10-K 1 wavx2014123110-k.htm 10-K WAVX 2014.12.31 10-K
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

FORM 10-K
 

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

For the fiscal year ended December 31, 2014

or

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

For the transition period from                to              

Commission File Number 0-24752

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

Delaware
(State or other jurisdiction of
incorporation or organization)
 
13-3477246
(I.R.S. Employer
Identification No.)
 
 
 
480 Pleasant Street
Lee, Massachusetts
(Address of principal executive offices)
 
01238
(Zip Code)
413-243-1600
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Class A Common Stock, $.01 par
value 
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES o    NO ý
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES o    NO ý
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES ý    NO o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter), during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES ý    NO o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See 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, 2013) was approximately $35 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 1, 2015, there were 51,475,368 shares of the registrant's Class A Common Stock and 8,885 shares of the registrant's Class B Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of our definitive Proxy Statement for the 2015 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2015, have been incorporated by reference into Part III of this annual report.
 



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.




Table of Contents
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



PART I
Item 1.    Business
Company Overview
References to "Wave," "we," "us," "our" or "the Company" refer to Wave Systems Corp. and its consolidated subsidiaries and include the financial statements of Wave Systems Corp. ("Wave" or "the Company"); Wave Systems Holdings, Inc., a wholly-owned subsidiary; Wavexpress, Inc. (referred to individually, as the context so requires, as "Wavexpress"), a majority-owned subsidiary; and Safend, Ltd. (referred to individually, as the context so requires, as "Safend"), a wholly-owned subsidiary; and Safend, Inc., a wholly owned US-based subsidiary of Safend, Ltd. Safend, Ltd. was acquired on September 22, 2011. All intercompany transactions have been eliminated.
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 reduces the complexity, cost and uncertainty of data protection and authentication by starting inside the device. Unlike other vendors who try to secure information by adding layers of software for security, Wave leverages the hardware security capabilities built directly into endpoint computing platforms themselves. Wave has been among the foremost experts on this growing trend, leading the way with first-to-market solutions and helping shape standards through its work as a board member for the Trusted Computing Group (TCG).
Industry Background
The market for information security products and services is being driven by three key factors: the adoption of cloud-computing; the mobilization of the workforce; and the "Bring Your Own Device" trend. Each of these factors pose significant new challenges for a company's Information Technology ("IT") department. This is resulting in increasing allocation of IT budget and resources to improve key security areas, such as user authentication and data protection. In many industries, such as Finance, Energy, and Healthcare, compliance requirements play a key role.
The increasing frequency and sophistication of cyberattacks against corporations mean that security is no longer purely the concern of IT. Junior level executives and board members are spending more time focused on security and risk. In 2014, major data breaches occurred at companies including Sony, J.P. Morgan Chase, Target, and Home Depot. In the public sector, hacks have occurred at the State Department, the White House, the U.S. Postal Service, and the National Oceanic and Atmospheric Administration. These high profile attacks are leading many companies to question whether continuing with a software-only approach to security will provide them with sufficient protection.
Wave believes that software alone does not offer sufficient protection against cyberattack. Wave has been instrumental in the development of purpose-built hardware to enable secure cryptographic operations. In other words, security is not an afterthought addressed with a software download, but rather it is a capability embedded within the device itself. This approach is commonly referred to as "Trusted Computing".
Trusted Computing is widely supported across the PC industry. The TCG was formed in April 2003 by its promoting founders: AMD, HP, IBM, Intel, and Microsoft. Wave was initially invited to join the founding group as a contributing member. Since 2008, Wave has held a permanent seat on the TCG Board of Directors. Permanent members of the TCG Board of Directors provide guidance to the organization's work groups in the creation of specifications used to protect computing devices from attacks and to help prevent data loss and theft. Wave's 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.
The TCG promotes 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 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 central processing unit(s) that enables secure protection of files and other digital secrets and performs critical security functions. 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.
The TCG also promotes the use of self-encrypting drives ("SEDs"). SEDs are based on TCG specifications which enable integrated encryption and access control within the protected hardware of the disk drive. SEDs are designed to provide

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advanced data protection technology and they differ from software-based full disk encryption in that encryption takes place in hardware in a manner designed to provide robust security without slowing processing speeds. Because the drives can be factory-installed, these systems can be configured such that encryption is "always on" for the protection of proprietary information.
The majority of Wave's TPM and SED related products, as detailed below in Products and Services, utilize the standards and specifications set by the TCG.
Products and Services
Cyberattacks are a constant threat to every company. Last year, the Target Corporation attack resulted in the theft of personal information from an estimated 110 million accounts. As the sophistication of cyberattacks grows, the inadequacies of many legacy, software-based solutions are exposed. Wave' products are purpose-built to prevent such attacks. Wave products can be combined to form a hardened cybersecurity solution covering access management, encryption, and data protection. Wave's products provide a complementary set of solutions that focus on authentication, encryption and data-loss protection. Unlike other solutions that depend on software as the foundation of security, Wave's solutions utilize hardware as the security foundation for devices. This security foundation is provided by built in hardware that is part of the device, not added on. With hardware as the security foundation, IT has unprecedented, yet straightforward control over exactly who has access to sensitive data and control over what devices can access that data.
Wave provides centralized remote management of its products in both on-premise and cloud platforms. For on-premise configurations, EMBASSY Remote Administration Server ("ERAS") hosts Wave’s Virtual Smart Card 2.0, TPM Management, SED Management and BitLocker Management products. The Data Protection Server hosts the Protector, Inspector and Encryptor products. For cloud configurations, Wave Cloud Encryption Management hosts SED Management, BitLocker Management and Macintosh Operating Systems ("Mac OS") Encryption management. Wave’s core set of offerings are set forth below:

Authentication Solutions

Wave Virtual Smart Card 2.0 ("VSC") provides two factor authentication for Windows login as well as authentication for any software application that supports the Microsoft Smart Card infrastructure. Currently, Wave’s VSC product eliminates the expense of distributing physical tokens and the expense of replacing lost tokens, removing the biggest barrier to entry for enterprises to use two factor solutions.

TPM Management - The TPM Management solution provides device and user identification management by allowing IT administrators to manage and provision TPMs. TPM Management provides the ability to use TPM security for authentication to Virtual Private Networks, 802.1x Wireless and Microsoft Direct Access. Access to a network can be restricted to only known devices based on a TPM based certificate, providing further protection for the corporate network.

Encryption Solutions
SED Management provides full lifecycle management of Opal 1 and Opal 2 SEDs. SEDs are the industry leading standard for hardware-based end point device encryption. Wave’s solution offers SED initialization, user management, SED locking, SED user recovery and SED crypto erase. Wave's solution support substantially more Opal SED's than any other product on the market today.
BitLocker® Management provides automated turn-key management for Microsoft BitLocker® encryption. Bitlocker is a suitable interim encryption solution for organizations that have not yet fully phased SEDs into their environment. Wave’s BitLocker® Management allows IT to set policies and monitor security from a single console-simplifying an organization's deployment by reducing the need for specialized knowledge or costly systems.
Mac OS Encryption provides management of encryption on Mac OS devices. It is available from the Wave Cloud Encryption platform only. Mac OS devices are typically a small percentage of an enterprise's population of devices. Wave Cloud Encryption Management of Mac OS devices provides an economic way to protect data for the enterprise.


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Data Loss Protection
The Protector product ("Protector") provides port control and removable media encryption. Protector blocks users from connecting to unauthorized devices or using unauthorized interfaces (including public hot spots). As an example, Protector allows an IT Administrator to define if users can use USB memory devices. Also when the action is authorized, it enforces encryption, automatically guiding the user through securing data.

The Inspector product ("Inspector") provides enforcement of data-centric security policies across multiple channels, including email, web (HTTP, HTTPS), FTP, external storage devices, CD/DVD burners, iPhone, iPad and other smart phones, file repositories, print screen, local printers, and network printers. Inspector will inspect, classify and block leakage of sensitive data in real time. Enterprise users access large amounts of data in the course of their normal jobs, Inspector ensures they do not mistakenly send a document with sensitive data to an unauthorized source.

The Encryptor product ("Encryptor") provides software full disk encryption. It is suitable as part of an enterprise migration to SED to cover their legacy systems running Windows XP or Vista

Market Overview
Software has traditionally secured critical information on networks and PCs and allowed for user access to various applications. Virus attacks and breaches of security are on the rise and have demonstrated that software, on its own, is not always capable of completely securing a network or platform. Because of these security concerns, we believe that there is a need in the computer industry for the development and deployment of a more robust and reliable security infrastructure including new security hardware in devices to guard against these persistent security risks. Wave is seeking to become a software, application and services leader in the hardware-based digital security market. We believe Wave has been a pioneer in developing hardware-based computer security systems and that we are distinctly positioned to take advantage of our unique knowledge, significant technology assets and trusted computing intellectual property. Our objective is to make our products and services the preferred applications and infrastructure for Trusted Platforms.
We operate in the information security market, a highly competitive and fragmented environment that is characterized by rapidly evolving technology. The competitive factors defining these evolving markets include product features, compatibility, standards compliance, quality and reliability, ease of use, performance, customer service and support, distribution and price. The features of Wave's products should allow it to compete favorably primarily because of its cross-platform interoperability and ease of use. The rate of market acceptance of trusted computing solutions continues to reflect its formative and early stages despite the substantial increase in distribution of the technology.
Our key competitors currently include WinMagic, Inc. ("WinMagic"), RSA Security, Inc., Sophos Ltd. ("Sophos"), Symantec Corporation ("Symantec"), McAfee Inc. ("McAfee"), SafeNet Inc. ("SafeNet"), Softex, Inc. ("Softex"), Entrust, Inc. and Absolute Software Corporation ("Absolute Software"). Recent consolidations of large competitors (including acquisitions made by our competitors named above) within our market have further increased the size and resources of some of these firms. These competitors are often able to offer more scale, which in some instances has enabled them to significantly discount their services in exchange for revenues in other areas or at later dates. Additionally, in an effort to maintain market share, many of our competitors are heavily discounting their services.
Marketing and Sales
Wave provides hardened cybersecurity solutions for the protection of corporate data. Many of our customers operate in industries that are subject to stringent data protection regulations. Our products focus on protecting these companies against the threats posed by unauthorized access and data breach. Our principal competitive strengths include our longstanding focus on hardware-enabled security; our experience with extremely large national and multi-national deployments; our industry reputation as a leader and a visionary; and our direct partnerships with many of the major hardware manufacturers and PC OEMs.
We market and sell our solutions worldwide primarily through our direct sales force and through indirect distribution channel partners and strategic partners. The direct sales force is responsible for providing highly responsive, quality service and ensuring client satisfaction. Strategic partnerships and alliances provide us with additional access to potential clients. We also market our solutions to original equipment manufacturers ("OEMs") in an effort to get our solutions in personal computers ("PCs") that are ultimately purchased by enterprise customers. Key decision makers involved in the sales process on the

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customer side typically consists of information technology executives, finance executives and managers of communications assets and networks.
Our marketing strategy is to focus on large national and multinational corporations, as well as significant opportunities in the government sector. The information security market is crowded with competitors. We believe we are differentiated by our consistent focus on leveraging the native capabilities of many computing devices in order to offer solutions that combine stronger security with a better user experience. We have developed a strong corporate identity and are focused on driving increased market awareness with a combination of corporate marketing and partner marketing programs. Our solutions are marketed to a precisely targeted set of customers within specific industry verticals.

Wave is an innovative company and thought leadership is a key component of our messaging strategy. We engage in a wide variety of marketing activities including digital marketing, e-mail and direct mail campaigns, co-marketing strategies designed to leverage existing strategic relationships, website marketing, webcasts, public relations campaigns, speaking engagements and forums. We participate in and sponsor conferences that cater to our target market and demonstrate and promote our software and services at trade shows targeted to information technology and finance executives. We also publish "white papers" relating to relevant cybersecurity issues and develop customer reference programs, such as customer case studies, in an effort to promote better awareness of industry issues and demonstrate that our solutions can address many of these risks to an organization.
Segment Reporting
Information required by this item is incorporated herein by reference to "Segment Reporting" in Note 19 of the Notes to Consolidated Financial Statements.
Financial Information about Geographic Areas
Information required by this item is incorporated herein by reference to "Segment Reporting" in Note 19 of the Notes to Consolidated Financial Statements.
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 products, we have applied for and received export classifications that allow us to export our products, without a license and with no restrictions, to any country throughout the world with the exception of Cuba, Iran, North Korea, Sudan and Syria.
We believe the export classifications that we have received for our software products allow us to sell our products internationally in an effective, competitively advantageous manner. Enhancements to existing products may, and new products will, be subject to reviews by the Bureau of Export Administration to determine what export classification they will receive. Some of our partners demand that our products be allowed to be exported without restrictions and/or reporting requirements. Current export regulations have, in part, allowed us to receive the desired classification without undue cost or effort. However, the export regulations may be modified at any time. Modifications to the export regulations could prevent us from exporting our existing and future products in an unrestricted manner without a license, as we are currently allowed for the products that we have received classification, or make it more difficult to receive the desired classification. If export regulations were to be modified in such a way we may be put at a competitive disadvantage with respect to selling our products internationally.
Proprietary Rights and Licenses and Intellectual Property
Our success depends, in part, on our ability to enjoy or obtain protection for our products and technologies under United States and foreign patent laws, copyright laws and other intellectual property laws, to preserve our trade secrets and to operate without infringing the proprietary rights of other parties. Any issued patent owned or licensed by us may not, however, afford adequate protection to us and may be challenged, invalidated, infringed upon or circumvented. Furthermore, you should understand that our activities may unknowingly infringe upon patents owned by others.
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.
Wave has eighteen (18) United States patents active and twelve (12) patents pending before the United States Patent and Trademark Office. In addition, we have nine (9) foreign patents active and fifteen (15) foreign patents pending before various foreign patent offices. Our patents are material to protecting some of our technology.

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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 technologies in which we have made a substantial investment in research and development ("R&D"). We will likely be required to continue to make substantial investments in the design of information security applications and services. For the years ended December 31, 2014, 2013 and 2012, we spent approximately $10.3 million, $11.4 million and $19.1 million, respectively, on R&D activities.
Employees
As of December 31, 2014, we employed one hundred thirty-two (132) full-time employees, eighty-six (86) of whom were involved in sales, marketing and administration and forty-six (46) of whom were involved in research and development. As of December 31, 2014, we retained the services of three (3) full-time and three (3) part-time consultants.
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) 924-9800.
        The public may read and copy any materials the Company files with the SEC at the SEC's Public Reference Room at 100 F Street, N.E., Washington, DC 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site that contains reports, proxies and information statements, and other information regarding issuers that file electronically with the SEC at http://www.sec.gov.

