Item 1A. Risk Factors
In preparing our financial statements for the fiscal year ended December 31, 2013, 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, 2013. 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, 2013 consisted of the failure to effectively execute controls over testing and reviewing vendor specific objective evidence of fair value of maintenance for the Safend unit. See
"Item 9A—Management's annual report on internal control over financial reporting" for further information. In addition, based on an evaluation of our disclosure controls and
procedures as of December 31, 2013, and due to the material weakness in our internal control over financial reporting described above, our chief executive officer and chief financial officer
concluded that, as of such date, our disclosure controls and procedures were not effective.
We
plan 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 operations 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 world economy is also facing a number of new challenges, including uncertainty related to the continuing discussions in the United States regarding the U.S. federal debt ceiling,
the combination of expiring tax cuts and mandatory reduction in federal spending, along with widespread skepticism about the implementation of any resulting agreements, and recent turmoil and
hostilities in the Middle East, North Africa and other geographic areas and countries. The deterioration in the global economy 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;
18
Table of Contents
-
•
-
our liquidity;
-
•
-
our ability to raise capital and obtain financing; and
-
•
-
the price of our common stock.
We have a history of net losses and expect net losses will continue. If we continue to operate at a loss our business will not be financially viable.
We have experienced significant losses and negative cash flow from operations since our inception. We have not realized a net operating
profit in any quarter since we began our operations. Wave's revenue in 2013 was less than operating expenses as our products have not yet attained widespread commercial acceptance. This is due in part
to the early stage nature of the digital security industry in which we operate. As of December 31, 2013, we had an accumulated deficit of approximately $417.2 million and negative
working capital of approximately $8.2 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 customers to purchase our upgrade software and server products for
trusted computing;
-
•
-
convince consumers to choose to order, purchase and accept products using our products and services;
-
•
-
continue to maintain the necessary resources, especially talented software programmers;
-
•
-
continue to develop relationships with personal computer manufacturers, computer chip manufacturers and computer systems
integrators to facilitate and to maximize acceptance of our products and services; and
-
•
-
generate substantial revenue, complete one or more commercial or strategic transactions or raise additional capital to
support our operations until we can generate sufficient revenues and cash flows.
If
we do not succeed in these objectives we will not generate revenues; hence our business will not be sustainable.
We may be unable to raise or generate the additional financing or cash flow which will be necessary to continue as a going concern for the next twelve months.
Since we began our operations we have incurred net losses and experienced significant negative cash flow from operations. This is due
to the early stage nature of market development for our products and services and the digital security industry as a whole. Wave expects to continue to incur substantial additional expenses associated
with continued research and development and business development activities that will be necessary to commercialize our technology. We may be unable to raise or generate the additional financing or
cash flow which will be necessary to continue as a going concern for the next twelve months.
In
addition to our efforts to generate revenue sufficient to fund our operations, or complete one or more commercial or strategic transactions, Wave may evaluate additional financing
options to
19
Table of Contents
generate
additional capital in order to continue as a going concern, to capitalize on business opportunities and market conditions and to insure the continued development of our technology, products
and services. We do not know if additional financing will be available or that, if available, it will be available on favorable terms. If we issue additional shares of our stock our stockholders'
ownership will be diluted and the shares issued may have rights, preferences or privileges senior to those of our common stock. In addition, if we pursue debt financing we may be required to pay
interest
costs. The failure to generate sufficient cash flow to fund our forecasted expenditures would require us to reduce our cash burn rate which would in turn impede our ability to achieve our business
objectives. Even if we are successful in raising additional capital, uncertainty with respect to Wave's viability will continue until we are successful in achieving our objectives. Furthermore,
although we may be successful at achieving our business objectives, a positive cash flow from operations may not ultimately be realized unless we are able to sell our products and services at a
profit. Given the early stage nature of the markets for our products and services considerable uncertainty exists as to whether or not Wave's business model is viable. If we are not successful in
generating sufficient cash flow or obtaining additional funding we may be unable to continue our operations, develop or enhance our products, take advantage of future opportunities or respond to
competitive pressures. Due to our current cash position, our forecasted capital needs over the next twelve months and beyond, the fact that we will require additional financing and uncertainty as to
whether we will achieve our sales forecast for our products and services, substantial doubt exists with respect to our ability to continue as a going concern.
A single customer accounts for a significant portion of our revenues and, therefore, the loss of that customer may have a material adverse effect on our results of
operations.
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 46% of our revenue for the year ended December 31, 2013, as discussed below. If our relationship with any of our significant customers were
disrupted we could lose a significant portion of our anticipated revenues which may have a material adverse effect on our results of operations as discussed below.
Factors
that could influence our relationships with our customers include, among other things:
-
•
-
our ability to sell our products at prices that are competitive with our competitors;
-
•
-
our ability to maintain features and quality standards for our products sufficient to meet the expectations of our
customers; and
-
•
-
our ability to produce and deliver a sufficient quantity of our products in a timely manner to meet our customers'
requirements.
If our OEM customers fail to purchase our components or to sell sufficient quantities of their products incorporating our components or if our OEM customers' sales timing
and volume fluctuates, it may have a material adverse effect on our results of operations.
In general, our ability to make sales to OEM customers depends on our ability to compete on price, delivery and quality. The timing and
volume of these sales depend upon the sales levels and shipping schedules for the products into which our OEM customers incorporate our products. Thus, even if we develop a successful component, our
sales will not increase unless the product into which our component is incorporated is successful. If our OEM customers decide not to incorporate our products as components of their products or fail
to sell a sufficient quantity of products incorporating our components, or if the OEM customers' sales timing and volume fluctuate, it may lead to a reduction in our sales and have a material adverse
effect on our results of operations.
Sales
to a relatively small number of OEM customers, as opposed to direct retail sales to end customers, comprise a large portion of our revenues. Dell accounted for approximately 46% of
our revenue for the year ended December 31, 2013. From time to time Dell updates its hardware platforms
20
Table of Contents
with
new security solutions packages. Our bundled software has been included on Dell platforms since 2006 (including the Dell Data Protection Access solution (DDPA) that is currently shipping). On
March 15, 2013, Dell notified us that it will be replacing the DDPA solution in its next generation of client hardware platforms that began shipping in late 2013. As it has with other solution
upgrades since 2006, Dell has also informed us that it will continue to discuss with Wave opportunities to include our software on new and future Dell platforms. However, Dell has not communicated to
us any decisions regarding the next platform and we have no assurance that our software will be included in Dell's new or future platforms. If we are not successful in continuing to sell our
technologies with Dell's new and future platforms, this could have a material adverse impact on our revenues in years after 2013.
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.
Wave is not established in the industry so we may not be accepted as a supplier or service provider to the market.
Wave's product offering represents a highly complex architecture designed to solve many of the security issues currently present with
computer systems such as identity theft, fraudulent transactions, virus attacks, unauthorized access to restricted networks and other security problems that users of computer systems generally
encounter. We are uncertain as to whether the marketplace will accept our solution to these security problems. We will not be successful if the market does not accept the value proposition that we
perceive to be present in our products and services.
Although
Wave has expended considerable resources in developing technology and products that utilize our technology and in business development activities in an attempt to drive the
development of the hardware security market, we do not have a track record as a substantial supplier or service provider to consumers of computer systems. Therefore, uncertainty remains as to whether
we will be accepted as a supplier to the enterprise and consumer markets which will likely be necessary for us to be a successful commercial enterprise.
Our products have not been accepted as industry standards which may slow their sales growth.
We believe platforms adopting integrated hardware security into the PC will become a significant standard feature in the overall PC
marketplace. However, our technologies have not been accepted as industry standards. Standards for trusted computing are still evolving. To be successful we must obtain acceptance of our technologies
as industry standards, modify our products and services to meet whatever industry standards ultimately develop and/or adapt our products to be complementary to whatever these standards become. If we
fail to do any of these we will not be
successful in commercializing our technology; and therefore, we will not generate sales to fund our operations and develop into a self-sustaining, profitable business.
21
Table of Contents
If we do not keep up with technological changes our product development and business growth will suffer.
Because the market in which we operate is characterized by rapidly changing technology, changes in customer requirements, frequent new
products, service introductions and enhancements and emerging industry standards, our success will depend upon, among other things, our ability to improve our products, develop and introduce new
products and services that keep pace with technological developments, remain compatible with changing computer system platforms, respond to evolving customer requirements and achieve market acceptance
on a timely and cost effective basis. If we do not identify, develop, manufacture, market and support new products and deploy new services effectively and timely our business will not grow, our
financial results will suffer and we may not have the ability to remain in business.
We are subject to risks relating to potential security breaches of our software products.
Although we have implemented in our products various security mechanisms, our products and services may nevertheless be vulnerable to
break-ins, piracy and similar disruptive problems caused by Internet users. Any of these disruptions would harm our business. Advances in computer capabilities, new discoveries in the field of
security or other developments may result in a compromise or breach of the technology we use to protect products and information in electronic form. Computer break-ins and other disruptions would
jeopardize the security of information stored in and transmitted through the computer systems of users of our products which may result in significant liability to us and may also deter potential
customers.
A
party who is able to circumvent our security measures could misappropriate proprietary electronic content or cause interruptions in our operations and those of our strategic partners.
We may be required to expend significant capital and other resources to protect against security breaches or to alleviate problems caused by breaches. Our attempts to implement contracts that limit
our liability to our customers, including liability arising from a failure of security features contained in our products and services, may not be enforceable. We currently do not have product
liability insurance to protect against these risks. If the security of products or services is breached, our results of operations may be materially adversely affected by the liability resulting from
the breach.
Competition and competing technologies may render some or all of our products non-competitive or obsolete.
An increasing number of market entrants have introduced or are developing products and services that compete with Wave's. Our
competitors may be able to develop products and services that are more attractive to customers than our products and services. Many of our competitors and potential competitors have substantially
greater financial, technical and marketing resources than we have. Also, many current and potential competitors have greater name recognition and larger customer bases that could be leveraged to
enable them to gain market share or product acceptance to our detriment. Wave's potential competitors include security solutions providers such as RSA Security, Inc. (a division of EMC),
Symantec, Computer Associates, Verisign, Inc., Entrust, Inc., Utimaco (acquired by Sophos), PGP (acquired by Symantec), Credant (acquired by Dell), 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
22
Table of Contents
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 personnel and on our ability to attract and
retain highly skilled technical, sales and marketing personnel. Our industry is characterized by a high level of employee mobility and aggressive recruiting of skilled personnel. There can be no
assurance that our current employees will continue to work for us or that we will be able to hire any additional personnel necessary for our growth. Our future success also depends on our continuing
ability to identify, hire, train and retain other highly qualified technical and managerial personnel. Competition for these employees can be intense. We may not be able to attract, assimilate or
retain qualified technical and managerial personnel in the future, and the failure of us to do so would have a material adverse effect on our business.
We have a limited ability to protect our intellectual property rights and others could infringe on or misappropriate our proprietary rights.
Our success depends, in part, on our ability to enjoy or obtain protection for our products and technologies under United States and
foreign patent laws, copyright laws and other intellectual property laws and to preserve our trade secrets. We cannot assure you that any patent owned or licensed by us will provide us with adequate
protection or will not be challenged, invalidated, infringed or circumvented.
23
Table of Contents
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 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
24
Table of Contents
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.
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.
25
Table of Contents
Regulation of international transactions may limit our ability to sell our products in foreign markets.
Most of our software products are controlled under various United States export control laws and regulations and may require export
licenses for certain exports of the products and components outside of the United States and Canada. With respect to our EMBASSY Trust Suite and EMBASSY Trust Server software applications, we have
applied for and received export classifications that allow us to export our products without a license and with no restrictions to any country throughout the world with the exception of Cuba, Iran,
North Korea, Sudan and Syria.
Any
new product offerings will be subject to review by the Bureau of Export Administration to determine what export classification they will receive. Enhancements to existing products
may be subject to review by the Bureau of Export Administration to determine their export classification. Some of our partners demand that our products be allowed to be exported without restrictions
and/or reporting requirements. Current export regulations have, in part, allowed us to receive the desired classification without undue cost or effort. However, the export regulations may be modified
at any time. Currently we are allowed to export the products for which we have received classification in an unrestricted manner without a license. However, modifications to the export regulations
could prevent us from exporting our existing and future products in an unrestricted manner without a license. Such modifications could also make it difficult to receive the desired classification. If
export regulations were to be modified in such a way, we may be put at a competitive disadvantage with respect to selling our products internationally.
In
addition, import and export regulations of encryption/decryption technology vary from country to country. We may be subject to different statutory or regulatory controls in different
foreign jurisdictions, and as such, our technology may not be permitted in these foreign jurisdictions. Violations of foreign regulations or regulation of international transactions could prevent us
from being able to sell our products in international markets. Our success depends in large part to having access to international markets. A violation of foreign regulations could limit our access to
such markets and have a negative effect on our results of operations.
Our stock price is volatile.
The price of our Class A Common Stock has been, and likely will continue to be, subject to wide fluctuations in response to a
number of events and factors such as:
-
•
-
quarterly variations in operating results;
-
•
-
announcements of technological innovations, new products, acquisitions, capital commitments or strategic alliances by us
or our competitors;
-
•
-
the operating and stock price performance of other companies that investors may deem comparable to us; and
-
•
-
news reports relating to trends in our markets.
In
addition, the stock market in general and the market prices for technology-related companies in particular, have experienced significant price and volume fluctuations. These broad
market fluctuations may adversely affect the market price of our Class A Common Stock and any of our other securities for which a market develops regardless of our operating performance.
Securities class action litigation has often been instituted against companies that have experienced periods of volatility in the market price for their securities. It is possible that we could become
the target of additional litigation of this kind that would require substantial management attention and expense. The diversion of management's attention and capital resources could have a material
adverse effect on our business. In addition, any negative publicity or perceived negative publicity of any such litigation could have an adverse impact on our business.
