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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to _____________
Commission File Number 0-24752
Wave Systems Corp.
------------------
(Exact name of registrant as specified in its charter)
Delaware 13-3477246
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
480 Pleasant Street
Lee, Massachusetts 01238
----------------------------------------
(Address of principal executive offices)
(Zip code)
(413) 243-1600
----------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--- ---
The number of shares outstanding of each of the issuer's classes of
common stock as of November 9, 1999: 38,123,140 shares of Class A Common Stock
and 2,125,507 shares of Class B Common Stock.
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<PAGE>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Balance Sheets
<TABLE>
<CAPTION>
ASSETS September 30, December 31,
1999 1998
------------ ------------
(Unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 13,123,125 $ 4,451,175
Prepaid expenses and other receivables 1,614,688 67,500
------------ ------------
Total current assets 14,737,813 4,518,675
Property and equipment, net 1,977,692 1,342,229
Other assets 194,846 163,087
------------ ------------
16,910,351 6,023,991
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses 4,290,344 3,477,803
Deferred license fee -- 1,250,000
Note payable -- 561,831
------------ ------------
Total current liabilities 4,290,344 5,289,634
------------ ------------
Series A Cumulative Redeemable Preferred Stock, $.01 par value
360 shares issued and outstanding in 1999 and 1998; involuntary
liquidation value of $493,201 in 1998 -- 493,201
------------ ------------
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 37,906,988 in 1999 and 30,682,970 in 1998 (note 5) 379,070 306,830
Common stock, $.01 par value. Authorized 13,000,000 shares as Class B;
issued and outstanding 2,166,507 in 1999 and 3,140,665 in 1998 21,665 31,407
Capital in excess of par value 96,494,794 64,919,050
Deficit accumulated during the development stage (84,122,567) (65,214,601)
Less: Note receivable from stockholder, including accrued interest
of $104,780 in 1999 and $101,167 in 1998 (152,955) (149,342)
------------ ------------
Total stockholders' equity 12,620,007 241,156
------------ ------------
Commitments and contingencies
$ 16,910,351 $ 6,023,991
============ ============
</TABLE>
See accompanying notes to unaudited consolidated financial statements.
2
<PAGE>
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
Period from
February 12,
1988
(inception)
Three months ended Nine months ended through
September 30, September 30, September 30, September 30, September 30,
1999 1998 1999 1998 1999
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Revenues, net $ 51,002 $ 10,827 $ 70,229 $ 47,763 $ 144,789
Cost of Sales 24,226 7,761 34,974 32,182 87,171
------------ ------------ ------------ ------------ ------------
Gross Margin 26,776 3,066 35,255 15,581 57,618
------------ ------------ ------------ ------------ ------------
Operating expenses:
Selling, general, and administrative 4,065,242 2,677,394 11,086,650 7,632,781 52,063,425
Acquisition Expenses (note 5) 1,494,000 0 1,494,000 0 1,494,000
Write-off of goodwill -- -- -- -- 769,886
Aladdin license and in-process
research and development expenses -- -- -- -- 3,889,000
Research and development 2,967,458 1,967,357 7,281,088 4,588,917 29,986,898
------------ ------------ ------------ ------------ ------------
8,526,700 4,644,751 19,861,738 12,221,698 88,203,209
------------ ------------ ------------ ------------ ------------
Other income (expense):
License fee -- 625,000 1,250,000 2,125,000 5,000,000
License warrant cost -- -- -- -- (1,100,000)
Interest income 190,606 76,944 501,146 121,629 1,805,418
Interest expense (1,162) (13,214) (832,629) (39,240) (1,695,114)
Other income -- -- -- -- 12,720
------------ ------------ ------------ ------------ ------------
189,444 688,730 918,517 2,207,389 4,023,024
------------ ------------ ------------ ------------ ------------
Net loss (8,310,480) (3,952,955) (18,907,966) (9,998,728) (84,122,567)
Accrued dividends on preferred stock
(including accretion of assured
incremental yield on preferred stock of
$750,000 in 1998 2,439 50,400 13,239 863,597 4,350,597
