Share-based Compensation

Employee Stock Option Plans

1994 Employee Stock Option Plan

In January 1994, Wave adopted the 1994 Employee Stock Option Plan (the "1994 Plan"). The total number of shares of Class A Common Stock reserved for issuance under the 1994 Plan, as amended is 6,000,000 shares. The 1994 Plan expires on July 1, 2024. Under the 1994 Plan, both incentive stock options and non-qualified stock options may be granted to officers, key employees and other persons providing services to Wave. Options granted under the plan generally vest over three years and expire ten years from the date of grant. In January 1994, Wave adopted the Non-Employee Directors Stock Option Plan (the "Directors' Plan"). The total number of shares of Class A Common Stock reserved for issuance under the Directors' Plan, as amended, is 250,000 shares. Under the Directors' Plan, as amended, each director who is not an employee of Wave receives an initial grant of options to purchase 3,750 shares of Class A Common Stock; and an additional annual grant to purchase 3,750 shares on the day immediately following each of the dates on which an incumbent director is reelected. The options granted to non-employee directors vest on the day following the grant and expire ten years from the date of grant. Under all of Wave's stock option plans, options are granted with exercise prices that approximate fair market value at the date of grant. All of Wave's stock option plans and amendments thereto have been approved by shareholder vote.

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

Stock-based compensation expense recognized for the years ended December 31, 2014, 2013 and 2012 was $209,961, $1,694,842 and $4,830,831, respectively. The classification of the cost of share based compensation, in the statement of operations, is consistent with the nature of the services being rendered in exchange for the share based payment.

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



	2014		2013		2012
Cost of Sales	$	13,845	$	28,084	$	47,371
Selling, General & Administrative	136,525		1,250,543		3,400,978
Research & Development	59,591		416,215		1,382,482
Total	$	209,961	$	1,694,842	$	4,830,831

Wave uses the Black-Scholes-Merton option pricing model to value stock options. The Black-Scholes-Merton model requires the use of employee exercise behavior data and the use of a number of assumptions including volatility of the company's stock price, the weighted-average risk-free interest rate and the weighted-average expected term of the options. As Wave does not pay dividends on its Class A Common Stock, the dividend rate variable in the Black-Scholes-Merton model is zero.

The following values for the indicated variables were used to value options granted during the years ended December 31:



	2014		2013		2012
	Stock Option Plans	Stock Purchase Plan	Stock Option Plans	Stock Purchase Plan	Stock Option Plans	Stock Purchase Plan
Expected Term	4.1 Years	6 Months	4.5 Years	6 Months	4.9 Years	6 Months
Risk-free Rate—range	1.41% - 1.80%	0.06% - 0.08%	0.65% - 1.68%	0.08% - 0.10%	0.57% - 1.20%	0.12% - 0.14%
Risk-free Rate—wt. avg.	1.57%	7.00%	1.09%	0.10%	0.85%	0.13%
Expected Volatility—range	81.8% - 87.4%	76.5% - 89.1%	88.4% - 98.1%	89.6% - 90.8%	91.8% - 96.0%	62.6% - 95.6%
Expected Volatility—wt. avg.	74.6%	84.2%	93.9%	90.5%	92.5%	75.5%
Dividend Yield	0%	0%	0%	0%	0%	0%

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

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

The expected term of employee stock options represents the weighted average period that the stock options are expected to remain outstanding. For Wave's stock option plans, the expected term is based upon an analysis of the historical behavior of option holders during the period from January 1, 2010 to December 31, 2014. Management believes historical data is representative of future exercise behavior. For Wave's Employee Stock Purchase Plan, the expected term of six months, is the length of each purchase period, pursuant to the plan.

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

A summary of option activity for all Wave option plans through December 31, 2014 follows:



	2014				2013				2012
	Number of Shares		Weighted Average Exercise Price		Number of Shares		Weighted Average Exercise Price		Number of Shares		Weighted Average Exercise Price
Balance at beginning of year	3,383,554		$	7.78	3,341,575		$	9.51	2,936,392		$	10.20
Granted	1,488,300		1.19		950,222		2.69		732,081		8.20
Forfeited	(593,476	)	1.73		(495,396	)	7.63		(123,875	)	10.88
Expired	(933,496	)	10.04		(399,864	)	10.55		(180,223	)	15.20
Exercised	—		—		(12,983	)	3.24		(22,800	)	3.48
Balance at end of year	3,344,882		5.20		3,383,554		7.78		3,341,575		9.51
Exercisable at end of year	1,833,719		8.04		2,304,154		$	8.94	2,129,510		$	8.68
Additional shares available for grant at end of year	2,190,092				2,371,405				1,146,683

The weighted average grant date fair value of options granted during the years ended December 31, 2014, 2013 and 2012 was $0.61, $1.89 and $5.72, respectively.

The weighted average remaining contractual term for options outstanding and options exercisable at December 31, 2014 were 6.8 and 4.9 years, respectively.

As of December 31, 2014, unrecognized stock-based compensation related to stock options was approximately $945,000. At December 31, 2014, the weighted average period this cost is expected to be expensed over is 1.4 years. The total fair value of shares that vested during the years ended December 31, 2014, 2013 and 2012 was approximately $2,402,000, $4,405,000 and $3,996,000, respectively.

As of December 31, 2014, the intrinsic value of outstanding, vested and currently exercisable share options was $0.

The following table summarizes information about stock options outstanding under the Wave stock options plans as of December 31, 2014:



	Options Outstanding				Options Exercisable
Exercise Price Range	Number Outstanding	Weighted Average Remaining Contractual Life	Weighted Average Exercise Price		Number Exercisable	Weighted Average Exercise Price
$0.25 - $3.50	1,707,528	8.3	$	1.47	454,541	$	2.74
$3.51 - $7.00	353,806	7.2	$	3.97	176,448	$	4.12
$7.01 - $8.00	482,654	3.4	$	7.69	482,654	$	7.69
$8.01 - $12.00	483,055	5.7	$	9.13	402,237	$	9.19
$12.01 - $18.00	81,306	2.9	$	13.19	81,306	$	13.19
$18.01 - $20.00	236,533	5.6	$	18.36	236,533	$	18.36
	3,344,882				1,833,719

Employee Stock Purchase Plan

In November 2004, the Board of Directors adopted the Wave Systems Corp. 2004 Employee Stock Purchase Plan. The Purchase Plan was ratified by a shareholder vote at Wave's 2005 annual shareholder meeting on May 23, 2005. Under the terms of the Purchase Plan, employees may elect to have withheld, up to 15% of their base earnings to purchase these shares during each offering period, up to a maximum of $25,000 in market value of Wave's Class A Common Stock. Offering periods commence on June 1st and December 1st and are for a period of six months. The purchase price under the Purchase Plan is 85% of the lesser of the market price on the beginning or the ending of the offering period.

For the year ended December 31, 2014, employees purchased 172,660 shares of Wave Class A Common Stock at an average share price of $0.92 per share, for an aggregate of $158,334 in proceeds to Wave. For the year ended December 31, 2013, employees purchased 226,886 shares of Wave Class A Common Stock at an average share price of $1.16 per share, for an aggregate of $263,599 in proceeds to Wave. For the year ended December 31, 2012, employees purchased 229,052 shares of Wave Class A Common Stock at an average share price of $2.92 per share, for an aggregate of $666,095 in proceeds to Wave.