26
Table of Contents
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, as amended on September 19, 2013, ("2012 ATM") with
MLV & Co. LLC ("MLV") under which we are able to sell shares of our common stock 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 of 1933, as amended (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 current Board of Directors does not include any representatives of our strategic partners. However, our Board of Directors has
included in the past and may include in the future, representatives of our strategic partners. It is possible that those corporations may be competing against us, or each other, directly or
indirectly. A director who also represents another company may voluntarily abstain from voting on matters where there could be conflicts of interest. Even if such a director does abstain, his presence
on the Board could affect the process or the results of the Board's deliberations. We have adopted no policies or procedures to reduce or avoid such conflicts. If such conflicts of interest arise they
may have a materially adverse effect on our business.
Governmental regulation may slow our growth and decrease our profitability.
There are currently few laws or regulations that apply directly to the Internet. Because our business is dependent, in significant
respect, on the Internet, the adoption of new local, state, national or international laws or regulations may decrease the growth of Internet usage or the acceptance of Internet commerce which could
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.
27
Table of Contents
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. In addition to the $1.00 bid price rule, in order to remain listed on the NASDAQ Capital Market, we must also maintain compliance with
all of the other required continued listing requirements of the NASDAQ Capital Market, including the $35 million market capitalization requirement. If our common stock ceases to be listed for
trading on the NASDAQ Capital Market we expect that our common stock would be traded on the Financial Industry Regulatory Authority's Over-the-Counter Bulletin Board (OTC-BB). The level of trading
activity of our common stock may decline if it is no longer listed on the NASDAQ Capital Market. If our common stock ceases to be listed for trading on the NASDAQ Capital Market for any reason it may
harm our stock price, increase the volatility of our stock price and make it more difficult to sell your shares of our common stock.
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended December 31, 2013, 2012 and 2011
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2013
|
|
2012
|
|
2011
|
|
|
Cash flows from operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(20,324,264
|
)
|
$
|
(33,962,548
|
)
|
$
|
(10,794,736
|
)
|
|
Adjustments to reconcile net loss to net cash used in operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
1,009,876
|
|
|
2,132,136
|
|
|
1,005,068
|
|
|
Compensation associated with issuance of stock options
|
|
|
1,694,842
|
|
|
4,830,831
|
|
|
5,379,961
|
|
|
Impairment of goodwill and purchased intangible assets
|
|
|
4,205,000
|
|
|
7,477,832
|
|
|
—
|
|
|
Accretion of royalty liability
|
|
|
81,400
|
|
|
67,500
|
|
|
—
|
|
|
Changes in assets and liabilities, net of effects from business acquisition:
|
|
|
|
|
|
|
|
|
|
|
|
Decrease in accounts receivable
|
|
|
2,315,840
|
|
|
1,900,250
|
|
|
5,514,845
|
|
|
(Increase) decrease in prepaid expenses and other current assets
|
|
|
(66,887
|
)
|
|
401,992
|
|
|
152,601
|
|
|
(Increase) decrease in other assets
|
|
|
157,468
|
|
|
11,993
|
|
|
(209,941
|
)
|
|
Increase (decrease) in accounts payable and accrued expenses
|
|
|
(735,449
|
)
|
|
924,087
|
|
|
810,406
|
|
|
Increase (decrease) in deferred revenue
|
|
|
238,454
|
|
|
106,922
|
|
|
(3,331,530
|
)
|
|
Increase (decrease) in royalty liability
|
|
|
(103,900
|
)
|
|
321,076
|
|
|
264,553
|
|
|
Increase (decrease) in other long-term liabilities
|
|
|
(19,378
|
)
|
|
31,713
|
|
|
(16,830
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in operating activities
|
|
|
(11,546,998
|
)
|
|
(15,756,216
|
)
|
|
(1,225,603
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities:
|
|
|
|
|
|
|
|
|
|
|
|
Acquisition of property and equipment
|
|
|
(186,715
|
)
|
|
(169,660
|
)
|
|
(995,403
|
)
|
|
Acquisition of Safend, Ltd., net of cash acquired
|
|
|
—
|
|
|
—
|
|
|
(803,315
|
)
|
|
Internal-use software development costs
|
|
|
(226,000
|
)
|
|
—
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in investing activities
|
|
|
(412,715
|
)
|
|
(169,660
|
)
|
|
(1,798,718
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
Payments on capital lease obligation
|
|
|
(44,658
|
)
|
|
(72,075
|
)
|
|
(66,771
|
)
|
|
Net proceeds from issuance of common stock
|
|
|
11,706,066
|
|
|
13,659,587
|
|
|
—
|
|
|
Proceeds from employee stock purchase plans
|
|
|
263,599
|
|
|
666,095
|
|
|
814,644
|
|
|
Proceeds from employee stock option exercises
|
|
|
42,039
|
|
|
79,503
|
|
|
806,119
|
|
|
Proceeds from exercise of warrants
|
|
|
—
|
|
|
320,500
|
|
|
1,260,288
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by financing activities
|
|
|
11,967,046
|
|
|
14,653,610
|
|
|
2,814,280
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net increase (decrease) in cash and cash equivalents
|
|
|
7,333
|
|
|
(1,272,266
|
)
|
|
(210,041
|
)
|
|
Cash and cash equivalents at beginning of year
|
|
|
2,112,769
|
|
|
3,385,035
|
|
|
3,595,076
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of year
|
|
$
|
2,120,102
|
|
$
|
2,112,769
|
|
$
|
3,385,035
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental cash flow information:
|
|
|
|
|
|
|
|
|
|
|
|
Non-cash financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
Issuance of common stock for developed technology
|
|
$
|
500,000
|
|
$
|
—
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cashless exercise of warrants
|
|
$
|
—
|
|
$
|
404
|
|
$
|
1,204
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid during the year for:
|
|
|
|
|
|
|
|
|
|
|
|
Interest
|
|
$
|
108,462
|
|
$
|
119,763
|
|
$
|
11,758
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income taxes
|
|
$
|
8,816
|
|
$
|
78,235
|
|
$
|
81,378
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
F-5
Table of Contents
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) Business of the Company
Wave Systems Corp. ("Wave" or "the Company") develops, produces and markets products for hardware-based digital security including security applications and services that are
complementary to and compliant with the specifications of the Trusted Computing Group, www.trustedcomputinggroup.org ("TCG"). Specifications developed by the TCG are designed to address a broad range
of current and evolving digital security issues facing the industry. These issues include the following: identity protection, data security, digital signatures, electronic transaction integrity,
platform trustworthiness, network security, data leak prevention and protection and regulatory compliance. Wave's products are designed to solve many of these digital security issues.
Safend, Ltd.
("Safend"), an Israeli company acquired by Wave on September 22, 2011, is engaged in research and sale of endpoint data loss protection products and services.
(2) Reverse Stock Split
On June 28, 2013, our Board of Directors approved a reverse stock split of our common stock at a ratio of 1-for-4, causing each four outstanding shares of Class A common
stock and Class B common stock to convert automatically into one share of Class A common stock or Class B common stock, respectively. The par value of Class A common stock
and Class B common stock remains $0.01 per share. The reverse split became effective on July 1, 2013. Stockholders' equity has been restated to give retroactive recognition to the
reverse split for all periods presented by reclassifying the excess par value resulting from the reduced number of shares from common stock to paid-in capital. Except as otherwise noted, all
references to common share and per common share amounts (including warrant shares, shares reserved for issuance and applicable exercise prices) for all periods presented have been retroactively
restated to reflect this reverse split.
(3) Liquidity
The accompanying consolidated financial statements have been prepared assuming that Wave will continue as a going concern. Wave has incurred substantial operating losses since its
inception, and as of December 31, 2013, has an accumulated deficit of approximately $417,240,000. We also expect Wave
will incur an operating loss for the fiscal year 2014. As of December 31, 2013, Wave had negative working capital of approximately $8,194,000.
Wave
does not expect to generate enough revenue to fund its cash flow requirements for the year ended December 31, 2014. As of December 31, 2013, we had approximately
$2,120,000 of cash on hand. Given Wave's forecasted capital requirements for the twelve-months ending December 31, 2014, and our cash balance as of December 31, 2013, Wave will be
required to raise additional capital prior to December 31, 2014 to continue to fund its operations. Wave's ability to raise additional capital is primarily based on three
sources:
-
•
-
Sales of registered Class A Common Stock under a $20,000,000 shelf registration statement filed with the SEC on
August 9, 2013 and declared effective by the Commission on September 12, 2013 ("2013 shelf registration statement");
-
•
-
Sales of registered Class A Common Stock via the At the Market Sales Agreement with
MLV & Co. LLC ("MLV") entered into during January, 2012. The At the Market Sales Agreement was amended on September 19, 2013 to authorize the issuance and sale of shares of
the Company's Class A Common Stock under the At the Market Sales Agreement for aggregate
F-6
Table of Contents
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(3) Liquidity (Continued)
During
the year ended December 31, 2013, Wave sold 3,811,523 shares of its Class A common stock through its At the Market Sales Agreement with MLV at an average price of
$1.45 per share, for net proceeds of approximately $5,353,000 after deducting offering costs of approximately $177,000. Subsequent to December 31, 2013, Wave sold 5,326,409 shares of its
Class A common stock through MLV at an average price of $1.02 per share, for net proceeds of approximately $5,282,000 after deducting offering costs of approximately $167,000. As of
March 11, 2014, Wave has sold a total of approximately 11.1 million shares of its common stock through MLV, raising net proceeds of approximately $19.7 million after deducting
offering costs of approximately $634,000.
On
December 18, 2013, Wave sold 1,253,351 shares of Class A Common Stock at $0.9725 per share for gross proceeds of $1,218,884. This financing was completed under the 2013
shelf registration statement. Wave also issued warrants to the subscribers to purchase 626,674 shares of Class A common stock at an exercise price of $0.91 per share. These warrants expire on
December 18, 2018. Security Research Associates, Inc. ("SRA") entered into a placement agency agreement with Wave in which they agreed to act as placement agent in connection with the
offering. Wave agreed to pay SRA a fee equal to 6% of the gross proceeds of this offering. Wave realized approximately $1,116,000 in net proceeds after deducting the placement agent fees of
approximately $73,000 and additional legal and other fees associated with the issuance of these securities totaling approximately $30,000. In connection with the financing, Wave also issued warrants
to SRA to purchase up to 75,201 shares of Wave Class A Common Stock for $0.91 per share. These warrants expire on December 18, 2018. At the time of the December 18, 2013
financing, Wave was required to calculate the amount of capital the Company was allowed to raise in accordance with the General Instruction I.B.6. on Form S-3 ("the one-third rule"). The
one-third rule restricts the amount of capital that can be raised in a 12-month period provided that the registrant's aggregate market value of the common equity held by non-affiliates is less than
$75 million. As a result of the December 18, 2013 financing and the application of the one-third rule, the funds available on the 2013 shelf registration statement were reduced. Until
Wave attains an aggregate market value of $75 million or more for shares held by non-affiliates, its available funds under the 2013 shelf registration statement will remain restricted to the
one-third rule computation. To determine the amount available under the one-third rule for future financings, the aggregate market value of the common equity is calculated using the price at which the
common equity was last sold, or the average of the bid and asked prices of the common equity as of a date within 60 days prior to the date of filing. As of March 11, 2014, approximately
$11,718,000 in gross proceeds remains under the 2013 shelf registration statement, however Wave is restricted to $6,721,000 as of such date due to the one-third rule. The total funds available under
the 2013 shelf registration statement are all allocated to the At the Market Sales Agreement with MLV which may be utilized for future financings.
On
July 25, 2013, Wave sold 1,204,470 shares of Class A Common Stock at $1.27 per share for gross proceeds of $1,529,677. This financing was completed under the 2011 shelf
registration statement. SRA entered into a placement agency agreement with Wave in which they agreed to act as placement agent in connection with the offering. Wave agreed to pay SRA a fee equal to 6%
of the gross proceeds of this offering. Wave realized approximately $1,408,000 in net proceeds after deducting the placement agent fees of approximately $92,000 and additional legal and other fees
associated with the
F-7
Table of Contents
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(3) Liquidity (Continued)
issuance
of these securities totaling approximately $30,000. In connection with the financing, Wave also issued warrants to SRA to purchase up to 72,268 shares of Wave Class A Common Stock for
$1.27 per share. These warrants expire on July 25, 2016.
On
April 23, 2013, Wave sold 1,585,000 shares of Class A Common Stock at $2.00 per share for gross proceeds of $3,170,000. This financing was completed under the 2011 shelf
registration statement. Dawson James Securities, Inc. ("Dawson") entered into a placement agency agreement with Wave in which they agreed to act as placement agent in connection with the
offering. Wave agreed to pay Dawson a fee equal to 6% of the gross proceeds of this offering. Wave realized approximately $2,920,000 in net proceeds after deducting the placement agent fees of
$190,200 and additional legal and other fees associated with the issuance of these securities totaling approximately $60,000. In connection with the financing, Wave also issued warrants to the
subscribers to purchase up to 792,500 shares of Wave Class A Common Stock for $2.48 per share. These warrants expire on October 23, 2018.
On
March 13, 2013, Wave entered into agreements with certain institutional investors for a private placement of 301,205 shares of its Class A common stock at a price of
$3.32 per share, yielding gross proceeds of $1,000,000. Wave agreed to pay Dawson, the placement agent, a fee equal to 6% of the gross proceeds of this offering. Wave realized approximately $910,000
in net proceeds after deducting the placement agent fees of $60,000 and additional legal and other fees associated with the issuance of these securities totaling approximately $30,000. Wave also
issued warrants to the subscribers to purchase 150,603 shares of Class A common stock at an exercise price of $3.32 per share. These warrants expire in October 2018.
