UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(|X|) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from . . . . . . . . to . . . . . . . .
Commission File Number 0-24752
Wave Systems Corp.
(Exact name of registrant as specified in its charter)
Delaware 13-3477246
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
480 Pleasant Street
Lee, Massachusetts 01238
(Address of principal executive offices) (Zip Code)
413-243-1600
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the
Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Class A Common Stock, $.01 par value
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES |X| NO ___
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the shares of Common Stock of the
registrant held by non-affiliates as of March 25, 1998 was $32,900,789 (For
purposes of this calculation, the market value of a share of Class B Common
Stock was assumed to be the same as a share of Class A Common Stock, into which
it is convertible.)
As of March 25, 1998, there were 22,223,683 shares of the registrant's
Class A Common Stock and 4,241,125 shares of the registrant's Class B Common
Stock outstanding.
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EXCEPT FOR HISTORICAL INFORMATION CONTAINED HEREIN, THIS FORM 10-K CONTAINS
FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF THE U.S. SECURITIES LITIGATION
REFORM ACT OF 1995. THESE STATEMENTS INVOLVE KNOWN AND UNKNOWN RISKS AND
UNCERTAINTIES THAT MAY CAUSE THE COMPANY'S ACTUAL RESULTS OR OUTCOMES TO BE
MATERIALLY DIFFERENT FROM THOSE ANTICIPATED AND DISCUSSED HEREIN. FURTHER, THE
COMPANY OPERATES IN AN INDUSTRY SECTOR WHERE SECURITIES VALUES MAY BE VOLATILE
AND MAY BE INFLUENCED BY REGULATORY AND OTHER FACTORS BEYOND THE COMPANY'S
CONTROL. IMPORTANT FACTORS THAT THE COMPANY BELIEVES MIGHT CAUSE SUCH
DIFFERENCES ARE DISCUSSED IN THE CAUTIONARY STATEMENTS ACCOMPANYING THE
FORWARD-LOOKING STATEMENTS AND IN THE RISK FACTORS DETAILED IN THE COMPANY'S
OTHER FILINGS WITH THE COMMISSION DURING THE PAST 12 MONTHS. IN ASSESSING
FORWARD-LOOKING STATEMENTS CONTAINED HEREIN, READERS ARE URGED TO READ CAREFULLY
ALL RISK FACTORS AND CAUTIONARY STATEMENTS CONTAINED IN THIS FORM 10-K AND IN
THOSE OTHER FILINGS WITH THE COMMISSION.
<PAGE>
PART I
Item 1. Business
Overview
Wave Systems Corp. ("Wave" or the "Company") has completed a transition
from a company focused principally on research and development of new technology
to a company focused on the commercialization of its technology through
licensing and product sales. Since its inception in February of 1988, the
Company has devoted substantially all of its efforts and resources to research,
feasibility studies, design, development, and market testing of a system that
meters the usage of electronic content (the "Wave System"). Electronic content
refers to any data, graphic software, video or audio sequence that can be
digitally transmitted. As its research and development activities matured, the
Company was able to devote increased resources to market research, market
development and other related activities. The Company has completed a shift in
business focus that began in June 1996 toward development of the commercial and
technical relationships required to establish an electronic content distribution
network.
The Company believes that the Wave System can fundamentally change how
electronic content is consumed by providing more efficient and flexible pricing,
greater protection against unauthorized usage and secure, low-cost, and accurate
data on the usage of the electronic content. The Wave System enables the
merchandising of electronic content at the point of purchase. This may increase
the interest of consumers to sample electronic content that they are considering
purchasing. The Wave System accurately and securely records information
pertaining to the usage of the electronic content. The Wave System facilitates
the payment of royalties to content providers and allows customized distribution
of content to customers.
The Wave System consists of many individually distributed processors
("WaveMeters") that decrypt content on demand from end users. The WaveMeter is a
proprietary application-specific integrated circuit, mounted on a printed
circuit board, or which may become available as an add-in device in a
stand-alone PC. The WaveMeter allows transactions to occur without the expense
of a real-time network connection for every transaction. The WaveMeter securely
stores electronic funds and batched information about the usage of electronic
content to be securely transmitted to a central transaction processing center
("WaveNet"). WaveNet manages encryption and decryption keys, processes credit
and usage charges, automatically obtains credit authorization, calculates
royalty distributions, and can provide user and usage data to electronic content
owners. The Wave System is designed to be compatible with existing content
delivery systems such as CD-ROM, the internet and Direct Broadcast Satellite.
The Company views the acceptance by developers, distributors and consumers of
entertainment and educational software as an important factor in the development
of a broad installed base of WaveMeters. The Company further believes that once
there is a broad installed base of WaveMeters, electronic content owners from
other market segments are likely to be attracted to the Wave System.
In 1996 the Company developed a production software version of the
WaveMeter that offers a subset of the features of the hardware version of the
WaveMeter and has been implemented as part of the Company's internet commerce
server (the "WaveMeter server"). The WaveMeter server supports a publishing
service called WINPublish and a purchasing function called WINPurchase. Through
WINPublish, an electronic content owner can sell encrypted content from its site
on the Web to purchasers using the WINPurchase function.
In order to achieve broad market acceptance of the Wave System, the Company
pursues strategic relationships with major personal computer manufacturers and
promotes the use of the Wave System to electronic content owners, particularly
developers and distributors of entertainment and educational software. The
compatibility with internet transmission provides the foundation for the broad
acceptance of the Wave System. Specifically, the Company believes that the
WaveMeter can be the foundation for a "client-side subscriber management system"
that is independent of a delivery network. This means that content can be
delivered on CD-ROM, Data Broadcast, Broadband and other forms of transmission.
The Company believes it has a sound strategy to achieve broad market
acceptance of the Wave System as a standard platform for commerce in electronic
content. During 1997 the Company established relationships with IBM and Aladdin
Knowledge Systems, Ltd. ("Aladdin"), as well as electronic content companies
such as Psygnosis, GT Interactive Software Corp. and Red Storm Entertainment
Corp. The Company also received a payment of $1 million pursuant to a joint
venture agreement with Internet Technology Group, PLC ("ITG"), a United Kingdom
company.
Through a number of strategic relationships established in 1997, the
Company enhanced the Wave System and furthered its goal of achieving broad
market acceptance. The Company and Aladdin entered into a licensing agreement
whereby in return for an equity position in Wave, Aladdin licensed its
proprietary persistent encryption technology (the "Hasp technology"). The Hasp
technology provided the Company with three distinct advantages. First, the Hasp
technology provides a turn-key execution protection system for software
applications that permits the option of software rental, which the Company
believes will facilitate commerce in electronic content on a pay-per-use basis.
Second, it allows the addition of execution-secure applette operations, allowing
a WaveMeter to function as a general purpose security chip in a personal
computer and provide basic operations in hardware. And third, it provides
commercial enhancements to the performance and security of the Great Stuff
Network (the Company's internet commerce website).
Under the terms and the Aladdin license agreement, the company is
prohibited from using any other encryption technology for the first five years.
This technology will be incorporated into the Wave System to facilitate
pay-per-view content distribution.
The Company acquired the license for this technology in exchange for
$950,000 plus two warrants to purchase the Company's Class A common stock valued
at approximately $2.9 million. The cost of this license was expensed as research
and development costs. Aladdin also is provided a royalty payment of 5% to 9% of
the Company's net content revenues.
In connection with this agreement, Aladdin acquired an equity position in
the Company by purchasing 500,000 shares of the Company's Class A common stock
for $900,000, which approximated the fair market value of the shares on the date
of purchase.
The Company also has set the groundwork for the acceptance of the Wave
System in Europe. In July, the Company entered into a joint venture with ITG to
promote the use of the Wave System in Europe.
The Company intends to continue to pursue strategic relationships with
additional hardware manufacturers, including personal computer manufacturers,
and companies involved in the commerce of electronic content both in North
America and overseas. The Company also seeks to expand the role of the WaveMeter
as a general security device in personal computers.
Significant uncertainty currently exists with respect to the adequacy of
current funds to support the Company's activities. This uncertainty will
continue until a positive cash flow from operations can be achieved.
Additionally, the Company is uncertain as to the availability of financing from
other sources to fund any cash deficiencies. These uncertainties raise doubt
about the Company's ability to continue as a going concern.
In order to reduce these uncertainties, the Company is currently evaluating
additional financing options and may therefore elect to raise capital, from time
to time, through equity or debt financings in order to capitalize on business
opportunities and market conditions and insure the continued development of the
Company's technology, products and services. However, there can be no assurance
that the Company can raise the additional financing.
As of October 19, 1997, the Company became obligated to redeem for
approximately $465,000 all of the outstanding shares of the Series A Redeemable
Preferred Stock issued to a certain individual pursuant to the terms of the
Restated Certificate of Incorporation. As of December 31, 1997, the Company's
total obligation (principal plus interest) under the Series A redemption was
$471,601, and it continues to accrue dividends and interest. The Company has not
redeemed such shares as of March 25, 1998, nor has any demand for redemption
been made.
The Company presently has no material commitments for capital expenditures.
However, in order to bring the Wave System to market, the Company anticipates
spending additional amounts on inventory items such as computer chips and
boards, additional hardware, and related materials. Such spending will vary
based on the Company's performance.
Effective from the close of trading on October 24, 1997 the Company was
delisted from The Nasdaq SmallCap Market. As a result, shares of the Company's
Class A Common Stock are now traded on the OTC Bulletin Board. Until October 3,
1997 the Company had been listed on The Nasdaq National Market. Because the
Company was unable to meet the minimum net tangible assets requirement of The
Nasdaq National Market, the Company was delisted from The Nasdaq National
Market. From October 3, 1997 to October 24, 1997, the Company was temporarily
listed on The Nasdaq SmallCap Market. Continued listing on The Nasdaq SmallCap
Market was dependent upon the Company meeting certain commercial objectives. The
Company was unable to meet these objectives within the prescribed time period.
The Company believes that not being listed on a national exchange or quotation
system will have a material adverse effect on the price and liquidity of its
securities and consequently its ability to raise capital in the future.
The Company was incorporated in Delaware under the name Indata Corp. on
August 12, 1988. The Company changed its name to Cryptologics International,
Inc. on December 4, 1989. The Company further changed its name to Wave Systems
Corp. on January 22, 1993. The Company's principal executive offices are located
at 480 Pleasant Street, Lee, Massachusetts 01238 and the telephone number of the
Company is (413) 243-1600.
The Company is a development stage company and has realized minimal
operating revenues since its inception. At December 31, 1997, the Company had an
accumulated deficit of approximately $45 million. There can be no assurance that
the Company will be successful in achieving commercial acceptance of the Wave
System.
The Wave System
The Wave System is designed to create new revenue streams for owners of
electronic content by improving upon existing distribution systems for
electronic content. Using existing distribution systems such as CD-ROM and the
Internet, electronic content owners distribute their products to customers in
segmented and encrypted ("Wave-enabled") form so it can be offered for sale
through the Wave System. Customers are then able to purchase and decrypt the
electronic content on an as-needed basis. The Company believes that the Wave
System allows electronic content owners to deliver their products to a larger
market because the efficient and secure metering technology facilitates greater
flexibility in content distribution and pricing. The Company believes that
greater flexibility in electronic distribution and pricing makes the Wave System
particularly attractive to developers, distributors and consumers of
entertainment and educational software.
The Wave System consists of the WaveMeter, a subsystem that records and
communicates the usage of electronic content, and WaveNet, a central transaction
processing network. The WaveMeter controls and monitors the customer's access to
encrypted electronic information and software. Because the Wave System uses
asynchronous communication, it is well suited to low-cost processing of micro,
rental and rent-to-own transactions. The Company has completed a prototype
incorporating the rental and rent-to-own functionality into the Wave System.
Transactions are executed locally against a source of funds stored in the
WaveMeter. The WaveMeter retains pricing and tax information, downloaded from
WaveNet, for use in the execution of these transactions. Transactions are
securely stored in the usage log of the WaveMeter for eventual reporting to
WaveNet. The WaveMeters and WaveNet communicate using Wave's proprietary secure
communications protocol.
WaveNet is composed of the WaveNet Transaction Processing System
("TXP") and the WaveNet Information Clearing House ("ICH"). TXP acts as the
principal interface with the WaveMeter and accumulates data pertaining to the
consumer's usage. ICH provides interfaces to the Wave System for partners, such
as third-party distributors of WaveMeters and electronic content owners. It
contains the WaveNet security server, which manages all the encryption and
decryption keys. ICH also does all the back-end processing of usage information
from the WaveMeter, calculating royalties, producing billing services, and
ensuring that all content owners are properly compensated. WaveNet is presently
in operation.
The WaveMeter is installed into the customer's stand-alone PC. It is based
on a semiconductor device that uses proprietary integrated circuit technology to
store decryption keys, credit information, and usage data. Presently, the
WaveMeter is packaged on a half-size ISA board with a battery and a clock and
can be installed in the ISA slot of a PC. In 1996 the Company also developed a
production software version of the WaveMeter which has been implemented as a
component of the WaveMeter server. The WaveMeter server is currently used to
facilitate WINPublish and WINPurchase transactions on the Web. The use of the
software version of the WaveMeter is compatible with the use of the hardware
version of the WaveMeter.
The Company believes that the hardware version of the WaveMeter is the most
secure form of metering technology available today. Tampering with the WaveMeter
is easily detected by both the WaveMeter and WaveNet. The keys are loaded at the
time of manufacture and are unique and specific to each WaveMeter. Every piece
of electronic content is protected using a unique key. The value of breaking an
individual WaveMeter to ascertain the keys is low since the keys have no
system-wide use.
Wave supplies the tools that developers need to build and successfully
supply applications to end users. Electronic content must be Wave-enabled to be
available to end users on the Wave System. A data preparation tool kit
structures data packages, which are individual elements of electronic content
that are uniquely identified, encrypted, priced and formatted to use within the
Wave System. Once Wave-enabled, each data package can be delivered to the end
user in many electronic forms. Currently, the two primary mechanisms of delivery
of electronic content to the end user are the Internet and CD-ROM. The Wave
System, however, will work with point-to-multi-point data broadcasting via
satellite or FM sideband, magnetic media, cable modem, DVD and broadband.
Markets and Business Strategy
The Company's long-term strategy is to achieve broad market acceptance of
the Wave System as a platform for commerce in electronic content. To achieve
this goal the Company pursues strategic relationships with hardware
manufacturers and companies involved in the development of commerce in
electronic content. In addition, the Company believes that, since the Wave
System permits greater flexibility in pricing and distribution of electronic
content, it is particularly well-suited for merchandising entertainment and
educational software. Therefore the Company is vigorously targeting this market
segment as a means of rapidly achieving the broad installed base of WaveMeters
and acceptance of the Wave System. The Company believes that once there is a
broad installed base of WaveMeters, electronic content owners from other market
segments are likely to be attracted to the Wave System. However, there can be no
assurances that the Wave System will achieve any significant market acceptance.
The Company has focused on forming agreements with strategic partners that
will help the Company promote the broad-based acceptance of the Wave System as a
platform for commerce in electronic content. Wave is currently in discussion
with original equipment manufacturers regarding the incorporation of the
WaveMeter into their products.
Wave has also focused on pursuing strategic relationships with companies
seeking to distribute electronic content via the Internet. The compatibility of
the Wave System with the Web has provided the Company with a product that has
already attracted the attention of leaders in the development of electronic
commerce solutions and particularly commerce in electronic content. Wave will
continue to focus on developing other strategic relationships to seek to achieve
the broad acceptance of the Wave System as a platform for electronic commerce.
As part of Wave's goal to achieve broad acceptance of the Wave System as a
platform for commerce in electronic content, the Company has made the Wave
System available to users of the Web through the WaveMeter server. The WaveMeter
server currently supports both WINPublish, a publishing service, and
WINPurchase, the purchasing component. WINPublish provides an easy-to-use system
so that anyone can publish electronic content on a Web site and offer it for
sale. Since its inception, WINPublish has registered over 400 publishers.
WINPurchase permits consumers to purchase electronic content that has been
published through WINPublish. WINPublish and WINPurchase transactions may be
executed using the WaveMeter server without the need to install a WaveMeter at
the consumer's site. WINPublish and WINPurchase, however, are fully compatible
with the use of the hardware version of the WaveMeter. The Company believes
that, while the volume of transactions processed to date by the Wave System has
been limited, the operation of the WaveMeter server demonstrates the viability
of the Wave System and therefore enhances the ability of Wave to market the Wave
System to the leading electronic content distributors on the Web by offering
them a standard platform for commerce in electronic content that is designed to
be compatible with the Internet, CD-ROM and developing distribution media such
as broadband.
Wave has focused on promoting the acceptance of the Wave System by
electronic content owners. The initial target market is entertainment and
educational software developers and distributors. Wave believes that if it is
able to incorporate the rental or rent-to-own functionality into the Wave
System, the Wave System will provide the home consumer with a new way of
acquiring interactive content and can offer electronic content developers and
distributors benefits similar to those provided by video rental in the film
industry. The Company has invested heavily in developing relationships with
entertainment and educational software providers. No assurance can be given that
any or all of these companies will be successful in developing or marketing
products that apply the Wave System technology or that are Wave-enabled.
Competition
The Company operates in a highly competitive and fragmented environment
that is characterized by rapidly evolving technology. Many of the Company's
competitors and potential competitors have substantially greater financial and
technical resources than the Company. Also, many current and potential
competitors have greater name recognition and more extensive customer bases that
could be leveraged, thereby gaining market share or product acceptance to the
Company's detriment. The Wave System competes with conventional information
delivery systems, such as on-line services, subscription services on CD-ROM, and
services on the Internet. However, the Company believes that its metering
capability is competitive with other electronic content delivery systems in a
number of applications due to its superior protection against unauthorized
usage, accurate and detailed information on content usage, and transparent
operation. Further, provided that the Company is successful in incorporating the
rental and rent-to-own functionality into the Wave System, the Company believes
that it will be competitive with existing distribution systems, including
traditional retail outlets for entertainment and educational software, due to
its ability to offer these innovative merchandising mechanisms.
The Company is aware of other metering systems which compete directly
with Wave, and other current and evolving technologies that provide some of the
functionality of the Wave System. There are other companies that have developed
or are in the process of developing technologies that are, or in the future may
be, the basis for competitive products in the field of electronic content
distribution. Some of those technologies may have an entirely different approach
or means of accomplishing the desired effects of the products being developed by
the Company. There can be no assurance that either existing or new competitors
will not develop products that are superior to or that otherwise achieve greater
market acceptance than the Company's products.
