Critical Accounting Policies

6 Months Ended

Jun. 30, 2012

Critical Accounting Policies

Critical Accounting Policies

2.     Critical Accounting Policies

Wave’s discussion and analysis of its financial condition and results of operations are based on the Company’s consolidated financial statements, which have been prepared in accordance with United States generally accepted accounting principles. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported revenues and expenses during the reporting periods. On an ongoing basis, management evaluates its estimates and judgments, including those related to depreciation and amortization, revenue recognition, accounts receivable reserves, valuation of long-lived and intangible assets, 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.

A detailed description of the accounting policies deemed critical to the understanding of the consolidated financial statements is included in the notes to Wave’s audited financial statements for the year ended December 31, 2011, included in its Form 10-K filed with the Securities and Exchange Commission on March 30, 2012.

Revenue Recognition — Wave derives revenues primarily from the licensing of its EMBASSY Trust Suite, endpoint data loss protection products and services and its eTMS software products and development contracts.  All of these sales arrangements may include multiple-elements and/or require significant modification or customization of our software.

Wave recognizes revenue when it is realized or realizable and earned. Wave considers revenue realized or realizable and earned when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectability is reasonably assured. Wave reduces revenue, if applicable, for estimated customer returns, rotations and sales rebates when such amounts can be estimated. When these amounts cannot be estimated Wave defers revenue until the product is sold to the end-user.  In addition to the aforementioned general policy, the following are the specific revenue recognition policies for each major category of revenue:

LICENSES

Wave receives revenue from licensing its EMBASSY Trust Suite software through distribution arrangements with our OEM partners, software development and other services.  Our distribution arrangements lead to separate software license upgrade agreements with the end users of the products distributed by the OEMs.  We apply 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 our OEM distribution arrangements, or delivered via a license key, for our license upgrade agreements.

We enter into perpetual software license agreements, referred to by us as license upgrade agreements, through direct sales to customers and indirect sales through our OEM partners, distributors and resellers with the end users of the products distributed by the OEMs.  We have defined our two classes of end user customers as large and small based on those with orders in excess of 5,000 licenses and those with less than 5,000 licenses, respectively. These license upgrade agreements, or arrangements, 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 licensing revenue.  VSOE of fair value is based upon the price for which the undelivered element is sold separately.  Through December 31, 2010, the Company lacked sufficient maintenance renewal history to determine VSOE for the maintenance component of the arrangement and as a result, recognized the total arrangement fee over the term of the maintenance performance period.

During the quarter ended March 31, 2011, we had sufficient independent maintenance renewals to establish VSOE of fair value of maintenance for our small class of customers.  Through June 30, 2012, we continue to lack sufficient independent maintenance renewals to establish VSOE for our large customer class.  As a result, beginning in the quarter ended March 31, 2011, for the small customer class, we have allocated the arrangement consideration among the elements included in our 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 still the case for our large customer class, the entire arrangement fee is recognized ratably over the performance period as licensing revenue.  At June 30, 2012 and December 31, 2011, our deferred revenue consists of the unamortized balance of maintenance for sales to our small class of customers during the year ended December 31, 2011 and the six-month period ended June 30, 2012 and arrangements where VSOE does not exist — all large customer orders and small customer orders received prior to January 1, 2011.

Safend receives revenue from licensing its endpoint data loss protection products and services through its distribution channels.  Safend 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 delivered via a license key.

Safend enters into perpetual software license agreements, referred to as license upgrade agreements, through direct sales to customers and indirect sales through its OEM partners, distributors and resellers.  These license upgrade agreements, or arrangements, 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 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 licensing revenue.  VSOE of fair value is based upon the price for which the undelivered element is sold separately.

Safend has achieved VSOE for its Encryptor, Protector and Inspector products.  As a result Safend has allocated the arrangement consideration among the elements included in its multi-element arrangements using the residual method. As noted above, under the residual method, the VSOE of fair value for 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 still the case for Safend’s Discoverer, Reporter and Auditor products, the entire arrangement fee is recognized ratably over the performance period as licensing revenue.

Licensing - cost of net revenues includes foreign tax withholdings, customer support personnel costs and share-based compensation expense.

SERVICES

Revenue from time and material service contracts is recognized as the services are provided. Revenue from fixed price, long-term service or development contracts is recognized using the percentage of completion method.  Wave measures the percentage of completion by reference to the proportion of contract hours incurred for work performed to date to the estimated total contract hours expected to be incurred.  Losses on fixed price contracts are recognized during the period in which the loss first becomes apparent.  Payment terms vary by contract.

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

Accounting for Transfers of Financial Assets - We derecognize 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.

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