<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON DC 20549
-------------
FORM 8-K/A
(Amendment No. 1)
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Date of Report (Date of earliest event reported): JULY 27, 1999
WAVE SYSTEMS CORP.
(Exact Name of Registrant as Specified in Charter)
DELAWARE 0-24752 13-3477246
(State or Other Jurisdiction (Commission (IRS Employer
of Incorporation) File Number) Identification No.)
480 PLEASANT STREET, LEE, MASSACHUSETTS 01238
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (413) 243-1600
<PAGE>
ITEM 2. ACQUISITION OR DISPOSITION OF ASSETS.
This Form 8-K/A amends the current report filed on Form 8-K filed on
August 11, 1999 to incorporate Item 7.
On July 27, 1999, Wave Systems Corp. (Wave), a provider of
electronic commerce, content distribution and security services, acquired,
via a reverse-triangular merger, all of the issued and outstanding shares of
capital stock of N*ABLE Technologies, Inc. ("N*ABLE"), a security solutions
company incorporated under Delaware law, from all of the shareholders
thereof.
The aggregate consideration paid by Wave to the Selling Shareholders
consisted of 2,781,263 shares of Wave's Class A Common Stock (subject to certain
post-closing adjustments as provided in the Agreement). The closing price per
share for Wave's Class A Common Stock as of July 27, 1999 was $10.38. The terms
of the Agreement were determined in arm's-length negotiations between Wave and
N*ABLE.
N*ABLE produces hardware-based security solutions for the protection of
sensitive user data within network client systems, including a hardware-based
security co-processor that manages the secure transfer of sensitive payment, or
personal information to and from desktop computers. Founded in 1996, N*ABLE is
located in Danvers, Massachusetts, with offices in Cupertino, California and
Bouguenais, France.
All other information required by Item 2 is set forth in the Agreement
filed as Exhibit 99.1, and is incorporated herein by reference.
ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS.
Item 7 is hereby amended to state as follows:
(a) FINANCIAL STATEMENTS OF BUSINESS ACQUIRED.
<TABLE>
<S> <C> <C>
1. Audited supplemental consolidated financial statements of
Wave Systems Corp. and Subsidiaries which include the
following:
a. Independent Auditors' Report; F-2
b. Supplemental Consolidated Balance Sheets as of and
for the years ended December 31, 1998 and 1997; F-3
c. Supplemental Consolidated Statement of Operations
for each of the years ended December 31, 1998,
1997 and 1996 and for the period from February 12,
1988 (inception) through December 31, 1998; F-4
d. Supplemental Consolidated Statements of Stockholders'
Equity for each of the years ended December 31,
1998, 1997 and 1996 and for the period from
February 12, 1988 (inception) through December 31,
1998; F-5
e. Supplemental Consolidated Statements of Cash Flows
for each of the years ended December 31, 1998,
1997 and 1996 and for the period from February 12,
1988 (inception) through December 31, 1998; and F-10
f. Notes to Supplemental Consolidated Financial
Statements for each of the years ended December
31, 1998, 1997 and 1996 and for the period from
February 12, 1988 (inception) through December 31,
1998. F-12
2. Audited financial statements of N*Able Technologies, Inc.
which include the following:
a. Independent Auditors' Report; F-34
b. Balance Sheets as of June 30, 1999 and 1998; F-35
c. Statements of Operations for years ended June 30,
1999 and 1998 and period from October 31, 1996
(inception) to June 30, 1999; F-36
d. Statements of Stockholders' Equity for years ended
June 30, 1999 and 1998 and period from October 31,
1996 (inception) to June 30, 1999; F-37
e. Statements of Cash Flows for years ended June 30,
1999 and 1998 and period from October 31, 1996
(inception) to June 30, 1999; and F-38
f. Notes to Financial Statements for years ended June
30, 1999 and 1998 and period from October 31, 1996
(inception) to June 30, 1999. F-39
</TABLE>
<PAGE>
F-2
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Wave Systems Corp.:
We have audited the supplemental consolidated financial statements of Wave
Systems Corp. and subsidiaries (a development stage corporation) as listed in
the accompanying index. These supplemental consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these supplemental 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.
The supplemental consolidated financial statements give retroactive effect to
the merger of Wave Systems Corp. and subsidiaries and N*Able Technologies,
Inc. on July 27, 1999, which has been accounted for as a pooling-of-interests
as described in Note 1 to the supplemental consolidated financial statements.
Generally accepted accounting principles proscribe giving effect to a
consummated business combination accounted for by the pooling-of-interests
method in financial statements that do not include the date of consummation.
These financial statements do not extend through the date of consummation.
However, they will become the historical consolidated financial statements of
Wave Systems Corp. and subsidiaries after financial statements covering the
date of consummation of the business combination are issued.
In our opinion, the supplemental 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, 1998 and 1997, and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 1998 and for the period from February 12, 1988 (date
of inception) to December 31, 1998 in conformity with generally accepted
accounting principles after financial statements are issued for a period which
includes the date of consummation of the business combination.
KPMG LLP
Boston, Massachusetts
October 12, 1999
<PAGE>
F-3
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Supplemental Consolidated Balance Sheets
December 31, 1998 and 1997
<TABLE>
<CAPTION>
ASSETS
1998 1997
---- ----
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 4,451,175 $ 6,593,275
Prepaid expenses and other receivables 67,500 -
------------- -------------
Total current assets 4,518,675 6,593,275
Property and equipment, net 1,342,229 1,246,706
Other assets 163,087 125,846
------------- -------------
6,023,991 7,965,827
------------- -------------
------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses 3,477,803 1,820,402
Deferred license fee 1,250,000 --
--
Note payable 561,831 522,124
------------- -------------
Total current liabilities 5,289,634 2,342,526
------------- -------------
Series A Cumulative Redeemable Preferred Stock, $.01 par value.
360 shares issued and outstanding in 1998 and 1997; involuntary
liquidation value, $493,201 493,201 471,601
------------- -------------
Stockholders' Equity:
Series G Convertible Preferred stock, $.01 par value. 150,000 shares
authorized and 20,000 outstanding in 1998 347,812 -
Common stock, $.01 par value. Authorized 75,000,000 shares as Class A;
issued and outstanding 31,183,412 in 1998 and 25,655,902 in 1997 311,835 256,560
Common stock, $.01 par value. Authorized 13,000,000 shares as Class B;
issued and outstanding 3,140,665 in 1998 and 4,421,953 in 1997 31,407 44,220
Capital in excess of par value 64,914,045 55,944,979
Deficit accumulated during the development stage (65,214,601) (50,882,035)
Less: Note receivable from stockholder, including accrued interest
of $101,167 in 1998 and $88,849 in 1997 (149,342) (212,024)
------------- -------------
Total stockholders' equity 241,156 5,151,700
------------- -------------
Commitments and contingencies
$ 6,023,991 $ 7,965,827
------------- -------------
------------- -------------
</TABLE>
See accompanying notes to supplemental consolidated financial statements.
<PAGE>
F-4
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Supplemental Consolidated Statements of Operations
Years ended December 31, 1998, 1997 and 1996
and period from February 12, 1988 (date of
inception)
through December 31, 1998
<TABLE>
<CAPTION>
Period from
February 12, 1988
(date of inception)
through
December 31,
1998 1997 1996 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net revenue $ 10,193 $ 10,712 $ 1,458 $ 22,363
------------ ------------ ------------ ------------
Operating expenses:
Selling, general and administrative 11,945,273 9,557,198 6,553,003 40,976,775
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 6,247,105 4,715,334 3,751,871 22,705,810
------------ ------------ ------------ ------------
18,192,378 18,931,418 10,304,874 68,341,471
------------ ------------ ------------ ------------
Other income (expense):
License fee 2,750,000 1,000,000 -- 3,750,000
License warrant cost (1,100,000) -- -- (1,100,000)
Interest income 231,820 85,939 197,016 1,304,272
Interest expense (285,662) (177,868) (20,146) (862,485)
Other Income -- -- -- 12,720
------------ ------------ ------------ ------------
1,596,158 908,071 176,870 3,104,507
------------ ------------ ------------ ------------
Net loss (16,586,027) (18,012,635) (10,126,546) (65,214,601)
Accrued dividends on preferred stock
(including accretion of assured incremental
yield on preferred stock of $750,000 in
1998, $1,673,000 in 1997 and 620,965 in 1996) 858,863 2,482,982 870,579 4,337,358
------------ ------------ ------------ ------------
Net loss to common stockholders $(17,444,890) $(20,495,617) $(10,997,125) $(69,551,959)
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Weighted average number of common
shares outstanding during the period 32,081,107 23,725,011 17,737,847 14,351,435
Loss per common share $ (.54) $ (.86) $ (.62) $ (4.85)
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
</TABLE>
See accompanying notes to supplemental consolidated financial statements.
<PAGE>
F-5
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Supplemental Consolidated Statements of Stockholders' Equity
Period from February 12, 1988 (date of inception) to December 31, 1998
<TABLE>
<CAPTION>
Class A Class B Capital
common stock common stock in excess of
Shares Amount Shares Amount Par Value
------ ------ ------ ------ ---------
<S> <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 -- -- -- -- --
---------- ----------- ---------- ----------- -----------
Balance at December 31, 1988 -- -- 4,980,000 49,800 304,226
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 -- -- -- -- --
---------- ----------- ---------- ----------- -----------
Balance at December 31, 1989 -- -- 5,251,920 52,519 946,657
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
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 -- -- -- -- --
---------- ----------- ---------- ----------- -----------
Balance at December 31, 1990 -- -- 5,647,920 56,479 1,713,947
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 -- -- -- -- --
---------- ----------- ---------- ----------- -----------
Balance at December 31, 1991 (carried forward) -- -- 5,982,720 59,827 2,268,599
</TABLE>
<TABLE>
<CAPTION>
Deficit
accumulated Note
during the receivable
development Deferred from
Stage Compensation Stockholder Total
----- ------------ ----------- -----
<S> <C> <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) -- (326,832)
----------- --- --- -----------
Balance at December 31, 1988 (326,832) -- --
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) -- (982,186)
----------- --- --- -----------
Balance at December 31, 1989 (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 -- -- 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) -- (1,178,129)
----------- --- --- -----------
Balance at December 31, 1990 (2,487,147) -- --
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) -- (1,009,368)
----------- --- --- -----------
Balance at December 31, 1991 (carried forward) (3,496,515) -- --
</TABLE>
<PAGE>
F-6
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Supplemental Consolidated Statements of Stockholders' Equity
(Continued)
<TABLE>
<CAPTION>
Class A Class B Capital
common stock common stock in excess of
Shares Amount Shares Amount Par Value
------ ------ ------ ------ ---------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1991 (brought forward) -- -- 5,982,720 59,827 2,268,599
Shares issued at $1.67 per share from January through
October 1992 -- -- 708,000 7,080 1,172,920
Shares issued at $1.67 per share in May 1992 in connection
with License and Cross-License Agreement -- -- 674,976 6,750 1,118,210
Shares issued at $1.67 per share in May 1992 as
compensation for services rendered -- -- 18,000 180 29,820
Shares issued at $2.50 per share in May and November
1992 as compensation for services rendered -- -- 771,000 7,710 1,919,790
Shares issued at $2.50 per share, net of expenses
of $7,500, in November and December 1992 -- -- 323,001 3,230 796,773
Shares issued by principal stockholder in
December 1992 at $2.50 per share as
compensation for services rendered -- -- -- -- 75,000
Shares canceled in October and December 1992 -- -- (75,000) (750) 750
Issuance of stock options at $.003 exercise price
per share in June 1992 -- -- -- -- 798,400
Amortization of deferred compensation -- -- -- -- --
Accrued dividends on preferred stock -- -- -- -- (6,383)
Note received from stockholder and accrual of
interest thereon -- -- -- -- --
Net loss for year ended December 31, 1992 -- -- -- -- --
---------- ---------- ---------- ---------- ----------
Balance at December 31, 1992 (carried forward) -- -- 8,402,697 84,027 8,173,879
</TABLE>
<TABLE>
<CAPTION>
Deficit
accumulated Note
during the receivable
development Deferred from
Stage Compensation Stockholder Total
----- ------------ ----------- -----
<S> <C> <C> <C> <C>
Balance at December 31, 1991 (brought forward) (3,496,515) -- -- (1,140,276)
Shares issued at $1.67 per share from January through
October 1992 -- -- -- 1,180,000
Shares issued at $1.67 per share in May 1992 in connection
with License and Cross-License Agreement -- -- -- 1,124,960
Shares issued at $1.67 per share in May 1992 as
compensation for services rendered -- -- -- 30,000
Shares issued at $2.50 per share in May and November
1992 as compensation for services rendered -- -- -- 1,927,500
Shares issued at $2.50 per share, net of expenses
of $7,500, in November and December 1992 -- -- -- 800,003
Shares issued by principal stockholder in
December 1992 at $2.50 per share as
compensation for services rendered -- -- -- 75,000
Shares canceled in October and December 1992 -- -- -- --
Issuance of stock options at $.003 exercise price
per share in June 1992 -- (398,660) -- 399,740
Amortization of deferred compensation -- 155,455 --
155,455
Accrued dividends on preferred stock -- -- -- (6,383)
Note received from stockholder and accrual of
interest thereon -- -- (152,974) (152,974)
Net loss for year ended December 31, 1992 (4,182,638) -- -- (4,182,638)
---------- ---------- ---------- ----------
Balance at December 31, 1992 (carried forward) (7,679,153) (243,205) (152,974) 210,387
</TABLE>
<PAGE>
F-7
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Supplemental Consolidated Statements of Stockholders' Equity
(Continued)
<TABLE>
<CAPTION>
Class A Class B Capital
common stock common stock in excess of
Shares Amount Shares Amount Par Value
------ ------ ------ ------ ---------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1992 (brought forward) -- -- 8,402,697 84,027 8,173,879
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 -- -- -- -- --
---------- ----------- ----------- ----------- -----------
Balance at December 31, 1993 -- -- 9,056,375 90,564 10,352,283
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 -- -- -- -- --
---------- ----------- ----------- ----------- -----------
Balance at December 31, 1994 (carried forward) 3,728,200 37,282 9,757,297 97,573 28,534,990
</TABLE>
<TABLE>
<CAPTION>
Deficit
accumulated Note
during the receivable
development Deferred from
Stage Compensation Stockholder Total
----- ------------ ----------- -----
<S> <C> <C> <C> <C>
Balance at December 31, 1992 (brought forward) (7,679,153) (243,205) (152,974) 210,387
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) -- -- (3,959,334)
----------- ----------- ----------- -----------
Balance at December 31, 1993 (11,638,487) -- (192,757) (1,360,584)
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) -- -- (4,271,501)
----------- ----------- ----------- -----------
Balance at December 31, 1994 (carried forward) (15,909,988) -- (210,072) 12,577,598
</TABLE>
<PAGE>
F-8
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Supplemental Consolidated Statements of Stockholders' Equity
(Continued)
<TABLE>
<CAPTION>
Class A Class B Capital
common stock common stock in excess of
Shares Amount Shares Amount Par Value
------ ------ ------ ------ ---------
<S> <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
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 -- -- -- -- --
------------ ------------ ----------- ------------ ------------
Balance at December 31, 1995 6,615,618 66,156 7,583,138 75,831 28,980,987
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) --
N*ABLE's APIC in connection with the issuance of
Class A common stock due to the merger 873,317 8,733 -- -- 1,296,241
Net loss for the year ended December 31, 1996 -- -- -- -- --
------------ ------------ ----------- ------------ ------------
Balance at December 31, 1996 12,455,403 124,554 6,208,141 62,081 34,348,673
------------ ------------ ----------- ------------ ------------
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
N*ABLE's APIC in connection with the issuance of
Class A common stock due to the merger 1,905,165 19,052 -- -- 10,128,492
Net loss -- -- -- -- --
Exchange of Class B stock for Class A stock 1,796,518 17,965 (1,796,518) (17,965) --
------------ ------------ ----------- ------------ ------------
Balance at December 31, 1997 25,653,121 $ 256,532 4,421,953 $ 44,220 $ 55,944,979
</TABLE>
<TABLE>
<CAPTION>
Deficit
accumulated Note
during the receivable
development Deferred from
Stage Compensation Stockholder Total
----- ------------ ----------- -----
<S> <C> <C> <C> <C>
Balance at December 31, 1994 (brought forward) (15,909,988) -- (210,072) 12,577,598
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) -- -- (6,832,866)
------------ --- ------------ ------------
Balance at December 31, 1995 (22,742,854) -- (227,390) 6,180,543
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 -- -- -- --
N*ABLE's APIC in connection with the issuance of
Class A common stock due to the merger -- -- -- 1,296,241
Net loss for the year ended December 31, 1996 (10,126,546) -- -- (10,126,546)
------------ --- ------------ ------------
Balance at December 31, 1996 (32,869,400) -- (244,705) 1,440,283
------------ --- ------------ ------------
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
N*ABLE's APIC in connection with the issuance of
Class A common stock due to the merger -- -- -- 10,128,492
Net loss (18,012,635) -- -- (18,012,635)
Exchange of Class B stock for Class A stock -- -- -- --
------------ --- ------------ ------------
Balance at December 31, 1997 $(50,882,035) $-- $ (212,024) $ 5,151,700
</TABLE>
See accompanying notes to supplemental consolidated financial statements.