The Wave System is subject to competition from producers of
hardware-based controllers such as dongles and software unlocking systems. The
Company will compete with well-established producers of dongle-based software
unlocking systems such as Rainbow Technologies, Inc. The Company also competes
with developers of software unlocking systems such as Portland Software. The
Company believes that the Wave System is superior to existing hardware-based and
software unlocking systems in several ways. These systems control the use of
electronic content but are very limited in their ability to measure and record
usage information. The Company believes that the Wave System offers superior
protection from unauthorized usage, low operating costs (because it does not
require constant communication with and authorization from a centralized
processor), and fast operation that is convenient and essentially transparent to
the end user. Both hardware controllers and software unlocking systems offer
only part of the functionality of the Wave System. Distinct from the existing
software unlocking systems, WaveNet provides centralized back-office support to
owners of electronic content.
Many large information industry players are forming alliances and
attempting to capitalize on the information delivery options offered by the
Internet. In electronic content delivery via the Internet, the Wave System
competes with electronic commerce payment technologies developed and offered by
IBM infoMarket(R) Service, Broadvision Inc., Connect, Inc., CyberCash, Inc.,
DigiCash and Open Market, Inc. However, the Company believes that many of the
electronic commerce payment technologies may be used as acceptable currency
through the Wave System and may be complementary to, rather than competitive
with, the Wave System. The Company is also aware of other companies, such as
TestDrive Corporation, Release Software Corporation and IBM Cryptolopes(R), that
provide electronic content encryption functionality for transmission of
electronic content over the Internet. The Company believes that the Wave System
is superior to currently available electronic content encryption technologies
due to the high level of security and usage reporting capabilities of the
WaveMeter.
The Company believes that the interoperability of the Wave System with
currently available and developing distribution media makes the Wave System
attractive to both distributors and consumers of electronic content. A consumer
with an installed WaveMeter will be able to purchase Wave-enabled content from
sources on CD-ROM and/or the Internet, as well as from sources distributing
electronic content on other developing media such as broadband. In addition,
with the incorporation of the rental and rent-to-own functionality, the Wave
System will offer greater merchandising flexibility than is possible using
currently available electronic commerce solutions. There can be no assurance
that the Wave System will achieve the broad-based acceptance necessary to make
the system a viable competitor with currently existing and developing electronic
commerce solutions.
International Market
The Company's technologies are controlled under various United States
export control laws and regulations and will require export licenses for certain
exports outside of the United States and Canada. The Company has received full
export license from the U.S. Department of Commerce for the sale and export of
the Company's single-key DES products. The Company has also received an export
license for its triple-key DES products under the provisions of a License
Exception KMI granted by the Bureau of Export Administration of the U.S.
Department of Commerce. There can be no assurance that the Company will have
patent protection or that it will not infringe patents of third parties in
foreign jurisdictions. Because electronic monitoring and the transmission of
audited usage and financial information on end users or payment instructions may
be subject to varying statutory or regulatory controls in foreign jurisdictions,
there can be no assurance that the use of all portions of the Wave System will
be permitted in any particular foreign jurisdiction.
Proprietary Rights and Licenses and Intellectual Property
The Company's success depends, in part, on its ability to enjoy or
obtain protection for its products and technologies under United States and
foreign patent laws, copyright laws and other intellectual property laws, to
preserve its trade secrets and to operate without infringing the proprietary
rights of third parties. There can be no assurance that any issued patent owned
or licensed by the Company affords adequate protection to the Company or will
not be challenged, invalidated, infringed or circumvented. Furthermore, there
can be no assurance that the Company's activities will not infringe patents
owned by others.
In addition, the Company may be required to obtain licenses to patents
or other proprietary rights of third parties. No assurance can be given that any
licenses required under any such patents or proprietary rights would be made
available on terms acceptable to the Company, if at all. If the Company is
required to and does not obtain such licenses it would be prevented from, or
encounter delays in the development and marketing of, its products and
technologies while it attempted to design around such patents or other rights
and there can be no assurance that such attempts would be successful. Failure to
obtain such licenses or to design around such patents or other rights would have
a material adverse effect on the Company.
The Company holds non-exclusive patent rights relating to the metered
use of encrypted data in local memory under a limited license (the "License
Agreement") from Titan Corporation ("Titan") to a patent (the "Licensed Patent")
jointly held by Titan and a third party. This License Agreement restricts Wave
from metering information produced and used solely by a government entity or
producing products that meter this information. In addition, the License
Agreement is subject to the rights of the joint owner of the Licensed Patent,
who has the right to exploit, or to license to third parties, the Licensed
Patent, including in a manner competitive with the Company. There can be no
assurance that the joint owner of the Licensed Patent will not compete with the
Company or license the Licensed Patent to a competitor of the Company, or that
the Company's business will not exceed the scope of the License Agreement.
Pursuant to the License Agreement, the Company is obligated to pay certain
royalties to Titan. Pursuant to the License Agreement, the Company has granted
to Titan the exclusive right to use the Company's patents for products
distributed to government entities. On February 28, 1997 the Company and Titan
executed an addendum to the License Agreement whereby the Company received a
sole license to the Licensed Patent to develop and distribute products to the
in-home consumer microcomputer market segment. Under this addendum to the
License Agreement, Titan waived any and all defaults by Wave under the License
Agreement occurring prior to February 28, 1997.
The Company is aware of four United States patents (the "Third Party
Patents") each having some claims that are similar to some of the claims in the
Licensed Patent. Based upon information currently known to the Company, some of
the claims of both the Licensed Patent and the Third Party Patents cover certain
material aspects of the Company's technology. Therefore, the commercialization
of the Company's technology would be subject to the rights of the holder of the
Third Party Patents unless the Company is able to invalidate or license such
claims. Also, the holder of the Third Party Patents or a licensee of the Third
Party Patents could seek to invalidate such claims of the Licensed Patent and
therefore be able to commercialize a technology similar to the Company's
technology. In either case, in order to invalidate the other party's patent
rights, the party claiming invalidity might need to prove that it invented the
claimed subject matter prior to the other party. There can be no assurance that
the Company would be successful in invalidating such claims of the Third Party
Patents or that the holder of the Third Party Patents or a licensee of the Third
Party Patents would not be successful in invalidating such claims of the
Licensed Patent. There also can be no assurance that the Third Party Patents
could be proven to be invalid on any other basis. Any proceeding involving the
validity of the Licensed Patent and the Third Party Patents would be protracted
and costly. In any suit contesting the validity of a patent, the patent being
contested would be entitled to a presumption of validity and the contesting
party would be required to demonstrate invalidity of such patent by clear and
convincing evidence.
If the Third Party Patents are not invalid insofar as their claims
relate to the Company's technology, then the Company would require a license
from the holder of the Third Party Patents to commercialize its technology and
make, use, or sell products or practice methods, or license others to sell
products or use methods, utilizing the technology in the United States. Due to
the uncertainty as to whether the Third Party Patents could be proved to be
invalid, the Company has engaged in preliminary negotiations with the holder of
the Third Party Patents to obtain a license under the Third Party Patents. The
negotiations have so far not produced any agreement and there can be no
assurance that a license will be obtainable on acceptable terms, if at all. The
inability to obtain a license, if needed, on commercially reasonable terms would
have a material adverse effect on the Company's business and its future
operations.
The Company has been issued three United States patents relating to
encryption and to the Company's proprietary WaveMeter(R) and WaveNet(R)
technology. The Company also has one patent pending before the United States
Patent Office and three corresponding foreign patent applications pending before
the European Patent Office (collectively, the "Wave Patents"). The Wave Patents
are material to protecting certain of the Company's technology. The Company's
rights to the Wave Patent derive from a license, amended and restated in
February 1994, from Mr. Peter J. Sprague, Chairman and Chief Executive Officer
of the Company, of his rights in the Wave Patents (the "Amended License
Agreement"), and several agreements with former officers of the Company
regarding their rights in the Wave Patents. The Amended License Agreement
provides for royalty payments to be made to Mr. Peter J. Sprague and Mr. John R.
Michener, a former officer of the Company, in the aggregate amount of two
percent of gross revenues less certain adjustments as defined in the Amended
License Agreement. The royalty payment is to be apportioned 75 percent to Mr.
Peter J. Sprague and 25 percent to Mr. John R. Michener. Payment of royalties is
secured by a security interest in and to the Wave Patents. The Company believes
that the agreements as a whole provide it with exclusive rights under the Wave
Patents. There can be no assurance that the Company will enjoy exclusive rights
to the Wave Patents under such agreements.
On January 26, 1996, the Company received notice from E-Data
Corporation (formerly Interactive Gift Express, Inc.), claiming that the
Company's practice of its technology infringes U.S. and foreign patents owned by
E-Data Corporation, and offering to license such patents to the Company. The
Company is currently obtaining information needed to investigate the merits of
this claim. The Company believes that there is a viable argument for
non-infringement. The patents owned by E-Data Corporation are currently being
litigated by third parties. The Company is not involved in these proceedings.
The Company relies on trade secrets and proprietary know-how, which it
protects, in part, by confidentiality agreements with its employees and contract
partners. However, there can be no assurance that the Company's confidentiality
agreements will not be breached or that the Company would have adequate remedies
for any breach. There can be no assurance that the Company's trade secrets will
not otherwise become known or be independently discovered by competitors.
The Company also relies on copyright to prevent the unauthorized
duplication of its software and hardware products. The Company has and will
continue to protect its software and its copyright interest therein through
agreements with its consultants. The Company also plans to seek protection for
its semiconductor integrated circuit designs under mask work laws. Existing
copyright and mask work laws afford only limited protection, particularly in
certain jurisdictions outside the United States where the Company may seek to
market its products and services. There can be no assurance that the copyright
laws or mask work laws will adequately protect the Company's technology.
The Company has registered trademark and service mark registrations
with the United States Patent and Trademark Office for the marks WaveMeter(R)
and WaveNet(R) and intends to apply for additional name and logo marks in the
United States and foreign jurisdictions as appropriate. No assurance can be
given that federal registration of any of these trademarks in the United States
will be granted. The Company has abandoned its prior applications for DataWave,
InfoWave, and WaveTrac.
Research and Development
The Wave System incorporates semiconductor, encryption/decryption, software
transaction processing and other technologies in which the Company has made a
substantial investment in research and development. The Company expects that it
will be required to continue to make substantial investments in the design of
the WaveMeter, WaveNet and software interfaces. For the years ended December 31,
1997, 1996, and 1995, the Company expended $2,146,127, $3,309,022 and $3,324,735
respectively, on research and development activities (which amounts include the
value of stock issued). In addition to its ongoing research and development
activities, in July 1997 the Company licensed technology and in-process research
and development from Aladdin Knowledge Systems for cash and warrants valued at
$3.89 million. From its inception in February 1988 through December 1997, the
Company expended $14,745,813.
The success of the Wave System depends to a large extent on the
Company's ability to adapt the Wave System for use with various methods for the
distribution of electronic content, the ability of the Wave technology to
interface with various platform environments, and the ability of the Wave System
to work in many application environments. Incorporation of Aladdin's Hasp
technology furthered these efforts and illustrates the adaptive capabilites of
the Wave System. The Company believes that a significant portion of its future
research and development expenditures will be used to adapt the Wave System
accordingly.
The Company will also continue to expend a significant amount of
resources on the development of new iterations of the WaveMeter. The Company
believes that by providing various means of linking the WaveMeter to the
customer's computer or network, the Company will be more likely to achieve broad
acceptance of the Wave System. The Company is currently developing other forms
of the WaveMeter to target other market needs.
Wave is now focusing increased resources on developing the operational
infrastructure of the Company. Greater emphasis is placed on developing internal
production and fulfillment systems and marketing infrastructure to distribute
WaveMeters. The Company will also increase the resources available to WaveNet to
adapt to changing market requirements. The Company plans to expand WaveNet to
handle more end users, to develop interfaces for new kinds of partners, to
implement more sophisticated pricing methodologies and to add greater financial
system flexibility.
Employees
As of December 31, 1997, the Company employed 41 full-time employees,
25 of whom are involved in marketing and administration and 16 of whom are
involved in research and development. The Company believes its employee
relations are satisfactory.
Item 2. Properties
The Company leases a 10,748 square foot facility for its executive
offices and to house the WaveNet installation, administration, and customer
support operations in Lee, Massachusetts at a monthly rent of $5,598 with a
monthly charge of $2,123 for common costs. The Lee, Massachusetts lease will
expire during February 2001. The Company leases offices in New York, New York,
at a monthly rent of $6,769. The lease is scheduled to expire in June 1999. The
Company leases a 6,400 square foot facility in Princeton, New Jersey at a
monthly base rent of $3,733 with a monthly payment for taxes, insurance and
maintenance reimbursements and improvements which currently totals approximately
$1,653 per month. This lease is scheduled to expire during January 2001. The
Company's principal research and development activities are conducted at the
Princeton facility. The Company leases a 2,730 square foot facility in San Jose,
California for $5,050 per month. The San Jose, California lease will expire
during January 1999.
Item 3. Legal Proceedings
On June 27, 1997 a complaint alleging breach of contract, among other
related claims, was filed against the Company by Carl A. Artopeous and Artopeous
Capital Management (collectively, "Artopeous") with the Sacramento Superior
Court in Sacramento, California in connection with the engagement of Artopeous
by the Company to arrange financing. The action has been removed to the Federal
Court, Eastern District of California. Wave filed its answer in December, 1997;
responses to its document requests are due in early April, 1998.
Item 4. Submission of Matters to a Vote of Security Holders
Not Applicable.
<PAGE>
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters
The Company made its initial public offering on August 31, 1994 at a price
to the public of $5.00 per share. Until October 3, 1997, the Company's Class A
Common Stock had been traded on The Nasdaq National Market tier of The Nasdaq
Stock Market. From October 3, 1997 to October 24, 1997 the Company's Class A
Common Stock was traded on The Nasdaq SmallCap Market. The Company's Class A
Common Stock now trades on The OTC Bulletin Board under the symbol: WAVX. Except
as provided below, the following table sets forth, for the periods indicated,
the high and low closing sales prices per share for the Company's Class A Common
Stock as reported by The Nasdaq National Market. For the period from October 24,
1997 to December 31, 1997 the following table sets forth the high and low bid
quotations for the Company's Class A Common Stock obtained from Bloomberg
Information Services, Inc. Such quotations reflect inter-dealer prices, without
retail mark-up, mark-down or commission, and may not necessarily represent
actual transactions. There is no established trading market for the Company's
Class B Common Stock.
High Low
Year Ended December 31, 1997
First Quarter (January 1, 1997-March 31, 1997)........ $3.00 $1.56
Second Quarter (April 1, 1997-June 30, 1997).......... $1.81 $1.25
Third Quarter (July 1, 1997-September 30, 1997)....... $2.00 $0.94
Fourth Quarter (October 1, 1997-October 23, 1997)..... $1.94 $1.06
Fourth Quarter (October 24, 1997-December 31, 1997)... $2.00 $0.63
High Low
Year Ended December 31, 1996
First Quarter (January 1, 1996-March 31, 1996)........ $4.44 $2.63
Second Quarter (April 1, 1996-June 30, 1996).......... 3.81 1.88
Third Quarter (July 1, 1996-September 30, 1996)....... 2.56 1.19
Fourth Quarter (October 1, 1996-December 31, 1996).... 3.53 1.00
As of March 25, 1998, there were approximately 217 holders of the Company's
Class A Common Stock. As of such date, there were 92 holders of the Company's
Class B Common Stock.
The Company has never declared or paid any cash dividends on its capital
stock. The Company currently anticipates that it will retain all future
earnings, if any, to fund the development and growth of its business and does
not anticipate paying any cash dividends on its Common Stock in the foreseeable
future.
Recent Sales of Unregistered Securities
On March 6, 1998 the Company issued 150,000 shares of newly created Series
G Convertible Preferred Stock, par value $.01 ("Series G Convertible Preferred
Stock") at a price of $20 per share, for an aggregate purchase price of
$3,000,000. The shares were sold to one (1) accredited investor pursuant to
Regulation D promulgated under the Act. The Series G Convertible Preferred Stock
is convertible into Class A Common Stock, par value $.01 ("Class A Common
Stock") at an effective conversion price of the lower of (a) $1.12 and (b) 80%
of the average of the five (5) lowest trading prices of the Class A Common Stock
during (x) a day on which the Class A Common Stock is traded on The Nasdaq
National Market or The Nasdaq SmallCap Market or principal national securities
exchange or market on which the Class A Common Stock has been listed, or (y) if
the Class A Common Stock is not listed on The Nasdaq National Market or The
Nasdaq SmallCap Market or any stock exchange or market, a day on which the Class
A Common Stock is traded in the over-the-counter market, as reported by the OTC
Bulletin Board, or (z) if the Class A Common Stock is not quoted on the OTC
Bulletin Board, a day on which the Class A Common Stock is quoted in the
over-the-counter market as reported by the National Quotation Bureau
Incorporated (or any similar organization or agency succeeding its functions of
reporting prices) ("Trading Days"), as reported by Bloomberg Information
Services, Inc. during the ten (10) Trading Days immediately preceding the
Conversion Date, as defined in the Certificate of Designation of the Series G
Convertible Preferred Stock. In addition to the Series G Convertible Preferred
Stock, the Company also issued warrants to purchase a total of 225,000 shares of
Class A Common Stock at an exercise price of $1.38 per share, exerciseable until
October 9, 2002.
On October 9, 1997 the Company issued 112,500 shares of newly created
Series F Convertible Preferred Stock, par value $.01 ("Series F Convertible
Preferred Stock"), at a price of $20 per share, for an aggregate purchase price
of $2,250,000. The shares were sold to one (1) accredited investor pursuant to
Regulation D promulgated under the Act. The Series F Convertible Preferred Stock
is convertible into the Class A Common Stock at an effective conversion price of
the lower of (a) $1.05 and (b) 80% of the average of the five (5) lowest trading
prices of the Class A Common Stock during (x) a day on which the Class A Common
Stock is traded on The Nasdaq National Market or The Nasdaq SmallCap Market or
principal national securities exchange or market on which the Class A Common
Stock has been listed, or (y) if the Class A Common Stock is not listed on The
Nasdaq National Market or The Nasdaq SmallCap Market or any stock exchange or
market, a day on which the Class A Common Stock is traded in the
over-the-counter market, as reported by the OTC Bulletin Board, or (z) if the
Class A Common Stock is not quoted on the OTC Bulletin Board, a day on which the
Class A Common Stock is quoted in the over-the-counter market as reported by the
National Quotation Bureau Incorporated (or any similar organization or agency
succeeding its functions of reporting prices) ("Trading Days"), as reported by
Bloomberg Information Services, Inc. during the ten (10) Trading Days
immediately preceding the Conversion Date, as defined in the Certificate of
Designation of the Series F Convertible Preferred Stock. In addition to the
Series F Convertible Preferred Stock, the Company also issued warrants to
purchase a total of 168,750 shares of Class A Common Stock at an exercise price
of $1.26 per share, exerciseable until October 9, 2002. As of December 31, 1997,
all of the shares of the Series F Preferred stock have been converted into Class
A Common Stock
On September 16, 1997, the Company issued 800,000 shares of the Company's
Class A Common Stock, and warrants to purchase 160,000 shares of Class A Common
Stock, which may be exercised at an exercise price equal to $1.00, for an
aggregate purchase price of $800,000 pursuant to Regulation D promulgated under
the Securities Act of 1933, as amended (the "Act"), to six (6) accredited
investors.