------------ ------------ ------------ ------------ ------------
Net loss to common stockholders $ (8,312,919) $ (4,003,355) $(18,921,205) $(10,862,325) $(88,473,164)
============ ============ ============ ============ ============
Weighted average number of common
shares outstanding during the period 39,929,969 32,570,877 37,489,993 30,919,210 15,304,539
------------ ------------ ------------ ------------ ------------
Loss per common share $ (0.21) $ (0.12) $ (0.50) $ (0.35) $ (5.78)
============ ============ ============ ============ ============
</TABLE>
See accompanying notes to unaudited consolidated financial statements
3
<PAGE>
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
Period from
February 12, 1988
(date of inception)
Nine months ended through
September 30, September 30, September 30,
1999 1998 1999
------------ ------------ ------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $(18,907,966) $ (9,998,728) $(84,122,567)
Adjustments to reconcile net loss to net cash
used in operating activities:
Write-off of goodwill -- -- 769,886
Depreciation and amortization 480,161 365,021 2,218,675
Reserve for note from affiliate -- -- 1,672,934
Accrued interest on marketable securities -- -- (106,962)
Noncash expenses:
Accretion of assured incremental yield on
convertible debt -- -- 119,000
Common stock issued in connection with
License and Cross-License Agreement -- -- 1,124,960
Common stock issued for services rendered
and conversion of note payable 728,092 482,667 3,491,866
Warrants issued as compensation for services 1,075,240 5,411 2,751,595
Issuance of warrants to Aladdin -- -- 2,939,000
Accrued interest on note payable 15,388 37,590 121,219
Preferred stock issued for services rendered -- -- 265,600
Compensation associated with issuance of
stock options -- -- 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 accrued interest on note receivable (3,613) -- (104,781)
Increase in prepaid expenses and
other receivables (1,547,189) -- (1,614,689)
Increase in other assets (31,758) (32,945) (209,761)
Increase (decrease) in deferred revenue (1,250,000) 1,922,005 0
Increase in accounts payable and
accrued expenses 812,541 618,684 4,527,856
------------ ------------ ------------
Net cash used in operating activities (18,629,104) (6,600,295) (63,818,254)
------------ ------------ ------------
(Continued)
</TABLE>
4
<PAGE>
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Cash Flows, Continued
(Unaudited)
<TABLE>
<CAPTION>
Period from
February 12, 1988
(date of inception)
Nine months ended through
September 30, September 30, September 30,
1999 1998 1999
------------ ------------ ------------
<S> <C> <C> <C>
Cash flows from investing activities:
Acquisition of property and equipment (1,115,625) (388,512) (3,966,842)
Short-term loans to affiliate -- -- (1,672,934)
Organizational costs -- -- (14,966)
Purchase of marketable securities-held to maturity -- -- (27,546,769)
Maturity of marketable securities-held to maturity -- -- 27,653,731
------------ ------------ ------------
Net cash used in investing activities (1,115,625) (388,512) (5,547,780)
------------ ------------ ------------
Cash flows from financing activities:
Net proceeds from issuance of common stock 27,498,373 10,171,099 67,292,747
Net proceeds from issuance of preferred stock
and warrants -- 2,777,500 12,283,027
Sale of warrants -- -- 4
Note receivable from stockholder -- -- (48,175)
Proceeds from notes payable and warrants to
stockholders 2,000,000 -- 4,083,972
Repayments of notes payable (575,254) -- (1,900,226)
Proceeds from notes payable and warrants -- -- 1,284,250
Advances from stockholder -- -- 227,598
Repayments of advances from stockholder -- -- (227,598)
Payments for redemption of Preferred Stock,
including accrued dividends (506,440) -- (506,440)
------------ ------------ ------------
Net cash provided by financing activities 28,416,679 12,948,599 82,489,159
------------ ------------ ------------
Net increase in cash and cash equivalents 8,671,950 5,959,792 13,123,125
Cash and cash equivalents at beginning of period 4,451,175 2,340,329 --
------------ ------------ ------------
Cash and cash equivalents at end of period $ 13,123,125 $ 8,300,121 $ 13,123,125
============ ============ ============
</TABLE>
See accompanying notes to unaudited consolidated financial statements.