Item 1A.    Risk Factors
Our business, financial condition and results of operations may be adversely affected by the unprecedented economic and market conditions.
The U.S. and numerous other leading markets around the world continue to experience slow recoveries or more challenging economic conditions, and we believe meaningful risk remains of returned deterioration in economic conditions and of substantial and continuing financial market disruptions in certain large economies. Conditions in the global financial markets and economic and geopolitical conditions throughout the world are outside of our control and difficult to predict, being influenced by factors such as national and international political circumstances (including governmental instability, wars, terrorist acts or security operations), interest rates, market volatility, asset or market correlations, equity prices, availability of credit, inflation rates, economic uncertainty, changes in laws or regulation including as regards taxation, trade barriers, commodity prices, interest rates, currency exchange rates and controls. While many governments, including the U.S. federal government, have taken substantial steps to stabilize economic conditions in an effort to increase liquidity and capital availability, if economic conditions should weaken, the business environment in our principal markets would be adversely affected, which may negatively impact, among other things:

the continued growth and development of our business;

our liquidity;

our ability to raise capital and obtain financing; and

the price of our common stock.
We have a history of net losses and expect net losses will continue. If we continue to operate at a loss our business will not be financially viable.
We have experienced significant losses and negative cash flow from operations since our inception. We have not realized a net operating profit in any quarter since we began our operations. Wave's revenue in 2014 was less than operating expenses as

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our products have not yet attained widespread commercial acceptance. This is due in part to the early stage nature of our products with respect to the digital security industry in which we operate. As of December 31, 2014, we had an accumulated deficit of approximately $430.1 million and negative working capital of approximately $5.0 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.
To achieve profitability we must, among other things:
continue to convince chip, personal computer motherboard, personal computer and computer peripheral manufacturers to license and distribute our products and services and/or make them available to their customers through their sales channels;

convince computer end users and enterprise computer customers to purchase our upgrade software and server products for trusted computing;

convince consumers to choose to order, purchase and accept products using our products and services;

continue to maintain the necessary resources, especially talented software programmers;

continue to develop relationships with personal computer manufacturers, computer chip manufacturers and computer systems integrators to facilitate and to maximize acceptance of our products and services; and

generate substantial revenue, complete one or more commercial or strategic transactions or raise additional capital to support our operations until we can generate sufficient revenues and cash flows.
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 will 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 or respond to competitive pressures. Due to our current cash position, our forecasted capital needs over the next twelve months and beyond, the fact that we will require additional financing and uncertainty as to whether we will achieve our sales forecast for our products and services, substantial doubt exists with respect to our ability to continue as a going concern.
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.

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We expect that a small number of customers will continue to account for a large portion of our revenues for the foreseeable future. Dell accounted for approximately 32% of our revenue for the year ended December 31, 2014, as discussed below. Barring another royalty agreement with Dell, we anticipate that this Dell royalty revenue will continue to decline until it terminates completely. For the year ended December 31, 2015 and beyond, the Company will attempt to mitigate the loss of Dell revenue by, among other things, increasing sales to large enterprise customers and engaging other OEM customers in long-term licensing and distribution agreements.
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 as discussed below.
Factors that could influence our relationships with our customers include, among other things:
our ability to sell our products at prices that are competitive with our competitors;

our ability to maintain features and quality standards for our products sufficient to meet the expectations of our customers; and

our ability to produce and deliver a sufficient quantity of our products in a timely manner to meet our customers' requirements.
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.
In general, 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.
Sales to a relatively small number of OEM customers, as opposed to direct retail sales to end customers, comprised a significant portion of our revenues for the year ended December 31, 2014. Dell accounted for approximately 32% of our revenue for the year ended December 31, 2014. From time to time Dell updates its hardware platforms with new security solutions packages. Our bundled software has been included on Dell platforms since 2006 with the Dell Data Protection Access solution (DDPA). On March 15, 2013, Dell notified us that it will be replacing the DDPA solution in its next generation of client hardware platforms that began shipping in late 2013. As it has with other solution upgrades since 2006, Dell has also informed us that it will continue to discuss with Wave opportunities to include our software on future Dell platforms. However, Dell has not communicated to us any decisions regarding future platforms and we have no assurance that our software will be included in Dell's future platforms. We anticipate that our royalty revenue received from Dell will continue to decline as the Dell platforms that include Wave software decrease in shipping volume. For each of the three-months ended March 31, June 30, September 30 and December 31, 2014, Dell royalty revenue declined quarter over quarter as we had anticipated. Barring another royalty agreement with Dell, we anticipate that this Dell royalty revenue will continue to decline until it terminates completely. For the year ended December 31, 2015 and beyond, the Company will attempt to mitigate the loss of Dell revenue by, among other things, increasing sales to large enterprise customers and engaging other OEM customers in long-term licensing and distribution agreements.
Our market is in the early stage of development so we are unable to accurately ascertain the size and growth potential for revenue in such a market.
The market for our products and services is still developing and is continually evolving. As a result, substantial uncertainty exists with respect to the size of the market for these products and the level of capital that will be required to meet the evolving technical requirements of the marketplace.
Wave's business model relies on an assumed market of tens of millions of units shipping with built-in security hardware. Because this market remains in the early stage of development there is significant uncertainty with respect to the validity of the future size of the market. If the market for computer systems that utilize our products and services does not grow to the extent necessary for us to realize our business plan, we may not be successful.
As this early stage market develops and evolves, significant capital will likely be required to fund the resources needed to meet the changing technological demands of the marketplace. There is uncertainty with respect to the level of capital that may

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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 product offering represents a highly complex architecture designed to solve many of the security issues currently present with computer systems such as identity theft, fraudulent transactions, virus attacks, unauthorized access to restricted networks and other security problems that users of computer systems generally encounter. We are uncertain as to whether the marketplace will accept our solution to these security problems. We will not be successful if the market does not accept the value proposition that we perceive to be present in our products and services.
Although Wave has expended considerable resources in developing technology and products that utilize our technology and in business development activities in an attempt to drive the development of the hardware security market, we do not have a track record as a substantial supplier or service provider to consumers of computer systems. Therefore, uncertainty remains as to whether we will be accepted as a supplier to the enterprise and consumer markets which will likely be necessary for us to be a successful commercial enterprise.
Our products have not been accepted as industry standards which may slow their sales growth.
We believe platforms adopting integrated hardware security into the PC will become a significant standard feature in the overall PC marketplace. However, our technologies have not been accepted as industry standards. Standards for trusted computing are still evolving. To be successful we must obtain acceptance of our technologies as industry standards, modify our products and services to meet whatever industry standards ultimately develop and/or adapt our products to be complementary to whatever these standards become. If we fail to do any of these we will not be successful in commercializing our technology; and therefore, we will not generate sales to fund our operations and develop into a self-sustaining, profitable business.
If we do not keep up with technological changes our product development and business growth will suffer.
Because the market in which we operate is characterized by rapidly changing technology, changes in customer requirements, frequent new products, service introductions and enhancements and emerging industry standards, our success will depend upon, among other things, our ability to improve our products, develop and introduce new products and services that keep pace with technological developments, 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. If the security of products or services is breached, our results of operations may be materially adversely affected by the liability resulting from the breach.
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 WinMagic, RSA Security, Inc., Sophos, Symantec, McAfee, SafeNet, Softex, Entrust, Inc. and Absolute Software.

9


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 lesser 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 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 personnel and on our ability to attract and retain highly skilled technical, sales and marketing personnel. Our industry is characterized by a high level of employee mobility and aggressive recruiting of skilled personnel. There can be no assurance that our current employees will continue to work for us or that we will be able to hire any additional personnel necessary for our growth. Our future success also depends on our continuing ability to identify, hire, train and retain other highly qualified technical and managerial personnel. Competition for these employees can be intense. We may not be able to attract, assimilate or retain qualified technical and managerial personnel in the future, and the failure of us to do so would have a material adverse effect on our business.
We have a limited ability to protect our intellectual property rights and others could infringe on or misappropriate our proprietary rights.
Our success depends, in part, on our ability to enjoy or obtain protection for our products and technologies under United States and foreign patent laws, copyright laws and other intellectual property laws and to preserve our trade secrets. We cannot assure you that any patent owned or licensed by us will provide us with adequate protection or will not be challenged, invalidated, infringed or circumvented.
We rely on trade secrets and proprietary know-how which we protect, in part, by confidentiality agreements with our employees and contract partners. However, our confidentiality agreements may be breached and we may not have adequate remedies for these breaches. Our trade secrets may become known or be independently discovered by competitors. We also rely on intellectual property laws to prevent the unauthorized duplication of our software and hardware products. However, intellectual property laws may not adequately protect our technology. We have registered various trademark and service mark registrations with the United States Patent and Trademark Office. Wave may apply for additional name and logo marks in the United States and foreign jurisdictions in the future but we cannot be assured that registration of any of these trademarks will be granted.
We conduct a portion of our operations in the State of Israel and, therefore, political, economic and military instability in Israel and its region may adversely affect our business.

10


Safend's operations are located in the State of Israel which will constitute a material portion of our business. Accordingly, political, economic and military conditions in Israel and the surrounding region may affect our business. Since the establishment of the State of Israel in 1948, a number of armed conflicts have occurred between Israel and its Arab neighbors. A state of hostility, varying in degree and intensity, has caused security and economic problems in Israel. Although Israel has entered into peace treaties with Egypt and Jordan, and various agreements with the Palestinian Authority, there has been a marked increase in violence, civil unrest and hostility, including armed clashes, between the State of Israel and the Palestinians and others, since September 2000. The establishment in 2006 of a government in the Gaza Strip by representatives of the Hamas militant group has created heightened unrest and uncertainty in the region. In mid-2006, Israel engaged in an armed conflict with Hezbollah, a Shiite Islamist militia group based in Lebanon, and in June 2007, there was an escalation in violence in the Gaza Strip. From December 2008 through January 2009, Israel engaged in an armed conflict with Hamas, which involved missile strikes against civilian targets in various parts of Israel and which negatively affected business conditions in Israel. During July 2014, Israel was again engaged in an armed conflict with Hamas involving missile strikes against civilian targets in various parts of Israel which negatively affected business conditions in the region. Also, there continues to be great international concern in connection with Iran’s efforts to develop and enrich uranium which could lead to the development of nuclear weapons. Iran’s successful enrichment of uranium could significantly alter the geopolitical landscape in the Middle East, including the threat of international war, which could significantly impact business conditions in Israel.
Recent political uprisings, regime changes and social unrest in various countries in the Middle East and North Africa are affecting the political stability of those countries. This instability may lead to deterioration of the political relationships that exist between Israel and these countries and have raised new concerns regarding security in the region and the potential for armed conflict. Among other things, this instability may affect the global economy and marketplace through changes in oil and gas prices. Further escalation of tensions or violence might result in a significant downturn in the economic or financial condition of Israel, which could have a material adverse effect on our operations in Israel and the portion of our business related to our operations there.
Safend received Israeli government grants for certain of its research and development activities. The terms of these grants may require Safend to meet certain requirements in order to manufacture products and transfer technologies outside of Israel. Safend may be required to pay penalties in addition to repayment of the grants. Such grants may be terminated or reduced in the future, which would increase our costs.
The research and development efforts of Safend have been financed, in part, through grants that Safend has received from the Israeli Office of the Chief Scientist, or OCS. Safend therefore must comply with the requirements of the Israeli Law for the Encouragement of Industrial Research and Development, 1984, and related regulations, or the Research Law regarding the intellectual property and products generated by Safend. The terms of these grants and the Research Law restrict the transfer of know-how if such know-how is related to products, know-how and/or technologies which were developed using the OCS grants, and the transfer of manufacturing or manufacturing rights of such products, technologies and/or know-how outside of Israel without the prior approval, pursuant to the Research Law, of the appropriate authority of the OCS. Therefore, the discretionary approval of an OCS committee will be required for any transfer to third parties outside of Israel of rights related to certain of Safend's technologies which have been developed with OCS funding. Safend may not receive the required approvals should it wish to transfer this technology and/or development outside of Israel in the future. Safend did not receive any grants during the year ended December 31, 2014 and does not intend on applying for new grants in the future.
Furthermore, the OCS may impose certain conditions on any arrangement under which Safend transfers technology or development out of Israel. Overseas transfers of technology, manufacturing and/or development from OCS funded programs, even if approved by the OCS, may be subject to restrictions set forth in the Research Law. We cannot be certain that any approval of the OCS will be obtained on terms that are acceptable to us, or at all. If Safend fails to comply with the conditions imposed by the OCS, including the payment of royalties with respect to grants received, we may be required to refund any OCS payments previously received by Safend, together with interest and penalties, and may also be subject to criminal penalties.
Failure to comply with the Foreign Corrupt Practices Act (“FCPA”), and other similar anti-corruption laws, could subject us to penalties and damage our reputation.
We are subject to the FCPA, which generally prohibits U.S. companies and their intermediaries from making corrupt payments to foreign officials for the purpose of obtaining or keeping business or otherwise obtaining favorable treatment, and requires companies to maintain certain policies and procedures. Certain of the jurisdictions in which we conduct business are at a heightened risk for corruption, extortion, bribery, pay-offs, theft and other fraudulent practices. Under the FCPA, U.S. companies may be held liable for actions taken by their strategic or local partners or representatives. If we, or our intermediaries, fail to comply with the requirements of the FCPA, or similar laws of other countries, governmental authorities in the United States or elsewhere, as applicable, could seek to impose civil and/or criminal penalties, which could damage our reputation and have a material adverse effect on our business, financial condition and results of operations.

11


Regulation of international transactions may limit our ability to sell our products in foreign markets.
Most of our software products are controlled under various United States export control laws and regulations and may require export licenses for certain exports of the products and components outside of the United States and Canada. With respect to our EMBASSY Trust Suite and EMBASSY Trust Server software applications, we have applied for and received export classifications that allow us to export our products without a license and with no restrictions to any country throughout the world with the exception of Cuba, Iran, North Korea, Sudan and Syria.
Any new product offerings will be subject to review by the Bureau of Export Administration to determine what export classification they will receive. Enhancements to existing products may be subject to review by the Bureau of Export Administration to determine their export classification. Some of our partners demand that our products be allowed to be exported without restrictions and/or reporting requirements. Current export regulations have, in part, allowed us to receive the desired classification without undue cost or effort. However, the export regulations may be modified at any time. Currently we are allowed to export the products for which we have received classification in an unrestricted manner without a license. However, modifications to the export regulations could prevent us from exporting our existing and future products in an unrestricted manner without a license. Such modifications could also make it difficult to receive the desired classification. If export regulations were to be modified in such a way, we may be put at a competitive disadvantage with respect to selling our products internationally.
In addition, import and export regulations of encryption/decryption technology vary from country to country. We may be subject to different statutory or regulatory controls in different foreign jurisdictions, and as such, our technology may not be permitted in these foreign jurisdictions. Violations of foreign regulations or regulation of international transactions could prevent us from being able to sell our products in international markets. Our success depends in large part to having access to international markets. A violation of foreign regulations could limit our access to such markets and have a negative effect on our results of operations.
Our stock price is volatile.
The price of our Class A Common Stock has been, and likely will continue to be, subject to wide fluctuations in response to a number of events and factors such as:
quarterly variations in operating results;

announcements of technological innovations, new products, acquisitions, capital commitments or strategic alliances by us or our competitors;

the operating and stock price performance of other companies that investors may deem comparable to us; and

