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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the transition period from                      to                    

Commission File Number 0-24752

Wave Systems Corp.

(Exact name of registrant as specified in its charter)

480 Pleasant Street

Lee, Massachusetts 01238

(Address of principal executive offices)

Registrant’s telephone number, including area code:

(413) 243-1600

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 x   No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, 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 x   No 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 “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o   No x

The number of shares outstanding of each of the issuer’s classes of common stock as of May 3, 2012: 92,331,618 shares of Class A Common Stock and 35,556 shares of Class B Common Stock.

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Wave Systems Corp. and Subsidiaries

Quarterly Report on Form 10-Q for the Quarter Ended March 31, 2012

Index

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PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

WAVE SYSTEMS CORP. AND SUBSIDIARIES

Consolidated Balance Sheets

(Unaudited)

See accompanying notes to unaudited consolidated financial statements.

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Consolidated Statements of Operations

(Unaudited)

See accompanying notes to unaudited consolidated financial statements.

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity and Comprehensive Income (Loss)

(Unaudited)

See accompanying notes to unaudited consolidated financial statements.

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Unaudited)

See accompanying notes to unaudited consolidated financial statements.

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WAVE SYSTEMS CORP. AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements

March 31, 2012 and 2011

In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the financial position of Wave Systems Corp. (“Wave”) as of March 31, 2012 and December 31, 2011, and the results of its operations and cash flows for the three-month periods ended March 31, 2012 and 2011.  Such financial statements have been prepared in accordance with the applicable regulations of the Securities and Exchange Commission (the “Commission”).

Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted.  It is suggested that these consolidated financial statements be read in conjunction with Wave’s audited financial statements and notes thereto for the year ended December 31, 2011, included in its Form 10-K filed on March 30, 2012.  The results of operations for the three-months ended March 31, 2012 are not necessarily indicative of the operating results for the full year or any future periods.

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 acquired on September 22, 2011.  All significant intercompany transactions have been eliminated.

1.     Business Combination

Acquisition of Safend

On September 22, 2011 we completed our acquisition of Safend, a company incorporated under the laws of Israel.  Safend provides endpoint data loss protection solutions, including port and device control, encryption for removable media and content inspection and discovery. The goodwill recorded in connection with this business combination is primarily related to the ability of the acquired company to develop new products and technologies in the future and incorporates expected synergies to be achieved in connection with the acquisition.  The goodwill recognized is not expected to be deductible for income tax purposes.  Transaction costs associated with this business combination consisted primarily of legal fees which were expensed as incurred and amounted to approximately $405,000.

The fair value of consideration transferred was $12,477,528.  The fair value of consideration consisted of $1.1 million in cash and 5,267,374 shares of Wave Class A common stock valued at the September 22, 2011 closing price of $2.16 per share.  There is no contingent consideration related to this transaction.  The assets, liabilities and operating results of Safend have been reflected in our consolidated financial statements from the date of acquisition.

Allocation of Purchase Price

The total purchase price paid for the 100% equity interest in Safend has been allocated to the acquired assets and assumed liabilities based on their estimated fair value at the date of acquisition. As part of the process, we performed a preliminary valuation analysis to determine the fair values of certain assets and liabilities of Safend as of the acquisition date. The determination of the value of these components required us to make various estimates and assumptions. Critical estimates in valuing certain of the intangible assets include, but are not limited to, the net present value of future expected cash flows from product sales and services. The fair value of deferred revenue was determined based on the estimated direct cost of fulfilling

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the obligation to the customer plus a normal profit margin, while the fair value for all other assets and liabilities acquired was determined based on estimated future benefits or legal obligations associated with such respective asset or liability. The excess of the purchase price over the net identifiable intangible assets, other identifiable assets acquired and liabilities assumed has been recorded as goodwill. Goodwill has been reflected in the Safend segment.  The following table summarizes the preliminary estimated fair values of the assets acquired and liabilities assumed at the acquisition date.

These preliminary estimates are subject to change during the measurement period (up to one year from the acquisition date) as we finalize the valuation of certain assets acquired and liabilities assumed in connection with the acquisition.

Adjustments for Receivables and Deferred Revenue

As previously reported, the Company has determined that certain previously filed financial statements relating to Safend should not be relied upon due to certain accounting errors including: (i) improperly applied revenue recognition criteria, (ii) a bookkeeping error in the accounting for deferred revenue, and (iii) certain accounts receivable determined to be uncollectible.  As a result of these errors, in the preliminary purchase price allocation reported by the Company during the third quarter ended September 30, 2011, acquired accounts receivable was overstated by $649,480 and acquired deferred revenue was understated by $383,726.

The Company has corrected the initial allocation of the purchase price to properly state the acquired receivables and deferred revenue.  The errors amounted to $1,033,206 in the aggregate, the details of which have been reflected in the table above.  Pursuant to the terms of the Share Purchase Agreement to acquire Safend (SPA), as part of the closing, 600,723 Wave shares with a value at September 22, 2011 of approximately $1,300,000 were placed into escrow with two thirds of the amount to be released 12 months subsequent to the closing date and one third to be released after an additional 6 months. Pursuant the terms of the SPA, the Company was provided 60 days subsequent to the closing date of September 22, 2011 to present a final working capital statement and any negative adjustment to the purchase price based upon final working capital being below an agreed upon target. The selling shareholders would have 45 days to review and dispute any such adjustment.  The SPA called for adjudication by an independent accounting firm of any proposed adjustments to the working capital statement if not agreed upon by the Company and

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the selling shareholders.  Once determined, any adjustment to the purchase price based upon the working capital being below the agreed upon target would have resulted in a return of that value to the Company from the shares held in escrow.  Because management did not identify the errors during the 60 day period, the Company did not propose to adjust the final working capital statement or the purchase price.  The errors were subsequently identified during the preparation of the Company’s consolidated financial statements for the year ended December 31, 2011. The Company is evaluating its rights under the SPA and may pursue legal remedies for breaches of representations and warranties arising from these errors.  As a result of the foregoing, the financial impact of these errors was recorded in the Company’s consolidated statement of operations during the three months ended December 31, 2011.

Adjustment for Royalty Obligation

As previously reported, Safend has received grants from the government of Israel through the Office of the Chief Scientist of Israel’s Ministry of Industry, Trade and Labor (OCS), for the financing of a portion of its research and development expenditures in Israel. Safend is required to pay back the grants to the Israeli government based on a royalty rate of 3.5% of total Safend revenues and there is no termination date for the payments.  The Israeli government charges interest at LIBOR for any outstanding grant amounts due to be repaid.  As part of the preliminary purchase price allocation recorded in the third quarter ended September 30, 2011, the Company did not record the fair value of the obligation to the Israeli government associated with these grants.  The total value of the grants owed as of September 22, 2011 was approximately $5.4 million and the Company determined the fair value of this liability was $4,043,000.  In connection with this adjustment, the Company also revised the amounts which had previously been recorded for acquired intangible assets in the amount of $1,770,000 and goodwill in the amount of $2,273,000.  These amounts have been reflected in the table above.  At March 31, 2012 and December 31, 2011, this liability amounted to $4,212,334 and $4,307,553, respectively, reflecting additional grants received and amounts repaid since the acquisition date.  The Company’s policy to accrete the discount recorded to the liability subsequent to the acquisition date is based on the effective interest method.

Unaudited Pro Forma Financial Information

As a result of historical errors identified in the historical Safend financial statements, presentation of unaudited pro forma financial information is impracticable.

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.

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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 March 31, 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 March 31, 2012 and December 31, 2011, our deferred revenue consists of the unamortized balance of maintenance for sales to our small class of customers 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

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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 VSOE of fair value 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.

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.

3.     Liquidity

The accompanying consolidated financial statements have been prepared assuming that Wave will continue as a going concern.  Wave has had substantial operating losses since its inception, and as of March 31, 2012, had an accumulated deficit of $371,266,758.  We also expect Wave will incur an operating loss for the fiscal year 2012.  As of March 31, 2012, we had negative working capital of $5,943,768.