5
<PAGE>
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Consolidated Statements of Stockholders' Equity
Nine months Ended September 30, 1999
(Unaudited)
<TABLE>
<CAPTION>
SERIES G
CONVERTIBLE CLASS A COMMON STOCK CLASS B COMMON STOCK
PREFERRED SHARES AMOUNT SHARES AMOUNT
STOCK
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1998 $ 347,812 30,682,970 $ 306,830 3,140,665 $ 31,407
------------ ------------ ------------ ------------ ------------
Shares issued at $11.00 per
share, net of expenses -- 2,122,205 21,222 -- --
Conversion of bridge-loans to
Class A common stock -- 787,349 7,874 -- --
Exercise of warrants to purchase
Class A common stock -- 2,448,438 24,484 -- --
Exercise of options to purchase
Class A common stock -- 500,931 5,009 -- --
Exchange of Class B stock for
Class A common stock -- 974,158 9,742 (974,158) (9,742)
Warrants to purchase Class A
common stock to be issued to
consultants for services -- -- -- -- --
Shares issued at prices ranging
from $5.00 per share to $15.00 per
share as compensation for services
rendered -- 13,835 138 -- --
Accrual of interest on note -- -- -- -- --
receivable
Conversion of Series G preferred
stock (347,812) 377,102 3,771 -- --
Accrued dividend on preferred
stock 0 -- -- -- --
Net loss -- -- -- -- --
- -------------------------------------------------------------------------------------------------------------------------
Balance at September 30, 1999 $ 0 37,906,988 $ 379,070 2,166,507 $ 21,665
============ ============ ============ ============ ============
DEFICIT
ACCUMULATED NOTE
CAPITAL IN DURING THE RECEIVABLE
EXCESS DEVELOPMENT FROM
OF PAR VALUE STAGE STOCKHOLDER TOTAL
------------ ------------ ------------ ------------
Balance at December 31, 1998 $ 64,939,732 $(65,214,601) $ (149,342) $ 261,838
------------ ------------ ------------ ------------
Shares issued at $11.00 per
share, net of expenses 21,522,634 -- -- 21,543,856
Conversion of bridge-loans to
Class A common stock 2,567,380 -- -- 2,575,254
Exercise of warrants to purchase
Class A common stock 4,834,995 -- -- 4,859,479
Exercise of options to purchase
Class A common stock 1,090,029 -- -- 1,095,038
Exchange of Class B stock for
Class A common stock -- -- -- --
Warrants to purchase Class A
common stock to be issued to
consultants for services 1,075,240 -- -- 1,075,240
Shares issued at prices ranging
from $5.00 per share to $15.00 per
share as compensation for services
rendered 133,982 -- -- 134,120
Accrual of interest on note -- -- (3,613) (3,613)
receivable
Conversion of Series G preferred
stock 344,041 -- -- --
Accrued dividend on preferred
stock (13,239) -- -- (13,239)
Net loss -- (18,907,966) -- (18,907,966)
- --------------------------------------------------------------------------------------------------------
Balance at September 30, 1999 $ 96,494,794 $(84,122,567) $ (152,955) $ 12,620,007
============ ============ ============ ============
</TABLE>
See accompanying notes to unaudited consolidated financial statements
6
<PAGE>
WAVE SYSTEMS CORP. AND SUBSIDIARIES
(a development stage corporation)
Notes To Consolidated Financial Statements
September 30, 1999 and 1998
In the opinion of management, the accompanying unaudited consolidated
financial statements contain all adjustments (consisting only of normal
recurring adjustments) necessary to present fairly the financial position of the
Company as of September 30, 1999 and 1998, and the results of its operations and
cash flows for the nine months ended September 30, 1999 and 1998. Such financial
statements have been prepared in accordance with the applicable regulations of
the Securities and Exchange Commission.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been omitted. It is suggested that these consolidated financial statements
be read in conjunction with the Company's audited financial statements and notes
thereto for the year ended December 31, 1998, included in its Form 10-K filed in
March 1999. The results of operations for the three and nine month period ended
September 30, 1999 are not necessarily indicative of the operating results for
the full year.
1. Loss per Share:
--------------
Loss per share is computed based on the weighted average number of common
shares outstanding. The inclusion of common stock equivalents (warrants, options
and convertible preferred stock) in this computation would be antidilutive.
2. Capital Stock:
-------------
On March 23, 1999 the Company sold 2,090,954 shares of its Class A Common
Stock, at a price of $11.00 per share, for an aggregate purchase price of
$23,000,494. The shares were sold to a group of accredited investors pursuant to
Regulation D promulgated under the Securities Act of 1933, as amended. Pacific
Growth Equities, Inc. acted as sole placement agent for the private placement,
receiving a commission of approximately $1.2 million.
On January 26, 1999 the Company issued warrants to purchase 275,000 shares
of its Class A Common Stock at an exercise price of $4.00 per share, exercisable
until January 26, 2004, (the "Warrants") to one (1) accredited investor. If,
over any sixty (60) 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 ($7.00), the Company may force
the conversion of the Warrants. The Warrants were issued as consideration for a
$2,000,000 promissory note, bearing no interest, due January 26, 2002. As a
result of the private placement on March 23, 1999, the Company was required to
convert the $2 million promissory note into Common Stock. The Company issued
181,818 shares of Class A Common Stock in satisfaction of the outstanding
principal amount of $2,000,000 and the fair value of the warrant was recorded as
interest expense.