<PAGE>
F-9
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Supplemental Consolidated Statements of Stockholders' Equity
(Continued)
<TABLE>
<CAPTION>
Class A Class B Capital
common stock common stock in excess of
Shares Amount Shares Amount Par Value
------ ------ ------ ------ ---------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1997 25,653,121 $ 256,532 4,421,953 $ 44,220 $ 55,944,979
------------ ------------ ------------ ------------ ------------
Exercise of options to purchase Class A common stock 77,558 775 -- -- 151,180
Options issued to employees below fair market-value -- -- -- -- 234,723
Exercise of warrants to purchase Class A common stock 1,652,770 16,528 -- -- 3,945,740
Warrants to purchase Class A common stock
to be issued as part of technology licensing
agreement and issued to consultants for services -- -- -- -- 1,546,824
Shares issued at prices ranging from $1.00 per share
to $5.00 per share as compensation for services
rendered 121,400 1,214 -- -- 647,274
Reduction in note receivable -- -- -- -- --
Issuance of Series G Convertible Preferred stock and
Common stock warrants, net of issuance costs of
$222,500 -- -- -- -- 218,250
Assured incremental yield on issuance of Series G
convertible preferred stock and debt -- -- -- -- 750,000
Accrual of interest on note receivable -- -- -- -- --
Accrued dividend on preferred stock including accretion
of assured incremental yield -- -- -- -- (858,863)
Conversion of Series G Preferred Stock 2,394,494 23,945 -- -- 2,274,756
N*ABLE's APIC in connection with the issuance of
Class A common stock due to the merger 2,781 28 -- -- 59,182
Net loss -- -- -- -- --
Adjustment for net loss of N*ABLE for the first six
months ended June 30,of 1998 -- -- -- -- --
Exchange of Class B stock for Class A stock 1,281,288 12,813 (1,281,288) (12,813) --
------------ ------------ ------------ ------------ ------------
Balance at December 31, 1998 31,183,412 $ 311,835 3,140,665 $ 31,407 $ 64,914,045
------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------
</TABLE>
<TABLE>
<CAPTION>
Deficit
accumulated Series G Note
during the Convertible receivable
development Preferred from
Stage Stock Stockholder Total
----- ----- ----------- -----
<S> <C> <C> <C> <C>
Balance at December 31, 1997 $(50,882,035) -- $ (212,024) $ 5,151,700
------------ ------------ ------------ ------------
Exercise of options to purchase Class A common stock -- -- -- 151,955
Options issued to employees below fair market-value -- -- -- 234,723
Exercise of warrants to purchase Class A common stock -- -- -- 3,962,268
Warrants to purchase Class A common stock
to be issued as part of technology licensing
agreement and issued to consultants for services -- -- -- 1,546,824
Shares issued at prices ranging from $1.00 per share
to $5.00 per share as compensation for services
rendered -- -- -- 648,488
Reduction in note receivable -- -- 75,000 75,000
Issuance of Series G Convertible Preferred stock and
Common stock warrants, net of issuance costs of -- 1,809,250 -- 2,027,500
Assured incremental yield on issuance of Series G
convertible preferred stock and debt -- -- -- 750,000
Accrual of interest on note receivable -- -- (12,318) (12,318)
Accrued dividend on preferred stock including accretion
of assured incremental yield -- 837,263 -- (21,600)
Conversion of Series G Preferred Stock -- (2,298,701) -- --
Net loss (16,586,027) -- -- (16,586,027)
Adjustment for net loss of N*ABLE for the six
months ended June 30, 1998 2,253,461 -- -- 2,253,461
Exchange of Class B stock for Class A stock -- -- -- --
------------ ------------ ------------ ------------
Balance at December 31, 1998 $(65,214,601) $ 347,812 $ (149,342) $ 241,156
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
</TABLE>
See accompanying notes to supplemental consolidated financial statements.
<PAGE>
F-10
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Supplemental Consolidated Statements of Cash Flows
Years ended December 31, 1998, 1997, 1996 and the
Period From February 12, 1988 (Date of Inception) through
December 31, 1998
<TABLE>
<CAPTION>
Period from
February 12, 1988
(date of inception)
through
December 31,
1998 1997 1996 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net loss $(16,586,027) $(18,012,635) $(10,126,546) $(65,214,601)
Adjustments to reconcile net loss to net cash
used in operating activities:
Write-off of goodwill -- 769,886 -- 769,886
Depreciation and amortization 487,155 609,661 324,260 1,738,514
Reserve for note from affiliate -- -- 1,004,934 1,672,934
Accrued interest on marketable securities -- 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 648,488 305,496 56,938 3,341,546
Warrants to be issued to ITG and warrants
issued as compensation for services 1,552,235 5,411 124,120 1,676,355
Issuance of warrants to Aladdin -- 2,939,000 -- 2,939,000
Accrued interest on note payable 39,707 56,624 9,500 105,831
Preferred stock issued for services rendered -- -- -- 265,600
Compensation associated with issuance of
stock options 234,723 -- -- 634,463
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 Deferred License fee 1,250,000 -- -- 1,250,000
Increase in accrued interest on note receivable (12,318) (17,319) (17,315) (101,168)
(Increase) decrease in prepaid expenses and
other receivables (67,500) 70,358 64,413 (67,500)
(Increase) decrease in other assets (37,241) 129,141 (53,346) (178,003)
(Decrease) increase in accounts payable and
accrued expenses 1,695,479 600,095 192,041 3,715,315
------------ ------------ ------------ ------------
Net cash used in operating activities (10,795,299) (12,425,282) (8,372,384) (45,184,667)
------------ ------------ ------------ ------------
</TABLE>
<PAGE>
F-11
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Supplemental Consolidated Statements of Cash Flows, Continued
<TABLE>
<CAPTION>
Period from
February 12, 1988
(date of inception)
through
December 31,
1998 1997 1996 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Cash flows from investing activities:
Acquisition of property and equipment (590,619) (644,671) (391,903) (2,851,217)
Short-term loans to affiliate -- -- (1,004,934) (1,672,934)
Organizational costs -- -- -- (14,966)
Purchase of marketable securities-held to maturity -- -- (2,945,458) (27,546,769)
Maturity of marketable securities-held to maturity -- -- 6,843,041 27,653,731
------------ ------------ ------------ ------------
Net cash provided by (used in) investing
activities (590,619) (644,671) 2,500,746 (4,432,155)
------------ ------------ ------------ ------------
Cash flows from financing activities:
Net proceeds from issuance of common stock 10,644,264 11,860,970 1,606,441 39,789,891
Net proceeds from issuance of preferred stock
and warrants 2,777,500 3,555,500 5,950,027 12,283,027
Sale of warrants -- -- -- 4
Note receivable from stockholder 75,000 50,000 -- (48,175)
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)
Increase in deferred offering costs -- -- -- --
------------ ------------ ------------ ------------
Net cash provided by financing activities 13,496,764 15,466,470 7,556,468 54,067,997
------------ ------------ ------------ ------------
Net increase in cash and cash equivalents 2,110,846 2,396,517 1,684,830 4,451,175
Cash and cash equivalents at beginning of period 2,340,329 4,196,758 2,511,928 --
Adjustment for net cash flows of N*Able for the
six months ended June 30, 1998 (4,252,946)
------------ ------------ ------------ ------------
Cash and cash equivalents at end of period $ 4,451,175 $ 2,340,329 $ 4,196,758 $ 4,451,175
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
</TABLE>
See accompanying notes to supplemental consolidated financial statements.
<PAGE>
F-12
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Supplemental Consolidated Financial Statements
December 31, 1998, 1997, 1996 and The Period From
February 12, 1988 (Date of Inception) Through
December 31, 1998
(1) ORGANIZATION AND BASIS OF PREPARATION
The accompanying supplemental consolidated financial statements of Wave
Systems Corp. and subsidiaries ("Wave" or the "Company") have been prepared
to give retroactive effect to the acquisition of N*Able Technologies, Inc.
("N*Able"), a Massachusetts based company that produces hardware-based
security solutions for the protection of sensitive user data within network
client systems, including a hardware-based security co-processor that
manages the secure transfer of sensitive payment, or personal information
to and from desktop computers. The acquisition was consummated through
the issuance of 2,781,263 of Wave Class A Common Shares in exchange for
all of the outstanding common and preferred shares of N*Able. The
combination has been accounted for as a pooling-of-interests combination
and, accordingly, the consolidated financial statements for periods
prior to the combination have been restated to include the accounts and
results of operations of N*Able. The supplemental consolidated financial
statements presented herein do not extend through the date of consummation,
however, they will become the historical consolidated financial statements
of the Company after financial statements covering the date of consummation
of the business combination are issued.
The fiscal year end for N*Able is June 30. In preparing these supplemental
consolidated financial statements, the calendar 1998 financial statements
of the Company were combined with financial statements of N*Able for the
same twelve month period. For 1997 and 1996, Wave's financial statements
were combined with the June 30, 1998 fiscal year end and eight months
ended June 30, 1997 statements for N*Able. Accordingly, an adjustment is
reflected in the statements of Stockholders' Equity and cash flows to
eliminate N*Able's net loss and net cash flows for the six months ended
June 30, 1998. For the presentation of financial data from inception to
December 31, 1998, Wave's financial data was combined with that of N*Able
from October 31, 1996 (date of inception) through December 31, 1998.
N*Able has generated no revenues since inception. The results of operations
previously reported by the separate companies and the combined amounts
presented in the accompanying supplemental consolidated financial
statements are summarized below:
<TABLE>
<CAPTION>
1998 1997
------------- -------------
Net loss
<S> <C> <C>
Wave $(11,895,944) $(13,897,794)
N*Able (4,690,083) (4,114,841)
------------- -------------
Combined $(16,586,027) $(18,012,635)
------------- -------------
------------- -------------
</TABLE>
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 and on March 23, 1999 completed an
offering of common stock for net proceeds of approximately $23 million, as
discussed in Note 13. Management anticipates that the proceeds of this
offering will be sufficient to fund operations through the end of the third
quarter of 2000. However, while management believes that it can
successfully research, develop and market its products and obtain
additional financing to fund operations beyond 2000, there can be no
assurance that it will be able to do so.
(2) SIGNIFICANT ACCOUNTING POLICIES
(A) PRINCIPLES OF CONSOLIDATION
The supplemental 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"); a wholly owned inactive
subsidiary; and
<PAGE>
F-13
N*Able as noted above. All significant intercompany
balances and transactions have been eliminated in consolidation.
(B) USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of expenses during the
reporting period. Actual results could differ from those estimates.
(C) CASH EQUIVALENTS
For purposes 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 in a purchase business combination, is amortized
on a straight-line basis over the period expected to be benefited of
five years. The Company assesses the recoverability of this intangible
asset by determining whether the amortization of the goodwill balance
over its remaining life can be recovered through undiscounted future
operating cash flows of the related acquired operation. The amount of
goodwill impairment, if any, is measured based on projected discounted
future operating cash flows using a discount rate reflecting the
Company's average cost of funds. The assessment of the recoverability
of goodwill is impacted if estimated future operating cash flows are
not achieved. During the third quarter of 1997, the Company wrote-off
goodwill related to the WIN acquisition as it was uncertain whether the
current and expected future results of operations of WIN would be
sufficient to support its carrying value.
