.38
)
$
(0.43
)Weighted average number of common shares outstanding during the year


68,526,572


55,379,118


46,660,794


See
accompanying notes to consolidated financial statements.

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, 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








152,712Cash paid for fraction shares exchanged
































(241
)







(241
)Stock based compensation
































1,969,271








1,969,271Exchange of Class B Common Stock for Class A Common Stock




















1,000


10


(1,000
)

(10
)










Balance as of December 31, 2007




$





$





$



49,744,327

$
497,443


38,232

$
382

$
325,481,336

$
(323,483,650
)
$


$
2,495,511Net 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








181,200


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

TotalIssuance 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
)Net loss



































(3,346,251
)




(3,346,251
)


F-6

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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

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














(456
)

(5
)

4,560,000


45,600








(45,595
)







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




















785,000


7,850








367,995








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




















1,881,136


18,811








923,736








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








(91
)

(1
)







910,000


9,100








(9,099
)







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




















3,448,042


34,480








2,652,759








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




















1,791,738


17,917








1,471,232








1,489,149Warrants exercised at $0.55 per share




















100,000


1,000








54,000








55,000Warrants exercised at $0.28 per share




















10,000


100








2,700








2,800Cashless exercise of warrants at $0.28 per share




















17,361


174








(174
)







Cashless exercise of warrants at $0.65 per share




















3,659


37








(37
)







Cashless exercise of warrants at $0.85 per share




















28,339


283








(283
)







Cashless exercise of warrants at $0.90 per share




















30,178


302








(302
)







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




















365,498


3,655








98,867








102,522Warrants exercised at $0.90 per share




















50,000


500








44,500








45,000Conversion of 8% Series I Preferred Stock for Class A Common Stock


(220
)

(2
)













2,200,000


22,000








(21,998
)







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




















152,135


1,521








156,242








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
































(77,440
)







(77,440
)Stock based compensation
































1,724,874








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




$





$





$



75,211,054

$
752,110


38,232

$
382

$
345,423,668

$
(348,036,115
)
$


$
(1,859,955
)


See accompanying notes to consolidated financial statements.

F-7

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Table of Contents



WAVE SYSTEMS CORP. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

Years ended December 31, 2009, 2008, 2007

2009

2008

2007Cash flows from operating activities:Net loss

$
(3,346,251
)
$
(20,549,214
)
$
(19,951,551
)Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization


259,210


395,253


355,884Impairment of property and equipment





447,128


Compensation associated with issuance of stock options


1,724,874


2,105,941


1,969,271Changes in assets and liabilities:Increase (decrease) in deferred revenue


2,016,817


1,195,019


(115,034
)Increase in accounts receivable


(2,148,191
)

(536,444
)

(529,533
)(Increase) decrease in prepaid expenses


20,624


111,375


(132,507
)(Increase) decrease in other assets


6,664


(3,388
)

(5,315
)Increase (decrease) in accounts payable and accrued expenses


(3,214,177
)

4,402,514


217,971Net cash used in operating activities


(4,680,430
)

(12,431,816
)

(18,190,814
)Cash flows from investing activities:Acquisition of property and equipment


(88,007
)

(232,512
)

(618,672
)Net cash used in investing activities


(88,007
)

(232,512
)

(618,672
)Cash flows from financing activities:Payments on capital lease obligation


(63,537
)

(26,898
)

Net proceeds from issuance of preferred stock





2,688,372


Net proceeds from issuance of common stock


5,494,780


7,011,013


14,229,331Proceeds from employee options under stock plans


260,285


229,428


328,432Proceeds from exercise of warrants


102,800





Payment of dividends on preferred stock


(77,440
)




Payment in lieu of fractional shares in reverse stock split





(54
)

(241
)Net cash provided by financing activities


5,716,888


9,901,861


14,557,522Net increase (decrease) in cash and cash equivalents


948,451


(2,762,467
)

(4,251,964
)Cash and cash equivalents at beginning of year


951,563


3,714,030


7,965,994Cash and cash equivalents at end of year

$
1,900,014

$
951,563

$
3,714,030Supplemental cash flow information:Non-cash financing activities:Conversion of 8% Series K Preferred Stock into Class A Common Stock

$
45,600

$


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

$
9,100

$


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

$
22,000

$


$
Capital lease obligation on property and equipment

$


$
335,797

$
Cash paid during the year for:Interest

$
21,384

$
10,415

$



See accompanying notes to consolidated financial statements.