On May 30, 1997 the Company issued 80,000 shares of newly created Series D
Convertible Preferred Stock, at a price of $20 per share, for an aggregate of
$1,600,000. The shares were sold to one (1) accredited investor pursuant to
Regulation D promulgated under the Act. The Series D Convertible Preferred Stock
is convertible into the Class A Common Stock of the Company at an effective
conversion price of the lower of (i) $1.35, or (ii) 80% of the average closing
bid price on the Nasdaq National Market System of the Company's Class A Common
Stock for the five (5) trading days immediately preceding the Date of
Conversion, defined in the Certificate of Designation of the Series D
Convertible Preferred Stock. In addition to the Series D Convertible Preferred
Stock, the Company also issued warrants to purchase a total of 120,000 shares of
Class A Common Stock at an exercise price of $1.62 per share, exercisable until
May 30, 2002. As of December 31, 1997, all of the shares of the Series D
Preferred Stock have been converted into Class A Common Stock.
<PAGE>
-15-
Item 6. Selected Financial Data
Statement of Operations Data
<TABLE>
<CAPTION>
Period from
February 12,
1988
(inception)
through
Year ended December 31 December 31
1997 1996 1995 1994 1993 1997
-----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Net Revenues $ 10,712 $ 1,458 $ - $ - $ - $ 12,170
------------ ------------ ---------- ----------- ------------ ------------
Operating expenses:
Selling, general and
administrative 7,983,151 5,560,620 4,080,185 2,432,283 2,251,094 27,436,506
Write-off of Goodwill 769,886 - - - - 769,886
Aladdin Technology
License Expense 3,889,000 - - - - 3,889,000
Research and
development 2,146,127 3,309,022 3,324,735 1,761,366 1,655,386 14,745,813
---------- ---------- ---------- ---------- --------- -----------
14,788,164 8,869,642 7,404,920 4,193,649 3,906,480 46,841,205
---------- ---------- ---------- ---------- ---------- -----------
Other income
(expense):
Technology License
Revenue 1,000,000 - - - - 1,000,000
Net interest and other
income (expense) (120,342) 184,369 572,054 (77,852) (52,854) 504,572
----------- ---------- ---------- --------- ---------- -----------
Net loss (13,897,794) (8,683,815) (6,832,866) (4,271,501) (3,959,334) (45,324,463)
Accrued dividends on
preferred stock 809,982 199,614 40,600 39,484 38,467 1,134,530
----------- ---------- ----------- ----------- ----------- -------------
Assured incremental
yield 1,673,000 670,965 - - 2,343,965
------------ ---------- ----------- ----------- ----------- ------------
Net loss to common
stockholders $(16,380,776) $(9,554,394) $(6,873,466) $(4,310,985) $(3,997,801) $(48,802,958)
============= ============ =========== =========== =========== ============
Weighted average
number of common
shares outstanding
during the period
20,943,748 14,956,584 13,794,373 10,503,621 8,659,841 9,777,559
Loss per common share
$(.78) $(.64) $(.50) $(.41) $(.46) $(4.99)
============ ============ ============ =========== =========== ============
<PAGE>
</TABLE>
<TABLE>
<CAPTION>
Balance Sheet Data
Year ended December 31
-------------------------------------------------------------------------------
1997 1996 1995 1994 1993
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Working capital (669,041) 3,197,519 5,458,512 12,463,502 (1,453,950)
(deficiency)
Total assets 1,678,213 6,237,219 7,754,042 13,766,864 918,303
Current liabilities 1,427,762 937,163 1,210,778 867,145 1,996,250
Long-term liabilities 522,124 465,500 - - -
Series A Cumulative
Redeemable Preferred
Stock 471,601 432,334 390,534 349,934 310,450
Series B Cumulative
Convertible Preferred
Stock -0- 195,520 - - -
Series C Cumulative
Convertible Preferred
Stock -0- 2,647,742 - - -
Deficit accumulated
during the development
stage (45,324,463) (31,426,669) (22,742,854) (15,909,988) (11,638,487)
Total stockholders'
equity (deficiency) (743,274) 1,558,960 6,152,730 12,549,785 (1,388,397)
</TABLE>
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Overview
Wave Systems Corp. ("Wave" or the "Company") has completed a transition
from a company focused principally on research and development of new technology
to a company focused on the commercialization of its technology through
licensing and product sales. Since its inception in February of 1988, the
Company has devoted substantially all of its efforts and resources to research,
feasibility studies, design, development and market testing of the Wave System.
During this period, the Company designed and successfully developed its
proprietary integrated circuit technology, WaveMeter, WaveNet and other
necessary components of the Wave System. During 1996 the Company devoted
substantial efforts and resources to designing and developing the technology
required to make the Wave System compatible with the distribution of electronic
content on the Web. Concurrent with its research and development activities, the
Company has devoted increased resources to market development and other related
activities. During 1997 the Company established relationships with IBM and
Aladdin Knowledge Systems, Ltd. as well electronic content companies such as
Psygnosis, GT Interactive Software Corp., and Red Storm Entertainment Corp. The
Company also received a license fee of $1 million pursuant to a joint venture
and licensing agreement with Internet Technology Group, PLC ("ITG"), a United
Kingdom company. The Company also has set the groundwork for the acceptance of
the Wave System in Europe with ITG by entering into a joint venture with ITG to
promote the use of the Wave System in Europe. From inception through December 3
1997, the Company has realized only minimal operating revenues, and does not
anticipate significant revenues in the near future. There are numerous risks
that could adversely affect the Company's efforts to achieve profitability.
Results of Operations
Years Ended December 31, 1997 and 1996
For the years ended December 31, 1997 and December 31, 1996 the Company
had only minimal operating revenues.
Selling, general and administrative expenses for the year ended December
31, 1997 were $7,983,151 as compared with $5,560,620 for 1996. The increase in
selling, general and administrative expenses was primarily attributable to
development and marketing of new applications of the Company's technology as
well as accrued expenses related to the ITG Joint Venture Agreement, and
bonuses and salary increases.
In the third quarter of 1997, the Company wrote off approximately $770,000
of Goodwill recorded for the Win acquisition because the Company was uncertain
as to whether the anticipated future operations of the business would be
sufficient to justify the carrying value.
Research and development expenses for the year ended December 31, 1997 were
$2,146,127 as compared with $3,309,022 for 1996. The decrease in research and
development expenses is attributable in part to the agreement with Aladdin
whereby Wave licensed Aladdin's Hasp technology for a share in content revenues
as well as cash and warrants totalling $3,889,600. More generally, the decrease
in research and development is attributable to the shift in the focus of the
Company from research and development to commercialization and marketing and
personnel adjustments consequent thereto.
In July of 1997, the Company entered into a joint-venture with Internet
Technology Group, PLC (ITG), a United Kingdom Internet service provider.
Pursuant to the joint venture agreement, the Company will receive a license fee
of up to $5 million in exchange for the joint venture's right to market the Wave
technology in European and Middle Eastern markets. During the third quarter of
1997, the Company received $1.0 million from the joint-venture representing
partial payment of the license fee, with the remaining payments to be made upon
the Company's attaining certain milestones related to the number of Wave Meters
distributed. The amount received was recorded as deferred license fee income in
the third quarter as it was uncertain whether the Company had met the
contractual requirements required in order to have earned the first payment.
During the fourth quarter of 1997, the Company met these requirements and
recorded the $1 million as a license fee. Also, the Company accrued $490,000 in
the fourth quarter for expenses related to the Company's obligation to
assist the joint-venture in setting up the Wave system in the designated
markets. These costs are included in selling, general and administrative
expense.
Net interest expense for the year ended December 31, 1997 was $120,342 as
compared with net interest income of $184,369 for 1996. Interest income of
$55,282 for the year ended December 31, 1997 was attributable to the interest
earned on proceeds from the issuance of convertible preferred stock of the
Company in May of 1996. Interest income of $194,766 for the year ended December
31, 1996 was attributable to the interest earned on proceeds from the issuance
of convertible preferred stock of the Company in May of 1996. The Company held
no marketable securities at December 31, 1997.
Due to the reasons set forth above, the Company's net loss was
$13,897.794 for the year ended December 31, 1997, as compared with $8,683,815
for 1996.
Years Ended December 31, 1996 and 1995
For the year ended December 31, 1996 the Company had only minimal
operating revenues. For the year ended December 31, 1995, the Company had no
operating revenues.
Selling, general and administrative expenses for the year ended
December 31, 1996 were $5,560,620, as compared with $4,080,185 for 1995. The
increase in selling, general and administrative expenses was primarily
attributable to an increase in personnel and other related costs associated with
the development and marketing of new applications of the Company's technology.
Research and development expenses for the year ended December 31, 1996
were $3,309,022 as compared with $3,324,735 for 1995. The increase in research
and development expenses consisted primarily of costs associated with
the design and development of the Company's ASIC, including non-recurring
engineering costs and prototype purchases, the design and development of WaveNet
and the development and implementation of WINPublish and WINPurchase.
Net interest income for the year ended December 31, 1996 was $184,369
as compared with net interest income of $559,334 for 1995. Interest income of
$194,766 for the year ended December 31, 1996 was attributable to the interest
earned on marketable securities purchased with proceeds from the issuance of
convertible preferred stock of the Company in May of 1996. Interest expense of
$10,397 for the year ended December 31, 1996 was primarily attributable to
short-term working capital loans.
Due to the reasons set forth above, the Company's net loss was
$8,683,815 for the year ended December 31, 1996, as compared with $6,832,866 for
1995.
Liquidity and Capital Resources
The Company has experienced net losses and negative cash flow from
operations since its inception, and, as of December 31, 1997 had a deficit
accumulated during the development stage of approximately $45 million. The
Company has financed its operations through December 31, 1997 principally
through the private placement of Class B Common Stock for an aggregate amount of
$6,201,931 (before deduction of expenses incurred in connection therewith), the
issuance of $2,873,250 in aggregate principal amount of its 10% Convertible
Notes and 15% Notes (of which $2,098,250 was converted into Class B Common
Stock), the sale of 3,728,200 shares of its Class A Common Stock in an initial
public offering raising approximately $15,711,000 after all expenses, the
private placement of 800,000 shares of Class A Common Stock and warrants raising
$800,000 (before deduction of expenses incurred in connection therewith), and
the private placements of convertible preferred stock for an aggregate of amount
of $10,350,000 (before deduction of expenses incurred in connection therewith).
In addition, the Company has attempted to reduce cash flow requirements by
compensating key employees, consultants, suppliers and other vendors with Common
Stock and options to purchase Common Stock.
At December 31, 1997, the Company had approximately $759,000 in cash and
cash equivalents. The Company held no marketable securities at December 31,
1997. At December 31, 1996, the Company had approximately $4,064,000 in cash and
cash equivalents. The Company held no marketable securities at December 31,
1996. The decrease in cash and cash equivalents is attributable to the net cash
used in operations, partially offset by the issuance of preferred and common
stock of the Company. At December 31, 1997, the Company had working capital
deficiency of approximately $669,041. The Company expects to incur substantial
additional expenses resulting in significant losses at least through the period
ending December 31, 1998 due to minimal revenues associated with initial market
entry, continued research and development costs as well as increased sales and
marketing expenses associated with market testing and roll-out. The Company
anticipates that its existing capital resources will be adequate to satisfy its
capital requirements into the second quarter. In order to continue operations,
however, the Company will need to raise additional funds through public or
private financings. In March, 1998 the Company issued 150,000 shares of newly
created Series G Convertible Preferred Stock for an aggregate price of
$3,000,000. The Company has no current commitment to obtain additional funds and
is unable to state the amount or source of such additional funds.
Significant uncertainty currently exists with respect to the adequacy
of current funds to support the Company's activities. This uncertainty will
continue until a positive cash flow from operations can be achieved.
Additionally, the Company is uncertain as to the availability of financing from
other sources to fund any cash deficiencies. These uncertainties raise doubt
about the Company's ability to continue as a going concern.
The Company is currently evaluating financing options and may therefore
elect to raise additional capital, from time to time, through equity or debt
financings in order to capitalize on business opportunities and market
conditions and insure the continued development of the Company's technology,
products and services.
The Company presently has no material commitments for capital
expenditures.
As of December 31, 1997, the Company had available net operating loss
carryforwards for Federal income tax purposes of approximately $36.9 million.
Because of the "change in ownership" provisions of the Tax Reform Act of 1986,
the Company's net operating loss carryforwards may be subject to an annual
limitation on the utilization of these carryforwards against taxable income in
future periods if a cumulative change in ownership of more than 50 percent of
the Company occurs within any three-year period. The Company has made no
determination concerning whether there has been such a cumulative change in
ownership. However, the Company believes that it is likely that such a change in
ownership occurred prior to or following the completion of its initial public
offering.
In June 1997, the FASB issued SFAS 130, "Reporting Comprehensive
Income," which establishes standards for reporting and display of comprehensive
income and its components in a full set of general-purpose financial statements.
Under this concept, all revenues, expenses, gains and losses recognized during
the period are included in income, regardless of whether they are considered to
be results of operations of the period. SFAS 130, which becomes effective for
the Company in its year ending December 31, 1998, is not expected to have a
material impact on the consolidated financial statements of the Company.
In June 1997, the FASB issued SFAS 131, "Disclosures about Segments of
an Enterprise and Related Information," which establishes standards for the way
that public business enterprises report selected information about operating
segments in annual financial statements and requires that those enterprises
report selected information about operating segments in interim financial
reports to shareholders. It also establishes standards for related disclosures
about products and services, geographic areas and major customers. SFAS 131,
which becomes effective for the Company in its year ending December 31, 1998, is
currently not expected to have a material impact on the Company's consolidated
financial statements and footnote disclosures.
Year 2000 Issues
The Company is in the process of evaluating its computer software and
databases to determine whether or not modifications will be required to prevent
problems related to the year 2000. At this time, it is not expected that
modifying or replacing the Company's software and databases will have a material
financial effect on the Company's financial position or results of operations in
any given year.
Item 7A. Quantitative and Qualitative Disclosure about Market Risk
Not applicable.
Item 8. Financial Statements and Supplementary Data
The consolidated financial statements, the notes thereto, and the
independent auditors' report thereon are presented beginning at page F-1 of this
Form 10-K and are hereby incorporated by reference into this Item 8.
Item 9. Changes in and Disagreements with Accountant on Accounting
and Financial Disclosure
Not Applicable.
PART III
Item 10. Directors and Executive Officers of the Registrant
Directors of the Registrant
<TABLE>
<CAPTION>
Business Experience and Principal
Occupation or Employment During
Past 5 Years; Positions held with
Name Age Company; Other Directorships Director Since
<S> <C> <C> <C>
Peter J. 58 Chairman of the Company since 1988 1991
Sprague(1)(4) and Chief Executive Officer of the
Company since July 1991; Chairman
of National Semiconductor Corporation
from 1965 until May 1995; Director of
Enlightened Software, Inc. and
Pantepec International, Inc.; Trustee
of the Strang Clinic; Member
of Academy of Distinguished
Entrepreneurs, Babson College.
John E. Bagalay, 64 Managing Director of Community 1993
Jr., Ph.D.(1) Technology Fund, a venture capital
(2)(4) affiliate of Boston University, since
September 1989; General Counsel of
Lower Colorado River Authority from
October 1984 to September 1988; former
General Counsel of Texas Commerce
Bancshares, Inc. and Houston First
Financial Group; Director of Seragen,
Inc., Cytogen, Inc., Hymedix
Inc. and several privately-held
corporations; President and CEO
of Cytogen Corporation from January
1998, CFO since October 1997;
Managing Director of Boston University
Venture Capital Fund from 1989-1997;
Senior Advisor to Chancellor, Boston
University from January 1998.
Philippe 48 Manager of Financiere Wagram Poncelet 1993
Bertin(3) (direct marketing; media) since
December 1991; Manager of Midial S.A.
(consumer goods) from 1984 until 1991;
Manager of FINOVELEC since October
1997.
George Gilder(4) 58 Chairman of the Executive Committee 1993
of the Company since 1996; Senior
Fellow at the Discovery Institute
in Seattle, Washington; author of nine
books, including Life After Television,
Microcosm, The Spirit of Enterprise
and Wealth and Poverty; contributing
editor to Forbes Magazine; Director
and President of Gilder Technology
Group, Inc. (publisher of monthly
technology reports); former chairman
of the Lehrman Institute Economic
Roundtable; former Program Director
for the Manhattan Institute; recipient
of White House award for
Entrepreneurial Excellence from
President Reagan.
John E. 68 Chairman and Chief Executive Officer 1988
McConnaughy,Jr. of JEMC Corporation (private
(1)(2)(3)(4) investments); Chairman and Chief
Executive Officer of Peabody
International Corporation (an
environmental services company) from
1969 through 1985; Chairman and Chief
Executive Officer of GEO International
Corporation (a nondestructive testing,
screen printing and oil field services
company which was spun-of from Peabody)
from February 1981 to October 1992;
Director of Riddell Sports Inc.,
Levcor International, Inc., Transact
International, Inc., De-Vlieg Bullard,
Inc. and Mego Financial Corp. Mr.
McConnaughy is also a member of the
Board of Trustees of the Strang Clinic
and the Chairman of the Board of the
Harlem School of the Arts.
Steven 33 President and Chief Operating Officer 1997
Sprague of the Company since May 1996;
President of Wave Interactive Network
from June 1995 to December 30, 1996;
Vice President of Operations of the
Company from April 1994 to June 1995;
employee of the Company in the areas
of operations and strategic planning
from November 1992 to April 1994;
consultant to the Company from March
1992 to November 1992; President of
Tech Support, Incorporated (hardware
technical support information on
CD-ROM)from June 1992 to November 1992;
sole proprietor of SKS Environmental
Sales (manufacturers' representative
for water treatment companies) from
June 1991 to November 1992.
</TABLE>
(1) Member of Nominating Committee.
(2) Member of Compensation Committee.
