WAVE SYSTEMS CORP, S-1, 1998-04-15

WAVE SYSTEMS CORP
S-1, 1998-04-15
COMPUTER PERIPHERAL EQUIPMENT, NEC

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<PAGE> 1

AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON APRIL 15, 1998

REGISTRATION NO. 333-
================================================================================

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------

FORM S-1
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
---------------------

WAVE SYSTEMS CORP.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

<TABLE>
<S> <C> <C>
DELAWARE 7379 13-3477246
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NO.)
</TABLE>

480 PLEASANT STREET
LEE, MASSACHUSETTS 01238
(413) 243-1600
(ADDRESS, INCLUDING ZIP CODE AND TELEPHONE NUMBER, INCLUDING
AREA CODE OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
------------------------

STEVEN SPRAGUE
PRESIDENT AND CHIEF OPERATING OFFICER
WAVE SYSTEMS CORP.
480 PLEASANT STREET
LEE, MASSACHUSETTS 01238
(413) 243-1600
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE
NUMBER, INCLUDING AREA CODE, OF AGENT FOR SERVICE)

Copy to:
JEFFREY N. OSTRAGER, ESQ.
CURTIS, MALLET-PREVOST, COLT & MOSLE
101 PARK AVENUE
NEW YORK, NEW YORK 10178-0061
(212) 696-6000

APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO PUBLIC: AT SUCH TIME
OR TIMES AFTER THE REGISTRATION STATEMENT BECOMES EFFECTIVE AS THE SELLING
HOLDERS MAY DETERMINE.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [X]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If the delivery of the prospectus is expected to be made pursuant to Rule
434 under the Securities Act, check the following box. [ ]
------------------------

CALCULATION OF REGISTRATION FEE
================================================================================

<TABLE>
<S> <C> <C> <C> <C>
TITLE OF EACH CLASS PROPOSED MAXIMUM PROPOSED MAXIMUM
OF SECURITIES TO BE AMOUNT TO BE OFFERING AGGREGATE AMOUNT OF
REGISTERED REGISTERED PRICE PER SHARE (2) OFFERING PRICE (2) REGISTRATION FEE
- -------------------------------------------------------------------------------------------------------------------------
Class A Common Stock,
$.01 par value............ 8,724,257 Shares $1.86 $16,227,118.02 $4,787
</TABLE>

- --------------------------------------------------------------------------------

(1) Includes (i) up to 6,966,386 shares issuable upon conversion of and as
dividends on outstanding Series G Convertible Preferred Stock, (ii) 225,000
shares issuable upon exercise of warrants issued in connection with the
placement of the Series G Convertible Preferred Stock, and (iii) 1,532,871
shares issued in private sales, exchange transactions or as compensation to
nine stockholders.
(2) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457(c), based on the average of the bid and ask prices
reported on the Over-the-Counter Bulletin Board on April 7, 1998.
------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.

================================================================================
<PAGE> 2

SUBJECT TO COMPLETION, DATED APRIL 15, 1998

PROSPECTUS

INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.

8,724,257 SHARES

WAVE SYSTEMS CORP.

CLASS A COMMON STOCK

This Prospectus relates to 8,724,257 shares of Class A Common Stock, par
value $.01 per share ("Class A Common Stock") of Wave Systems Corp. (the
"Company" or "Wave") to be offered and sold from time to time by certain
stockholders of the Company ("the Selling Security Holders"). The Company will
not receive any proceeds from the sale of the Shares offered hereby. The
Company's Class A Common Stock trades on the Over-the-Counter Bulletin Board
under the Symbol: "WAVX". The last reported sales price of the Company's Stock
on April 13, 1998 was $1.92 per share.

The shares of Class A Common Stock offered hereby by the Selling Security
Holders consist of (i) up to 6,966,386 shares issuable upon conversion of
150,000 shares of the Company's Series G Convertible Preferred Stock, par value
$0.01 per share (the "Series G Preferred Stock") and as dividends on the Series
G Preferred Stock; (ii) 225,000 shares issuable upon the exercise of warrants
issued in connection with the placement of the Series G Preferred Stock (the
"Placement Warrants"); (iii) 1,532,871 shares of Class A Common Stock issued, or
issuable upon conversion of warrants, in a series of private sale or exchange
transactions or as compensation for services rendered (collectively, the "Other
Shares"). All of the transactions involved were exempt from the registration
requirements of the Securities Act of 1933, as amended (the "Securities Act").
The Series G Preferred Stock was sold on March 6, 1998 for an aggregate purchase
price of $3,000,000 in a transaction exempt from the registration requirements
of the Securities Act. The Registration Statement of which this Prospectus is a
part has been filed with the Securities and Exchange Commission (the
"Commission") pursuant to a Registration Rights Agreement, dated as of March 6,
1998 (the "Registration Agreement"), between the Company and the purchaser of
the Series G Preferred Stock.

The Series G Preferred Stock is convertible into shares of Class A Common
Stock upon the earlier of (i) May 5, 1998 and (ii) the effective date of the
Registration Statement of which this Prospectus is a part. The conversion price
for the Series G Preferred stock is the lower of (a) $1.12 and (b) 80% of the
average of the five (5) lowest trading prices during the twenty-five (25)
calendar days immediately preceding the conversion date. Holders of the Series G
Preferred Stock are entitled to receive quarterly dividends at a rate of 6% per
annum, payable in cash or, subject to certain conditions, shares of Class A
Common Stock. Pursuant to the terms of the Registration Agreement, the
Registration Statement of which this Prospectus is a part registers 6,966,386
shares of Class A Common Stock with respect to shares issuable upon conversion
of the Series G Preferred Stock and as dividends on the Series G Preferred
Stock. The number of shares of Class A Common Stock issuable upon conversion of
the Series G Preferred Stock will depend on the conversion price which, in turn,
will depend upon the lowest trading prices of the Class A Common Stock for five
(5) trading days during the twenty-five (25) calendar days immediately preceding
the date of conversion, as well as the number of shares issuable as dividends on
the Series G Preferred Stock. Pursuant to the terms of the Series G Preferred
Stock, the minimum number of shares issuable upon conversion (without taking
into

2
<PAGE> 3

account shares issuable as dividends) would be 2,678,571 shares, assuming a
conversion price of $1.12 per share. The actual number of shares issuable upon
conversion of the Series G Preferred stock and available for resale under this
Prospectus could be materially greater based upon the market price of the Class
A Common Stock at the time or times of conversion.

The Placement Warrants have an exercise price of $1.38 per share, and
expire on March 6, 2003. The shares issuable upon exercise of the Placement
Warrants are included in this Prospectus pursuant to the terms of the
Registration Agreement.

The shares of Class A Common Stock offered hereby may be offered for resale
by the Selling Security Holders (or their donees) from time to time in
transactions for their own account (which may include block transactions) on any
national securities exchange or quotation service on which the Class A Common
Stock may be listed at the time of sale, in the over-the-counter market, in
negotiated transactions, through the writing of options on the shares, or a
combination of such methods of sale, at fixed prices (which may be changed), at
market prices prevailing at the time of sale, at prices related to such
prevailing market prices or at negotiated prices. The Selling Security Holders
may effect such transactions by selling the shares of Class A Common Stock to or
through broker-dealers, and such broker-dealers may receive compensation in the
form of discounts, concessions or commissions from the Selling Security Holders
and/or the purchasers of shares for whom such broker-dealers may act as agent or
to whom they sell as principal, or both (which compensation as to a particular
broker-dealer might be in excess of customary commissions). See "Plan of
Distribution."

The Company has two classes of outstanding common stock. Class A Common
Stock, which is offered hereby, has one vote per share. Class B Common Stock
also has 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. Both classes vote together as a single class on all matters, except
where class voting is required by Delaware General Corporation Law.
------------------------

THE SECURITIES OFFERED HEREBY INVOLVE A HIGH DEGREE OF RISK. SEE "RISK
FACTORS" BEGINNING ON PAGE 11.
------------------------

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED
UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
------------------------

The date of this Prospectus is , 1998.

3
<PAGE> 4

AVAILABLE INFORMATION

The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and, in accordance
therewith, files reports, proxy and information statements and other information
with the Commission. Such reports, proxy and information statements and other
information may be inspected and copied at the public reference facilities
maintained by the Commission at Room 1024, Judiciary Plaza, 450 Fifth Street,
N.W., Washington, D.C. 20549 and at the Commission's Regional Offices located at
Seven World Trade Center, 13th Floor, New York, New York 10048 and at 500 West
Madison Street, Suite 1400, Chicago, Illinois 60661. Copies of such materials
also can be obtained from the Public Reference Section of the Commission at 450
Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates. The Commission
also maintains a site on the World Wide Web (the "Web") that contains reports,
proxy and information statements and other information regarding registrants
(including Wave) that file electronically with the Commission. The address of
this site is http://www.sec.gov.

The Company has filed with the Commission a Registration Statement on Form
S-1 (herein, together with all amendments and exhibits thereto, called the
"Registration Statement") under the Securities Act with respect to the
securities offered by this Prospectus. This Prospectus does not contain all of
the information set forth or incorporated by reference in the Registration
Statement and the exhibits and schedules relating thereto, certain portions of
which have been omitted as permitted by the rules and regulations of the
Commission. For further information with respect to the Company and the
securities offered by this Prospectus, reference is made to the Registration
Statement and the exhibits filed or incorporated as a part thereof, which are on
file at the offices of the Commission and may be obtained upon payment of the
fee prescribed by the Commission, or may be examined without charge at the
offices of the Commission. Statements contained in this Prospectus as to the
contents of any documents referred to are not necessarily complete, and, in each
such instance, are qualified in all respects by reference to the applicable
documents filed with the Commission.

EXCEPT FOR HISTORICAL INFORMATION CONTAINED HEREIN, THIS REGISTRATION
STATEMENT 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 CONTAINED IN THIS PROSPECTUS
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 PROSPECTUS AND IN THOSE OTHER FILINGS
WITH THE COMMISSION.

4
<PAGE> 5

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
AVAILABLE INFORMATION....................................... 4
PROSPECTUS SUMMARY.......................................... 6
RISK FACTORS................................................ 10
PRICE RANGE OF COMMON STOCK................................. 17
USE OF PROCEEDS............................................. 17
SELECTED CONSOLIDATED FINANCIAL DATA........................ 18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS................................. 19
BUSINESS.................................................... 22
MANAGEMENT.................................................. 31
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT................................................ 34
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.............. 35
DESCRIPTION OF SECURITIES................................... 36
SELLING SECURITY HOLDERS.................................... 40
PLAN OF DISTRIBUTION........................................ 42
LEGAL MATTERS............................................... 43
EXPERTS..................................................... 43
FINANCIAL STATEMENTS........................................ F-1
</TABLE>

NO PERSON IS AUTHORIZED IN CONNECTION WITH ANY OFFERING MADE HEREBY TO GIVE
ANY INFORMATION OR TO MAKE ANY REPRESENTATION OTHER THAN AS CONTAINED IN THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT
BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY, ANY SELLING SECURITY
HOLDER OR ANY UNDERWRITER. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL
OR A SOLICITATION OF AN OFFER TO BUY ANY OF THE SECURITIES OFFERED HEREBY TO ANY
PERSON IN ANY JURISDICTION IN WHICH IT IS UNLAWFUL TO MAKE ANY SUCH OFFER OR
SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL UNDER ANY CIRCUMSTANCE IMPLY THAT THERE HAS BEEN NO CHANGE IN
THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF.

5
<PAGE> 6

PROSPECTUS SUMMARY

The following summary is qualified in its entirety by, and should be read
in conjunction with, the more detailed information and financial information and
statements incorporated by reference in this Prospectus. Prospective investors
should carefully consider the factors set forth under the caption "Risk
Factors". Capitalized terms not defined in this Summary have the meanings given
them elsewhere in this Prospectus.

The Company anticipates that its existing capital resources, including the
net proceeds from the sale of the Series G Preferred Stock, will be adequate to
satisfy its capital requirements into June, 1998. In order to continue
operations, the Company will need to raise additional funds through public or
private financings. The Company does not have any other current commitment to
obtain additional funds and is unable to state the amount or potential source of
such additional funds. No assurance can be given that additional financing will
be available or that, if available, it will be available on terms favorable to
the Company or its stockholders. 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 COMPANY

The Company believes that the market for electronic content is
unnecessarily burdened by inflexible pricing, insecure delivery problems, and
limited information on content usage. For electronic content delivered by
subscription, the customer is generally required to pay up front for access to
all of the content, although actual usage may be for only a small portion of the
content. Distribution systems currently in use that permit customers to purchase
electronic content on a pay-per-use basis are inefficient, not secure and
costly. In the case of "on-line" delivery systems, the customer's price for
electronic content generally reflects the operating costs of the on-line
distribution system and also includes on-line "connect time." Existing
distribution systems provide limited data pertaining to usage patterns.