Due to the early stage nature of its market category, Wave is unable to predict with a high enough level of certainty whether enough revenue will be generated to fund its cash flow requirements for the twelve-months ending March 31, 2013.  As of March 31, 2012, we had approximately $2.3 million of cash on hand.  Given Wave’s forecasted capital requirements for the twelve-months ending March 31, 2013, our cash balance as of March 31, 2012, and the uncertainty as to whether we will generate sufficient revenue, Wave will be required to raise additional capital to continue to fund its operations.  We expect to obtain additional funding as needed from further sales of newly issued shares of Class A Common Stock, including the sale of Class A Common Stock under the remaining availability of our $30,000,000 shelf

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registration statement that we filed on June 21, 2011 and was declared effective by the Commission on July 22, 2011.  As of May 8, 2012, approximately $23,979,000 in gross proceeds are available under the June 21, 2011 shelf registration statement, which may be utilized for future financings.  We can provide no assurances as to whether, if necessary, we will be successful in raising the needed capital to continue as a going concern.

During January 2012, we entered into an At the Market Sales Agreement with MLV & Co. LLC (“MLV”) under which we are able to sell shares of our common stock for aggregate gross proceeds of $20,000,000 from time to time through MLV. During the three-month period ended March 31, 2012, Wave sold 1,114,241 shares of its Class A common stock through MLV at an average price of $2.19 per share, for net proceeds of approximately $2.4 million after deducting offering costs of approximately $75,000. Subsequent to March 31, 2012, Wave sold 997,418  shares of its Class A common stock through MLV at an average price of $1.57 per share, for net proceeds of approximately $1.5 million after deducting offering costs of approximately $47,000.   As of May 8, 2012, Wave has sold a total of approximately 2.1 million shares of its common stock through MLV, raising net proceeds of approximately $3.9 million after deducting offering costs of approximately $122,000.

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.

4.               Loss per Share

Basic net loss per common share has been calculated based upon 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 excludes dilutive potential common shares outstanding, as their effect is anti-dilutive.  Dilutive potential common shares consist primarily of employee stock options and stock warrants.  Diluted net loss per share is equal to basic net loss per share and is therefore not presented separately in the financial statements.  The weighted average number of potential common shares that would have been included in diluted loss per share, had their effect not been anti-dilutive for each of the quarters ended March 31, 2012 and 2011, were approximately 3,969,000 shares and 8,599,000 shares, respectively.  Employee stock options and other stock warrants to purchase a weighted average of approximately 16,852,000 and 15,715,000 shares were outstanding for the quarters ended March 31, 2012 and 2011 respectively, but these shares were not included in the computation of diluted loss per share because the exercise price of these stock options and other stock warrants was greater than the average share price of Wave’s common shares and, therefore, their effect would have been anti-dilutive.

5.               Recent Accounting Pronouncements

In May 2011, the Financial Accounting Standards Board (“FASB”) issued new guidance to achieve common fair value measurement and disclosure requirements between GAAP and International Financial Reporting Standards. This new guidance amends current fair value measurement and disclosure guidance to include increased transparency around valuation inputs and investment categorization. This new guidance is effective for fiscal years and interim periods beginning after December 15, 2011. The adoption of this guidance has not had a material impact on our consolidated financial position, results of operations or cash flows.

In September 2011, the FASB issued new guidance intended to simplify goodwill impairment testing. Under this guidance, an entity is allowed to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. An entity is not required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. This new guidance includes a number of factors to consider in conducting the qualitative assessment. We do not expect that the adoption of this new accounting guidance will have a material impact on our consolidated financial position, results of operations or cash flows.

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6.     Share-based Compensation

Wave recognized $1,355,752 and $1,193,883 of share-based compensation during the three-months ended March 31, 2012 and 2011, respectively.  During the three-months ended March 31, 2012, Wave granted 2,616,250 stock options at a weighted-average estimated fair value of $1.53.  During the three-months ended March 31, 2011, Wave granted 2,070,415 stock options at a weighted-average estimated fair value of $2.88.

The following table summarizes the effect of share based compensation in Wave’s statement of operations, for the three-month periods ended March 31, 2012 and 2011:

7.     Amortizable Intangible Assets and Goodwill

Wave’s amortizable intangible assets consist of two patents acquired on May 7, 2010 for $1,100,000 and $10,578,000 of identifiable intangible assets acquired as a result of the Company’s acquisition of Safend on September 22, 2011.

The patents were acquired by Wave from a company owned by Robert Thibadeau, Ph. D., a noted computer security expert who joined Wave in February 2010 as Senior Vice President and Chief Scientist.  The patents were issued in 2006 and 2008 and are valid until 2021.  Both patents concern the methods and systems for promoting security in a computer employing attached storage devices.  The patents are being amortized on a straight-line basis over 5 years based upon their estimated useful life.

The fair value of the identifiable intangible assets acquired as a result of the Company’s acquisition of Safend on September 22, 2011 was determined based on the present value of the expected future cash flows from the Safend intangibles acquired. Wave also recorded $6,216,059 of goodwill in connection with the acquisition of Safend. All goodwill is reported in the Safend operating segment. None of the goodwill recorded upon the acquisition is expected to be deductible for tax purposes.

The allocation of the purchase price for the acquisition of Safend was based upon a preliminary valuation and changes to amounts recorded as assets or liabilities, such as tax assets and liabilities, which may result in corresponding adjustments to goodwill during the measurement period (up to one year from the acquisition date).  The Company expects the allocation of the purchase price for Safend to be finalized in the third quarter of 2012.

The following schedule presents the changes in the carrying amount of goodwill during the period ended March 31, 2012:

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Wave will test goodwill for impairment annually at the reporting unit level using a fair value approach in accordance with the provisions of ASC Topic 350, Intangibles—Goodwill and Other. Wave will conduct an annual impairment test on September 30, of each year. The initial step requires Wave to determine the fair value of each reporting unit and compare it to the carrying value, including goodwill, of such reporting unit. If the fair value exceeds the carrying value, no impairment loss is to be recognized. However, if the carrying value of the reporting unit exceeds its fair value, the goodwill of this unit may be impaired. The amount of impairment, if any, is then measured based upon the estimated fair value of goodwill at the valuation date.  If an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value, goodwill will be evaluated for impairment between annual tests.

The following schedule presents the details of intangible assets as of March 31, 2012 and December 31, 2011:

Amortization expense associated with intangible assets was $402,799 and $55,000 for the three months ended March 31, 2012 and 2011, respectively. The estimated amortization expense for intangible assets for the next five years and thereafter is as follows (in thousands):

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8.     Income Taxes

Wave has not recorded any income tax expense due to the net loss incurred for all periods presented.  Wave has federal and state net operating loss carryforwards of approximately $276.3 million, which expire beginning in 2012 through 2031 and include approximately $7.2 million of net operating loss carryforwards of Safend, Inc., a wholly owned US-based subsidiary of Safend.  Pursuant to Section 382 of the Internal Revenue Code, the annual utilization of Wave’s net operating and capital loss carryforwards may be substantially limited if a cumulative change in ownership of more than 50% occurs within any three-year period.  Wave has not determined whether there have been such cumulative changes in ownership or the impact on the utilization of the loss carryforwards if such changes have occurred.  However, in considering Section 382 of the Internal Revenue Code, Wave believes that it is likely that such a change in ownership occurred prior to or following Wave’s initial public offering in September 1994 and, potentially, in periods following, thus raising the likelihood that such net operating and capital loss carryforwards are subject to annual limitations.

9.           Segment Reporting

Wave’s products include the Wave EMBASSY® digital security products and services (“EMBASSY®”) and Safend’s endpoint data loss protection products and services.  These products and services constitute Wave’s reportable segments as of March 31, 2012.  The 2011 segment information previously included financial information pertaining to Wavexpress and their broadband media distribution products and services.  The operations of Wavexpress were suspended in late 2008.  Since that time, Wavexpress’ expenses have consisted primarily of a minor amount of share-based compensation expense and interest expense.  For all periods presented, these expenses are included with the Wave EMBASSY® digital security products and services segment.

Net losses for reportable segments exclude net interest income (expense) and other income.  These items are not reported by segment since they are excluded from the measurement of segment performance reviewed by Wave’s Chief Financial Officer.