(3) Member of Audit Committee
(4) Member of Executive Committee
Executive Officers of the Registrant
The executive officers of the Company are Mr. Peter J. Sprague, Chairman
and Chief Executive Officer and Mr. Steven Sprague, President and Chief
Operating Officer.
All officers are elected annually at the first meeting of the Board of
Directors following the annual meeting of the stockholders, and are subject to
removal at any time by the Board of Directors.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act") requires the Company's directors and executive officers, and
persons owning more than ten percent of a registered class of the Company's
equity securities, to file with the Securities and Exchange Commission reports
of ownership and changes in ownership of equity securities of the Company. Such
persons are also required to furnish the Company with copies of all such forms.
Based solely upon a review of the copies of such forms furnished to the
Company and, in certain cases, written representations that no Form 5 filings
were required, the Company believes that, with respect to the 1997 fiscal year,
all required Section 16(a) filings were made, except that (i) the Forms 5 for
Mr. Philippe Bertin, a director of the Company, and Mr. Steven Sprague, director
and President of the Company, were filed late; and (ii) the Form 5 for Mr. Gene
Ray, a director of the Company in 1997, was filed late and later amended to
correct the number of derivative securities beneficially owned as of December
31, 1997 from 20,000 to 42,000.
Item 11. Executive Compensation
Summary Compensation Table
The following table sets forth information with respect to the compensation
paid or awarded by the Company to the Chief Executive Officer and the only other
executive officer whose cash compensation exceeded $100,000 (collectively, the
"Named Executive Officers") for services rendered in all capacities during 1995,
1996 and 1997.
<TABLE>
<CAPTION>
Long Term
Compensation Awards
Annual Compensation Number of Shares
Name and Principal Underlying
Position Year Salary($) Bonus($) Options(#)
- ------------------- ----- --------- ----------- ------------
<S> <C> <C> <C> <C>
Peter J. Sprague(1) 1997 $160,000 $ 100,000 10,000
Chairman and Chief 1996 $160,000 $ 50,000 -0-
Executive Officer 1995 $160,000 $ -0- 1,995
Steven Sprague(2) 1997 $150,000 $ 117,500 -0-
President and 1996 $131,666 $ -0- 150,000
Chief Operating Officer 1995 $110,000 $ -0- 1,995
</TABLE>
(1) Mr. Peter Sprague received a bonus of $100,000 for 1997; $50,000 was
received in cash and $50,000 was applied to reduce his debt to the Company
(see Item 13).
(2) Mr. Steven Sprague was elected President and Chief Operating Officer on May
23, 1996 and was not previously an executive officer during 1996. Prior to
that, Mr. Steven Sprague was Vice President of Operations of the Company
from April 1994 to June 1995 and employee of the Company in the areas of
operations and strategic planning from November 1992 to April 1994.
Option Grants Table
The following table sets forth certain information regarding options
granted during the fiscal year ended December 31, 1997 by the Company to the
Named Executive Officers.
<TABLE> <CAPTION>
Potential Realizable Value
Number of % of Total at Assumed Annual Rates of
Shares Options Stock Price Appreciation For
Underlying Granted to Exercise Option Term (1)
Options Employees Price Expiration ---------------------------
Name Granted (#) Fiscal Year ($/Share) Date 5% ($) 10% ($)
- ---- ----------- ----------- --------- --------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Peter J. Sprague 10,000 4.9 $1.94 7/17/07 13,200 32,500
Steven Sprague -0- -0- - - -0- -0-
- --------------
</TABLE>
(1) The potential realizable value of the options reported above was calculated
by assuming 5% and 10% compounded annual rates of appreciation of the
common stock from the date of grant of the options until the expiration of
the options, based upon the market price on the date of grant. These
assumed annual rates of appreciation were used in compliance with the rules
of the Securities and Exchange Commission and are not intended to forecast
future price appreciation of the common stock.
Fiscal Year End Option Value Table
The following table sets forth information regarding the aggregate number
and value of options held by the Named Executive Officers as at December 31,
1997. No options were exercised by the Named Executive Officers during 1997.
<TABLE>
<CAPTION>
Number of Shares
Underlying Unexercised Options Value of Unexercised
at December 31, 1997(#) In-The-Money Options
at December 31, 1997($)(1)
Name Exercisable Unexercisable Exercisable Unexercisable
- --------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Peter J. Sprague................. 331,330 10,665 $ 46 $ 23
Steven Sprague................... 94,530 100,665 $ 47 $ 23
</TABLE>
(1) The last reported bid price for the Company's Class A Common Stock on the
OTC Bulletin Board on December 31, 1997 was $1.125 per share. Value is
calculated on the basis of the difference between the respective option exercise
prices and $1.125, multiplied by the number of shares of common stock underlying
the respective options.
Compensation of Directors
Directors presently receive no cash compensation for serving on the Board
of Directors. Under the Company's Non-Employee Directors Stock Option Plan, each
director who is not an employee of the Company receives an annual grant of
options to purchase 10,000 shares of Class A Common Stock at fair market value.
The options are granted upon re-election after the annual meeting of the
stockholders and vest 25% after each three-month period following grant. Options
terminate upon the earliest to occur of (i) subject to (ii) below, three months
after the optionee ceases to be a director of the Company, (ii) one year after
the death or disability of the optionee, and (iii) ten years after the date of
grant. If there is a change of control of the Company, all outstanding stock
options will become immediately exercisable.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth certain information concerning the
beneficial ownership of the Company's Class A and Class B Common Stock as of
March 25, 1998 (except as otherwise noted) by (i) each stockholder who is known
by the Company to own beneficially more than five percent of the outstanding
Class A or Class B Common Stock, (ii) each director of the Company, (iii) each
of the executive officers of the Company named in the Summary Compensation Table
above, and (iv) all directors and executive officers of the Company as a group.
Holders of Class A Common Stock are entitled to one vote per share on all
matters submitted to a vote of the stockholders of the Company. Holders of Class
B Common Stock are entitled to one vote per share on all matters submitted to a
vote of the stockholders, except that holders of Class B Common Stock will have
five votes per share in cases where one or more directors are nominated for
election by persons other than the Company's Board of Directors and where there
is a vote on any merger, consolidation or other similar transaction which is not
recommended by the Company's Board of Directors. In addition, holders of Class B
Common Stock will have five votes per share on all matters submitted to a vote
of the stockholders in the event that any person or group of persons acquires
beneficial ownership of 20% or more of the outstanding voting securities of the
Company. Shares of Class B Common Stock are convertible into shares of Class A
Common Stock on a one-for-one basis at the option of the holder.
<TABLE>
<CAPTION>
Percent
of All
Number of Shares Number of Shares Percent Outstanding
of Class A Common Percent of of Class B Common of Common
Beneficial Owner(1) Stock Owned(2) Class Stock Owned Class Stock(3)
------------------- -------------- -------- ------------- -------- --------
<S> <C> <C> <C> <C> <C>
Peter J. Sprague(4) 1,995 * 1,873,834 41.4 7.0
Steven Sprague(5) 152,195 * 190,659 4.4 1.3
John E. Bagalay, Jr.(6) 43,500 * 0 * *
Philippe Bertin(7) 43,500 * 0 * *
George Gilder(8) 76,833 * 2,000 * *
John E. McConnaughy, Jr.(9) 56,030 * 335,000 8.0 1.5
Aladdin Knowledge Sys. (10) 4,537,973 17.3 0 * 14.9
Financiere Wagram Poncelet 0 * 442,857 11.0 1.8
All executive officers and
directors as a group
(6 persons)(11) 373,403 1.7 2,401,493 52.5 10.2
</TABLE>
*Less than one percent.
(1) Each individual or entity has sole voting and investment power, except
as otherwise indicated.
(2) Does not include shares of Class A Common Stock issuable upon the
conversion of Class B Common Stock.
(3) In circumstances where the Class B Common Stock has five votes per
share, the percentages of total voting power would be as follows: Peter J.
Sprague, 24.2%; Steven Sprague, 2.9%; John E. Bagalay, Jr., less than 1%;
Philippe Bertin, less than 1%; George Gilder, less than 1%; John E. McConnaughy,
Jr., 4.5%; Aladdin Knowledge Systems, 11.7%; Financiere Wagram Poncelet, 6.0%;
and all Executive Officers and Directors as a group, 32.6%.
(4) Includes 331,995 shares which are subject to options presently
exercisable or exercisable within 60 days. Also includes 320,000 shares held in
trust for the benefit of Mr. Sprague's adult children, and for which Mr. Sprague
is a trustee.
(5) Includes 145,195 shares which are subject to options presently
exercisable or exercisable within 60 days.
(6) Includes 39,500 shares which are subject to options presently
exercisable or exercisable within 60 days.
(7) Includes 39,500 shares which are subject to options presently
exercisable or exercisable within 60 days.
(8) Includes 72,833 shares which are subject to options presently
exercisable or exercisable within 60 days.
(9) Includes 52,030 shares which are subject to options presently
exercisable or exercisable within 60 days.
(10) Includes 4,037,973 shares which are subject to options presently
exercisable or exercisable within 60 days.
(11) Includes 681,043 shares which are subject to options presently
exercisable or exercisable within 60 days.
Item 13. Certain Relationships and Related Transactions
Note Receivable from Director/Officer
On November 16, 1992, the Company made a personal loan to Mr. Peter
J.Sprague, Chairman and Chief Executive Officer of the Company, as evidenced by
a note for $150,000, which sum was due and payable to the Company on January 16,
1993 and which bore interest at the rate of ten percent (10%) per annum. On the
due date, the note was canceled and the total amount owed was "rolled-over" into
a subsequent note, dated May 12, 1993 for $150,000, plus accrued interest. The
note is due on demand by the Company and accrues interest at the rate of 10% per
annum. On April 22, 1993, the Company made an additional loan to Mr. Peter
Sprague for $23,175 as evidenced by a subsequent note, which is due on demand by
the Company and which bears interest at a rate of 10% per annum. All of these
loans were made to Mr. Sprague for personal reasons. As part of Mr. Sprague's
$100,000 bonus for 1997, $50,000 was applied against his indebtedness to the
Company. As of December 31, 1997, Mr. Sprague's aggregate indebtedness
(including accrued interest) to the Company under the notes totaled $212,024. No
demand has been made as of the date hereof. The notes are secured by a pledge of
67,000 shares of Class B Common Stock.
Compensation to Steven Sprague
Steven Sprague received aggregate compensation of $267,500, $131,666
and $110,000 for services rendered to the Company in 1997, 1996 and 1995,
respectively. Steven Sprague is the son of Mr. Peter J. Sprague, the Chairman
and Chief Executive Officer of the Company.
Transactions Involving Michael Sprague
In 1997, Wave paid $182,209 to Enterprise Engineering Associates
("EEA"), during which time Mr. Michael Sprague was an employee of EEA. On August
1, 1997, Michael Sprague became an employee of Wave, at an annual salary of
$110,000. Michael Sprague is the son of Mr. Peter J. Sprague, the Chairman and
Chief Executive Officer of the Company.
Amended and Restated License Agreement and Assignment
Pursuant to an Amended and Restated License Agreement, dated February
14, 1994, and related Patent Assignment and Security Agreement, Mr. Peter J.
Sprague assigned his interest in a patent for the metering and usage of serial
data information to the Company in exchange for a non-terminable royalty
interest. The Company has agreed to payment of royalties to Mr. Sprague of 2% of
the gross revenues (less actual amounts paid to information, database and
content providers, hardware manufacturers and suppliers, search and retrieval
software suppliers, consolidators of information and network providers) derived
from the Company's technology based on the patent. The royalty payments are
allocated 75% to Mr. Sprague and 25% to a former officer of the Company, and are
secured by a security interest in and to the patent.
License and Cross-License Agreement
On May 1, 1992, the Company entered into a Joint Technology Development
Agreement and License and Cross-License Agreement with The Titan Corporation
whereby Titan granted to the Company license rights to the use of certain
patents which are co-owned by Titan. Dr. Gene W. Ray, a director of the Company,
is a director, President and Chief Executive Officer of Titan. The Company
granted to Titan the exclusive right to make for, sell in, and lease in a
"Retained Market," as defined in the agreement, the subject matter described in
any Company patent. The Retained Market is defined generally as the market for
"Government Information," as defined in the agreement, used solely by a
government entity, and the market for products used to access such information.
On February 28, 1997 the Company and Titan executed an addendum to the License
and Cross-License Agreement whereby the Company received a sole license to the
licensed patent to develop and distribute products to the in-home consumer
microcomputer market segment. Under this addendum to the License and
Cross-License Agreement, Titan waived any and all defaults by the Company under
the License and Cross-License Agreement occurring prior to February 28, 1997.
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
14 (a) (1) Financial Statements:
Consolidated Financial Statements
December 31, 1997 and 1996
(With Independent Auditors' Report Thereon)
<TABLE>
<CAPTION>
Page(s)
<S> <C>
Index to Consolidated Financial Statements F-1
Independent Auditors' Report F-2
Consolidated Balance Sheets as of December 31, 1997 and 1996 F-3
Consolidated Statements of Operations for each of the years ended December 31,
1997, 1996 and 1995 and for the period from February 12,
1988 (inception) through December 31, 1997 F-4
Consolidated Statements of Stockholders' Equity (Deficiency) for each of the
years ended December 31, 1997, 1996 and 1995 and for the period from
February 12, 1988 (inception) through December 31, 1997 F-5
Consolidated Statements of Cash Flows for each of the years ended December 31,
1997, 1996 and 1995 and for the period from
February 12, 1988 (inception) through December 31, 1997 F-13
Notes to Consolidated Financial Statements F-15
</TABLE>
(a) (2) Financial Statement Schedules:
All schedules have been omitted since they are either not required or not
applicable.
(a) (3) Exhibits
Exhibit No. Description of Exhibit
3.1 Restated Certificate of Incorporation of Registrant (incorporated by
reference to Exhibit 3.1 of the Registrant's Registration Statement on
Form S-1, File No. 33-75286)
3.2 Bylaws of Registrant (incorporated by reference to Exhibit 3.2 of the
Registrant's Registration Statement on Form S-1, File No. 33-75286)
4.1 Form of Stock Certificate of Class A Common Stock (incorporated by
reference to Exhibit 4.1 of the Registrant's Registration Statement on
Form S-1, File No. 33-75286)
4.2 Form of Representative's Warrant Agreement, including the form of
Representative's Warrant (incorporated by reference to Exhibit 4.2 of
the Registrant's Registration Statement on Form S-1, File No.
33-75286)
4.3 Certificate of Designation of Series B Preferred Stock of Wave Systems
Corp. as filed with the Delaware Secretary of State on May 24, 1996
(incorporated by reference to Exhibit 3.1 of the Registrant's Current
Report on Form 8-K filed on May 30, 1996, File No. 0-24752)
4.4 Certificate of Designation of Series C Convertible Preferred Stock of
Wave Systems Corp. as filed with the Delaware Secretary of State on
December 27, 1996 (incorporated by reference to Exhibit 3.1 of the
Registrant's Current Report on Form 8-K filed on January 8, 1997, File
No. 0-24752)
4.5 Certificate of Designation of Series D Convertible Preferred Stock of
Wave Systems Corp. as filed with the Delaware Secretary of State on
December 27, 1996 (incorporated by reference to Exhibit 3.1 of the
Registrant's Current Report on Form 8-K filed on June 3, 1997, File
No. 0-24752)
4.6 Certificate of Designation of Series F Convertible Preferred Stock of
Wave Systems Corp. as filed with the Delaware Secretary of State on
October 9, 1997 (incorporated by reference to Exhibit 3.1 of the
Registrant's Current Report on Form 8-K filed on October 15, 1997,
File No. 0-24752)
4.7 Certificate of Designation of Series G Convertible Preferred Stock of
Wave Systems Corp. as filed with the Delaware Secretary of State on
March 5, 1998 (incorporated by reference to exhibit 3.1 of the
Registrant's Current Report on Form 8-K filed on March 19, 1998, File
No. 0-24752)
+10.1 Joint Technology Development Agreement, dated as of May 1, 1992,
between The Titan Corporation and Cryptologics International, Inc.
(incorporated by reference to Exhibit 10.2 of the Registrant's
Registration Statement on Form S-1, File No. 33-75286)
+10.2 License and Cross-License Agreement, dated as of May 1, 1992,
between The Titan Corporation and Cryptologics International, Inc.
(incorporated by reference to Exhibit 10.3 of the Registrant's
Registration Statement on Form S-1, File No. 33-75286)
10.3 Amendment to License and Cross-License Agreement, dated as of August
27, 1993, between The Titan Corporation and Wave Systems Corp.
(incorporated by reference to Exhibit 10.4 of the Registrant's
Registration Statement on Form S-1, File No. 33-75286)
10.4 Amended and Restated License Agreement, dated February 14, 1994, by
and among Wave Systems Corp., Peter J. Sprague and John R. Michener
(incorporated by reference to Exhibit 10.5 of the Registrant's
Registration Statement on Form S-1, File No. 33-75286)
+10.5 Wave Systems Corp. 1994 Stock Option Plan (incorporated by reference
to Exhibit 10.6 of the Registrant's Registration Statement on Form
S-1, File No. 33-75286)
+10.6 Wave Systems Corp. Non-Employee Directors Stock Option Plan
(incorporated by reference to Exhibit 10.7 of the Registrant's
Registration Statement on Form S-1, File No. 33-75286)
10.7 Regulation S Securities Subscription Agreement, dated as of May 29,
1996 (incorporated by reference to Exhibit 4.1 of the Registrant's
Current Report on Form 8-K filed on May 30, 1996, File No. 0-24752)
10.8 Purchase Agreement between Wave Systems Corp. and JNC Opportunity Fund
Ltd., dated as of December 27, 1996 (incorporated by reference to
Exhibit 4.1 of the Registrant's Current Report on Form 8-K filed on
January 8, 1997, File No. 0-24752)
10.9 Registration Rights Agreement between Wave Systems Corp. and JNC
Opportunity Fund Ltd., dated as of December 27, 1996 (incorporated by
reference to Exhibit 4.2 of the Registrant's Current Report on Form
8-K filed on January 8, 1997, File No. 0-24752)
10.10 Purchase Agreement between Wave Systems Corp. and JNC Opportunity Fund
Ltd., dated as of May 30, 1997 (incorporated by reference to Exhibit
4.1 of the Registrant's Current Report on Form 8-K filed on June 3,
1997, File No. 0-24752)
10.11 Registration Rights Agreement between Wave Systems Corp. and JNC
Opportunity Fund Ltd., dated as of May 30, 1997 (incorporated by
reference to Exhibit 4.2 of the Registrant's Current Report on Form
8-K filed on June 30, 1997, File No. 0-24752)
10.12 Purchase Agreement between Wave Systems Corp. and Combination, Inc.,
dated as of October 9, 1997 (incorporated by reference to Exhibit 4.1
of the Registrant's Current Report on Form 8-K filed on October 15,
1997, File No. 0-24752)
10.13 Registration Rights Agreement between Wave Systems Corp. and
Combination, dated as of October 9, 1997 (incorporated by reference to
Exhibit 4.2 of the Registrant's Current Report on Form 8-K filed on
October 15, 1997, File No. 0-24752)
10.14 Purchase Agreement between Wave Systems Corp. and Combination Inc.,
dated as of March 6, 1998 (incorporated by reference to Exhibit 4.1 of
Registrant's Current Report on Form 8-K filed on March 19, 1998 file
No. 0-24752)
10.15 Registration Rights Agreement between Wave Systems Corp. and
Combination Inc., dated as of March 6, 1998 (incorporated by reference
to Exhibit 4.2 of the Registrant's Current Report on Form 8-K filed on
March 19, 1998, file No. 0-24752)
10.16 Addendum to License and Cross-License Agreement, dated February 28,
1997, between The Titan Corporation and Wave Systems Corp.