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

12


acquired business, technology, service or product may result in operating difficulties and expenditures and may absorb significant management attention that would otherwise be available for ongoing development of our business. Moreover, we may never realize the anticipated benefits of any acquisition. Future acquisitions could result in potentially dilutive issuances of equity securities, the incurrence of debt, contingent liabilities and/or amortization expenses related to certain intangible assets and increased operating expenses which could adversely affect our results of operations and financial condition.
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 National Association of Securities Dealers Automated Quotations Capital Market ("NASDAQ"). In order to maintain our NASDAQ listing, NASDAQ Marketplace Rule 5550(a)(2) (the “Bid Price Rule”) requires that the bid price for our common stock not fall below $1.00 per share for a period of 30 consecutive trading days. On January 15, 2015, we received notification from the Listing Qualifications Department of the NASDAQ Stock Market indicating that our common stock is subject to potential delisting from the NASDAQ Capital Market because for a period of 30 consecutive business days, the bid price of our common stock closed below the minimum $1.00 per share requirement for continued inclusion under the Bid Price Rule. The NASDAQ notice indicated that, in accordance with NASDAQ Marketplace Rule 5810(c)(3)(A), we will be provided 180 calendar days, or until July 14, 2015, to regain compliance. If, at anytime before July 14, 2015, the bid price of the our common stock closes at $1.00 per share or more for a minimum of 10 consecutive business days, NASDAQ staff will provide written notification that it has achieved compliance with the Bid Price Rule. If we fail to regain compliance with the Bid Price Rule before July 14, 2015 but we meet all of the other applicable standards for initial listing on the NASDAQ Capital Market with the exception of the minimum bid price, then we may be eligible to have an additional 180 calendar days, or until January 10, 2016, to regain compliance with the Bid Price Rule. In addition to the Bid Price Rule, in order to remain listed on the NASDAQ Capital Market, we must also maintain compliance with all of the other required continued listing requirements of the NASDAQ Capital Market, including the $35 million market capitalization requirement. 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 Financial Industry Regulatory Authority’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. 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.
Our ability to raise capital may be limited by applicable laws and regulations.
Our ability to raise capital using a shelf registration statement may be limited by, among other things, current Securities and Exchange Commission (“SEC”) rules and regulations. Under current SEC rules and regulations, we must meet certain requirements to use a Form S−3 registration statement to raise capital without restriction as to the amount of the market value of securities sold thereunder. One such requirement is that the market value of our outstanding common stock held by non−affiliates, or public float, be at least $75.0 million as of a date within 60 days prior to the date of filing the Form S−3. If we do not meet that requirement, then the aggregate market value of securities sold by us or on our behalf under the Form S−3 in any 12−month period is limited to an aggregate of one−third of our public float. Moreover, even if we meet the public float requirement at the time we file a Form S−3, SEC rules and regulations require that we periodically re−evaluate the value of our public float, and if, at a re−evaluation date, our public float is less than $75.0 million, we would become subject to the one−third of public float limitation described above. If our ability to utilize a Form S−3 registration statement for a primary offering of our securities is limited to one−third of our public float, we may conduct such an offering pursuant to an exemption from registration under the Securities Act or under a Form S−1 registration statement and we would expect either of those alternatives to increase the cost of raising additional capital relative to utilizing a Form S−3 registration statement.

In addition, under current SEC rules and regulations, our common stock must be listed and registered on a national securities exchange in order to utilize a Form S−3 registration statement (i) for a primary offering, if our public float is not at least $75.0 million as of a date within 60 days prior to the date of filing the Form S−3, or a re−evaluation date, whichever is later, and (ii) to register the resale of our securities by persons other than us (i.e., a resale offering). While currently our common stock is listed on the NASDAQ, there can be no assurance that we will be able to maintain such listing. The NASDAQ reviews the appropriateness of continued listing of any issuer that falls below the exchange’s continued listing standards. Previously, including as recently as January 2015, we were not in compliance with certain NASDAQ continued listing standards and were at risk of having our common stock delisted from the NASDAQ. For additional information regarding this risk, see the risk factor above titled “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 ability to timely raise sufficient additional capital also may be limited by the NASDAQ’s stockholder approval requirements for transactions involving the issuance of our common stock or securities convertible into our common stock. For instance, the NASDAQ requires that we obtain stockholder approval of any transaction involving the sale, issuance or potential issuance by us of our common stock (or securities convertible into our common stock) at a price less than the greater of book or

13


market value, which (together with sales by our officers, directors and principal stockholders) equals 20% or more of our then outstanding common stock, unless the transaction is considered a “public offering” by the NASDAQ staff. Based on 51,475,368 shares of our common stock outstanding as of March 2, 2014 and the closing price per share of our common stock on such date, which was $0.81, we could not raise more than approximately $8.3 million without obtaining stockholder approval, unless the transaction is deemed a public offering or does not involve the sale, issuance or potential issuance by us of our common stock (or securities convertible into our common stock) at a price less than the greater of book or market value. In addition, certain prior sales by us may be aggregated with any offering we may propose in the future, further limiting the amount we could raise in any future offering that is not considered a public offering by the NASDAQ staff and involves the sale, issuance or potential issuance by us of our common stock (or securities convertible into our common stock) at a price  less than the greater of book or market value. The NASDAQ also requires that we obtain stockholder approval if the issuance or potential issuance of  additional shares will be considered by the NASDAQ staff to result in a change of control of our company.

Obtaining stockholder approval is a costly and time-consuming process. If we are required to obtain stockholder approval for a potential transaction, we would expect to spend substantial additional money and resources. In addition, seeking stockholder approval would delay our receipt of otherwise available capital, which may materially and adversely affect our ability to execute our current business strategy, and there is no guarantee our stockholders ultimately would approve a proposed transaction. A public offering under the NASDAQ rules typically involves broadly announcing the proposed ultimately would approve a proposed transaction. A public offering under the NASDAQ rules typically involves broadly announcing the proposed transaction, which often times has the effect of depressing the issuer’s stock price. Accordingly, the price at which we could sell our securities in a public offering may be less, and the dilution existing stockholders experience may in turn be greater, than if we were able to raise capital through other means.


Item 1B.    Unresolved Staff Comments
None.
Item 2.    Properties
Summarized below is a listing of properties leased by Wave and Safend. Our principal research and development activities are conducted at the Princeton and Cupertino facilities in the United States and at the Tel Aviv facility in Israel. We believe our office facilities are suitable and adequate for our business as it is presently conducted.
Facility
Sq. Ft.
 
Annualized
Lease Cost
 
Lease Expires
Cupertino, CA
16,000

 
$
624,000

 
Jul. 2016
Tel Aviv, Israel
10,000

 
209,000

 
Jan. 2016
Lee, MA
13,000

 
159,000

 
Feb. 2016
Princeton, NJ
5,000

 
103,000

 
Dec. 2015
Frankfurt, Germany
500

 
27,000

 
Monthly
London, UK
250

 
26,000

 
Monthly
Orvault, France
250

 
24,000

 
Mar. 2018
Taipei, Taiwan
250

 
7,000

 
Monthly
Item 3.    Legal Proceedings
Brian Berger, a former employee of Wave who was terminated on November 1, 2013, has indicated that he may file a lawsuit against the company for unpaid compensation and penalties. The parties are currently in discussions regarding Mr. Berger’s claims and the Company is evaluating its defenses. The Company has also advised Mr. Berger that he may not misappropriate Wave’s proprietary technology and information and that the Company has reserved all of its rights with respect to any such activities.
Item 4.    Mine Safety Disclosures
Not applicable.

14


PART II
Item 5.    Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information & Dividends
Our Class A Common Stock trades on the NASDAQ Capital Market under the symbol "WAVX". The following table sets forth, for the periods indicated, the high and low sales prices per share for our Class A Common Stock. There is no established trading market for our Class B Common Stock.
 
High
 
Low
Year Ended December 31, 2014
 

 
 

First Quarter
$
1.18

 
$
0.69

Second Quarter
2.32

 
0.80

Third Quarter
1.66

 
1.03

Fourth Quarter
1.34

 
0.76


Year Ended December 31, 2013
 

 
 

First Quarter
$
4.24

 
$
2.60

Second Quarter
2.80

 
1.20

Third Quarter
1.91

 
0.87

Fourth Quarter
1.44

 
0.82

As of March 1, 2015, there were approximately 17,500 holders of our Class A Common Stock. As of such date, there were 11 holders of our Class B Common Stock.
On March 2, 2015, the last sale price reported on the NASDAQ Capital Market for the Class A Common Stock was $0.81.
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.

15


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, 2009 through December 31, 2014. These comparisons assume the investment of $100 on December 31, 2009 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, 2009 through December 31, 2014

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


 
*    $100 invested on 12/31/09 in stock or index, including reinvestment of dividends.
Fiscal year ending December 31.
 
Wave Systems
 
Peer Group
(SIC Code 7379)
 
NASDAQ Market
12/31/2009
$
100.00

 
$
100.00

 
$
100.00

12/31/2010
277.46

 
56.56

 
117.61

12/31/2011
152.82

 
1,433.24

 
118.70

12/31/2012
50.49

 
1,310.01

 
139.00

12/31/2013
16.02

 
1,258.64

 
196.83

12/31/2014
14.08

 
924.71

 
223.74

Item 6.    Selected Financial Data
The selected historical consolidated financial data presented below as of December 31, 2014 and 2013 and for the years ended December 31, 2014, 2013 and 2012 are derived from our audited Consolidated Financial Statements contained in Item 8 of this report. The historical consolidated data as of December 31, 2012, 2011 and 2010 and for the years ended December 31, 2011 and 2010 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.

16


Consolidated Statement of Operations Data
 
2014
 
2013
 
2012
 
2011
 
2010
Net Revenues
$
16,970,834

 
$
24,400,852

 
$
28,844,513

 
$
36,139,015

 
$
26,050,792

Operating expenses:
 

 
 

 
 

 
 

 
 

Cost of net revenues
1,288,776

 
3,696,936

 
6,866,332

 
2,037,649

 
1,776,818

Adjustments to purchase accounting

 

 

 
1,033,206

 

Selling, general and administrative
18,794,273

 
26,829,636

 
32,632,237

 
27,871,223

 
18,019,707

Research and development
10,333,607

 
11,380,258

 
19,055,894

 
16,087,129

 
10,288,460

Impairment of goodwill and purchased intangible assets

 
2,590,000

 
4,054,732

 

 

Total operating expenses
30,416,656

 
44,496,830

 
62,609,195

 
47,029,207

 
30,084,985

Operating loss
(13,445,822
)
 
(20,095,978
)
 
(33,764,682
)
 
(10,890,192
)
 
(4,034,193
)
Other income (expense):
 

 
 

 
 

 
 

 
 

Net currency transaction gain (loss)
(14,828
)
 
(17,220
)
 
12,156

 
175,004

 

Gain on sale of eSign
1,304,579

 

 

 

 

Net interest and other income (expense)
(712,527
)
 
(200,456
)
 
(197,989
)
 
(4,589
)
 
(15,842
)
Total other income (expense)
577,224

 
(217,676
)
 
(185,833
)
 
170,415

 
(15,842
)
Loss before income taxes
(12,868,598
)
 
(20,313,654
)
 
(33,950,515
)
 
(10,719,777
)
 
(4,050,035
)
Income tax expense
(12,000
)
 
(10,610
)
 
(12,033
)
 
(74,959
)
 
(72,782
)
Net loss
$
(12,880,598
)
 
$
(20,324,264
)
 
$
(33,962,548
)
 
$
(10,794,736
)
 
$
(4,122,817
)
Weighted average number of common shares outstanding during the period
43,024,449

 
29,825,854

 
24,051,126

 
21,086,182

 
19,981,119

Loss per common share—basic and diluted
$
(0.30
)
 
$
(0.68
)
 
$
(1.41
)
 
$
(0.51
)
 
$
(0.21
)
Cash dividends declared per common share
-0-

 
-0-

 
-0-

 
-0-

 
-0-



Consolidated Balance Sheet Data
 
2014
 
2013
 
2012
 
2011
 
2010
Working capital
$
(5,048,377
)
 
$
(8,194,200
)
 
$
(5,731,535
)
 
$
(1,984,916
)
 
$
2,588,456

Total assets
8,033,360

 
11,824,909

 
18,633,158

 
30,122,257

 
17,083,883

Long-term liabilities
5,904,762

 
5,591,861

 
6,396,437

 
5,188,545

 
1,466,734

Total liabilities
14,949,187

 
20,808,084

 
21,498,615

 
18,580,902

 
14,387,112

Total stockholders' (deficit) equity
$
(6,915,827
)
 
$
(8,983,175
)
 
$
(2,865,457
)
 
$
11,540,575

 
$
2,696,771


17


Item 7.    Management's Discussion and Analysis of Financial Condition and Results of Operations
Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to provide a reader of our financial statements with a narrative from the perspective of our management on our financial condition, results of operations, liquidity and certain other factors that may affect our future results. Unless otherwise noted, transactions and other factors significantly impacting our financial condition, results of operations and liquidity are discussed in order of magnitude. Our MD&A is presented in five sections:
Business Highlights

Results of Operations

Liquidity and Capital Resources

Contractual Obligations

Critical Accounting Policies
Our MD&A should be read in conjunction with the Consolidated Financial Statements and related Notes included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K. Wave's consolidated financial statements as of December 31, 2014 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 9, 2015, 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 4 to Wave's consolidated financial statements).
Business Highlights
The 2014 fiscal year has been a period of critical transition for Wave-marked by numerous changes to its operations, a more focused sales and marketing strategy and targeted headcount changes across the organization.  Management has strived to establish ways to improve efficiency across Wave’s business, particularly in the manner in which Wave develops, markets and sells its products.
The following are the critical business items that occurred during the twelve-months ended December 31, 2014:
On March 31, 2014, Mr. Gerard T. Feeney was terminated from his positions of Chief Financial Officer and Secretary of the Company, but he remained employed as a non-executive officer through April 30, 2014.  Effective April 1, 2014, Mr. Walter Shephard was appointed as Chief Financial Officer, replacing Mr. Feeney.  Prior to his appointment as Chief Financial Officer, Mr. Shephard, age 60, served as the Chief Financial Officer of Luminus Devices, Inc. from 2010 to November 2013.  From 2004 to 2010, Mr. Shephard served as Chief Financial Officer, Vice President of Finance and Treasurer of Zygo Corporation.

In addition to the change in the Company’s Chief Financial Officer, there have been other changes to Wave’s operations that are focused on the Company’s goals of clarity, efficiency and accountability.  The Company has significantly revised its sales and marketing plans to focus its sales efforts on higher margin Wave solutions and products and to target sales efforts toward larger customers with the Wave security message.  With this change, the Company hired many new sales reps with the background and skills to help address these sophisticated sales opportunities.  The Company has also reduced sales reps in other areas in order to remain headcount neutral and control costs.

The Company added Lorraine Hariton and David Côté to its Board of Directors. Ms. Hariton and Mr. Côté each have over 25 years of technology industry experience, having led successful technology firms as Chief Executive Officer. On December 15, 2014, David Côté was elected as the company’s newly appointed Chairman of the Board of Directors, replacing the Company's longtime Chairman, John Bagalay Jr., who passed away in November 2014.

On June 11, 2014 Wave sold 5,225,560 shares of Class A Common Stock at $1.90 per share for gross proceeds of $9,928,564.  Craig-Hallum Capital Group LLC acted as placement agent in connection with the offering.  In connection with the offering, the At the Market Sales Agreement with MLV & Co. LLC was terminated.  Management believes that this financing was a very important undertaking for Wave and its capital requirement.

On July 22, 2014 Wave released Virtual Smart Card 2.0, the only enterprise-grade, comprehensive lifecycle management solution for virtual smart cards on devices running Windows. Virtual smart cards are designed to emulate

18


the functionality of physical tokens but can offer greater convenience to users, lower total cost of ownership and a reduced risk of inappropriate or unauthorized use. Because virtual smart cards utilize the built-in security of the Trusted Platform Module security chip, no physical card or token is required.