On May 19, 1999 the Company issued 1,216,136 shares of the Company's Class
A common stock to Aladdin Knowledge Systems, Ltd. upon the exercise by Aladdin
of its warrant at an exercise price of $1.70 per share. The company issued two
warrants to Aladdin in connection with a technology license agreement on July
18, 1997. Warrant number one was exercised on May 19, 1999. 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 and still has the right to acquire shares approximating 3.45% of
the Company's Class A common stock.
7
<PAGE>
3. Prepaid expenses and other receivables:
--------------------------------------
On April 19, 1999 the Company and Sarnoff Corporation announced the planned
formation of Novitera, a joint venture whose mission is to provide secure data
broadcast architecture, infrastructure and content services for Digital
Television broadcasting to the personal computer. The name was later changed to
WaveXpress. The Fantastic Corporation, a provider of broadband multimedia
solutions has agreed to enter into a relationship with WaveXpress which allows
WaveXpress to offer broadcasters proven broadband multimedia solutions for
seamless packaging, management, broadcasting and viewing of TV-quality digital
content. As part of this relationship, WaveXpress and The Fantastic Corporation,
signed a software License agreement. At the end of September, the Company paid
on behalf of the joint venture $1,000,000 to Fantastic for the license of
technology to the joint venture by Fantastic. The company has recorded the
initial payment in the company's Balance sheet under Prepaid expenses and other
receivables. This amount, as well as approximately $500,000 of WaveXpress
operating expenses funded by the Company, are expected to be repaid by
WaveXpress upon the closing of its equity financing, or at Wave's option,
converted into additional equity in WaveXpress.
On June 9, 1999 the company and PC Free Inc., a worldwide customer-based
computer system provider signed an agreement to embed the company's EMBASSY
E-commerce system in PC Free's computer systems. Part of the agreement required
the company to advance PC Free Inc. $240,000 which is an advance of projected
future revenue sharing. The $240,000 advance is recorded in the company's
Balance sheet under Prepaid expenses and other receivables. As consideration for
the advance, the company received from PC Free Inc. a warrant to purchase the
stock of PC Free. The company is currently evaluating the value of the warrant
of PC Free shares received to determine the proper classification of the asset
on the Balance Sheet.
4. Non-Cash Financing Activities:
-----------------------------
On March 23, 1999, the Company converted a $2,000,000 promissory note by
issuing 181,818 shares of its Class A Common Stock. On April 1, 1999 a Holder of
a Note surrendered the Note for conversion into 605,531 shares of Company Class
A Common Stock for the unpaid principal and interest.
5. N*Able Technologies Acquisition:
-------------------------------
On July 28, 1999 the company announced it had acquired all of the
outstanding common and preferred shares of N*ABLE Technologies, a security
solutions company in exchange for 2,781,263 shares of the company's Class A
Common Stock. Acquisition expenses related to the transaction amounted to
$1,494,000 and are included in Selling, General and Administrative expenses. The
transaction is being accounted for under the pooling-of interest-method of
accounting and accordingly, all financial data presented herein has been
restated as if N*Able was acquired on the first day of the earliest period
presented.
CERTAIN FORWARD-LOOKING INFORMATION:
This Quarterly Report on Form 10-Q contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section
21E of the Securities Exchange Act of 1934. These statements include, but are
not limited to, statements regarding contingencies, future prospects,
liquidity and capital expenditures herein under "Part I Financial
Information--Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations." Actual results could differ materially
from those projected in the forward-looking statements as a result of the
risk factors set forth below and detailed in our other filings with the
Commission during the past 12 months.
8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
Our Business........Wave is creating a new, pay-per use electronic commerce
model for the delivery of digital information and services.
We are involved in the research, development, and market
testing of the Wave System, designed to meter the consumer's
usage of electronic content and services. Electronic content
and services refers to any data, graphic, software, video or
audio sequence that can be digitally transmitted or stored.
Under this model, electronic content and service providers
use the Wave System to allow consumers to purchase use of
their e-content on a pay-for-use basis, much like a phone
card or a pay-per-view cable system. We believe that the
Wave System can fundamentally change today's centralized
e-commerce model by creating a distributed trust and
security system, under which consumers will be able to make
individual purchases of images, text, music or video, or
make use of software, all from the consumer's desktop, by
payment of a small fee for each purchase or use. This means
that e-content can be consumed with more efficient and
flexible pricing, broader distribution opportunities,
greater protection against unauthorized usage and more
secure, low-cost, and accurate collection of consumer usage
data.