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 uniquely identified 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
6
<PAGE> 7

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. However, there can be no
assurances that the Company will be successful in achieving any significant
installed base of WaveMeters.

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. The Company has
commercialized this technology through its Internet commerce website, the Great
Stuff Network. To date, the Company has recognized a minimal amount of revenue
from this technology.

In order to seek 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 Company believes that 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. However, to date, the
Company has not been successful in achieving any significant market acceptance
of the Wave System.

The Company believes it has made progress in pursuing its 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. 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.

Through a number of strategic relationships established in 1997, the
Company enhanced the Wave System. 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 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. Also, in July 1997, the
Company entered into a joint venture with ITG to promote the use of the Wave
System in Europe.

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<PAGE> 8

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.

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.

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 April 14, 1998, no demand for
redemption has 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.

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.

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<PAGE> 9

SUMMARY CONSOLIDATED FINANCIAL INFORMATION

STATEMENT OF OPERATIONS DATA:

<TABLE>
<CAPTION>
PERIOD FROM
FEBRUARY 12,
1998
(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... 14,788,164 8,869,642 7,404,920 4,193,649 3,906,480 46,841,205
License fee.......... 1,000,000 1,000,000
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
(including accre-
tion of assured in-
cremental yield on
preferred stock of
$1,673,000 in 1997
and $670,965 in
1996).............. 2,482,982 870,579 40,600 39,484 38,467 3,478,495
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 out-
standing 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)
============ =========== =========== =========== =========== ============
</TABLE>

BALANCE SHEET DATA:

<TABLE>
<CAPTION>
DECEMBER 31, 1997
-----------------
<S> <C>
Working Capital (Deficiency)................................ $ (1,191,165)
Total Assets................................................ $ 1,678,213
Series A Cumulative Redeemable Preferred Stock.............. $ 471,601
Deficit Accumulated During Development...................... $(45,324,463)
Total Stockholders' Equity (Deficiency)..................... $ (743,274)
</TABLE>

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<PAGE> 10

RISK FACTORS

An investment in the Class A Common Stock involves the following risks,
which, together with other matters set forth in this Prospectus, should be
carefully considered by investors prior to any purchase of the Class A Common
Stock.

MINIMAL REVENUES: ABILITY TO CONTINUE AS A GOING CONCERN

The Company has recognized minimal revenues to date, has experienced
significant losses and negative cash flow from operations since its inception.
As of December 31, 1997 the Company had a deficit accumulated during the
development stage of approximately $45 million and a working capital deficit of
$1,191,165. The Company's independent auditors have included an explanatory
paragraph in their report on the Company's consolidated financial statements as
of December 31, 1997, and 1996, and for each of the years in the three year
period ended December 31, 1997 and for the period from February 12, 1988
(inception) to December 31, 1997 which paragraph expresses substantial doubt
about the Company's ability to continue as a going concern.

FUTURE CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FUNDING

The Company anticipates that its existing capital resources, including the
net proceeds from the sale of the Series G Preferred Stock, will be adequate to
satisfy its capital requirements into June, 1998. The Company's long-term
capital requirements will depend upon many factors, including, but not limited
to, the rate at which the Company's strategic partners incorporate the Wave
System into their products, the market acceptance of such products, the levels
of promotion and advertising required to launch such products and attain a
competitive position in the marketplace, the extent to which the Company invests
in technology, and the response of competitors to the products based upon the
Company's technology.

In order to continue operations, the Company will need to raise additional
funds through public or private financings. The Company does not have any other
current commitment to obtain additional funds and is unable to state the amount
or potential source of such additional funds. No assurance can be given that
additional financing will be available or that, if available, it will be
available on terms favorable to the Company or its stockholders. If adequate
funds are not available to satisfy either short- or long-term capital
requirements, the Company may be required to curtail its operations
significantly or to obtain funds through arrangements with strategic partners or
others that may require the Company to relinquish material rights to certain of
its technologies or potential markets.

EFFECT OF DE-LISTING FROM NASDAQ ON LIQUIDITY AND ABILITY TO RAISE CAPITAL

DEVELOPMENT STAGE COMPANY; NEED FOR ACCEPTANCE OF THE COMPANY'S TECHNOLOGY

The Company is a development stage company and is subject to all of the
risks inherent in the establishment of a new business enterprise. To address
these risks, the Company must, among other things, establish technical
feasibility and complete development of its technology, respond to competitive
developments, continue to attract, retain and motivate qualified personnel, and
successfully market its technology.

The Company's licensed technology is incorporated into the WaveMeter which
has the capability to retrieve encrypted electronic data and record each usage.
The Company is in the early stages of product

10
<PAGE> 11

introduction. Transaction processing of all transactions recorded by the
WaveMeter will be conducted by WaveNet. There can be no assurance that WaveNet
will be able to successfully process all of its transactions.

The Company will depend upon a number of strategic partners to adapt their
technology to the Wave System and market the Wave System to consumers of
electronic content. The Company must therefore be successful in achieving
acceptance of its technology by its strategic partners. Even if the Company's
technology is accepted by its strategic partners, the ultimate success of the
Wave System will depend upon its acceptance by consumers of electronic content.
There can be no assurance that the Wave System will be accepted by consumers or
that, if accepted, it will be accepted at a sufficient level to ensure continued
acceptance of the Wave System.

There are a number of commercial and technological objectives that the
Company must meet in order for the Company's systems to achieve commercial
feasibility. These include, without limitation, formalizing strategic
relationships with hardware producers to include the WaveMeter in their product
lines, to build a sufficient base of WaveMeters to achieve average revenue per
home sufficient to maintain operations and to attract content owners to the Wave
System. The Company has incorporated persistent encryption technology for
executable electronic content into the Wave System. This would permit consumers
to rent or rent-to-own executable electronic content through the Wave System.
There can be no assurance that the Company will be successful in achieving any
or all of these objectives.

RAPID TECHNOLOGICAL CHANGE; NEW PRODUCT INTRODUCTIONS

The market for the Company's technology is characterized by rapidly
changing technology and frequent new product introductions. Even if the
Company's technology gains initial market acceptance, the Company's success will
depend, among other things, upon its ability to enhance its product offerings
and to develop and introduce new products and services that keep pace with
technological developments, respond to evolving customer requirements and
achieve market acceptance. There can be no assurance that the Company will be
able to identify, develop, manufacture, market or support new products or deploy
new services successfully, that such new products or services will gain market
acceptance, or that the Company will be able to respond effectively to
technological changes or product announcements by competitors. Any failure by
the Company to anticipate or respond adequately to technological developments
and customer requirements or any significant delays in product development or
introductions could result in a loss of market share or revenues.

DEPENDENCE ON CD-ROM, INTERNET AND BROADBAND MARKETS

Although the Company believes that its system is adaptable to all
significant present modes for the delivery of electronic content, the Company
believes that its technology is particularly well-suited for the CD-ROM,
Internet and broadband markets and that growth in the CD-ROM, Internet and
broadband markets will facilitate and enhance the acceptance of the Company's
technology. There can be no assurance that the CD-ROM, Internet and broadband
markets will continue to grow or that the CD-ROM, Internet and broadband
technologies will not be replaced by other information and software distribution
and access technologies.

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

11
<PAGE> 12

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.

DEPENDENCE ON STRATEGIC PARTNERS

The Company is dependent on strategic partners in the development of a
sufficient installed base of WaveMeters to attract content providers to the Wave
System. The Company is dependent on semiconductor companies to manufacture
functioning WaveMeters in sufficient numbers and at a low enough cost to enable
the Company to convince hardware manufacturers to incorporate the WaveMeters
into hardware they manufacture or retrofit. The Company is dependent on
electronic content owners to modify their products to be used with the
WaveMeters and to charge for their products on a per-use basis. Such companies
may choose not to utilize the Company's technology and could develop or market
products or technologies that compete

12
<PAGE> 13

directly with the Company. Moreover, there can be no assurance that these third
parties will commit the resources necessary to the successful commercialization
of the Company's technology. The Company expects that these strategic partners
will develop their products on schedule. However, any delay would have a
material adverse impact on the ability of the Company to introduce and achieve
commercialization of its systems. The Company has not concluded definitive
agreements with many of its strategic partners, and there can be no assurance
that the Company will be successful in entering into definitive agreements or
that the terms of such agreements will be satisfactory to the Company. Most of
these agreements will provide for the sharing by the Company of its revenues
with its strategic partners.

DEPENDENCE ON KEY PERSONNEL

The Company believes that its future success will be dependent upon the
continued service of its key technical and management personnel and on its
ability to attract and retain highly skilled technical, management, sales and
marketing personnel. The Company is particularly dependent on the skills and
contributions of several key individuals, including Peter J. Sprague and Steven
Sprague, each of whom may voluntarily terminate employment with the Company at
any time and whose departure would have a material adverse effect on the
Company's business. The Company does not have "key person" life insurance
policies on any of its employees. The industry is characterized by a high level
of employee mobility and aggressive recruiting of skilled personnel. There can
be no assurance that the Company's current employees will continue to work for
the Company or that the Company will be able to obtain the services of
additional personnel necessary for the Company's growth.

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.

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.

14
<PAGE> 15

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.

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.

CONFLICTS OF INTEREST

The Company's Board of Directors has included, and is likely to include in
the future, representatives of the Company's strategic partners. It is possible
that the corporations represented by such directors may be in direct or indirect
competition with the Company or among themselves, including competition with
respect to certain business strategies and transactions that the Company may
propose to undertake. Although the affected directors may abstain from voting on
matters in which the interests of the Company and the corporations they
represent are in conflict, the presence of potential or actual conflicts could
affect the process or outcome of Board deliberations and no policies, procedures
or practices have been adopted by the Company to reduce or avoid such conflicts.
There can be no assurance that such conflicts of interest will not materially
adversely affect the Company.

VOTING RIGHTS; CONTROL BY EXISTING STOCKHOLDERS

The Company's Common Stock is divided into two classes with different
voting rights, which allows for the maintenance of control of the Company by the
holders of the Class B Common Stock. 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 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. Both classes vote together as a single class on all matters, except
where class voting is required by the Delaware General Corporation Law ("DGCL"),
which would apply, among other situations, to a vote on any proposal to modify
the voting rights of the Class B Common Stock. Upon conversion of the Series G
Preferred Stock and upon the exercise of the warrants, the Company's executive
officers and directors and

15
<PAGE> 16

entities affiliated with them will have approximately 10% of the combined voting
power of the outstanding capital stock (approximately 29% in those circumstances
where holders of Class B Common Stock have five votes per share).

The disproportionate voting rights of Class A Common Stock relative to the
Class B Common Stock could have an adverse effect on the market price of the
Class A Common Stock. Such disproportionate voting rights may make the Company a
less attractive target for a takeover than it otherwise might be, or render more
difficult or discourage a merger proposal, a tender offer or a proxy contest,
even if such actions were favored by a majority of the holders of the Class A
Common Stock.

ANTI-TAKEOVER PROVISIONS

In addition to the voting rights granted to the holders of Class B Common
Stock, certain provisions of the Company's Restated Certificate of Incorporation
and Bylaws, as well as the ability of the Board of Directors to issue shares of
preferred stock without further vote or action by the stockholders, may have the
effect of delaying, deferring or preventing a change in control of the Company.
In addition, Section 203 of the DGCL restricts certain business combinations
with any "interested stockholder" as defined in such law. This statute may
delay, defer, or prevent a change in control of the Company.

VOLATILITY OF STOCK PRICE

Factors such as announcements of the introduction of new products by the
Company or its competitors, market conditions in the technology and emerging
growth company sectors and rumors relating to the Company or its competitors may
have a significant impact on the market price of the Class A Common Stock. In
addition, the stocks of many technology companies have experienced extreme price
and volume fluctuations which reflect market conditions for technology and
emerging growth stocks generally and have often been unrelated to the operating
performance of specific companies. These market fluctuations may adversely
affect the price of the Class A Common Stock.

ABSENCE OF DIVIDENDS

The Company has neither declared nor paid any cash dividends on its Common
Stock to date. The Company currently anticipates that it will retain all future
cash earnings, if any, to fund the development and growth of its business and
does not anticipate paying dividends on its Common Stock for the foreseeable
future.

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. Year 2000 issues are not expected to affect the operations or
sales of Wave products.

16
<PAGE> 17

PRICE RANGE OF COMMON STOCK

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.

<TABLE>
<CAPTION>
HIGH LOW
----- -----
<S> <C> <C>
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
</TABLE>

<TABLE>
<CAPTION>
HIGH LOW
----- -----
<S> <C> <C>
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
</TABLE>

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.

USE OF PROCEEDS

The Selling Security Holders will receive all of the net proceeds from the
Class A Common Stock sold pursuant to this Prospectus.