(incorporated by reference to Exhibit 10.10 of the Registrant's
Current Report on Form 10-K filed on March 24, 1997, file No.
0-24752).
23.1 Consent of Independent Auditors - KPMG Peat Marwick LLP
+Confidential treatment has been granted as to portions of this exhibit.
+Management contract or compensatory plan.
(b) The company filed a Form 8-K on October 15, 1997 in connection with the
sale of its Series F Convertible Preferred Stock to Combination Inc.
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Dated: March 31, 1998
WAVE SYSTEMS CORP.
By: /s/ Peter J. Sprague
-----------------------------
Name: Peter J. Sprague
Title: Chairman, Chief Executive Officer
(Principal Financial Officer and Duly
Authorized Officer of the Registrant)
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed by the following persons on behalf of the registrant
and in the capacities and on the dates indicated.
Signature Title Date
/s/ Peter J. Sprague
- ------------------------
Peter J. Sprague Chairman and Chief Executive Officer March 31, 1998
(Principal Financial Officer and Duly
/s/ Steven Sprague Authorized Officer of the Registrant)
- ------------------------
Steven Sprague President, Chief Operating Officer and March 31, 1998
Director
/s/ John E. Bagalay, Jr.
- ------------------------
John E. Bagalay, Jr. Director March 31, 1998
/s/ Philippe Bertin
- ------------------------
Philippe Bertin Director March 31, 1998
/s/George Gilder
- ------------------------
George Gilder Director March 31, 1998
/s/John E. McConnaughy, Jr.
- ------------------------
John E. McConnaughy, Jr. Director March 31, 1998
<PAGE>
F-1
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Financial Statements
December 31, 1997 and 1996
(With Independent Auditors' Report Thereon)
Index to Consolidated Financial Statements
<TABLE>
<CAPTION>
Page(s)
<S> <C>
Independent Auditors' Report F-2
Consolidated Balance Sheets as of December 31, 1997 and 1996 F-3
Consolidated Statements of Operations for each of the years ended December 31,
1997, 1996 and 1995 and for the period from February 12,
1988 (inception) through December 31, 1997 F-4
Consolidated Statements of Stockholders' Equity (Deficiency) for each of the
years ended December 31, 1997, 1996 and 1995 and for the period from
February 12, 1988 (inception) through December 31, 1997 F-5
Consolidated Statements of Cash Flows for each of the years ended December 31,
1997, 1996 and 1995 and for the period from
February 12, 1988 (inception) through December 31, 1997 F-13
Notes to Consolidated Financial Statements F-15
</TABLE>
<PAGE>
F-2
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Wave Systems Corp.:
We have audited the consolidated financial statements of Wave Systems Corp. and
subsidiaries (a development stage corporation) as listed in the accompanying
index. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Wave Systems Corp.
and subsidiaries as of December 31, 1997 and 1996, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 1997 and for the period from February 12, 1988 (date of
inception) to December 31, 1997 in conformity with generally accepted accounting
principles.
The accompanying consolidated financial statements have been prepared assuming
that Wave Systems Corp. and subsidiaries will continue as a going concern. As
discussed in note 1 to the consolidated financial statements, the Company has
suffered recurring losses from operations since inception that raise substantial
doubt about the entity's ability to continue as a going concern. Management's
plans in regard to these matters are also described in note 1. The consolidated
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
KPMG PEAT MARWICK LLP
Boston, Massachusetts
March 27, 1998
<PAGE>
F-3
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Balance Sheets
December 31, 1997 and 1996
<TABLE>
<CAPTION>
Assets 1997 1996
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 758,721 4,064,324
Prepaid expenses and other receivables - 70,358
------------- -------------
Total current assets 758,721 4,134,682
Property and equipment, less accumulated depreciation of
$964,184 in 1997 and $622,356 in 1996 849,276 934,798
Goodwill, net of accumulated amortization of $39,686 in 1996 - 912,752
Other assets 70,216 254,987
------------- -------------
$ 1,678,213 6,237,219
============= =============
Liabilities and Stockholders' equity (deficiency)
Current liabilities:
Accounts payable and accrued expenses $ 1,427,762 937,163
Note payable 522,124 465,500
------------ ------------
Total Current Liabilities 1,949,886 1,402,663
------------ ------------
Series A Cumulative Redeemable Preferred Stock, $.0l par value.
360 shares issued and outstanding in 1997 and 1996; involuntary
liquidation value, $471,601 471,601 432,334
Series B Preferred Stock, $.0l par value. 20 shares issued and
outstanding in 1996 - 195,520
Series C Convertible Preferred Stock $.0l par value. 150,000
shares issued and outstanding in 1996 - 2,647,742
------------ -----------
Total preferred stock 471,601 3,275,596
------------ -----------
Stockholders' equity:
Preferred stock, $.0l par value. Authorized 2,000,000 shares;
360 shares issued and outstanding as Series A Cumulative
Redeemable Preferred Stock - -
Common stock, $.0l par value. Authorized 25,000,000 shares as Class A;
issued and outstanding 22,874,639 in 1997 and 11,582,086 in 1996 228,747 115,821
Common stock, $.01 par value. Authorized 13,000,000 shares as
Class B; issued and outstanding 4,421,953 in 1997 and 6,208,141 in 1996 44,220 62,081
Capital in excess of par value 44,520,246 33,052,432
Deficit accumulated during the development stage (45,324,463) (31,426,669)
Less: Note receivable from stockholder, including accrued interest
of $88,849 in 1997 and $71,530 in 1996 (212,024) (244,705)
------------ ------------
Total stockholders' equity (deficiency) (743,274) 1,558,960
------------ -----------
Commitments and contingencies
$ 1,678,213 6,237,219
=========== ===========
See accompanying notes to consolidated financial statements.
</TABLE>
<TABLE>
<CAPTION>
F-4
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Operations
Years ended December 31, 1997, 1996 and
1995 and period from February 12, 1988
(date of inception)
through December 31, 1997
Period from
February 12, 1988
(date of inception)
through
December 31,
1997 1996 1995 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net revenue $ 10,712 1,458 - 12,170
------------- ------------ ------------- -------------
Operating expenses:
Selling, general and administrative 7,983,151 5,560,620 4,080,185 27,436,506
Write-off of goodwill 769,886 - - 769,886
Aladdin license and in process
research and development expense 3,889,000 - - 3,889,000
Research and development 2,146,127 3,309,022 3,324,735 14,745,813
----------- ----------- ----------- ----------
14,788,164 8,869,642 7,404,920 46,841,205
---------- ----------- ----------- ----------
Other income (expense):
License fee 1,000,000 - - 1,000,000
Interest income 55,282 194,766 560,875 1,058,332
Interest expense (175,624) (10,397) (1,541) (566,480)
Other income - - 12,720 12,720
------------ ------------ ------------ -------------
879,658 184,369 572,054 1,504,572
------------ ------------ ------------ -----------
Net loss (13,897,794) (8,683,815) (6,832,866) (45,324,463)
Accrued dividends on preferred stock (including
accretion of assured incremental yield on preferred
stock of $1,673,000 in 1997 and $670,965 in 1996) 2,482,982 870,579 40,600 3,478,495
----------- ------------ ------------- -----------
Net loss to common stockholders $ (16,380,776) (9,554,394) (6,873,466) (48,802,958)
=============== =========== =========== ==========
Weighted average number of common shares
outstanding during the period 20,943,748 14,956,584 13,794,373 9,777,559
Loss per common share $ (.78) (.64) (.50) (4.99)
================ ============ ============ ============
See accompanying notes to consolidated financial statements.
</TABLE>
<TABLE>
<CAPTION>
F-5
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Stockholders' Equity (Deficiency)
Period from February 12, 1988 (date of inception) to December 31, 1997
Deficit
accumulated
Class A Class B Capital during the
common stock common stock in excess of development
Shares Amount Shares Amount par value stage
--------- --------- --------- -------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Shares issued to founders at $.003 per share - - 4,680,000 46,800 (31,200) -
Shares issued at $1.25 per share, net of
expenses of $36,574 from September through
November 1988 - - 300,000 3,000 335,426 -
Net loss for period ended December 31, 1988 - - - - - (326,832)
--------- --------- --------- --------- ----------- -----------
Balance at December 31, 1988 - - 4,980,000 49,800 304,226 (326,832)
Shares issued at $1.25 per share, net of
expenses of $68,750, from January through
December 1989 - - 270,000 2,700 266,050 -
Shares issued at $1.25 per share in July 1989 as
compensation for services rendered - - 1,920 19 2,381 -
Shares issued by principal stockholders at $1.25
per share in December 1989 as compensation
for services rendered - - - - 374,000 -
Net loss for year ended December 31, 1989 - - - - - (982,186)
--------- --------- --------- --------- ----------- -----------
Balance at December 31, 1989 - - 5,251,920 52,519 946,657 (1,309,018)
Shares issued by principal stockholder at $1.25 -
per share in March 1990 as compensation for
services rendered - - - - 56,250
Shares issued by principal stockholder at $.50
per share in March 1990 as compensation for
services rendered - - - - 60,000 -
Shares issued at $1.67 per share in May 1990 as
compensation for services rendered - - 6,000 60 9,940 -
Shares issued at $1.67 per share, net of
expenses of $5,000 in March, April,
November and December 1990 - - 390,000 3,900 641,100 -
Net loss for year ended December 31, 1990 - - - - - (1,178,129)
--------- --------- --------- --------- ----------- -----------
Balance at December 31, 1990 - - 5,647,920 56,479 1,713,947 (2,487,147)
Shares issued at $1.67 per share from March
through November 1991 - - 315,000 3,150 521,850 -
Shares issued at $1.67 per share in November
1991 as compensation for services rendered - - 19,800 198 32,802 -
Net loss for year ended December 31, 1991 - - - - - (1,009,368)
--------- --------- --------- --------- ----------- -----------
Balance at December 31, 1991 (carried forward) - - 5,982,720 59,827 2,268,599 (3,496,515)
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
F-6
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Stockholders' Equity (Deficiency)
Period from February 12, 1988 (date of inception) to December 31, 1997
Note
receivable
Deferred from
compensation stockholder Total
<S> <C> <C> <C>
Shares issued to founders at $.003 per share - - 15,600
Shares issued at $1.25 per share, net of
expenses of $36,574 from September through
November 1988 - - 338,426
Net loss for period ended December 31, 1988 - - (326,832)
----- ----- -------------
Balance at December 31, 1988 - - 27,194
Shares issued at $1.25 per share, net of
expenses of $68,750, from January through
December 1989 - - 268,750
Shares issued at $1.25 per share in July 1989 as
compensation for services rendered - - 2,400
Shares issued by principal stockholders at $1.25
per share in December 1989 as compensation
for services rendered - - 374,000
Net loss for year ended December 31, 1989 - - (982,186)
----- ----- -------------
Balance at December 31, 1989 - - (309,842)
Shares issued by principal stockholder at $1.25
per share in March 1990 as compensation for
services rendered - - 56,250
Shares issued by principal stockholder at $.50
per share in March 1990 as compensation for
services rendered - - 60,000
Shares issued at $1.67 per share in May 1990 as
compensation for services rendered - - 10,000
Shares issued at $1.67 per share, net of
expenses of $5,000 in March, April,
November and December 1990 - - 645,000
Net loss for year ended December 31, 1990 - - (1,178,129)
----- ----- -------------
Balance at December 31, 1990 - - (716,721)
Shares issued at $1.67 per share from March
through November 1991 - - 525,000
Shares issued at $1.67 per share in November
1991 as compensation for services rendered - - 33,000
Net loss for year ended December 31, 1991 - - (1,009,368)
----- ----- -------------
Balance at December 31, 1991 (carried forward) - - (1,168,089)
</TABLE>
<TABLE>
<CAPTION>
<PAGE>
F-7
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Stockholders' Equity (Deficiency) - (Continued)
Deficit
accumulated
Class A Class B Capital in during the
common stock common stock excess of development
Shares Amount Shares Amount par value stage
---------- ---------- ---------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1991 (brought forward) - $ - 5,982,720 $59,827 2,268,599 (3,496,515)
Shares issued at $1.67 per share from January
through October 1992 - - 708,000 7,080 1,172,920 -
Shares issued at $1.67 per share in May 1992 in
connection with License and Cross-License
Agreement - - 674,976 6,750 1,118,210 -
Shares issued at $1.67 per share in May 1992 as
compensation for services rendered - - 18,000 180 29,820 -
Shares issued at $2.50 per share in May and
November 1992 as compensation for services
rendered - - 771,000 7,710 1,919,790 -
Shares issued at $2.50 per share, net of
expenses of $7,500, in November and
December 1992 - - 323,001 3,230 796,773 -
Shares issued by principal stockholder in
December 1992 at $2.50 per share as
compensation for services rendered - - - - 75,000 -
Shares canceled in October and December 1992 - - (75,000) (750) 750 -
Issuance of stock options at $.003 exercise
price per share in June 1992 - - - - 798,400 -
Amortization of deferred compensation - - - - - -
Accrued dividends on preferred stock - - - - (6,383) -
Note received from stockholder and accrual of
interest thereon - - - - - -
Net loss for year ended December 31, 1992 - - - - - (4,182,638)
---------- ---------- ---------- ---------- ---------- -----------
Balance at December 31, 1992 (carried forward) - - 8,402,697 84,027 8,173,879 (7,679,153)
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
F-8
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Stockholders' Equity (Deficiency) - (Continued)
Note
receivable
Deferred from
compensation stockholder Total
------------ ------------ ------------
<S> <C> <C> <C>
Balance at December 31, 1991 (brought forward) - - (1,168,089)
Shares issued at $1.67 per share from January
through October 1992 - - 1,180,000
Shares issued at $1.67 per share in May 1992 in
connection with License and Cross-License
Agreement - - 1,124,960
Shares issued at $1.67 per share in May 1992 as
compensation for services rendered - - 30,000
Shares issued at $2.50 per share in May and
November 1992 as compensation for services
rendered - - 1,927,500
Shares issued at $2.50 per share, net of
expenses of $7,500, in November and December 1992 - - 800,003
Shares issued by principal stockholder in
December 1992 at $2.50 per share as
compensation for services rendered - - 75,000
Shares canceled in October and December 1992 - - -
Issuance of stock options at $.003 exercise
price per share in June 1992 (398,660) - 399,740
Amortization of deferred compensation 155,455 - 155,455
Accrued dividends on preferred stock - - (6,383)
Note received from stockholder and accrual of
interest thereon - (152,974) (152,974)
Net loss for year ended December 31, 1992 - - (4,182,638)
------------ ------------ ------------
Balance at December 31, 1992 (carried forward) (243,205) (152,974) 182,574
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
F-9
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Stockholders' Equity (Deficiency) - (Continued)
Deficit
accumulated
Class A Class B Capital in during the
common stock common stock excess of development
Shares Amount Shares Amount par value stage
---------- ---------- ---------- ---------- ---------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1992 (brought forward) - $ - 8,402,697 $84,027 8,173,879 (7,679,153)
Shares issued at $1.67 per share in February
1993 - - 30,000 300 49,800 -
Shares issued at $3.50 per share, net of
expenses of $82,427, from April through
December 1993 - - 550,359 5,504 1,838,294 -
Shares issued at $3.50 per share from May to
December 1993 as compensation for services
rendered, for the acquisition of property
and equipment and as additional interest on
borrowings - - 73,319 733 255,884 -
Issuance of warrants to purchase Class B
common stock from September to December
1993 in conjunction with the issuance of
convertible debt - - - - 72,893 -
Amortization of deferred compensation - - - - - -
Accrued dividends on preferred stock - - - - (38,467) -
Note received from stockholder and accrual of
interest thereon - - - - - -
Net loss for year ended December 31, 1993 - - - - - (3,959,334)
---------- ---------- ---------- ---------- ---------- -------------
Balance at December 31, 1993 - - 9,056,375 90,564 10,352,283 (11,638,487)
Shares issued at $3.50 per share in January
and February 1994 - - 95,715 957 334,046 -
Shares issued at $3.50 per share in February
1994 as additional interest on borrowings - - 5,700 57 19,893 -
Issuance of warrants to purchase Class B
common stock in January and February
1994 in conjunction with the issuance
of convertible debt - - - - 115,234 -
Accrued dividends on preferred stock - - - - (39,484) -
Accrual of interest on note receivable from
stockholder - - - - - -
Sale of warrants to underwriter in September
1994 - - - - 4 -
Conversion of notes payable - - 599,507 5,995 2,079,131 -
Shares issued at $5.00 per share in initial
public offering in September 1994, net of
expenses of $2,929,835 3,728,200 37,282 - - 15,673,883 -
Net loss for year ended December 31, 1994 - - - - - (4,271,501)
---------- ---------- ---------- ---------- ---------- -------------
Balance at December 31, 1994 (carried 3,728,200 37,282 9,757,297 97,573 28,534,990 (15,909,988)
forward)
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
F-10
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Stockholders' Equity (Deficiency) - (Continued)
Note
receivable
Deferred from
compensation stockholder Total
<S> <C> <C> <C>
Balance at December 31, 1992 (brought forward) (243,205) (152,974) 182,574
Shares issued at $1.67 per share in February
1993 - - 50,100
Shares issued at $3.50 per share, net of
expenses of $82,427, from April through
December 1993 - - 1,843,798
Shares issued at $3.50 per share from May to
December 1993 as compensation for services
rendered, for the acquisition of property
and equipment and as additional interest on
borrowings - - 256,617
Issuance of warrants to purchase Class B
common stock from September to December
1993 in conjunction with the issuance of
convertible debt - - 72,893
Amortization of deferred compensation 243,205 - 243,205
Accrued dividends on preferred stock - - (38,467)
Note received from stockholder and accrual of
interest thereon - (39,783) (39,783)
Net loss for year ended December 31, 1993 - - (3,959,334)
----------- ----------- -----------
Balance at December 31, 1993 - (192,757) (1,388,397)
Shares issued at $3.50 per share in January
and February 1994 - - 335,003
Shares issued at $3.50 per share in February
1994 as additional interest on borrowings - - 19,950
Issuance of warrants to purchase Class B
common stock in January and February 1994
in conjunction with the issuance of convertible
debt - - 115,234
Accrued dividends on preferred stock - - (39,484)
Accrual of interest on note receivable from
stockholder - (17,315) (17,315)
Sale of warrants to underwriter in September
1994 - - 4
Conversion of notes payable - - 2,085,126
Shares issued at $5.00 per share in initial
public offering in September 1994, net of
expenses of $2,929,835 - - 15,711,165
Net loss for year ended December 31, 1994 - - (4,271,501)
----------- ----------- -----------
Balance at December 31, 1994 (carried forward) - (210,072) 12,549,785
----------- ----------- -----------
</TABLE>
<PAGE>
F-11