Wave
will be required to sell shares of common stock, preferred stock, obtain debt financing or engage in a combination of these financing alternatives, to raise additional capital to
continue to fund its operations for the twelve months ending December 31, 2014. If Wave is not successful in executing its business plan, it will be required to sell additional shares of common
stock, preferred stock, obtain debt financing or engage in a combination of these financing alternatives or it could be forced to reduce expenses which may significantly impede its ability to meet its
sales, marketing and development objectives, cease operations or merge with another company. No assurance can be provided that any of these initiatives will be successful. Due to its current cash
position, capital needs over the next year and beyond, and the uncertainty as to whether it will achieve its sales forecast for its products and services, substantial doubt exists with respect to
Wave's ability to continue as a going concern.
(4) Significant Accounting Policies
(a) Basis of Consolidation
The consolidated financial statements include the financial statements of Wave, Wave Systems Holdings, Inc., a wholly owned
subsidiary, Safend, Ltd. (and its wholly owned subsidiary, Safend, Inc., collectively referred to as "Safend"), a wholly owned subsidiary (see note 8) and Wavexpress, Inc.
a majority-owned subsidiary. All significant intercompany accounts and transactions have been eliminated in consolidation.
F-8
Table of Contents
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(4) Significant Accounting Policies (Continued)
(b) Foreign Currency Translation
The functional currency of Safend is the U.S dollar. Transactions and balances originally denominated in U.S. dollars are presented at
their original amounts. Foreign currency transaction gains or losses are credited or charged to the consolidated statements of operations as incurred as a component of other income (expense), net.
(c) Use of Estimates
The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the
United States requires management to make estimates and assumptions that affect amounts reported in the Consolidated Financial Statements and accompanying notes. Estimates are used for, but not
limited to, depreciation and amortization, revenue recognition, accounts receivable reserves, valuation of long-lived and intangible assets, software development, contingencies and share-based
compensation. Actual results could differ from those estimates.
(d) Cash and Cash Equivalents
Wave considers all highly liquid instruments with an original or remaining maturity of three months or less to be cash equivalents.
Substantially all cash and cash equivalents are on deposit with two major financial institutions.
(e) Accounts Receivable and Allowance For Doubtful Accounts
Included in accounts receivable at December 31, 2013 and 2012 are unbilled amounts totaling $125,497 and $118,088, respectively.
The
determination of the allowance for doubtful accounts is based on management's estimate of uncollectible accounts receivable. Management records specific reserves for receivable
balances that are considered high risk due to known facts regarding the customer.
(f) Accounting for Transfers of Financial Assets
Wave derecognizes financial assets, specifically accounts receivable, when control has been surrendered in compliance with ASC Topic
860, Transfers and Servicing. Transfers of
accounts receivable that meet the requirements of ASC 860 for sale accounting treatment are removed from the balance sheet and gains or losses on the sale are recognized. If the conditions for sale
accounting treatment are not met, or are no longer met, accounts receivable transferred are classified as collateralized receivables in the consolidated balance sheets and cash received from these
transactions is classified as secured borrowings. All transfers of assets are accounted for as secured borrowings. Transaction costs associated with secured borrowings, if any, are treated as
borrowing costs and recognized in interest expense.
(g) Concentrations of Credit Risks
Sales to Wave's largest customer in 2013, 2012 and 2011, Dell, Inc., were approximately 46%, 55% and 62% of revenue,
respectively. Accounts receivable at December 31, 2013, 2012 and 2011 included receivables from Dell, Inc. and its affiliates of $1,025,377, $1,187,398 and $4,189,388, respectively. At
F-9
Table of Contents
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(4) Significant Accounting Policies (Continued)
December 31,
2013 and 2012, $1,683,188 and $1,299,283, respectively, of Dell receivables are classified as pledged receivables on the consolidated balance sheet.
(h) Property and Equipment
Property and equipment, including purchased computer software, are stated at cost less accumulated depreciation and amortization.
Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets which range from between three to five years. Amortization of leasehold
improvements is computed using the shorter of the useful life or remaining lease term which range from between three and fifteen years.
(i) Capitalized internal-use software development costs
The Company follows the provisions of ASC Topic 350-40,
Intangibles Goodwill and Other—Internal Use
Software.
ASC Topic 350-40 provides guidance for determining whether computer software is internal-use software and also provides guidance on capitalization of the costs
incurred for computer software developed or obtained for internal use. These capitalized costs are related to Wave's cloud platform that is hosted by the Company and accessed by its clients on a
subscription basis. The Company expenses all costs incurred during the preliminary project stage of development and capitalizes the costs incurred during the application development stage. Costs
incurred relating to upgrades and enhancements to the software are capitalized if it is determined that these upgrades or enhancements add additional functionality to the software. Costs incurred to
improve and support products after they become available are charged to expense as incurred. The Company records amortization of the software on a straight-line basis over five years, which is the
estimated useful life of the software. At each balance sheet date, management evaluates the unamortized capitalized software costs for potential impairment by comparing the balance to the net
realizable value of the products. The Company capitalized $726,000 of software development costs during the year ended December 31, 2013 (see Note 9).
(j) Income Taxes
Wave accounts for income taxes under the asset and liability method. As such, deferred tax assets and liabilities are recognized for
the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax
credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. At December 31, 2013 and
2012, a full valuation allowance has been recorded against the gross deferred tax asset since management believes that, after considering all the available objective evidence, both positive and
negative, historical and prospective, with greater weight given to historical evidence, it is more likely than not that these assets will not be realized. Wave classifies any interest and penalties
related to uncertain tax positions as components of the income tax provision.
F-10
Table of Contents
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(4) Significant Accounting Policies (Continued)
(k) Share-based Payments
Wave recognizes compensation expense for all share-based payment awards made to employees and directors including employee stock
options and employee stock purchases related to the Employee Stock Purchase Plan. Stock-based compensation expense recognized is based on the value of the portion of stock-based payment awards that is
ultimately expected to vest and has been reduced for estimated forfeitures. Wave determines the fair value of stock-based payment awards on the date of grant using an option-pricing model that is
affected by Wave's stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to Wave's expected stock price
volatility over the term of the awards and actual and projected employee stock option exercise behaviors.
(l) Research and Development and Software Development Costs
Research and development costs are expensed as incurred. Such costs related to software development are included in research and
development expense until the point that technological feasibility is reached, which for our software products, is generally shortly before the products are released. Once technological feasibility is
reached, such costs are capitalized and amortized to cost of revenue over the estimated lives of the products.
(m) Loss Per Share
Basic net loss per common share has been calculated by dividing the net loss attributable to common stockholders by the weighted
average number of shares of common stock outstanding during the period. Diluted net loss per share is also computed using the weighted average number of common shares and includes dilutive potential
common shares outstanding. Dilutive potential common shares consist primarily of employee stock options and stock warrants. Diluted net loss per share is equal to basic net loss per share and is
therefore not presented separately in the financial statements. The weighted average number of potential common shares that would have been included in diluted loss per share had their effect not been
anti-dilutive for each of the years ended December 31, 2013, 2012 and 2011 were approximately 99,000 shares, 615,000 shares and 1,676,000 shares, respectively. Employee stock options and other
stock warrants to purchase a weighted average of approximately 5,504,000, 3,669,000 and 2,254,000 shares were outstanding for the years ended December 31, 2013, 2012 and 2011 respectively, but
are not included in the computation of diluted loss per share because their exercise price was greater than the average share price of Wave's common shares and, therefore, their effect would have been
anti-dilutive.
(n) Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of
Wave reviews the valuation of long-lived assets, including property and equipment, amortizable intangible assets and capitalized
software, whenever events and circumstances indicate that the carrying value may not be recoverable. Factors considered important that could trigger an impairment review include the
following:
-
•
-
significant underperformance relative to expected historical or projected future operating results;
-
•
-
significant changes in the manner of use of the acquired assets or the strategy of the overall business;
F-11
Table of Contents
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(4) Significant Accounting Policies (Continued)
-
•
-
significant negative industry or economic trends; and
-
•
-
significant decline in the stock price for a sustained period.
When
Wave determines that the carrying value of applicable long-lived assets may not be recoverable based upon the existence of one or more of the above indicators of impairment, the
Company evaluates whether the carrying amount of the asset exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of that asset. If such a circumstance
exists, Wave would measure an impairment loss to the extent the carrying amount of the particular long-lived asset or group exceeds its fair value. Wave would determine the fair value based on a
projected
discounted cash flow method using a discount rate determined by management to be commensurate with the risk inherent in their current business model. When Wave determines that the carrying value of
capitalized software development costs may not be recoverable, we evaluate whether the unamortized cost exceeds the expected future net realizable value of the products. If the unamortized costs
exceed the expected future net realizable value of the products, the excess amount is written off. Changes in judgments on any of these factors could impact the value of the asset being evaluated.
(o) Goodwill
Wave tests goodwill for impairment annually on September 30 and during interim periods whenever events or changes in
circumstances indicate the carrying value of goodwill may not be recoverable. Wave uses a fair value approach in testing goodwill for impairment in accordance with the provisions of ASC Topic 350,
Intangibles—Goodwill and
Other
. The goodwill impairment test involves a two-step process. In the first step, we compare the fair value of
each reporting unit to its carrying value. If the fair value of the reporting unit exceeds its carrying value, goodwill is not impaired and no further testing is required. If the fair value of the
reporting unit is less than the carrying value, we must perform the second step of the impairment test to measure the amount of impairment loss. In the second step, the reporting unit's fair value is
allocated to all of the assets and liabilities of the reporting unit, including any unrecognized intangible assets, in a hypothetical analysis that calculates the implied fair value of goodwill in the
same manner as if the reporting unit was being acquired in a business combination. If the implied fair value of the reporting unit's goodwill is less than the carrying value, the difference is
recorded as an impairment loss.
(p) Revenue Recognition
Wave's business model targets revenues from various sources including: licensing of the EMBASSY Trust Suite, Safend's endpoint
data loss protection suite, eTMS software products and development contracts. Many of these sales arrangements include multiple-elements and/or require significant modification or customization of
Wave's software.
Wave
recognizes revenue when 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. In addition to the aforementioned general policy, the following are the specific revenue recognition
policies for each major category of revenue.
F-12
Table of Contents
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(4) Significant Accounting Policies (Continued)
Licensing and Maintenance
Wave receives revenue from licensing its EMBASSY Trust Suite software through distribution arrangements with its OEM partners, software
development and other services including maintenance. Wave's distribution arrangements also gives rise to separate software license upgrade agreements with the end users of the products distributed by
the OEMs. Wave applies software revenue recognition guidance to all transactions except those where no software is involved. Revenue is recognized when persuasive evidence of an arrangement
exists, delivery has occurred, the fee is fixed or determinable and collectability is reasonably assured. Persuasive evidence is generally a binding purchase order or license agreement. Delivery
occurs when product is shipped, for its OEM distribution arrangements, or delivered via a license key, for our license upgrade agreements.
Wave
enters into perpetual software license agreements through direct sales to customers and indirect sales through its OEM partners, distributors and resellers with the end users of the
products distributed by the OEMs. Wave has defined its 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 generally include a maintenance component. For arrangements with multiple elements, including software licenses, maintenance and/or services,
revenue is allocated and deferred in amounts equivalent to the vendor specific objective evidence ("VSOE") of fair value for the undelivered elements and the difference between the total arrangement
fee and the amount deferred for the undelivered elements is recognized as license revenue. VSOE of fair value is based upon the price for which the undelivered element is sold separately.
Beginning
in the quarter ended March 31, 2011, Wave had sufficient independent maintenance renewals to establish VSOE of fair value of maintenance for its small class of
customers. Through December 31, 2013, Wave continues to lack sufficient independent maintenance renewals to establish VSOE for its large customer class. As a result, beginning in the quarter
ended March 31, 2011, for the small customer class, Wave has allocated the arrangement consideration to the elements in multi-element arrangements using the residual method. Under the residual
method, the VSOE of the undelivered elements is deferred and the remaining portion of the arrangement fee for perpetual licenses is recognized as revenue upon delivery of the software, assuming all
other revenue recognition criteria are met.
When
VSOE of fair value for the undelivered elements does not exist, as is still the case for Wave's large customer class, the entire arrangement fee is recognized ratably over the
performance period as licensing and maintenance revenue. At December 31, 2013, Wave's deferred revenue consists of the
unamortized maintenance for sales to its small class of customers and bundled license and maintenance arrangements where VSOE does not exist.
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 through direct sales to customers and indirect sales through its OEM partners, distributors and resellers. These license
arrangements,
F-13
Table of Contents
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(4) Significant Accounting Policies (Continued)
generally
also include a maintenance component. For arrangements with multiple elements, including software licenses, maintenance and/or services, revenue is allocated and deferred in amounts
equivalent to the VSOE of fair value for the undelivered elements and the difference between the total arrangement fee and the amount deferred for the undelivered elements is recognized as licensing
revenue. VSOE of fair value is based upon the price for which the undelivered element is sold separately.
Safend
has VSOE of fair value of maintenance for Protector product. As a result Safend allocates the arrangement consideration among the elements in its multi-element arrangements using
the residual method. Under the residual method, the VSOE of the undelivered elements is deferred and the remaining portion of the arrangement fee for perpetual licenses is recognized as revenue upon
delivery of the software, assuming all other revenue recognition criteria are met. When VSOE of fair value for the undelivered elements does not exist, as is the case for maintenance for its Safend's
Encryptor, Inspector, Discover, Reporter and Auditor products, the entire arrangement fee is recognized ratably over the performance period as licensing and maintenance revenue.