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The following sets forth reportable segment data:

The following table details Wave’s sales by geographic area for the three-month periods ended March 31, 2012 and 2011.  Geographic area is based on the location of where the products were shipped or services rendered.

Approximately 90% of all long-lived assets of Wave are located within the United States of America and approximately 10% are located in the State of Israel.

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Customers, by segment, from which Wave derived revenue in excess of 10% for the three-month periods ended March 31st are as follows:

10.   Issuance of Common Stock

During the three-month period ended March 31, 2012, Wave received net proceeds of $2,359,382 after deducting offering costs of approximately $75,000,  in connection with the issuance of 1,114,241 shares of Class A Common Stock in its at the market offerings through MLV.  The shares were sold at prices ranging from $2.10 - $2.28 per share.

During the three-month period ended March 31, 2012, Wave received gross proceeds of $118,250 in connection with the issuance of 215,000 shares of Class A Common Stock upon the exercise of warrants that were granted to investors as part of Wave’s March and April 2009 financings.  The warrants were exercised at $0.55 per share.

During the three-month period ended March 31, 2012, 13,299 shares of Class A Common Stock were issued to SRA upon the cashless exercise of warrants that were granted to this placement agent as part of Wave’s March 2009 financing.  The warrants were exercised at $0.55 per share.

During the three-month period ended March 31, 2012, Wave received gross proceeds of $60,552 in connection with the issuance of 65,432 shares of Class A Common Stock upon the exercise of employee stock options.  The employee stock options were exercised at exercise prices ranging from $0.81 - $1.95 per share.

During the three-month period ended March 31, 2011, Wave received gross proceeds of $826,557 in connection with the issuance of 802,403 shares of Class A Common Stock upon the exercise of warrants that were granted to investors as part of Wave’s 2009 and 2008 financings.  The warrants were exercised at exercise prices ranging from $0.55 - $1.155 per share.

During the three-month period ended March 31, 2011, 83,304 shares of Class A Common Stock were issued to Security Research Associates upon the cashless exercises of warrants that were granted to this placement agent as part of Wave’s 2009 and 2008 financings.  The warrants were exercised at exercise prices ranging from $0.40 - $0.55 per share.

During the three-month period ended March 31, 2011, Wave received gross proceeds of $636,080 in connection with the issuance of 361,300 shares of Class A Common Stock upon the exercise of employee stock options.  The employee stock options were exercised at exercise prices ranging from $0.50 - $3.54 per share.

11.   Fair Value Measurement

As of March 31, 2012, Wave’s financial assets that are measured at fair value on a recurring basis are comprised of overnight money market fund investments.  Wave invests excess cash from its operating cash accounts in overnight money market funds and reflects these amounts (approximately $1,431,000 at March 31, 2012) within cash and cash equivalents on the consolidated balance sheet using quoted prices in active markets for identical assets (Level 1) at a net value of 1:1 for each dollar invested.

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

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12.   Contingencies

Landmark Ventures, Inc. (“Landmark”) has asserted that Safend Inc. (“Safend USA”), a subsidiary of Safend Ltd. (Wave’s Israeli subsidiary), has breached a consulting agreement between Landmark and Safend USA (the “Consulting Agreement”) which was terminated by Safend USA in July of 2011. According to an amended complaint filed in January 2012 by Landmark in the federal district court in New York, Safend USA (a) owes unspecified amounts to Landmark and (b) violated a provision of the Consulting Agreement by working with a former Landmark employee, resulting in damages of no less than $5,000,000.  Landmark has also named Safend Ltd. and Wave Systems Corp. (“Wave”) as defendants, alleging that both companies are legally responsible for Safend USA’s alleged breaches.  Safend USA, Safend Ltd. and Wave have moved to dismiss the Landmark amended complaint in its entirety.  The motion to dismiss is currently pending before the court.

13.   Subsequent Events

Subsequent to March 31, 2012, Wave sold 997,418  shares of its Class A common stock through MLV at an average price of $1.57 per share, for net proceeds of approximately $1.5 million after deducting offering costs of approximately $47,000.   As of May 8, 2012, Wave has sold a total of approximately 2.1 million shares of its common stock through MLV, raising net proceeds of approximately $3.9 million after deducting offering costs of approximately $122,000.

CERTAIN FORWARD-LOOKING INFORMATION:

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  These statements include, but are not limited to, statements regarding contingencies, future prospects, liquidity and capital expenditures herein under “Part I Financial Information—Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations.”  The words “may,” “would,” “will,” “expect,” “estimate,” “anticipate,” “believe,” “intend” and similar expressions and variations thereof are intended to identify forward-looking statements.  Investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, many of which are beyond our ability to control.  Actual results could differ materially from those projected in the forward-looking statements as a result of the risk factors set forth below and detailed in our other filings with the Commission during the past 12 months.  Wave assumes no duty to and does not undertake to update any forward-looking statements.

Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

Our Business

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

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

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 (the “TCG Board”).  Wave has also elevated its

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membership status to “Promoter”, the highest level of the TCG. Permanent members of the TCG Board provide guidance to the organization’s work groups in the creation of specifications used to protect personal computers (“PCs”) and other computing devices from attacks and to help prevent data loss and theft.  Wave’s enhanced membership status allows it to take a more active role in helping to develop, define and promote hardware-enabled trusted computing security technologies, including related hardware building blocks and software interfaces.  Wave is eligible to serve on and chair the TCG Board and the Work Groups and Special Committees thereof.  Wave is permitted to submit revisions and addendum proposals for specifications with design guides and is similarly permitted to review and comment on design guides prior to their adoption.

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

The TCG has significantly expanded industry participation in security hardware standards and now includes industry leaders offering additional platforms such as storage devices, SmartPhones, cell phones and other consumer electronics.  The overall number of PC models being offered by original equipment manufacturers (“OEMs”) and equipped with a TPM, combined with the increased number of OEMs that have introduced TPM-equipped models, has continued to accelerate the rate at which TPMs are being shipped by the PC industry.  Within the TCG there are TCG Working Groups that are developing specifications to extend TCG technologies to other devices such as storage devices, network products, servers, peripherals and mobile devices.  The offering of products using TCG specifications to the PC market is an important development in the creation of the market for hardware-based computer security.  Wave is continuing to execute its strategy to leverage its EMBASSY Trust System in an effort to become a leading developer of software, applications and services for this market.

Prior to the formation of the TCG, Wave developed its pioneering EMBASSY® (EMBedded Application Security SYstem) Trust System.  The EMBASSY Trust System is a combination of client hardware consisting of the EMBASSY 2100 security chip (the “EMBASSY chip”) and its firmware, and software consisting of the Trust Assurance Network (“TAN”), a back-office infrastructure that manages its security functions.  As the market for TPM-enabled products has developed with computing devices being shipped in volume by leaders in the PC industry, Wave has enabled the development work on the EMBASSY Trust System to support security hardware based on the TCG specifications by repurposing these product assets.  Wave has since developed a set of applications known as the EMBASSY Trust Suite, EMBASSY Trust Server products, middleware and software tools to work with various other chip manufacturers’ TCG-specified TPMs that are now available.  Wave’s products support cross-platform interoperability for the currently available TPM chips from Nuvoton Technology Corporation, Atmel, Broadcom, Infineon Technologies AG, and ST Microelectronics and have been verified for usage on TPM platforms shipped by Dell, Acer, Intel, Lenovo, HP, ASUS, NEC and Fujitsu.

Wave’s operations to-date have consisted primarily of product development, performance under contract to develop products and marketing and sales to PC and semi-conductor chip OEMs, resellers, and enterprises.  Wave has been successful in signing distribution and reseller contracts with Intel, Nuvoton, ST Microelectronics, Dell Products LP (“Dell”), Acer, ASUS and Broadcom.