Our Market..........Our long-term strategy is to achieve broad market acceptance
of the Wave System as a standard platform for electronic
commerce. The growth of e-commerce is creating consumer
demand for a powerful merchandising interface at the point
of purchase, whether in the office or at home. E-content
providers seek a system that will allow consumers to pay
royalties easily and quickly for usage while allowing both
customized and broad, inexpensive distribution. Consumers in
turn seek enhanced control of their individual privacy and
secure storage of sensitive information. We believe that
there are three major weaknesses in the current e-content
transaction market: inflexible pricing, weak security and
lack of demographic feedback. The Inflexible pricing problem
occurs when customers subscribe to an electronic content
delivery system (an on-line news service, for example), and
are required to pay an up-front fee for access to ALL of the
content offered by the system, even though a subscriber may
only use a small portion of the content. Weak security is a
deterrent to consumer usage of e-commerce, as many
electronic content delivery systems do not have sufficiently
sophisticated cryptography and security systems in place to
afford confidence to content providers with respect to
unauthorized usage and piracy of their e-content. Lastly,
existing e-content delivery systems provide very limited
feedback data about customers' usage. We believe that by
addressing these problems, we will be able to achieve
widespread adoption of the Wave System as a standard for
e-commerce.
Our Product.........The Wave System consists of an EMBedded Application Security
SYstem ("EMBASSY") in consumer devices that provides a core
hardware and software foundation for consumers to purchase
e-content and use software on a pay-per use basis. The
EMBASSY system is a programmable, low cost "system within a
system" that can perform independent transactions such as
meter pay-per-use of e-content, store sensitive information
such as identities, credit information and account balances,
and run secure applications for pay-per-use access to
software. The EMBASSY system is an open model based on
secure smart card hardware technology that can be integrated
into PCs, peripherals, set top boxes or used as an
independent component. The WaveMeter application running in
the EMBASSY system allows e-commerce transactions to occur
without the expense of a real-time network connection for
every transaction. We have started production of a software
version of the WaveMeter application that offers many of the
features of the hardware version, and we have implemented it
as part of our Internet commerce server. The WaveMeter
server enables e-content owners to securely sell
9
<PAGE>
usage of their intellectual property from a Web site. This
secure e-content delivery service, offered through the Wave
Meter server, does not require either the consumer or the
publisher to install any additional hardware or software.
The EMBASSY securely stores electronic funds and transaction
information about the usage of electronic content to be
transmitted securely to a central transaction processing
center ("WaveNet") periodically. The WaveNet application
manages encryption and decryption keys, processes credit and
usage charges, automatically obtains credit authorization,
calculates royalty distributions, and can provide user and
usage data to e- content owners. The Wave System is designed
to be compatible with existing content delivery system such
as CD-ROM, the Internet, and broadband services. Using these
distribution systems, e-content providers can distribute
their products in an encrypted or otherwise secured
("Wave-enabled") form, so it can be offered for sale through
the EMBASSY system, which in turn allows consumers to
purchase and access the e-content on an as-desired basis.
Our Partners........We are pursuing strategic relationships with software
developers and hardware manufacturers developing e-content
delivery. We have attracted other companies to port their
applications and services to the Wave System and its EMBASSY
platform, which we believe will in turn increase the value
of the system to other potential deployment partners. During
1998, we established relationships with RSA Data Security,
NEC Technologies, Pollex Technology, Hewlett-Packard's
VerSecure division, Sun Microsystems, SMSC, ITE, IGST,
Hauppauge Computer Systems and WavePhore. In 1999, we hope
to expand the number of commitments from hardware
manufacturers, including personal computer manufacturers,
peripheral companies and other companies involved in
e-commerce. Most recently, we entered into a strategic
partnership with Sigma Designs, a leading producer of
DVD/MPEG-2 decoder chips, OEM modules and add-in cards.
Sigma intends to incorporate our EMBASSY technology into its
products to be used in a variety of popular consumer
electronics, such as PCs and set-top boxes. We have also
partnered with Sarnoff Corporation to form inTelecast, a new
company that will offer network services enabling broadcast
delivery of digital content such as games, music, corporate
data and Internet pages, to the consumer at speeds up to 300
times faster than a dial-up connection, utilizing unused
bandwidth from the Digital Television spectrum. We also seek
to expand the role of the Wave System and its EMBASSY
platform as a general security device used in networks to
enable telecommunications vendors and Internet service
providers to provide virtual private networks and other new
services.
Recent Financings...We are currently evaluating additional financing options. We
may choose to raise capital from time to time, through
equity or debt financings, in order to capitalize on
business opportunities and market conditions. This would
help to insure the continued development of our technology,
products and services. In January 1999, we issued a $2
million convertible promissory note, which was subsequently
converted into Class A common stock in March 1999. We also
completed a $23 million private placement with
institutional, strategic and accredited investors in March
1999, which we expect will be sufficient to fund operations
through the first quarter of 2000. We cannot, however,
assure you that we can raise additional financing in the
future. While we do not have any material commitments for
capital expenditures at this time, in order to bring the
Wave System to market, we do anticipate spending additional
amounts on contracting for software development, licensing
key technologies, and purchasing inventory items such as
computer chips and boards. Such spending will vary based on
our performance.