On October 15, 2014, Wave sold its eSignSystems product line to DocMagic, Inc. for $1,214,000.  The disposition of the eSignSystems product line is part of Wave’s strategy to refocus assets on pursuing targeted market segments for its current solutions, as well as accelerating the development of new solutions. This is a positive step in management’s plan to complete a realignment of the Company for the purpose of greater business efficiency.
As the Company has stated over the past year, the current business plan is not a short-term proposition, and it will likely take several quarters before the financial benefits become clear.
Results of Operations
Comparison of the years ended December 31, 2014 and 2013
Net Revenues:
 
2014
 
2013
 
Increase
(Decrease)
 
% Change
Licensing and maintenance
$
16,670,834

 
$
22,591,914

 
$
(5,921,080
)
 
(26
)%
Services
300,000

 
1,808,938

 
(1,508,938
)
 
(83
)%
Total Net Revenues
$
16,970,834

 
$
24,400,852

 
$
(7,430,018
)
 
(30
)%
The decrease in licensing and maintenance revenues was due primarily to lower revenue recognized on Wave’s license upgrade sales of approximately $939,000 and a decrease in OEM revenue of approximately $5,027,000.
The decrease in license upgrade revenue of approximately $939,000 primarily related to the approximate $928,000 decline in consulting services from one of the world’s leading international oil and gas companies.
The decrease in OEM revenue of approximately $5,027,000 consisted of lower Dell royalty revenue of approximately $4,542,000, primarily as the result of a decrease in the volume of Dell shipments. We anticipate that the Dell royalty revenue will continue to decline as Dell previously notified Wave that it has replaced Wave’s solution in its next generation of client hardware platforms that are currently shipping. Additionally, revenues relating to a license and service agreement with Samsung decreased $510,000 at the total value of the license and service agreement with Samsung was recognized ratably beginning in March 2013 through the March 2014.
Services revenue earned during the year ended December 31, 2014 was from a fixed-price agreement with an OEM partner. Services revenue earned during the year ended December 31, 2013 was from fixed-price modifications to a contract awarded by the United States Department of Defense which was completed during 2013.
Operating Expenses:
 
2014
 
2013
 
Increase
(Decrease)
 
% Change
Licensing and maintenance—cost of net revenues
$
1,215,776

 
$
3,419,271

 
$
(2,203,495
)
 
(64
)%
Services—cost of net revenues
73,000

 
277,665

 
(204,665
)
 
(74
)%
Selling, general and administrative
18,794,273

 
26,829,636

 
(8,035,363
)
 
(30
)%
Research and development
10,333,607

 
11,380,258

 
(1,046,651
)
 
(9
)%
Impairment of goodwill and intangible assets

 
2,590,000

 
(2,590,000
)
 
(100
)%
Total operating expenses
$
30,416,656

 
$
44,496,830

 
$
(14,080,174
)
 
(32
)%
Licensing and maintenance—cost of net revenues, consists primarily of customer support personnel costs, share-based compensation expense, foreign tax withholdings and amortization expense and impairment charges on the developed technology intangible asset. The decrease in licensing and maintenance—cost of net revenues was due primarily to a $1,615,000 impairment charge on the developed technology intangible asset during the year ended December 31, 2013. As a result of the impairment charges to the developed technology intangible asset, amortization expense was approximately $25,000 for the year ended December 31, 2014 as compared to approximately $99,000 for 2013, a decrease of $74,000. The decrease in licensing and maintenance—cost of net revenues was also due to lower Wave support costs of approximately $464,000 for consulting services to one of the world’s leading international oil and gas companies. The consulting services were substantially completed during 2013.

19


Services — cost of net revenues incurred during the year ended December 31, 2014 was for work performed on fixed-price contract with an OEM partner. Services — cost of net revenues incurred during the year ended December 31, 2013 was for work performed on fixed-price modifications to a contract with the United States Department of Defense which was completed in 2013.
The decrease in SG&A expenses during year ended December 31, 2014 as compared to 2013 was due primarily to: (i) a decrease in Wave salaries and related benefits, totaling approximately $6,362,000, (ii) a decrease of approximately $716,000 in travel expenses, (iii) a decrease of $205,000 in Wave telephone expenses, consisting primarily of new systems implemented in 2014, (iv) a decrease of approximately $105,000 in professional fees, and (v) a decrease of approximately $363,000 in Wave’s conferences and trade show expenses. These decreases were primarily the result of cost cutting measures implemented during 2013 and continuing during 2014. Approximately $634,000 of the decrease in salaries and related benefits was the result of an immaterial correction of an error in our accounting for share-based compensation.
On March 31, 2014, Mr. Gerard T. Feeney was terminated from his positions of Chief Financial Officer and Secretary of the Company, but he remained employed as a non-executive officer through April 30, 2014. In connection with Mr. Feeney’s employment agreement with the Company, Mr. Feeney was entitled to a lump sum in an amount equal to one year’s annual base salary and a lump sum in an amount equal to the fixed bonus that would have been earned in the one year period following termination. As a result of Mr. Feeney’s termination, the salary and fixed bonus severance amounts were $275,600 and $137,800, respectively. The total severance of $413,400 is included in selling, general and administrative expense for 2014. The 2013 selling, general and administrative expense includes a $1,013,000 severance for Wave's former President and CEO.
The activities supported by SG&A expenses include business development, sales, marketing, corporate communications and public relations, information technology and management information systems, human resources, accounting, executive management, corporate governance and general administrative functions.
The decrease in research and development expenses during the year ended December 31, 2014 as compared to 2013 was due primarily to a decrease in Wave salaries and related benefits totaling approximately $1,709,000, resulting from cost cutting measures implemented during 2013, partially offset by the $600,000 credit recorded to R&D expense during 2013 related to the completion of funded software development for Dell, and an increase in rent and utilities expense of approximately $236,000, primarily relating to an increase in rent at Wave’s Cupertino, CA office. Approximately $272,000 of the decrease in salaries and related benefits was the result of an immaterial correction of an error in our accounting for share-based compensation.
During the first quarter of 2013, the Company determined that sufficient indicators of potential impairment existed to require an interim goodwill impairment analysis for the Safend reporting unit. These indicators included, among others, significantly lower than expected revenue and billings during the first quarter of 2013 and downward revisions to management’s short-term and long-term forecast for the Safend business. The revised forecast reflected changes related to revenue growth rates, current market trends and other expectations impacting the anticipated short-term and long-term operating results of Safend. Due to the aforementioned indicators, the Company concluded that there were qualitative factors for the Safend unit that indicated it is more likely than not that the fair value of the Safend reporting unit was less than its carrying amount.
When indicators of impairment are present, such as those noted above, the Company tests long-lived assets (other than goodwill) for recoverability by comparing the carrying value of an asset group to its undiscounted cash flows. Based on the results of the recoverability test, the Company determined that the carrying value of the Safend asset group exceeded its undiscounted cash flows and was therefore not recoverable. The Company estimated the fair value of the intangible assets under an income approach as described in the critical accounting policies section below. Based on the analysis, the Company recorded an impairment charge of approximately $1,615,000 for developed technology intangible assets. The decline in the fair value of the Safend intangible assets is attributable to the same factors as discussed above for decline of the fair value of the Safend reporting unit.
After adjusting the carrying value of the reporting unit for the impairment of the intangibles noted above, the Company completed the two step goodwill impairment test for the Safend reporting unit. The step two goodwill impairment test resulted in an implied fair value of goodwill substantially below the carrying value of the goodwill. As a result, the Company recorded a goodwill impairment charge of $2,590,000, which resulted in a $1,448,000 remaining carrying value of Safend goodwill as of March 31, 2013. The goodwill impairment totaling $2,590,000 was included in the impairment of goodwill line item in the consolidated statements of operations. The developed technology impairment charge of $1,615,000 is included in the licensing and maintenance—cost of net revenues line item in the consolidated statements of operations.
The Company tested Safend goodwill as of September 30, 2014 and concluded that there was no impairment to goodwill. There was significant headroom between the carrying value goodwill and its fair value. The significant headroom was primarily due to the cost cutting measures that were implemented during 2013 and continued into 2014.
Due to the reasons set forth above, the Company's operating loss for the year ended December 31, 2014 was $13,445,822 as compared to $20,095,978 for 2013.

20


Comparison of the years ended December 31, 2013 and 2012
 
2013
 
2012
 
Increase
(Decrease)
 
% Change
Licensing and maintenance
$
22,591,914

 
$
27,480,732

 
$
(4,888,818
)
 
(18
)%
Services
1,808,938

 
1,363,781

 
445,157

 
33
 %
Total Net Revenues
$
24,400,852

 
$
28,844,513

 
$
(4,443,661
)
 
(15
)%
The decrease in licensing and maintenance revenues was due primarily to a decrease in OEM revenue of approximately $2,550,000, primarily as the result of a decrease in the volume of Dell shipments and a net decrease in revenue recognized on Wave's license upgrade sales of approximately $1,509,000 during the year ended December 31, 2013 as compared to 2012. The decrease in revenue recognized on Wave's license upgrade sales was due primarily to a decrease of approximately $1,274,000 in revenue recognized for an order from one of the world's leading international oil and gas companies. The order, which involved tens of thousands of licenses as well as related software maintenance and consulting services through the end of 2012, was a "large" class order for which VSOE has not yet been achieved. As a result, we recognized the $1,700,000 of license and maintenance order ratably through the end of 2012, which resulted in revenue of approximately $1,578,000 for the year ended December 31, 2012. For this same customer, we recognized approximately $304,000 during the year ended December 31, 2013 for continued maintenance and additional license upgrades purchased during 2013.
Services revenue earned during the year ended December 31, 2013 and 2012 was from fixed-price modifications to a contract awarded by the United States Department of Defense.
 
2013
 
2012
 
Increase
(Decrease)
 
% Change
Licensing and maintenance—cost of net revenues
$
3,419,271

 
$
6,722,221

 
$
(3,302,950
)
 
(49
)%
Services—cost of net revenues
277,665

 
144,111

 
133,554

 
93
 %
Selling, general and administrative
26,829,636

 
32,632,237

 
(5,802,601
)
 
(18
)%
Research and development
11,380,258

 
19,055,894

 
(7,675,636
)
 
(40
)%
Impairment of goodwill
2,590,000

 
4,054,732

 
(1,464,732
)
 
(36
)%
Total operating expenses
$
44,496,830

 
$
62,609,195

 
$
(18,112,365
)
 
(29
)%
Licensing and maintenance—cost of net revenues, consists primarily of foreign tax withholdings, customer support personnel costs, share-based compensation expense, and amortization expense and impairment charges on the developed technology intangible asset. The decrease in licensing and maintenance—cost of net revenues was due primarily to a $1,615,000 impairment charge on the developed technology intangible asset during the year ended December 31, 2013 as compared to a $3,400,000 impairment charge to this same asset during the year ended December 31, 2012, a decrease of $1,785,000. As a result of the impairment charges to the developed technology intangible asset, amortization expense was approximately $99,000 for the year ended December 31, 2013 as compared to approximately $915,000 for 2012, a decrease of $816,000. The decrease in licensing and maintenance—cost of net revenues was also due to a decrease in Wave salaries of approximately $248,000 and a decrease in tax withholdings associated with OEM revenue due to declining OEM shipments of approximately $219,000, offset by an increase of approximately $96,000 in support costs for consulting services to one of the world's leading international oil and gas companies.
Services—cost of net revenues incurred during year ended December 31, 2013 and 2012 was for work performed on fixed-price modifications to a contract with the United States Department of Defense.
The decrease in selling, general and administrative ("SG&A") expenses during the year ended December 31, 2013 as compared to 2012 was due primarily to (i) a decrease in salaries and related benefits totaling approximately $3,030,000 consisting of a decrease in salaries of approximately $1,855,000 due to headcount reductions, a decrease in stock compensation expense of approximately $2,188,000 due to a lower share price and forfeitures, partially offset by severance expense of approximately $1,013,000 for Wave's former CEO and President, (ii) a decrease of approximately $533,000 in travel expenses, (iii) a decrease of $448,000 in professional services expenses, consisting primarily of consulting and recruitment fees, (iv) a decrease of $124,000 in maintenance agreements, (v) a decrease of approximately $1,140,000 in trade show and marketing expenses, (vi) a decrease of approximately $279,000 in depreciation and amortization expense primarily as a result of an impairment charge to the customer relationship intangible asset during the fourth quarter of 2012 and (vii) a decrease of approximately $175,000 in office related expenses.
The decrease in R&D expenses during the year ended December 31, 2013 as compared to 2012 was due primarily to (i) a decrease in salaries and related benefits totaling approximately $6,064,000, which included an approximate $947,000 decrease in stock compensation as a result of a lower share price and forfeitures during 2013, (ii) a decrease in outsourced engineering totaling approximately $649,000, (iii) a decrease of approximately $36,000 in travel expenses and (iv) a credit of

21


$600,000 related to the completion of funded software development for Dell. In November 2012, Wave received $600,000 from Dell for the performance of certain software development services. The $600,000 received from Dell was deferred as a current liability on the consolidated balance sheet at December 31, 2012 and was offset against research and development expense during the year ended December 31, 2013 upon completion of the software development.
During the first quarter of 2013 and the fourth quarter of 2012, the Company determined that sufficient indicators of potential impairment existed to require an interim goodwill impairment analysis for the Safend reporting unit. These indicators included, among others, significantly lower than expected revenue, identification of increased competition for transactions involving Safend products, inability of the combined sales force to close large transactions and downward revisions to management's short-term and long-term forecast for Safend. The revised forecast reflected changes related to revenue growth rates, current market trends, expected deal synergies and other expectations impacting the anticipated short-term and long-term operating results of Safend. Due to the aforementioned indicators, the Company concluded that there were qualitative factors for the Safend unit that indicated it is more likely than not that the fair value of the Safend reporting unit was less than its carrying amount.
When indicators of impairment are present, such as those noted above, the Company tests long-lived assets for recoverability by comparing the carrying value of an asset group to its undiscounted cash flows. Based on the results of the recoverability test during the first quarter of 2013 and fourth quarter of 2012, the Company determined that the carrying value of the Safend asset group exceeded its undiscounted cash flows and was therefore not recoverable. The Company estimated the fair value of the intangible assets under an income approach as described below in the critical accounting policies section. Based on the analysis, the Company recorded impairment charges of $1,600,000 and $5,300,000 on intangible assets during the first quarter of 2013 and fourth quarter of 2012, respectively. The decline in the fair value of the Safend intangible assets is attributable to the same factors as discussed above for the decline of the fair value of the Safend reporting unit.
After adjusting the carrying value of the reporting unit for the impairment of the intangibles noted above in the first quarter of 2013 and the fourth quarter of 2012, the Company completed the two step goodwill impairment test for the Safend reporting unit. This test resulted in an implied fair value of goodwill substantially below the carrying value of the goodwill. As a result, the Company recorded a goodwill impairment charge of $2,200,000 during the fourth quarter of 2012, which resulted in a $4,038,000 remaining carrying value of Safend goodwill as of December 31, 2012 and an additional goodwill impairment charge of $2,590,000 during the first quarter of 2013, which resulted in a $1,448,000 remaining carrying value of Safend goodwill as of December 31, 2013. The goodwill impairment charge totaling approximately $2,590,000 for the year ended December 31, 2013 and the impairment charge totaling approximately $4,100,000 for the year ended December 31, 2012, which consists of the goodwill impairment of approximately $2,200,000 and an additional $1,900,000 of impairment on the customer relationship and in-process technology intangible assets, are included in the impairment of goodwill and intangible assets line item in the consolidated statements of operations. The developed technology impairment charge of approximately $1,600,000 and $3,400,000 for the years ended December 31, 2013 and 2012, respectively, are included in the licensing and maintenance—cost of net revenues line item in the consolidated statements of operations.
Due to the reasons set forth above, our net operating loss for the year ended December 31, 2013 was $20,095,978 as compared to $33,764,682 for year ended December 31, 2012.
Segments are defined by authoritative guidance as components of a company in which separate financial information is available and is evaluated by the chief operating decision maker (CODM), or a decision-making group, in deciding how to allocate resources and in assessing performance. Our CODM is our chief executive officer.
In the 2013 fiscal year, the Company previously reported two operating segments: EMBASSY® digital security products and services and Safend endpoint data loss security products and services. Information technology solutions were historically segmented as a result of the acquisition of Safend in September 2011 and the way in which the previous CODM viewed the business.
During the 2014 fiscal year, our CODM decided that our product offerings constitute a single business activity and that our financial results should be evaluated on that basis. Our CODM determined that a functional management approach with centralized roles and responsibilities would be best to enable the Company to efficiently scale and deliver its solutions to its customers. Our CODM assembled an executive team with specific business functional responsibility to move further towards an integrated and scalable operation and drive our business as an integrated offering. In the fourth quarter of the 2014 fiscal year our CODM discontinued our historical segmented reporting as a management tool. The Company presents a single segment for purposes of financial reporting and prepared its consolidated financial statements upon that basis.
The comparison of the years ended December 31, 2013 and 2012 have been restated to align with the single segment approach adopted in 2014.
Liquidity and Capital Resources