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Our Products

Client-side Applications

EMBASSY Trust Suite

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

The ESC enables the user to set up and configure the TPM platform.  In addition to the basic function of making the TPM operational, the ESC is designed to enable the user to manage extended TPM-based security settings and policies, including strong authentication, Windows logon preferences to add biometrics and streamlined password policy management.  In January 2009, the TCG published storage specifications for another major trusted hardware component, the self-encrypting drive or SED.  The ESC software contains advanced lifecycle management tools for the SED.  Trusted Drive Manager is the software utilized for managing SEDs.  SEDs are designed to provide advanced data protection technology and they differ from software-based full disk encryption in that encryption takes place in hardware in a manner designed to provide robust security without slowing processing speeds.  Because the drives are factory-installed, the systems can be configured such that encryption is “always on” for the protection of proprietary information.  SEDs from Seagate (DriveTrustTM technology) and Samsung, which unveiled the first solid-state SED using flash memory, work with Wave’s client software EMBASSY Trusted Drive Manager for pre-boot authentication and initialization of the drive.

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

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

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

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

Wave plans to continue to develop and enhance the current products being developed within this product group and to develop new applications and services as the trusted computing market continues to evolve.  Current planned development costs for this product group are expected to be approximately $5.6 million for the twelve months ending March 31, 2013.

Middleware and Tools

TCG-Enabled Toolkit

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

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Wave TCG-Enabled Cryptographic Service Provider (“CSP”)

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

Current planned development costs for this product group are expected to be approximately $5.7 million for the twelve months ending March 31, 2013.

EMBASSY Trust Server Applications

EMBASSY Key Management Server (“EKMS”)

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

EMBASSY Authentication Server (“EAS”)

EAS is offered to provide centralized management, provisioning and enforcement of multifactor domain access policies.  With EAS, authentication policies can be based on TPM credentials, smart card credentials, user passwords and fingerprint templates.  With EAS, authentication policies can be provisioned and managed from the domain controller.  EAS also has an integrated biometric template capability.

EMBASSY Remote Administration Server (“ERAS”)

ERAS is a server product that is offered to provide centralized management and auditing of TPMs and SEDs.  ERAS is designed to give IT administrators the ability to deploy and remotely manage SED and TPM systems, including initialization, pre-boot authentication management, recovery and repurposing of TPMs and SEDs.  ERAS is designed to provide auditing capabilities that aid in compliance management by allowing for validation of TPM and SED security settings and to allow IT administrators to assess the risk of whether a lost or compromised PC is adequately secure.  ERAS is designed to facilitate enterprise adoption of TPM and SED technology as it provides IT administrators with tools to utilize the security of these devices while reducing deployment and management costs.  The latest version of EMBASSY Trust Suite, including TDM, incorporates support for Seagate’s Momentus FDE 7200-RPM SED and Samsung’s SEDs (standard and solid-state versions) — both shipping on Dell’s E-Series notebook PCs.  This version also supports Fujitsu’s 2.5-inch High Definition Drive - technology based upon the Opal Security Subsystem Class (SSC) specification — an industry standard issued by the TCG.  The SSC specification gives vendors an industry standard for developing SEDs that secure data.  Wave’s products currently support Opal compliant SED offerings from Fujitsu, Toshiba, Samsung, Hitachi and Seagate.

Current planned development costs for this product are expected to be approximately $3.5 million for the twelve months ending March 31, 2013.

Electronic/Digital Signature and Electronic Document Management

eSign Transaction Management Suite

Our SmartSafe Bundle, previously known as eSign Transaction Management Suite or eTMS, originally consisted of four core products: SmartIdentity, SmartSignature, SmartSAFE and SmartConnect.  SmartIdentity is an optional service to verify a signer’s identity through strong authentication methods, including issuing encrypted digital certificates based on public key infrastructure technology.  SmartSignature is a digital signature application that can connect signers and institutions — banks, insurance companies, enterprises, etc. — through a digital signature process.  Wave’s SignatureServer 5.04, a server-side electronic signature application, enables individuals to electronically sign and store virtually any format of document, while connected to a server, as opposed to the signing taking place on the client PC.  SmartSAFE is a core component of the SmartSAFE Bundle that provides record retention of the

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electronically signed documents.  SmartSAFE Version 5.0.4 is a web-based document management application where signed documents are archived and tracked.  SmartSAFE was designed to provide an environment where a client institution can view, manage, store and transfer sensitive signed and unsigned documents.  SmartSAFE meets the requirements of Federal Rule 901 which requires that the user demonstrate that electronic documents offered as evidence in a legal proceeding are authentic.  Wave’s SigningRoom Version 2.04 was designed to enhance the functionality of SmartSAFE, enabling an organization to offer signers a secure virtual environment to review, annotate and electronically sign documents.  SmartConnect is a core component of the SmartSAFE Bundle that offers a web service that can retrieve signing and transactional data for viewing and/or for use in populating other systems such as CRM and other workflow applications.  An enhancement to SmartSAFE Bundle known as SmartClose has been designed to allow for mortgage closing documents to be signed and notarized in a secure environment.  The electronic note is then registered through the Mortgage Electronic Registry System, a system for electronically tracking mortgage ownership and servicing rights.  SmartClose also offers lenders protection against borrowers claiming not to have understood their debt obligation by requiring the borrower to electronically sign and initial key line items while providing audit capabilities for the entire transaction.  SmartClose has been designed to allow a lender to originate, sign, track, access, store and transfer electronic mortgages.  Wave plans to continue to allocate resources toward marketing and sales to promote these products.

Wave’s SmartSAFE Bundle is being independently marketed to insurance, mortgage, banking and governmental institutions, offering electronic signature solutions that are designed to comply with the Electronic Signatures in Global and National Commerce Act (“ESIGN”) and Uniform Electronic Transaction Act (“UETA”).  Some of the flagship organizations that are currently utilizing the SmartSAFE Bundle include: Bank of NY Mellon, Mortgage Cadence, Medallion Analytics, Ellie Mae, ala mode, DocuTech, SigniaDocs, Xerox Mortgage Services and Insurance Administrative Solutions.

Current planned development costs for this product are expected to be approximately $600,000 for the twelve months ending March 31, 2013.

Endpoint Data Loss Protection

Safend FIPS 140-2 and Common Criteria-Certified Data Loss Prevention Suite

Safend FIPS 140-2 and Common Criteria-Certified Data Loss Prevention suite of products include:

Current planned development costs for this product group are expected to be approximately $4.6 million for the twelve months ending March 31, 2013.

Broadband Media Distribution Services

Wave offered broadband content distribution products and services through Wavexpress and its TVTonic consumer media service, which was a joint venture between Wave and Sarnoff Corporation.  On September 23, 2008, Wave, Sarnoff Corporation and Wavexpress entered into a Restructuring Agreement and an Amended and Restated Stockholder Agreement whereby, among other things, the parties agreed to terminate the Joint Venture Agreement between the parties, dated October 15, 1999.  As of March 31, 2012, Wave owned 97.3% of Wavexpress, while Sarnoff owned 1.7% (on a fully diluted basis).  On

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December 1, 2008, Wavexpress announced that it had suspended its TVTonic consumer media service and was exploring opportunities to sell or license its technology to third parties that may provide “download and play” services.

Our Market

Software has traditionally secured critical information on networks and PCs and allowed for user access to various applications.  Virus attacks and breaches of security 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.  TCG was formed to develop, define and promote open industry standard specifications for embedded hardware-enabled trusted computing and security technologies, including secure hardware and software interfaces across multiple platforms, peripherals and devices.  The underlying premise of the creation of a Trusted Platform that meets the TCG specification is that only when a platform is secured by hardware, in effect creating a root of trust and a security environment which can be authenticated within the computer itself, will the information stored on the platform be adequately secure.  Wave is seeking to become a software, application and services leader in hardware-based digital security and e-commerce products markets.  We believe Wave has been a pioneer in developing hardware-based computer security systems and that we are distinctively positioned to take advantage of our unique knowledge, significant technology assets and trusted computing intellectual properties.

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

R&D

Wave’s products incorporate encryption/decryption, client and server software applications and other technologies in which we have made a substantial investment in research and development (“R&D”).  We will likely be required to continue to make substantial investments in the design of information security applications and services, including the EMBASSY Trust Suite, EMBASSY Server applications and eTMS products.  For the years ended December 31, 2011, 2010 and 2009, we spent approximately $16.1 million, $10.3 million and $7.8 million, respectively, on R&D activities. Planned development expenditures for the twelve-month period ending March 31, 2013 are expected to be approximately $20.0 million.