(F) INCOME TAXES
The Company accounts for income taxes under the asset and liability method.
As such, deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases and operating loss and tax credit carryforwards.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date.
(G) STOCK OPTION PLAN
The Company accounts for its stock option plans in accordance with the
provisions of Accounting Principles Board ("APB") Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations. As
such, compensation expense is recorded on the date of grant only if the
current market price of the underlying stock exceeds the exercise price.
On January 1, 1996, the Company adopted the disclosure provisions of
Statement of Financial Accounting Standards ("SFAS") No. 123, Accounting
for Stock Based Compensation and accordingly, provides pro forma net
income and pro forma earnings per share footnote disclosures for employee
stock options as if the fair value-based method defined in SFAS No. 123
had been applied.
(H) RESEARCH AND DEVELOPMENT
Research and development costs are expensed as incurred. Software
development costs are required to be capitalized when a product's
technological feasibility has been established either by completion of a
detailed program design or a working model of the product and ending when
a product is available for general release to consumers. Technological
feasibility of the Company's product has not yet been established, and as
a result, no software development costs have been capitalized.
(Continued)
<PAGE>
F-14
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Supplemental Consolidated Financial Statements - (Continued)
(I) LOSS PER SHARE
Basic net loss per common share has been calculated based upon the weighted
average number of shares of common stock outstanding during the period.
No effect has been given to common stock equivalents or convertible
preferred stock, warrants 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, F and G preferred stockholders to acquire common
stock upon conversion at a discount. The assured incremental yield is
being accreted as a dividend over the periods from the dates of issuance
of the preferred stock to the earliest eligible dates for conversion.
(J) IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF
The Company reviews its long-lived assets and certain identifiable
intangibles for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable.
Recoverability of assets to be held and used is measured by a comparison
of the carrying amount of an asset to future net cash flows expected to
be generated by the asset. If such assets are considered to be impaired,
the impairment to be recognized is measured by the amount by which the
carrying amount of the assets exceed the fair value of the assets. Assets
to be disposed of are reported at the lower of the carrying amount or
fair value less costs to sell.
(K) RECLASSIFICATIONS
Certain reclassifications have been made to the 1996 and 1997
consolidated financial statements to conform to the 1998 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, 1998 and 1997 under two
promissory notes totaling $149,342, including accrued interest, due on
demand. During 1998 and 1997, $75,000 and $50,000, respectively, of the
Chairman and Chief Executive Officer's bonus was used to reduce the
principal owed.
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 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 1998, the Company paid $25,000 to Studio 2, during which time Mr. Kevin
Sprague was an employee of Studio 2. Kevin Sprague is the son of the
Chairman and CEO of the Company.
(Continued)
<PAGE>
F-15
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Supplemental Consolidated Financial Statements, (Continued)
(C) ACQUISITION AND DISPOSITIONS
In November 1995, the Company entered into a transaction with certain
individuals whereby shares in its newly-formed subsidiary, Wave
Interactive Network, Inc. ("WIN"), were transferred in exchange for a
demand note. The amount of the demand note was based on the level of
funding provided to WIN by the Company during 1995. The demand note from
WIN accrued interest at a rate of Prime plus 1% and, subject to certain
limitations associated with WIN's ability to raise additional capital,
was convertible into an undiluted 20% of the common shares of WIN at the
option of Wave. The Company retained a 1% ownership in WIN and
transferred the remaining ownership to certain individuals, including
former employees. Approximately 65% of the ownership was transferred to
Steven Sprague, President and CEO of WIN, and three other children of Mr.
Peter J. Sprague, Chairman and CEO of Wave. The note was fully reserved
as its collectibility was dependent upon WIN's ability to raise
additional capital. In addition, the Company entered into a separate
commercial agreement that, among other things, granted certain
distribution rights to WIN in exchange for royalties and other
consideration.
During 1996, the Company continued to finance the operations of WIN through
additional demand notes with terms similar to the original demand note.
The additional notes amounting to $1,004,000 were also fully reserved. On
December 30, 1996, effective as of October 18, 1996, the Company entered
into a merger agreement with WIN whereby the Company exchanged, for all
of the outstanding WIN common stock that it did not own, 375,000 shares
of Class B common stock. These Class B shares are restricted securities
within the meaning of Rule 144 of the Securities Act of 1933, as amended
(the "Act"). Additionally, based on the attainment of a specified
milestone, the shareholders of WIN are entitled to receive an additional
325,000 shares of the Company's Class B common stock. The Company also
issued a 10% convertible note and a warrant to refinance a convertible
note obligation of WIN amounting to approximately $456,000, which
included accrued interest to October 18, 1996, and an outstanding
warrant. Included in the results of operations are WIN's operations from
October 18, 1996. The acquisition was 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
and 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 of an additional
325,000 shares is issued, the 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>
1998 1997
---- ----
<S> <C> <C>
Equipment $ 1,687,032 $ 1,425,409
Furniture, fixtures and improvements 635,913 465,300
Computer software 534,614 452,580
---------- ----------
2,857,559 2,343,289
Less: Accumulated depreciation 1,515,330 1,096,583
---------- ------------
Total $ 1,342,229 $ 1,246,706
-------------- ------------
-------------- ------------
</TABLE>
Depreciation expense on property and equipment amounted to approximately
$487,000, $408,000, $272,000 and $1,515,000 for the years ended December
31, 1998, 1997, and 1996 and for the period from inception through December
31, 1998, respectively.
(Continued)
<PAGE>
F-16
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Supplemental Consolidated Financial Statements, (Continued)
(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 was convertible any time after
April 1, 1997 and became due, including accrued interest of $66,125, on
April 18, 1998. The note was 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.
On October 18, 1998 the Company restated and amended the note. The note is
now convertible any time after April 1, 1999 and up to April 18, 1999. The
conversion price was reduced to $0.95 per share of common stock. An
additional 75,000 warrants were issued as part of this amended note and the
fair value of these warrants was $106,000. Additionally, the fair value of
the reduced conversion price was $274,000. Such amounts will be amortized
as additional interest expense from the date the note was amended and
warrant issued through the earliest conversion date of April 1, 1999.
During 1998, approximately $123,000 of the value of the reduced conversion
rate and warrant was recorded as interest expense.
(6) ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses as of December 31 consisted of the
following:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Accrual of costs related to the ITG agreement $ 490,000 $ 490,000
Accounts payable 947,486 607,672
Accrued consulting and professional fees 155,000 302,695
Legal settlement (note 13) 602,000 -
Accrued payroll and related costs 934,545 346,103
Lease payable 60,169 -
Other accrued liabilities 288,603 73,932
---------- ------------
Total $ 3,477,803 $ 1,820,402
---------- ------------
---------- ------------
</TABLE>
(7) CAPITAL STOCK
(A) REDEEMABLE PREFERRED STOCK
The Company has authorized 2,000,000 shares of preferred stock having a par
value of $.01 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.
(Continued)
<PAGE>
F-17
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Supplemental Consolidated Financial Statements, (Continued)
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 $21,600, $39,267, and $41,800 have been accrued for
the years ended December 31, 1998, 1997 and 1996, respectively. The
holder has not notified the Company of his intention to redeem the stock.
The Company continues to accrue dividends until receipt of such
intention.
In May of 1996, the Company raised $3,214,026, net of issuance costs of
$285,974, through the placement of 350 shares of Series B Preferred Stock
("Series B Preferred Stock") pursuant to Regulation S of the Securities
Act of 1933 ("the Act"). The Series B Preferred Stock has a stated value
of $10,000 per share, which accrues dividends for liquidation and
conversion purposes at 6% per annum, and ranks senior to the Company's
common stock and Series C Convertible Preferred Stock ("Series C
Preferred Stock") and junior to the Series A Preferred Stock. Series B
Preferred Stock was convertible by the holder, in increments, into the
Company's Class A common stock. The Series B Preferred Stock was
convertible at the lesser of 110% of the average closing bid price for
the five days immediately preceding the issue date or 85% of the average
closing bid price for the five days immediately preceding the conversion
date. During 1996, 330 shares of the Company's Series B Preferred Stock
were converted into 2,960,303 shares of the Company's Class A common
stock and the remaining 20 shares of Series B preferred were converted
in 1997 into 117,240 shares of the Company's Class A common stock.
In December of 1996, the Company raised $2,634,037 net of issuance costs
of $365,963 ($101,964 of which related to the value ascribed to warrants
issued) through the placement of 150,000 shares of Series C Preferred
Stock pursuant to Regulation D of the Act. The Series C Preferred Stock
has a stated value of $20 per share, which accrues dividends payable
quarterly in cash at 6% per annum.
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 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%.
(Continued)
<PAGE>
F-18
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Supplemental Consolidated Financial Statements, (Continued)
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.
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 five lowest closing bids for the 25 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.
As of December 31, 1998, 20,000 shares remained outstanding.
(C) COMMON STOCK
In December 1989, March through October 1990, and November 1991,
substantially all stockholders as of December 29, 1989 were offered the
right to acquire a number of shares equivalent to their pre-offering
holdings at a price of $.003 per share. Substantially all stockholders
that received the offer accepted this opportunity. This was accounted for
essentially as a stock split effected in the form of a rights offering,
and all shares issued in conjunction with this offering were reflected in
the accompanying consolidated financial statements retroactively.
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
(Continued)
<PAGE>
F-19
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Supplemental Consolidated Financial Statements, (Continued)
rights were offered to the individuals in compensation for services rendered
to the Company, compensation expense equal to the difference between the
estimated fair value as of the date of issuance and the purchase price of
the stock was recorded. The estimated fair value of the common stock was
determined based on sales to third parties near the date of issuance.
Compensation expense associated with the issuance of these shares of
$430,250 is included in the accompanying consolidated statement of
operations for the period from inception to December 31, 1998.
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. As of
December 31, 1998, 600,000 of the shares had been exercised.
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.
(Continued)
<PAGE>
F-20
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Supplemental Consolidated Financial Statements, (Continued)
(D) RECAPITALIZATION
In January 1994, the Board of Directors authorized the Company to amend
and restate the Company's Certificate of Incorporation to reflect the
authorization of 25,000,000 shares of a newly created Class A common
stock, which stock has voting rights of one vote per share, and the
reclassification of the then current outstanding shares of common stock
into Class B common stock. In June 1994, the Board of Directors
authorized that the Class B common stock will have one vote per share,
except that Class B common stock will have five votes per share in cases
where one or more directors are nominated for election by persons other
than the Company's Board of Directors and where there is a vote on any
merger, consolidation or other similar transaction, which is not
recommended by the Company's Board of Directors. In addition, the Class B
common stock will have five votes per share on all matters submitted to a
vote of the stockholders in the event that any person or group of persons
acquires beneficial ownership of 20% or more of the outstanding voting
securities of the Company. The Class B common stock is convertible into
shares of Class A common stock at any time. The classes of common stock
are alike in all other respects.
(E) N*ABLE EQUITY ISSUANCES
The following summarizes the equity issuances of N*Able. Each of these
transactions have been reflected in the Wave supplemental consolidated
financial statements on a Wave common share equivalent basis based on
the exchange ratio in the merger.
In connection with formation of N*Able, in October 1996,the Company
issued 300 shares of common stock to N*Able's founders. In April
1997, N*Able issued 1,600,000 shares of common stock to a private
investor as partial payment for services rendered. The fair market
value of the shares, which are restricted as to resale, was determined
to be $16,000 and was included in general and administrative expenses.
In April 1997, N*Able issued 2,900,000 shares of Series A Convertible
Preferred Stock ("Series A Preferred Stock") at $0.431 per share
to private investors for total consideration of $1,183,931, net of
offering costs of $65,969. Of the total consideration, $450,000
was paid by certain investors through the cancellation of certain
promissory and demand subordinated notes owed by N*Able.
In August 1997, N*Able issued 4,129,712 shares of Series B Convertible
Preferred Stock ("Series B Preferred Stock") at $0.902 per share to
private investors for total consideration of $3,652,197, net costs of
$72,803. Of the total consideration, $100,000 was of offering a related
party investor through the forgiveness of amounts paid by owed by N*Able.
In June 1998, N*Able issued 5,674,268 shares of Series C Convertible
Preferred Stock ("Series C Preferred Stock") at $1.153 per share to
private investors for total consideration of $6,528,509, net of offering
costs of $13,922.
In April 1997, N*Able issued 1,160,000 warrants to purchase Series A
Preferred Stock at $0.431 per share to a related party investor in
connection with the issuance of the Series A Preferred Stock. The
estimated fair market value ascribed to the warrants was $124,120 and
was included in general and administrative expense in the period the
warrants were issued. The warrants expire in April 2002 and were fully
vested upon issuance.
In August 1997, in connection with the issuance of Series B Preferred
Stock, N*Able issued 200,000 warrants to a private investor to
purchase Series B Preferred Stock at $0.902 per share. The warrants
carry contingent vesting provisions based on the occurrence of certain
future events related to manufacture and sale of N*Able's
product. During the period ended December 31, 1998, 25,000 of the
warrants had vested. The fair value ascribed to the vested warrants
was $5,411 and is included in general and administrative expenses in
the period the warrants were issued. The warrants expire in August
2002.
As discussed in Note 1, on July 27, 1999, Wave acquired all of the
outstanding Common and Preferred Stock of N*Able in a transaction to
be accounted for under the pooling-of-interests method. In conjunction
with this business combination all common preferred stock of N*Able
was exchanged for Wave common stock and an N*Able investor, Databook,
Inc., exercised 1,160,000 warrants to acquire 886,483 Series A Preferred
Shares (all of which was also exchanged for Wave common stock as part
of the merger), at an exercise price of $0.431 per share in a non-cash
transaction.
(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 pro rata 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.
(Continued)
<PAGE>
F-21
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Supplemental Consolidated Financial Statements, (Continued)
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, July 1997, and November 1998 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 by
1,000,000, 1,000,000 and 5,000,000, respectively. Therefore, the 1994 Plan
number of shares of Class A common stock reserved for issuance is 8,000,000
shares.