22


Summary
We closely manage our liquidity and capital resources. Key variables we use to manage our liquidity requirements include discretionary SG&A and R&D spending, capital expenditures, financing arrangements and working capital management. We plan to continue to exercise a disciplined approach to liquidity and capital management, while investing in key areas such as product development and research and development.
Given Wave's forecasted capital requirements for the year ending December 31, 2015, as detailed below in Liquidity requirements and future sources of capital, and our cash balance as of December 31, 2014, Wave will be required to raise additional capital prior to December 31, 2015 to continue to fund its operations. Wave's ability to raise additional capital is primarily based on two sources (see Liquidity requirements and future sources of capital below for discussion of restrictions):
Sales of registered Class A Common Stock under a $15,000,000 shelf registration statement filed with the U.S. Securities and Exchange Commission ("SEC") on December 18, 2014 and declared effective by the SEC on January 7, 2015 ("2015 shelf registration statement"); and

Sales of Class A Common Stock through private placements.
Cash Flows
The following table summarizes our cash flows from operating, investing and financing activities for each of the past three years ended December 31:
 
2014
 
2013
 
2012
Total cash provided by (used in):
 

 
 

 
 

Operating activities
$
(16,176,856
)
 
$
(11,546,998
)
 
$
(15,756,216
)
Investing activities
1,096,183

 
(412,715
)
 
(169,660
)
Financing activities
14,737,985

 
11,967,046

 
14,653,610

(Decrease) increase in cash and cash equivalents
$
(342,688
)
 
$
7,333

 
$
(1,272,266
)
Operating Activities
The net cash used in operating activities of approximately $16,177,000 during the year ended December 31, 2014 was primarily related to the net loss adjusted for non-cash items of approximately $12,992,000, a decrease in accounts payable and accrued expenses, a decrease in deferred revenue and a decrease in accounts receivable. The decrease in accounts payable and accrued expenses during the year ended December 31, 2014 of approximately $2,961,000 was largely the result of severance payments made to Wave’s former President of approximately $976,000 and a decrease in accounts payable and accrued expenses of approximately $1,985,000. Proceeds from the June 11, 2014 financing were used to reduce other accounts payable and accrued expenses. The decrease in deferred revenue of approximately $1,833,000 was the result of the recognition of deferred revenue outpacing additions to deferred revenue during the year ended December 31, 2014. The decrease in accounts receivable of approximately $1,162,000 was largely due to the decline in Dell royalties.
The net cash used in operating activities of approximately $11,547,000 in the year ended December 31, 2013 was primarily related to the net loss adjusted for non-cash items of approximately $13,333,000, a decrease in accounts receivable of approximately $2,316,000 and a decrease in accounts payable and accrued expenses of approximately $735,000. The decrease in accounts receivable was primarily the result of the cash collection of a three-year maintenance renewal invoice from a significant customer of approximately $1,681,000 during the year ended December 31, 2013. The decrease in accounts payable and accrued expenses was the result of cost cutting measures implemented throughout the year ended December 31, 2013.
Investing Activities
The $1,096,000 in net cash provided by investing activity in 2014 was the result of the $1,214,000 in proceeds received from the sale of the eSign product line offset by $118,000 in capital expenditures.
The increase in cash used in investing activities in 2013 compared to 2012 of approximately $243,000 was the result of internal-use software developments costs of $226,000 in 2013 associated with the development of Wave Cloud.
Financing Activities
The increase in net cash provided by financing activities during the year ended December 31, 2014 compared to 2013 of approximately $2,771,000 was primarily the result of increases in net proceeds from the issuance of common stock via registered share offerings.

23


The significant amount of proceeds received in 2014 and 2013 from the sale of common stock were necessary in to support Wave's growth strategy and SG&A and R&D capital requirements.
Liquidity requirements and future sources of capital
Sources of capital may include the following:
cash on hand of approximately $1,777,000 as of December 31, 2014;

collection of receivables; and

additional financings.
If Wave is not successful in improving sales performance, Wave will not generate enough revenue to fund its cash flow requirements for the year ending December 31, 2015. As of December 31, 2014, we had approximately $1,777,000 of cash on hand. Given Wave’s forecasted capital requirements for the twelve-months ending December 31, 2015, and our cash balance as of December 31, 2014, Wave will be required to raise additional capital prior to December 31, 2015 to continue to fund its operations. Wave has historically raised additional capital from registered share offerings, sales of Class A Common Stock via the At the Market Sales Agreement with MLV & Co. LLC ("MLV") and through private placements. As a result of the June 11, 2014 offering, which used substantially all of the remaining availability of the 2013 shelf registration statement, the Company terminated all future sales under the At the Market Sales Agreement with MLV.
On January 26, 2015, Wave sold 5,513,044 shares of Class A Common Stock at $0.65 per share for gross proceeds of $3,583,479. This financing was completed under the 2015 shelf registration statement. Wave also issued warrants to the subscribers to purchase 2,205,216 shares of Class A Common Stock at an exercise price of $0.70 per share. These warrants expire on July 26, 2020. Security 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% of the gross proceeds of this offering. Wave realized approximately $3,338,000 in net proceeds after deducting the placement agent fees of approximately $215,000 and additional legal and other fees associated with the issuance of these securities totaling approximately $30,000. In connection with the financing, Wave also issued warrants to SRA to purchase up to 330,783 shares of Wave Class A Common Stock for $0.70 per share. These warrants expire on July 26, 2018.
For registered offerings, Wave is required to calculate the amount of capital the Company is allowed to raise in accordance with the General Instruction I.B.6. on Form S-3 (“the one-third rule”). The one-third rule restricts the amount of capital that can be raised in a 12-month period provided that the registrant’s aggregate market value of the common equity held by non-affiliates is less than $75 million. As a result of the application of the one-third rule, the funds available on the 2015 shelf registration statement are reduced. Until Wave attains an aggregate market value of $75 million or more for shares held by non-affiliates, its available funds under the 2015 shelf registration statement will remain restricted to the one-third rule computation. To determine the amount available under the one-third rule for future financings, the aggregate market value of the common equity is calculated using the price at which the common equity was last sold, or the average of the bid and asked prices of the common equity as of a date within 60 days prior to the date of filing. As of March 1, 2015, approximately $9,872,000 in gross proceeds remains under the 2015 shelf registration statement; however Wave is restricted to $9,203,000 as of such date due to the one-third rule.
Wave will be required to sell 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, 2015. If Wave is not successful in executing its business plan, it will 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.
We have previously transferred certain accounts receivable to buyers through CapFlow Funding Group Managers, LLC ("CapFlow") that are accounted for as secured borrowings because we are required to repurchase the pledged receivables under certain circumstances in case of specific defaults by our customers as set forth in the program terms. The carrying value of each secured borrowing approximates 85% of each associated pledged receivable taking into consideration a 15% holdback provision per the CapFlow agreement. The customers' payment of the pledged receivables constitutes the repayment of the related amounts borrowed. Capflow will then remit the remaining 15% holdback to Wave less interest. The interest rate on the secured borrowings was approximately 1.50% for every thirty days outstanding.

24


Known trends and uncertainties affecting future cash flows
Because Wave does not have sufficient cash to fund operations for the year ending December 31, 2015, and there is uncertainty as to whether Wave will generate sufficient revenues to fund its operations over this time period, Wave has been, and will continue to be, actively engaged in financing activities in order to generate additional funding to cover its operating costs for the year ending December 31, 2015. As detailed above, the funds available under the 2015 shelf registration statements will remain restricted if Wave is unable to exceed $75 million in aggregate market value of the common equity held by non-affiliates. As such, our ability to raise the necessary capital to fund operations may not be sufficient for the year ended December 31, 2015.
We will be required to sell additional shares of common stock or preferred stock 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, 2015. The availability and amount of any such financings are unknown at this time and as a result of the one-third rule as detailed above, proceeds available to us under the 2015 shelf registration statement may not be adequate. Due to our current cash position, our forecasted capital needs over the next year and beyond, the fact that we will require additional financing and uncertainty as to whether we will achieve our sales forecast for our products and services, substantial doubt exists with respect to our ability to continue as a going concern.
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, 2015 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, 2015. The challenges presented by the recent economic climate 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.
Contractual Obligations
Royalty Liability
Safend is required to pay back grants received from the Israeli government through the Office of the Chief Scientist ("OCS") for the financing of a portion of its research and development expenditures in Israel. Safend's repayments are based on a royalty rate of 3.5% of total Safend revenues and there is no termination date for the payments. Interest is accrued based on the 12 month LIBOR rate at the time of each individual grant and remains fixed at that rate until the grant is repaid. At December 31, 2014 and 2013, the book value of the liability amounted to $5,157,306 and $4,673,629, respectively. The actual amount owed to the OCS is approximately $6,200,000 at December 31, 2014 and $6,235,000 at December 31, 2013. The difference between the amount owed at December 31, 2014 and 2013 and the book value relates to the remaining accretion of the fair value discount recorded when Safend was acquired. During the year ended December 31, 2014, approximately $580,000 was recorded as interest expense relating to the LIBOR component of the arrangement. The $580,000 represents the cumulative interest incurred on the grants to correct an out of period error. We assessed the materiality of the error on prior periods' financial statements and concluded that the error was not material to any of our prior period annual or current and prior period interim financial statements. We elected to correct the error in the three-month period ended December 31, 2014 by increasing interest expense by $580,000 and increasing the royalty liability on the consolidated balance sheet by the same amount. For the three and twelve month periods ended December 31, 2014, loss per basic and diluted share decreased by $0.01 as a result of the correction.
Operating Leases
Wave has no significant long-term contractual obligations other than with respect to the royalty liability obligation described above and operating leases for its facilities, which are all listed below:

25


 
Within
one year
 
Years two
and three
 
Years four
and five
 
Thereafter
 
Total
Operating lease commitments
$
1,091,000

 
$
436,000

 
$
2,000

 
$

 
$
1,529,000

Total commitments
$
1,091,000

 
$
436,000

 
$
2,000

 
$

 
$
1,529,000

Critical Accounting Policies
Wave's discussion and analysis of its financial condition and results of operations are based on the Company's consolidated financial statements which have been prepared in accordance with United States generally accepted accounting principles or GAAP. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported revenues and expenses during the reporting periods. On an ongoing basis management evaluates its estimates and judgments, including those related to depreciation and amortization, revenue recognition, accounts receivable reserves, valuation of long-lived assets, goodwill, 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 software products and development contracts. Many of these sales arrangements include multiple-elements and/or require significant modification or customization of Wave's software.
Wave recognizes revenue when 1) persuasive evidence of an arrangement exists, 2) delivery has occurred or services have been rendered, 3) fees are fixed or determinable and 4) collectability is reasonably assured. If we determine that any one of the four criteria is not met, we will defer recognition of revenue until all the criteria are met. In addition to the aforementioned general policy, the following are the specific revenue recognition policies for each major category of revenue.
Licensing and Maintenance
Wave receives revenue from licensing its software through distribution arrangements with its OEM partners, license upgrade agreements with end users of the products, software development and other services including maintenance. Wave applies software revenue recognition guidance to all transactions except those where no software is involved.  Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable and collectability is reasonably assured.  Persuasive evidence is generally a binding purchase order or license agreement.  Delivery occurs when product is shipped for its OEM distribution arrangements, or delivered via a license key for our license upgrade agreements.
Wave enters into perpetual software license agreements through direct sales to customers and indirect sales through its OEM partners, distributors and resellers. Wave has defined its classes of end user customers: large customers, whose orders are in excess of 5,000 licenses and small customers, whose orders are less than 5,000 licenses. These license upgrade agreements generally include a maintenance component. For arrangements with multiple elements, including software licenses, maintenance and/or services, revenue is allocated and deferred in amounts equivalent to the vendor specific objective evidence ("VSOE") of fair value for the undelivered elements and the difference between the total arrangement fee and the amount deferred for the undelivered elements is recognized as license revenue. VSOE of fair value is based upon the price for which the undelivered element is sold separately.
During the year ended December 31, 2014, Wave further stratified the VSOE of fair value of maintenance analysis to align it with current sales trends with respect to product mix and maintenance terms.  The following represents the resulting updates to VSOE of fair value of maintenance as a result of such further stratification.
 
·Wave products:
 
·VSOE of fair value of maintenance is only applied to bundled license and maintenance arrangements with maintenance terms of one year and less than 5,000 licenses.

Wave has VSOE of fair value of maintenance for its small class of customers based on independent one-year maintenance renewals for its EMBASSY Remote Administration Server (“ERAS”) for Self Encrypting Drives (“SED”) product

26


and its Protector product.  As a result, for the ERAS SED and Protector small customer class licenses with one year of maintenance bundled, Wave allocates the arrangement consideration to the elements in multi-element arrangements using the residual method.  Under the residual method, the VSOE of the undelivered elements is deferred and the remaining portion of the arrangement fee for perpetual licenses is recognized as revenue upon delivery of the software, assuming all other revenue recognition criteria are met.
 
When VSOE of fair value for the undelivered elements does not exist, as is the case for Wave’s maintenance for all products other than ERAS SED and Protector, large customer class ERAS SED and Protector orders, and small customer class ERAS SED and Protector orders when maintenance terms are in excess of one year, the entire arrangement fee is recognized ratably over the performance period as licensing and maintenance revenue.
 