Licensing
and maintenance—cost of net revenues includes customer support personnel costs, foreign tax withholdings, amortization expense of the developed technology
intangible asset, costs associated with providing consulting services and related share-based compensation expense.
Services
Revenue from time and material service contracts is recognized as the services are provided. Revenue from fixed price, long-term
service or development contracts is recognized using the percentage of completion method. The Company measures the percentage of completion by reference to the proportion of contract hours incurred
for work performed to date to the estimated total contract hours expected to be incurred. Losses on fixed price contracts are recognized during the period in which the loss first becomes apparent.
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 related share-based compensation expense.
(q) Reclassifications
Certain amounts in the Company's prior period consolidated financial statements have been reclassified to conform to the current period
presentation including $389,000 of support expense from selling, general and administrative expense to licensing and maintenance—cost of net revenue for the year ended December 31,
2012.
All
references to common shares and per common share amounts of the Company have been adjusted to give effect to the implementation of a 1-for-4 reverse stock split of the Company's
authorized and issued common stock which was effected on July 1, 2013. See Note 2 above.
F-14
Table of Contents
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(5) Secured Borrowings and Pledged Receivables
Pursuant to agreements entered into on April 23, 2012 with The Receivables Exchange ("TRE") and on November 26, 2013 with CapFlow Funding Group Managers LLC
("CapFlow), both of which are unrelated third parties, Wave has transferred certain accounts receivable to buyers which are accounted for as secured borrowings. The transferred receivables are
classified as pledged receivables and Wave's obligation to repurchase the transferred receivables is presented as secured borrowings on the
consolidated balance sheet. The carrying value of each secured borrowing approximates 85% of each associated pledged receivable and takes into consideration a 15% holdback provision per the TRE and
CapFlow agreements. The customers' payment of the pledged receivables constitutes the repayment of the related amounts borrowed. The respective financial institution will then remit the remaining 15%
holdback to Wave less interest. Beginning on November 26, 2013 Wave no longer transfers accounts receivable to TRE and utilizes CapFlow exclusively. The interest rate on the secured borrowings
was 1.50% for every thirty days outstanding.
With
Wave's approval, CapFlow establishes arrangements with buyers providing for borrowings that are secured by our accounts receivable, and for which recourse exists against Wave. Wave
can be required to repurchase the receivables under certain circumstances in case of specific defaults by our customers as set forth in the program terms. CapFlow acts as the servicing agent for
receivables transferred to buyers. CapFlow collects the pledged receivables from Wave's customers and makes the repayment to the buyers on its behalf once the receivables are collected.
At
December 31, 2013 and 2012, receivables totaling $1,683,188 and $1,801,683, respectively, were transferred to CapFlow, and TRE, respectively, remain uncollected and are subject
to repurchase. The secured borrowings totaled $1,430,710 and $1,537,710 as of December 31, 2013 and 2012, respectively. Wave recognized $117,907 and $123,065 of interest expense associated with
the secured borrowings for year ended December 31, 2013 and 2012, respectively. Proceeds from the transfer of receivables are included in cash provided by operating activities in the
consolidated statements of cash flows. Proceeds from the transfer of pledged receivables were $8,316,898 and $10,531,356 for the years ended December 31, 2013 and 2012, respectively. CapFlow
and TRE collected $6,886,188 and $8,993,646 of pledged receivables in the years ended December 31, 2013 and 2012, respectively, which thereby reduced Wave's repurchase obligation and were
accounted for as reductions of pledged receivables and secured borrowings on the consolidated balance sheet. No pledged receivables were repurchased by the Company during the years ended
December 31, 2013 and 2012.
(6) Related Party Transactions
Per an employment agreement with the Company, Steven Sprague, Wave's former President and Chief
Executive Officer, was entitled to a lump sum payment equal to three (3) years base salary should his employment with the Company terminate without cause or in certain other circumstances.
During the fourth quarter of 2013, the Company recorded an expense of approximately $1,013,000 as a result of Mr. Sprague's termination effective as of October 6, 2013. As of
December 31, 2013, approximately $976,000 remains unpaid and is included in accounts payable and accrued expenses. Mr. Sprague continues to serve Wave as a member of the Board of
Directors.
Peter
Sprague, the father of Steven Sprague, was paid a salary of $134,200, $134,200, and $134,160 for the years ended December 31, 2013, 2012, and 2011, respectively. Peter
Sprague earned bonuses of $-0-, $30,000 and $125,000 for the years ended December 31, 2013, 2012 and 2011, respectively.
F-15
Table of Contents
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(6) Related Party Transactions (Continued)
Michael
Sprague, the brother of Steven Sprague and the son of Peter Sprague, was paid a salary of $189,300, $189,300 and $189,280 for the years ended December 31, 2013, 2012 and
2011, respectively. Michael Sprague earned bonuses of $-0-, $45,000 and $55,000 for the years ended December 31, 2013, 2012 and 2011, respectively.
On
September 16, 2013 Wave entered into a Software Development and License Agreement ("the Development Agreement") with EXO5, LLC ("EXO5"). EXO5 is a company owned by
Richard Lee, an experienced software project manager who joined Wave in September 2011 as Project Manager for Cloud Services. Pursuant to the Development Agreement, Wave issued
EXO5 372,578 shares of Class A Common Stock valued at $500,000 to acquire a perpetual license for EXO5's Cloud Application Platform ("the Platform").
(7) Property and Equipment
Property and equipment as of December 31 consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
2013
|
|
2012
|
|
|
Computer equipment
|
|
$
|
4,391,637
|
|
$
|
4,274,386
|
|
|
Furniture, fixtures and improvements
|
|
|
812,977
|
|
|
822,290
|
|
|
Computer software
|
|
|
2,725,290
|
|
|
2,684,479
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
7,929,904
|
|
|
7,781,155
|
|
|
Less: Accumulated depreciation and amortization
|
|
|
(7,333,084
|
)
|
|
(6,909,587
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
596,820
|
|
$
|
871,568
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation
and amortization expense on property and equipment amounted to approximately $461,000 $535,000 and $399,000 for the years ended December 31, 2013, 2012 and 2011,
respectively.
(8) Acquisition of Safend, Ltd.
On September 22, 2011, Wave completed its 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 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 are included in general and
administrative expenses in the consolidated statement of operations. Such transaction costs were approximately $405,000 for the year ended December 31, 2011.
The
fair value of consideration transferred was $12,477,528. The fair value of consideration consisted of $1.1 million in cash and 1,316,844 shares of Wave Class A common
stock valued at the September 22, 2011 closing price of $8.64 per share. There is no contingent consideration related to this transaction.
The assets, liabilities and operating results of Safend have been reflected in Wave's consolidated financial statements from the date of acquisition.
F-16
Table of Contents
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(8) Acquisition of Safend, Ltd. (Continued)
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 values at the date of acquisition. As part of the process, Wave 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 Wave 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 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 the respective asset or liability. The excess of the purchase price over the net identifiable intangible assets, other identifiable assets acquired
and assumed liabilities has been recorded as goodwill. Goodwill has been reflected in the Safend segment. The following table summarizes the fair values of the assets acquired and liabilities assumed
at the acquisition date.
|
|
|
|
|
|
|
Costs to acquire:
|
|
|
|
|
|
Cash payment
|
|
$
|
1,100,000
|
|
|
Stock-based consideration
|
|
|
11,377,528
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
12,477,528
|
|
|
Allocated to:
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
296,685
|
|
|
Accounts receivable
|
|
|
469,461
|
|
|
Prepaid expenses and other current assets
|
|
|
557,153
|
|
|
Long-term prepaid expenses
|
|
|
12,197
|
|
|
Property and equipment
|
|
|
133,235
|
|
|
Acquired intangible assets
|
|
|
10,578,000
|
|
|
Accounts payable and accrued expenses
|
|
|
(1,209,764
|
)
|
|
Royalty liability
|
|
|
(4,043,000
|
)
|
|
Deferred revenue
|
|
|
(1,565,704
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Net assets acquired
|
|
$
|
5,228,263
|
|
|
Charge for adjustments to working capital
|
|
$
|
1,033,206
|
|
|
Allocation to goodwill
|
|
$
|
6,216,059
|
|
As previously reported, the Company 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 deemed 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 were overstated by $649,480 and acquired deferred revenue was understated by $383,726.
F-17
Table of Contents
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(8) Acquisition of Safend, Ltd. (Continued)
The
Company 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, 150,181 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 to 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 on 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 the
selling shareholders. Once determined, any adjustment to the purchase price based upon 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. 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. None of the escrow shares
have been released as of December 31, 2013.
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 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. The Company concluded that while the adjustment to the OCS liability and corresponding adjustments to intangible assets and
goodwill affected the purchase price allocation and the balance sheet at September 30, 2011, they were not the result of new information obtained during the measurement period. At
December 31, 2013 and 2012 this liability amounted to $4,673,629 and $4,696,127, respectively, reflecting additional grants received since the acquisition date, less amounts repaid since the
acquisition date and accretion of the discount. The Company's discount is accreted using the effective interest method.
The consolidated results of operations include the results of Safend since the acquisition date of September 22, 2011. Had the
Company completed the acquisition at the beginning of 2011, in its
F-18
Table of Contents
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(8) Acquisition of Safend, Ltd. (Continued)
consolidated
results of operations, the net revenue, net loss and loss per share would have been as follows:
|
|
|
|
|
|
|
|
Twelve Months
Ended
December 31,
2011
|
|
|
Net revenue
|
|
$
|
40,378,944
|
|
|
Operating loss
|
|
$
|
(13,242,454
|
)
|
|
Net loss
|
|
$
|
(13,095,178
|
)
|
|
Basic and diluted EPS—Net loss
|
|
$
|
(0.60
|
)
|
(9) Goodwill and Intangible Assets
The following schedule presents the changes in the carrying amount of goodwill associated with the Safend unit during the years ended
December 31, 2013 and 2012:
|
|
|
|
|
|
|
Balance as of December 31, 2011
|
|
$
|
6,216,059
|
|
|
Impairment loss
|
|
|
(2,178,059
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of December 31, 2012
|
|
|
4,038,000
|
|
|
Impairment loss
|
|
|
(2,590,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of December 31, 2013
|
|
$
|
1,448,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Wave
tests goodwill for impairment annually on September 30 and during interim periods whenever events or changes in circumstances indicate the carrying value of goodwill may not
be recoverable. Wave uses a fair value approach in testing goodwill for impairment in accordance with the provisions of ASC Topic 350,
Intangibles—Goodwill and
Other
. The goodwill impairment test involves a two-step process. In the first step, we compare the fair value of each reporting unit to its carrying value. If the fair value of
the reporting unit exceeds its carrying value, goodwill is not impaired and no further testing is required. If the fair value of the reporting unit is less than the carrying value, we must
perform the second step of the impairment test to measure the amount of impairment loss. In the second step, the reporting unit's fair value is allocated to all of the assets and liabilities of the
reporting unit, including any unrecognized intangible assets, in a hypothetical analysis that calculates the implied fair value of goodwill in the same manner as if the reporting unit was being
acquired in a business combination. If the implied fair value of the reporting unit's goodwill is less than the carrying value, the difference is recorded as an impairment loss. The Company completed
its annual goodwill impairment test as of September 30, 2013 which resulted in no impairment of goodwill.
During
the fourth quarter of 2012 and the first quarter of 2013, the Company determined that sufficient indicators of potential impairment existed to require an interim goodwill
impairment analysis for the Safend reporting unit. These indicators included, among others, significantly lower than expected revenue, identification of increased competition for transactions
involving Safend products, inability of the combined sales force to close large transactions and downward revisions to management's short-term and long-term forecast for Safend. The revised forecast
reflected changes related to revenue growth rates, current market trends, expected deal synergies and other expectations
F-19
Table of Contents
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(9) Goodwill and Intangible Assets (Continued)
impacting
the anticipated short-term and long-term operating results of Safend. Due to the aforementioned indicators, the Company concluded that there were qualitative factors for the Safend unit that
indicated it is more likely than not that the fair value of the Safend reporting unit was less than its carrying amount.
The
Company estimates the fair value of its reporting units using the income approach. Under the income approach, the Company calculates the fair value of a reporting unit based on the
present value of estimated future cash flows. Cash flow projections are based on management's estimates of revenue growth rates and operating margins, taking into consideration industry and market
conditions. The discount rate used is based on the weighted-average cost of capital adjusted for the relevant risk associated with business-specific characteristics and the uncertainty related to the
business's ability to execute on the projected cash flows. The inputs used for the income approach are significant unobservable inputs, or Level 3 inputs, as described in ASC Topic 820,
Fair Value
Measurement
.
When
indicators of impairment are present, such as those noted above, the Company tests long-lived assets (other than goodwill) for recoverability by comparing the carrying value of an
asset group to its undiscounted cash flows. Based on the results of the recoverability test during the first quarter of 2013 and fourth quarter of 2012, the Company determined that the carrying value
of the Safend asset group exceeded its undiscounted cash flows and was therefore not recoverable. The Company estimated the fair value of the intangible assets under an income approach as described
above. Based on the analysis, the Company recorded impairment charges of $1.6 million and $5.3 million on intangible assets during the first quarter of 2013 and fourth quarter of 2012,
respectively. The decline in the fair value of the Safend intangible assets is attributable to the same factors as discussed above for the fair value of the Safend reporting unit.