In January 1994, the Board of Directors authorized the establishment of the
Non-Employee Directors Stock Option Plan (the "Directors' Plan"). The total
number of shares of Class A common stock subject to the Directors' Plan was
200,000. Pursuant to the Directors' Plan, each director who was not an
employee of the Company received an initial grant of options to purchase
12,000 shares of Class A common stock at an exercise price of $3.50 per
share.
Any person subsequently elected as a director who is not an employee of the
Company will receive an initial grant of options to purchase 12,000 shares
of Class A common stock on the day he or she is elected a director. In
addition, on the day immediately following each of the dates on which an
incumbent director is reelected, he or she received an additional grant of
options to purchase 2,000 shares of Class A common stock.
In February 1995, the Board of Directors authorized certain changes to the
Directors' Plan. The annual option grant for directors was increased from a
total of 2,000 shares of Class A common stock to 10,000 shares of Class A
common stock. In July 1995, the stockholders of the Company authorized an
increase to the total number of shares subject to the Directors' Plan from
200,000 shares to 500,000 shares. Options to purchase a total of 110,000
and 100,000 shares of Class A common stock at $1.94 to $3.09 and $3.09 per
share, were issued in 1997 and 1996, respectively, to nonemployee
directors. In November 1998, the stockholders of the Company authorized an
increase to the total number of shares subject to the Directors' Plan from
500,000 shares to 1,000,000 shares. The stockholders also amended the
Directors' Plan to provide that options issued to non-employee directors
under such plan vest on the day following the grant.
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.
<PAGE>
F-22
(Continued)
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Supplemental Consolidated Financial Statements, (Continued)
In September 1996, the Board of Directors authorized the establishment of the
1996 Performance Stock Option Plan ( the "1996 Plan"). The initial number
of shares of Class A common stock subject to the 1996 Plan was 800,000. The
terms of the 1996 Plan are similar to those of the 1994 and 1991 Plans.
Options are granted with exercise prices that approximate fair market value
at the date of grant.
At December 31, 1998, there were approximately 3,360,000 additional shares
available for grant under the 1994 Plan. The per share weighted-average
fair value of stock options granted during 1998, 1997 and 1996 was $2.48,
$1.58 and $2.65 on the dates of grant using the Black Scholes
option-pricing model with the following weighted-average assumptions:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Expected Life (Years) 10 10 10
Interest Rate 6.0% 6.5% 6.4%
Volatility 105% 111% 124%
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,
except for $234,723 of expense recorded in 1998 for options issued at
exercise prices below the fair market value of the Company's stock.
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>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Net loss - as reported $ ( 16,586,027 ) $ (18,012,635) $ (10,126,546)
Net loss - pro forma ( 22,305,606 ) (19,425,653) (11,479,691)
Net loss to common stockholders - as reported ( 17,444,890 ) (20,495,617) (10,997,125)
Net loss to common shareholders - pro forma ( 23,164,469 ) (21,908,635) (12,350,270)
Loss per common share - as reported ( .54 ) (.86) (.62)
Loss per common share - pro forma ( .72 ) (.92) (.70)
</TABLE>
Pro forma net loss reflects only options granted since 1995. Therefore, the
full impact of calculating compensation cost for stock options under SFAS
No. 123 is not reflected in the pro forma net loss amounts presented above
because compensation cost is reflected over the options' vesting periods
and compensation cost for options granted prior to January 1, 1995 are not
considered.
(Continued)
<PAGE>
F-23
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Supplemental Consolidated Financial Statements, (Continued)
SUMMARY OF OPTION ACTIVITY
A summary of option activity through December 31, 1998 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 707,914 1.03
Options canceled (676,741) 1.57
Options exercised (70,326) 1.90
-----------
Balance at December 31, 1997 2,329,533 2.38
Options granted 5,756,893 2.47
Options canceled (707,384) 2.48
Options exercised (78,653) 1.94
-------------
Balance at December 31, 1998 7,300,389 $2.40
-------------
-------------
</TABLE>
At December 31, 1998, there were approximately 1,984,175 options
exercisable at prices ranging from $0.49 to $7.06.
(Continued)
<PAGE>
F-24
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Supplemental Consolidated Financial Statements, (Continued)
The following table summarizes information about stock options outstanding at
December 31, 1998:
<TABLE>
<CAPTION>
Weighted
Weighted average
average remaining
Range of Number Number exercise contractual
Exercise Prices Outstanding Exercisable Price Life
- --------------- ----------- ----------- ----- ----
<S> <C> <C> <C> <C>
$0.49 - 1.06 492,411 256,928 $1.06 8.6 years
1.07 - 1.69 3,037,809 357,293 1.30 8.5 years
1.70 - 2.31 254,484 54,298 2.10 8.8 years
2.32 - 2.97 89,243 72,707 2.62 5.7 years
2.98 - 3.50 870,767 291,669 3.32 8.2 years
3.51 - 3.81 2,254,894 878,500 3.66 9.4 years
3.82 - 7.06 300,780 72,780 7.06 8.6 years
</TABLE>
N*ABLE OPTIONS
In 1997, N*ABLE adopted a Stock Option Plan (the "Plan") which provides for
the issuance of incentive stock options to employees of the Company. The Plan
which is administered by the Board of Directors and was approved by the
stockholders, permits the Company to grant stock options for the purchase of
Common Stock. The maximum number of shares available under the plan at
December 31, 1998 was 5,217,530.
Stock option activity for the period from October 31, 1996 (inception) to
December 31, 1997 and for the year ended December 31, 1998 was as follows:
<TABLE>
<CAPTION>
Weighted
average
Number exercise
of shares price
--------- ---------
<S> <C> <C>
Granted 3,830,700 0.06
Terminated (70,000) 0.05
---------
Outstanding at January 1, 1998 3,760,700 0.06
Granted 895,500 0.19
Exercised (10,708) 0.15
Terminated (59,792) 0.15
---------
Outstanding at December 31, 1998 4,585,700 0.12
---------
---------
Exercisable at December 31, 1998 2,185,673 0.11
---------
---------
</TABLE>
At December 31, 1998, 631,830 shares of authorized but unissued common
stock were reserved and available for granting additional options. Of the
total stock options outstanding at December 31, 1998, 780,500 carried an
exercise price of $0.20, 275,000 carried an exercise price of $0.15, and
3,530,200 carried an exercise price of $0.05. Of the total stock options
exercisable at December 31, 1998, 95,419 carried an exercise price of
$0.20, 69,247 carried an exercise price of $0.15, and 2,021,007 carried
an exercise price of $0.05.
Options granted under the Plan vest ratably from the date of grant over
four years and expire not more than 10 years from the date of grant.
Options which are terminated become available for future grants. The
weighted average remaining contractual life of stock options outstanding
at December 31, 1998 is 8.86 years.
As part of the acquisition of N*ABLE by Wave, Wave assumed the N*ABLE
stock Option Plan and the number of options outstanding and their
exercise price were adjusted based upon the exchange ratio of Wave shares
issued for the acquisition of N*ABLE shares outstanding.
<PAGE>
The per-share weighted-average fair value of stock options issued by
N*ABLE during the year ended December 31, 1998 was $0.054, on the date of
grant using the minimum value method. N*ABLE used the following
weighted-average assumptions for the year ended December 31, 1998 to
determine the fair value of stock options granted: expected dividend
yield of 0%, risk-free interest rates of 6.5%, and an average expected
life of 5 years.
The N*ABLE stock option information has been included above in the pro
forma net loss disclosure pursuant to SFAS No. 123 and in the summary of
option activity.
WARRANTS
In 1993 and 1994, the Company issued warrants to acquire a total of 151,600
shares of Class B common stock at $3.50 per share in conjunction with sales
of Class B common stock to individuals and institutions. All warrants are
exercisable for a period of five years from the date of issuance.
In 1993 and 1994, the Company issued warrants to acquire a total of 376,253
shares of Class B common stock at $3.50 per share in conjunction with the
issuance of its 10% Convertible Notes which have since been repaid and in
1994, the Company issued warrants to acquire a total of 46,799 shares of
Class B common stock at $6.00 per share in conjunction with the issuance of
its 15% Notes, also which have since been repaid. All warrants are
exercisable for a period of five years from their dates of issuance.
Under the terms of the Company's initial public offering, the underwriter
acquired warrants to purchase 360,000 Class A common shares at a price of
$6.50 per share for nominal consideration. These warrants are exercisable
for four years commencing in September 1995.
As a result of the successful placement of 350 shares of Series B Preferred
Stock, a consultant from Digital Media Group, Inc. was issued warrants by
the Company to purchase 30,000 Class A common shares at a price of $3.09
per share. These warrants are exercisable for ten years commencing in March
1996.
(Continued)
<PAGE>
F-25
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Supplemental Consolidated Financial Statements, (Continued)
Due to the successful placement of 150,000 shares of the Company's Series C
Convertible Stock, Wharton Capital Partners Ltd. and The Shemano Group,
Inc., two financial consulting firms, were issued warrants by the Company
to purchase 37,500 Class A common shares each at a price of $2.54 per
share. These warrants expire on December 27, 1999.
In connection with the acquisition of WIN, the Company issued a warrant that
allows the holder the ability to purchase unregistered shares of the
Company's Class A common stock at a price of $1.25 per share at the earlier
of the conversion of a note or April 18, 1998 for a period of five years.
The number of shares able to be purchased under this warrant is based on a
formula of $170,000 divided by 80% of the fair market value of the Class A
common stock at the time of conversion.
As a result of the successful placement of 80,000 shares of the Company's
Series D Preferred Stock, JNC Opportunity Fund, the acquirer of the
placement, received 80,000 warrants to purchase the Company's unregistered
Class A Common Stock, and financial consultants, primarily Wharton Capital
Partners, received a total of 40,000 warrants. The warrants have an
exercise price of $1.62, and expire on May 30, 2002.
As a result of the successful placement of 112,500 shares of the Company's
Series F Preferred Stock, Combination Inc., the acquirer of the placement,
received 112,500 warrants to purchase the Company's unregistered Class A
Common Stock, and Wharton Capital Partners received 56,250 warrants. The
warrants have an exercise price of $1.26, and expire on October 9, 2002.
In connection with the private placement of approximately 800,000 shares of
the Company's Class A Common Stock, the Company issued 160,000 warrants to
purchase shares of the Company's unregistered Class A Common Stock at an
exercise price of $1.00. The warrants expire on September 16, 2000.
In connection with a technology license agreement with Aladdin, the Company
issued two warrants on July 18, 1997 to purchase the Company's Class A
Common Stock. The first warrant is exercisable in 100,000 share lots, and
provides the holder with the right to acquire 1,216,136 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. During June of 1998, Aladdin exercised a
portion of the second warrant to purchase 1,000,000 shares of common stock
and still has the right to acquire shares approximating 3.45% of the
Company's Class A common stock.
(Continued)
<PAGE>
F-26
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Supplemental Consolidated Financial Statements, (Continued)
A summary of warrants outstanding at December 31, 1998, based upon a year end
price of the Class A common stock of $3.718 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> <C>
1994 542,800 $ 3.50 -6.50 5 years
1996 191,905 1.25 - 3.09 5-10 years
1997 1,080,000 1.00 - 1.75 5 years
1997 1,216,136 1.70 2 years
1998 225,000 1.38 - 1.49 5 years
1998 120,000 1.10 - 4.05 5 years
1998 34,680 1.83 10 years
------
3,410,521
---------
---------
</TABLE>
At December 31, 1998, warrants to acquire approximately 3.4 million shares of
Class A and Class B common stock were exercisable.
The above information table does not include the Aladdin warrant to
purchase 3.45% of the Company due to its variable nature.
(9) LICENSING AGREEMENTS
(A) LICENSED PATENTS
In February 1994, the Company entered into an Amended and Restated License
Agreement (the "Agreement") with Mr. Peter J. Sprague, the Chairman and
Chief Executive Officer of the Company, and Mr. John Michener, then a
shareholder and officer of the Company, whereby the Company was granted an
exclusive license to make, have made, use, lease, sell or otherwise perform
services covered by certain licensed patents (the "Licensed Patents") which
are a fundamental part of the Company's product. The Agreement amends and
restates certain license agreements entered into by the Company prior to
February 1994.
The Agreement provides for royalty payments to be made to the licensors in
the aggregate amount of two percent of the total gross revenues derived by
the Company and any sublicensee of the Company from the exploitation of the
Licensed Patents, less any amounts paid, if any to (i) information and
database providers for information distributed to or through the Company or
its sublicensees, and to (ii) the Company's sublicensees for manufacturing
the product or performing the services covered by the Licensed Patents.
Royalty payments are payable quarterly and are to be apportioned 75% to Mr.
Sprague and 25% to Mr. Michener.
(Continued)
<PAGE>
F-27
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Supplemental Consolidated Financial Statements, (Continued)
Payment of royalties is secured by a security interest in and to the
Licensed Patents. Mr. Sprague assigned all of his right, title, and
interest in the Licensed Patents to the Company.
The Company believes that the agreements as a whole provide it with exclusive
rights under the Wave Patents. There can be no assurance that the Company
will enjoy exclusive rights to the Licensed patents under these agreements.
(B) ALADDIN LICENSE AGREEMENT
During the third quarter of 1997 the Company entered into a license agreement
with Aladdin Knowledge Systems, Ltd. ("Aladdin"), an Israeli company, for
technology and in-process research and development related to Aladdin's
proprietary persistent encryption system. Under the terms of the Aladdin
license agreement, the Company is prohibited from using any other
encryption technology for the first five years. This technology will be
incorporated into the Wave System to facilitate pay-per-view content
distribution.
The Company acquired the license for this technology in exchange for $950,000
plus two warrants to purchase the Company's Class A common stock valued at
approximately $2.9 million (see note 8). 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 (see note 7).