Results of Operations

Three-Months Ended March 31, 2012 and 2011

Wave had net revenues of $6,982,137 and $7,476,236 for the three-months ended March 31, 2012 and 2011, respectively.  The decrease in revenue was due primarily to a decrease in licensing revenues.  Licensing revenues decreased by $605,852 during the three-months ended March 31, 2012 as compared to the same period in 2011.  This decrease in licensing revenues was due primarily to a decrease in OEM revenue, primarily as the result of an amendment to Wave’s software license agreement with Dell effective November 1, 2011.  The amendment, among other changes, extends the term of our software license agreement with Dell by five years to January 18, 2017.  Additionally, the per-unit royalties that Wave receives for each Dell PC model shipped subsequent to November 1, 2011 with Wave’s EMBASSY Trust Suite software were decreased by approximately 25%. The amendment also provides for a 285% per unit additional royalty for notebooks shipping with both a universal serial hub module and at least one internal

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authentication hardware solution such as a fingerprint reader or smart card. The amendment also increases the per unit royalty rate by approximately 33% for each trusted drive unit shipped after October 31, 2011.    Services revenue, consisting primarily of non-recurring government contracts, increased by $111,753 during the three-months ended March 31, 2012 as compared to the same period in 2011.  Services revenue earned during the three-months ended March 31, 2011 was from a $1,600,000 fixed-price modification to a contract awarded by the United States Department of Defense and which was completed during mid-February 2011.  Services revenue earned during the three-months ended March 31, 2012 was from a second $1,507,120 fixed-price modification which began in late August 2011 and is expected to be completed by no later than August 2012.  Approximately $983,000 of this second fixed-price modification will be earned as the result of qualifying Wave software on new PC and SED models and with new PC OEM and SED partners.  Fees will be earned for each qualifying model and/or partner after being verified by the Department of Defense.  Approximately $206,000 of these fees have been earned and approved by the Department of Defense during the three-months ended March 31, 2012.  This component of revenue will increase the gross margin for this second fixed-price modification as compared to previous contract modifications.

Licensing - cost of net revenues, consisting primarily of customer support and foreign tax withholdings, was $463,630, for the three-months ended March 31, 2012, as compared to $298,881 for the same period in 2011.  The increase in licensing - costs of net revenues was due primarily to an increase in customer support headcount in support of Wave’s expanding number of OEM relationships during the three-months ended March 31, 2012 versus the comparable prior year period.  Services - cost of net revenues, consisting of non-recurring government time and materials costs, was $61,830, for the three-months ended March 31, 2012, as compared to $74,047 for the same period in 2011.

Selling, general and administrative (“SG&A”) expenses for the three-months ended March 31, 2012 were $9,773,783, as compared to $6,060,907 for the comparable period of 2011, an increase of approximately 61%.  The increase in SG&A expenses during the three-months ended March 31, 2012 was due primarily to (i) an increase in salaries and related benefits totaling approximately $1,340,000 and an increase of approximately $236,000 in travel expenses, supporting Wave’s growing customer base, (ii) an increase of approximately $123,000 in share-based compensation, (iii) an increase of approximately $92,000 in trade show and marketing expenses, (iv) an increase of approximately $725,000 in professional services expenses, consisting primarily of legal, accounting and recruitment fees and (v) Safend’s SG&A expenses amounting to approximately $1,059,000, consisting primarily of salaries and related benefits, travel expenses and amortization of intangible assets, in each case as compared to the three-months ended March 31, 2011.  Share-based compensation expense allocated to SG&A was approximately $972,000 for the three-months ended March 31, 2012, as compared to approximately $839,000 for the comparable period of 2011.

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

R&D expenses for the three-months ended March 31, 2012 were $5,017,479, as compared to $3,298,787 for the comparable period of 2011, an increase of 52%.  This increase was primarily attributable to (i) increased salaries, fringe and benefit expenditures of approximately $551,000, supporting Wave’s expanding number of OEM relationships and (ii) Safend’s R&D expenses amounting to approximately $1,143,000, consisting primarily of salaries and related benefits, in each case as compared to the three-months ended March 31, 2011.  Share-based compensation expense allocated to R&D was approximately

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$372,000 for the three-months ended March 31, 2012 as compared to approximately $343,000 for the comparable period of 2011.

Interest income for the three-months ended March 31, 2012, was $21 as compared to $2,114 for the comparable period of 2011. Interest expense consisted of interest incurred on a capital lease obligation for equipment acquired for the expansion of the Wavexpress broadband infrastructure and was $2,126 for the three-months ended March 31, 2012 as compared to $3,415 for the comparable period of 2011.

Due to the reasons set forth above, our net loss to common stockholders for the three-months ended March 31, 2012 was $8,313,090 as compared to $2,257,687 for the comparable period of 2011.

Liquidity and Capital Resources

Wave has incurred substantial operating losses since its inception, and as of March 31, 2012, has an accumulated deficit of $371,266,758.  We may also incur an operating loss for the fiscal year of 2012.  As of March 31, 2012, we had negative working capital of $5,943,768.

Sources and uses of cash

As of March 31, 2012, Wave had $2,255,835 in cash and cash equivalents.  As of December 31, 2011, Wave had $3,385,035 in cash and cash equivalents.  The decrease in cash and cash equivalents of $1,129,200 resulted from (i) $3,602,522 used in operating activities and (ii) $47,358 used in investing activities for the acquisition of capital assets, offset by (iii) $2,520,680 provided by financing activities, primarily from the issuance of shares of our Class A common stock in at the market offerings through MLV.

Our largest source of operating cash flow is cash collections from our customers.  Cash collections from customers amounted to approximately $9,187,000 and $13,901,000 for the three-months ended March 31, 2012 and 2011, respectively.  This decrease was due, in part, to the collection of $8.1 million of accounts receivable during the three-months ended March 31, 2011 for orders received in late December 2010 through our OEM partners on behalf of their customer, a U.S.-based global automaker, offset by Safend collections of approximately $1,413,000 and the collection of a $1.7 million order from one of the world’s leading international oil and gas companies during the three-months ended March 31, 2012.  Our primary uses of cash in operations are for personnel related expenditures, marketing and other general operating expenses.

Comparison of the periods ended March 31, 2012 and 2011

Cash provided by (used in) operations

During the three-months ended March 31, 2012, the amount of cash used in operations was $3,602,522 as compared to $4,863,922 provided by operations for the comparable period of 2011.  The fluctuations in cash provided by (used in) operations were the result of the changes in the net losses in each of the three-months ended March 31, 2012 and 2011, as discussed in detail in the previous Results of Operations section, adjusted for non-cash items of the net losses such as non-cash share-based compensation and changes to assets and liabilities for net cash outlays and/or receipts, which, under generally accepted accounting principles, are not reported in the Statement of Operations.  Additionally, Wave experienced a decrease in cash collected from customers during the three-months ended March 31, 2012 as compared to the same period in 2011 due to the collection of $8.1 million of accounts receivable during the three-months ended March 31, 2011 for orders received in late December 2010 through our OEM partners on behalf of their customer, a U.S.-based global automaker, offset by Safend collections of approximately $1,413,000 and the collection of a $1.7 million order from one of the world’s leading international oil and gas companies during the three-months ended March 31, 2012.  Also, cash used in operating activities resulted from an increase in cash payments for personnel related expenditures, primarily from a higher average headcount during the three-months ended March 31, 2012 as compared to the comparable period of 2011, and an increase in payments for professional services, primarily for legal and accounting fees associated with the acquisition of Safend.  Cash used in operations was also due to an increase in cash payments to suppliers, primarily as a result of increased tradeshow and marketing activities during the three-months ended March 31, 2012 as compared to the comparable period of 2011.

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Cash flows from investing activities

Cash used in investing activities consisted of funds used to acquire capital assets totaling $47,358 and $172,044 for the three-months ended March 31, 2012 and 2011, respectively.  Wave expects to continue to acquire capital assets primarily to replace computer equipment to be used internally. These expenditures are expected to continue for the remainder of 2012 at approximately the same level expended during the three-months ended March 31, 2012.  As a result of lower capital expenditures, net cash used in investing activities decreased by $124,686 for the three-months ended March 31, 2012 as compared to the comparable period of 2011.