Growth..............We are focusing on our operational and marketing
infrastructure, in order to evolve our internal production
and fulfillment systems. We plan also to increase the
resources available to WaveNet to adapt to changing market
requirements, and expand it to handle more end users, to
implement more sophisticated pricing methodologies and to
add greater financial system flexibility.
R&D.................We are a development stage company and have realized minimal
operating revenues since our inception. At September 30,
1999, we had an accumulated deficit of approximately $84.1
10
<PAGE>
million. We have made a substantial investment in research
and development, and we expect that we will be required to
continue to make substantial investments in our products and
technology. For the years ended December 31, 1998, 1997, and
1996, we spent approximately $6.2 million, $4.7 million and
$3.8 million, respectively, on research and development
activities (which amounts include the value of stock
issued). In addition, we licensed technology and in-process
research and development from Aladdin Knowledge Systems for
cash and warrants valued at $3.9 million in July 1997. From
our inception in February 1988 through September 1999, we
have spent approximately $30 million on research and
development activities.
Nasdaq Listing......We filed an application with the Nasdaq Stock Market on
January 29, 1999, seeking to list our common stock on the
Nasdaq National Market. As of May 27, 1999 we were re-listed
on the Nasdaq National Market.
Recent Acquisition..On July 28, 1999 the company announced it had acquired all
of the outstanding common and preferred shares of N*ABLE
Technologies, a security solutions company in exchange for
2,781,263 shares of the company's Class A Common Stock.
Acquisition expenses related to the transaction amounted to
$1,494,000 and are included in Selling, General and
Administrative expenses. The transaction is being accounted
for under the pooling-of interest-method of accounting and
accordingly, all financial data presented herein has been
restated as if N*Able was acquired on the first day of the
earliest period presented.
We are incorporated in Delaware, and were known previously as Indata Corp.
We changed our name to Wave Systems Corp. in January 1993. Our principal
executive offices are located at 480 Pleasant Street, Lee, Massachusetts 01238,
and our telephone number is (413) 243-1600.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
For the three months ended September 30, 1999 and September 30, 1998, we
had minimal net revenues of $51,002, primarily from shipments to Compaq Computer
Corporation.
Research and development expenses for the three months ended September 30,
1999 were $2,967,458, as compared to $1,967,357 for the comparable period of
1998, an increase of 51%. This increase is primarily attributable to an increase
in headcount and consulting-related expenses during the three months ended
September 30, 1999.
Selling, general and administrative expenses, net of acquisition expenses
for the three months ended September 30, 1999 were $4,065,242, as compared to
$2,677,394 for the comparable period of 1998, an increase of 52%. This increase
is primarily attributable to an increase in personnel, consultants and
professional fees, trade shows, equipment and other related costs associated
with the development and marketing of new applications and new markets for our
technology. Acquisition costs related to the N*Able acquisition amounted to
$1,494,000.
Interest income for the three months ended September 30, 1999 was $190,606,
as compared to $76,944 for the comparable period of 1998. The increase in
interest income is primarily attributable to an increase in interest-bearing
assets, which were a direct result of the private placement of Class A Common
Stock for an aggregate purchase price of $23,000,494.
Due to the reasons set forth above, our net loss for the three months ended
September 30, 1999 was $8,310,480, as compared to $3,952,955 for the comparable
period of 1998. We did not receive any cash license fee payments in the three
months ended September 30, 1999 and the net loss for the three months ended
September 30, 1999 to common stockholders was $8,312,919 as compared to
$4,003,355 for the comparable period of 1998.
11
<PAGE>
NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
Research and development expenses for the nine months ended September 30,
1999 were $7,281,088, as compared to $4,588,917 for the comparable period of
1998. This 59% increase in research and development expenses was primarily
attributable to an increase in headcount and consultant costs associated with
the design and development of the Company's proprietary integrated circuit
technology and software.
Selling, general and administrative expenses, net of acquisition costs, for
the nine months ended September 30, 1999 were $11,086,650 as compared to
$7,632,781 for the comparable period of 1998. The 45% increase in selling,
general and administrative expenses was primarily attributable to an increase in
personnel, consultants and professional fees, trade shows, equipment and other
related costs associated with the development and marketing of new applications
and new markets for the Company's technology.