(10) LICENSE AND CROSS-LICENSE AGREEMENTS
On May 1, 1992, the Company entered into a Joint Technology Development
Agreement and License and Cross-License Agreement ("License and
Cross-License Agreement") with The Titan Corporation ("Titan") whereby
Titan granted to the Company license rights to the use of certain patents
which are co-owned or licensed by Titan. The Company granted to Titan the
exclusive right to make for, sell in, and lease in a "Retained Market," as
defined in the agreement, the subject matter described in any Company
patent. The Retained Market is defined generally as the market for
"Government Information," as defined in the agreement, used solely by a
government entity, and the market for products used to access such
information. The Company issued to Titan 674,976 shares of Class B common
stock in return for the license to Titan's patents. These shares were
valued at $1.67 per share (total $1,124,960), the estimated fair value of
the shares at the time of issuance (based on the price at which shares were
sold to third parties near the time of issuance), and were included in
research and development expense in the accompanying consolidated statement
of operations for the period from February 12, 1988 through December 31,
1996.
The License and Cross-License Agreement provides for royalties to be paid by
the Company to Titan based upon the Company's "Net Revenues," as defined in
the agreement. Net Revenues are defined generally as gross product revenues
less amounts paid to information providers and data base providers for
information provided to the Company for use in its products and services.
Royalties are payable on a quarterly basis.
(Continued)
<PAGE>
F-28
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Supplemental Consolidated Financial Statements, (Continued)
The License and Cross-License Agreement also provides for royalties to be
paid to the Company by Titan based upon Titan's "Allocable Net Revenues,"
as defined in the agreement. Allocable Net Revenues are generally defined
as that portion that a Company patent or information adds to Titan's gross
amounts invoiced to purchasers for all products or information services
making use of a Company patent or know-how and information. Royalties are
payable on a quarterly basis.
The License and Cross-License Agreement specifies certain events of
termination, some of which have already occurred but which have been waived
or extended by Titan.
A director of the Company, who resigned from the Board at the end of 1997, is
also the President, Chief Executive Officer, and a director of Titan.
Pursuant to the terms of a related stockholders agreement, Titan has the
right to designate a member of the Company's Board of Directors for as long
as Titan continues to own at least 50% of the shares originally issued to
Titan. As of December 31, 1998, no royalties have been earned by Titan. On
February 28, 1997, the Company and Titan executed an addendum to the
License Agreement whereby the Company received a sole license to Titan's
patent to develop and distribute products to the in-home consumer
microcomputers market segment. Under this addendum, Titan waived all
defaults previously incurred by Wave as well as extended the license
agreement to expire at the time the patents expire.
(11) REVENUE SHARING AGREEMENTS WITH PARTNERS
The Company has, and intends to continue to, enter into revenue sharing
arrangements with information providers, software developers, and hardware
and systems manufacturers such as IBM discussed below. These revenue
sharing arrangements will be negotiated between each of the partners and
the Company. It is anticipated that revenue sharing arrangements will vary
according to the market in which the Wave system is adopted and from which
revenues are derived. Generally, a significant portion of the revenue
collected by the Company will be paid directly to the information provider
or software developer. Once these payments are made the remainder of
revenues will be shared between the Company and other partners. There can
be no assurance that the Company will be successful in entering into
definitive agreements with these parties, or that the terms of such
agreements will be favorable to the Company.
In December 1997, the Company entered into a series of agreements ("the
agreements") with IBM pursuant to which the Company and IBM agreed to
explore ways to incorporate the Company's WaveMeter chip into PC products
and to support each other in achieving industry-wide adoption of the
WaveMeter technology. Pursuant to the agreements, the Company must
subsidize the incremental cost of using the Wave technology in IBM
products. The total subsidy is capped at $30 million. The Company must also
share varying percentages of its usage and advertising fee income that
results from usage of any Wave technology distributed by IBM. In addition,
the Company must provide user and technical service and support to IBM
customers for the end-user application of Wave technology. Finally, the
agreements provide for cash payments upon the attainment of certain
milestones. The amount of such cash payments is based upon the appreciation
of the Company's stock. To date, none of these milestones have been
achieved; therefore, no costs have been recognized in the financial
statements.
<PAGE>
F-29
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Supplemental Consolidated Financial Statements, (Continued)
(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 received 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 was 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 of 1997 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 began recognizing the license
fee ratably over the contractual refund, and recorded the $1 million as a
license fee. Also the Company accrued $490,000 in the fourth quarter of
1997 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 Company also received the final payment of $3.25 million
in June 1998 pursuant to the licensing and joint venture agreement ("the
Agreement") with Internet Technology Group, PLC, a United Kingdom company.
This payment and the $750,000 received in January 1998 total $4 million
received in 1998. As part of the Agreement, after the final license fee is
paid, the Company and Internet Technology Group, PLC are to issue a
significant warrant to each other for approximately one million shares of
each others' common stock. The exercise price of the Wave warrants is $1.75
per share. The exercise price of the ITG warrant is approximately .995
British pound per share. On June 5, 1998, the final milestone for the last
payment on the license fee was attained and the Company became obligated to
issue its warrant to ITG pending approval by the shareholders of ITG for it
to issue its reciprocal warrant. On this date the net fair market value of
the exchange of warrants represented a net cost to the Company of
approximately $1.1 million. The Company, upon determining this cost, has
recorded the total amount as ITG net warrant cost in the Supplemental
Consolidated Statement of Operations.
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, 1998 and 1997, the
Company's investment in the joint venture was $0 for financial reporting
purposes.
<PAGE>
F-30
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Supplemental Consolidated Financial Statements, (Continued)
(13) COMMITMENTS AND CONTINGENCIES
LITIGATION
The Company is party to legal proceedings generally incidental to its
business. Management believes that the outcome of such litigation will not
have a material adverse effect on the consolidated financial position or
results of operations of the Company.
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 and agreed to a settlement on January 25,
1999. The settlement cost of approximately, $602,000 and has been accrued
in the December 31, 1998 financial statements.
LEASES
The Company entered into an operating lease for its offices in New York,
New York. The minimum annual rent for the lease is approximately
$81,000 and its expiration is June 1999. The Company also leases
premises in Princeton, New Jersey; San Jose and Cupertino, California;
Danvers and Lee, Massachusetts, under operating leases, which expire on
various dates through January 14, 2001.
The Company is obligated under a capital lease for a phone system in the Lee,
Massachusetts office. At December 31, 1998 the gross amount of equipment
and related accumulated amortization recorded under capital leases were
as follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Phone Equipment $ 111,291 $ 111,291
Less: Accumulated Amortization 33,387 11,129
------- -------
Ending Balance $ 77,904 $ 100,162
------- -------
------- -------
</TABLE>
Amortization of assets held under capital leases is included with
depreciation expense.
(Continued)
<PAGE>
F-31
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Supplemental Consolidated Financial Statements, (Continued)
Future minimum lease payments under noncancelable operating leases (with initial
or remaining lease terms in excess of one year) and future minimum capital
lease payments as of December 31, 1998 are as follows:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31, CAPITAL LEASE OPERATING LEASE
<S> <C> <C>
1999 $ 42,372 $ 548,964
2000 21,186 699,157
2001 - 679,633
2002 - 428,982
-------- -------
Total minimum lease payments 63,558 $ 2,356,736
---------
---------
Less: interest 3,389
-----
Present Value of net minimum
lease payments 60,169
Less: current installment of obligations
under capital lease 39,409
-----
Obligation under capital lease
excluding current installments $ 20,760
-----
-----
</TABLE>
Rent expense for the years ended December 31, 1998, 1997, 1996 and for the
period from inception through December 31, 1998 amounted to approximately
$307,000, $383,000, $341,000 and $1,800,000, respectively.
(14) INCOME TAXES
The Company has net operating loss carryforwards for tax return purposes of
approximately $51.9 million which expire beginning in 2003 through 2018.
Pursuant to the Tax Reform Act of 1986, annual utilization of the Company's
net operating loss carryforwards may be limited if a cumulative change in
ownership of more than 50% occurs within a three year period. The Company
has not determined whether there has been such a cumulative change in
ownership or the impact on the utilization of the loss carryforwards if
such change has occurred.
The tax effects of temporary differences that give rise to the deferred tax
asset at December 31, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards $ 21,706,000 $16,677,000
Start-up costs 1,383,000 975,000
Accrued expenses 32,000 11,000
License rights 980,000 1,307,000
---------- ---------
Total gross deferred tax assets 24,101,000 18,970,000
Less valuation allowance (24,101,000) (18,970,000)
----------- ----------
Net deferred tax asset $ - $ -
----------- ----------
----------- ----------
</TABLE>
The valuation allowance increased by approximately $6.0 million and
$6.8 million, during the years ended December 31, 1998 and 1997,
respectively.
<PAGE>
F-32
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes to Supplemental Consolidated Financial Statements, (Continued)
(15) DEFINED CONTRIBUTION PLAN
The Company adopted the Wave Systems Corp. 401(k) Savings and Investment
Plan, a defined contribution plan, to which substantially all employees can
contribute on January 1, 1995. Employees of the Company become eligible
immediately on employment. The Company has the option to make discretionary
matching contributions; no contributions were made in 1998, 1997 or 1996.
(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
During March 1999, the Company raised approximately $23,000,000 through
the private placement to institutional, strategic and accredited individual
investors of approximately 2.1 million shares of Class A common stock at
$11.00 per share.
During January of 1999, the Company issued a non-interest bearing convertible
promissory note for $2,000,000 to one accredited investor. The note
shall be due and payable on January 26, 2002 unless the Company raises
financing of at least $5,000,000, whereby the Company must repay the
principal of the note within five business days of such financing, unless
converted into Class A common stock of the Company. The note holder is
entitled to 275,000 warrants to purchase Class A common stock at an
exercise price of $4.00, and the warrants expire on January 26, 2004. If,
over any sixty consecutive day period, the average of the averaged
daily high and low prices of the Class A Common Stock, as reported by
Bloomberg Information Services, Inc., exceeds seven dollars, the
Company has the option to force the conversion of the Warrants. The fair
value of such warrant will be recorded as interest expense through the
earliest available conversion date of the note. In March 1999, subsequent
to and in addition to the Company's completion of the $23 million private
placement, the $2 million note was converted into 181,818 shares of the
Company's Class A common stock at a conversion price of $11.00 a share.
<PAGE>
F-34
INDEPENDENT AUDITORS' REPORT
The Board of Directors
N*Able Technologies, Inc.:
We have audited the accompanying balance sheets of N*Able Technologies, Inc. (a
development stage enterprise) as of June 30, 1999 and 1998 and the related
statements of operations, stockholders' equity, and cash flows for the two years
then ended and the period from October 31, 1996 (inception) to June 30, 1999.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these 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 financial statements referred to above present fairly, in
all material respects, the financial position of N*Able Technologies, Inc. (a
development stage enterprise) as of June 30, 1999 and 1998, and the results of
its operations and its cash flows for the two years then ended and the period
from October 31, 1996 (inception) to June 30, 1999, in conformity with generally
accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in note 1 to the
financial statements, the Company has suffered recurring losses from operations
that raise substantial doubt about its ability to continue as a going concern.
Management's plans in regard to these matters are also described in note 1. The
financial statements do not include any adjustments that might result from this
uncertainty.
KPMG LLP
Boston, Massachusetts
July 9, 1999, except as to
Note 9 which is as
of July 27, 1999
<PAGE>
F-35
N*ABLE TECHNOLOGIES, INC.
(A Development Stage Enterprise)
Balance Sheets
June 30, 1999 and 1998
<TABLE>
<CAPTION>
ASSETS 1999 1998
------------ -----------
<S> <C> <C>
Cash and cash equivalents $ 812,731 5,834,554
Accounts receivable 3,798 --
Prepaid inventory from affiliate (note 8) 29,750 --
Prepaid royalty 62,500 --
------------ -----------
Total current assets 908,779 5,834,554
Property and equipment, net (note 3) 405,791 397,430
Deposits 55,630 55,630
------------ -----------
Total assets $ 1,370,200 6,287,614
------------ -----------
------------ -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable (note 8) $ 296,001 309,186
Accrued expenses (note 4) 296,874 83,454
------------ -----------
Total current liabilities 592,875 392,640
Commitments (note 7)
Stockholders' equity (note 6):
Series A Preferred Stock, $0.01 par value; 4,060,000 shares authorized;
2,900,000 shares issued and outstanding at June 30, 1999 and 1998;
liquidation value, $1,249,900 29,000 29,000
Series B Preferred Stock, $0.01 par value; 4,157,428 shares authorized;
4,129,712 shares issued and outstanding at June 30, 1999 and 1998;
liquidation value, $3,725,000 41,297 41,297
Series C Preferred Stock, $0.01 par value; 6,071,118 shares authorized;
5,674,268 issued and outstanding at June 30, 1999 and 1998;
liquidation value, $6,542,432 56,743 56,743
Common stock, $0.01 par value; 21,000,000 shares authorized;
1,698,173 and 1,600,800 shares issued and outstanding at June 30,
1999 and 1998, respectively 16,982 16,008
Additional paid-in capital 11,388,389 11,367,148
Deficit accumulated during the development stage (10,755,086) (5,557,572)
Preferred stock subscribed -- (57,650)
------------ -----------
Total stockholders' equity 777,325 5,894,974
------------ -----------
Total liabilities and stockholders' equity $ 1,370,200 6,287,614
------------ -----------
------------ -----------
</TABLE>
See accompanying notes to financial statements.
<PAGE>
F-36
N*ABLE TECHNOLOGIES, INC.
(A Development Stage Enterprise)
Statements of Operations
Years ended June 30, 1999 and 1998
and period from October 31, 1996 (inception) to June 30, 1999
<TABLE>
<CAPTION>
PERIOD FROM
OCTOBER 31,
1996
(INCEPTION) TO
JUNE 30,
1999 1998 1999
----------- ---------- -----------
<S> <C> <C> <C>
Sales $ 3,798 -- 3,798
Operating expenses:
Selling, general and administrative 2,273,212 1,574,047 4,839,642
Research and development 3,103,422 2,569,207 6,115,478
----------- ---------- -----------
Total operating expenses 5,376,634 4,143,254 10,955,120
----------- ---------- -----------
Operating loss (5,372,836) (4,143,254) (10,951,322)
Interest expense -- (2,244) (11,993)
Interest income 175,322 30,657 208,229
----------- ---------- -----------
Net loss $(5,197,514) (4,114,841) (10,755,086)
----------- ---------- -----------
----------- ---------- -----------
Net loss per share - basic and diluted $ (3.22) (2.57) (8.08)
----------- ---------- -----------
----------- ---------- -----------
Weighted average number of common shares
outstanding - basic and diluted 1,613,292 1,600,468 1,330,340
----------- ---------- -----------
----------- ---------- -----------
</TABLE>
See accompanying notes to financial statements.