Cash flows from financing activities

For the three-months ended March 31, 2012, cash provided by financing activities totaled $2,520,680 and consisted of $2,359,382, after deducting offering costs of approximately $75,000,  in connection with the issuance of 1,114,241 shares of Class A Common Stock in its at the market offerings through MLV, $118,250 of investor stock warrant exercises related to our 2009 financings and $60,552 of employee stock option exercises offset by $17,504 of payments on a capital lease obligation.  For the three-months ended March 31, 2011, cash provided by financing activities totaled $1,446,420 and consisted of $826,557 of investor stock warrant exercises related to our 2009 and 2008 financings and $636,080 of employee stock option exercises offset by $16,217 of payments on a capital lease obligation.

Liquidity requirements and future sources of capital

Wave estimates that its total expenditures to fund operations for the twelve-months ending March 31, 2013 will be approximately $52,500,000, including research and development, acquisition of capital assets, sales and marketing, general corporate expenses and overhead.

Sources of capital may include the following:

·                  cash on hand of $2,255,835 as of March 31, 2012;

·                  collection of receivables; and

·                  additional financings

Given Wave’s capital requirements for the twelve-months ending March 31, 2013 as indicated above, our cash balance as of March 31, 2012 and the uncertainty as to whether we will generate sufficient revenue, Wave will be required to raise additional capital to continue to fund its operations.  We expect to obtain additional funding as needed from further sales of newly issued shares of Class A Common Stock, including the sale of Class A Common Stock under the remaining availability of our $30,000,000 shelf registration statement that we filed on June 21, 2011 and was declared effective by the Commission on July 22, 2011.  As of May 8, 2012, approximately $23,979,000 in gross proceeds are available under the June 21, 2011 shelf registration statement, which may be utilized for future financings.  We can provide no assurances as to whether, if necessary, we will be successful in raising the needed capital to continue as a going concern.

During January 2012, we entered into an At the Market Sales Agreement with MLV & Co. LLC (“MLV”) under which we are able to sell shares of our common stock for aggregate gross proceeds of $20,000,000 from time to time through MLV. During the three-month period ended March 31, 2012, Wave sold 1,114,241 shares of its Class A common stock through MLV at an average price of $2.19 per share, for net proceeds of approximately $2.4 million after deducting offering costs of approximately $75,000. Subsequent to March 31, 2012, Wave sold 997,418  shares of its Class A common stock through MLV at an average price of $1.57 per share, for net proceeds of approximately $1.5 million after deducting offering costs of approximately $47,000.   As of May 8, 2012, Wave has sold a total of approximately 2.1 million shares of its common stock through MLV, raising net proceeds of approximately $3.9 million after deducting offering costs of approximately $122,000.

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Revenue outlook

Wave receives revenue from licensing its EMBASSY Trust Suite software through distribution arrangements with its OEM partners.  In addition, Wave received revenues from software development and other services.  Total cash received from all revenue sources for the three-months ended March 31, 2012 was approximately $9,187,000 versus approximately $13,901,000 for the comparable period of 2011.  This decrease was due, in part, to the collection of $8.1 million of accounts receivable during the three-months ended March 31, 2011 for orders received in late December 2010 through our OEM partners on behalf of their customer, a U.S.-based global automaker, offset by Safend collections of approximately $1,413,000 and the collection of a $1.7 million order from one of the world’s leading international oil and gas companies during the three-months ended March 31, 2012.

During November 2011, we entered into a strategic distribution agreement with Ingram Micro, Inc. (“Ingram”) authorizing Ingram to distribute our EMBASSY management software, including ERAS, our enterprise-grade console for the centralized management of endpoint security for data protection and authentication. Ingram is the world’s largest technology distributor and a leading technology, sales, marketing and logistics company for the IT industry worldwide. As a vital link in the technology value chain, Ingram connects technology solution providers with vendors worldwide, supporting global operations through an extensive sales and distribution network throughout North America, Europe, the Middle East and Africa (EMEA), Latin America and Asia-Pacific. Ingram serves more than 150 countries on six continents and maintains the world’s most comprehensive portfolio of IT products and services.  Also during November 2011, we announced an agreement to provide Samsung Electronics with engineering services, consulting, validation and a customized version of our local management software for Samsung’s Trusted Platform Module (TPM) security chips designed for OEM distribution.  On September 22, 2011, Wave acquired 100% of the equity interests of Safend.  Safend provides endpoint data loss protection solutions, including port and device control, encryption for removable media and content inspection and discovery.

Wave also continues to work with all of its partners and customers to introduce and promote its existing software products and new software products which are under development, in an effort to expand the market for TPM-based secure computing and thereby increase its market share and revenues.  However, it should be noted that because of the early stage of Wave’s market and other factors, a high level of uncertainty exists with respect to the ability to forecast future revenues.  Although there has been a substantial increase in the volume of shipments of TPM-equipped PCs and self-encrypting drives, which our business model depends upon, this remains a new and developing category within the computer security market and the ultimate size of this market and the timeframe for its development are unknown and difficult to predict.

Wave’s OEM distribution agreements began to generate royalty revenue during 2006.  The aggregate amount of royalty revenue from these arrangements has been a significant contributor to Wave’s revenue growth to date.  Revenue from these contracts in future years may also be material.  We expect to continue to generate cash flow from these agreements as long as the agreements remain in effect and our software continues to ship with these products.

Our OEM distribution agreements have given rise to separate software upgrade contracts with the end users of the products distributed by the OEMs.  The contracts, referred to by us as license upgrade agreements, include a software license and a maintenance agreement.  The contracts are separately negotiated with end users and are not associated with our OEM distribution agreements.  Sales from the license upgrade agreements began in the latter part of the third quarter of fiscal year 2007.  The sales consist of licensed use of Wave’s EMBASSY Trust Suite of products, primarily Wave’s EMBASSY Security Center paired with our ERAS server product, and our Safend Data Protection Suite of products.  On November 30, 2011, we delivered in-full against a $1.7 million order from one of the world’s leading international oil and gas companies for our ERAS, EMBASSY Protector software and related maintenance services to manage laptop computers with self-encrypting drives.  The order, which involves tens of thousands of licenses and related software maintenance through the end of 2012, is a “large” class order (5,000 or more licenses) for which VSOE has not yet been achieved. As a result, we are recognizing $1.7 million as revenue ratably through the end of 2012.  During May 2011, we fulfilled a $3.5 million order from BASF in which we provided the global chemical firm with our EMBASSY client and server software

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and maintenance services for its global fleet of personal computers.  The order involved tens of thousands of ERAS licenses, maintenance orders for 2011 and additional maintenance orders for all of 2012 and is a “large” class order for which VSOE has not yet been achieved. As a result we recognized approximately $3.0 million of license sales and 2011 maintenance as revenue ratably over the balance of 2011, with 2012 maintenance of approximately $682,000 being recognized ratably over the full year of 2012.  In late December 2010 Wave received a series of significant license and maintenance orders for its ERAS software from a U.S.-based automotive company.  The orders were received by Wave through its PC OEM partners and totaled approximately $5.2 million.  The orders increased the total value of the automaker’s software orders to $10.9 million, $1.9 million of which was recorded as revenue in 2010, $6.7 million of which was recorded as revenue in 2011, and $2.3 million of which is expected to be recognized as revenue in 2012 through 2014.  Initial orders from this U.S.-based automotive company for software licenses and maintenance totaling $5.7 million were received by Wave in December 2009 through a PC OEM partner.

At March 31, 2012, as a result of establishing VSOE for the fair value of each undelivered element for our software and maintenance services for our small customer class effective January 1, 2011, our deferred revenue consists primarily of the unamortized balance of maintenance for sales to our large customer class during the year ended December 31, 2011 and arrangements where VSOE does not exist — small customer orders received prior to January 1, 2011 where the maintenance term is in excess of twelve months.  For arrangements where VSOE for the fair value of each undelivered element does not exist, our license and maintenance sales are recorded as deferred revenue and then recognized over the maintenance period which is typically a 365-day period.  The current portion of deferred revenue decreased $965,073 (to $5,564,184 from $6,619,257) at March 31, 2012 versus December 31, 2011 primarily as the result of the partial recognition of revenue on the $1.7 million order from one of the world’s leading international oil and gas companies as noted above.  Wave recognized approximately $1,752,000 and $2,781,000 of license upgrade revenue during the three-months ended March 31, 2012 and 2011, respectively.