17
<PAGE> 18

SELECTED CONSOLIDATED FINANCIAL DATA

The following table sets forth selected consolidated financial data with
respect to the Company as of the end of and for each of the years in the
five-year period ended December 31, 1997, and for the period from February 12,
1988 (inception) through December 31, 1997. The selected consolidated financial
data as of December 31, 1996 and 1997 and for each of the years in the five-year
period ended December 31, 1997 have been derived from and should be read in
conjunction with the consolidated financial statements of the Company and the
accompanying report of KPMG Peat Marwick LLP, appearing elsewhere herein, which
report contains an explanatory paragraph that states that the Company's
recurring losses from operations since inception raise substantial doubt about
the entity's 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.

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 Fee...... 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 on
preferred stock........... 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)
============ =========== =========== =========== =========== ============
</TABLE>

18
<PAGE> 19

BALANCE SHEET DATA

<TABLE>
<CAPTION>
AS OF DECEMBER 31
-------------------------------------------------------------------
1997 1996 1995 1994 1993
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Working capital (deficiency).... (1,191,165) 3,197,519 5,458,512 12,463,502 (1,453,950)
Total assets.................... 1,678,213 6,237,219 7,754,042 13,766,864 918,303
Long-term liabilities........... -- 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>

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 entered into a joint venture with ITG to
promote the use of the Wave System in Europe. From inception through December
31, 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.

The Company is a development stage company and has recognized minimal
revenues to date and experienced significant losses and negative cash flow from
operations since its inception. As of December 31, 1997 the Company had a
deficit accumulated during the development stage of approximately $45 million
and a working capital deficit of $1,191,165. The Company's independent auditors
have included an explanatory paragraph in their report on the Company's
consolidated financial statements as of December 31, 1997, and 1996, and for
each of the years in the three year period ended December 31, 1997 and for the
period from February 12, 1988 (inception) to December 31, 1997 which paragraph
expresses substantial doubt about the Company's ability to continue as a going
concern. There can be no assurance that the Company will be successful in
achieving commercial acceptance of the Wave System.

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<PAGE> 20

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 totaling $3,889,000. 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 payment 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

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<PAGE> 21

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 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 a working capital
deficiency of approximately $1,191,165. 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.

The Company is currently evaluating financing options to raise additional
capital, from time to time, through equity or debt financings in order to insure
the continued development of the Company's technology, products and services. No
assurance can be given that additional financing will be available or that, if
available, it will be available on terms favorable to the Company or its
stockholders. If adequate funds are not available to satisfy either short- or
long-term capital requirements, the Company may be required to curtail its
operations significantly or to obtain funds through arrangements with strategic
partners or others that may require the Company to relinquish material rights to
certain of its technologies or potential markets.

The Company presently has no material commitments for capital expenditures.
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<PAGE> 22

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

BUSINESS

The Wave System consists of many uniquely identified 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

22
<PAGE> 23

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. However,
there can be no assurances that the Company will be successful in achieving any
significant installed base of WaveMeters.

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. The company has
commercialized this technology through its Internet commerce website, the Great
Stuff Netork. To date, the company has recognized a minimal amount of revenue
from this technology.

In order to seek 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 Company believes that 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. However, to date, the
Company has not been successful in achieving any significant market acceptance
of the Wave System.

Through a number of strategic relationships established in 1997, the
Company enhanced the Wave System. 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

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<PAGE> 24

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.

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 to IBM upon the
attainment of certain milestones. The amount of such cash payments is based upon
the appreciation of the Company's stock. The agreements do not obligate IBM to
any product implementations and there can be no assurance that Wave and IBM
reach a mutually acceptable means of incorporating WaveMeters into PC products
at a reasonable cost.

In July 1997, the Company entered into a joint venture with ITG to promote
the use of the Wave System in Europe. 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. 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 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.

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

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<PAGE> 25

and interest. The Company has not redeemed such shares as of April 14, 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.

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
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<PAGE> 26

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 the Company believes is attractive 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 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,

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<PAGE> 27

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

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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.

INTERNATIONAL MARKET

PROPRIETARY RIGHTS AND LICENSES AND INTELLECTUAL PROPERTY

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.

29
<PAGE> 30

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, not including the cost of the
Aladdin technology.

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 capabilities 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,

30
<PAGE> 31

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.

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.

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.

MANAGEMENT

DIRECTORS OF THE REGISTRANT

31
<PAGE> 32

<TABLE>
<CAPTION>
BUSINESS EXPERIENCE AND PRINCIPAL OCCUPATION OR EMPLOYMENT
DURING PAST 5 YEARS; POSITIONS HELD WITH COMPANY; DIRECTOR
NAME AGE OTHER DIRECTORSHIPS SINCE
---- --- ---------------------------------------------------------- --------
<S> <C> <C> <C>
Philippe Bertin(3) 48 Manager of Financiere Wagram Poncelet (direct marketing; 1993
media) since December 1991; Manager of Midial S.A.
(consumer goods) from 1984 until 1991; Manager of
FINOVELEC since October 1997.
Georg Gilder(4) 58 Chairman of the Executive Committee of the Company since 1993
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. McConnaughy, 68 Chairman and Chief Executive Officer of JEMC Corporation 1988
Jr.(1)(2)(3)(4) (private 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 off from
Peabody) from February 1981 to October 1992; Director of
Riddell Sports Inc., Levcor International, Inc., Trans-
act 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 Sprague 33 President and Chief Operating Officer of the Company since 1997
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.

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<PAGE> 33

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(3)
COMPENSATION AWARDS
ANNUAL COMPENSATION ---------------------
------------------------ NUMBER OF SHARES
NAME AND PRINCIPAL POSITION YEAR SALARY($) BONUS($) UNDERLYING 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 Note Receivable from Officer/Director).

(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.

(3) In February, 1998, for services rendered during 1997, the Compensation
Committee awarded 250,005 and 50,005 options to Messrs. Steven Sprague and
Peter J. Sprague, respectively.

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
AT ASSUMED
ANNUAL RATES OF
NUMBER OF % OF TOTAL STOCK PRICE
SHARES OPTIONS 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.

33
<PAGE> 34

<TABLE>
<CAPTION>
NUMBER OF SHARES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED OPTIONS IN-THE-MONEY OPTIONS
AT DECEMBER 31, 1997(#) 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.

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>
NUMBER OF
SHARES NUMBER OF PERCENT
OF CLASS A SHARES OF ALL
COMMON PERCENT OF CLASS B PERCENT OUTSTANDING
STOCK OF COMMON OF COMMON
BENEFICIAL OWNER(1) 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 * * * *
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>

34
<PAGE> 35

- ---------------

*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.

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.

LICENSE FROM MR. PETER SPRAGUE

35
<PAGE> 36

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.

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.

DESCRIPTION OF SECURITIES

The Company's authorized capital stock consists of (i) 50,000,000 shares of
Class A Common Stock, $.01 par value, (ii) 13,000,000 shares of Class B Common
Stock, $.01 par value, and (iii) 2,000,000 shares of preferred stock, $.01 par
value.

The following summary description of the Company's capital stock does not
purport to be complete and is qualified in its entirety by reference to the
Company's Restated Certificate of Incorporation, which is filed as an exhibit to
the Registration Statement of which this Prospectus forms a part, and the
Delaware General Corporation Law (the "DGCL"). Reference is made to such exhibit
and the DGCL for a detailed description of the provisions thereof summarized
below.

COMMON STOCK

The Company's Class A Common Stock and Class B Common Stock are equal in
all respects except for voting rights, conversion rights and restrictions on
transferability, as discussed more fully below.

Voting Rights

The voting powers, preferences and relative rights of the Class A Common
Stock and the Class B Common Stock are identical in all respects, subject to the
following provisions. Holders of Class A Common Stock have one vote per share on
all matters submitted to a vote of the stockholders of the Company. Holders of
Class B Common Stock have 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 on the following matters: (i) any election of directors where
one or more directors has been nominated by any person or persons other than the
Company's Board of Directors or in the event of an "Election Contest" (as
described in Rule 14a-11 promulgated under the Securities Exchange Act of 1934,
as amended) or other solicitation of proxies or consents by or on behalf of any
person or persons other than the Company's Board of Directors for the purpose of
electing directors; and (ii) any vote on a merger, consolidation or
reorganization of the Company or similar business combination or transaction, or
any sale, lease, exchange or other disposition of all or substantially all of
the assets of the Company to or with any other person, if the particular
business combination or other transaction has not been 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
of the Company in the event that any person or group (within the meaning of
Section 13(d)(3) of the Securities Exchange Act of 1934, as amended) acquires
beneficial ownership of 20% or more of the outstanding voting securities of the
Company (provided that this provision will not apply to any person who
beneficially owns 3% or more of the outstanding voting securities at the time of
the closing of this offering or any group including any such person). No class
of outstanding Common Stock alone is entitled to elect any directors. There is
no cumulative voting with respect to the election of directors. Following the
offering, holders of the issued and outstanding Class B Common Stock (assuming
conversion of all outstanding convertible notes into Class B Common Stock and
excluding Class B Common Stock issuable upon the exercise of outstanding options
and warrants) will retain effective control of the Company through holding
approximately 73.0% of the combined

36
<PAGE> 37

voting power of the outstanding Common Stock (93.1% in those circumstances where
holders of Class B Common Stock have five votes per share) and will have the
ability to elect all of the directors of the Company and to effect or prevent
certain corporate transactions which require majority approval of the combined
classes, including mergers and other business combinations. See "Risk Factors --
Voting Rights; Control by Existing Stockholders."

Under the Company's Restated Certificate of Incorporation and the DGCL, the
holders of Class A Common Stock and Class B Common Stock are entitled to vote as
separate classes with respect to any amendment to the Company's Restated
Certificate of Incorporation that would increase or decrease the aggregate
number of authorized shares of any class, increase or decrease the par value of
the shares of any class, or modify or change the powers, preferences or special
rights of the shares of any class so as to affect such class adversely.

Dividends

Holders of the Class A Common Stock and the Class B Common Stock are
entitled to receive ratably such dividends, if any, as are declared by the
Company's Board of Directors out of funds legally available for that purpose,
provided, that dividends paid in shares of Class A Common Stock or Class B
Common Stock shall be paid only as follows: Shares of Class A Common Stock shall
be paid only to holders of Class A Common Stock and shares of Class B Common
Stock shall be paid only to holders of Class B Common Stock. The Company's
Restated Certificate of Incorporation provides that if there is any dividend,
subdivision, combination or reclassification of either class of Common Stock, a
proportionate dividend, subdivision, combination or reclassification of the
other class of Common Stock shall simultaneously be made.

Conversion; Limitation on Transferability of Class B Common Stock

The Class A Common Stock has no conversion rights. At the option of the
holder, each share of Class B Common Stock is convertible at any time, and from
time to time, into one share of Class A Common Stock. In the event of the
transfer or attempted transfer of shares of Class B Common Stock, except to
certain permitted transferees (including certain family members and trusts
established for their benefit, other holders of Class B Common Stock and
entities controlled by a holder of Class B Common Stock), or in the event that
transfered entities controlled by a holder of Class B Common Stock cease to be
so controlled, such shares of Class B Common Stock will automatically convert
into an equal number of shares of Class A Common Stock.

Other Rights

Stockholders of the Company have no preemptive or other rights to subscribe
for additional shares. In the event of the liquidation, dissolution or winding
up of the Company, holders of Class A Common Stock and Class B Common Stock are
entitled to share ratably in all assets available for distribution to holders of
Common Stock after payment in full of creditors. No shares of any class of
Common Stock are subject to a redemption or a sinking fund. All outstanding
shares are, and all shares offered by this Prospectus will be, when sold,
validly issued, fully paid and nonassessable.

Transfer Agent and Registrar

The Company has appointed American Stock Transfer & Trust Company as the
transfer agent and registrar for the Class A Common Stock.

PREFERRED STOCK

The Company is authorized to issue 2,000,000 shares of preferred stock. The
Board of Directors is authorized, without any further action by the
stockholders, to determine the voting rights, dividend rights, dividend rates,
liquidation preferences, redemption provisions, sinking fund terms, conversion
or exchange rights and other rights, preferences, privileges and restrictions of
any wholly unissued series of preferred stock and the number of shares
constituting any such series. In addition, such preferred stock could have other
rights, including economic rights senior to the Class A Common Stock, so that
the issuance of such preferred stock could adversely effect the market value of
the Class A Common Stock. The issuance of preferred stock

37
<PAGE> 38

may also have the effect of delaying, deferring or preventing a change in
control of the Company without any action by the stockholders.