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Stockholders' Equity (Deficiency) - (Continued)
<TABLE>
<CAPTION>
Deficit
accumulated
Class A Class B Capital in during the
common stock common stock excess of development
Shares Amount Shares Amount par value stage
--------- --------- --------- --------- ---------- ------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1994 (brought forward) 3,728,200 $37,282 9,757,297 $97,573 28,534,990 (15,909,988)
Shares issued at prices ranging from $1.00 per
share to $3.13 per share as compensation for
services rendered 31,559 315 - - 57,184 -
Exercise of options to purchase Class B stock - - 681,700 6,817 429,413 -
Accrued dividends on preferred stock - - - - (40,600) -
Accrual of interest on note receivable from
stockholder - - - - - -
Exchange of Class B stock for Class A stock 2,855,859 28,559 (2,855,859) (28,559) - -
Net loss for the year ended December 31, 1995 - - - - - (6,832,866)
--------- --------- --------- --------- ---------- ------------
Balance at December 31, 1995 6,615,618 66,156 7,583,138 75,831 28,980,987 (22,742,854)
Exercise of options to purchase Class A stock 214,091 2,141 - - 420,366 -
Shares issued at prices ranging from $2.06 per
share to $3.44 per share as compensation for
services rendered 42,077 421 - - 123,029 -
Issuance of unregistered Class B common stock
to acquire Wave Interactive Network valued
at approximately $.98 per share - - 375,000 3,750 364,688 -
Issuance of warrants to purchase unregistered
shares of
Class A common stock in conjunction with - - - - 283,455 -
the issuance
of convertible debt and preferred stock
Conversion of Class B Preferred Stock 2,960,303 29,603 - - 3,078,921 -
Accrual of interest on note receivable - - - - - -
Accrued dividends on preferred stock - - - - (199,014) -
Exchange of Class B stock for Class A stock 1,749,997 17,500 (1,749,997) (17,500) - -
Net loss for the year ended December 31, 1996 - - - - - (8,683,815)
---------- --------- --------- --------- ---------- ------------
Balance at December 31, 1996 11,582,086 115,821 6,208,141 62,081 33,052,432 (31,426,669)
---------- --------- --------- --------- ---------- ------------
Exercise of options to purchase Class A
and B common stock 70,326 703 10,330 104 139,081 -
Shares issued at prices ranging from $1.00
per share to $3.00 per share as
compensation for services rendered 126,885 1,269 - - 304,227 -
Conversion of preferred stock into common stock 7,998,860 79,989 - - 6,703,028 -
Issuance of Class A common stock and warrants
to purchase Class A common stock to Aladdin 500,000 5,000 - - 3,834,000 -
Issuance of Class A common stock and warrants
to purchase Class A common stock 799,964 8,000 - - 792,000 -
Reduction in note receivable - - - - - -
Accrual of interest on note receivable - - - - - -
Issuance of warrants to purchase Class A
common stock in conjunction with the
issuance of Preferred Stock - - - - 386,462 -
Accrued dividend on preferred stock including
accretion of assured incremental yield - - - - (1,372,984) -
Assured incremental yield on issuance of
Series F convertible preferred stock
and debt - - - - 682,000 -
Net loss - - - - - (13,897,794)
Exchange of Class B stock for Class A stock 1,796,518 17,965 (1,796,518) (17,965) - -
---------- --------- --------- --------- ---------- ------------
Balance at December 31, 1997 22,874,639 228,747 4,421,953 44,220 44,520,246 (45,324,463)
========== ========= ========= ========= ========== ============
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
F-12
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Stockholders' Equity (Deficiency) - (Continued)
Note
receivable
Deferred from
compensation stockholder Total
------------ ----------- -----------
<S> <C> <C> <C>
Balance at December 31, 1994 - (210,072) 12,549,785
(brought forward)
Shares issued at prices ranging
from $1.00 per share to $3.13
per share as compensation for
services rendered - - 57,499
Exercise of options to purchase
Class B stock - - 436,230
Accrued dividends on preferred
stock - - (40,600)
Accrual of interest on note
receivable from stockholder - (17,318) (17,318)
Exchange of Class B stock for
Class A stock - - -
Net loss for the year ended
December 31, 1995 - - (6,832,866)
----------- ----------- -----------
Balance at December 31, 1995 - (227,390) 6,152,730
Exercise of options to purchase
Class A stock - - 422,507
Shares issued at prices ranging
from $2.06 per share to $3.44
per share as compensation for
services rendered - - 123,450
Issuance of unregistered Class B
common stock to acquire
Wave Interactive Network
valued at approximately
$.98 per share - - 368,438
Issuance of warrants to purchase
unregistered shares of Class
A common stock in conjunction
with the issuance of convertible
debt and preferred stock - - 283,455
Conversion of Class B Preferred
Stock - - 3,108,524
Accrual of interest on note
receivable - (17,315) (17,315)
Accrued dividends on preferred
stock - - (199,014)
Exchange of Class B stock for
Class A stock - - -
Net loss for the year ended
December 31, 1996 - - (8,683,815)
----------- ----------- -----------
Balance at December 31, 1996 - (244,705) 1,558,960
----------- ----------- -----------
Exercise of options to purchase - - 139,888
Class A and B common stock
Shares issued at prices ranging
from $1.00 per share
to $3.00 per share as - - 305,496
compensation for services
rendered
Conversion of preferred stock - - 6,783,017
into common stock
Issuance of Class A common stock
and warrants to purchase
Class A common stock
to Aladdin - - 3,839,000
Issuance of Class A common stock
and warrants to purchase Class A
common stock - - 800,000
Reduction in note receivable - 50,000 50,000
Accrual of interest on note
receivable - (17,319) (17,319)
Issuance of warrants to purchase
Class A common stock
in conjunction with the
issuance of Preferred Stock - - 386,462
Accrued dividend on preferred
stock including accretion
of assured incremental yield - - (1,372,984)
Assured incremental yield on
issuance of Series F
convertible preferred stock
and debt - - 682,000
Net loss - - (13,897,794)
Exchange of Class B stock for
Class A stock - - -
----------- ----------- -----------
Balance at December 31, 1997 - (212,024) (743,274)
=========== =========== ===========
See accompanying notes to consolidated financial statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
F-13
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Cash Flows
Years ended December 31, 1997, 1996, 1995 and the Period
From February 12, 1988 (Date of Inception) through December 31, 1997
Period from
February 12, 1988
(date of inception)
through
December 31,
1997 1996 1995 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net loss $ (13,897,794) (8,683,815) (6,832,866) (45,324,463)
Adjustments to reconcile net loss to net cash
used in operating activities:
Write-off of goodwill 769,886 - - 769,886
Depreciation and amortization 486,693 316,829 177,393 1,187,368
Reserve for note from affiliate - 1,004,934 668,000 1,672,934
Accrued interest on marketable securities - 48,617 (48,617) (106,962)
Noncash expenses:
Accretion of assured incremental yield on
convertible debt 119,000 - - 119,000
Common stock issued in connection with
License and Cross-License Agreement - - - 1,124,960
Common stock issued for services rendered
and additional interest on borrowings 305,496 40,938 57,499 2,677,058
Issuance of warrants to Aladdin 2,939,000 - - 2,939,000
Accrued interest on note payable 56,624 9,500 - 66,124
Preferred stock issued for services rendered - - - 265,600
Compensation associated with issuance of
stock options - - - 399,740
Amortization of deferred compensation - - - 398,660
Amortization of discount on notes payable - - - 166,253
Common stock issued by principal stockholder
for services rendered - - - 565,250
Changes in assets and liabilities:
Increase in accrued interest on note receivable (17,319) (17,315) (17,318) (88,850)
Increase (decrease) in prepaid expenses and
other receivables 70,358 64,413 (70,602) -
Increase in other assets 184,771 (53,346) (88,114) (85,132)
(Decrease) increase in accounts payable and
accrued expenses 490,599 (191,103) 343,633 1,565,274
------------ ---------- ------------ -----------
Net cash used in operating activities (8,492,686) (7,460,348) (5,810,992) (31,688,300)
----------- --------- ----------- ----------
(Continued)
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
F-14
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Cash Flows, Continued
Period from
February 12, 1988
(date of inception)
through
December 31,
1997 1996 1995 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Cash flows from investing activities:
Acquisition of property and equipment (256,306) (252,439) (814,205) (1,807,118)
Short-term loans to affiliate - (1,004,934) (668,000) (1,672,934)
Organizational costs - - - (14,966)
Purchase of marketable securities-held to maturity - (2,945,458) (16,601,235) (27,546,769)
Maturity of marketable securities-held to maturity - 6,843,041 20,810,690 27,653,731
------------ ----------- ---------- ----------
Net cash provided by (used in) investing
activities (256,306) 2,640,210 2,727,250 (3,388,056)
------------ ----------- ----------- -----------
Cash flows from financing activities:
Net proceeds from issuance of common stock 1,839,888 422,507 436,230 24,409,471
Net proceeds from issuance of preferred stock
and warrants 3,553,501 5,950,027 - 9,505,527
Sale of warrants - - - 4
Note receivable from stockholder 50,000 - - (123,175)
Proceeds from notes payable and warrants to
stockholders - - - 2,083,972
Repayments of notes payable to stockholders - - - (1,069,972)
Proceeds from notes payable and warrants - - - 1,284,250
Repayments of note payable - - - (255,000)
Advances from stockholder - - - 227,598
Repayments of advances from stockholder - - - (227,598)
--------- --------- ---------- -----------
Net cash provided by financing activities 5,443,389 6,372,534 436,230 35,835,077
--------- --------- ---------- -----------
Net increase (decrease) in cash and cash equivalents (3,305,603) 1,552,396 (2,647,512) 758,721
Cash and cash equivalents at beginning of period 4,064,324 2,511,928 5,159,440 -
--------- --------- ---------- -----------
Cash and cash equivalents at end of period $ 758,721 4,064,324 2,511,928 758,721
========== ========= ========== ===========
See accompanying notes to consolidated financial statements.
</TABLE>
<PAGE>
F-15
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements
December 31, 1997, 1996, 1995 and The Period From February 12, 1988
(Date Of Inception) Through December 31, 1997
(1) Organization and Basis of Preparation
Wave Systems Corp. (the "Company" or "Wave") is engaged in the
research and development of a proprietary system (the "Wave System") for
use with a computer, that measures, controls, and records the use of
electronic content. The Company is also engaged in various research,
development and marketing efforts to commercialize the Wave System to
provide more efficient and flexible pricing (e.g., pay per use or rent to
own) and greater security on the usage of the electronic content. The
Company is in the development stage and, accordingly, the accompanying
consolidated financial statements are presented in a format prescribed for
a development stage enterprise.
The Company has incurred significant losses in current and prior
periods. Management intends to continue to devote resources toward the
research, development and marketing of its products in order to generate
future revenues from licensing and product sales. In addition, the Company
is actively pursuing additional short- and long-term financing sources,
including debt and equity financing. Although management believes that it
can successfully research, develop and market its products and obtain
additional financing, there can be no assurance that it will be able to do
so.
(2) Significant Accounting Policies
(a) Principles of Consolidation
The consolidated financial statements include the financial statements
of Wave; a wholly owned subsidiary, Harvard International Medical Library,
Inc., doing business as MedWave; a majority owned inactive subsidiary,
Network News Corp., ("NNC"); and a wholly owned inactive subsidiary. All
significant intercompany balances and transactions have been eliminated in
consolidation.
(b) Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of expenses during the
reporting period. Actual results could differ from those estimates.
(c) Cash Equivalents
For purpose of the consolidated statements of cash flows, the Company
considers all highly liquid instruments with a maturity of three months or
less to be cash equivalents.
(d) Property and Equipment
Property and equipment, including computer software, are stated at
cost. Depreciation is computed using the straight-line method over
estimated useful lives of five years.
<PAGE>
F-16
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements - (Continued)
(e) Goodwill
Goodwill, which represents the excess of purchase price over the fair
value of net assets acquired, is amortized on a straight-line basis over
the period expected to be benefited of five years. The Company assesses the
recoverability of this intangible asset by determining whether the
amortization of the goodwill balance over its remaining life can be
recovered through undiscounted future operating cash flows of the related
acquired operation. The amount of goodwill impairment, if any, is measured
based on projected discounted future operating cash flows using a discount
rate reflecting the Company's average cost of funds. The assessment of the
recoverability of goodwill is impacted if estimated future operating cash
flows are not achieved. During the third quarter of 1997, the Company
wrote-off goodwill related to the WIN acquisition as it was uncertain
whether the current and expected future results of operations of WIN would
be sufficient to support its carrying value.
(f) Income Taxes
The Company 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.
(g) Stock Option
Plan The Company accounts for its stock option plans in accordance
with the provisions of Accounting Principles Board ("APB") Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations. As
such, compensation expense is recorded on the date of grant only if the
current market price of the underlying stock exceeds the exercise price. On
January 1, 1996, the Company adopted the disclosure provisions of Statement
of Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock
Based Compensation and accordingly, provides pro forma net income and pro
forma earnings per share footnote disclosures for employee stock options as
if the fair value-based method defined in SFAS No. 123 had been applied.
(h) Research and Development
Research and development costs are expensed as incurred.
<PAGE>
F-17
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements - (Continued)
(i) Loss Per Share
During the fourth quarter of 1997 the Company adopted Statement of
Financial Accounting Standards No. 128 ("SFAS 128"), Earnings Per Share.
Pursuant to SFAS 128, basic net loss per common share has been calculated
based upon the weighted average number of shares of common stock
outstanding during the period. No effect has been given to common stock
equivalents or convertible preferred stock or debt in the diluted loss per
common share as they are all anti-dilutive. Included in net loss to common
stockholders is the accretion of the assured incremental yield related to
the ability of the Series B, C, D and F preferred stockholders to acquire
common stock upon conversion at a discount. The assured incremental yield
is being accreted as a dividend over the periods from the dates of issuance
of the preferred stock to the earliest eligible dates for conversion.
(j) Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of
The Company reviews its long-lived assets and certain identifiable
intangibles for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable.
Recoverability of assets to be held and used is measured by a comparison of
the carrying amount of an asset to future net cash flows expected to be
generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amount of the assets exceed the fair value of the assets. Assets to be
disposed of are reported at the lower of the carrying amount or fair value
less costs to sell.
(k) Reclassifications
Certain reclassifications have been made to the 1996 consolidated
financial statements to conform to the 1997 presentation.
(3) Related Party Transactions
(a) Note Receivable from Stockholder
A stockholder, the Chairman and Chief Executive Officer of the
Company, was indebted to the Company at December 31, 1997 under two
promissory notes totaling $212,024, including accrued interest, due on
demand. During 1997, $50,000 of the Chairman and Chief Executive Officer's
bonus was used to reduce the principal owned.
The notes are secured by a pledge of 67,000 shares of Class B common
stock held by the stockholder and officer. The notes bear interest at 10%
per annum. The notes and accrued interest thereon have been shown as a
deduction from stockholders' equity in the accompanying consolidated
financial statements.
(b) Payment to Employer of Related Party
In 1997, the Company paid $182,209 to Enterprise Engineering
Associates ("EEA"), during which time Mr. Michael Sprague was an employee
of EEA. On August 1, 1997, Michael Sprague became an employee of Wave, at
an annual salary of $110,000. Michael Sprague is the son of the Chairman
and Chief Executive Officer of the Company.
<PAGE>
F-18
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements, (Continued)
(b) Acquisition and Dispositions
In November 1995, the Company entered into a transaction with certain
individuals whereby shares in its newly-formed subsidiary, Wave Interactive
Network, Inc. ("WIN"), were transferred in exchange for a demand note. The
amount of the demand note was based on the level of funding provided to WIN
by the Company during 1995. The demand note from WIN accrued interest at a
rate of Prime plus 1% and, subject to certain limitations associated with
WIN's ability to raise additional capital, was convertible into an
undiluted 20% of the common shares of WIN at the option of Wave. The
Company retained a 1% ownership in WIN and transferred the remaining
ownership to certain individuals, including former employees. Approximately
65% of the ownership was transferred to Steven Sprague, President and CEO
of WIN, and three other children of Mr. Peter J. Sprague, Chairman and CEO
of Wave. The note was fully reserved as its collectibility was dependent
upon WIN's ability to raise additional capital. In addition, the Company
entered into a separate commercial agreement that, among other things,
granted certain distribution rights to WIN in exchange for royalties and
other consideration.
During 1996, the Company continued to finance the operations of WIN
through additional demand notes with terms similar to the original demand
note. The additional notes amounting to $1,004,000 were also fully
reserved. On December 30, 1996, effective as of October 18, 1996, the
Company entered into a merger agreement with WIN whereby the Company
exchanged, for all of the outstanding WIN common stock that it did not own,
375,000 shares of Class B common stock. These Class B shares are restricted
securities within the meaning of Rule 144 of the Securities Act of 1933, as
amended (the "Act"). Additionally, based on the attainment of a specified
milestone, the shareholders of WIN are entitled to receive an additional
325,000 shares of the Company's Class B common stock. The Company also
issued a 10% convertible note and a warrant to refinance a convertible note
obligation of WIN amounting to approximately $456,000, which included
accrued interest to October 18, 1996, and an outstanding warrant. Included
in the results of operations are WIN's operations from October 18, 1996.
This acquisition has been accounted for by the purchase method.