Wave’s deferred revenue consists of the unamortized maintenance for sales to its small class of customers and bundled license and maintenance arrangements where VSOE does not exist.
Licensing and maintenance—cost of net revenues includes customer support personnel costs, foreign tax withholdings, amortization expense of the developed technology intangible asset, costs associated with providing consulting services and related share-based compensation expense.
Services
Revenue from time and material service contracts is recognized as the services are provided. Revenue from fixed price, long-term service or development contracts is recognized using the percentage of completion method or the completed contract method. The determination between completed contract method and the percentage of completion method is based on the Company's reasonable ability to estimate costs at completion. The Company measures the percentage of completion by reference to the proportion of contract hours incurred for work performed to date to the estimated total contract hours expected to be incurred. Losses on fixed price contracts are recognized during the period in which such losses are identified.
Services—cost of net revenues includes non-recurring time and materials costs incurred in connection with fixed price contracts and related share-based compensation expense.
Valuation Long Lived Assets—We review intangible assets with finite lives for impairment whenever events or changes in circumstances indicate the carrying value of an asset group may not be recoverable. Recoverability of asset groups is assessed based on the estimated undiscounted future cash flows expected to be generated by the asset group, including its ultimate disposition. If the sum of the undiscounted cash flows is less than the carrying value, the impairment to be recognized is measured by the amount by which the carrying amount of the asset group exceeds the fair value of the asset group. Assets to be disposed of are reported at the lower of the carrying amount or fair value, less costs to sell.
Goodwill—We review goodwill for impairment annually and whenever events or changes in circumstances indicate the fair value of a reporting unit is more likely than not below its carrying value. If the implied fair value of the reporting unit’s goodwill is less than the carrying value, the difference is recorded as an impairment loss. We perform a quantitative test and determine the fair value using the income approach. Under the income approach, we calculate the fair value of the unit based on the present value of estimated future cash flows. Cash flow projections are based on management’s estimates of revenue growth rates and operating margins, taking into consideration industry and market conditions. The discount rate used is based on the weighted-average cost of capital adjusted for the relevant risk associated with business-specific characteristics and the uncertainty related to the business’s ability to execute on the projected cash flows. In the first step of the goodwill impairment test, the fair value of a reporting unit is compared to its carrying amount. Since the carrying amount of our reporting unit is negative, we revert directly to step two of the goodwill impairment test. In the second step of the goodwill impairment test, the reporting unit’s fair value is allocated to all of the assets and liabilities of the reporting unit, including any unrecognized intangible assets, in a hypothetical analysis that calculates the implied fair value of goodwill in the same manner as if the reporting unit was being acquired in a business combination. If the implied fair value of the reporting unit’s goodwill is less than the carrying value, the difference is recorded as an impairment loss.
Determining the fair value of a reporting unit is judgmental in nature and involves the use of significant estimates and assumptions. These estimates and assumptions include revenue growth rates and operating margins used to calculate projected future cash flows, risk-adjusted discount rates and future economic and market conditions. We base our fair value estimates on assumptions we believe to be reasonable but they are unpredictable and inherently uncertain. Actual future results may differ from those estimates.
We will continue to evaluate goodwill on an annual basis as of September 30 and whenever events or changes in circumstances, such as significant adverse changes in business climate or operating results or changes in management’s business strategy, indicate that there may be a potential indicator of impairment.

27


Share-based Compensation—We recognize compensation expense for all share-based payment awards made to employees and directors including employee stock options and employee stock purchases related to the Employee Stock Purchase Plan. Share-based compensation expense recognized is based on the value of the portion of share-based payment award that is ultimately expected to vest and has been reduced for estimated forfeitures. We value share-based payment awards at grant date using the Black-Scholes valuation model to estimate fair value at the grant date. Our determination of the fair value of the share-based payment award on the date of grant using the option-pricing model is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, the expected life of the option, the risk-free interest rate, the expected volatility of our common stock price and the expected dividend yield.
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
(a)    Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our chief executive officer ("CEO") and chief financial officer ("CFO"), evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2014. The term "disclosure controls and procedures," as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Securities Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Securities Exchange Act is accumulated and communicated to the Company's management, including its CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
Based on the evaluation of our disclosure controls and procedures as of December 31, 2014, our CEO and CFO concluded that, as of such date, our disclosure controls and procedures were effective.
(b)    Management's Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting for our company. Internal control over financial reporting is defined in Rule 13a-15(f) and 15d-15(f) promulgated under the Exchange Act, as a process designed by, or under the supervision of, a company's principal executive and principal financial officers and effected by the Company's board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles, and includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) 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 in accordance with authorizations of management and directors of the company; and (iii) 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. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may

28


become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Our management, including our CEO and CFO, assessed the effectiveness of our internal control over financial reporting as of December 31, 2014, based on the criteria established in Internal Control—Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, we have concluded that the Company maintained effective internal control over financial reporting as of December 31, 2014 based on the specified criteria.
(c) Changes in Internal Control Over Financial Reporting
As previously reported in Item 9A of our Annual Report on Form 10-K for the year ended December 31, 2013, we reported the following material weakness in our internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act).
We failed to timely execute our control to test the existence of vendor specific objective evidence ("VSOE") of fair value of maintenance for the Safend unit.
As a result of that material weakness in our internal control over financial reporting, our principal financial officer concluded that our internal control over financial reporting was not effective as of December 31, 2013.
During the three-months ended June 30, 2014, no changes (other than those in conjunction with certain remediation efforts described below) were identified in our internal control over financial reporting that materially affect, our internal control over financial reporting.
During the three-months ended December 31, 2014, management made several structural changes to the accounting department to strengthen internal controls over financial reporting including several personnel changes and the revision of roles and responsibilities of individuals within the department.
(d) Remediation Efforts
We determined that the following material weakness (reported in our Annual Report on Form 10-K for the year ended December 31, 2013) was remediated as of June 30, 2014:
We failed to timely execute our control to test the existence of vendor specific objective evidence ("VSOE") of fair value of maintenance for the Safend unit.
The remediation efforts taken during 2014, which were evidenced in the second quarter, included the following:
Formalize accounting processes to bring the Safend VSOE of fair value of maintenance testing and review in line with the same process that is currently applied to the Wave products and
Reallocate resources within the accounting department to ensure that our testing and review of VSOE of fair value of maintenance for the Safend unit can be completed accurately and in a timely manner.



29


Item 9B.    Other Information
Not Applicable.
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 2015 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2015 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 2015 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2015, under the caption "Section 16(a) Beneficial Ownership Reporting Compliance." Such information is incorporated herein by reference.
Information concerning Wave's Audit Committee will appear in Wave's Proxy Statement for the 2014 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2015, under the caption "Corporate Governance—Audit Committee." Such information is incorporated herein by reference.
Wave's Board of Directors has adopted a code of ethics that applies to its Chief Executive Officer and Chief Financial Officer (the "Code of Ethics"). The Code of Ethics has been posted on Wave's Internet website at www.wave.com. Wave intends to satisfy the disclosure requirements under Item 10 of Form 8-K regarding an amendment to, or waiver from, a provision of the Code of Ethics that relates to a substantive amendment or material departure from a provision of the Code of Ethics by posting such information on its internet website at www.wave.com.
Item 11.    Executive Compensation
Information regarding executive compensation will appear in Wave's Proxy Statement for the 2015 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2015, under the captions "Executive Compensation", "Compensation Committee Report" and "Compensation Committee Interlocks and Insider Participation." Such information is incorporated herein by reference.
Item 12.    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information regarding security ownership of certain beneficial owners and management and related stockholder matters will appear in Wave's Proxy Statement for the 2015 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2015, under the captions "Security Ownership of Certain Beneficial Owners and Management" and "Equity Compensation Plan Information." Such information is incorporated herein by reference.
Item 13.    Certain Relationships and Related Transactions and Director Independence
Information regarding certain relationships and related transactions and director independence will appear in Wave's Proxy Statement for the 2015 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2015, under the captions "Certain Relationships and Related Transactions" and "Director Independence." Such information is incorporated herein by reference.
Item 14.    Principal Accounting Fees and Services
Information regarding Wave's principal accountant's fees will appear in Wave's Proxy Statement for the 2015 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2015, under the caption "Ratification of Independent Registered Public Accounting Firm." Such information is incorporated herein by reference.
PART IV



30


Item 15.    Exhibits and Financial Statement Schedules
(a)
(1)  Financial Statements:

(a)
(2)  Financial Statement Schedules:
All schedules have been omitted since they are either not required or not applicable.
(a)
(3)  Exhibits:
Exhibit No.
 
Description of Exhibit
2.1*
Asset Purchase Agreement, dated October 15, 2014, by and between Wave Systems Corp. (Seller) and DocMagic, Inc. (Buyer), (incorporated by reference to Exhibit 2.1 of Wave's Current Report on Form 8-K, filed on October 21, 2014, File No. 0-24752)
3.1*
Restated Certificate of Incorporation of Wave, as amended (incorporated by reference to Exhibit 3.1 of Wave's Quarterly Report on Form 10-Q, filed on August 9, 2006, File No. 0-24752)
3.2*
Certificate of Amendment of Restated Certificate of Incorporation of Wave (incorporated by reference to Exhibit 3.1 of Wave's Current Report on Form 8-K, filed on July 3, 2013, File No. 0-24752)
3.3*
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).

31



Exhibit No.
 
Description of Exhibit
4.3*
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).
4.4*
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).
4.5*
Form of Warrant issued to Purchasers (incorporated by reference to Exhibit 4.1 of Wave's Current Report on Form 8-K, filed August 10, 2012, File # 0-24752).
4.6*
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 10, 2012, File # 0-24752).
4.7*
Form of Warrant issued to Purchasers (incorporated by reference to Exhibit 4.1 of Wave's Current Report on Form 8-K, filed October 22, 2012, File # 0-24752).
4.8*
Form of Warrant issued to Purchasers (incorporated by reference to Exhibit 4.1 of Wave's Current Report on Form 8-K, filed March 18, 2013, File # 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 April 30, 2013, File # 0-24752).
4.10*
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 July 30, 2013, 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, File December 20, 2013, File #0-24752).
4.12*
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 December 20, 2013, 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, File June 17, 2014, 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*
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)
†10.3*
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)
†10.4*
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)
†10.5*
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).
†10.6*
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).

32



Exhibit No.
 
Description of Exhibit
10.7*

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).
10.8*

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).
10.9*

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).
10.10*

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).
10.11*

At Market Issuance Sales Agreement dated January 30, 2012 between Wave Systems Corp. and MLV & Co. LLC (incorporated by reference to Exhibit 1.1 of Wave's Current Report on Form 8-K, filed January 30, 2012, File #0-24752)
10.12*

Form of Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed August 9, 2012, File # 0-24752)
10.13*

Placement Agency Agreement, dated as of August 7, 2012, 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 9, 2012, File # 0-24752).
10.14*

Form of Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed October 22, 2012, File # 0-24752).
10.15*

Securities Purchase Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed March 18, 2013, File # 0-24752).
10.16*

Form of Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed April 30, 2013, File # 0-24752).
10.17*

Form of Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed July 30, 2013, File # 0-24752).
10.18*

Amendment, dated September 19, 2013, to At Market Issuance Sales Agreement dated January 30, 2012 between Wave Systems Corp. and MLV & Co. LLC (incorporated by reference to Exhibit 1.1 to the Company's Current Report on form 8-K, filed September 20, 2013, File # 0-24752)
10.19*

Factoring and Security Agreement, dated as of November 26, 2013 (incorporated by reference to Exhibit 10.1 of Wave's Form 8-K, filed on December 3, 2013, File #0-24752)
10.20*

Form of Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed December 20, 2013, File # 0-24752).
10.21*

 
Letter Agreement, dated December 19, 2013, between William M. Solms and Wave
10.22*

 
Letter Agreement, dated March 31, 2014, between Walter A. Shephard and Wave
10.23*

 
Form of Subscription Agreement (incorporated by reference to Exhibit 10.1 of Wave's Current Report on Form 8-K, filed June 17, 2014, File # 0-24752).
21.1*

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

Consent of Independent Registered Public Accounting Firm—KPMG LLP
31.1

Section 302 Certification by William M. Solms, President and Chief Executive Officer
31.2

Section 302 Certification by Walter A. Shephard, Chief Financial Officer
32.1

Section 906 Certification

33



Exhibit No.
 
Description of Exhibit
99.1*

Share Purchase Agreement, dated September 22, 2011, by and among Wave Systems Corp., Safend, Ltd., each of the shareholders of Safend named therein and Paul Weinberg & Co., as representative of the shareholders (incorporated by reference to Wave's Form 8-K filed on September 22, 2011)
99.2*

SMB Master Program Agreement, by and between The Receivables Exchange LLC and the other parties thereto, dated as of January 1, 2012 (incorporated by reference to Exhibit 99.1 of Wave's Quarterly Report on Form 10-Q, filed on August 9, 2012, File #0-24752)
99.3*

Registration Rights Agreement by and among Wave and the purchasers of the Class A Common Stock, dated as of March 12, 2013 (incorporated by reference to Wave's Form 8-K filed on March 18, 2013)
101.1

XBRL Instance Document
101.2

XBRL Taxonomy Extension Schema Document
101.3

XBRL Taxonomy Extension Calculation Linkbase Document
101.4

XBRL Taxonomy Extension Definition Linkbase Document
101.5

XBRL Taxonomy Extension Label Linkbase Document
101.6

XBRL Taxonomy Extension Presentation Linkbase Document
 
*    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

34


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 9, 2015
 
 
WAVE SYSTEMS CORP.
 
 
 
 
 
 
 
By:
 
/s/ WILLIAM M. SOLMS
 
 
 
 
 
 
 
 
 
Name:
 
William M. Solms
 
 
 
 
Title:
 
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature
 
Title
 
Date
 
 
 
 
 
/s/ WILLIAM M. SOLMS
 
President, Chief Executive Officer and Director (Principal Executive Officer)
 
March 9, 2015
William M. Solms
 
 
 
 
/s/ DAVID CÔTÉ
 
Chairman
 
March 9, 2015
David Côté
 
 
 
 
/s/ GEORGE GILDER
 
Director
 
March 9, 2015
George Gilder
 
 
 
 
/s/ NOLAN BUSHNELL
 
Director
 
March 9, 2015
Nolan Bushnell
 
 
 
 
/s/ ROBERT FRANKENBERG
 
Director
 
March 9, 2015
Robert Frankenberg
 
 
 
 
/s/ LORRAINE HARITON
 
Director
 
March 9, 2015
Lorraine Hariton
 
 
 
 
/s/ WALTER A SHEPHARD
 
Senior Vice President, Finance and Administration, Chief Financial Officer and Secretary (Principal Financial and Accounting Officer and Duly Authorized Officer of the Registrant)
 
March 9, 2015
Walter A. Shephard
 
 
 

35


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, 2014 and 2013, and the related consolidated statements of operations, stockholders’ deficit, and cash flows for each of the years in the three‑year period ended December 31, 2014. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements 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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
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, 2014 and 2013, and the results of their operations and their cash flows for each of the years in the three‑year period ended December 31, 2014, in conformity with U.S. generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming that Wave Systems Corp. will continue as a going concern. As discussed in note 4 to the consolidated financial statements, Wave Systems Corp. has suffered recurring losses from operations and has a net capital deficiency 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 4. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.