After
adjusting the carrying value of the reporting unit for the impairment of the intangibles noted above in the first quarter of 2013 and the fourth quarter of 2012, the Company
completed the two step goodwill impairment test for the Safend reporting unit. This test resulted in an implied fair value of goodwill substantially below the carrying value of the goodwill. As a
result, the Company recorded a goodwill impairment charge of $2.2 million during the fourth quarter of 2012, which resulted in a $4.0 million remaining carrying value of Safend goodwill
as of December 31, 2012 and an additional goodwill impairment charge of $2.6 million during the first quarter of 2013, which resulted in a $1.4 million remaining carrying value of
Safend goodwill as of December 31, 2013. The goodwill impairment charge totaling approximately $2.6 million for the year ended December 31, 2013 and the impairment charge totaling
approximately $4.1 million for the year ended December 31, 2012 which consists of the goodwill impairment of approximately $2.2 million and an additional $1.9 million of
impairment on the customer relationship and in-process technology intangible assets, are included in the impairment of goodwill and intangible assets line item in the consolidated statements of
operations. The developed technology impairment charge of approximately $1.6 million and $3.4 million for the years ended December 31, 2013 and 2012, respectively, are included in
the licensing and maintenance—cost of net revenues line item in the consolidated statements of operations.
F-20
Table of Contents
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(9) Goodwill and Intangible Assets (Continued)
The following schedule presents the details of intangible assets as of December 31, 2013 and 2012:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2013
|
|
|
Intangible Asset
|
|
Gross
Carrying
Amount
|
|
Accumulated
Amortization
|
|
Accumulated
Impairment
Loss
|
|
Net
|
|
Weighted
Average
Remaining
Useful Life
(in years)
|
|
|
Developed Technology
|
|
$
|
6,426,000
|
|
$
|
(1,266,803
|
)
|
$
|
(5,038,100
|
)
|
$
|
121,097
|
|
|
4.8
|
|
|
In-Process Technology
|
|
|
90,000
|
|
|
—
|
|
|
(90,000
|
)
|
|
—
|
|
|
—
|
|
|
Customer Relationships
|
|
|
3,972,000
|
|
|
(697,327
|
)
|
|
(1,786,673
|
)
|
|
1,488,000
|
|
|
7.8
|
|
|
Trade Name
|
|
|
90,000
|
|
|
(90,000
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
Internal-use software
|
|
|
726,000
|
|
|
(37,510
|
)
|
|
—
|
|
|
688,490
|
|
|
4.8
|
|
|
Acquired Patents
|
|
|
1,100,000
|
|
|
(806,667
|
)
|
|
—
|
|
|
293,333
|
|
|
1.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
12,404,000
|
|
$
|
(2,898,307
|
)
|
$
|
(6,914,773
|
)
|
$
|
2,590,920
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2012
|
|
|
Intangible Asset
|
|
Gross
Carrying
Amount
|
|
Accumulated
Amortization
|
|
Accumulated
Impairment
Loss
|
|
Net
|
|
Weighted
Average
Remaining
Useful Life
(in years)
|
|
|
Developed Technology
|
|
$
|
6,426,000
|
|
$
|
(1,167,900
|
)
|
$
|
(3,423,100
|
)
|
$
|
1,835,000
|
|
|
5.8
|
|
|
In-Process Technology
|
|
|
90,000
|
|
|
—
|
|
|
(90,000
|
)
|
|
—
|
|
|
—
|
|
|
Customer Relationships
|
|
|
3,972,000
|
|
|
(505,327
|
)
|
|
(1,786,673
|
)
|
|
1,680,000
|
|
|
8.8
|
|
|
Trade Name
|
|
|
90,000
|
|
|
(90,000
|
)
|
|
|
|
|
—
|
|
|
—
|
|
|
Acquired Patents
|
|
|
1,100,000
|
|
|
(586,667
|
)
|
|
|
|
|
513,333
|
|
|
2.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
11,678,000
|
|
$
|
(2,349,894
|
)
|
$
|
(5,299,773
|
)
|
$
|
4,028,333
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization
expense associated with intangible assets was approximately $548,000, $1,597,000 and $606,000 for the years ended December 31, 2013, 2012 and 2011 respectively. The
estimated amortization expense for intangible assets for the next five years and thereafter is as follows (in thousands):
|
|
|
|
|
|
|
Period
|
|
Estimated
Amortization
Expense
|
|
|
2014
|
|
$
|
583
|
|
|
2015
|
|
|
436
|
|
|
2016
|
|
|
363
|
|
|
2017
|
|
|
363
|
|
|
2018
|
|
|
319
|
|
|
Thereafter
|
|
|
527
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
2,591
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
F-21
Table of Contents
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(10) Accounts Payable and Accrued Expenses
The following schedule presents the details of accounts payable and accrued expenses as of December 31, 2013 and 2012:
|
|
|
|
|
|
|
|
|
|
|
2013
|
|
2012
|
|
|
Accounts payable
|
|
$
|
1,808,335
|
|
$
|
1,973,106
|
|
|
Accrued payroll and related costs
|
|
|
3,878,131
|
|
|
4,100,859
|
|
|
Accrued consulting and professional fees
|
|
|
50,000
|
|
|
25,000
|
|
|
Royalty liability
|
|
|
164,000
|
|
|
210,000
|
|
|
State & local taxes payable
|
|
|
23,300
|
|
|
29,734
|
|
|
Funded software development
|
|
|
—
|
|
|
600,000
|
|
|
Other accrued expenses
|
|
|
865,508
|
|
|
632,024
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total accounts payable and accrued expenses
|
|
$
|
6,789,274
|
|
$
|
7,570,723
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(11) Preferred Stock
Wave has authorized the issuance of 2,000 shares of convertible preferred stock having a par value of $.01 per share. At December 31, 2013, 2012 and 2011, -0- shares of
convertible preferred stock are issued and outstanding.
(12) Common Stock
During the year ended December 31, 2013, Wave received proceeds of $5,352,893 after deducting offering costs of approximately $177,000, in connection with the issuance of
3,811,523 shares of Class A Common Stock in its at the market offerings through MLV. The shares were sold at prices ranging from $0.90 - $2.90 per share.
On
December 18, 2013, Wave sold 1,253,351 shares of Class A Common Stock at $0.9725 per share for gross proceeds of $1,218,884. This financing was completed under the 2013
shelf registration statement. Wave also issued warrants to the subscribers to purchase 626,674 shares of Class A common stock at an exercise price of $0.91 per share. These warrants expire on
December 18, 2018. SRA entered into a placement agency agreement with Wave in which they agreed to act as placement agent in connection with the offering. Wave agreed to pay SRA a fee equal to
6% of the gross proceeds of this offering. Wave realized approximately $1,116,000 in net proceeds after deducting the placement agent fees of approximately $73,000 and additional legal and other fees
associated with the issuance of these securities totaling approximately $30,000. In connection with the financing, Wave also issued warrants to SRA to purchase up to 75,201 shares of Wave
Class A Common Stock for $0.91 per share. These warrants expire on December 18, 2018.
On
September 16, 2013 Wave entered into the Development Agreement with EXO5. EXO5 is a company owned by Richard Lee, an experienced software project manager who joined Wave in
September 2011 as Project Manager for Cloud Services. Pursuant to the Development Agreement, Wave issued EXO5 372,578 shares of Class A Common Stock valued at $500,000 to acquire a
perpetual license for EXO5's Platform. Wave also entered into separate statements of work with EXO5 to develop a SED Management Feature to incorporate with the licensed Platform to allow for the
management of SED's in the cloud. The cost associated with the issuance of Class A Common Stock and the development costs, which were paid in cash, have been accounted for in accordance with
F-22
Table of Contents
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(12) Common Stock (Continued)
ASC Topic 350-40
Internal-Use Software
and these costs have led to the creation of Wave's hosted cloud platform. Customers can access
Wave's cloud platform on a subscription basis.
On
July 25, 2013, Wave sold 1,204,470 shares of Class A Common Stock at $1.27 per share for gross proceeds of $1,529,677. This financing was completed under the 2011 shelf
registration statement. SRA entered into a placement agency agreement with Wave in which they agreed to act as placement agent in connection with the offering. Wave agreed to pay SRA a fee equal to 6%
of the gross proceeds of this offering. Wave realized approximately $1,408,000 in net proceeds after deducting the placement agent fees of approximately $92,000 and additional legal and other fees
associated with the issuance of these securities totaling approximately $30,000. In connection with the financing, Wave also issued warrants to SRA to purchase up to 72,268 shares of Wave
Class A Common Stock for $1.27 per share. These warrants expire on July 25, 2016.
On
April 23, 2013, Wave sold 1,585,000 shares of Class A Common Stock at $2.00 per share for gross proceeds of $3,170,000. This financing was completed under the 2011 shelf
registration statement. Dawson entered into a placement agency agreement with Wave in which they agreed to act as placement agent in connection with the offering. Wave agreed to pay Dawson a fee equal
to 6% of the gross proceeds of this offering. Wave realized approximately $2,920,000 in net proceeds after deducting the placement agent fees of $190,200 and additional legal and other fees associated
with the issuance of these securities totaling approximately $60,000. In connection with the financing, Wave also issued warrants to the subscribers to purchase up to 792,500 shares of Wave
Class A Common Stock for $2.48 per share. These warrants expire on October 23, 2018.
On
March 13, 2013, Wave entered into agreements with certain institutional investors for a private placement of 301,205 shares of its Class A Common Stock at a price of
$3.32 per share, yielding gross proceeds of $1,000,000. Wave agreed to pay Dawson, the placement agent, a fee equal to 6% of the gross proceeds of this offering. Wave realized approximately $910,000
in net proceeds after deducting the placement agent fees of $60,000 and additional legal and other fees associated with the issuance of these securities totaling approximately $30,000. Wave also
issued warrants to the subscribers to purchase 150,603 shares of Class A common stock at an exercise price of $3.32 per share. These warrants expire in October 2018.
During
year ended December 31, 2013, Wave received gross proceeds of $42,039 in connection with the issuance of 12,983 shares of Class A Common Stock upon the exercise of
employee stock options. The employee stock options were exercised at $3.24 per share.
During
the year ended December 31, 2012, Wave received proceeds of $9,053,593 after deducting offering costs of approximately $290,000, in connection with the issuance of
1,973,267 shares of Class A
Common Stock in its at the market offerings through MLV & Co. LLC ("MLV"). The shares were sold at prices ranging from $2.60 - $9.12 per share.
On
October 23, 2012, Wave sold 831,188 shares of Class A Common Stock at $4.01 per share for gross proceeds of $3,333,062. This financing was completed under a shelf
registration filed with the SEC on June 21, 2011. Wave realized approximately $3,073,000 in net proceeds after deducting the placement agent fees of $199,984 and additional legal and other fees
associated with the issuance of these securities totaling approximately $60,000. Wave also issued warrants to the subscribers to purchase 415,594 shares of Class A common stock at an exercise
price of $3.76 per share. These warrants expire in October 2017.
F-23
Table of Contents
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(12) Common Stock (Continued)
On
August 8, 2012, Wave sold 646,956 shares of Class A Common Stock at $2.57 per share for gross proceeds of $1,662,677. This financing was completed under a shelf
registration filed with the SEC on June 21, 2011. Wave realized approximately $1,533,000 in net proceeds after deducting the placement agent fees of $99,761 and additional legal and other fees
associated with the issuance of these securities totaling approximately $30,000. In connection with the financing, Wave also issued warrants to the subscribers to purchase 323,478 shares of Wave
Class A Common Stock for $2.32 per share. These warrants expire on August 8, 2015. Wave also issued a warrant to the placement agent (as part of the fees paid to the placement agent)
that will allow the placement agent to acquire 38,817 shares of Wave Class A Common Stock for $2.32 per share. This warrant expires on August 8, 2015.
During
2012, Wave received gross proceeds of $320,500 in connection with the issuance of 145,000 shares of Class A Common Stock upon the exercise of warrants that were granted to
investors as part of Wave's 2012 and 2009 financings. The warrants were exercised at prices ranging from $2.20 - $2.32 per share. Additionally, 10,111 shares of Class A Common Stock were issued
to SRA upon the partial cashless exercise of warrants that were granted to SRA in its capacity as placement agent as part of Wave's 2009 financings (See Note 14).
During
2012, Wave received gross proceeds of $79,503 in connection with the issuance of 22,800 shares of Class A Common Stock upon the exercise of employee stock options. The
employee stock options were exercised at exercise prices ranging from $2.08 - $7.80 per share.
On
September 22, 2011, Wave paid consideration with an aggregate value of U.S. $12,477,528, subject to post-closing adjustments for working capital, cash, indebtedness and
transaction expenses (the "total consideration") to Safend in exchange for all of the issued and outstanding share capital of Safend. The total consideration consisted of $1,100,000 in cash and
1,316,844 shares of Wave's Class A Common Stock with a deemed value equal to $11,377,528 (based on the September 22, 2011 closing price).
During
2011, Wave received gross proceeds of $1,260,288 in connection with the issuance of 502,059 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 $1.12 - $4.62 per share. Additionally, 20,826 shares of Class A Common Stock
were issued to SRA upon the partial cashless exercise of warrants that were granted to SRA in its capacity as placement agent as part of Wave's 2009 and 2008 financings (See Note 14).
During
2011, Wave received gross proceeds of $806,119 in connection with the issuance of 124,655 shares of Class A Common Stock upon the exercise of employee stock options. The
employee stock options were exercised at exercise prices ranging from $2.00 - $14.16 per share.
On
December 1, 2013, Wave issued 93,916 shares of Class A common stock to Wave employees for $0.9775 per share, pursuant to the Wave 2004 Employee Stock Purchase Plan. Wave
received proceeds of $91,803 from the sale of these shares.
On
June 1, 2013, Wave issued 132,970 shares of Class A common stock to Wave employees for $1.29 per share, pursuant to the Wave 2004 Employee Stock Purchase Plan. Wave
received proceeds of $171,796 from the sale of these shares.
F-24
Table of Contents
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(12) Common Stock (Continued)
On
December 1, 2012, Wave issued 89,571 shares of Class A Common Stock to Wave employees for $2.144 per share, pursuant to the Wave 2004 Employee Stock Purchase Plan. Wave
received proceeds of $191,862 from the issuance of these shares.