<PAGE>
F-37
N*ABLE TECHNOLOGIES, INC.
(A Development Stage Enterprise)
Statements of Stockholders' Equity
Years ended June 30, 1999 and 1998
and period from October 31, 1996 (inception) to June 30, 1999
<TABLE>
<CAPTION>
SERIES A SERIES B SERIES C
PREFERRED STOCK PREFERRED STOCK PREFERRED STOCK
------------------ ----------------- ------------------
SHARES PAR VALUE SHARES PAR VALUE SHARES PAR VALUE
------ --------- ------ --------- ------ ---------
<S> <C> <C> <C> <C> <C> <C>
Issuance of common stock in connection with
the formation of the Company -- $ -- -- $ -- -- $ --
Issuance of common stock in exchange for
services on April 4, 1997 at $0.01 per share -- -- -- -- -- --
Issuance of Series A Preferred Stock on April 4,
1997 at $0.431, net of offering costs of
$65,969 1,855,916 18,559 -- -- -- --
Issuance of Series A Preferred Stock upon
conversion of demand subordinate notes
on April 4, 1997 at $0.431 1,044,084 10,441 -- -- -- --
Issuance of Series A Preferred Stock purchase
warrants on April 4, 1997 -- -- -- -- -- --
Net loss -- -- -- -- -- --
--------- -------- --------- -------- --------- --------
Balance at June 30, 1997 2,900,000 29,000 -- -- -- --
Exercise of options -- -- -- -- -- --
Issuance of Series B Preferred Stock on
August 27, 1997 at $0.902, net of offering
costs of $72,803 -- -- 4,018,847 40,188 -- --
Issuance of Series B Preferred Stock in
exchange for forgiveness of amounts owed
on August 27, 1997 at $0.902 -- -- 110,865 1,109 -- --
Issuance of Series B Preferred Stock purchase
warrants on August 27, 1997 -- -- -- -- -- --
Issuance of Series C Preferred Stock on
June 15, 1998 at $1.153, net of offering costs
of $13,922 -- -- -- -- 5,674,268 56,743
Net loss -- -- -- -- -- --
--------- -------- --------- -------- --------- --------
Balance at June 30, 1998 2,900,000 29,000 4,129,712 41,297 5,674,268 56,743
Exercise of options -- -- -- -- -- --
Issuance of common shares in exchange for
services on June 30, 1999 -- -- -- -- -- --
Payment of preferred stock subscribed -- -- -- -- -- --
Net loss -- -- -- -- -- --
--------- -------- --------- -------- --------- --------
Balance at June 30, 1999 2,900,000 $ 29,000 4,129,712 $ 41,297 5,674,268 $ 56,743
--------- -------- --------- -------- --------- --------
--------- -------- --------- -------- --------- --------
<CAPTION>
DEFICIT
ACCUMULATED TOTAL
ADDITIONAL DURING THE PREFERRED STOCKHOLDERS'
COMMON STOCK PAID-IN DEVELOPMENT STOCK EQUITY
SHARES PAR VALUE CAPITAL STAGE SUBSCRIBED (DEFICIT)
--------- -------- ------------ ------------- --------- ------------
<S> <C> <C> <C> <C> <C> <C>
Issuance of common stock in connection with
the formation of the Company 300 $ 3 $ -- $ -- $ -- $ 3
Issuance of common stock in exchange for
services on April 4, 1997 at $0.01 per share 1,600,000 16,000 -- -- -- 16,000
Issuance of Series A Preferred Stock on April 4,
1997 at $0.431, net of offering costs of
$65,969 -- -- 715,372 -- -- 733,931
Issuance of Series A Preferred Stock upon
conversion of demand subordinate notes
on April 4, 1997 at $0.431 -- -- 439,559 -- -- 450,000
Issuance of Series A Preferred Stock purchase
warrants on April 4, 1997 -- -- 124,120 -- -- 124,120
Net loss -- -- -- (1,442,731) -- (1,442,731)
--------- -------- ------------ ------------- --------- ------------
Balance at June 30, 1997 1,600,300 16,003 1,279,051 (1,442,731) -- (118,677)
Exercise of options 500 5 20 -- -- 25
Issuance of Series B Preferred Stock on
August 27, 1997 at $0.902, net of offering
costs of $72,803 -- -- 3,512,009 -- -- 3,552,197
Issuance of Series B Preferred Stock in
exchange for forgiveness of amounts owed
on August 27, 1997 at $0.902 -- -- 98,891 -- -- 100,000
Issuance of Series B Preferred Stock purchase
warrants on August 27, 1997 -- -- 5,411 -- -- 5,411
Issuance of Series C Preferred Stock on
June 15, 1998 at $1.153, net of offering costs
of $13,922 -- -- 6,471,766 -- (57,650) 6,470,859
Net loss -- -- -- (4,114,841) -- (4,114,841)
--------- -------- ------------ ------------- --------- ------------
Balance at June 30, 1998 1,600,800 16,008 11,367,148 (5,557,572) (57,650) 5,894,974
Exercise of options 87,373 874 5,141 -- -- 6,015
Issuance of common shares in exchange for
services on June 30, 1999 10,000 100 16,100 -- -- 16,200
Payment of preferred stock subscribed -- -- -- -- 57,650 57,650
Net loss -- -- -- (5,197,514) -- (5,197,514)
--------- -------- ------------ ------------- --------- ------------
Balance at June 30, 1999 1,698,173 $ 16,982 $ 11,388,389 $ (10,755,086) $ -- $ 777,325
--------- -------- ------------ ------------- --------- ------------
--------- -------- ------------ ------------- --------- ------------
</TABLE>
See accompanying notes to financial statements.
<PAGE>
F-38
N*ABLE TECHNOLOGIES, INC.
(A Development Stage Enterprise)
Statements of Cash Flows
Years ended June 30, 1999 and 1998
and period from October 31, 1996 (inception) to June 30, 1999
<TABLE>
<CAPTION>
PERIOD FROM
OCTOBER 31,
1996
(INCEPTION) TO
JUNE 30,
1999 1998 1999
----------- ---------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $(5,197,514) (4,114,841) (10,755,086)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 196,766 122,968 327,165
Warrants issued for services rendered -- 5,411 129,531
Common stock issued for services rendered 16,200 -- 32,200
Changes in operating assets and liabilities:
Accounts receivable, prepaid inventory and prepaid
royalty (96,048) -- (96,048)
Deposits -- (55,630) (55,630)
Accounts payable and accrued expenses 200,235 181,582 592,875
Amount due to related party, net -- (72,086) 100,000
----------- ---------- -----------
Net cash used in operating activities (4,880,361) (3,932,596) (9,724,993)
----------- ---------- -----------
Cash flows from investing activities:
Purchases of property and equipment (205,127) (388,365) (732,956)
----------- ---------- -----------
Net cash used in investing activities (205,127) (388,365) (732,956)
----------- ---------- -----------
Cash flows from financing activities:
Proceeds from issuance of common stock -- -- 3
Proceeds from exercise of stock options 6,015 25 6,040
Proceeds from issuance of Series A Preferred Stock,
net of offering costs of $65,969 -- -- 733,931
Proceeds from issuance of Series B Preferred Stock,
net of offering costs of $72,803 -- 3,552,197 3,552,197
Proceeds from issuance of Series C Preferred Stock,
net of offering costs of $13,922 -- 6,470,859 6,470,859
Proceeds from preferred stock subscribed 57,650 -- 57,650
Borrowings under notes payable -- -- 450,000
----------- ---------- -----------
Net cash provided by financing activities 63,665 10,023,081 11,270,680
----------- ---------- -----------
Net increase in cash and cash equivalents (5,021,823) 5,702,120 812,731
Cash and cash equivalents at beginning of period 5,834,554 132,434 --
----------- ---------- -----------
Cash and cash equivalents at end of period $ 812,731 5,834,554 812,731
----------- ---------- -----------
----------- ---------- -----------
Supplemental schedule of cash flow information:
Interest paid $ -- 2,244 2,244
----------- ---------- -----------
----------- ---------- -----------
Supplemental schedule of non-cash operating and financing transactions:
Warrants issued for services rendered $ -- 5,411 129,531
----------- ---------- -----------
----------- ---------- -----------
Common stock issued for services rendered $ 16,200 -- 32,200
----------- ---------- -----------
----------- ---------- -----------
Conversion of debt into Series A Preferred Stock $ -- -- 450,000
----------- ---------- -----------
----------- ---------- -----------
Conversion of amount due to related party into Series B
Preferred Stock $ -- 100,000 100,000
----------- ---------- -----------
----------- ---------- -----------
</TABLE>
See accompanying notes to financial statements.
<PAGE>
F-39
N*ABLE TECHNOLOGIES, INC.
(A Development Stage Enterprise)
Notes to Financial Statements
June 30, 1999 and 1998
and period from October 31, 1996 (inception) to June 30, 1999
(1) THE COMPANY
Prior to the formation of the Company in October 1996, certain members of
N*Able Technologies, Inc.'s ("N*Able" or the "Company") management were
employed in similar positions by Databook, Inc. ("Databook"). Databook
discontinued operations in September 1996 and N*Able Technologies Inc.
was formed by former members of Databook Management to develop, market
and sell standards-based host reader silicon that enables fast, secure
transmission of financial and corporate data across the Internet or an
Intranet utilizing "Smart Card" technology. Databook is an N*Able
shareholder.
The Company has incurred net losses of approximately $10,755,086 through
June 30, 1999 which raises substantial doubt about the Company's ability
to continue as a going concern. The ultimate success of the Company is
dependent upon the development and marketing of its products and its
ability to secure adequate financing until the Company is operating
profitably. The Company is reviewing possible merger arrangements and
private financing to fund operations. However, there can be no assurances
that the Company will complete a merger or continue to receive sufficient
financing from private investors. The accompanying financial statements
have been prepared assuming that the Company will continue as a going
concern, and, as such, do not include any adjustments that may result
from the outcome of any uncertainties regarding the development,
marketing or financing of the Company's operations.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) DEVELOPMENT STAGE ENTERPRISE
During the period from October 31, 1996 (inception) to June 30,
1999, the Company has devoted most of its efforts towards
financial planning, raising capital and research and development
activities. Accordingly, the Company has classified itself as a
development stage enterprise for all periods presented.
(b) USE OF ESTIMATES
Management of the Company has made a number of estimates and
assumptions relating to the reporting of assets and liabilities
and the disclosure of contingent assets and liabilities to prepare
these financial statements in conformity with generally accepted
accounting principles. Actual results could differ from those
estimates.
<PAGE>
F-40
N*ABLE TECHNOLOGIES, INC.
(A Development Stage Enterprise)
Notes to Financial Statements
June 30, 1999 and 1998
and period from October 31, 1996 (inception) to June 30, 1999
(c) CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investment securities with
original or remaining maturities, at the time of purchase, of 90
days or less to be cash equivalents.
(d) PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation and
amortization are computed using the straight-line method over the
estimated useful lives of the assets, generally three years for
computer equipment and purchased software and five years for
furniture and fixtures.
Leasehold improvements are amortized using the straight-line
method over the estimated useful life of the asset or the lease
term, whichever is shorter.
(e) INCOME TAXES
The Company accounts for income taxes under the asset and
liability method. Under this method, deferred tax assets and
liabilities are recognized for the estimated future tax
consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities
are measured using enacted rates in effect for the year in which
those temporary differences are expected to be recovered or
settled.
(f) RESEARCH AND DEVELOPMENT AND SOFTWARE DEVELOPMENT COSTS
Research and development expenditures are expensed as incurred.
Software development costs are required to be capitalized when a
product's technological feasibility has been established either by
completion of a detailed program design or a working model of the
product and ending when a product is available for general release
to consumers. Technological feasibility of the Company's product
has not yet been established, and as a result no software
development costs have been capitalized.
(g) IMPAIRMENT OF LONG-LIVED ASSETS
The Company records impairment losses on long-lived assets used in
operations when indicators of impairment are present and the
undiscounted cash flows estimated to be generated by those assets
are less than the assets' carrying amount.
(Continued)
<PAGE>
F-41
N*ABLE TECHNOLOGIES, INC.
(A Development Stage Enterprise)
Notes to Financial Statements
June 30, 1999 and 1998
and period from October 31, 1996 (inception) to June 30, 1999
(h) FINANCIAL INSTRUMENTS AND CONCENTRATION OF CREDIT RISK
The fair market values of cash, accounts receivable, prepaids,
deposits, accounts payable, and accrued expenses at June 30, 1999
and 1998 approximate their carrying amounts due to the short term
nature of these items.
(i) STOCK-BASED COMPENSATION
The Company applies Statement of Financial Accounting Standards
No. 123, ACCOUNTING FOR STOCK-BASED Compensation ("SFAS 123"),
which gives companies the option to adopt the fair value method
for expense recognition of employee stock options and other
stock-based awards or to continue to account for such items using
the intrinsic value method as outlined under Accounting Principles
Board Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES
("APB 25") with pro forma disclosures of net income or loss as if
the fair value method had been applied. The Company has elected to
continue to apply APB 25 and related interpretations for employee
stock options and other employee stock-based awards and has
disclosed pro forma net loss as if the fair value method had been
applied.
(j) NET LOSS PER SHARE
In 1997, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 128 ("SFAS 128"), EARNINGS PER
SHARE. SFAS 128 requires the presentation of basic and diluted net
income (loss) per share for all periods presented. Basic net loss
per share was calculated based on weighted average common shares
outstanding. As the Company has been in a net loss position for
the years ended June 30, 1999 and 1998 and the period from October
31, 1996 (inception) to June 30, 1999, common stock equivalents
were excluded from the diluted net loss per share calculation as
they would be antidilutive. As a result, diluted net loss per
share is the same as basic net loss per share, and has not been
presented separately.