The Company has issued and outstanding 360 shares of preferred stock
designated as Series A Cumulative Redeemable Preferred Stock, par value $.01 per
share (the "Series A Cumulative Redeemable Preferred Stock"), all of which is
held by one person. The holder of the Series A Cumulative Redeemable Preferred
Stock is entitled to a cumulative annual dividend of $60 per share payable upon
redemption as and if declared by the Board of Directors, which dividend shall be
declared and payable prior to any dividend being declared or paid upon the
Company's Common Stock or any other stock of the Company ranking junior to, or
on a parity with, the Series A Cumulative Redeemable Preferred Stock as to
dividends or liquidation rights. In the event of any liquidation, dissolution or
winding up of the Company, whether voluntary or involuntary, the holder of the
Series A Cumulative Redeemable Preferred Stock is entitled to receive a
liquidation preference of $1,000 per share plus the accrued dividends payable
thereon. The Series A Cumulative Redeemable Preferred Stock is redeemable, in
whole or in part, at any time at the option of the Company, at a price of $1,000
per share and must be redeemed by the Company by October 1997 at a price of
$1,000 per share.

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.

CERTAIN PROVISIONS OF THE COMPANY'S RESTATED CERTIFICATE OF INCORPORATION AND
BYLAWS

Certain provisions of the Company's Restated Certificate of Incorporation
and Bylaws summarized below may have an anti-takeover effect and may delay,
defer or prevent a tender offer or takeover attempt that a stockholder may
consider in its best interest, including attempts that might result in a premium
over the market price for the shares held by stockholders.

No Stockholder Action by Written Consent; Special Meetings

The Restated Certificate of Incorporation generally provides that
stockholder action may be taken only at an annual or special meeting of
stockholders and cannot be taken by written consent in lieu of a meeting. The
Restated Certificate of Incorporation and Bylaws also provide that, subject to
the rights of the holders of any class or series of Preferred Stock, special
meetings of the stockholders may only be called pursuant to a resolution adopted
by a majority of the Board of Directors. Stockholders are not permitted to call
a special meeting or to require the Board of Directors to call a special meeting
of stockholders. Any call for a meeting must specify the matters to be acted
upon at the meeting. Stockholders are not permitted to submit additional matters
or proposals for consideration at any special meeting.

Stockholder Proposals

The Bylaws establish an advance notice procedure for nominations (other
than by or at the direction of the Board) of candidates for election as
directors at, and for proposals to be brought before, an annual meeting of
stockholders of the Company. Subject to any other applicable requirements, only
such business may be conducted at an annual meeting as has been brought before
the meeting by, or at the direction of, the Board of

38
<PAGE> 39

Directors or by a stockholder who has given to the Secretary of the Company
timely written notice, in proper form, of the stockholder's intention to bring
that business before the meeting. In addition, only persons who are nominated
by, or at the direction of, the Board of Directors, or who are nominated by a
stockholder who has given timely written notice, in proper form, to the
Secretary prior to a meeting at which directors are to be elected, will be
eligible for election as directors of the Company.

Amendment of Certain Certificate Provisions

The Restated Certificate of Incorporation requires the affirmative vote of
the holders of at least 80% of the outstanding shares of the Company's stock
generally entitled to vote to amend the provisions of the Restated Certificate
of Incorporation and the Bylaws described in the preceding two paragraphs.

SECTION 203 OF THE DELAWARE GENERAL CORPORATION LAW

The Company is subject to Section 203 of the DGCL, which generally
prohibits a publicly held Delaware corporation from engaging in a "business
combination" with an "interested stockholder" for a period of three years after
the date of the transaction in which the person became an interested
stockholder, unless (i) prior to such date the Board of Directors of the
corporation approved either the business combination or the transaction in which
the person became an interested stockholder, (ii) upon consummation of the
transaction that resulted in the stockholder becoming an interested stockholder,
the interested stockholder owned at least 85% of the outstanding voting stock of
the corporation excluding shares owned by directors who are also officers of the
corporation and by certain employee stock plans, or (iii) on or after such date
the business combination is approved by the Board of Directors of the
corporation and by the affirmative vote of at least 66 2/3% of the outstanding
voting stock of the corporation that is not owned by the interested stockholder.
A "business combination" generally includes mergers, asset sales and similar
transactions between the corporation and the interested stockholder, and other
transactions resulting in a financial benefit to the stockholder. An "interested
stockholder" is a person who, together with affiliates and associates, owns 15%
or more of the corporation's voting stock or who is an affiliate or associate of
the corporation and, together with his affiliates and associates, has owned 15%
or more of the corporation's voting stock within three years.

SELLING SECURITY HOLDERS

The Selling Security Holders are (i) Combination, the purchaser of the
Series G Preferred Stock and 150,000 Placement Warrants (which are exercisable
at $1.38 per share) in connection with the placement of the Series G Preferred
Stock; (ii) Wharton Capital Partners, Ltd., which received 75,000 Placement
Warrants in connection with the placement of the Series G Preferred Stock; (iii)
Mr. Kevin Kimberlin, who purchased 360,000 shares of Class A Common Stock
(including 60,000 warrants exercisable at $1.00 per share); (iv) Mr. Michael
Seedman, who purchased 240,000 shares of Class A Common Stock (including 40,000
warrants exercisable at $1.00 per share; (v) Mr. Nicholas Negroponte, who
purchased 60,000 shares of Class A Common Stock (including 10,000 warrants
exercisable at $1.00 per share); (vi) Media Technologies, which purchased 60,000
shares of Class A Common Stock (including 10,000 warrants exercisable at $1.00
per share); (vii) Mr. Jan Murray, who purchased 120,000 shares of Class A Common
Stock (including 20,000 warrants exercisable at $1.00 per share); (viii)
Mongoose Executive Pension Trust, which purchased 120,000 shares of Class A
Common Stock (including 20,000 warrants exercisable at $1.00 per share); (ix)
Aladdin Knowledge Systems, which purchased 500,000 shares of Class A Common
Stock; (x) Messrs. Richard Chemel, Bobby Orbach and Martin Wargon, who
collectively received 47,000 shares of Class A Common Stock for services
rendered; and (xi) ChipShots Associates LLC which received 25,871 shares of
Class A Common Stock in an exchange transaction.

The following table sets forth the names of the Selling Security Holders,
the number of shares of Class A Common Stock beneficially owned by each of the
Selling Security Holders, and the number of shares which may be offered for
resale pursuant to this Prospectus. For the purpose of calculating the number of
shares of Class A Common Stock beneficially owned by the holder of the Series G
Preferred Stock, the number of shares of Class A Common Stock calculated to be
issuable upon conversion is based upon a conversion price of $1.12 per share
(without taking into account shares issuable as dividends). The conversion price
for the Series G Preferred Stock is the lower of: (a) $1.12 and (b) 80% of the
average of the five (5) lowest trading

39
<PAGE> 40

prices during the twenty-five (25) calendar days immediately preceding the
conversion date. Holders of the Series G Preferred Stock are entitled to
quarterly dividends at a rate of 6% per annum, payable in cash, or, subject to
certain conditions, shares of Class A Common Stock. The actual number of shares
issuable upon conversion of the Series G Preferred Stock and available for
resale under this Prospectus could be materially greater based upon the market
price of the Class A Common Stock at the time or times of conversion. The number
of shares shown as being offered hereunder by the holder of the Series G
Preferred Stock is the number of shares registered by the Registration Statement
of which this Prospectus is a part with respect to shares issuable upon
conversion of and as dividends on the Series G Preferred Stock, pursuant to the
terms of the Registration Agreement.

The information included below is based upon information provided by the
Selling Security Holders. Because the Selling Security Holders may offer all,
some or none of their shares, no definitive estimate as to the number of shares
that will be held by the Selling Security Holders after such offering can be
provided.

<TABLE>
<CAPTION>
NUMBER OF SHARES OF CLASS A NUMBER OF SHARES OF
COMMON STOCK BENEFICIALLY CLASS A COMMON STOCK
SELLING SECURITY HOLDER OWNED PRIOR TO THE OFFERING BEING OFFERED
----------------------- --------------------------- --------------------
<S> <C> <C>
Combination Inc.................................... 3,559,090(1) 7,116,386(14)
Wharton Capital Partners, Ltd...................... 193,750(2) 75,000
Kevin Kimberlin.................................... 382,000(3) 360,000
Michael Seedman.................................... 240,000(4) 240,000
Nicholas Negroponte................................ 60,000(5) 60,000
Media Technologies................................. 60,000(6) 60,000
Jan Murray......................................... 120,000(7) 120,000
Mongoose Executive Pension Trust................... 120,000(8) 120,000
Aladdin Knowledge Systems, Ltd..................... 4,537,973(9) 500,000
ChipShots Associates LLC........................... 25,871(10) 25,871
Richard Chemel..................................... 18,000(11) 18,000
Bobby Orbach....................................... 20,000(12) 20,000
Martin Wargon...................................... 9,000(13) 9,000
--------- ----------
TOTAL......................................... 9,345,684 8,724,257
========= ==========
</TABLE>

- ------------------------

(1) Represents shares held plus shares issuable upon a hypothetical conversion
of 150,000 shares of Series G Preferred Stock, with a stated value of
$3,000,000 acquired on March 6, 1998 and 150,000 shares issuable upon
exercise of Purchase Warrants.

(2) Represents shares issuable upon exercise of warrants. 37,500 shares of
Class A Common Stock issuable upon the exercise of a warrant issued to
Wharton Capital Partners, Ltd. in connection with the placement of the
Series C Preferred Stock, par value $.01, were registered pursuant to a
registration statement filed with the Commission on January 17, 1997 which
was amended on March 7, 1997 and March 21, 1997. 25,000 shares of Class A
Common Stock issuable upon the exercise of a warrant issued to Wharton
Capital Partners, Ltd. in connection with the placement of the Series D
Preferred Stock, par value $.01, were registered pursuant to a registration
statement filed with the Commission on June 9, 1997, which was amended on
June 16, 1997. 56,250 shares of Class A Common stock issuable upon the
exercise of a warrant issued to Wharton Capital Partners, Ltd. in
connection with the placement of the Series F Preferred Stock, par value
$.01, were registered pursuant to a registration statement filed with the
Commission on October 20, 1997, which was amended December 5, 1997.

(3) Represents (i) 22,000 shares held by Kevin Kimberlin Partners, LP, of which
Mr. Kimberlin is a general partner. Mr. Kimberlin disclaims beneficial
ownership of all but his proportional interest in the partnership,
representing 3,220 shares. (ii) 300,000 shares of Class A Common Stock and
60,000 shares issuable upon exercise of a warrant sold to Mr. Kimberlin
pursuant to a Stock and Warrant Purchase Agreement dated September 22,
1997, which shares are entitled to certain piggyback registration rights.

40
<PAGE> 41

(4) Represents (i) 200,000 shares of Class A Common Stock and (ii) 40,000
shares issuable upon exercise of a warrant sold to Mr. Seedman pursuant to
a Stock and Warrant Purchase Agreement dated September 16, 1997, which
shares are entitled to certain piggyback registration rights.

(5) Represents (i) 50,000 shares of Class A Common Stock and (ii) 10,000 shares
issuable upon exercise of a warrant sold to Mr. Negroponte pursuant to a
Stock and Warrant Purchase Agreement dated September 16, 1997, which shares
are entitled to certain piggyback registration rights.

(6) Represents (i) 50,000 shares of Class A Common Stock and (ii) 10,000 shares
issuable upon exercise of a warrant sold to Media Technologies pursuant to
a Stock and Warrant Purchase Agreement dated September 16, 1997, which
shares are entitled to certain piggyback registration rights.

(7) Represents (i) 100,000 shares of Class A Common Stock and (ii) 20,000
shares issuable upon exercise of a warrant sold to Mr. Murray pursuant to a
Stock and Warrant Purchase Agreement dated September 16, 1997, which shares
are entitled to certain piggyback registration rights.

(8) Represents (i) 100,000 shares of Class A Common Stock and (ii) 20,000
shares issuable upon exercise of a warrant sold to Mongoose Executive
Pension Trust pursuant to a Stock and Warrant Purchase Agreement dated
September 16, 1997, which shares are entitled to certain piggyback
registration rights.

(9) Represents shares held and 39,500 shares of Class A Common Stock which are
subject to options presently exercisable or exercisable within 60 days.

(10) Represents 25,871 shares of Class A Common Stock issued in an exchange
transaction with ChipShots Associates LLC.

(11) Represents 18,000 shares of Class A Common Stock issued to Mr. Chemel as
payment for consultancy services rendered during 1997.

(12) Represents 20,000 shares of Class A Common Stock issued to Mr. Orbach as
payment for consultancy services rendered during 1997.

(13) Represents 9,000 shares of Class A Common Stock issued to Mr. Wargon as
payment for consultancy services rendered during 1997.

(14) The number of shares of Class A Common Stock registered pursuant to the
registration statement of which this Prospectus is a part and the number of
shares of Class A Common Stock offered hereby have been determined by
agreement between the Company and Combination. Because the number of shares
of Class A Common Stock that will ultimately be issued to Combination upon
conversion of the Series G Preferred Stock is dependent upon the conversion
formula described above, such number of shares (and therefore the number of
shares of Class A Common Stock offered hereby) cannot be determined at this
time.