The purchase price of $952,438 was determined based on the estimated
fair value of the consideration given to the WIN shareholders and
noteholders. Due to its restricted nature, the Class B common stock was
valued at a discount of 25% from the market value of the Class A common
stock as of October 18, 1996. The convertible note was valued at its face
amount as any discount attributable to the incremental yield imbedded in
the conversion feature was assumed to be offset by the restricted nature of
the Class A common stock into which the note is convertible. The warrant
was valued at $128,000, its estimated fair value, using the BlackScholes
model and assuming:
Expected Life 5 years
Interest Rate 6.25%
Volatility 124%
Dividend Yield 0.0%
The entire purchase price was allocated to goodwill as WIN had no net
tangible assets. Subsequently, in 1997, the Company determined it was
uncertain whether the current and expected future results of operations of
WIN would be adequate to support the goodwill capitalization, and wrote-off
the goodwill as impaired. If the contingent consideration is issued, value
ascribed to such consideration will be expensed.
<PAGE>
F-19
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements, (Continued)
<TABLE>
<CAPTION>
(4) Property and Equipment
Property and equipment as of December 31 consisted of the following:
1997 1996
---- ----
<S> <C> <C>
Equipment $ 1,297,702 1,094,036
Furniture, fixtures and improvements 389,530 350,744
Computer software 128,228 112,374
---------- ----------
1,815,460 1,557,154
Less: Accumulated depreciation 966,184 622,356
---------- ----------
Total $ 849,276 934,798
=========== ===========
</TABLE>
Depreciation expense on property and equipment amounted to
approximately $344,000, $272,000, $172,000 and $966,000 for the years ended
December 31, 1997, 1996, and 1995 and for the period from inception through
December 31, 1997, respectively.
(5) Notes Payable
In connection with the acquisition of WIN, the Company issued a 10%
convertible note amounting to $456,000 and a warrant to refinance WIN's
obligation to a WIN noteholder. The note is convertible any time after
April 1, 1997 and will become due, including accrued interest of $66,125,
on April 18, 1998. The note is convertible into a number of the Company's
unregistered Class A common stock for a period beginning on April 1, 1997
and ending April 18, 1998 calculated as the greater of (a) the number of
shares that would be acquired at 80% of the fair market value of the Class
A common stock or (b) 250,000 shares plus 2,000 shares for each month the
note is outstanding.
(6) Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses as of December 31 consisted of the
following:
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Accrual of costs related to the ITG agreement $ 490,000 -
Accounts payable 298,486 403,447
Accrued consulting and professional fees 264,495 409,562
Accrued payroll and related costs 318,403 111,340
Other accrued liabilities 56,378 12,814
----------- -----------
Total $ 1,427,762 937,163
========= =========
</TABLE>
(7) Capital Stock
(a) Redeemable Preferred Stock
The Company has authorized 2,000,000 shares of preferred stock having a par
value of $.0l per share. On October 19, 1992, the Board of Directors designated
and issued 360 shares of this preferred stock of the Company as "Series A
Cumulative Redeemable Preferred Stock" ("Series A Preferred Stock").
(Continued)
<PAGE>
F-20
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements, (Continued)
The Series A Preferred Stock was issued in settlement of compensation
owed to a former officer of the Company for services provided to the
Company. The holder of the Series A Preferred Stock is entitled to receive
a dividend at the rate of $60 per share per annum, when and as declared by
the Board of Directors of the Company. Dividends are cumulative from the
date of original issue, and payable upon redemption.
No dividends may be declared upon the common stock of the Company
unless full cumulative dividends on the Series A Preferred Stock have been
declared and a sum sufficient for the payment thereof has been set apart
for such payment. The stock is non-voting and redeemable at $1,000 per
share, plus accumulated dividends, at any time at the option of the
Company. The stock is subject to mandatory redemption five years from the
date of issuance, or October 1997. Because the dividend rate on the
Preferred Stock was below market rates, the stock was discounted to yield a
market rate of 12% at the time of issuance, resulting in a discount of
$94,400. Dividends of $39,267 (including amortization of the discount of
$17,667), $41,800 (including amortization of the discount of $20,200), and
$40,600 (including amortization of the discount of $18,998) have been
accrued for the years ended December 31, 1997, 1996 and 1995, respectively.
The holder has not notified the Company of his intention to redeem the
stock. The Company continues to accrue dividends until receipt of such
intention.
In May of 1996, the Company raised $3,214,026, net of issuance costs
of $285,974, through the placement of 350 shares of Series B Preferred
Stock ("Series B Preferred Stock") pursuant to Regulation S of the
Securities Act of 1933 ("the Act"). The Series B Preferred Stock has a
stated value of $10,000 per share, which accrues dividends for liquidation
and conversion purposes at 6% per annum, and ranks senior to the Company's
common stock and Series C Convertible Preferred Stock ("Series C Preferred
Stock") and junior to the Series A Preferred Stock. Series B Preferred
Stock was convertible by the holder, in increments, into the Company's
Class A common stock. The Series B Preferred Stock was convertible at the
lesser of 110% of the average closing bid price for the five days
immediately preceding the issue date or 85% of the average closing bid
price for the five days immediately preceding the conversion date. During
1996, 330 shares of the Company's Series B Preferred Stock were converted
into 2,960,303 shares of the Company's Class A common stock and the
remaining 20 shares of Series B preferred were converted in 1997 into
117,240 shares of the Company's Class A common stock.
In December of 1996, the Company raised $2,634,037 net of issuance
costs of $365,963 ($101,964 of which related to the value ascribed to
warrants issued) through the placement of 150,000 shares of Series C
Preferred Stock pursuant to Regulation D of the Act. The Series C Preferred
Stock has a stated value of $20 per share, which accrues dividends payable
quarterly in cash at 6% per annum.
(Continued)
<PAGE>
F-21
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements, (Continued)
The Series C Preferred Stock ranks senior to the Company's common
stock and junior to the Series A and B Preferred Stock. Series C Preferred
Stock was convertible by the holder, in increments, into the Company's
Class A common stock based on the market price of the Company's Class A
common stock at the time of conversion.
The Series C Preferred Stock was convertible at the lesser of $2.31
per share or 80%, as adjusted, of the average of the fair value of the
Class A common stock for the five days prior to the conversion date. During
1997 all of the Series C preferred stock was converted into 2,850,439
shares of the Company's Class A common stock.
In May of 1997 the Company raised approximately $1,316,000, net of
issuance costs of $272,000 ($162,000 of which related to the value ascribed
to warrants issued), through the placement of 80,000 shares of newly
created Series D Convertible Preferred Stock. The Series D Preferred Stock
had a stated value of $20 per share, which accrued dividends payable
quarterly in cash at 6%.
The Series D Convertible Preferred Stock was convertible into the
Class A Common Stock of the Company at an effective conversion price of the
lower of (i) $1.35, or (ii) 80% of the average closing bid price on the
NASDAQ National Market System of the Company's Class A Common Stock for the
five (5) trading days immediately preceding the date of conversion. During
1997 all of the Series D Convertible Preferred Stock was converted into
2,070,095 shares of the Company's Class A Common Stock.
(b) Convertible Preferred Stock
In October 1997 the Company raised approximately $1,850,000, net of
issuance costs of $397,000 ($224,000 of which related to the value ascribed
to warrants issued), though the private placement 112,500 shares of newly
created Series F Convertible Preferred Stock. The Series F Convertible
Preferred Stock has a stated value of $20 per share, which accrued
dividends payable quarterly in cash at 6%.
The Series F Convertible Preferred Stock was convertible into the
Class A Common Stock at an effective conversion price of the lower of (a)
$1.05 and (b) 80% of the average of the five (5) lowest trading prices of
Class A Common Stock. During 1997 all of the Series F Convertible Preferred
Stock was converted into 2,961,086 shares of the Company's Class A Common
Stock.
(c) Common Stock
In December 1989, March through October 1990, and November 1991,
substantially all stockholders as of December 29, 1989 were offered the
right to acquire a number of shares equivalent to their pre-offering
holdings at a price of $.003 per share. Substantially all stockholders that
received the offer accepted this opportunity. This was accounted for
essentially as a stock split effected in the form of a rights offering, and
all shares issued in conjunction with this offering were reflected in the
accompanying consolidated financial statements retroactively.
(Continued)
<PAGE>
F-22
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements, (Continued)
Two principal stockholders did not acquire the full amount of shares
to which they were entitled. Most of the additional proportionate shares
that these stockholders would have been credited with were offered instead
to certain officers, employees and stockholders for $.003 per share. To the
extent that these rights were offered to the individuals in compensation
for services rendered to the Company, compensation expense equal to the
difference between the estimated fair value as of the date of issuance and
the purchase price of the stock was recorded. The estimated fair value of
the common stock was determined based on sales to third parties near the
date of issuance. Compensation expense associated with the issuance of
these shares of $430,250 is included in the accompanying consolidated
statement of operations for the period from inception to December 31, 1997.
In May and November, 1992, the Company issued 770,000 shares of Class
B restricted common stock to certain employees, officers and stockholders
of the Company for a purchase price of $.003 per share, payable in the form
of services to the Company.
As these shares were issued for services rendered, compensation
expense of $1,927,500 was recorded representing the estimated fair value of
$2.50 per share at the date of issuance, the price at which common stock
was sold to third parties near the time of issuance.
In February 1995, the Company agreed to grant 36,000 shares of Class A
common stock, 12,000 of which were issued in 1995 with the remainder issued
in 1996, to two consultants and six non-employee directors as compensation
for services rendered. Expenses of $112,500 were recorded in 1995
representing the stock's fair value of $3.13 per share at the time of the
agreement to grant.
In July 1995, the Company issued 19,559 shares to two vendors in
payment for services rendered. Costs of $20,000 were recorded representing
the stock's fair value of approximately $1.00 per share at the time the
services were rendered.
In July and August 1996, the Company issued 15,000 and 3,077 shares of
Class A common stock to two consultants as compensation for services
rendered. Expenses of $40,938 have been recorded representing the stock's
fair value of $2.06 and $3.44 per share, respectively, at their dates of
issuance.
During 1997 the Company issued 126,885 shares of the Company's Class A
common stock to vendors or for the settlement of liabilities. Expenses of
$305,496 have been recorded representing the stocks' fair value at the date
of issuance.
(Continued)
<PAGE>
F-23
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements, (Continued)
During 1997 the Company sold approximately 800,000 shares of the
Company's Class A common stock and warrants to purchase 160,000 shares of
the Company's Class A common stock, which may be exercised at an exercise
price of $1.00, for an aggregate purchase price of $800,000.
During 1997 the Company issued 500,000 shares of the Company's Class A
common stock in connection with a license agreement with Aladdin Knowledge
Systems, Ltd. for its proprietary persistent encryption technology. The
shares were issued at their fair value on the date of
issuance.
(d) Recapitalization
In January 1994, the Board of Directors authorized the Company to
amend and restate the Company's Certificate of Incorporation to reflect the
authorization of 25,000,000 shares of a newly created Class A common stock,
which stock has voting rights of one vote per share, and the
reclassification of the then current outstanding shares of common stock
into Class B common stock. In June 1994, the Board of Directors authorized
that the Class B common stock will have one vote per share, except that
Class B common stock will have five votes per share in cases where one or
more directors are nominated for election by persons other than the
Company's Board of Directors and where there is a vote on any merger,
consolidation or other similar transaction, which is not recommended by the
Company's Board of Directors. In addition, the Class B common stock will
have five votes per share on all matters submitted to a vote of the
stockholders in the event that any person or group of persons acquires
beneficial ownership of 20% or more of the outstanding voting securities of
the Company. The Class B common stock is convertible into shares of Class A
common stock at any time. The classes of common stock are alike in all
other respects.
(8) Options and Warrants
1991 Plan
In September 1991, the Board of Directors authorized the establishment
of a stock option plan (the "1991 Plan"). The total number of shares of
Class B common stock subject to the Plan is 2,700,000. Options terminate
upon the earlier of the date of the expiration of the option or upon
termination of the employment relationship between the Company or a
subsidiary and the optionee for any reason other than death, disability or
retirement.
Employees are entitled to exercise their options on dates determined
by the Compensation Committee of the Board of Directors. Vesting provisions
for options granted generally range from immediate vesting to prorata
vesting over a three-year period. Options granted under the 1991 Plan may,
in the discretion of the Compensation Committee, include the right to
acquire a reload option. A reload option provides for the automatic grant
of a new option at the then-current market price in exchange for each
previously owned share tendered by an employee in a stock-for-stock
exercise.
Subsequent to January 1994 no further options, other than reload
options, may be granted under the 1991 Plan. All options outstanding under
the 1991 Plan continue in full force and effect subject to their original
terms. (Continued)
<PAGE>
F-24
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements, (Continued)
Other Options
In 1993, in connection with an investment banking agreement, the
Company granted options to purchase 30,000 shares of Class B common stock
at an exercise price of $1.67 per share, and options to purchase 14,286
shares of Class B common stock at an exercise price of $3.50 per share. The
options vested immediately and are exercisable for a period of seven years
from the date of issuance.
1994 Plans
In January 1994, the Board of Directors authorized the establishment
of the 1994 Employee Stock Option Plan (the "1994 Plan"). The initial
number of shares of Class A common stock subject to the 1994 Plan was
1,000,000. The terms of the 1994 Plan are similar to those of the 1991
Plan. Options are granted with exercise prices that approximate fair market
value at the date of grant. In May 1996, the Board of Directors approved an
amendment to the Company's 1994 Plan to increase the number of shares of
Class A common stock reserved for issuance thereunder to 2,000,000 shares.
In January 1994, the Board of Directors authorized the establishment
of the Non-Employee Directors Stock Option Plan (the "Directors' Plan").
The total number of shares of Class A common stock subject to the
Directors' Plan was 200,000. Pursuant to the Directors' Plan, each director
who was not an employee of the Company received an initial grant of options
to purchase 12,000 shares of Class A common stock at an exercise price of
$3.50 per share.
Any person subsequently elected as a director who is not an employee
of the Company will receive an initial grant of options to purchase 12,000
shares of Class A common stock on the day he or she is elected a director.
In addition, on the day immediately following each of the dates on which an
incumbent director is reelected, he or she received an additional grant of
options to purchase 2,000 shares of Class A common stock.
In February 1995, the Board of Directors authorized certain changes to
the Directors' Plan. The annual option grant for directors was increased
from a total of 2,000 shares of Class A common stock to 10,000 shares of
Class A common stock. In July 1995, the stockholders of the Company
authorized an increase to the total number of shares subject to the
Directors' Plan from 200,000 shares to 500,000 shares. Options to purchase
a total of 110,000 and 100,000 shares of Class A common stock at $ 1.94 to
$ 3.09 and $3.09 per share, were issued in 1997 and 1996, respectively, to
nonemployee directors.
Initial option grants under the Directors' Plan vest one-third upon
grant, and one-third on each of the first and second anniversaries. Annual
option grants vest 25% after each three-month period following grant.
(Continued)
<PAGE>
F-25
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements, (Continued)
Options under the Directors' Plan are exercisable for a period of ten
years from the date of grant. Options may not be exercised after the option
holder ceases to be a director of the Company, except that in the event of
death or disability of the option holder, the option may be exercised for a
period of one year after the date of death or disability, and, in the event
of retirement of the option holder, the option may be exercised for a
period of three months after the date of retirement.
At December 31, 1997, there were approximately 953,000 additional
shares available for grant under the 1994 Plan. The per share
weighted-average fair value of stock options granted during 1997, 1996 and
1995 was $1.58, $2.65 and $2.22 on the dates of grant using the Black
Scholes option-pricing model with the following weighted-average
assumptions:
1997 1996 1995
---- ---- ----
Expected Life (Years) 10 10 10
Interest Rate 6.5% 6.4% 5.6%
Volatility 111% 124% 135%
Dividend Yield 0% 0% 0%
The Company applies APB Opinion No. 25 in accounting for its Plans
and, accordingly, no compensation cost has been recognized for stock
options granted to employees at fair market value in the financial
statements.
Had the Company determined compensation cost based on the fair value
at the grant dates for its stock options under SFAS No. 123, the Company's
net loss would have been increased to the pro forma amounts indicated
below:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Net loss - as reported $ (13,897,794) (8,683,815) (6,832,866)
Net loss - pro forma $ (15,300,187) (10,025,517) (7,102,627)
Net loss to common stockholders - as reported $ (16,380,776) (9,554,394) (6,873,466)
Net loss to common shareholders - pro forma $ (17,783,169) (10,896,096) (7,143,227)
Loss per common share - as reported $ (.78) (.64) (.50)
Loss per common share - pro forma $ (.85) (.73) (.52)
</TABLE>
Pro forma net loss reflects only options granted in 1997, 1996 and
1995. Therefore, the full impact of calculating compensation cost for stock
options under SFAS No. 123 is not reflected in the pro forma net loss
amounts presented above because compensation cost is reflected over the
options' vesting periods and compensation cost for options granted prior to
January 1, 1995 are not considered.
(Continued)
<PAGE>
F-26
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements, (Continued)
<TABLE>
<CAPTION>
Summary of Option Activity
A summary of option activity through December 31, 1997 follows:
Class A and B shares Weighted average
subject to option exercise price
<S> <C> <C>
Balance at January 1, 1991 - $ -
Options granted 30,000 1.67
-----------
Balance at December 31, 1991 30,000 1.67
Options granted 816,750 1.18
----------
Balance at December 31, 1992 846,750 1.20
Options granted 949,186 3.10
----------
Balance at December 31, 1993 1,795,936 2.20
Options granted 310,200 3.05
Options canceled (108,500) 3.38
----------
Balance at December 31, 1994 1,997,636 2.27
Options granted 777,850 2.22
Options canceled (349,205) 2.11
Options exercised (681,700) .64
----------
Balance at December 31, 1995 1,744,581 2.92
Options granted 1,342,075 2.65
Options canceled (503,879) 3.20
Options exercised (214,091) 1.97
----------
Balance at December 31, 1996 2,368,686 2.79
Options granted 316,010 1.58
Options canceled (669,580)
Options exercised (70,326) 1.90
-----------
Balance at December 31, 1997 1,944,790 2.73
=========
</TABLE>
At December 31, 1997, there were approximately 988,000 options
exercisable at prices ranging from $1.06 to $7.06.
(Continued)
<PAGE>
F-27
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements, (Continued)
The following table summarizes information about stock options outstanding at
December 31, 1997:
<TABLE>
<CAPTION>
Weighted
Weighted average
average remaining
Range of Number Number exercise contractual
exercise prices outstanding exercisable price life
<S> <C> <C> <C> <C>
$1.06 131,250 6417 $1.06 9.9 years
1.09 - 1.67 440,260 203,063 1.30 7.4 years
1.94 - 2.31 134,810 23,400 2.04 8.2 years
2.50 - 2.97 154,690 118,603 2.61 6.5 years
3.06 - 3.50 924,000 559,339 3.31 7.2 years
3.81 87,000 29,000 3.81 8.1 years
7.06 72,780 48,522 7.06 7.6 years
</TABLE>
Warrants
In 1993 and 1994, the Company issued warrants to acquire a total of
151,600 shares of Class B common stock at $3.50 per share in conjunction
with sales of Class B common stock to individuals and institutions. All
warrants are exercisable for a period of five years from the date of
issuance.