/s/ KPMG LLP
Hartford, Connecticut
March 9, 2015

F-1


WAVE SYSTEMS CORP. AND SUBSIDIARIES
Consolidated Balance Sheets
 
December 31,
 
2014
 
2013
Assets
 

 
 

Current Assets:
 

 
 

Cash and cash equivalents
$
1,777,414

 
$
2,120,102

Accounts receivable, net of allowance for doubtful accounts of $-0- at December 31, 2014 and 2013, respectively
1,820,945

 
2,730,077

Pledged receivables

 
1,683,188

Prepaid expenses
397,689

 
488,656

Total current assets
3,996,048

 
7,022,023

Property and equipment, net
411,755

 
596,820

Amortizable intangible assets, net
2,008,227

 
2,590,920

Goodwill
1,448,000

 
1,448,000

Other assets
169,330

 
167,146

Total Assets
8,033,360

 
11,824,909

Liabilities and Stockholders' Deficit
 

 
 

Current Liabilities:
 

 
 

Secured borrowings

 
1,430,710

Accounts payable and accrued expenses
3,918,493

 
6,789,274

Deferred revenue
5,125,932

 
6,996,239

Total current liabilities
9,044,425

 
15,216,223

Other long-term liabilities
50,779

 
78,618

Royalty liability
4,982,306

 
4,509,629

Long-term deferred revenue
871,677

 
1,003,614

Total liabilities
14,949,187

 
20,808,084

Stockholders' Deficit:
 

 
 

Common Stock, $.01 par value. Authorized 150,000,000 shares as Class A; 45,962,324 shares issued and outstanding at December 31, 2014 and 35,019,740 at December 31, 2013
459,623

 
350,197

Common Stock, $.01 par value. Authorized 13,000,000 shares as Class B; 8,885 shares issued and outstanding at December 31, 2014 and 2013
89

 
89

Capital in excess of par value
422,745,539

 
407,907,019

Accumulated deficit
(430,121,078
)
 
(417,240,480
)
Total Stockholders' Deficit
(6,915,827
)
 
(8,983,175
)
Total Liabilities and Stockholders' Deficit
$
8,033,360

 
$
11,824,909



See accompanying notes to consolidated financial statements.

F-2


WAVE SYSTEMS CORP. AND SUBSIDIARIES
Consolidated Statements of Operations
Years ended December 31, 2014, 2013 and 2012
 
2014
 
2013
 
2012
Net revenues:
 

 
 

 
 

Licensing and maintenance
$
16,670,834

 
$
22,591,914

 
$
27,480,732

Services
300,000

 
1,808,938

 
1,363,781

Total net revenues
16,970,834

 
24,400,852

 
28,844,513

Operating expenses:
 

 
 

 
 

Licensing and maintenance—cost of net revenues
1,215,776

 
3,419,271

 
6,722,221

Services—cost of net revenues
73,000

 
277,665

 
144,111

Selling, general and administrative
18,794,273

 
26,829,636

 
32,632,237

Research and development
10,333,607

 
11,380,258

 
19,055,894

Impairment of goodwill and intangible assets

 
2,590,000

 
4,054,732

Total operating expenses
30,416,656

 
44,496,830

 
62,609,195

Operating loss
(13,445,822
)
 
(20,095,978
)
 
(33,764,682
)
Other income (expense):
 

 
 

 
 

Net currency transaction gain (loss)
(14,828
)
 
(17,220
)
 
12,156

Gain on sale of eSign
1,304,579

 

 

Net interest expense
(712,527
)
 
(200,456
)
 
(197,989
)
Total other income (expense)
577,224

 
(217,676
)
 
(185,833
)
Loss before income tax expense
(12,868,598
)
 
(20,313,654
)
 
(33,950,515
)
Income tax expense
12,000

 
10,610

 
12,033

Net loss
(12,880,598
)
 
(20,324,264
)
 
(33,962,548
)
Loss per common share—basic and diluted
$
(0.30
)
 
$
(0.68
)
 
$
(1.41
)
Weighted average number of common shares outstanding during the year
43,024,449

 
29,825,854

 
24,051,126


   
See accompanying notes to consolidated financial statements.

F-3


WAVE SYSTEMS CORP. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Deficit for each of the years ended December 31, 2014, 2013 and 2012
 
Class A Common
Stock
 
Class B
Common
Stock
 
Capital in
Excess of Par
Value
 
Accumulated
Deficit
 
Total
 
Shares
 
Amount
 
Shares
 
Amount
 
Balance as of December 31, 2011
22,393,595

 
$
223,935

 
8,889

 
$
89

 
$
374,270,219

 
$
(362,953,668
)
 
$
11,540,575


Net loss

 
 

 

 

 
 

 
(33,962,548
)
 
(33,962,548
)
Issuance of Class A Common Stock at prices ranging from $2.60 to $9.12 per share, less issuance costs of $289,617
1,973,267

 
19,733

 

 

 
9,033,860

 

 
9,053,593

Issuance of Class A Common Stock at $2.57 per share, less issuance costs of $129,761
646,956

 
6,470

 

 

 
1,526,446

 

 
1,532,916

Issuance of Class A Common Stock at $4.01 per share, less issuance costs of $259,984
831,188

 
8,312

 

 

 
3,064,766

 

 
3,073,078

Warrants exercised at $2.20 - $2.32 per share
145,000

 
1,450

 

 

 
319,050

 

 
320,500

Employee stock options exercised at $2.08 - $7.80 per share
22,800

 
228

 

 

 
79,275

 

 
79,503

Cashless exercise of warrants at $2.20 per share
10,111

 
101

 

 

 
(101
)
 

 

Shares of Class A Common Stock Issued pursuant to the Wave Employee Stock Purchase Plan at $3.40
139,480

 
1,395

 

 

 
472,838

 

 
474,233

Shares of Class A Common Stock Issued pursuant To the Wave Employee Stock Purchase Plan at $2.144
89,571

 
896

 

 

 
190,966

 

 
191,862

Share-based compensation

 

 

 

 
4,830,831

 

 
4,830,831

Balance at December 31, 2012
26,251,968

 
$
262,520

 
8,889

 
$
89

 
$
393,788,150

 
$
(396,916,216
)
 
$
(2,865,457
)
Net loss

 
 

 

 

 

 
(20,324,264
)
 
(20,324,264
)
Issuance of Class A Common Stock at prices ranging from $0.90 to $2.90 per share, less issuance costs of $188,627
3,811,523

 
38,115

 

 

 
5,314,778

 

 
5,352,893

Issuance of Class A Common Stock at $2.00 per share, less issuance costs of $250,200
1,585,000

 
15,850

 

 

 
2,903,950

 

 
2,919,800

Issuance of Class A Common Stock at $1.27 per share, less issuance costs of $121,781
1,204,470

 
12,045

 

 

 
1,395,851

 

 
1,407,896

Issuance of Class A Common Stock at $0.9725 per share, less issuance costs of $103,133
1,253,351

 
12,533

 

 

 
1,103,217

 

 
1,115,750

Private placement of Class A Common Stock at $3.32 per share, less issuance costs of $90,000
301,205

 
3,012

 

 

 
906,989

 

 
910,001

Employee stock options exercised at $3.24 per share
12,983

 
130

 

 

 
41,909

 

 
42,039

Issuance of Class A Common Stock for developed technology at $1.34 per share
372,578

 
3,726

 

 

 
496,274

 

 
500,000

Shares of Class A Common Stock Issued pursuant to the Wave Employee Stock Purchase Plan at $1.29 per share
132,970

 
1,329

 

 

 
170,467

 

 
171,796

Shares of Class A Common Stock Issued pursuant To the Wave Employee Stock Purchase Plan at $0.98 per share
93,916

 
939

 

 

 
90,864

 

 
91,803

Cash paid for fractional shares in connection with reverse stock split
(224
)
 
(2
)
 
(4
)
 

 
(272
)
 

 
(274
)
Share-based compensation

 

 

 

 
1,694,842

 

 
1,694,842

Balance at December 31, 2013
35,019,740

 
$
350,197

 
8,885

 
$
89

 
$
407,907,019

 
$
(417,240,480
)
 
$
(8,983,175
)
Net loss

 

 

 

 

 
(12,880,598
)
 
(12,880,598
)
Issuance of Class A Common Stock at prices ranging from $0.90 to $1.39 per share, less issuance costs of $171,168
5,410,450

 
54,105

 

 

 
5,328,904

 

 
5,383,009

Issuance of Class A Common Stock at $1.90 per share, less issuance costs of $853,784
5,225,560

 
52,256

 

 

 
9,022,524

 

 
9,074,780

Warrants exercised at $0.91 per share
133,914

 
1,339

 

 

 
120,523

 

 
121,862

Issuance of Class A Common Stock pursuant to the Wave Employee Stock Purchase Plan at $0.94 per share
105,454

 
1,054

 

 

 
98,441

 

 
99,495

Issuance of Class A Common Stock pursuant to the Wave Employee Stock Purchase Plan at $0.88 per share
67,206

 
672

 

 

 
58,167

 

 
58,839

Share-based compensation

 

 

 

 
209,961

 

 
209,961

Balance at December 31, 2014
45,962,324

 
$
459,623

 
8,885

 
$
89

 
$
422,745,539

 
$
(430,121,078
)
 
$
(6,915,827
)



See accompanying notes to consolidated financial statements.

F-4


WAVE SYSTEMS CORP. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended December 31, 2014, 2013 and 2012
 
2014
 
2013
 
2012
Cash flows from operating activities:
 

 
 

 
 

Net loss
$
(12,880,598
)
 
$
(20,324,264
)
 
$
(33,962,548
)
Adjustments to reconcile net loss to net cash used in operating activities:
 

 
 

 
 

Depreciation and amortization
885,657

 
1,009,876

 
2,132,136

Share-based compensation expense
209,961

 
1,694,842

 
4,830,831

Gain on sale of eSign
(1,304,579
)
 

 

Impairment of goodwill and purchased intangible assets

 
4,205,000

 
7,477,832

Accretion of royalty liability
97,300

 
81,400

 
67,500

Changes in assets and liabilities, net of effects from business acquisition:
 

 
 

 
 

Decrease in accounts receivable
1,161,610

 
2,315,840

 
1,900,250

Decrease (increase) in prepaid expenses and other current assets
90,967

 
(66,887
)
 
401,992

(Increase) decrease in other assets
(2,184
)
 
157,468

 
11,993

(Decrease) increase in accounts payable and accrued expenses
(2,960,783
)
 
(735,449
)
 
924,087

(Decrease) increase in deferred revenue
(1,832,745
)
 
238,454

 
106,922

Increase (decrease) in royalty liability
386,377

 
(103,900
)
 
321,076

(Decrease) increase in other long-term liabilities
(27,839
)
 
(19,378
)
 
31,713

Net cash used in operating activities
(16,176,856
)
 
(11,546,998
)
 
(15,756,216
)
Cash flows from investing activities:
 

 
 

 
 

Acquisition of property and equipment
(117,899
)
 
(186,715
)
 
(169,660
)
Internal-use software development costs

 
(226,000
)
 

Proceeds from sale of eSign
1,214,082

 

 

Net cash provided by (used in) investing activities
1,096,183

 
(412,715
)
 
(169,660
)
Cash flows from financing activities:
 

 
 

 
 

Payments on capital lease obligation

 
(44,658
)
 
(72,075
)
Net proceeds from issuance of common stock
14,457,789

 
11,706,066

 
13,659,587

Proceeds from employee stock purchase plans
158,334

 
263,599

 
666,095

Proceeds from employee stock option exercises

 
42,039

 
79,503

Proceeds from exercise of warrants
121,862

 

 
320,500

Net cash provided by financing activities
14,737,985

 
11,967,046

 
14,653,610

Net (decrease) increase in cash and cash equivalents
(342,688
)
 
7,333

 
(1,272,266
)
Cash and cash equivalents at beginning of year
2,120,102

 
2,112,769

 
3,385,035

Cash and cash equivalents at end of year
$
1,777,414

 
$
2,120,102

 
$
2,112,769

Supplemental cash flow information:
 

 
 

 
 

Non-cash financing activities:
 

 
 

 
 

Issuance of common stock for developed technology
$

 
$
500,000

 
$

Cashless exercise of warrants
$

 
$

 
$
404

Cash paid during the year for:
 

 
 

 
 

Interest
$
116,209

 
$
108,462

 
$
119,763

Income taxes
$
7,895

 
$
8,816

 
$
78,235


See accompanying notes to consolidated financial statements.

F-5


WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) Business of the Company
Wave Systems Corp. ("Wave" or "the Company") reduces the complexity, cost and uncertainty of data protection by starting inside the device. Unlike other vendors who try to secure information by adding layers of software for security, Wave leverages the hardware security capabilities built directly into endpoint computing platforms themselves. Wave has been among the foremost experts on this growing trend, leading the way with first-to-market solutions and helping shape standards through its work as a board member for the Trusted Computing Group (the "TCG").
(2) 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, Safend, Ltd. (and its wholly owned subsidiary, Safend, Inc., collectively referred to as "Safend"), a wholly owned subsidiary and Wavexpress, Inc. a majority-owned subsidiary that is dormant. All intercompany accounts and transactions have been eliminated in consolidation.
(b)    Foreign Currency Translation
The functional currency of Safend is the U.S dollar. Transactions and balances originally denominated in U.S. dollars are presented at their original amounts. Foreign currency transaction gains or losses are credited or charged to the consolidated statements of operations as incurred as a component of other income (expense), net.
(c)    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, contingencies and share-based compensation. Actual results could differ from those estimates.
(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.
(e)    Accounts Receivable and Allowance For Doubtful Accounts
Included in accounts receivable at December 31, 2014 and 2013 are unbilled amounts totaling $164,834 and $125,497, 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 of non-collectability due to known facts regarding the customer.
(f)    Accounting for Transfers of Financial Assets
Wave derecognizes financial assets, specifically accounts receivable, when control has been surrendered in compliance with ASC Topic 860, Transfers and Servicing. Transfers of accounts receivable that meet the requirements of ASC 860 for sale accounting treatment are removed from the balance sheet and gains or losses on the sale are recognized. If the conditions for sale accounting treatment are not met, or are no longer met, accounts receivable transferred are classified as collateralized receivables in the consolidated balance sheets and cash received from these transactions is classified as secured borrowings. All transfers of assets are accounted for as secured borrowings. Transaction costs associated with secured borrowings, if any, are treated as borrowing costs and recognized in interest expense.
(g)    Concentrations
Sales to Wave's largest customer in 2014, 2013 and 2012, Dell, Inc., were approximately 32%, 46% and 55% of revenue, respectively. Accounts receivable at December 31, 2014, 2013 and 2012 included receivables from Dell, Inc. and its affiliates of

F-6


WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(2) Significant Accounting Policies (Continued)