PLAN OF DISTRIBUTION

The shares of Class A Common Stock offered hereby may be offered for resale
by the Selling Security Holders (or their donees, transferees or successors in
interest) from time to time in transactions for their own account (which may
include block transactions) on any national securities exchange or quotation
service on which the Class A Common Stock may be listed or quoted at the time of
sale, in the over-the-counter market, in transactions otherwise than on such
exchanges (including privately negotiated transactions) or in the
over-the-counter market, through the writing of options, or a combination of
such methods of sale, at fixed prices (which may be changed), at market prices
prevailing at the time of sale, at prices related to such prevailing market
prices or at negotiated prices. The Selling Security Holders may effect such
transactions by selling the shares of Class A Common Stock to or through
broker-dealers, and such broker-dealers may receive compensation in the form of
discounts, concessions or commissions from the Selling Security Holders and/or
the purchasers of shares for whom such broker-dealers may act as agent or to
whom they sell as principal, or both (which compensation as to a particular
broker-dealer might be in excess of customary commissions). From time to time
the Selling Security Holders may engage in short sales, including short sales
against the box, puts and calls and other transactions in securities of the
Company or derivatives thereof, and may sell and deliver the Class A Common
Stock in connection therewith. Further, except as set forth herein,

41
<PAGE> 42

the Selling Security Holders are not restricted as to the number of shares which
may be sold at any one time, and it is possible that a significant number of
shares could be sold at the same time, which may have a depressive effect on the
market price of the Company's Class A Common Stock. The Selling Security Holders
may also pledge shares of Class A Common Stock as collateral for margin
accounts, and such shares could be resold pursuant to the terms of such
accounts. The Selling Security Holders and any dealers or agents participating
in the distribution of the Class A Common Stock may be deemed to be
"underwriters" as defined in the Securities Act and any profit on the sale of
the Class A Common Stock by them and any discounts, commissions or concessions
received by any such dealers or agents might be deemed to be underwriting
discounts and commissions under the Securities Act. The Company will not receive
any proceeds of the sales of the Class A Common Stock by the Selling Security
Holders.

To comply with the securities laws of certain jurisdictions, if applicable,
the Class A Common Stock will be offered or sold in such jurisdictions only
through registered or licensed brokers or dealers. In addition, in certain
jurisdictions the Class A Common Stock may not be offered or sold unless they
have been registered or qualified for sale in such jurisdictions or an exemption
from registration or qualification is available and is complied with.

Under applicable rules and regulations under the Exchange Act, any person
engaged in a distribution of the Class A Common Stock may not simultaneously
engage in market-making activities with respect to such securities for a period
of two to nine business days prior to the commencement of such distribution. In
addition to and without limiting the foregoing, each Selling Security Holder and
any other person participating in a distribution will be subject to applicable
provisions of the Exchange Act and the rules and regulations thereunder,
including without limitation Regulation M, which may limit the timing of
purchases and sales of any of the securities by the Selling Security Holders or
any such other person. All of the foregoing may affect the marketability of the
Class A Common Stock and the brokers' and dealers' ability to engage in
market-making activities with respect to these securities.

Pursuant to the Registration Agreement, all expenses of the registration of
the Class A Common Stock will be paid by the Company, including, without
limitation, Commission filing fees and expenses of compliance with state
securities or "blue sky" laws; provided, however, that the Selling Security
Holders will pay all underwriting discounts and selling commissions, if any. The
Selling Security Holders will be indemnified by the Company against certain
civil liabilities, including certain liabilities under the Securities Act, or
will be entitled to contribution in connection therewith. The Company will be
indemnified by the Selling Security Holders against certain civil liabilities,
including certain liabilities under the Securities Act, or will be entitled to
contribution in connection therewith.

LEGAL MATTERS

The validity of the securities offered hereby will be passed upon for the
Company by Curtis, Mallet-Prevost, Colt & Mosle, New York, New York.

EXPERTS

The consolidated financial statements of Wave Systems Corp. and
Subsidiaries as of December 31, 1997 and 1996, and for each of the years in the
three-year period ended December 31, 1997 and for the period from February 12,
1988 (inception) to December 31, 1997, included herein and elsewhere in the
Registration Statement have been included herein and in the Registration
Statement in reliance upon the report of KPMG Peat Marwick LLP, independent
certified public accountants, appearing elsewhere herein upon the authority of
said firm as experts in accounting and auditing. The report of KPMG Peat Marwick
LLP covering the December 31, 1997 consolidated financial statements contains an
explanatory paragraph that states that the Company's recurring losses from
operations since inception raise substantial doubt about the Company's 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.

42
<PAGE> 43

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-10
Notes to Consolidated Financial Statements.................. F-12
</TABLE>

F-1
<PAGE> 44

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.

/s/ KPMG PEAT MARWICK LLP

Boston, Massachusetts
March 27, 1998

F-2
<PAGE> 45

WAVE SYSTEMS CORP. AND SUBSIDIARIES
(A DEVELOPMENT STAGE CORPORATION)

CONSOLIDATED BALANCE SHEETS

DECEMBER 31, 1997 AND 1996

<TABLE>
<CAPTION>
1997 1996
------------ -----------
<S> <C> <C>
ASSETS
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, $.01 par
value.
360 shares issued and outstanding in 1997 and 1996;
involuntary
liquidation value, $471,601............................... 471,601 432,334
Series B Preferred Stock, $.01 par value. 20 shares issued
and
outstanding in 1996....................................... -- 195,520
Series C Convertible Preferred Stock $.01 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, $.01 par value. Authorized 2,000,000
shares; 360 shares issued and outstanding as Series A
Cumulative Redeemable Preferred Stock.................. -- --
Common stock, $.01 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
============ ===========
</TABLE>

See accompanying notes to consolidated financial statements.
F-3
<PAGE> 46

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

<TABLE>
<CAPTION>
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)
============ ========== ========== ===========
</TABLE>

See accompanying notes to consolidated financial statements.
F-4
<PAGE> 47

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
<TABLE>
<CAPTION>
DEFICIT
CLASS A CLASS B ACCUMULATED
COMMON STOCK COMMON STOCK CAPITAL DURING THE
--------------------- --------------------- 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)

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>

F-5
<PAGE> 48

WAVE SYSTEMS CORP. AND SUBSIDIARIES
(A DEVELOPMENT STAGE CORPORATION)

NOTE
RECEIVABLE
DEFERRED FROM
COMPENSATION STOCKHOLDER TOTAL
------------ ----------- -----------
<S> <C> <C> <C>
BALANCE AT DECEMBER 31, 1991 (BROUGHT
FORWARD)................................... -- -- (1,169,089)
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.... -- -- (4,182,618)
-------- -------- -----------
BALANCE AT DECEMBER 31, 1992 (CARRIED
FORWARD)................................... (243,205) (152,974) 182,574
</TABLE>

F-6
<PAGE> 49

WAVE SYSTEMS CORP. AND SUBSIDIARIES
(A DEVELOPMENT STAGE CORPORATION)

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIENCY) -- (CONTINUED)
<TABLE>
<CAPTION>
DEFICIT
CLASS A CLASS B ACCUMULATED
COMMON STOCK COMMON STOCK CAPITAL DURING THE
--------------------- --------------------- IN 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
FORWARD)................................... 3,728,200 37,282 9,757,297 97,573 28,534,990 (15,909,988)
---------- -------- ---------- -------- ---------- -----------

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>

F-7
<PAGE> 50

WAVE SYSTEMS CORP. AND SUBSIDIARIES
(A DEVELOPMENT STAGE CORPORATION)

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIENCY) -- (CONTINUED)
<TABLE>
<CAPTION>
DEFICIT
CLASS A CLASS B ACCUMULATED
COMMON STOCK COMMON STOCK CAPITAL DURING THE
--------------------- --------------------- IN 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 the issuance of
convertible debt and preferred stock....... -- -- -- -- 283,455 --
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 (CARRIED
FORWARD)................................... 11,582,086 115,821 6,208,141 62,081 33,052,432 (31,426,669)
---------- -------- ---------- -------- ---------- -----------

NOTE
RECEIVABLE
DEFERRED FROM
COMPENSATION STOCKHOLDER TOTAL
------------ ----------- -----------
<S> <C> <C> <C>
BALANCE AT DECEMBER 31, 1994 (BROUGHT
FORWARD)................................... -- (210,072) 12,549,785
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 (CARRIED
FORWARD)................................... -- (244,705) 1,558,960
-------- -------- -----------
</TABLE>

F-8
<PAGE> 51

WAVE SYSTEMS CORP. AND SUBSIDIARIES
(A DEVELOPMENT STAGE CORPORATION)

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIENCY) -- (CONTINUED)
<TABLE>
<CAPTION>
DEFICIT
CLASS A CLASS B ACCUMULATED
COMMON STOCK COMMON STOCK CAPITAL DURING THE
--------------------- --------------------- IN EXCESS OF DEVELOPMENT
SHARES AMOUNT SHARES AMOUNT PAR VALUE STAGE
---------- -------- ---------- -------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1996 (BROUGHT
FORWARD)................................... 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)
========== ======== ========== ======== ========== ===========

NOTE
RECEIVABLE
DEFERRED FROM
COMPENSATION STOCKHOLDER TOTAL
------------ ----------- -----------
<S> <C> <C> <C>
BALANCE AT DECEMBER 31, 1996 (BROUGHT
FORWARD)................................... -- (244,705) 1,558,960
Exercise of options to purchase Class A and B
common stock............................... -- -- 139,888
Shares issued at prices ranging from $1.00
per share to $3.00 per share as
compensation for services rendered......... -- -- 305,496
Conversion of preferred stock into common
stock...................................... -- -- 6,783,017
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)
======== ======== ===========
</TABLE>

See accompanying notes to consolidated financial statements.

F-9
<PAGE> 52

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

<TABLE>
<CAPTION>
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)
------------ ---------- ----------- -----------
</TABLE>

F-10
<PAGE> 53

<TABLE>
<CAPTION>
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................................. 3,555,501 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
============ ========== =========== ===========
</TABLE>

See accompanying notes to consolidated financial statements.
F-11
<PAGE> 54

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.

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.

(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

F-12
<PAGE> 55
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(A DEVELOPMENT STAGE CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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.

(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

F-13
<PAGE> 56
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(A DEVELOPMENT STAGE CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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.

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

F-14
<PAGE> 57
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(A DEVELOPMENT STAGE CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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.

(4) PROPERTY AND EQUIPMENT

Property and equipment as of December 31 consisted of the following:

<TABLE>
<CAPTION>
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.

F-15
<PAGE> 58
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(A DEVELOPMENT STAGE CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(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").

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.

F-16
<PAGE> 59
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(A DEVELOPMENT STAGE CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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.

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.

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.

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

F-17
<PAGE> 60
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(A DEVELOPMENT STAGE CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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.

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

F-18
<PAGE> 61
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(A DEVELOPMENT STAGE CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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.

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

F-19
<PAGE> 62
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(A DEVELOPMENT STAGE CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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.

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:

<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Expected Life (Years)................................... 10 10 10
Interest Rate........................................... 6.5% 6.4% 5.6%
Volatility.............................................. 111% 124% 135%
Dividend Yield.......................................... 0% 0% 0%
</TABLE>

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.

F-20
<PAGE> 63
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(A DEVELOPMENT STAGE CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

SUMMARY OF OPTION ACTIVITY

A summary of option activity through December 31, 1997 follows:

<TABLE>
<CAPTION>
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) 2.49
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.

The following table summarizes information about stock options outstanding
at December 31, 1997:

<TABLE>
<CAPTION>
WEIGHTED
WEIGHTED AVERAGE
AVERAGE REMAINING
NUMBER NUMBER EXERCISE CONTRACTUAL
RANGE OF EXERCISE PRICES OUTSTANDING EXERCISABLE PRICE LIFE
------------------------ ----------- ----------- -------- -----------
<S> <C> <C> <C> <C>
$1.06........................... 131,250 6,417 $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>

F-21
<PAGE> 64
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(A DEVELOPMENT STAGE CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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.

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 exerciseable 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.

F-22
<PAGE> 65
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.

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.

F-23
<PAGE> 66
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(A DEVELOPMENT STAGE CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(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.

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-

F-24
<PAGE> 67
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(A DEVELOPMENT STAGE CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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.

(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.
F-25
<PAGE> 68
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(A DEVELOPMENT STAGE CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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.

(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:

<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31 OPERATING LEASE
- ----------------------- ---------------
<S> <C>
1998................................... $245,151
1999................................... 107,922
2000................................... 65,280
--------
$418,353
========
</TABLE>

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.

(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.

F-26
<PAGE> 69
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(A DEVELOPMENT STAGE CORPORATION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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>
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.