Interest income for the nine months ended September 30, 1999 was $501,146,
as compared to $121,629 for the comparable period of 1998. The increase in
interest income is primarily attributable to an increase in interest-bearing
assets, which were a direct result of the private placement of Class A Common
Stock for an aggregate purchase price of $23,000,494.
Interest expense for the nine months ended September 30, 1999 was $832,629,
as compared to interest expense of $39,240 for the comparable period of 1998.
This increase in interest expense is primarily attributable to a non-cash
expense of approximately $666,000 for the value of warrants to acquire 275,000
shares of Common Stock issued as part of the bridge loan financing, and a
non-cash interest charge of approximately $151,000 on a note to Southeast
Interactive Technologies Fund I. On October 18, 1998, we amended the Southeast
Interactive Technologies note so that it was convertible at any time from April
1, 1999 to April 18, 1999, reducing the conversion price to $0.95 per share.
Additional warrants for 75,000 shares were issued as part of this amendment, and
the fair value of these warrants was $106,000. Additionally, the fair value of
the reduced conversion price was $274,000. We amortized such amounts as
additional interest expense from the date that the note was amended and the
warrant issued through the earliest conversion date of April 1, 1999. During the
first quarter of 1999, approximately $151,000 of the value of the reduced
conversion rate was recorded as interest expense.
Due to the reasons set forth above, the Company's net loss for the nine
months ended September 30, 1999 was $18,907,966 as compared to $9,998,728 for
the comparable period of 1998. The net loss for the nine months ended September
30, 1998 to common stockholders was $18,921,205 as compared to $10,862,325 for
the comparable period of 1998.
LIQUIDITY AND CAPITAL RESOURCES
We have experienced net losses and negative cash flow from operations since
our inception, and, as of September 30, 1999, had a $84,122,567 deficit
accumulated during the development stage, and stockholders' equity of
$12,620,007. We have financed our operations through September 30, 1999
principally through:
o the private placement of Class A and B Common Stock for an aggregate amount
of $31,201,931 before expenses;
o the issuance of $2,873,250 in aggregate principal amount of our 10%
Convertible Notes and 15% Notes (of which $2,098,250 was converted into
Class B Common Stock);
o the sale of 3,728,200 shares of our Class A Common Stock in an initial
public offering raising approximately $15,711,000 after expenses;
o the private placement of 800,000 shares of Class A Common Stock raising
$800,000 before expenses; and
o the private placements of convertible preferred stock for an aggregate
amount of $13,350,000 before expenses.
12
<PAGE>
At September 30, 1999, we had $13,123,125 in cash and cash equivalents. At
December 31, 1998, we had $4,451,175 in cash and cash equivalents. We did not
hold any marketable securities at September 30, 1999 or December 31, 1998. The
increase in cash and cash equivalents is primarily attributable to cash proceeds
from private placements during the first quarter of 1999. In January 1999, we
issued a $2 million convertible promissory note, which was subsequently
converted into Class A common stock in March 1999. We also completed a $23
million private placement with institutional, strategic and accredited investors
in March 1999. On March 6, 1998, we sold 150,000 shares of newly created Series
G Convertible Preferred Stock to one accredited investor at a price of $20 per
share, for an aggregate purchase price of $3,000,000, which was converted into
2,771,596 shares of Class A Common Stock. We also issued warrants to purchase a
total of 225,000 shares of Class A Common Stock at an exercise price of $1.38
per share, exercisable until October 9, 2002. On October 19, 1997, the Company's
Series A Cumulative Redeemable Preferred Stock became redeemable. Redemption of
this stock was completed in the third quarter for the current redemption value
of approximately $506,000.
As of December 31, 1998, we had available net operating loss carryforwards
for Federal income tax purposes of approximately $47.6 million. Because of the
"change in ownership" provisions of the Tax Reform Act of 1986, our net
operating loss carryforwards may be subject to an annual limitation on the
utilization of these carryforwards against taxable income in future periods if a
cumulative change in ownership of more than 50 percent of Wave occurs within any
three-year period. We have made no determination concerning whether there has
been such a cumulative change in ownership. However, we believe that it is
likely that such a change in ownership occurred prior to or following the
completion of our initial public offering in September 1994.
At September 30, 1999, we had working capital of $10,447,469. We expect we
may incur substantial additional expenses resulting in significant losses at
least through the period ending December 31, 1999, due to minimal revenues and
increased sales and marketing expenses associated with initial market entry, and
continued research and development costs. We anticipate that our existing
capital resources will be adequate, however, to satisfy our capital requirements
through the first quarter of 2000. In order to continue operations, we will need
to raise additional funds through public or private financings. We have no
current commitment to obtain additional funds, nor can we state the amount or
source of such additional funds.