Known trends and uncertainties affecting future cash flows

Because Wave does not have sufficient cash to fund operations for the twelve-months ending March 31, 2013, 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 twelve-months ending March 31, 2013.  These activities have included the issuance of approximately 2.1 million shares of our common stock through MLV as of May 8, 2012, raising net proceeds of approximately $3.9 million after deducting offering costs of approximately $122,000.

We will be required to sell additional shares of common stock or preferred stock, obtain debt financing or engage in a combination of these financing alternatives, to raise additional capital to continue to fund our operations for the twelve-months ending March 31, 2013.  The availability and amount of any such financings are unknown at this time. Wave may also be required to reduce expenses, which may significantly impede its ability to meet its sales, marketing and development objectives.  Based upon the available cash currently on hand, including the net proceeds from the 2012 ATM described above, if we meet our current revenue and expenditure forecast for the twelve-months ending March 31, 2013 (both of which are uncertain), we estimate that we will need at least $2,000,000 in additional cash in order to continue as a going concern for the next twelve-months ending March 31, 2013.  The foregoing is based on meeting our current revenue forecast for both Dell and non-Dell revenues for the twelve-months ending March 31, 2013.  Dell revenue increased during 2010 and 2009 primarily as a result of an amendment signed in December 2008 where the per-unit royalties that Wave receives for each Dell PC model with Wave’s EMBASSY Trust Suite software were increased by at least 100% per unit, retroactive to November 1, 2008.  Wave’s software license agreement with Dell was amended again during January 2012, retroactive to November 1, 2011.  As a result of this amendment the per-unit royalties that Wave receives for each Dell PC model shipped with Wave’s EMBASSY Trust Suite software were decreased by approximately 25%. The amended agreement also increases the per unit royalty rate by approximately 33% for each trusted drive unit shipped after October 31, 2011.  Additionally, the amended agreement provides for a per unit additional royalty for notebooks shipping with both a universal serial hub module and at least

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one internal authentication hardware solution such as a fingerprint reader or smart card.  Finally, the amendment extends the term of the software license agreement through January 18, 2017.  While the foregoing assumes current shipment volumes at a per-unit royalty rate throughout March 2013, our contract with Dell contains no guaranteed minimum royalties or minimum shipment volume requirements.

Other uncertainties that may impact the future business outlook

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

Furthermore, the achievement of sufficient revenue is dependent upon continued significant expenditures, which will likely be required for research and development and sales and marketing to increase market awareness for our products.  Therefore, if Wave is not able to begin to generate significant revenues by March 31, 2013 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 March 31, 2013.  The challenges presented by the current 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.

Commitments

Safend is required to pay back grants received from the Israeli government through the Office of the Chief Scientist of Israel’s Ministry of Industry, Trade and Labor (“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.  Wave determined the fair value of this liability to be $4,043,000 at September 22, 2011.  At March 31, 2012, the liability amounted to $4,212,334, reflecting additional grants received and amounts repaid since the acquisition date.

Wave has a capitalized lease obligation for computer equipment due July 2013 of $99,229 and $167,287 as of March 31, 2012 and 2011, respectively.  The interest rate is 7.7% per annum.  This lease obligation is collateralized by the related assets with a net book value of $-0- as of March 31, 2012 reflecting an impairment charge recorded during 2008 due to the suspension of Wavexpress’ TVTonic consumer media services as of December 1, 2008.

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

Net operating loss carryforwards

As of December 31, 2011, Wave had available net operating loss carryforwards for Federal income tax purposes of approximately $276.3 million, inclusive of approximately $7.2 million of Safend, Inc., a U.S.-

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based subsidiary of Safend, which expire beginning in 2012 through 2031.  Because of the “change in ownership” provisions of the Tax Reform Act of 1986, our net operating loss carryforwards may be subject to an annual limitation on the utilization of these carryforwards against taxable income in future periods if a cumulative change in ownership of more than 50 percent of Wave occurs within any three-year period.  We have made no determination concerning whether there have been such cumulative changes in ownership or the impact on the utilization of the loss carryforwards if such changes have occurred.  However, in considering Section 382 of the Internal Revenue Code, we believe that it is likely that such a change in ownership occurred prior to or following the completion of our initial public offering in September 1994 and, potentially, in periods following.  As a result, all of the utilization of our net operating losses is likely to be subject to annual limitations.

Item 3. 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 4.  Controls and Procedures

a)     Disclosure controls and Procedures

Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of March 31, 2012. 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 principal executive and principal financial officers, 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 March 31, 2012, and due to the material weakness in our internal control over financial reporting described in our Management’s Report on Internal Control over Financial Reporting included in our Annual Report on Form 10-K for the year ended December 31, 2011 filed with the Securities and Exchange Commission on March 30, 2012, our chief executive officer and chief financial officer concluded that, as of such date, our disclosure controls and procedures were not effective.

b)     Changes in Internal Control Over Financial Reporting

During the three months ended March 31, 2012, no changes other than those in conjunction with certain remediation efforts described below, were identified to our internal control over financial reporting that materially affected, or were reasonably likely to materially affect, our internal control over financial reporting.

c)     Remediation Efforts

In the three months ended March 31, 2012, we are continuing to implement the following measures, originally described in Item 9A of our Annual Report on Form 10-K for the year ended December 31, 2011 filed with the Securities and Exchange Commission on March 30, 2012, to improve our internal controls over the financial reporting process. We plan to further enhance these measures in the remaining quarters of 2012:

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· ensure that we utilize sufficient accounting personnel and/or consulting resources with appropriate expertise in the evaluation of complex, non-routine business acquisition transactions to thoroughly review the financial statements and records of the target company and to evaluate and determine the manner in which the transaction will affect our financial statements,

· organize and design our internal review and evaluation process to include more formal management and audit committee oversight of the methods and review procedures utilized and the conclusions reached, and

· appropriately document and evidence the financial review conducted, the internal reporting and evaluation measures undertaken and the material conclusions reached by our finance department.

d)     Remediation Plans

We have made no significant changes in our remediation plans during the three months ended March 31, 2012 that could materially affect, or are reasonably likely to materially affect, our internal control over financial reporting. For further information with regard to our “Remediation Plans,” please refer to Item 9A of our Annual Report on Form 10-K for the year ended December 31, 2011 filed with the Securities and Exchange Commission on March 30, 2012.

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PART II - OTHER INFORMATION

Item 1. Legal Proceedings.

Landmark Ventures, Inc. (“Landmark”) has asserted that Safend Inc. (“Safend USA”), a subsidiary of Safend Ltd. (Wave’s Israeli subsidiary), has breached a consulting agreement between Landmark and Safend USA (the “Consulting Agreement”) which was terminated by Safend USA in July of 2011. According to an amended complaint filed in January 2012 by Landmark in the federal district court in New York, Safend USA (a) owes unspecified amounts to Landmark and (b) violated a provision of the Consulting Agreement by working with a former Landmark employee, resulting in damages of no less than $5,000,000.  Landmark has also named Safend Ltd. and Wave Systems Corp. (“Wave”) as defendants, alleging that both companies are legally responsible for Safend USA’s alleged breaches.  Safend USA, Safend Ltd. and Wave have moved to dismiss the Landmark amended complaint in its entirety.  The motion to dismiss is currently pending before the court.

Item 1a. Risk Factors.

This report contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from the results contemplated by these forward-looking statements due to certain factors, including those discussed below, and elsewhere in this Quarterly Report on Form 10-Q.

In preparing our financial statements for the fiscal year ended December 31, 2011, we identified a material weakness in our internal control over financial reporting, and our failure to remedy this or other material weaknesses could result in material misstatements in our financial statements.

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.  Our management identified a material weakness in our internal control over financial reporting as of December 31, 2011. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis.  The material weakness identified by management as of December 31, 2011 consisted of inadequate and ineffective controls and procedures for non-routine transactions, specifically in relation to our acquisition of Safend.  See “Item 9A - Management’s annual report on internal control over financial reporting” included in the December 31, 2011 Form 10-K filed on March 30, 2012 for further information.