(k) COMPREHENSIVE INCOME (LOSS)
In 1997, the Company adopted Statement of Financial Accounting
Standards No. 130 ("SFAS 130"), REPORTING COMPREHENSIVE INCOME.
This statement requires that all components of comprehensive
income (loss) be reported in the consolidated financial statements
in the period in which they are recognized. For each period
presented, comprehensive loss under SFAS 130 was equivalent to the
Company's net loss reported in the accompanying statements of
operations.
<PAGE>
F-42
N*ABLE TECHNOLOGIES, INC.
(A Development Stage Enterprise)
Notes to Financial Statements
June 30, 1999 and 1998
and period from October 31, 1996 (inception) to June 30, 1999
(l) SEGMENT REPORTING
The Company has adopted SFAS No. 131, "Disclosures About Segments
of an Enterprise and Related Information" ("SFAS 131"). SFAS 131
establishes standards for the way that public business enterprises
report selected information about operating segments in annual and
interim financial statements. It also establishes standards for
related disclosures about products and services, geographic areas
and major customers. SFAS 131 requires the use of the "management
approach" in disclosing segment information, based largely on how
senior management generally analyzes the business operations. SFAS
131 has been adopted effective July 1, 1998. The Company currently
operates in only one segment and as such, no additional
disclosures are required.
(m) RECENT ACCOUNTING PRONOUNCEMENTS
In March 1998, the Accounting Standards Executive Committee of the
American Institute of Certified Public Accountants ("AcSEC")
issued Statement of Position 98-1 , "Accounting for the Cost of
Computer Software Developed or Obtained for Internal Use" ("SOP
98-1"). SOP 98-1 requires the capitalization of certain internal
costs related to the implementation of computer software obtained
for internal use. The Company is required to adopt this standard
in the first quarter of fiscal year 2000, and expects that the
adoption of SOP 98-1 will not have a material impact on its
financial position or its results of operations.
In April 1998, the AcSEC issued Statement of Position 98-5,
"Reporting Costs of Start-Up Activities" ("SOP 98-5"). Under SOP
98-5, the cost of start-up activities should be expensed as
incurred. Start-up activities are broadly defined as those
one-time activities related to opening a new facility, introducing
a new product or service, conducting business in a new territory,
conducting business with a new class of customer, commencing some
new operation or organizing a new entity. SOP 98-5 is effective
for the Company's fiscal 2000 consolidated financial statements.
The Company does not expect its adoption to have a material impact
on its financial position or results of operations.
In June 1998, the Financial Accounting Standards Board issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS 133"). SFAS 133 establishes accounting and
reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts (collectively
referred to as derivatives) and for hedging activities. SFAS 133
requires the recognition of all derivatives as either assets or
liabilities in the statement of financial position and the
measurement of those instruments at fair value. The Company is
required to adopt this standard in the first quarter of fiscal
year 2001, pursuant to SFAS No. 137 (issued in June 1999),
which delays the adoption of SFAS 133 until that time. The
Company expects that the adoption of SFAS 133 will not have a
material impact on its financial position or its
<PAGE>
F-43
N*ABLE TECHNOLOGIES, INC.
(A Development Stage Enterprise)
Notes to Financial Statements
June 30, 1999 and 1998
and period from October 31, 1996 (inception) to June 30, 1999
results of operations.
(3) PROPERTY AND EQUIPMENT
Property and equipment consisted of the following at June 30:
<TABLE>
<CAPTION>
ESTIMATED USEFUL
LIFE (YEARS) 1999 1998
------------ ---- ----
<S> <C> <C> <C>
Computer equipment 3 $ 187,701 127,707
Furniture and fixtures 5 119,751 75,770
Purchased software 3 366,002 324,352
Leasehold improvements 4 59,502 --
----------- -----------
732,956 527,829
Less accumulated depreciation and amortization (327,165) (130,399)
----------- -----------
$ 405,791 397,430
----------- -----------
----------- -----------
</TABLE>
(4) ACCRUED EXPENSES
Accrued expenses consist of the following at June 30:
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Vacation accrual $ 115,000 27,700
Professional fees 62,200 38,200
Other accruals 119,674 17,554
---------- --------
$ 296,874 83,454
---------- --------
---------- --------
</TABLE>
<PAGE>
F-44
N*ABLE TECHNOLOGIES, INC.
(A Development Stage Enterprise)
Notes to Financial Statements
June 30, 1999 and 1998
and period from October 31, 1996 (inception) to June 30, 1999
(5) INCOME TAXES
The tax effects of temporary differences that give rise to deferred tax
assets are as follows at June 30:
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Deferred tax assets:
Start-up costs $ 1,842,321 975,000
Accrued expenses 46,080 11,000
Net operating loss carryforwards 2,354,454 1,184,000
-------------- -------------
4,242,855 2,170,000
Less valuation allowance (4,242,855) (2,170,000)
-------------- -------------
Net deferred taxes $ -- --
-------------- -------------
-------------- -------------
</TABLE>
In assessing the realizability of deferred tax assets, the Company
considers whether it is more likely than not that some portion or all of
the deferred tax assets will not be realized. Due to the fact that the
Company expects to experience significant losses in the near future, it
appears as though the Company will not have sufficient future taxable
income necessary to utilize any of the deferred tax assets over the
periods which the deferred tax assets are deductible for federal and
state income tax purposes. As a result of the losses incurred by the
Company, a 100% valuation allowance has been applied against the
Company's deferred tax assets.
At June 30, 1999, the Company has net operating loss carryforwards of
approximately $5,890,000 for federal and state income tax purposes.
Approximately $2,960,000 of the federal losses expire beginning in 2012,
with the remaining balance of approximately $2,930,000 beginning to
expire in 2019. State loss carryforwards begin expiration in 2002. Under
the provisions of tax law, utilization of net operating loss
carryforwards can be limited if the Company undergoes a greater than
fifty percent change in ownership over a three year period. The Company
has not assessed whether there has been an ownership change and if this
provision adversely impacts the future utilization of the net operating
loss carryforwards.
<PAGE>
F-45
N*ABLE TECHNOLOGIES, INC.
(A Development Stage Enterprise)
Notes to Financial Statements
June 30, 1999 and 1998
and period from October 31, 1996 (inception) to June 30, 1999
(6) STOCKHOLDERS' EQUITY
(a) COMMON STOCK
In connection with formation of the Company, in October 1996, the
Company issued 300 shares of common stock to the Company's
founders. During the period ended June 30, 1997, the Company
issued 1,600,000 shares of common stock to a private investor as
partial payment for services rendered. The fair market value of
the shares, which are restricted as to resale, was determined to
be $16,000 and was included in general and administrative expenses
in the June 30, 1997 statement of operations.
(b) PREFERRED STOCK
- SERIES A PREFERRED STOCK
In April 1997, the Company issued 2,900,000 shares of Series A
Convertible Preferred Stock ("Series A Preferred Stock") at
$0.431 per share to private investors for total consideration
of $1,183,931, net of offering costs of $65,969. Of the total
consideration, $450,000 was paid by certain investors through
the cancellation of certain promissory and demand subordinated
notes owed by the Company.
The Series A Preferred Stock is voting. Holders of Series A
Preferred Stock are entitled to receive dividends, if and when
declared, at the rate of 10% per annum. Dividends are
non-cumulative. Dividends declared must be paid before any
other dividends can be declared or paid on any class of Common
Stock. Dividends declared on Common Stock cannot exceed those
which have been declared and paid on the Series A Preferred
Stock. The Series A Preferred Stock is convertible into Common
Stock at any time by the holders, at the then applicable
conversion rate as adjusted from time to time (one to one on
the issuance date). In addition, the Series A Preferred Stock
automatically converts into common stock upon the completion
of a qualifying initial public offering. The Series A
Preferred Stock has a liquidation preference of $0.431 per
share plus any declared but unpaid dividend. At June 30, 1999,
the Company had reserved 2,900,000 shares of Common Stock for
conversion of Series A Preferred Stock.
<PAGE>
F-46
N*ABLE TECHNOLOGIES, INC.
(A Development Stage Enterprise)
Notes to Financial Statements
June 30, 1999 and 1998
and period from October 31, 1996 (inception) to June 30, 1999
- SERIES B PREFERRED STOCK
In August 1997, the Company issued 4,129,712 shares of Series
B Convertible Preferred Stock ("Series B Preferred Stock") at
$0.902 per share to private investors for total consideration
of $3,652,197, net of offering costs of $72,803. Of the total
consideration, $100,000 was paid by a related party investor
through the forgiveness of amounts owed by the Company (see
note 8).
The Series B Preferred Stock is voting. Holders of the Series
B Preferred Stock are entitled to receive dividends, if and
when declared, at the rate of 10% per annum. Dividends are
non-cumulative. Dividends declared must be paid before any
other dividends can be declared or paid on Series A Preferred
Stock or Common Stock. Dividends declared on Series A
Preferred Stock or Common Stock cannot exceed those which have
been declared and paid on the Series B Preferred Stock. The
Series B Preferred Stock is convertible into Common Stock at
any time by the holders at the then applicable conversion
rate, as adjusted from time to time (one to one on the
issuance date). In addition the Series B Preferred Stock
automatically converts into common stock upon the completion
of a qualifying initial public offering. The Series B
Preferred Stock has a liquidation preference of $0.902 per
share plus any declared but unpaid dividend. At June 30, 1999,
the Company had reserved 4,129,712 shares of Common Stock for
conversion of Series B Preferred Stock.
Concurrent with the issuance of the Series B Preferred Stock,
the Company issued warrants to a private investor to purchase
200,000 shares of Series B Preferred Stock at $0.902 per share
(see note 6(c)).
- SERIES C PREFERRED STOCK
In June 1998, the Company issued 5,674,268 shares of Series C
Convertible Preferred Stock ("Series C Preferred Stock") at
$1.153 per share to private investors for total consideration
of $6,528,509, net of offering costs of $13,922.
The Series C Preferred Stock is voting. Holders of the Series
C Preferred Stock are entitled to receive dividends, if and
when declared, at the rate of 10% per annum. Dividends are
non-cumulative. Dividends declared must be paid before any
other dividends can be declared or paid on any other class of
Preferred or Common Stock. Dividends declared on any other
class of Preferred or Common Stock cannot exceed those which
have been declared and paid on the Series C Preferred Stock.
The Series C Preferred Stock is convertible into Common Stock
at any time by the holders at the then applicable conversion
rate, as adjusted from time to time (one to one on the
issuance date). In addition the Series C
<PAGE>
F-47
N*ABLE TECHNOLOGIES, INC.
(A Development Stage Enterprise)
Notes to Financial Statements
June 30, 1999 and 1998
and period from October 31, 1996 (inception) to June 30, 1999
Preferred Stock automatically converts into common stock upon
the completion of a qualifying initial public offering. The
Series C Preferred Stock has a liquidation preference of
$1.153 per share plus any declared but unpaid dividend. At
June 30, 1999, the Company had reserved 5,674,268 shares of
Common Stock for conversion of Series C Preferred Stock.
The Series A, B and C Preferred Stocks participate with the
Common Stock after satisfaction of all liquidation
preferences, including a liquidation preference of $0.10 per
common share.
(c) WARRANTS
During the period from October 31, 1996 (inception) to June 30,
1997 the Company issued 1,160,000 warrants to purchase Series A
Preferred Stock at $0.431 per share to a related party investor in
connection with the issuance of the Series A Preferred Stock. The
estimated fair market value ascribed to the warrants was $124,120
and was included in general and administrative expense in the June
30, 1997 statement of operations. The warrants expire in April
2002 and were fully vested upon issuance.
During the year ended June 30, 1998, in connection with the
issuance of Series B Preferred Stock, the Company issued 200,000
warrants to a private investor to purchase Series B Preferred
Stock at $0.902 per share. The warrants carry contingent vesting
provisions based on the occurrence of certain future events
related to manufacture and sale of the Company's product. During
the year ended June 30, 1998, 25,000 of the warrants had vested.
The fair value ascribed to the vested warrants was $5,411 and is
included in selling, general and administrative expenses in the
June 30, 1998 statement of operations. The warrants expire in
August 2002.
(d) STOCK COMPENSATION
In 1997, the Company adopted a Stock Option Plan (the "Plan")
which provides for the issuance of incentive stock options to
employees of the Company. The Plan which is administered by the
Board of Directors and was approved by the stockholders, permits
the Company to grant stock options for the purchase of Common
Stock. The maximum number of shares available under the plan at
June 30, 1999 was 5,217,530.
<PAGE>
F-48
N*ABLE TECHNOLOGIES, INC.
(A Development Stage Enterprise)
Notes to Financial Statements
June 30, 1999 and 1998
and period from October 31, 1996 (inception) to June 30, 1999
Stock option activity for the period from October 31, 1996
(inception) through June 30, 1999 was as follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
NUMBER EXERCISE
OF SHARES PRICE
------------ -----
<S> <C> <C> <C>
Granted 3,279,700 $ 0.05
------------
Outstanding at June 30, 1997 3,279,700 0.05
Granted 691,000 0.10
Exercised (500) 0.05
Terminated (70,000) 0.05
------------
Outstanding at June 30, 1998 3,900,200 0.06
Granted 822,500 0.20
Exercised (97,373) 0.08
Terminated (99,732) 0.16
------------
Outstanding at June 30, 1999 4,525,595 0.12
------------
------------
Exercisable at June 30, 1999 2,199,162 0.11
------------
------------
</TABLE>
At June 30, 1999, 691,935 shares of authorized but unissued common
stock were reserved and available for granting additional options.
Of the total stock options outstanding at June 30, 1999, 3,457,200
carried an exercise price of $0.05, 258,333 carried an exercise
price of $0.15, and 810,062 carried an exercise price of $0.20. Of
the total stock options exercisable at June 30, 1999, 1,921,482
carried an exercise price of $0.05, 97,168 carried an exercise
price of $0.15, and 180,512 carried an exercise price of $0.20
Options granted under the Plan vest ratably from the date of grant
over four years and expire not more than 10 years from the date of
grant. Options which are terminated become available for future
grants. The weighted average remaining contractual life of stock
options outstanding at June 30, 1999 is 8.33 years.
<PAGE>
F-49
N*ABLE TECHNOLOGIES, INC.