YEAR 2000 ISSUES
The Year 2000 issue results from computer programs written using two digits
rather than four to define the applicable year. Any of our computer programs
that have date-sensitive software may recognize a date using "00" as the year
1900 rather than the year 2000. This could result in a system failure or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices or engage
in similar normal business activities.
We have made an assessment with regard to whether our own internal
information systems are Year 2000 compliant. Since January 1998, in addition to
updating employee computers and workstations, we have upgraded various
accounting, telecommunications, customer care systems and transaction systems at
an aggregate cost of approximately $620,000, with systems that are warranted by
the vendors to be Year 2000 compliant. To the extent we purchase additional
systems, we require that such systems are warranted by the vendors to be Year
2000 compliant. We continue to seek assurances from our existing vendors whose
systems are not warranted to be Year 2000 compliant that such systems will be
Year 2000 compliant. We employ a manager of management information systems,
whose responsibilities include oversight of Year 2000 compliance. We do not
separately track the internal costs incurred for Year 2000 projects, which are
principally the related payroll costs for our information systems personnel.
Although we do not believe that any additional Year 2000 compliance-related
costs will be significant, we cannot assure you that that costs incurred to
address unanticipated issues would not have a material adverse effect on our
business, operating results and financial conditions. Any failure of third-party
equipment or software comprising any part of our systems to operate properly
with regard to Year 2000 and thereafter could require us to incur unanticipated
expenses to address associated problems, which could have a material adverse
effect on our business, operating results and financial condition.
13
<PAGE>
We believe, based on an internal assessment, that the current versions of
our software products are Year 2000 compliant. We have no plan to ascertain
whether the internal systems and products of our potential future customers are
Year 2000 compliant. We may in the future be subject to claims based on Year
2000 problems in others' products or issues arising from the integration of
multiple products within an overall system. Although we have not been involved
in any litigation or proceeding to date involving our products or services
related to Year 2000 issues, we cannot assure you that we will not in the future
be required to defend our products or services or to negotiate resolutions of
claims based on Year 2000 issues. The costs of defending and resolving Year
2000-related disputes, and any of our liabilities for Year 2000-related damages,
including consequential damages, could have a material adverse effect on our
business, operating results and financial condition.
We do not have any specific contingency plans if any Year 2000 problems
develop with respect to our embedded systems or systems acquired from vendors.
Contingency plans will be developed if we identify instances of noncompliance,
and such noncompliance is expected to have a material adverse impact on our
operations. The cost of developing and implementing such plans may itself be
material.
Year 2000 issues may affect the purchasing patterns of customers and
potential customers in a variety of ways. Many companies are expending
significant resources to replace or remedy their current hardware and software
systems for Year 2000 compliance. These expenditures may result in reduced funds
available to purchase products such as those offered by us. We do not believe
that there is any practical way to ascertain the extent of, and have no plan to
address problems associated with such a reduction in purchasing resources of our
customers. Any such reduction could, however, result in a material adverse
effect on our business, operating results and financial condition. The Year 2000
problem is pervasive and complex, as virtually every computer operation will be
affected in some way. Consequently, you should understand that Year 2000
compliance may not be achieved without significant additional costs to us.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits
27 Financial Data Schedule
Reports on Form 8-K: None.
14
<PAGE>
SIGNATURE
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 thereunto duly authorized.
Dated: November 15, 1999
WAVE SYSTEMS CORP.
(Registrant)
By: /s/ Peter J. Sprague
---------------------------------------
Name: Peter J. Sprague
Title: Chairman, Chief Executive Officer
Duly Authorized Officer of the Registrant)
By: /s/ Gerard T. Feeney
---------------------------------------
Name: Gerard T. Feeney
Title: Chief Financial Officer
15
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THE ENCLOSED FINANCIAL DATA SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION
EXTRACTED FROM THE FINANCIAL STATEMENTS OF WAVE SYSTEMS CORP. FOR THE NINE
MONTHS ENDED SEPTEMBER 30, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JUL-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 13,125,125
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 14,737,813
<PP&E> 4,196,367
<DEPRECIATION> (2,218,675)
<TOTAL-ASSETS> 16,910,351
<CURRENT-LIABILITIES> 4,290,344
<BONDS> 0
0
0
<COMMON> 400,735
<OTHER-SE> 12,620,007
<TOTAL-LIABILITY-AND-EQUITY> 16,910,351
<SALES> 35,255
<TOTAL-REVENUES> 0
<CGS> 0
<TOTAL-COSTS> 19,861,738
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 832,629
<INCOME-PRETAX> (18,907,966)
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (18,907,966)
<EPS-BASIC> (.50)
<EPS-DILUTED> 0
</TABLE>