We have begun to implement remedial measures designed to address this material weakness. If our remedial measures are insufficient to address this material weakness, or if additional material weaknesses or significant deficiencies in our internal control are discovered or occur in the future, our consolidated financial statements may contain material misstatements and we could be required to restate our financial results.

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

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

· 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.

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

We have experienced significant losses and negative cash flow from operations since our inception. We have not realized a net operating profit in any quarter since we began our operations.  Wave’s revenue during the three-months ended March 31, 2012 was less than operating expenses as our products have not yet attained widespread commercial acceptance. This is due in part to the early stage nature of the digital security industry in which we operate. As of March 31, 2012, we had an accumulated deficit of approximately $371.3 million and negative working capital of approximately $5.9 million. Given the lack of widespread adoption of the technology for our products and services, there is little basis for evaluating the financial viability of our business and our long-term prospects. You should consider our prospects in light of the risks, expenses and difficulties that companies in their early stage of development encounter, particularly companies in new and rapidly evolving markets, such as digital security and online commerce.

To achieve profitability we must, among other things:

· 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 users 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 R&D and business development activities that will be necessary to commercialize our technology. We may be unable to raise or generate the additional financing or cash flow which will be necessary to continue as a going concern for the next twelve months.

In addition to our efforts to generate revenue sufficient to fund our operations, or complete one or more commercial or strategic transactions, Wave may evaluate additional financing options to generate additional capital in order to continue as a going concern, to capitalize on business opportunities and market conditions and to insure the continued development of our technology, products and services.  We do not know if additional financing will be available or that, if available, it will be available on favorable terms. If we issue additional shares of our stock, our stockholders’ ownership will be diluted and the shares issued may have rights, preferences or privileges senior to those of our common stock.  In addition, if we pursue debt financing we may be required to pay interest costs.  The failure to generate sufficient cash flow to fund our forecasted expenditures would require us to reduce our cash burn rate, which would in turn impede our ability to achieve our business objectives.  Even if we are successful in raising additional capital, uncertainty with respect to Wave’s viability will continue until we are successful in achieving our

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objectives. Furthermore, although we may be successful at achieving our business objectives, a positive cash flow from operations may not ultimately be realized unless we are able to sell our products and services at a profit. Given the early stage nature of the markets for our products and services, considerable uncertainty exists as to whether or not Wave’s business model is viable.  If we are not successful in generating sufficient cash flow or obtaining additional funding, we may be unable to continue our operations, develop or enhance our products, take advantage of future opportunities, respond to competitive pressures or continue as a going concern.

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

We expect that a small number of customers will continue to account for a large portion of our revenues for the foreseeable future. We have one customer that accounted for approximately 59% of our revenue for the three-month period ended March 31, 2012.  If our relationship with any of our significant customers were disrupted, we could lose a significant portion of our anticipated revenues which may have a material adverse effect on our results of operations.

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

·                  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.

Sales to a relatively small number of OEM customers, as opposed to direct retail sales to end customers, comprise a large portion of our revenues. For example, we have one customer that accounted for approximately 59% of our revenue for the three-month period ended March 31, 2012. Our ability to make sales to OEM customers depends on our ability to compete on price, delivery and quality. The timing and volume of these sales depend upon the sales levels and shipping schedules for the products into which our OEM customers incorporate our products. Thus, even if we develop a successful component, our sales will not increase unless the product into which our component is incorporated is successful. If our OEM customers decide not to incorporate our products as components of their products, or fail to sell a sufficient quantity of products incorporating our components, or if the OEM customers’ sales timing and volume fluctuate, it may lead to a reduction in our sales and have a material adverse effect on our results of operations.

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

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

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

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

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

Wave’s 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, 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

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

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

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

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

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

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

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

We believe that our future success depends upon the continued service of our key technical and management personnel and on our ability to attract and retain highly skilled technical, management, sales

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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.

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.  Presently, there is 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

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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.

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.

We may not be able to realize all of the anticipated benefits of our acquisition of Safend if we fail to integrate Safend successfully, which could reduce our profitability.

Our ability to realize the anticipated benefits of our acquisition of Safend will depend, in part, on our ability to integrate the business of Safend successfully and efficiently with our business. The combination of two independent companies is a complex, costly and time-consuming process. The integration process may disrupt the business of either or both of the companies and, if implemented ineffectively, preclude realization of the full benefits expected by us. If we are not successful in this integration, our financial results could be adversely impacted. Our management will be required to dedicate significant time and effort to this integration process, which could divert their attention from other business concerns. In addition, the overall integration of the two companies may result in unanticipated problems, expenses, liabilities, competitive responses, loss of customer and other relationships, a loss of key employees, and diversion of management’s attention, and may cause our stock price to decline. The difficulties of combining the operations of the two companies include, among others:

· challenges associated with minimizing the diversion of management attention from ongoing business concerns;

· addressing differences in the business cultures of Wave and Safend;

· coordinating geographically separate organizations which may be subject to additional complications resulting from being geographically distant from our other operations;

· coordinating and combining international operations, information systems, relationships, and facilities, and eliminating duplicative operations;

· retaining key employees and maintaining employee moral;

· unanticipated changes in general business or market conditions that might interfere with our ability to carry out all of its integration plans; and

· preserving important strategic and customer relationships.

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In addition, even if Safend’s operations are integrated successfully with ours, we may not realize the full potential benefits of the transaction, including the leveraging of production and combined research and development that are expected. Such benefits may not be achieved within our anticipated time frame, or at all.

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 on 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 or any of our other securities for which a market develops, regardless of our operating performance. Securities class action litigation has often been instituted against companies that have experienced periods of volatility in the market price for their

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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 affect on our business.  In addition, any negative publicity or perceived negative publicity of any such litigation could have an adverse impact on our business.

Sales of our common stock in our ATM Program, or the perception that such sales may occur, could cause the market price of our common stock to fall.

During January 2012, we entered into an At Market Issuance Sales Agreement (“2012 ATM”) with MLV & Co. LLC (“MLV”) under which are able to sell shares of our common stock for aggregate proceeds of $20,000,000 from time to time through MLV.  Continued sales of our common stock, if any, under the 2012 ATM will depend upon market conditions and other factors to be determined by us and may be made in negotiated transactions or transactions that are deemed to be “at the market offerings” as defined in Rule 415 under the Securities Act.  Future sales of our common stock are not guaranteed, and there are no firm commitments to receive funding under the 2012 ATM.  The issuance from time to time of these new shares of common stock, or the perception that such sales may occur, could have the effect of depressing the market price of our common stock.

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

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

Governmental regulation may slow our growth and decrease our profitability.

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

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

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

If appropriate opportunities become available, we may attempt to acquire businesses, technologies, services or products that we believe are a strategic fit with our business. If we do undertake any transaction of this sort, the process of integrating an acquired business, technology, service or product may result in operating difficulties and expenditures and may absorb significant management attention that would otherwise be available for ongoing development of our business. Moreover, we may never realize the anticipated benefits of any acquisition. Future acquisitions could result in potentially dilutive issuances of equity securities, the incurrence of debt, contingent liabilities and/or amortization expenses related to certain intangible assets and increased operating expenses, which could adversely affect our results of operations and financial condition.

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

Our common stock is listed on the NASDAQ Capital Market.  In order to maintain our NASDAQ listing NASDAQ Marketplace Rule 5550(a)(2) requires that the bid price for our common stock not fall below $1.00 per share for a period of 30 consecutive trading days.  Because of the volatility in our common stock price there can be no assurance that we will be able to maintain compliance with this requirement. If our minimum bid price remains below $1.00 for 30 consecutive trading days, under the current NASDAQ Capital Market rules, we will have a period of 180 days to attain compliance by meeting the minimum bid price requirement for 10 consecutive days during the compliance period. In the event that we do not regain compliance during such 180 day period we would be entitled to an additional 180 day compliance period if we meet the other initial listing requirements of the NASDAQ Capital Market at the end of such initial 180 day period.  If our common stock ceases to be listed for trading on the NASDAQ Capital Market we expect that our common stock would be traded on the 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.

Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds.

None.

Item 6.  Exhibits.

(a)          Exhibits

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