F-8

---





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, 2009, has an accumulated deficit of $348,036,115. Wave may incur an operating loss for the calendar year of 2010. As of December 31, 2009, Wave had
negative working capital of $2,046,998.

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

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

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

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

F-9

---



Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(3) Significant Accounting Policies

(a)   Basis of Consolidation

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

(b)   Use of Estimates

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

(c)   Method of Accounting for Joint Ventures

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

(d)   Cash and Cash Equivalents

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

(e)   Accounts Receivable and Allowance For Doubtful Accounts

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

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

(f)    Concentrations of Credit Risks

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

(g)   Property and Equipment

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

F-10

---



Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(3) Significant Accounting Policies (Continued)

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

(h)   Income Taxes

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

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

(i)    Share-based Payments

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

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

(j)    Research and Development and Software Development Costs

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

F-11

---



Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(3) Significant Accounting Policies (Continued)

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

(k)   Loss Per Share

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

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

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



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

F-12

---



Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(3) Significant Accounting Policies (Continued)

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

(m)  Revenue Recognition

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

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

LICENSES

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

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.

F-13

---



Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(3) Significant Accounting Policies (Continued)

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 ASC 718 and amortization of software and development costs. In order to
enhance the comparability of its results of operations with other security software providers in the industry, Wave has reclassified cost of sales to a component of operating expenses. As a result, a
gross profit analysis is not presented.

(n)   Accounting for Warrants Containing Cash Settlement Provisions

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

(o)   Recent Accounting Pronouncements

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

F-14

---



Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(3) Significant Accounting Policies (Continued)

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

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

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

(4) Related Party Transactions

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

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

(5) Property and Equipment

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

2009

2008Computer equipment

$
2,588,084

$
2,521,987Furniture, fixtures and improvements


218,151


218,151Computer software


2,446,801


2,429,9555,253,036


5,170,093Less: Accumulated depreciation and amortization


5,015,799


4,761,653Total

$
237,237

$
408,440


F-15

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(5) Property and Equipment (Continued)

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

(6) Accounts Payable and Accrued Expenses

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

2009

2008Accounts payable

$
1,382,511

$
4,513,954Accrued payroll and related costs


2,190,037


1,945,735Accrued consulting and professional fees


321,939


589,202State & local taxes payable


186,468


225,798Other accrued expenses


360,702


381,145Total accounts payable and accrued expenses

$
4,441,657

$
7,655,834


(7) Preferred Stock

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

(a)   Series K Preferred Stock

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

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

F-16

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(7) Preferred Stock (Continued)

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

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

Shares of converted Class A Common Stock


4,560,000Closing 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. On August 12, 2009, Wave received gross proceeds of $2,800, in connection with the issuance of 10,000 shares of Class A Common Stock upon the exercise of a warrant
that was granted to an investor as part of this financing. Additionally, 17,361 shares of Class A Common Stock were issued to the placement agent during 2009 upon the cashless exercise of a
warrant that was granted to the placement agent as part of this financing.