On
June 1, 2012, Wave issued 139,480 shares of Class A Common Stock to Wave employees for $3.40 per share pursuant to the Wave 2004 Employee Stock Purchase Plan. Wave
received proceeds of $474,233 from the issuance of these shares.
On
December 1, 2011, Wave issued 49,395 shares of Class A Common Stock to Wave employees for $7.648 per share, pursuant to the Wave 2004 Employee Stock Purchase Plan. Wave
received proceeds of $377,873 from the issuance of these shares.
On
June 1, 2011, Wave issued 46,884 shares of Class A Common Stock to Wave employees for $9.316 per share pursuant to the Wave 2004 Employee Stock Purchase Plan. Wave
received proceeds of $436,771 from the issuance of these shares.
(13) Share-based Compensation
Employee Stock Option Plans
1994 Employee Stock Option Plan
In January 1994, Wave adopted the 1994 Employee Stock Option Plan (the "1994 Plan"). The total number of shares of Class A
Common Stock reserved for issuance under the 1994 Plan, as amended is 6,000,000 shares. The 1994 Plan Expires on July 1, 2014. Under the 1994 Plan, both incentive stock options and
non-qualified stock options may be granted to officers, key employees and other persons providing services to Wave. Options granted under the plan generally vest over three years and expire ten years
from the date of grant. In January 1994, Wave adopted the Non-Employee Directors Stock Option Plan (the "Directors' Plan"). The total number of shares of Class A Common Stock reserved for
issuance under the Directors' Plan, as amended, is 250,000 shares. Under the Directors' Plan, as amended, each director who is not an employee of Wave receives an initial grant of options to purchase
15,000 shares of Class A Common Stock; and an additional annual grant to purchase 15,000 shares on the day immediately following each of the dates on which an incumbent director is reelected.
The options granted to non-employee directors vest on the day
following the grant and expire ten years from the date of grant. Under all of Wave's stock option plans, options are granted with exercise prices that approximate fair market value at the date of
grant. All of Wave's stock option plans and amendments thereto have been approved by shareholder vote.
Wave
recognizes compensation expense for all share-based payment awards made to employees and directors including employee stock options and employee stock purchases related to the
Purchase Plan. Wave estimates the fair value of stock-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest
is recognized as expense over the requisite service periods in the Company's consolidated statement of operations.
Stock-based
compensation expense recognized for the years ended December 31, 2013, 2012 and 2011 was $1,694,842, $4,830,831 and $5,379,961, respectively. The classification of the
cost of share based compensation, in the statement of operations, is consistent with the nature of the services being rendered in exchange for the share based payment.
F-25
Table of Contents
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(13) Share-based Compensation (Continued)
The
following table summarizes the effect of share based compensation in Wave's statement of operations for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2013
|
|
2012
|
|
2011
|
|
|
Cost of Sales
|
|
$
|
28,084
|
|
$
|
47,371
|
|
$
|
54,454
|
|
|
Selling, General & Administrative
|
|
|
1,250,543
|
|
|
3,400,978
|
|
|
3,845,116
|
|
|
Research & Development
|
|
|
416,215
|
|
|
1,382,482
|
|
|
1,480,391
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
1,694,842
|
|
$
|
4,830,831
|
|
$
|
5,379,961
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Wave
uses the Black-Scholes-Merton option pricing model to value stock options. The Black-Scholes-Merton model requires the use of employee exercise behavior data and the use of a number
of assumptions including volatility of the company's stock price, the weighted-average risk-free interest rate and the weighted-average expected term of the options. As Wave does not pay dividends on
its Class A common stock, the dividend rate variable in the Black-Scholes-Merton model is zero.
The
following values for the indicated variables were used to value options granted during the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
2013
|
|
2012
|
|
|
Stock Option
Plans
|
|
Stock Purchase
Plan
|
|
Stock Option
Plans
|
|
Stock Purchase
Plan
|
|
Expected Term
|
|
4.5 Years
|
|
6 Months
|
|
4.9 Years
|
|
6 Months
|
|
Risk-free Rate—range
|
|
0.65% - 1.68%
|
|
0.08% - 0.10%
|
|
0.57% - 1.20%
|
|
0.12% - 0.14%
|
|
Risk-free Rate—wt. avg.
|
|
1.09%
|
|
0.10%
|
|
0.85%
|
|
0.13%
|
|
Expected Volatility—range
|
|
88.4% - 98.1%
|
|
89.6% - 90.8%
|
|
91.8% - 96.0%
|
|
62.6% - 95.6%
|
|
Expected Volatility—wt. avg.
|
|
93.9%
|
|
90.5%
|
|
92.5%
|
|
75.5%
|
|
Dividend Yield
|
|
0%
|
|
0%
|
|
0%
|
|
0%
|
The
volatility assumptions are based on the historical daily price data of Wave's stock over a period equivalent to the weighted average expected term of the options. Management did not
identify any factors during that period which were unusual and which would distort the volatility figure if used to estimate future volatility.
The
risk-free interest rate assumption is based upon the implied yield available on U.S. Treasury zero-coupon issues with a remaining term equal to the expected term of the option
granted.
The
expected term of employee stock options represents the weighted average period that the stock options are expected to remain outstanding. For Wave's stock option plans, it is based
upon an analysis of the historical behavior of option holders during the period from January 1, 2009 to December 31, 2013. Management believes historical data is representative of future
exercise behavior. For Wave's Employee Stock Purchase Plan, the expected term of six months, is the length of each purchase period, pursuant to the plan.
As
stock-based compensation expense recognized in the consolidated statement of operations is based on awards ultimately expected to vest, stock-based compensation expense reduced for
estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures are estimated
based on historical experience.
F-26
Table of Contents
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(13) Share-based Compensation (Continued)
A
summary of option activity for all Wave option plans through December 31, 2013 follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2013
|
|
2012
|
|
2011
|
|
|
|
Number of
Shares
|
|
Weighted
Average
Exercise
Price
|
|
Number of
Shares
|
|
Weighted
Average
Exercise
Price
|
|
Number of
Shares
|
|
Weighted
Average
Exercise
Price
|
|
|
Balance at beginning of year
|
|
|
3,341,575
|
|
$
|
9.51
|
|
|
2,936,392
|
|
$
|
10.20
|
|
|
2,510,583
|
|
$
|
9.88
|
|
|
Granted
|
|
|
950,222
|
|
|
2.69
|
|
|
732,081
|
|
|
8.20
|
|
|
714,036
|
|
|
15.92
|
|
|
Forfeited
|
|
|
(495,396
|
)
|
|
7.63
|
|
|
(123,875
|
)
|
|
10.88
|
|
|
(41,990
|
)
|
|
12.76
|
|
|
Expired
|
|
|
(399,864
|
)
|
|
10.55
|
|
|
(180,223
|
)
|
|
15.20
|
|
|
(121,582
|
)
|
|
40.80
|
|
|
Exercised
|
|
|
(12,983
|
)
|
|
3.24
|
|
|
(22,800
|
)
|
|
3.48
|
|
|
(124,655
|
)
|
|
6.48
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of year
|
|
|
3,383,554
|
|
|
7.78
|
|
|
3,341,575
|
|
|
9.51
|
|
|
2,936,392
|
|
|
10.20
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at end of year
|
|
|
2,304,154
|
|
|
8.94
|
|
|
2,129,510
|
|
$
|
8.68
|
|
|
1,667,443
|
|
$
|
9.12
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additional shares available for grant at end of year
|
|
|
2,371,405
|
|
|
|
|
|
1,146,683
|
|
|
|
|
|
1,384,504
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The
weighted average grant date fair value of options granted during the years ended December 31, 2013, 2012 and 2011 was $1.89, $5.72 and $10.28, respectively.
The
weighted average remaining contractual term for options outstanding and options exercisable at December 31, 2013 were 6.0 and 4.6 years, respectively.
As
of December 31, 2013, unrecognized stock-based compensation related to stock options was approximately $1,355,000. At December 31, 2013, the weighted average period this
cost is expected to be expensed is 1.3 years. The total fair value of shares that vested during the years ended December 31, 2013, 2012 and 2011 was approximately $4,405,000, $3,996,000
and $2,054,000, respectively.
As
of December 31, 2013, the intrinsic value of outstanding, vested and currently exercisable share options was $-0-.
The
following table summarizes information about stock options outstanding under the Wave stock options plans as of December 31, 2013:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding
|
|
Options Exercisable
|
|
|
Exercise Price Range
|
|
Number
Outstanding
|
|
Weighted
Average
Remaining
Contractual Life
|
|
Weighted
Average
Exercise
Price
|
|
Number
Exercisable
|
|
Weighted
Average
Exercise
Price
|
|
|
$0.25 - $3.50
|
|
|
862,763
|
|
|
6.7
|
|
$
|
2.24
|
|
|
477,177
|
|
$
|
3.14
|
|
|
$3.51 - $7.00
|
|
|
427,385
|
|
|
8.4
|
|
$
|
3.99
|
|
|
81,852
|
|
$
|
4.54
|
|
|
$7.01 - $8.00
|
|
|
784,312
|
|
|
3.2
|
|
$
|
7.65
|
|
|
783,479
|
|
$
|
7.65
|
|
|
$8.01 - $12.00
|
|
|
727,738
|
|
|
5.7
|
|
$
|
9.20
|
|
|
473,193
|
|
$
|
9.34
|
|
|
$12.01 - $18.00
|
|
|
161,010
|
|
|
3.4
|
|
$
|
13.20
|
|
|
149,861
|
|
$
|
13.19
|
|
|
$18.01 - $20.00
|
|
|
355,083
|
|
|
5.3
|
|
$
|
18.36
|
|
|
272,329
|
|
$
|
18.36
|
|
|
$20.01 - $25.00
|
|
|
65,263
|
|
|
0.1
|
|
$
|
20.13
|
|
|
65,263
|
|
$
|
20.16
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,383,554
|
|
|
|
|
|
|
|
|
2,304,154
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
F-27
Table of Contents
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(13) Share-based Compensation (Continued)
1999 Wavexpress Stock Incentive Plan
In April 2000, the board of directors of Wavexpress authorized the establishment of a stock option plan. The total number of shares of
Wavexpress' Class A Common Stock subject to the Plan was 2,500,000. Options terminated upon the earlier of the date of expiration of the option or upon termination of the employment
relationship between Wavexpress and the optionee for any reason other than death, disability or retirement.
Employees
were entitled to exercise their options on dates determined by Wavexpress' Compensation Committee of the Board of Directors. Vesting provisions for options granted generally
ranged from immediate vesting to pro rata vesting over a three-year period.
No
options were granted under the Wavexpress stock option plan during the years ended December 31, 2013, 2012 and 2011.
Employee Stock Purchase Plan
In November 2004, the Board of Directors adopted the Wave Systems Corp. 2004 Employee Stock Purchase sold to eligible employees at a
15% discount from the market value of the shares. The Purchase Plan was ratified by a shareholder vote at Wave's 2005 annual shareholder meeting on May 23, 2005. Under the terms of the Purchase
Plan, employees may elect to have withheld, up to 15% of their base earnings to purchase these shares during each offering period, up to a maximum of $25,000 in market value of Wave's Class A
Common Stock. Offering periods commence on June 1st and December 1st and are for a period of six months. The purchase price under the Purchase Plan is 85% of the lesser of
the market price on the beginning or the ending of the offering period.
Approximately
26%, 43% and 50% of eligible employees participated in the Purchase Plan for the years ended December 31, 2013, 2012 and 2011, respectively. For the year ended
December 31, 2013 employees purchased 226,886 shares of Wave Class A Common Stock at an average share price of $1.16 per share, for an aggregate of $263,599 in proceeds to Wave. For the
year ended December 31, 2012 employees purchased 229,052 shares of Wave Class A Common Stock at an average share price of $2.92 per share, for an aggregate of $666,095 in proceeds to
Wave. For the year ended December 31, 2011 employees purchased 96,279 shares of Wave Class A Common Stock at an average share price of $8.48 per share, for an aggregate of $814,644 in
proceeds to Wave.
(14) Warrants
On December 18, 2013, Wave issued warrants to investors to purchase 626,674 shares of Class A Common Stock pursuant to which Wave sold and issued 1,253,351 shares of
Class A Common Stock for net proceeds of approximately $1,116,000 after deducting the placement agent fees of $73,000 and additional legal and other fees associated with the issuance of these
securities totaling approximately $30,000. The warrants are exercisable at an exercise price of $0.91 per share and expire on December 18, 2018. If exercised in full, the investor warrants
granted in connection with this financing may generate up to an additional $570,273, at the exercise price. Wave also issued to SRA, the placement agent, warrants to purchase 75,201 shares of
Class A Common Stock, in connection with a securities purchase agreement. The warrants are exercisable at an exercise price of $0.91 per share and expire on December 18, 2018. If
exercised in full, the warrants granted to the placement agent may generate up to an additional $68,433, at the exercise price.
F-28
Table of Contents
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(14) Warrants (Continued)
On
July 25, 2013, Wave issued warrants to SRA, the placement agent, to purchase 72,268 shares of Class A Common Stock pursuant to which Wave sold and issued 1,204,470
shares of Class A Common Stock, par value $0.01 per share for net proceeds of approximately $1,408,000 after deducting the placement agent fees of $92,000 and additional legal and other fees
associated with the issuance of these securities totaling approximately $30,000. The warrants are exercisable at an exercise price of $1.27 per share and expire on July 25, 2018. If exercised
in full, the investor warrants granted in connection with this financing may generate up to an additional $91,780, at the exercise price.