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 exercise price of $1.38

F-27
<PAGE> 70

PART II
INFORMATION NOT REQUIRED IN PROSPECTUS

ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION

The following table sets forth the various expenses to be paid by the
Company in connection with the sale of the securities being registered, other
than sales commissions. All of the amounts shown are estimated except the
Commission registration fee.

<TABLE>
<S> <C>
Commission registration fee.............................. $ 4,787
Accounting fees and expenses............................. 15,000
Printing expenses........................................ 5,000
Miscellaneous............................................ 1,213
Legal fees and expenses.................................. 25,000
-------
Total.................................................. $51,000
=======
</TABLE>

ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS

In accordance with Section 102(b)(7) of the Delaware General Corporation
Law (the "DGCL"), the Restated Certificate of Incorporation of the Company
contains a provision to limit the personal liability of the directors of the
Company for violations of their fiduciary duties. This provision eliminates each
director's liability to the Company or its stockholders for monetary damages
except (i) for any breach of the director's duty of loyalty to the Company or
its stockholders, (ii) for acts or omissions not in good faith or which involve
intentional misconduct or a knowing violation of law, (iii) under Section 174 of
the DGCL providing for liability of directors for unlawful payment of dividends
or unlawful stock purchases or redemptions, or (iv) for any transaction from
which the director derived an improper personal benefit. The effect of this
provision is to eliminate the personal liability of directors for monetary
damages for actions involving a breach of their fiduciary duty of care,
including any such actions involving gross negligence. Also, there may be
certain liabilities, such as those under the federal securities laws or other
state or federal laws, which a court may hold are unaffected by the Restated
Certificate of Incorporation.

The Restated Certificate of Incorporation also provides that if the DGCL is
amended to further eliminate or limit the liability of directors, then the
liability of a director of the Company shall be so eliminated or limited,
without further stockholder action, to the fullest extent permissible under the
DGCL as so amended.

Section 145 of the DGCL provides that a corporation may indemnify any
person, including officers and directors, who are, or are threatened to be made,
parties to any threatened, pending or completed legal action, suit or
proceeding, whether civil, criminal, administrative or investigative (other than
an action by or in the right of such corporation), by reason of the fact that
such person was an officer, director, employee or agent of such corporation, or
is or was serving at the request of such corporation as a director, officer,
employee or agent of another corporation. The indemnity may include expenses
(including attorneys' fees), judgments, fines and amounts paid in settlement
actually and reasonably incurred by such person in connection with such action,
suit or proceeding, provided such officer, director, employee or agent acted in
good faith and in a manner he reasonably believed to be in or not opposed to the
corporation's best interests and, for criminal proceedings, had no reasonable
cause to believe that his conduct was unlawful. A Delaware corporation may
indemnify officers and directors in an action by or in the right of the
corporation under the same conditions, except that no indemnification is
permitted without judicial approval if the officer or director is adjudged to be
liable to the corporation. Where an officer or director is successful on the
merits or otherwise in defense of any action referred to above, the corporation
must indemnify him against the expenses which such officer or director actually
or reasonably incurred. The Bylaws of the Company provide for indemnification of
the officers and directors to the fullest extent permitted by the DGCL. In
addition, the Company maintains officers' and directors' liability insurance
which insures against liabilities that officers and directors of the Company may
incur in such capacities.

II-1
<PAGE> 71

ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES

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, exercisable 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
II-2
<PAGE> 72

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.

On December 27, 1996 the Company issued 150,000 shares of newly created
Series C Convertible Preferred Stock, par value $.01 (the "Series C Preferred
Stock"), at a price of $20 per share, for an aggregate price of $3,000,000. The
Series C Preferred Stock was sold to one (1) accredited investor pursuant to
Regulation D promulgated under the Act. The Series C Preferred Stock is
convertible into the Class A Common Stock at an effective conversion price of
the lower of (i) $2.31, or (ii) 80%, which is subject to adjustment, 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 that the holders of the Series C Preferred Stock choose to convert the
Series C Preferred Stock into the Class A Common Stock. In addition to the
Series C Preferred Stock, the Company also issued warrants to purchase a total
of 75,000 shares of Class A Common Stock at an exercise price of $2.54 per share
as part of the aforementioned transaction. As of July 23, 1997, all of the
shares of the Series C Preferred stock have been converted into Class A Common
Stock.

On May 29, 1996 the Company issued 350 shares of newly created Series B
Preferred Stock, par value $.01 (the "Series B Preferred Stock"), at a price of
$10,000 per share, for an aggregate price of $3,500,000. The Series B Preferred
Stock was sold to five (5) off-shore investors pursuant to Regulation S
promulgated under the Act. The Series B Preferred Stock was convertible into the
Class A Common Stock at an effective conversion price of the lower of (i) $3.01,
or (ii) 85% 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 that the holders of the Series B Preferred Stock
chose to convert the Series B Preferred Stock into the Class A Common Stock. As
of March 17, 1997, all of the shares of Series B Preferred Stock have been
converted into Class A Common Stock.

ITEM 16. EXHIBITS AND FINANCIAL STATEMENTS SCHEDULES

<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION OF EXHIBIT
- ----------- ----------------------
<C> <S>
4.1 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)
4.2 Bylaws of Registrant (incorporated by reference to Exhibit
3.2 of the Registrant's Registration Statement on Form S-1,
File No. 33-75286)
4.3 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,
Registration No. 33-75286)
4.4 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)
4.5 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)
4.6 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)
4.7 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)
4.8 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)
</TABLE>

II-3
<PAGE> 73

<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION OF EXHIBIT
- ----------- ----------------------
<C> <S>
4.9 Purchase Agreement between Wave Systems Corp. and
Combination Inc., dated as of March 6, 1998 (incorporated by
reference to Exhibit 4.1 of the Registrant's Current Report
on Form 8-K filed on March 19, 1998, File No. 0-24752)
4.10 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)
4.11 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)
4.12 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)
4.13 Registration Rights Agreement between Wave Systems Corp. and
Combination Inc., 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)
4.14 Certificate of Amendment to Restated Certificate of
Incorporation (as filed with Secretary of State of Delaware
on July 17, 1997)
*5.1 Opinion of Curtis, Mallet-Prevost, Colt & Mosle
+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)
</TABLE>

II-4
<PAGE> 74

<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION OF EXHIBIT
- ----------- ----------------------
<C> <S>
10.12 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).
10.13 Wave Systems Corp. 1996 Performance Stock Option Plan
*23.1 Consent of Curtis, Mallet-Prevost, Colt & Mosle (included as
part of Exhibit 5.1 hereto)
23.2 Consent of KPMG Peat Marwick LLP
24.1 Power of Attorney (included on signature pages)
</TABLE>

- ---------------

* To be filed as an amendment.

(b) Financial Statement Schedules:

All schedules have been omitted since they are either not required or not
applicable.

ITEM 17. UNDERTAKINGS

The undersigned registrant hereby undertakes:

(1) To file, during any period in which offers or sales are being
made, a post-effective amendment to this registration statement:

(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act;

(ii) To reflect in the prospectus any facts or events arising after
the effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth
in the registration statement. Notwithstanding the foregoing, any
increase or decrease in the volume of securities offered (if the total
dollar value of securities offered would not exceed that which was
registered) and any deviation from the low or high end of the estimated
maximum offering range may be reflected in the form of a prospectus
filed with the Commission pursuant to Rule 424(b) if, in the aggregate,
the changes in volume and price represent no more than a 20% change in
the maximum aggregate offering price set forth in the "Calculation of
Registration Fee" table in the effective registration statement;

(iii) To include any material information with respect to the plan
of distribution not previously disclosed in the registration statement
or any material change to such information in the registration
statement;

Provided, however, that paragraphs (1)(i) and (1)(ii) do not apply if
the registration statement is on Form S-3 or Form S-8, and the
information required to be included in a post-effective amendment by
those paragraphs is contained in periodic reports filed by the
registrant pursuant to Section 13 or Section 15(d) of the Exchange Act
that are incorporated by reference in the registration statement.

(2) That, for the purpose of determining any liability under the
Securities Act, each such post-effective amendment shall be deemed to be a
new registration statement relating to the securities offered therein, and
the offering of such securities at that time shall be deemed to be the
initial bona fide offering thereof.

(3) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the
termination of the offering.

Insofar as indemnification for liabilities arising under the
Securities Act may be permitted to directors, officers and controlling
persons of the registrant pursuant to the foregoing provisions, or
otherwise, the Company has been advised that in the opinion of the
Commission such indemnification is against public policy as expressed in
the Securities Act and is, therefore, unenforceable. In the event that a
claim for indemnification against such liabilities (other than payment by
the Company of expenses

II-5
<PAGE> 75

incurred or paid by a director, officer or controlling person of the
Company in the successful defense of any action, suit or proceeding) is
asserted by such director, officer or controlling person in connection with
the securities being registered, the Company will, unless in the opinion of
its counsel the matter has been settled by controlling precedent, submit to
a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the
Securities Act and will be governed by the final adjudication of such
issue.

II-6
<PAGE> 76

SIGNATURES

Pursuant to the requirements of the Securities Act of 1933, the registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-1 and has duly caused this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of New York, State of New York, on the 15th day of
April, 1998.

Wave Systems Corp.

By: /s/ PETER J. SPRAGUE
------------------------------------
Name: Peter J. Sprague
Title: Chairman and Chief Executive
Officer

POWER OF ATTORNEY

KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below hereby constitutes and appoints Peter J. Sprague and Steven Sprague and
each of them, his true and lawful attorneys-in-fact and agents, with full power
of substitution and resubstitution, for him or her and in his or her name, place
and stead, in any and all capacities, to sign any and all amendments (including
post-effective amendments) to this Registration Statement, and to file the same,
with all exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, and each of them, full power and authority to do and perform each and
every act and thing requisite and necessary to be done in and about the
premises, as full to all intents and purposes as he or she might or could do in
person, hereby ratifying and confirming all that said attorneys-in-fact and
agents or any of them, or their or his or her substitute or substitutes, may
lawfully do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the dates indicated.

<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ PETER J. SPRAGUE Chairman and Chief Executive April 15, 1998
- --------------------------------------------------- Officer (Chief Executive
Peter J. Sprague Officer, Principal Financial
Officer and Principal
Accounting Officer)

/s/ STEVEN SPRAGUE President, Chief Operating April 15, 1998
- --------------------------------------------------- Officer and Director
Steven Sprague

/s/ JOHN E. BAGALAY, JR. Director April 15, 1998
- ---------------------------------------------------
John E. Bagalay, Jr.

Director
- ---------------------------------------------------
Philippe Bertin

/s/ GEORGE GILDER Director April 15, 1998
- ---------------------------------------------------
George Gilder

/s/ JOHN E. MCCONNAUGHY, JR. Director April 15, 1998
- ---------------------------------------------------
John E. McConnaughy, Jr.
</TABLE>

II-7
<PAGE> 77

EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION PAGE
- ----------- ----------- ----
<C> <S> <C>
4.1 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)...................................................
4.2 Bylaws of Registrant (incorporated by reference to Exhibit
3.2 of the Registrant's Registration Statement on Form S-1,
File No. 33-75286)..........................................
4.3 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,
Registration No. 33-75286)..................................
4.4 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)................................
4.5 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).............................
4.6 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).....
4.7 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)........
4.8 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)......
4.9 Purchase Agreement between Wave Systems Corp. and
Combination Inc., dated as of March 6, 1998 (incorporated by
reference to Exhibit 4.1 of the Registrant's Current Report
on Form 8-K filed on March 19, 1998, File No. 0-24752)......
4.10 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)......
4.11 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)....
4.12 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)....................................................
4.13 Registration Rights Agreement between Wave Systems Corp. and
Combination Inc., 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)....................................................
4.14 Certificate of Amendment to Restated Certificate of
Incorporation (as filed with Secretary of State of Delaware
on July 17, 1997)...........................................
*5.1 Opinion of Curtis, Mallet-Prevost, Colt & Mosle.............
+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)..........................................
</TABLE>
<PAGE> 78

<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION PAGE
- ----------- ----------- ----
<C> <S> <C>
+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 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).................................
10.13 Wave Systems Corp. 1996 Performance Stock Option Plan.......
*23.1 Consent of Curtis, Mallet-Prevost, Colt & Mosle (included as
part of Exhibit 5.1 hereto).................................
23.2 Consent of KPMG Peat Marwick LLP............................
24.1 Power of Attorney (included on signature pages).............
</TABLE>

- ---------------

* To be filed as an amendment.

<PAGE> 1

EXHIBIT 4.14

CERTIFICATE OF AMENDMENT OF

RESTATED CERTIFICATE OF INCORPORATION

WAVE SYSTEMS CORP.