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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. In addition, $233,585 was allocated to the Series K Warrants as an additional discount to the Series K
Preferred Stock. After allocating $101,608 of commissions and fees on the Series K Preferred Stock, the remaining gross proceeds of $440,007 were allocated to the preferred stock. Wave followed
ASC 505-10, formerly EITF 98-5 and EITF 00-27, in determining the beneficial conversion feature, whereby the proceeds were first allocated to the
Series K Preferred Stock and the Series K warrants on a relative fair value basis.
Wave utilized the Black-Scholes-Merton option pricing model to calculate the fair value of the Series K Warrants with the following assumptions:

Expected Life in years


3Interest rate


1.1
%Volatility


89.2
%Dividend yield


0
%


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

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

Gross offering proceeds

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


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


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


1,115,000Additional discounts:Series K Warrants


(173,393
)Beneficial Conversion Feature (BCF)


(501,600
)Total additional discounts


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


440,007Accretion of discount related to BCF


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

$
941,607


(b)   Series J Preferred Stock

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

F-18

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(7) Preferred Stock (Continued)

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

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

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

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

Shares of converted Class A Common Stock


1,110,000Closing 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

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(7) Preferred Stock (Continued)

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

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

Expected Life in years (investor/SRA)

5/3Interest rate (investor/SRA)

2.8%/1.8%Volatility

89.2%Dividend yield

0%


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

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


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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(7) Preferred Stock (Continued)

(c)   Series I Preferred Stock

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

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

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

(8) Common Stock

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

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

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(8) Common Stock (Continued)

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

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

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

F-22

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(8) Common Stock (Continued)

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

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

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

F-23

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(8) Common Stock (Continued)

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

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

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

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

F-24

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(8) Common Stock (Continued)

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

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

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

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

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

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

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

(9) Share-based Compensation

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

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

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(9) Share-based Compensation (Continued)

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

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

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

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

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

2009

2008

2007Cost of Sales

$
49,038

$
28,896

$
19,247Selling, General & Administrative


1,068,314


1,309,729


1,230,392Research & Development


607,522


767,316


719,632Total

$
1,724,874

$
2,105,941

$
1,969,271


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

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(9) Share-based Compensation (Continued)

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

2009

2008Stock Option
Plans

Stock Purchase
Plan

Stock Option
Plans

Stock Purchase
PlanExpected Term (in years)


5 Years


6 Months


5 Years


6 MonthsRisk-free Raterange


1.75% - 2.75%


0.15% - 0.29%


2.34% - 3.33%


0.44% - 1.99%Risk-free Ratewt. avg.


1.83%


0.25%


2.81%


1.34%Expected Volatilityrange


75.2% - 78.1%


52.2% - 67.7%


83.7% - 97.9%


44.8% - 69.2%Expected Volatilitywt. avg.


75.52%


63.18%


97.38%


54.97%Dividend Yield


0%


0%


0%


0%


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

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

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

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

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(9) Share-based Compensation (Continued)

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

2009

2008

2007Number of
Shares

Weighted
Average
Exercise
Price

Number of
Shares

Weighted
Average
Exercise
Price

Number of
Shares

Weighted
Average
Exercise
PriceBalance at beginning of year


6,528,296

$
6.24


6,916,478

$
6.80


4,825,928

$
8.97Granted


3,242,900


0.82


932,300


1.67


2,313,667


2.15Forfeited


(105,654
)

1.27


(507,127
)

2.00


(127,913
)

2.31Expired


(588,065
)

9.74


(813,355
)

8.42


(91,889
)

10.25Exercised














(3,315
)

2.43Balance at end of year


9,077,477


4.13


6,528,296


6.24


6,916,478


6.80Exercisable at end of year


4,907,817

$
6.70


4,311,378

$
8.44


3,936,647

$
10.33Additional shares available for grant at end of year


4,593,175





3,970,837





3,933,187


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

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

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

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

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

Options Outstanding

Options ExercisableExercise Price
Range

Number
Outstanding

Weighted
Average
Remaining
Contractual
Life

Weighted
Average
Exercise
Price

Number
Exercisable

Weighted
Average
Exercise
Price$0.25 - $1.00


3,167,250


9.1

$
0.81


120,529

$
0.87$1.01 - $2.00


2,540,449


7.4


1.85


1,665,231


1.88$2.01 - $2.50


1,025,839


6.5


2.40


786,918


2.39$2.51 - $3.00


349,517


3.5


2.97


340,717


2.98$3.01 - $5.00


521,079


4.4


3.69


521,079


3.69$5.01 - $10.00


677,437


3.1


5.65


677,437


5.65$10.01 - $25.00


406,343


1.1


12.70


406,343


12.70$25.01 - $112.50


389,563


.2


40.62


389,563


40.629,077,477


6.7

$
4.13


4,907,817

$
6.70


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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(9) Share-based Compensation (Continued)