On
April 23, 2013, Wave issued warrants to investors to purchase 792,500 shares of Class A Common Stock pursuant to which Wave sold and issued 1,585,000 shares of
Class A Common Stock, par value $0.01 per share for net proceeds of approximately $2,920,000 after deducting the placement agent fees of $190,200 and additional legal and other fees associated
with the issuance of these securities totaling
approximately $60,000. The warrants are exercisable at an exercise price of $2.48 per share and expire on October 23, 2018. If exercised in full, the investor warrants granted in connection
with this financing may generate up to an additional $1,965,400, at the exercise price.
On
March 13, 2013, Wave issued warrants to investors to purchase 150,603 shares of Class A Common Stock pursuant to which Wave sold and issued 301,205 shares of
Class A Common Stock, par value $0.01 per share for net proceeds of approximately $910,000 after deducting the placement agent fees of $60,000 and additional legal and other fees associated
with the issuance of these securities totaling approximately $30,000. The warrants are exercisable at an exercise price of $3.32 per share and expire in October 2018. If exercised in full, the
investor warrants granted in connection with this financing may generate up to an additional $500,002, at the exercise price.
On
October 23, 2012, Wave issued warrants to investors to purchase 415,594 shares of Class A Common Stock pursuant to which Wave sold and issued 831,188 shares of
Class A Common Stock, par value $0.01 per share for net proceeds of $3,073,000 after deducting the placement agent fees of $199,984 and additional legal and other fees associated with the
issuance of these securities totaling approximately $60,000. The warrants are exercisable at an exercise price of $3.76 per share and expire on October 23, 2017. If exercised in full, the
investor warrants granted in connection with this financing may generate up to an additional $1,562,633, at the exercise price.
On
August 8, 2012, Wave issued warrants to investors to purchase 323,478 shares of Class A Common Stock pursuant to which Wave sold and issued 646,956 shares of
Class A Common Stock for net proceeds of $1,533,000 after deducting the placement agent fees of $99,761 and additional legal and other fees associated with the issuance of these securities
totaling approximately $30,000. The warrants are exercisable at an exercise price of $2.32 per share and expire on August 8, 2015. If exercised in full, the investor warrants granted in
connection with this financing may generate up to an additional $750,469, at the exercise price. Wave also issued to a placement agent warrants to purchase 38,817 shares of Class A
Common Stock, in connection with a securities purchase agreement. The warrants are exercisable at an exercise price of $2.32 per share and expire on August 8, 2015. If exercised in full, the
warrants granted to the placement agent may generate up to an additional $90,056, at the exercise price. During 2012, Wave received gross proceeds of $29,000 in connection with the issuance of
12,500 shares of Class A Common Stock upon the exercise of warrants that were granted to investors as part of this financing.
On
July 21, 2009, Wave issued warrants to investors to purchase 223,967 shares of Class A Common Stock pursuant to which Wave sold and issued 447,935 shares of
Class A Common Stock, par
F-29
Table of Contents
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(14) Warrants (Continued)
value
$.01 per share for an aggregate purchase price of $1,648,400. The warrants are exercisable at an exercise price of $4.62 per share and expire on January 21, 2015. If exercised in full,
the investor warrants granted in connection with this financing may generate an additional $1,034,728, at the exercise price. During 2011 Wave received gross proceeds of $226,605 in connection with
the issuance of 49,049 shares of Class A Common Stock upon the exercise of warrants that were granted to investors as part of this financing.
On
July 16, 2009, Wave issued warrants to investors to purchase 431,006 shares of Class A Common Stock pursuant to which Wave sold and issued 862,011 shares of
Class A Common Stock, par value $.01 per share for an aggregate purchase price of $3,172,199. The warrants are exercisable at an exercise price of $4.62 per share and expire on
January 16, 2015. If exercised in full, the investor warrants granted in connection with this financing may generate an additional $1,991,248, at the exercise price. During 2011 Wave received
gross proceeds of $408,018 in connection with the issuance of 88,316 shares of Class A Common Stock upon the exercise of warrants that were granted to investors as part of this financing.
On
April 8, 2009, Wave issued warrants to investors to purchase 235,142 shares of Class A Common Stock pursuant to which Wave sold and issued 470,284 shares of
Class A Common Stock, par value $.01 per share for an aggregate purchase price of $1,034,625. The warrants were exercisable at an exercise price of $2.20 per share and expired on
April 8, 2012. If exercised in full, the investor warrants granted in connection with this financing would have generated an additional $517,312, at the exercise price. Wave also issued to a
placement agent warrants to purchase 28,217 shares of Class A Common Stock, in connection with a securities purchase agreement. The warrants were exercisable at an exercise price of $2.20 per
share and expired on April 8, 2012. If exercised in full, the warrants granted to the placement agent would have generated an additional $62,077, at the exercise price. During 2012 and 2011,
Wave received gross proceeds of $217,250, and $58,813, respectively, in connection with the issuance of 98,750, and 26,733 shares, respectively, of Class A Common Stock upon the exercise of
warrants that were granted to investors as part of this financing. Also, 6,786 and 7,518 shares of Class A Common Stock were issued to SRA during 2012 and 2011, respectively, upon the partial
cashless exercise of the warrants that were granted to SRA as part of this financing.
On
March 13, 2009, Wave issued warrants to investors to purchase 98,125 shares of Class A Common Stock pursuant to which Wave sold and issued 196,250 shares of
Class A Common Stock, par value $.01 per share for an aggregate purchase price of $431,750. The warrants were exercisable at an exercise price of $2.20 per share and expired on March 13,
2012. If exercised in full, the investor warrants granted in connection with this financing would have generated an additional $215,875, at the exercise price. Wave also issued to a placement agent
warrants to purchase 11,775 shares of Class A Common Stock, in connection with a securities purchase agreement. The warrants were exercisable at an exercise price of $2.20 per share and expired
on March 13, 2012. If exercised in full, the warrants granted to the placement agent would have generated an additional $25,905, at the exercise price. During 2012 and 2011, Wave received gross
proceeds of $74,250 and $2,750, respectively, in connection with the issuance of 33,750 and 1,250 shares, respectively, of Class A Common Stock upon the exercise of warrants that were granted
to investors as part of this financing. Also, 3,325 and 5,426 shares, respectively, of Class A
Common Stock were issued to SRA during 2012 and 2011 upon the partial cashless exercise of the warrants that were granted to SRA as part of this financing.
F-30
Table of Contents
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(14) Warrants (Continued)
On
December 24, 2008, Wave issued warrants to investors to purchase 285,000 shares of Class A Common Stock pursuant to which Wave sold and issued 456 shares of 8%
Series K Convertible Preferred Stock, par value $.01 per share for an aggregate purchase price of $1,276,800. The warrants were exercisable at an exercise price of $1.12 per share and expired
on December 24, 2011. Wave also issued to a placement agent warrants to purchase 68,400 shares of Class A Common Stock, in connection with a securities purchase agreement. The warrants
were exercisable at an exercise price of $1.12 per share and expired on December 24, 2011. If exercised in full and in cash, the warrants granted to the placement agent would have generated an
additional $76,608, at the exercise price. During 2011 Wave received gross proceeds of $268,100 in connection with the issuance of 239,375 shares of Class A Common Stock upon the
exercise of warrants that were granted to investors as part of this financing.
On
October 30, 2008, Wave issued warrants to investors to purchase 555,000 shares of Class A Common Stock pursuant to which Wave sold and issued 111 shares of
Series J Convertible Preferred Stock, par value $.01 per share for an aggregate purchase price of $721,500. The warrants were exercisable at an exercise price of $1.60 per share and expired on
October 30, 2013. If exercised in full, the investor warrants granted in connection with this financing would have generated an additional $888,000, at the exercise price. Wave also issued to a
placement agent warrants to purchase 16,650 shares of Class A Common Stock, in connection with a securities purchase agreement. The warrants were exercisable at an exercise price of
$1.60 per share and expired on October 30, 2011. If exercised in full and in cash, the warrants granted to the placement agent would have generated an additional $26,640, at the exercise price.
During 2011 7,883 shares of Class A Common Stock were issued to SRA upon the complete and cashless exercise of the warrants that were granted to SRA as part of this financing.
On
June 30, 2008, Wave issued warrants to investors to purchase 117,531 shares of Class A Common Stock pursuant to which Wave sold and issued 470,125 shares of
Class A Common Stock, par value $.01 per share for an aggregate purchase price of $1,598,425. The warrants were exercisable at an exercise price of $3.60 per share and expired on
June 30, 2011. If exercised in full and in cash, the investor warrants granted in connection with this financing would have generated an additional $423,113, at the exercise price. Wave also
issued to a placement agent warrants to purchase 28,208 shares of Class A Common Stock, in connection with a securities purchase agreement. The warrants were exercisable at an exercise
price of $3.60 per share and would have expired on December 31, 2009. If exercised in full and in cash, the warrants granted to the placement agent would have generated an additional $101,547,
at the exercise price. During 2011, Wave received gross proceeds of $27,350 in connection with the issuance of 16,868 shares of Class A Common Stock upon the complete and partial cashless
exercise of warrants that were granted to investors as part of this financing.
On
May 23, 2008, Wave issued warrants to investors to purchase 134,453 shares of Class A Common Stock pursuant to which Wave sold and issued 537,913 shares of
Class A Common Stock, par value $.01 per share for an aggregate purchase price of $1,721,000. The warrants were exercisable at an exercise price of $3.40 per share and expired on May 23,
2011. If exercised in full, the investor warrants granted in connection with this financing would have generated an additional $457,140, at the exercise price. Wave also issued to a placement agent
warrants to purchase 32,269 shares of Class A Common Stock, in connection with a securities purchase agreement. The warrants were exercisable at an exercise price of $3.40 per share and would
have expired on November 23, 2009. If exercised in full and in cash,
F-31
Table of Contents
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(14) Warrants (Continued)
the
warrants granted to the placement agent would have generated an additional $109,714, at the exercise price. During 2011, Wave received gross proceeds of $273,594 in connection with the issuance of
80,469 shares of Class A Common Stock upon the exercise of warrants that were granted to investors as part of this financing.
A
summary of warrants outstanding at December 31, 2013, follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Warrants Outstanding
|
|
Warrants Exercisable
|
|
|
Exercise Price
|
|
Number of
Shares
|
|
Weighted
Average
Remaining
Contractual Life
(in years)
|
|
Weighted
Average
Exercise
Price
|
|
Number of
Shares
|
|
Weighted
Average
Exercise
Price
|
|
|
$0.25 - $2.00
|
|
|
774,144
|
|
|
4.5
|
|
$
|
0.94
|
|
|
774,144
|
|
$
|
0.94
|
|
|
$2.01 - $4.00
|
|
|
1,708,492
|
|
|
3.7
|
|
$
|
2.83
|
|
|
1,708,492
|
|
$
|
2.83
|
|
|
$4.01 - $4.62
|
|
|
117,934
|
|
|
1.1
|
|
$
|
4.62
|
|
|
117,934
|
|
$
|
4.62
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,600,570
|
|
|
3.8
|
|
$
|
2.35
|
|
|
2,600,570
|
|
$
|
2.35
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(15) Commitments and Contingencies
Royalty Liability
Safend is required to pay back grants received from the Israeli government through the 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 December 31, 2013 and 2012, the book value of the liability amounted to $4,673,629 and $4,696,129, respectively,
reflecting additional grants received since the acquisition date, less amounts repaid since the acquisition date and accretion of the discount. During the years ended December 31, 2013 and 2012
approximately $183,000 and $202,000, respectively, was repaid to the OCS while approximately $80,000 and $79,000, respectively, was received as additional grants from the OCS. During the years ended
December 31, 2013 and 2012 approximately $81,000 and $68,000, respectively, of accretion is included in the net interest expense on the consolidated statements of operations.
Operating Leases
Future minimum lease payments under non-cancelable operating leases (with initial or remaining lease terms in excess of one year) as of
December 31, 2013 are as follows:
|
|
|
|
|
|
|
2014
|
|
$
|
915,000
|
|
|
2015
|
|
|
830,000
|
|
|
2016
|
|
|
396,000
|
|
|
2017
|
|
|
14,000
|
|
|
Thereafter
|
|
|
2,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total minimum lease payments
|
|
$
|
2,157,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
F-32
Table of Contents
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(15) Commitments and Contingencies (Continued)
Rent
expense for the years ended December 31, 2013, 2012 and 2011 amounted to approximately $1,123,000, $1,143,000 and $1,177,000, respectively. Rent expense for the year ended
December 31, 2011 included a $100,000 termination fee in connection with the cancellation of an operating lease for Wave's Cupertino facility. During November 2011, Wave completed a move to a
new facility in Cupertino where it continues to conduct research and development activities.