Wave Systems Corp. (hereinafter called the "corporation"), a corporation
organized and existing under and by virtue of the General Corporation Law of the
State of Delaware, DOES HEREBY CERTIFY:

1. The name of the corporation is Wave Systems Corp.

2. The Restated Certificate of Incorporation of the corporation is
hereby amended by amending Article FOURTH, paragraph 1 thereof so that said
paragraph shall be and read as follows:

"FOURTH: (1) The total number of shares of stock which the Corporation
shall have authority to issue is Sixty-Five Million (65,000,000) shares divided
into the following classes:

(a) Fifty Million (50,000,000) shares of Class A Common Stock with a par
value of one cent ($0.01) per share;

(b) Thirteen Million (13,000,000) shares of Class B Common Stock with a
par value of one cent ($0.01) per share; and

3. The amendment of the Restated Certificate of Incorporation herein
certified has been duly adopted in accordance with the provisions of Sections
222 and 242 of the General Corporation Law of the State of Delaware.

IN WITNESS WHEREOF, we have made and signed this certificate this 17th day
of July, 1997.

/s/ PETER J. SPRAGUE
-------------------------
Name: Peter J. Sprague
Title: Chief Executive

Attest:
/s/ GAIL TITUS
----------------------
Gail Titus
Secretary

<PAGE> 1

EXHIBIT 10.13

WAVE SYSTEMS CORP.

1996 PERFORMANCE STOCK OPTION PLAN

I. PURPOSES AND SCOPE OF PLAN

Under this 1996 Performance Stock Option Plan (the "Plan") of Wave Systems
Corp. (the "Company"), options shall be granted to employees of the Company or
any of its subsidiaries, consultants and others to purchase shares of the
Company's capital stock. The Plan is designed to enable the Company to attract
and retain the best available personnel, to provide additional incentive to
employees, consultants and others and to promote the success of the Company.
These objectives will be promoted through the granting to employees equity
instruments including (i) incentive stock options ("Incentive Options") which
are intended to qualify under Section 422 of the Internal Revenue Code of 1986,
as amended (the "Code") and (ii) options which are not intended to so qualify
("NQSOs"). Vesting of the performance options granted under the Plan shall be in
accordance with the criteria established by the Compensation Committee (the
"Committee"), or the Board of Directors of the Company (the "Board of
Directors") if there is no Committee, as provided in Article V, Section 1 of
this Agreement.

The options offered pursuant to this Plan are a matter of separate
inducement and are not in lieu of any salary or other compensation for services.

II. AMOUNT OF STOCK SUBJECT TO THE PLAN

The total number of shares of common stock of the Company reserved and
available for distribution pursuant to options granted hereunder shall not
exceed, in the aggregate, 800,000 shares of the authorized Class A common stock,
$0.01 par value, per share, of the Company (the "Shares"), subject to adjustment
described below.

Shares which may be acquired under the Plan may be either authorized but
unissued Shares or Shares of issued stock held in the Company's treasury, or
both, at the discretion of the Company. Whenever any outstanding option or
portion thereof expires, is canceled, is forfeited or is otherwise terminated
for any reason without having been exercised or payment having been made in
respect of the entire option, the Shares allocable to the expired, canceled,
forfeited or otherwise terminated portion of the option may again be the subject
of options granted hereunder.

In the event of any stock dividend, stock split, combination or exchange of
Shares, recapitalization or other change in the capital structure of the
Company, corporate separation or division (including, but not limited to,
split-up, spin-off or distribution to Company shareholders other than a normal
cash dividend), sale by the Company of all or a substantial portion of its
assets, rights offering, merger, consolidation, reorganization or partial or
complete liquidation, or any other corporate transaction or event having an
effect similar to any of the foregoing, the aggregate number of Shares reserved
for issuance under the Plan, the number and option price of Shares subject to
outstanding options and any other characteristics or terms of the options as the
Committee shall deem necessary or appropriate to reflect equitably the effects
of such changes to the holders of options, shall be appropriately substituted
for new shares or adjusted, as determined by the Committee in its discretion.
Notwithstanding the foregoing, (i) each such adjustment with respect to an
Incentive Option shall comply with the rules of Section 424(a) of the Code, and
(ii) in no event shall any adjustment be made which would render any Incentive
Option granted hereunder other than an incentive stock option for purposes of
Section 422 of the Code without the consent of the grantee.

III. ADMINISTRATION

The Committee, or the Board of Directors if there is no Committee, will
have sole and exclusive authority to administer the Plan. The Committee shall
consist of no fewer than two (2) members of the Board of Directors, each of whom
shall be a "Non-Employee Director" within the meaning of Rule 16b-3 or any
successor rule or regulation ("Rule 16b-3") promulgated under the Securities
Exchange Act of 1934, as
<PAGE> 2

amended (the "Exchange Act"). The Committee shall administer the Plan so as to
comply at all times with Rule 16b-3. A majority of the members of the Committee
shall constitute a quorum, and the act of a majority of the members of the
Committee shall be the act of the Committee. Any member of the Committee may be
removed at any time, either with or without cause, by resolution adopted by a
majority of the Board of Directors, and any vacancy on the Committee may at any
time be filled by resolution adopted by a majority of the Board of Directors.

Any or all powers and functions of the Committee may at any time and from
time to time be exercised by the Board of Directors, subject to compliance with
Rule 16b-3.

Subject to the express provisions of the Plan, the Board of Directors or
the Committee, as the case may be, shall have authority, in its discretion, to
(i) select employees of the Company, consultants, and others as recipients of
options; (ii) determine the number and type of options to be granted; (iii)
determine the terms and conditions, not inconsistent with the terms hereof, of
any options granted; (iv) adopt, alter and repeal such administrative rules,
guidelines and practices governing the Plan as it shall, from time to time, deem
advisable; (v) interpret the terms and provisions of the Plan and any option
granted and any agreements relating thereto; and (vi) otherwise supervise the
administration of the Plan.

The determination of the Board of Directors or the Committee, as the case
may be, on matters referred to in this Article III shall be conclusive.

The Board of Directors or the Committee, as the case may be, may employ
such legal counsel, consultants and agents as it may deem desirable for the
administration of the Plan and may rely upon any opinion received from any such
counsel or consultant and any computation received from any such consultant or
agent. Expenses incurred by the Board of Directors or the Committee in the
engagement of such counsel, consultant or agent shall be paid by the Company. No
member or former member of the Committee or of the Board of Directors shall be
liable for any action or determination made in good faith with respect to the
Plan or any option granted hereunder.

The Company shall indemnify each member of the Committee for all costs and
expenses and, to the extent permitted by applicable law, any liability incurred
in connection with defending against, responding to, negotiation for the
settlement of, or otherwise dealing with any claim, cause of action or dispute
of any kind arising in connection with any actions in administering the Plan or
in authorizing or denying authorization to any transaction hereunder.

IV. ELIGIBILITY

Options may be granted only to employees of the Company and its
subsidiaries, consultants and others who are not members of the Committee;
provided, that no person shall be eligible for any award if the granting of such
award to such person would prevent the satisfaction by the Plan of the general
exemptive conditions of Rule 16b-3. The Plan shall not confer upon any employee,
consultant or other any right with respect to continuation of employment or
services by the Company, nor shall it interfere in any way with his or her right
or the Company's right to terminate his or her employment or services at any
time, with or without cause.

V. STOCK OPTIONS

1. General. Any options granted under the Plan shall be in such form as
the Committee may from time to time approve and the provisions of the option
grants need not be the same with respect to each optionee. Options granted under
the Plan may be either Incentive Options or NQSOs. The Committee may grant to
any optionee Incentive Options, NQSOs or both types of options.

Options granted under the Plan shall be subject to the following terms and
conditions and shall contain such additional terms and conditions not
inconsistent with the terms of the Plan, as the Committee deems appropriate.
Each option grant shall be evidenced by an agreement executed on behalf of the
Company by an officer designated by the Committee and accepted by the optionee.
Such agreement shall describe the options and state that such options are
subject to all the terms and provisions of the Plan and shall contain such other
terms and provisions, consistent with the Plan, as the Committee may approve.
<PAGE> 3

2. Exercise Price and Payment. The price per Share under any option
granted hereunder shall be such amount as the Board of Directors or the
Committee, as the case may be, shall determine, provided, however, that such
price shall not be less than one hundred percent (100%) of the fair market value
of the Shares subject to such option, as determined below, at the date the
option is granted (110% in the case of an Incentive Option granted to any person
who, at the time the option is granted, owns stock of the Company or any
subsidiary or parent of the Company possessing more than ten percent (10%) of
the total combined voting power of all classes of stock of the Company or of any
subsidiary or parent of the Company (a "10% Shareholder")).

If the Shares are listed on a national securities exchange in the United
States on the date any option is granted, the fair market value per Share shall
be deemed to be the average of the high and low sale price on such national
securities exchange in the United States on the date upon which the option is
granted, but if the Shares are not traded on such date, or such national
securities exchange is not open for business on such date, the fair market value
per Share shall be the average of the high and low sale price determined as of
the closest preceding date on which such exchange shall have been open for
business and the Shares were traded. If the Shares are listed on more than one
national securities exchange in the United States on the date any such option is
granted, the Board of Directors or the Committee, as the case may be, shall
determine which national securities exchange shall be used for the purpose of
determining the fair market value per Share. If the Shares are not listed on a
national securities exchange but are reported on the National Association of
Securities Dealers, Inc. Automated Quotation System ("Nasdaq"), the fair market
value per share shall be deemed to be the average of the high bid and low sale
prices on the date upon which the option is granted as reported by Nasdaq or, if
the Shares are not traded on such date or Nasdaq is not open for business on
such date, the fair market value per Share shall be the average of the high and
low sale price determined as of the closest preceding date on which Nasdaq shall
have reported the Shares.

For purposes of this Plan, the determination by the Board of Directors or
the Committee, as the case may be, of the fair market value of a Share shall be
conclusive.

3. Term of Options and Limitations on the Right of Exercise. The term of
each option will be for such period as the Board of Directors or the Committee,
as the case may be, shall determine, provided that, except as otherwise provided
herein, in no event may any option granted hereunder be exercisable more than
ten (10) years from the date of grant of such option (five years in the case of
an Incentive Option granted to a 10% Shareholder). Each option shall become
exercisable in such installments and at such times as may be designated by the
Board of Directors or the Committee, as the case may be, and set forth in the
agreement related to the grant of options. To the extent not exercised,
installments shall accumulate and be exercisable, in whole or in part, at any
time after becoming exercisable, but not later than the date the option expires.

The Board of Directors or the Committee, as the case may be, shall have the
right to limit, restrict or prohibit, in whole or in part, from time to time,
conditionally or unconditionally, rights to exercise any option granted
hereunder.

To the extent that an option is not exercised within the period of
exercisability specified therein, it shall expire as to the then unexercised
part.

4. Exercise of Options. Options granted under the Plan shall be exercised
by the optionee as to all or part of the Shares covered thereby by the giving of
written notice of the exercise thereof to the Secretary of the Company at the
principal business office of the Company, specifying the number of Shares to be
purchased, accompanied by payment therefor made to the Company for the full
purchase price of such Shares. The date of actual receipt by the Company of such
notice shall be deemed the date of exercise of the option with respect to the
Shares being purchased.

Upon the exercise of an option granted hereunder, the Company shall cause
the purchased Shares to be issued only when it shall have received the full
purchase price for the Shares in cash; provided, however, that in lieu of cash,
the holder of an option may, to the extent permitted by applicable law, exercise
an option in whole or in part, by delivering to the Company unrestricted Shares
(in proper form for transfer and accompanied by all requisite stock transfer tax
stamps or cash in lieu thereof) owned by such holder having
<PAGE> 4

a fair market value equal to the cash exercise price applicable to that portion
of the option being exercised. The fair market value of the Shares so delivered
shall be determined as of the date immediately preceding the date on which the
option is exercised, or as may be required in order to comply with or to conform
to the requirements of any applicable laws or regulations. For purposes of this
paragraph, the provisions of Section 2 hereof relating to the fair market value
of Shares shall apply in all respects.

Notwithstanding the foregoing, the Company, in its sole discretion, may
establish cashless exercise procedures whereby an option holder, subject to the
requirements of Rule 16b-3, Regulation T, federal income tax laws, and other
federal, state and local tax and securities laws, can exercise an option or a
portion thereof without making a direct payment of the option price to the
Company, including a program whereby option shares would be sold on behalf of
and at the request of an option holder by a designated broker and the exercise
price would be satisfied out of the sale proceeds and delivered to the Company.
If the Company so elects to establish a cashless exercise program, the Company
shall determine, in its sole discretion, and from time to time, such
administrative procedures and policies as it deems appropriate and such
procedures and policies shall be binding on any option holder wishing to utilize
the cashless exercise program.

5. Nontransferability of Options. An option granted hereunder shall not
be transferable, whether by operation of law or otherwise, other than by will or
the laws of descent and distribution, and any option granted hereunder shall be
exercisable, during the lifetime of the holder, only by such holder.