$134,621, $1,025,377 and $1,187,398, respectively. At December 31, 2014 and 2013, $0 and $1,683,188, respectively, of Dell receivables are classified as pledged receivables on the consolidated balance sheet.
(h)    Property and Equipment
Property and equipment, including purchased computer software, are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets which range from between 3 years to 5 years. Amortization of leasehold improvements is computed using the shorter of the useful life or remaining lease term which range from between 3 years and 4 years.
(i)    Capitalized internal-use software development costs
The Company follows the provisions of ASC Topic 350-40, Intangibles Goodwill and Other—Internal Use Software. ASC Topic 350-40 provides guidance for determining whether computer software is internal-use software and also provides guidance on capitalization of the costs incurred for computer software developed or obtained for internal use. The capitalized costs as of December 31, 2014 and 2013 are related to Wave's cloud platform that is hosted by the Company and accessed by its clients on a subscription basis. The Company expenses all costs incurred during the preliminary project stage of development and capitalizes the costs incurred during the application development stage. Costs incurred relating to upgrades and enhancements to the software are capitalized if it is determined that these upgrades or enhancements add additional functionality to the software. Costs incurred to improve and support products after they become available are charged to expense as incurred. The Company records amortization of the software on a straight-line basis over five, which is the estimated useful life of the software. At each balance sheet date, management evaluates the unamortized capitalized software costs for potential impairment by comparing the balance to the net realizable value of the products.
(j)    Income Taxes
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, 2014 and 2013, 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. Wave classifies any interest and penalties related to uncertain tax positions as components of the income tax provision.
(k)    Share-based Compensation
Wave recognizes compensation expense for all share-based payment awards made to employees and directors including employee stock options and employee stock purchases related to the Employee Stock Purchase Plan. Share-based compensation expense recognized is based on the value of the portion of share-based payment awards that is ultimately expected to vest and has been reduced for estimated forfeitures. Wave determines the fair value of share-based payment awards on the date of the grant using the Black-Scholes option pricing method which is affected by Wave's stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to the estimated term of the award and Wave's estimated stock price volatility.
(l)    Research and Development and Software Development Costs
Research and development costs are expensed as incurred. Such costs related to software development are included in research and development expense until the point that technological feasibility is reached, which for our software products, is generally shortly before the products are released. Once technological feasibility is reached, such costs are capitalized and amortized to cost of revenue over the estimated lives of the products.
(m)    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. Diluted net loss per share is also computed using the weighted average number of common shares and includes dilutive potential common shares outstanding. Dilutive

F-7


WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(2) Significant Accounting Policies (Continued)

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, 2014, 2013 and 2012 were approximately 144,000 shares, 99,000 shares and 615,000 shares, respectively. Employee stock options and other stock warrants to purchase a weighted average of approximately 6,104,000, 5,504,000 and 3,669,000 shares were outstanding as of December 31, 2014, 2013 and 2012 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.
(n)   Valuation of Long Lived Assets
We review purchased intangible assets with finite lives for impairment whenever events or changes in circumstances indicate the carrying value of an asset group may not be recoverable. Recoverability of asset groups is assessed based on the estimated undiscounted future cash flows expected to be generated by the asset group, including its ultimate disposition. If the sum of the undiscounted cash flows is less than the carrying value, the impairment to be recognized is measured by the amount by which the carrying amount of the asset group exceeds the fair value of the asset group. Assets to be disposed of are reported at the lower of the carrying amount or fair value, less costs to sell.
(o)    Goodwill
We review goodwill for impairment annually and whenever events or changes in circumstances indicate the fair value of a reporting unit is more likely than not below its carrying value. If the implied fair value of the reporting unit’s goodwill is less than the carrying value, the difference is recorded as an impairment loss. We perform a quantitative test and determine the fair value of the reporting unit using the income approach. Under the income approach, we calculate the fair value of the reporting unit based on the present value of estimated future cash flows. Cash flow projections are based on management’s estimates of revenue growth rates and operating margins, taking into consideration industry and market conditions. The discount rate used is based on the weighted-average cost of capital adjusted for the relevant risk associated with business-specific characteristics and the uncertainty related to the business’s ability to execute on the projected cash flows. The reporting unit’s fair value is allocated to all of the assets and liabilities of the reporting unit, including any unrecognized intangible assets, in a hypothetical analysis that calculates the implied fair value of goodwill in the same manner as if the reporting unit was being acquired in a business combination. If the implied fair value of the reporting unit’s goodwill is less than the carrying value, the difference is recorded as an impairment loss.
Determining the fair value of a reporting unit is judgmental in nature and involves the use of significant estimates and assumptions. These estimates and assumptions include revenue growth rates and operating margins used to calculate projected future cash flows, risk-adjusted discount rates and future economic and market conditions. We base our fair value estimates on assumptions we believe to be reasonable but they are unpredictable and inherently uncertain. Actual future results may differ from those estimates.
We will continue to evaluate goodwill on an annual basis as of September 30 and whenever events or changes in circumstances, such as significant adverse changes in business climate or operating results or changes in management’s business strategy, indicate that there may be a potential indicator of impairment.
(p)    Revenue Recognition
Wave's business model targets revenues from various sources including software products and development contracts. Many of these sales arrangements include multiple-elements and/or require significant modification or customization of Wave's software.
Wave recognizes revenue when 1) persuasive evidence of an arrangement exists, 2) delivery has occurred or services have been rendered, 3) fees are fixed or determinable and 4) collectability is reasonably assured. If we determine that any one of the four criteria is not met, we will defer recognition of revenue until all the criteria are met. In addition to the aforementioned general policy, the following are the specific revenue recognition policies for each major category of revenue.
Licensing and Maintenance
Wave receives revenue from licensing its software through distribution arrangements with its OEM partners, license upgrade agreements with end users of the products, software development and other services including maintenance. Wave applies software revenue recognition guidance to all transactions except those where no software is involved.  Revenue is

F-8


WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(2) Significant Accounting Policies (Continued)

recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable and collectability is reasonably assured.  Persuasive evidence is generally a binding purchase order or license agreement.  Delivery occurs when product is shipped for its OEM distribution arrangements, or delivered via a license key for our license upgrade agreements.
Wave enters into perpetual software license agreements through direct sales to customers and indirect sales through its OEM partners, distributors and resellers. Wave has defined its two classes of end user customers: large customers, whose orders are in excess of 5,000 licenses and small customers, whose orders are less than 5,000 licenses. These license upgrade agreements generally include a maintenance component. For arrangements with multiple elements, including software licenses, maintenance and/or services, revenue is allocated and deferred in amounts equivalent to the vendor specific objective evidence ("VSOE") of fair value for the undelivered elements and the difference between the total arrangement fee and the amount deferred for the undelivered elements is recognized as license revenue. VSOE of fair value is based upon the price for which the undelivered element is sold separately.
During the year ended December 31, 2014, Wave further stratified the VSOE of fair value of maintenance analysis to align it with current sales trends with respect to product mix and maintenance terms.  The following represents the resulting updates to VSOE of fair value of maintenance as a result of such further stratification.
 
·Wave products:
 
·VSOE of fair value of maintenance is only applied to bundled license and maintenance arrangements with maintenance terms of one year and less than 5,000 licenses.

Wave has VSOE of fair value of maintenance for its small class of customers based on independent one-year maintenance renewals for its EMBASSY Remote Administration Server (“ERAS”) for Self Encrypting Drives (“SED”) product and its Protector product.  As a result, for the ERAS SED and Protector small customer class licenses with maintenance bundled, Wave allocates the arrangement consideration to the elements in multi-element arrangements using the residual method.  Under the residual method, the VSOE of the undelivered elements is deferred and the remaining portion of the arrangement fee for perpetual licenses is recognized as revenue upon delivery of the software, assuming all other revenue recognition criteria are met.
 
When VSOE of fair value for the undelivered elements does not exist, as is the case for Wave’s maintenance for all products other than ERAS SED and Protector, large customer class ERAS SED and Protector orders, and small customer class ERAS SED and Protector orders when maintenance terms are in excess of one year, the entire arrangement fee is recognized ratably over the performance period as licensing and maintenance revenue.
 
Wave’s deferred revenue consists of the unamortized maintenance for sales to its small class of customers and bundled license and maintenance arrangements where VSOE does not exist.
Licensing and maintenance—cost of net revenues includes customer support personnel costs, foreign tax withholdings, amortization expense of the developed technology intangible asset, costs associated with providing consulting services and related share-based compensation expense.
Services
Revenue from time and material service contracts is recognized as the services are provided. Revenue from fixed price, long-term service or development contracts is recognized using the percentage of completion method or the completed contract method. The determination between use of the completed contract method and the percentage of completion method is based on our ability to reasonably estimate the costs to fulfill the contract. The Company measures the percentage of completion by reference to the proportion of contract hours incurred for work performed to date to the estimated total contract hours expected to be incurred. Losses on fixed price contracts are recognized during the period in which such losses are identified.
Services—cost of net revenues includes non-recurring time and materials costs incurred in connection with fixed price contracts.
(q) Immaterial Correction of an Error

F-9


WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(2) Significant Accounting Policies (Continued)

During the third quarter of 2014, we identified an error in our accounting for share-based compensation recorded in fiscal years 2013, 2012 and 2011and through the six-months ended June 30, 2014. We assessed the materiality of the error on prior periods’ financial statements and concluded that the error was not material to any of our prior period annual or current and prior period interim financial statements. We elected to correct the error in the three-month period ended September 30, 2014 by decreasing operating expenses by $820,000 and decreasing capital in excess of par value on the consolidated balance sheet by the same amount. For the three and nine month periods ended September 30, 2014, loss per basic and diluted share decreased by $0.02 as a result of the correction.
During the fourth quarter of 2014, we identified an error in our accounting for the royalty liability for grants received from the Israeli government through the Office of the Chief Scientist ("OCS") for fiscal years 2013 and 2012 and through the nine months ended September 30, 2014. We assessed the materiality of the error on prior periods' financial statements and concluded that the error was not material to any of our prior period annual or current and prior period interim financial statements. We elected to correct the error in the three-month period ended December 31, 2014 by increasing interest expense by $580,000 and increasing the royalty liability on the consolidated balance sheet by the same amount. For the three and twelve month periods ended December 31, 2014, loss per basic and diluted share decreased by $0.01as a result of the correction.
(r) Recently Adopted Accounting Pronouncements
In August 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-15, Presentation of Financial Statements - Going Concern, which amends the disclosures of uncertainties about an entity's ability to continue as a going concern. The amendments provide guidance in GAAP about management's responsibility to evaluate whether there is substantial doubt about an entity's ability to continue as a going concern and to provide related footnote disclosures. In doing so, the amendments should reduce the diversity in the timing and content of footnote disclosures. The Company is required to adopt the amendments in the first quarter of 2017. Early adoption is permitted. The Company is currently evaluating the impact of these amendments on its Consolidated Financial Statements.
In May 2014, the FASB issued ASU No. 2014-09, Revenue From Contracts With Customers (Topic 606), which amended the existing accounting standards for revenue recognition. The amendments are based on the principle that revenue should be recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The Company is required to adopt the amendments in the first quarter of 2017. Early adoption is not permitted. The amendments may be applied retrospectively to each prior period presented or retrospectively with the cumulative effect recognized as of the date of initial application. The Company is currently evaluating the impact of these amendments and the transition alternatives on its Consolidated Financial Statements.
In April 2014, the FASB issued ASU 2014-08, Reporting Discontinued Operations and Disclosures of Components of an Entity, which updates the definition of discontinued operations under GAAP. Going forward, only those disposals of components of an entity that represent a strategic shift that has (or will have) a major effect on an entity’s operations and financial results will be reported as discontinued operations in the financial statements. Previously, a component of an entity that is a reportable segment, an operating segment, a reporting unit, a subsidiary, or an asset group was eligible for discontinued operations presentation. Additionally, the condition that the entity will not have any significant continuing involvement in the operations of the component after the disposal transaction has been removed. The effective date for the revised standard is for applicable transactions that occur within annual periods beginning on or after December 15, 2014. Early adoption is permitted, but only for disposals (or classifications as held for sale) that have not been reported in financial statements previously issued or available for issuance. The Company adopted this standard in the third quarter of 2014.
(3) Reverse Stock Split
On June 28, 2013, our Board of Directors approved a reverse stock split of our common stock at a ratio of 1-for-4, causing each four 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 on July 1, 2013. Stockholders' equity has been restated to give retroactive recognition to the reverse split for all periods presented by reclassifying the excess par value resulting from the reduced number of shares from common stock to paid-in capital. 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.

F-10

WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)


(4) 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, 2014, has an accumulated deficit of approximately $430,121,000. We also expect Wave will incur an operating loss for the fiscal year 2015. As of December 31, 2014, Wave had negative working capital of approximately $5,048,000.
If Wave is not successful in executing its business plan, Wave will not generate enough revenue to fund its cash flow requirements for the year ended December 31, 2015. As of December 31, 2014, we had approximately $1,777,000 of cash on hand. Given Wave's forecasted cash requirements for the twelve-months ending December 31, 2015, and our cash balance as of December 31, 2014, Wave will be required to raise additional capital prior to December 31, 2015 if its sales and operating performance do not meet expectations. Wave's ability to raise additional capital is primarily based on two sources:
Sales of registered Class A Common Stock under a $15,000,000 shelf registration statement filed with the U.S. Securities and Exchange Commission ("SEC") on December 18, 2014 and declared effective by the SEC on January 7, 2015 ("2015 shelf registration statement"); and

Sales of Class A Common Stock through private placements.
On January 26, 2015, Wave sold 5,513,044 shares of Class A Common Stock at $0.65 per share for gross proceeds of $3,583,479. This financing was completed under the 2015 shelf registration statement. Wave also issued warrants to the subscribers to purchase 2,205,216 shares of Class A Common Stock at an exercise price of $0.70 per share. These warrants expire on July 26, 2020. Security 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% of the gross proceeds of this offering. Wave realized approximately $3,338,000 in net proceeds after deducting the placement agent fees of approximately $215,000 and additional legal and other fees associated with the issuance of these securities totaling approximately $30,000. In connection with the financing, Wave also issued warrants to SRA to purchase up to 330,783 shares of Wave Class A Common Stock for $0.70 per share. These warrants expire on July 26, 2018.
For registered offerings, Wave is required to calculate the amount of capital the Company is allowed to raise in accordance with the General Instruction I.B.6. on Form S-3 (“the one-third rule”). The one-third rule restricts the amount of capital that can be raised in a 12-month period provided that the registrant’s aggregate market value of the common equity held by non-affiliates is less than $75 million. As a result of the application of the one-third rule, the funds available on the 2015 shelf registration statement are reduced. Until Wave attains an aggregate market value of $75 million or more for shares held by non-affiliates, its available funds under the 2015 shelf registration statement will remain restricted to the one-third rule computation. To determine the amount available under the one-third rule for future financings, the aggregate market value of the common equity is calculated using the price at which the common equity was last sold, or the average of the bid and asked prices of the common equity as of a date within 60 days prior to the date of filing. As of March 2, 2015, approximately $9,872,000 in gross proceeds remains under the 2015 shelf registration statement, however Wave is restricted to $9,203,000 as of such date due to the one-third rule.
Wave will be required to sell 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, 2015. If Wave is not successful in executing its business plan, it will 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, cash 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-11


WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)

(5) Property and Equipment
Property and equipment as of December 31 consisted of the following:
 
2014
 
2013
Computer equipment
$
2,729,409

 
$
4,391,637

Furniture, fixtures and improvements
812,977

 
812,977

Computer software
751,248

 
2,725,290

 
4,293,634

 
7,929,904

Less: Accumulated depreciation and amortization
(3,881,879
)
 
(7,333,084
)
Total
$
411,755

 
$
596,820

Depreciation and amortization expense on property and equipment amounted to approximately $303,000, $461,000 and $535,000 for the years ended December 31, 2014, 2013 and 2012, respectively.
(6) Goodwill and Intangible Assets
Goodwill
The following schedule presents the changes in the carrying amount of goodwill associated with the Safend reporting unit during the years ended December 31, 2014 and 2013:
Balance as of December 31, 2012
$
4,038,000