(A Development Stage Enterprise)
Notes to Financial Statements
June 30, 1999 and 1998
and period from October 31, 1996 (inception) to June 30, 1999
Had compensation cost been recognized consistent with SFAS 123,
the Company's reported net loss of $(5,197,514), $(4,114,841) and
$(10,755,086) for the years ended June 30, 1999 and 1998 and the
period from October 31, 1996 (inception) to June 30, 1999,
respectively, would have been increased on a pro forma basis to
$(5,254,301), $(4,125,466) and $(10,833,941), respectively.
The per-share weighted-average fair value of stock options issued
by the Company during the years ended June 30, 1999 and 1998 was
$0.05 and $0.02, respectively, on the date of grant using the
minimum value method. The Company used the following
weighted-average assumptions for the years ended June 30, 1999 and
1998 to determine the fair value of stock options granted:
expected dividend yield of 0%, risk free interest rates of 5.48%
and 5.48%, respectively, and an average expected life of five
years.
(7) COMMITMENTS
(a) LEASES
The Company leases office space for its operations under operating
leases. The arrangements call for the Company to pay rent for
space occupied based on market rates which were in effect at the
time the lease arrangements were negotiated. The accompanying
statements of operations include rental expenses of $194,385,
$182,955 and $422,340 for the years ended June 30, 1999 and 1998,
and the period from October 31, 1996 (inception) to June 30, 1999,
respectively.
Future minimum payments under non-cancelable operating leases are
as follows:
<TABLE>
<CAPTION>
YEAR ENDING
JUNE 30,
--------
<S> <C>
2000 $ 513,273
2001 540,771
2002 564,471
2003 137,773
------------
$ 1,756,288
------------
------------
</TABLE>
During the period from October 31, 1996 (inception) to June 30,
1997, the Company leased office space from a related party (see
note 8). Total rent expense under related party leases amounted to
$45,000 for the period from October 31, 1996 (inception) to June
30, 1997.
<PAGE>
F-50
N*ABLE TECHNOLOGIES, INC.
(A Development Stage Enterprise)
Notes to Financial Statements
June 30, 1999 and 1998
and period from October 31, 1996 (inception) to June 30, 1999
(b) ROYALTY AGREEMENTS
The Company has entered into certain royalty agreements that
provide for royalty payments to become payable as a percentage of
net revenues generated from products that include licensed
technology.
(8) RELATED PARTY TRANSACTIONS
During the period from October 31, 1996 (inception) to June 30, 1997, the
Company issued 1,392,019 shares of Series A Convertible Preferred Stock
at $0.431 per share to Databook (see note 6). Total consideration from
the issuance were $599,960, of which $300,000 was paid through
forgiveness of demand subordinated notes owed by the Company to Databook.
The Company also issued warrants to purchase 1.16 million shares of
Series A Convertible Preferred Stock to Databook during the period from
October 31, 1996 (inception) to June 30, 1997. The ascribed fair value of
$124,120 associated with these warrants was charged to operations (see
note 6).
During the period from October 31, 1996 (inception) to June 30, 1997, the
Company leased facilities from Databook (see note 7) and Databook paid
certain invoices on the Company's behalf. At June 30, 1997, the Company
owed Databook $172,086 for such payments.
During the year ended June 30, 1998, the Company issued 249,446 shares of
Series B Preferred Stock at $0.902 per share and 43,365 shares of Series
C Preferred Stock at $1.153 per share to Databook (see note 6). Total
consideration from the issuances were $225,000 and $50,000, respectively.
Of the $225,000 received in exchange for the Series B Preferred Stock,
$100,000 was paid through forgiveness of amounts due to Databook.
During the year ended June 30, 1999, the Company purchased inventory from
Samsung Semiconductor ("Samsung"), an affiliate of an investor in the
Company, totaling $29,750. Furthermore, in fiscal 1999, the Company
signed an engineering and development contract with Samsung for a fixed
price of $154,000. As of June 30, 1999, the Company incurred $107,000 in
research and development expense related to this contract, of which
$77,000 is included in accounts payable at June 30, 1999.
For the years ended June 30, 1999 and 1998, the Company incurred $60,000
in annual management fees from Techfarm Management Inc. ("Techfarm"),
relating to administrative functions performed by Techfarm on the
Company's behalf. For the period from October 31, 1996 (inception) to
June 30, 1999, the total management fee was $190,000.
<PAGE>
F-51
N*ABLE TECHNOLOGIES, INC.
(A Development Stage Enterprise)
Notes to Financial Statements
June 30, 1999 and 1998
and period from October 31, 1996 (inception) to June 30, 1999
(9) SUBSEQUENT EVENT
In July 1999, Databook, Inc., an N*Able investor, exercised 1,160,000
warrants to acquire 886,483 Series A Preferred Shares, at an exercise
price of $0.431 per share in a non-cash transaction in accordance with
the original terms of the warrant.
On July 27, 1999, Wave Systems Corp. ("Wave") acquired, via a
reverse-triangular merger, all of the outstanding Common and Preferred
Stock of N*Able in a transaction accounted for under the
pooling-of-interests method.
<PAGE>
F-52
(b) PRO FORMA FINANCIAL INFORMATION
1. Unaudited Pro forma Consolidated Financial Statements of
Wave Systems Corp. and Subsidiaries, which includes the
following:
a. Pro forma Consolidated Balance Sheet as of June 30,
1999;
b. Pro forma Consolidated Statement of Operations for six
months ended June 30, 1999; and
c. Note to the Unaudited Pro Forma Financial Statements.
WAVE SYSTEMS CORP. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
BASIS OF PRESENTATION
The following unaudited pro forma consolidated financial statements
give effect to the acquisition, via a reverse-triangular merger, by Wave
Systems Corp. (Wave), on July 27, 1999 of all of the issued and outstanding
shares of capital stock of N*Able Technologies, Inc. ("N*Able"), from all of
the shareholders thereof. The aggregate consideration paid by Wave to the
selling shareholders consisted of 2,781,263 shares of Wave's Class A Common
Stock (subject to certain post-closing adjustments as provided in the
Agreement). The closing price per share for Wave's Class A Common Stock as of
July 27, 1999 was $10.38. The terms of the Agreement were determined in
arm's-length negotiations between Wave and N*Able. The unaudited pro forma
consolidated statements of operations give effect to the acquisition of
N*Able as if it had occurred on January 1, 1999. The unaudited pro forma
consolidated balance sheet also gives effect to the acquisition of N*Able as
if it had occurred on January 1, 1999 pursuant to the pooling-of-interest
method of accounting. These statements are based on historical financial
statements of Wave and N*Able and the estimates and assumptions set forth
below and in the note to the audited pro forma consolidated financial
statements.
The unaudited pro forma consolidated financial data presented herein
are not necessarily indicative of the results Wave would have obtained had
such events occurred on January 1, 1999, as assumed, or the future results of
Wave. The unaudited pro forma consolidated financial statements should be
read in conjunction with the other financial statements and notes thereto
included therein.
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Pro Forma Consolidated Balance Sheet
June 30, 1999
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Unaudited Pro Forma Consolidated Balance Sheet
June 30, 1999
<TABLE>
<CAPTION>
PROFORMA
ADJUSTMENTS PROFORMA
ASSETS WAVE N*ABLE (a) CONSOLIDATED
------------------------------------------- -------------
<S> <C> <C> <C> <C>
Current Assets:
Cash and cash equivalents $ 19,989,416 $ 812,731 -- 20,802,147
Prepaid expenses and other receivables 928,816 96,048 -- 1,024,864
-------------- -------------- ----------- --------------
Total current assets 20,918,232 908,779 -- 21,827,011
Property and equipment, net 1,356,604 405,791 -- 1,762,395
Other assets 139,215 55,630 -- 194,845
-------------- -------------- ----------- --------------
22,414,051 1,370,200 -- 23,784,251
-------------- -------------- ----------- --------------
-------------- -------------- ----------- --------------
Liabilities and Stockholders' equity
Current liabilities:
Accounts payable and accrued expenses 2,880,347 592,875 -- 3,473,222
Note payable 577,219 -- -- 577,219
-------------- -------------- ----------- --------------
Total current liabilities 3,457,566 592,875 -- 4,050,441
-------------- -------------- ----------- --------------
Series A Cumulative Redeemable Preferred Stock 504,001 -- -- 504,001
-------------- -------------- ----------- --------------
Total preferred stock 504,001 -- -- 504,001
-------------- -------------- ----------- --------------
Stockholders' Equity:
Series A Preferred Stock -- 29,000 (29,000) --
Series B Preferred Stock -- 41,297 (41,297) --
Series C Preferred Stock -- 56,743 (56,743) --
Class A Common stock, $.01 par value 341,427 16,982 10,831 369,240
Class B Common stock, $.01 par value 22,808 -- -- 22,808
Capital in excess of par value 83,297,001 11,388,389 116,209 94,801,599
Deficit accumulated during the development
stage (65,057,001) (10,755,086) -- (75,812,087)
Less: Note receivable from stockholder (151,751) -- -- (151,751)
-------------- -------------- ----------- --------------
Total stockholders' equity 18,452,484 777,325 -- 19,229,809
-------------- -------------- ----------- --------------
22,414,051 1,370,200 -- 23,784,251
-------------- -------------- ----------- --------------
-------------- -------------- ----------- --------------
</TABLE>
<PAGE>
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Unaudited Pro Forma Consolidated Statement of Operations
For the Six Months Ended June 30, 1999
<TABLE>
<CAPTION>
PROFORMA
WAVE N*ABLE CONSOLIDATED
--------------------------- -------------
<S> <C> <C> <C>
Net revenue 4,681 3,798 8,479
------------- ------------- --------------
Operating expenses:
Selling, general and administrative 5,847,869 1,173,539 7,021,408
Research and development 2,649,181 1,664,449 4,313,630
------------- ------------- --------------
8,497,050 2,837,988 11,335,038
------------- ------------- --------------
Other income (expense):
License fee 1,250,000 -- 1,250,000
Interest income 237,242 73,298 310,540
Interest expense (831,467) -- (831,467)
------------- ------------- --------------
655,775 73,298 729,073
Net loss (7,836,594) (2,760,892) (10,597,486)
Accrued dividends on preferred stock 10,800 -- 10,800
Net loss to common stockholders (7,847,394) (2,760,892) (10,608,286)
Weighted average number of common shares outstanding during the
period 33,709,337 2,781,263 36,490,600
Loss per common share $ (0.23) $ (0.29)
------------- ------------- --------------
</TABLE>
<PAGE>
WAVE SYSTEMS CORP. AND SUBSIDIARIES
Note to the Unaudited Pro Forma Consolidated Financial Statements
June 30, 1999
Unaudited consolidated adjustments
On July 27, 1999, Wave Systems Corp. (Wave), a provider of electronic
commerce, content distribution and security services, acquired, via a
reverse-triangular merger, all of the issued and outstanding shares of
capital stock of N*ABLE Technologies (N*ABLE).
(a) The aggregate consideration paid by Wave to the Selling
Shareholders consisted of 2,781,263 shares of Wave's Class A Common Stock
(subject to certain post-closing adjustments as provided in the Agreement).
The Pro forma adjustments reflect the elimination of N*ABLE's Stockholders'
Equity and the issuance of the 2,781,263 shares issued to effect the
combination pursuant to the pooling-of-interest method of accounting as if
the combination had occurred on January 1, 1999.
<PAGE>
(C) EXHIBITS.
Exhibit 23.1 Consent of KPMG LLP regarding Wave Systems Corp.
Exhibit 23.2 Consent of KPMG LLP regarding N*Able Technologies,
Inc.
Exhibit 99.1* Agreement and Plan of Merger, dated as of July
27, 1999, by and among Wave, Wave Acquisition
Corporation (a Delaware corporation and a
wholly-owned subsidiary of Wave) and N*ABLE
Technologies Incorporated. (Does not include Exhibits
or Disclosure Schedules. Wave will furnish a copy of
any such omitted exhibit or schedule to the
Commission upon request.)
- ---------
*Previously filed.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
WAVE SYSTEMS CORP.
By: /s/ STEVEN K. SPRAGUE
----------------------------
Steven K. Sprague
President and Chief Operating Officer
Dated: October 12, 1999
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
----------- -----------
<S> <C>
23.1 Consent of KPMG LLP regarding Wave Systems Corp.
23.2 Consent of KPMG LLP regarding N*Able Technologies,
Inc.
99.1* Agreement and Plan of Merger, dated as of July
27, 1999, by and among Wave, Wave Acquisition
Corporation (a Delaware corporation and a
wholly-owned subsidiary of Wave) and N*ABLE
Technologies Incorporated. (Does not include Exhibits
or Disclosure Schedules. Wave will furnish a copy of
any such omitted exhibit or schedule to the
Commission upon request.)
</TABLE>
- ---------
*Previously filed.
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
Wave Systems Corp.
We consent to the incorporation by reference in the registration
statements Nos. 333-38265, 333-28819, and 333-20017 on Form S-3 and Nos.
333-68911, 333-69041, 33-97612, 333-11611 and 333-11609 on Form S-8, of
our report dated March 26, 1999, relating to the supplemental
consolidated balance sheets of Wave Systems Corp. and subsidiaries as of
December 31, 1998 and 1997, and the related supplemental consolidated
statements of operations, stockholders' equity, and cash flows for each
of the years in the three-year period ended December 31, 1998 and for
the period from February 12, 1988 (inception) through December 31, 1998
which report appears in the Form 8-K of Wave Systems Corp and
subsidiaries dated October 12, 1999.
KPMG LLP
/s/ KPMG LLP
Boston, Massachusetts
October 12, 1999
<PAGE>
Exhibit 23.2
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
N*Able Technologies, Inc.:
We consent to the inclusion of our report dated July 9, 1999, except as to
note 9, which is as of July 27, 1999, with respect to the balance sheets of
N*Able Technologies, Inc. as of June 30, 1999 and 1998, and the related
statements of operations, stockholders' equity, and cash flows for the two
years ended June 30, 1999 and the period from October 31, 1996 (inception) to
June 30, 1999, which report appears in the Form 8-K of Wave Systems
Corp. dated October 12, 1999.
Boston, Massachusetts
October 12, 1999