1999 Wavexpress Stock Incentive Plan

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

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

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

2009

2008

2007Number 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


624,663

$
1.23


637,163

$
1.23Granted

















Canceled


(68,400
)










(12,500
)

1.20Balance at end of year


556,263


1.23


624,663


1.23


624,663


1.23Exercisable at end of year


556,263

$
1.23


624,663

$
1.23


624,663

$
1.23Additional shares available for grant at end of year


1,915,960





1,847,560





1,847,560


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

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

Options Outstanding

Options ExercisableExercise
Price

Number
Outstanding

Weighted
Average
Remaining
Contractual Life
(in years)

Weighted
Average
Exercise Price

Number
Exercisable

Weighted
Average
Exercise Price$1.20


548,066


2.3

$
1.20


548,066

$
1.20$3.00 - $4.50


8,197


0.6


3.37


8,197


3.37$1.20 - $4.50


556,263


2.3

$
1.23


556,263

$
1.23


Employee Stock Purchase Plan

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

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(9) Share-based Compensation (Continued)

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

(10) Warrants

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

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

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

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(10) Warrants (Continued)

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

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

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

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

F-31

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(10) Warrants (Continued)

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

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

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

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

F-32

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(10) Warrants (Continued)

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

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

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

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

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

Warrants Outstanding

Warrants ExercisableExercise Price

Number of
Shares

Weighted
Average
Remaining
Contractual Life
(in years)

Weighted
Average
Exercise
Price

Number of
Shares

Weighted
Average
Exercise Price$0.25 - $0.50


3,769,928


3.0

$
0.36


3,769,928

$
0.36$0.51 - $1.00


2,768,318


1.8

$
0.68


2,768,318

$
0.68$1.01 - $2.00


3,767,352


4.3

$
1.16


3,767,352

$
1.16$2.01 - $4.35


14,788


3.2

$
3.38


14,788

$
3.3810,320,386


3.2

$
0.74


10,320,386

$
0.74


F-33

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(11) Wavexpress

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

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

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

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

F-34

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(12) Commitments and Contingencies

Operating Leases

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

Location

Annual
Lease
Cost

Lease Expiration
DateLee, MA

$
144,545

Jan. 2011Princeton, NJ


68,320

Dec. 2014Cupertino, CA


528,953

Feb. 2013Orvault, France


13,563

Feb. 2012Total

$
755,381


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

2010

$
755,3812011


640,3292012


632,7662013


188,219Thereafter


100,942Total minimum lease payments

$
2,317,637


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

Capital Leases

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

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

2010

$
78,5292011


78,5292012


78,5292013


45,808Total minimum lease payments


281,395Less: Amount representing interest


(36,033
)Balance at December 31, 2009

$
245,362


F-35

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(12) Commitments and Contingencies (Continued)

Purported Class Actions

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

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

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

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

(13) Income Taxes

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

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

2009

2008

2007Statutory tax rate


34
%

34
%

34
%Stock-based compensation on ISO's


(18
)

(3
)

(3
)BCF on Preferred Stock


(0
)

(1
)

(0
)Change in valuation allowance


(16
)

(30
)

(31
)Total



%


%


%


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

2009

2008Deferred tax assets:Net operating and capital loss carryforwards

$
99,472,000

$
105,624,154Accrued expenses


720,000


940,000Intangibles


303,000


365,000Reserves


921,000


945,000Depreciation


382,000


458,000Total gross deferred tax assets


101,798,000


108,332,154Less valuation allowance


(101,798,000
)