In 1993 and 1994, the Company issued warrants to acquire a total of
376,253 shares of Class B common stock at $3.50 per share in conjunction
with the issuance of its 10% Convertible Notes which have since been repaid
and in 1994, the Company issued warrants to acquire a total of 46,799
shares of Class B common stock at $6.00 per share in conjunction with the
issuance of its 15% Notes, also which have since been repaid. All warrants
are exercisable for a period of five years from their dates of issuance.
Under the terms of the Company's initial public offering, the
underwriter acquired warrants to purchase 360,000 Class A common shares at
a price of $6.50 per share for nominal consideration. These warrants are
exercisable for four years commencing in September 1995.
As a result of the successful placement of 350 shares of Series B
Preferred Stock, a consultant from Digital Media Group, Inc. was issued
warrants by the Company to purchase 30,000 Class A common shares at a price
of $3.09 per share. These warrants are exercisable for ten years commencing
in March 1996.
(Continued)
<PAGE>
F-28
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements, (Continued)
Due to the successful placement of 150,000 shares of the Company's
Series C Convertible Stock, Wharton Capital Partners Ltd. and The Shemano
Group, Inc., two financial consulting firms, were issued warrants by the
Company to purchase 37,500 Class A common shares each at a price of $2.54
per share. These warrants expire on December 27, 1999.
In connection with the acquisition of WIN, the Company issued a
warrant that allows the holder the ability to purchase unregistered shares
of the Company's Class A common stock at a price of $1.25 per share at the
earlier of the conversion of a note or April 18, 1998 for a period of five
years. The number of shares able to be purchased under this warrant is
based on a formula of $170,000 divided by 80% of the fair market value of
the Class A common stock at the time of conversion.
As a result of the successful placement of 80,000 shares of the
Company's Series D Preferred Stock, JNC Opportunity Fund, the acquirer of
the placement, received 80,000 warrants to purchase the Company's
unregistered Class A Common Stock, and financial consultants, primarily
Wharton Capital Partners, received a total of 40,000 warrants. The warrants
have an exercise price of $1.62, and expire on May 30, 2002.
As a result of the successful placement of 112,500 shares of the
Company's Series F Preferred Stock, Combination Inc., the acquirer of the
placement, received 112,500 warrants to purchase the Company's unregistered
Class A Common Stock, and Wharton Capital Partners received 56,250
warrants. The warrants have an exercise price of $1.26, and expire on
October 9, 2002.
In connection with the private placement of approximately 800,000
shares of the Company's Class A Common Stock, the Company issued 160,000
warrants to purchase shares of the Company's unregistered Class A Common
Stock at an exercise price of $1.00. The warrants expire on September 16,
2000.
In connection with a technology license agreement with Aladdin, the
Company issued two warrants on July 18, 1997 to purchase the Company's
Class A Common Stock. The first warrant is excerciseable in 100,000 share
lots, and provides the holder with the right to acquire 2,185,437 shares of
the Company's unregistered Class A Common Stock at an exercise price of
$1.70 per share. The first warrant has a life of two years. The second
warrant provides the holder with the right to acquire 7% of the Company's
Class A Common Stock on a fully diluted basis for the average closing price
for the 15 trading days prior to exercise. The warrant must be exercised in
its entirety and expires at the end of three years.
(Continued)
<PAGE>
F-29
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements, (Continued)
A summary of warrants outstanding at December 31, 1997, based upon a year
end price of the Class A common stock of $1.125 per share, follows:
<TABLE>
<CAPTION>
Range of
Class A and B shares exercise Expiration
Year of issuance subject to warrants prices Term
<S> <C> <C> <C>
1993 249,529 $ 3.50 5 years
1994 685,123 3.50 - 6.50 4-5 years
1996 30,000 3.09 10 years
1996 75,000 2.54 3 years
1996 188,889 1.25 5 years
1997 120,000 1.62 5 years
168,750 1.26 5 years
160,000 1.00 3 years
2,185,437 1.70 2 years
---------
3,862,728
</TABLE>
At December 31, 1997, warrants to acquire approximately 3.5 million shares
of Class A and Class B common stock were exercisable.
The above information table does not include the Aladdin warrant to
purchase 7% of the Company due to its variable nature.
(9) Licensing Agreements
(a) Licensed Patents
In February 1994, the Company entered into an Amended and Restated
License Agreement (the "Agreement") with Mr. Peter J. Sprague, the Chairman
and Chief Executive Officer of the Company, and Mr. John Michener, then a
shareholder and officer of the Company, whereby the Company was granted an
exclusive license to make, have made, use, lease, sell or otherwise perform
services covered by certain licensed patents (the "Licensed Patents") which
are a fundamental part of the Company's product. The Agreement amends and
restates certain license agreements entered into by the Company prior to
February 1994.
The Agreement provides for royalty payments to be made to the
licensors in the aggregate amount of two percent of the total gross
revenues derived by the Company and any sublicensee of the Company from the
exploitation of the Licensed Patents, less any amounts paid, if any to (i)
information and database providers for information distributed to or
through the Company or its sublicensees, and to (ii) the Company's
sublicensees for manufacturing the product or performing the services
covered by the Licensed Patents. Royalty payments are payable quarterly and
are to be apportioned 75% to Mr. Sprague and 25% to Mr. Michener.
(Continued)
<PAGE>
F-30
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements, (Continued)
Payment of royalties is secured by a security interest in and to the
Licensed Patents. Mr. Sprague assigned all of his right, title, and
interest in the Licensed Patents to the Company.
The Company believes that the agreements as a whole provide it with
exclusive rights under the Wave Patents. There can be no assurance that the
Company will enjoy exclusive rights to the Licensed patents under these
agreements.
(b) Aladdin License Agreement
During the third quarter of 1997 the Company entered into a license
agreement with Aladdin Knowledge Systems, Ltd. ("Aladdin"), an Israeli
company, for technology and in-process research and development related to
Aladdin's proprietary persistent encryption system. Under the terms of the
Aladdin license agreement, the company is prohibited from using any other
encryption technology for the first five years. This technology will be
incorporated into the Wave System to facilitate pay-per-view content
distribution.
The Company acquired the license for this technology in exchange for
$950,000 plus two warrants to purchase the Company's Class A common stock
valued at approximately $2.9 million. The cost of this license was expensed
as research and development costs. Aladdin also is provided a royalty
payment of 5% to 9% of the Company's net content revenues.
In connection with this agreement, Aladdin acquired an equity position
in the Company by purchasing 500,000 shares of the Company's Class A common
stock for $900,000, which approximated the fair market value of the shares
on the date of purchase.
(10) License and Cross-License Agreements
On May 1, 1992, the Company entered into a Joint Technology
Development Agreement and License and Cross-License Agreement ("License and
Cross-License Agreement") with The Titan Corporation ("Titan") whereby
Titan granted to the Company license rights to the use of certain patents
which are co-owned or licensed by Titan. The Company granted to Titan the
exclusive right to make for, sell in, and lease in a "Retained Market," as
defined in the agreement, the subject matter described in any Company
patent. The Retained Market is defined generally as the market for
"Government Information," as defined in the agreement, used solely by a
government entity, and the market for products used to access such
information. The Company issued to Titan 674,976 shares of Class B common
stock in return for the license to Titan's patents. These shares were
valued at $1.67 per share (total $1,124,960), the estimated fair value of
the shares at the time of issuance (based on the price at which shares were
sold to third parties near the time of issuance), and were included in
research and development expense in the accompanying consolidated statement
of operations for the period from February 12, 1988 through December 31,
1996.
The License and Cross-License Agreement provides for royalties to be
paid by the Company to Titan based upon the Company's "Net Revenues," as
defined in the agreement. Net Revenues are defined generally as gross
product revenues less amounts paid to information providers and data base
providers for information provided to the Company for use in its products
and services. Royalties are payable on a quarterly basis.
(Continued)
<PAGE>
F-31
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements, (Continued)
The License and Cross-License Agreement also provides for royalties to
be paid to the Company by Titan based upon Titan's "Allocable Net
Revenues," as defined in the agreement. Allocable Net Revenues are
generally defined as that portion that a Company patent or information adds
to Titan's gross amounts invoiced to purchasers for all products or
information services making use of a Company patent or know-how and
information. Royalties are payable on a quarterly basis.
The License and Cross-License Agreement specifies certain events of
termination, some of which have already occurred but which have been waived
or extended by Titan.
A director of the Company, who resigned from the Board at the end of
1997, is also the President, Chief Executive Officer, and a director of
Titan. Pursuant to the terms of a related stockholders agreement, Titan has
the right to designate a member of the Company's Board of Directors for as
long as Titan continues to own at least 50% of the shares originally issued
to Titan. As of December 31, 1997, no royalties have been earned by Titan.
On February 28, 1997, the Company and Titan executed an addendum to the
License Agreement whereby the Company received a sole license to Titan's
patent to develop and distribute products to the in-home consumer
microcomputers market segment. Under this addendum, Titan waived all
defaults previously incurred by Wave as well as extended the license
agreement to expire at the time the patents expire.
(11) Revenue Sharing Agreements With Partners
The Company has, and intends to continue to, enter into revenue
sharing arrangements with information providers, software developers, and
hardware and systems manufacturers such as IBM discussed below. These
revenue sharing arrangements will be negotiated between each of the
partners and the Company. It is anticipated that revenue sharing
arrangements will vary according to the market in which the Wave system is
adopted and from which revenues are derived. Generally, a significant
portion of the revenue collected by the Company will be paid directly to
the information provider or software developer. Once these payments are
made the remainder of revenues will be shared between the Company and other
partners. There can be no assurance that the Company will be successful in
entering into definitive agreements with these parties, or that the terms
of such agreements will be favorable to the Company.
In December 1997, the Company entered into a series of agreements
("the agreements") with IBM pursuant to which the Company and IBM agreed to
explore ways to inexpensively incorporate the Company's WaveMeter chip into
PC products and to support each other in achieving industry-wide adoption
of the WaveMeter technology. Pursuant to the agreements, the Company must
subsidize the incremental cost of using the Wave technology in IBM
products. The total subsidy is capped at $30 million. The Company must also
share varying percentages of its usage and advertising fee income that
results from usage of any Wave technology distributed by IBM. In addition,
the Company must provide user and technical service and support to IBM
customers for the end-user application of Wave technology. Finally, the
agreements provide for cash payments upon the attainment of certain
milestones. The amount of such cash payments is based upon the appreciation
of the Company's stock. To date, none of these milestones have been
achieved; therefore, no costs have been recognized in the financial
statements.
<PAGE>
F-32
(12) Joint Venture
In July of 1997, the Company entered into a joint-venture with Internet
Technology Group, PLC ("ITG"), a United Kingdom Internet service provider. The
joint venture is owned 25% by the Company and 75$ by ITG. The Company
contributed its technical expertise and ITG contributed initial working capital
and the commitment to fund all future working capital requirements of the joint
venture. The objective of the joint venture company, Global Wave, Ltd., is to
promote and commercialize the Wave technology in certain European and Middle
Eastern markets. Pursuant to the joint venture agreement, the Company will
receive a license fee of up to $5 million in exchange for the joint venture's
right to market the Wave technology in European and Middle Eastern markets. The
license fee will be paid by ITG as part of its commitment to fund the joint
venture. During the third quarter of 1997, the Company received $1.0 million
from the joint-venture representing partial payment of the license fee, with the
remaining payments to be made upon the Company's attaining certain milestones
related to the number of Wave Meters distributed. The amount received was
recorded as deferred license fee income in the third quarter as it was uncertain
whether the Company had met the contractual requirements required in order to
have earned the first payment. During the fourth quarter of 1997, the Company
met these requirements and recorded the $1 million as a license fee. Also the
Company accrued $490,000 in the fourth quarter for expenses related to the
Company's obligation to assist the joint venture in setting up the Wave system
in the designated markets. In January 1998, the joint venture agreement was
modified to extend the milestone dates and provide for the payment of an
additional $750,000 of the $5 million license fee to the Company. The payment of
$750,000 was received in January 1998. The remaining portion of the license fee
will be paid in 1998 if the remaining milestones are achieved; however, there
can be no assurance that the remaining milestones will be achieved. Also, at
this time neither ITG nor the joint venture have the resources to fund the
remaining payments.
The joint venture is entirely funded through advances from ITG and the Company
has no commitment to fund the operations of the joint venture.
The Company accounts for its 25% interest in the joint venture pursuant to the
equity method of accounting. At December 31, 1997 the Company's investment in
the joint venture was $0 for financial reporting purposes.
<PAGE>
F-33
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements, (Continued)
(13) Commitments and Contingencies
Litigation
The Company is party to legal proceedings generally incidental to its
business. Management believes that the outcome of such litigation will not
have a material adverse effect on the consolidated financial position or
results of operations of the Company,
Leases
In December 1994, the Company entered into an operating lease
beginning March 1995 for its offices in New York, New York, which expired
on February 28, 1998. The lease provides for minimum annual rent of
$200,000 per annum plus applicable escalations. The Company has
subsequently terminated this lease and entered into a new lease in the same
facility. The minimum annual rent for the new lease is approximately
$81,000 and its expiration is June 1999. The Company also leases premises
in Princeton, New Jersey; San Jose, California; and Lee, Massachusetts,
under operating leases, which expire on various dates through January 14,
2001.
Future minimum lease payments under noncancelable operating leases as
of December 31, 1997 are as follows:
Year ending December 31 Operating Lease
1998 $ 245,151
1999 107,922
2000 65,280
--------
$ 418,353
=========
Rent expense for the years ended December 31, 1997, 1996, 1995 and for
the period from inception through December 31, 1997 amounted to
approximately $383,000, $341,000, $262,000 and $1,500,000, respectively.
<PAGE>
F-34
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements, (Continued)
(14) Income Taxes
The Company has net operating loss carryforwards for tax return
purposes of approximately $36,900,000 which expire beginning in 2003
through 2012.
Pursuant to the Tax Reform Act of 1986, annual utilization of the
Company's net operating loss carryforwards may be limited if a cumulative
change in ownership of more than 50% occurs within a three year period. The
Company has not determined whether there has been such a cumulative change
in ownership or the impact on the utilization of the loss carryforwards if
such change has occurred.
The tax effects of temporary differences that give rise to the
deferred tax asset at December 31, 1997 and 1996 are as follows:
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C> <C>
Deferred tax assets:
Net operating loss carryforwards $ 15,493,000 11,554,000
License rights 1,307,000 45,000
---------- -------------
Total gross deferred tax assets 16,800,000 11,599,000
Less valuation allowance (16,800,000) (11,599,000)
---------- -------------
Net deferred tax asset $ - -
========== ============
</TABLE>
The valuation allowance increased by $5,201,000 and $3,599,000, during
the years ended December 31, 1997 and 1996, respectively.
(15) Defined Contribution Plan
The Company adopted the Wave Systems Corp. 401 (k) Savings and
Investment Plan, a defined contribution plan, on January 1, 1995 to which
substantially-all employees can contribute. Employees of the Company become
eligible immediately on employment. The Company has the option to make
discretionary matching contributions; no contributions were made in 1997 or
1996 or 1995.
(16) Disclosures about the Fair Value of Financial Instruments Cash and Cash
Equivalents, Accounts Receivable, Accounts Payable and Accrued Expenses,
and Note Payable
The carrying amounts of these instruments, other than the note,
approximate fair value because of their short maturities. The note payable
approximates its estimated fair value based on the timing of its issue.
(Continued)
<PAGE>
F-35
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Consolidated Financial Statements, (Continued)
Limitations
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.
(17) Subsequent Events (unaudited)
During March of 1998, the Company issued 150,000 shares of newly
created Series G Convertible Preferred stock for an aggregate purchase
price of $3,000,000. The Series G Convertible preferred stock is senior to
the Company's classes of common stock, and is junior to the Company' Series
A Redeemable Preferred in liquidation rights. The Series G Convertible
Preferred Stock accrues dividends at the rate of 6% per annum. The Series G
Convertible Preferred stock is convertible into the Company's unregistered
Class A Common stock at the lower of $1.12 or 80% of the average of the 5
lowest closing bids for the 10 calendar days prior to conversion. In
addition, the company issued warrants to the purchaser and placement agent
for 225,000 shares of the Company's Class A common stock at an excercise
price of $1.38
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
Wave Systems Corp.
We consent to the incorporation by reference in the registration statements Nos.
333-38265, 333-28819, and 333-20017 on Form S-3 and Nos. 33-97612, 333-11611 and
333-11609 on Form S-8, of our report dated March 27, 1998, relating to the
consolidated balance sheets of Wave Systems Corp. and subsidiaries as of
December 31, 1997 and 1996, and the related consolidated statements of
operations, stockholders' equity (deficiency), and cash flows for each of the
years in the three-year ended December 31, 1997 and for the period from February
12, 1998 (inception) through December 31, 1997 which report appears in the
December 31, 1997 annual report on Form 10-K of Wave Systems Corp.
Our report dated March 27, 1998 contains an explanatory paragraph that states
that the Company has suffered recurring losses from operations since inception
that raise substantial doubt about its ability to continue as a going concern.
The consolidated financial statements do not include any adjustments that might
result from the outcome of that uncertainty.
KPMG Peat Marwick LLP
Boston, Massachusetts
March 31, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<CIK> 0000919013
<NAME> WAVE SYSTEMS CORP.
<CURRENCY> US DOLLARS
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-1-1996
<PERIOD-END> DEC-31-1997
<EXCHANGE-RATE> 1
<CASH> 758,721
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 758,721
<PP&E> 1,815,460
<DEPRECIATION> 966,184
<TOTAL-ASSETS> 1,678,213
<CURRENT-LIABILITIES> 1,427,762
<BONDS> 0
471,601
0
<COMMON> 272,967
<OTHER-SE> (1,016,241)
<TOTAL-LIABILITY-AND-EQUITY> 1,678,213
<SALES> 0
<TOTAL-REVENUES> 10,712
<CGS> 0
<TOTAL-COSTS> 14,788,164
<OTHER-EXPENSES> (1,000,000)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 120,342
<INCOME-PRETAX> 0
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 13,897,794
<EPS-PRIMARY> (.78)
<EPS-DILUTED> (.78)
</TABLE>