(16) Income Taxes
Loss before income tax expense for the United States of America and the State of Israel for the years ended December 31, 2013, 2012 and 2011 consisted of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2013
|
|
2012
|
|
2011
|
|
|
Loss before income tax expense:
|
|
|
|
|
|
|
|
|
|
|
|
United States of America
|
|
$
|
(15,416,885
|
)
|
$
|
(23,482,045
|
)
|
$
|
(8,729,693
|
)
|
|
State of Israel
|
|
|
(4,896,769
|
)
|
|
(10,468,470
|
)
|
|
(1,990,084
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(20,313,654
|
)
|
$
|
(33,950,515
|
)
|
$
|
(10,719,777
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
tax expense attributable to income from continuing operations for the years ended December 31, 2013, 2012 and 2011 consisted of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2013
|
|
2012
|
|
2011
|
|
|
Current income tax expense:
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
|
State
|
|
|
10,610
|
|
|
12,033
|
|
|
74,959
|
|
|
Foreign
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
10,610
|
|
|
12,033
|
|
|
74,959
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred income tax expense:
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
State
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
Foreign
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
Total income tax expense
|
|
$
|
10,610
|
|
$
|
12,033
|
|
$
|
74,959
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The
following table summarizes the significant differences between the United States federal statutory tax rate and the Company's effective tax rate for financial statement reporting
purposes:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2013
|
|
2012
|
|
2011
|
|
|
Statutory tax rate
|
|
|
34
|
%
|
|
34
|
%
|
|
34
|
%
|
|
Stock-based compensation on ISO's
|
|
|
(4
|
)
|
|
(7
|
)
|
|
(17
|
)
|
|
State tax, net of federal benefit
|
|
|
—
|
|
|
—
|
|
|
(1
|
)
|
|
Change in valuation allowance
|
|
|
(30
|
)
|
|
(27
|
)
|
|
(17
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
—
|
%
|
|
—
|
%
|
|
(1
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
F-33
Table of Contents
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(16) Income Taxes (Continued)
The
tax effects of temporary differences that give rise to the deferred tax asset at December 31, 2013 and 2012 are as follows:
|
|
|
|
|
|
|
|
|
|
|
2013
|
|
2012
|
|
|
Deferred tax assets:
|
|
|
|
|
|
|
|
|
Net operating loss carryforwards
|
|
$
|
106,210,000
|
|
$
|
101,486,000
|
|
|
Accrued expenses
|
|
|
2,463,000
|
|
|
2,569,000
|
|
|
Intangibles
|
|
|
289,000
|
|
|
284,000
|
|
|
Reserves
|
|
|
846,000
|
|
|
858,000
|
|
|
Depreciation
|
|
|
159,000
|
|
|
140,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net deferred tax assets
|
|
|
109,967,000
|
|
|
105,337,000
|
|
|
Less valuation allowance
|
|
|
(109,565,000
|
)
|
|
(104,458,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred tax assets
|
|
|
402,000
|
|
|
879,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred tax liabilities:
|
|
|
|
|
|
|
|
|
Acquired intangible assets
|
|
|
(402,000
|
)
|
|
(879,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net deferred tax assets (liabilities)
|
|
$
|
—
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The
valuation allowance increased by approximately $5.1 million during the year ended December 31, 2013 and increased approximately $6.1 million during the year
ended December 31, 2012.
Significant
management judgment is required in determining any valuation allowance recorded against deferred tax assets and liabilities. At December 31, 2013 and 2012, Wave's
historical operating results, its cumulative loss positions and uncertainty surrounding its forecasts, led management to conclude that a valuation allowance of $109,565,000 and $104,458,000,
respectively, is needed to offset its deferred tax assets. Subsequently reported tax benefits relating to the valuation allowance for deferred tax assets as of December 31, 2013 will be
allocated as follows: $108,825,000 to continuing operations and $740,000 to additional paid-in-capital for amounts attributable to exercises of employee stock options.
Wave
has federal and state net operating loss carryforwards of approximately $300.1 million, which expire beginning in 2014 through 2033 and include approximately
$8.2 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 has occurred thus raising the likelihood that such net operating and capital loss
carryforwards are subject to annual limitations. In addition, the Company maintains approximately $16.0 million of operating loss carryforwards associated with Safend, Ltd. which may be
carried forward indefinitely.
The
Company had no gross unrecognized tax benefits at December 31, 2013, 2012 and 2011.
F-34
Table of Contents
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(16) Income Taxes (Continued)
The
Company's policy is to recognize interest and penalties related to unrecognized tax benefits as a component of income tax expense. The Company files United States Federal and state
income tax returns. In general, the statute of limitations with respect to the Company's United States Federal income taxes has expired for years prior to 2009, and the relevant state statutes vary.
However,
preceding years remain open to examination by United States Federal and state taxing authorities to the extent of future utilization of net operating losses and capital losses generated in each
preceding year. The Company does not anticipate that the total unrecognized tax benefits will change significantly prior to December 31, 2014. As described above, utilization of the Company's
loss carryforwards may be limited pursuant to Section 382 of the Internal Revenue Code. Any limitation may result in expiration of a portion of the net operating and capital loss carryforwards
before utilization. Until a study is completed and any limitation known, no amounts are being presented as an uncertain tax position.
(17) Defined Contribution Plan
Wave adopted the Wave Systems Corp. 401(k) Savings and Investment Plan, a defined contribution plan, to which substantially all employees can contribute, on January 1, 1995.
Employees of Wave become eligible immediately on employment. Wave has the option to make discretionary matching contributions; no contributions were made in 2013, 2012 or 2011.
(18) Disclosures about the Fair Value of Financial Instruments
As of December 31, 2013 and 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 $1,417,000 and $1,017,000 at December 31, 2013 and 2012,
respectively) 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.
Financial
instruments not measured or recorded at fair value in the accompanying unaudited consolidated financial statements consist of accounts receivable, collateralized receivables,
accounts payable and secured borrowings. The estimated fair value of accounts receivable, collateralized receivables, accounts payable and secured borrowings approximates their carrying value.
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.
F-35
Table of Contents
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(19) 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 December 31, 2013, 2012 and 2011.
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.
The
following sets forth reportable segment data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the years ended December 31,
|
|
|
|
2013
|
|
2012
|
|
2011
|
|
|
Operating Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
EMBASSY® digital security products and services
|
|
$
|
19,755,513
|
|
$
|
23,185,461
|
|
$
|
34,415,818
|
|
|
Safend endpoint data loss protection products and services
|
|
|
4,645,339
|
|
|
5,659,052
|
|
|
1,723,197
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Operating Revenues
|
|
$
|
24,400,852
|
|
$
|
28,844,513
|
|
$
|
36,139,015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Loss:
|
|
|
|
|
|
|
|
|
|
|
|
EMBASSY® digital security products and services
|
|
|
(15,319,925
|
)
|
|
(23,351,556
|
)
|
|
(8,734,824
|
)
|
|
Safend endpoint data loss protection products and services
|
|
|
(4,776,053
|
)
|
|
(10,413,126
|
)
|
|
(2,155,368
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Segments Net Loss
|
|
|
(20,095,978
|
)
|
|
(33,764,682
|
)
|
|
(10,890,192
|
)
|
|
Net other income (expense)
|
|
|
(17,220
|
)
|
|
12,156
|
|
|
175,004
|
|
|
Net interest expense
|
|
|
(200,456
|
)
|
|
(197,989
|
)
|
|
(4,589
|
)
|
|
Income tax expense
|
|
|
(10,610
|
)
|
|
(12,033
|
)
|
|
(74,959
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Loss
|
|
$
|
(20,234,264
|
)
|
$
|
(33,962,548
|
)
|
$
|
(10,794,736
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Impairment of Goodwill and Intangible Assets:
|
|
|
|
|
|
|
|
|
|
|
|
EMBASSY® digital security products and services
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
Safend endpoint data loss protection products and services
|
|
|
2,590,000
|
|
|
4,054,732
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Impairment of Goodwill and Intangible Assets
|
|
$
|
2,590,000
|
|
$
|
4,054,732
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and Amortization Expense:
|
|
|
|
|
|
|
|
|
|
|
|
EMBASSY® digital security products and services
|
|
|
681,303
|
|
|
705,319
|
|
|
592,227
|
|
|
Safend endpoint data loss protection products and services
|
|
|
328,573
|
|
|
1,426,817
|
|
|
412,841
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Depreciation and Amortization Expense
|
|
$
|
1,009,876
|
|
$
|
2,132,136
|
|
$
|
1,005,068
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital Expenditures:
|
|
|
|
|
|
|
|
|
|
|
|
EMBASSY® digital security products and services
|
|
|
165,338
|
|
|
137,567
|
|
|
982,821
|
|
|
Safend endpoint data loss protection products and services
|
|
|
21,377
|
|
|
32,093
|
|
|
12,582
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Capital Expenditures
|
|
$
|
186,715
|
|
$
|
169,660
|
|
$
|
995,403
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
F-36
Table of Contents
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(19) Segment Reporting (Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of
|
|
|
|
December 31,
2013
|
|
December 31,
2012
|
|
December 31,
2011
|
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
EMBASSY® digital security products and services
|
|
$
|
7,733,322
|
|
$
|
9,695,864
|
|
$
|
12,373,734
|
|
|
Safend endpoint data loss protection products and services
|
|
|
4,091,587
|
|
|
8,937,294
|
|
|
17,748,523
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Assets
|
|
$
|
11,824,909
|
|
$
|
18,633,158
|
|
$
|
30,122,257
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The
following table details Wave's sales by geographic area for the years ended December 31, 2013, 2012 and 2011. Geographic area is based on the location of where the products
were shipped or services rendered.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States
of America
|
|
Europe
|
|
Asia
|
|
Total
|
|
|
2013
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
EMBASSY® digital security products and services
|
|
$
|
14,422,288
|
|
$
|
3,951,305
|
|
$
|
1,381,920
|
|
$
|
19,755,513
|
|
|
Safend endpoint data loss protection products and services
|
|
|
1,845,373
|
|
|
2,413,402
|
|
|
386,564
|
|
|
4,645,339
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
16,267,661
|
|
$
|
6,364,707
|
|
$
|
1,768,484
|
|
$
|
24,400,852
|
|
|
% of Total
|
|
|
67
|
%
|
|
26
|
%
|
|
7
|
%
|
|
100
|
%
|
|
2012
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
EMBASSY® digital security products and services
|
|
$
|
18,857,487
|
|
$
|
3,892,693
|
|
$
|
435,281
|
|
$
|
23,185,461
|
|
|
Safend endpoint data loss protection products and services
|
|
|
2,332,216
|
|
|
2,656,320
|
|
|
670,516
|
|
|
5,659,052
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
21,189,703
|
|
$
|
6,549,013
|
|
$
|
1,105,797
|
|
$
|
28,844,513
|
|
|
% of Total
|
|
|
73
|
%
|
|
23
|
%
|
|
4
|
%
|
|
100
|
%
|
|
2011
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
EMBASSY® digital security products and services
|
|
$
|
30,260,537
|
|
$
|
3,813,236
|
|
$
|
342,045
|
|
$
|
34,415,818
|
|
|
Safend endpoint data loss protection products and services
|
|
|
743,404
|
|
|
872,494
|
|
|
107,299
|
|
|
1,723,197
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
31,003,941
|
|
$
|
4,685,730
|
|
$
|
449,344
|
|
$
|
36,139,015
|
|
|
% of Total
|
|
|
86
|
%
|
|
13
|
%
|
|
1
|
%
|
|
100
|
%
|
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.
F-37
Table of Contents
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(19) Segment Reporting (Continued)
Customers,
by segment, from which Wave derived revenue in excess of 10% for the years ended December 31
st
are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2013
|
|
2012
|
|
2011
|
|
|
Customer
|
|
Segment
|
|
Revenue
|
|
|
Dell, Inc.
|
|
EMBASSY®
|
|
$
|
11,175,396
|
|
$
|
15,829,535
|
|
$
|
22,259,058
|
|
|
% of Total Revenue
|
|
|
|
|
46
|
%
|
|
55
|
%
|
|
62
|
%
|
(20) Selected Quarterly Financial Data (unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter-ended
|
|
|
|
December 31,
2013
|
|
September 30,
2013
|
|
June 30,
2013
|
|
March 31,
2013
|
|
|
Revenues
|
|
$
|
5,613,559
|
|
$
|
6,251,325
|
|
$
|
6,742,242
|
|
$
|
5,793,726
|
|
|
Cost of net revenues*
|
|
|
313,310
|
|
|
471,200
|
|
|
579,466
|
|
|
2,332,960
|
|
|
Loss from operations
|
|
|
(3,611,657
|
)
|
|
(2,895,031
|
)
|
|
(3,432,071
|
)
|
|
(10,157,219
|
)
|
|
Net loss
|
|
|
(3,676,389
|
)
|
|
(2,943,823
|
)
|
|
(3,490,297
|
)
|
|
(10,213,755
|
)
|
|
Net loss per common share—basic and diluted
|
|
$
|
(0.11
|
)
|
$
|
(0.09
|
)
|
$
|
(0.12
|
)
|
$
|
(0.39
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter-ended
|
|
|
|
December 31,
2012
|
|
September 30,
2012
|
|
June 30,
2012
|
|
March 31,
2012
|
|
|
Revenues
|
|
$
|
7,130,639
|
|
$
|
6,970,263
|
|
$
|
7,761,474
|
|
$
|
6,982,137
|
|
|
Cost of net revenues*
|
|
|
4,510,166
|
|
|
737,209
|
|
|
867,497
|
|
|
751,460
|
|
|
Loss from operations
|
|
|
(12,909,486
|
)
|
|
(6,073,772
|
)
|
|
(6,446,839
|
)
|
|
(8,334,585
|
)
|
|
Net loss
|
|
|
(13,019,811
|
)
|
|
(6,108,492
|
)
|
|
(6,521,155
|
)
|
|
(8,313,090
|
)
|
|
Net loss per common share—basic and diluted
|
|
$
|
(0.50
|
)
|
$
|
(0.25
|
)
|
$
|
(0.28
|
)
|
$
|
(0.37
|
)
|
-
*
-
Beginning
in the quarter ended September 30, 2013, the Company reclassified support expense from selling, general and administrative expense to cost of
net revenues. For conformity with the 2013 presentation, this resulted in a reclassification of $92,000 for the quarter ended June 30, 2013; $187,000 for the quarter ended March 31,
2013; $179,000 for the quarter ended December 31, 2012; $105,000 for the quarter ended September 30, 2012 and $105,000 for the quarter ended June 30, 2012. The quarters ended
March 31, 2013 and December 31, 2012 include the developed technology impairment losses of $1,615,000 and $3,423,100, respectively.
(21) Subsequent Events
On March 7, 2014, Wave named Lorraine Hariton and David Côté to its Board of Directors. Their appointments increase the size of Wave's Board of
Directors to eight members.
F-38