(108,332,154
)Net deferred tax asset

$


$



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

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

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

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

F-37

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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 activity related to the Company's gross unrecognized tax benefits:

2009

2008

2007Balance at beginning of year

$
11,353,354

$
9,428,187

$
7,123,302Increases related to current year tax positions


0


1,925,167


2,304,885Decreases related to prior year tax positions


(6,187,819
)

0


0Balance at end of year

$
5,165,535

$
11,353,354

$
9,428,187


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

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

(14) Defined Contribution Plan

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

(15) Disclosures about the Fair Value of Financial Instruments

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

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

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

F-38

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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 ASC 280-10,
formerly SFAS No. 131,"Disclosures about Segments of an Enterprise and Related Information". Net losses for reportable segments exclude interest
income and other income. These items are not reported by segment since they are excluded from the measurement of segment performance reviewed by Wave's Chief Financial Officer.

F-39

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(16) Segment Reporting (Continued)

The
following sets forth reportable segment data:

For the years ended December 31,2009

2008

2007Operating Revenues:EMBASSY® digital security products and services

$
18,888,879

$
8,809,815

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








Total Operating Revenues


18,888,879


8,809,815


6,306,960Net Loss:EMBASSY® digital security products and services


(2,695,763
)

(16,409,060
)

(17,401,966
)Wavexpress broadband media distribution products and services


(631,022
)

(4,130,582
)

(2,883,877
)Total Segments Net Loss


(3,326,785
)

(20,539,642
)

(20,285,843
)Net interest income (expense)


(19,466
)

(9,572
)

334,292Other income








Net Loss

$
(3,346,251
)
$
(20,549,214
)
$
(19,951,551
)Depreciation and Amortization Expense:EMBASSY® digital security products and services


259,210


309,642


317,311Wavexpress broadband media distribution products and services





85,611


38,573Total Depreciation and Amortization Expense

$
259,210

$
395,253

$
355,884Capital Expenditures:EMBASSY® digital security products and services


88,007


132,789


500,042Wavexpress broadband media distribution products and services





99,723


118,630Total Capital Expenditures

$
88,007

$
232,512

$
618,672




As ofDecember 31,
2009

December 31,
2008

December 31,
2007Assets:EMBASSY® digital security products and services


6,312,854


3,367,690


5,915,158Wavexpress broadband media distribution products and services


15,071


62,084


122,698Total Assets

$
6,327,925

$
3,429,774

$
6,037,856


F-40

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(16) Segment Reporting (Continued)

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

United States
of America

Europe

Asia

Total2009EMBASSY® digital security products and services

$
18,350,388

$
5,440

$
533,051

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











Total

$
18,350,388

$
5,440

$
533,051

$
18,888,879% of Total


97
%

0
%

3
%

100
%2008EMBASSY® digital security products and services

$
8,576,635

$
57,018

$
176,162

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











Total

$
8,576,635

$
57,018

$
176,162

$
8,809,815% of Total


97
%

1
%

2
%

100
%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
%


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

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

2009

2008

2007Customer

Segment

RevenueDell, Inc.

EMBASSY®

$
15,281,863

$
7,048,920

$
4,483,053Broadcom

EMBASSY®








682,129Total



$
15,281,863

$
7,048,920

$
5,165,182% of Total Revenue




81
%

80
%

81
%


F-41

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Table of Contents

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(17) Selected Quarterly Financial Data (unaudited)

Quarter-endedDecember 31,
2009

September 30,
2009

June 30,
2009

March 31,
2009Revenues

$
5,213,252

$
4,843,806

$
4,797,640

$
4,034,181Loss from operations


(996,925
)

(473,706
)

(338,630
)

(1,517,524
)Net loss


(1,000,551
)

(478,716
)

(343,752
)

(1,523,232
)Net loss attributable to common shareholders


(1,000,551
)

(478,716
)

(343,752
)

(1,523,232
)Net loss per common share

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




Quarter-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 shareholders


(3,951,539
)

(5,604,732
)

(5,639,895
)

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

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


F-42

---