The option of any person to acquire Shares and all his rights thereunder
shall terminate immediately if the holder: (a) attempts to or does sell, assign,
transfer, pledge, hypothecate or otherwise dispose of the option or any rights
thereunder to any other person except as permitted above; or (b) becomes
insolvent or bankrupt or becomes involved in any manner so that the option or
any rights thereunder becomes subject to being taken from him to satisfy his
debts or liabilities.

6. Termination of Employment. Upon termination of employment of any
option holder, any option previously granted to such option holder, unless
otherwise specified by the Board of Directors or the Committee, as the case may
be, shall, to the extent not theretofore exercised, terminate and become null
and void three (3) months from the date of termination of employment, provided
that:

(a) if the option holder shall die while in the employ of the Company
or any subsidiary of the Company, and at a time when such employee,
consultant or other was entitled to exercise an option as herein
provided, his estate or the legatees or distributees of his estate
or of the option, as the case may be, of such option holder, may,
within one (1) year following the date of death, but not beyond
that time and in no event later than the expiration date of the
option, exercise such option, to the extent not theretofore
exercised, in respect of any or all of such number of Shares which
the option holder was entitled to purchase; and

(b) if the employment of any option holder to whom such option shall
have been granted shall terminate by reason of the option holder's
retirement on or after he reaches the age of 60 years in such
manner as would entitle him to receive full Social Security
benefits if he were then 65 years of age, or disability (as
described in Section 22(e)(3) of the Code), and while such
employee, consultant or other is entitled to exercise such option
as herein provided, such option holder shall have the right to
purchase under the option the number of Shares, if any, which he
was entitled to purchase at the time of such termination, at any
time up to and including three (3) months after the date of such
termination of employment, but not beyond that time and in no event
shall an option be exercised later than the expiration date of the
option.

In no event shall any person be entitled to exercise any option after the
expiration of the period of exercisability of such option as specified therein.

Except as otherwise determined by the Board of Directors or the Committee,
as the case may be, and other than as set forth above, if an option holder
voluntarily terminates his or her employment, or is discharged, any option
granted hereunder shall be canceled and the option holder shall have no further
rights
<PAGE> 5

to exercise any such option and all of the option holder's rights thereunder
shall terminate as of the effective date of such termination of employment.

If an option granted hereunder shall be exercised by the legal
representative of a deceased option holder or former option holder or by a
person who acquired an option granted hereunder by bequest or inheritance or by
reason of the death of any option holder or former option holder, written notice
of such exercise shall be accompanied by a certified copy of letters
testamentary or equivalent proof of the right of such legal representative or
other person to exercise such option.

For the purposes of the Plan, an employment relationship shall be deemed to
exist between an individual and a corporation if, at the time of the
determination, the individual was an "employee" of such corporation for purposes
of Section 422(a) of the Code.

A termination of employment shall not be deemed to occur by reason of (i)
the transfer of an employee from employment by the Company to employment by a
subsidiary of the Company or (ii) the transfer of an employee from employment by
a subsidiary of the Company to employment by the Company or by another
subsidiary of the Company.

7. Maximum Allotment of Incentive Options. If the aggregate fair market
value of Shares with respect to which Incentive Options are exercisable for the
first time by an employee, consultant or other during any calendar year (under
all stock option plans of the Company and any parent or any subsidiary of the
Company) exceeds $100,000, any options which otherwise qualify as Incentive
Options, to the extent of the excess, will be treated as NQSOs.

VI. CHANGE OF CONTROL

Notwithstanding anything to the contrary contained herein, upon a Change of
Control (as defined below) of the Company, all options shall immediately vest
and become exercisable in full during the remaining term thereof, and shall
remain so, whether or not the option holder to whom such options have been
granted remains an employee of the Company or its subsidiaries.

A Change of Control shall be deemed to have taken place upon the occurrence
of any of the following events:

(i) any Person (which shall mean and include any individual, corporation,
partnership, group, association or other "person", as such term is used in
Sections 13 and 14 of the Exchange Act) is, becomes, or has the right to become
the beneficial owner, directly or indirectly, of securities of the Company
representing 30% or more of the Shares then outstanding, whether or not such
Person continues to be the beneficial owner of securities representing 30% or
more of such outstanding shares; or

(ii) as the result of, or in connection with, any tender or exchange
offer, merger or other business combination, sale of assets or contested
election, any announcement of an intention to make any of the foregoing
transactions, or any combination of the foregoing transactions (a
"Transaction"), those persons who were directors of the Company before the
Transaction and were otherwise unaffiliated with any other party to the
Transaction shall cease to constitute a majority of the Board of Directors of
the Company or any successor to the Company (a "Change in the Board"); or

(iii) the stockholders of the Company approve any merger, consolidation,
reorganization, liquidation, dissolution, or sale of all or substantially all of
the Company's assets in which neither the Company nor a successor resulting from
a change in domicile or form of organization will survive as an independent,
publicly owned corporation.

Notwithstanding anything herein to the contrary, no Change of Control (only
with respect to the particular option holder or award grantee referred to
therein in the case of (i)(A) and (ii) below) shall be deemed to have occurred
by virtue of any event which results in any of the following:

(i) the acquisition, directly or indirectly, of 30% or more of the total
outstanding shares by (A) the option holder or a person including the option
holder, (B) the Company, (C) a subsidiary of the Company, or (D) any employee
benefit plan of the Company or of a subsidiary, or any entity holding securities
of the
<PAGE> 6

Company recognized, appointed, or established by the Company or by a subsidiary
for or pursuant to the terms of such plan; or

(ii) a Change in the Board resulting from any Transaction in which the
option holder or a Person including the option holder participates directly or
indirectly with any party to the Transaction other than the Company.

VII. PURCHASE FOR INVESTMENT

Except as hereafter provided, the Company may require the recipient of
Shares pursuant to an option granted hereunder, upon receipt thereof, to execute
and deliver to the Company a written statement, in form satisfactory to the
Company, in which such holder represents and warrants that such holder is
purchasing or acquiring the Shares acquired thereunder for such holder's own
account, for investment only and not with a view to the resale or distribution
thereof, and agrees that any subsequent offer for sale or sale or distribution
of any of such Shares shall be made only pursuant to either (a) a Registration
Statement on an appropriate form under the Securities Act of 1933, as amended
(the "Act"), which Registration Statement has become effective and is current
with regard to the Shares being offered or sold, or (b) a specific exemption
from the registration requirements of the Act, but in claiming such exemption
the holder shall, prior to any offer for sale or sale of such Shares, obtain a
prior favorable written opinion, in form and substance satisfactory to the
Company, from counsel for or approved by the Company, as to the applicability of
such exemption thereto. The foregoing restriction shall not apply to (i)
issuances by the Company so long as the Shares being issued are registered under
the Act and a prospectus in respect thereof is current or (ii) reofferings of
Shares by affiliates of the Company (as defined in Rule 405 or any successor
rule or regulation promulgated under the Act) if the Shares being reoffered are
registered under the Act and a prospectus in respect thereof is current.

VIII. ISSUANCE OF CERTIFICATES; LEGENDS; PAYMENT OF EXPENSES

The Company may endorse such legend or legends upon the certificates for
Shares issued pursuant to a grant hereunder and may issue such "stop transfer"
instructions to its transfer agent in respect of such Shares as, in its
discretion, it determines to be necessary or appropriate to (i) prevent a
violation of, or to perfect an exemption from, the registration requirements of
the Act, (ii) implement the provisions of the Plan and any agreement between the
Company and the optionee with respect to such Shares, or (iii) permit the
Company to determine the occurrence of a disqualifying disposition, as described
in Section 421(b) of the Code, of Shares transferred upon exercise of an
Incentive Option granted under the Plan.

The Company shall pay all issue or transfer taxes with respect to the
issuance or transfer of Shares upon exercise of an option, as well as all fees
and expenses necessarily incurred by the Company in connection with such
issuance or transfer, except fees and expenses which may be necessitated by the
filing or amending of a Registration Statement under the Act, which fees and
expenses shall be borne by the recipient of the Shares unless such Registration
Statement has been filed by the Company for its own corporate purposes (and the
Company so states) in which event the recipient of the Shares shall bear only
such fees and expenses as are attributable solely to the inclusion of the Shares
he or she receives in the Registration Statement, provided that the Company
shall have no obligation to include any Shares in any Registration Statement.

All Shares issued as provided herein shall be fully paid and non-assessable
to the extent permitted by law.

IX. WITHHOLDING TAXES

The Company may require an employee, consultant or other exercising an NQSO
or disposing of Shares acquired pursuant to the exercise of an Incentive Option
in a disqualifying disposition (within the meaning of Section 421(b) of the
Code) to reimburse the Company for any taxes required by any government to be
withheld or otherwise deducted and paid by the Company in respect of the
issuance or disposition of Shares. In lieu thereof, the Company shall have the
right to withhold the amount of such taxes from any other sums due or to become
due from the Company to the employee, consultant or other upon such terms and
conditions as the Board of Directors or the Committee, as the case may be, shall
prescribe. Notwithstanding the foregoing, the Committee may, by the adoption of
rules or otherwise, modify the provisions of this Article IX
<PAGE> 7

or impose such other restrictions or limitations as may be necessary to
ensure that the withholding transactions described above will be exempt
transactions under Section 16(b) of the Exchange Act.

If an optionee makes a disposition, within the meaning of Section 424(c) of
the Code and regulations promulgated thereunder, of any Share or Shares issued
to such optionee pursuant to the exercise of an Incentive Option within the
two-year period commencing on the day after the date of the grant or within the
one-year period commencing on the day after the date of transfer of such Share
or Shares to the optionee pursuant to such exercise, the optionee shall, within
ten (10) days of such disposition, notify the Company thereof, by delivery of
written notice to the Company at its principal executive office.

X. LISTING OF SHARES AND RELATED MATTERS

If at any time the Board of Directors or the Committee, as the case may be,
shall determine in its discretion that the listing, registration or
qualification of the Shares covered by the Plan upon any national securities
exchange or under any state or federal law or the consent or approval of any
governmental regulatory body, is necessary or desirable as a condition of, or in
connection with, the sale or purchase of Shares under the Plan, no Shares shall
be issued unless and until such listing, registration, qualification, consent or
approval shall have been effected or obtained, or otherwise provided for, free
of any conditions not acceptable to the Board of Directors or the Committee, as
the case may be.

XI. AMENDMENT OF THE PLAN

The Board of Directors or the Committee, as the case may be, may, from time
to time, amend the Plan, provided that no amendment shall be made, without the
approval of the stockholders of the Company, that will (i) increase the total
number of Shares which may be issued under the Plan (other than an increase
resulting from an adjustment provided for in Article II), (ii) modify the
provisions of the Plan relating to eligibility, (iii) materially increase the
benefits accruing to participants under the Plan, or (iv) extend the maximum
period of the Plan. The Board of Directors or the Committee, as the case may be,
shall be authorized to amend the Plan and the awards granted hereunder to permit
the Incentive Options granted hereunder to qualify as incentive stock options
within the meaning of Section 422 of the Code. The rights and obligations under
any option or award granted before amendment of the Plan or any unexercised
portion of such option shall not be adversely affected by amendment of the Plan
or the option without the consent of the holder of the option.

XII. TERMINATION OR SUSPENSION OF THE PLAN

The Board of Directors or the Committee, as the case may be, may at any
time suspend or terminate the Plan. The Plan, unless sooner terminated by action
of the Board of Directors or the Committee, as the case may be, shall terminate
at the close of business on the tenth anniversary of the grant of an option. An
option may not be granted while the Plan is suspended or after it is terminated.
Rights and obligations under any option granted while the Plan is in effect
shall not be altered or impaired by suspension or termination of the Plan,
except upon the consent of the person to whom the option was granted. The power
of the Board of Directors or the Committee, as the case may be, to construe and
administer any options granted prior to the termination or suspension of the
Plan under Article III nevertheless shall continue after such termination or
during such suspension.

XIII. GOVERNING LAW

The Plan, such options as may be granted thereunder and all related matters
shall be governed by, and construed and enforced in accordance with, the laws of
the State of Delaware.

XIV. PARTIAL INVALIDITY

The invalidity or illegality of any provision herein shall not be deemed to
affect the validity of any other provision.
<PAGE> 8

XV. EFFECTIVE DATE

The Plan shall become effective upon the adoption by the Board of
Directors, subject only to the approval by the affirmative vote of the holders
of a majority of the securities of the Company present, or represented, and
entitled to vote at a meeting of stockholders duly held. Grants made prior to
such stockholder approval shall be contingent on such approval.

<PAGE> 1

EXHIBIT 23.2

CONSENT OF INDEPENDENT AUDITORS

The Board of Directors
Wave Systems Corp.:

We consent to the use of our report dated March 27, 1998 in the
Registration Statement on Form S-1 of Wave Systems Corp., and to the reference
to our firm under the heading "Experts" in the Prospectus. 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.

/s/ KPMG PEAT MARWICK LLP

Boston, Massachusetts
April 13, 1998